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, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2) of the Exchange Act:
Yes |X| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date:
Class Outstanding at November 5, 2005
Common Stock, $.01 par value 123,684,931
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Financial Condition-September 30, 2005 (Unaudited) and December 31, 2004 1
Consolidated Statements of Operations and Comprehensive Income (Loss)
(Unaudited) for the quarters and nine months ended September 30, 2005
and September 30, 2004 2
Consolidated Statement of Stockholders' Equity (Unaudited) for the nine months ended September 30, 2005 3
Consolidated Statements of Cash Flows (Unaudited) for the quarters and nine months ended September 4
30, 2005 and September 30, 2004
Notes to Consolidated Financial Statements (Unaudited) 5-14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-30
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31-32
Item 4. Controls and Procedures 32
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 34
CERTIFICATIONS 35-38
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except for share data)
September 30, 2005 DECEMBER 31,
(UNAUDITED) 2004
--------------------- ----------------------
ASSETS
Cash and cash equivalents $ 1,684 $ 5,853
Mortgage-Backed Securities, at fair value 18,697,385 19,038,386
Agency debentures, at fair value 258,616 390,509
Receivable for Mortgage-Backed Securities sold 788 1,025
Accrued interest receivable 83,806 81,557
Receivable for advisory and service fees 4,579 2,359
Intangible for customer relationships 15,367 15,613
Goodwill 23,122 23,122
Other assets 1,218 1,875
--------------------- ----------------------
Total assets $ 19,086,565 $ 19,560,299
===================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $ 17,038,226 $ 16,707,879
Payable for Mortgage-Backed Securities purchased 429,502 1,044,683
Accrued interest payable 34,171 35,721
Dividends payable 16,079 60,632
Other liabilities 625 2,819
Accounts payable 8,602 8,095
--------------------- ----------------------
Total liabilities 17,527,205 17,859,829
--------------------- ----------------------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 8,000,000
authorized, 7,412,500 shares issued and outstanding, 177,088 177,077
respectively
Common stock: par value $.01 per share; 500,000,000 authorized,
123,684,931, and 121,263,000 shares issued and outstanding, 1,237 1,213
respectively
Additional paid-in capital 1,679,452 1,638,635
Accumulated other comprehensive loss (304,555) (120,800)
Retained earnings 6,138 4,345
--------------------- ----------------------
Total stockholders' equity 1,559,360 1,700,470
--------------------- ----------------------
Total liabilities and stockholders' equity $ 19,086,565 $ 19,560,299
===================== ======================
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(dollars in thousands, except per share amounts)
For the For the For the Nine For the Nine
Quarter Ended Quarter Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
----------------- --------------- ---------------- --------------
Interest income $177,474 $138,970 $525,358 $375,545
Interest expense 155,043 70,173 402,794 176,124
----------------- --------------- ---------------- --------------
Net interest income 22,431 68,797 122,564 199,421
----------------- --------------- ---------------- --------------
Other income:
Investment advisory and service fees 10,945 4,811 26,923 6,369
Gain on sale of Mortgage-Backed Securities 32 1,350 12,047 4,071
----------------- --------------- ---------------- --------------
Total other income 10,977 6,161 38,970 10,440
----------------- --------------- ---------------- --------------
Expenses:
Distribution fees 2,414 1,024 6,151 1,322
General and administrative expenses 6,455 6,159 19,919 17,167
----------------- --------------- ---------------- --------------
Total expenses 8,869 7,183 26,070 18,489
----------------- --------------- ---------------- --------------
Income before income taxes 24,539 67,775 135,464 191,372
Income taxes 3,353 1,155 7,952 2,074
----------------- --------------- ---------------- --------------
Net income 21,186 66,620 127,512 189,298
Dividends on preferred stock 3,648 2,082 10,945 4,080
----------------- --------------- ---------------- --------------
Net income available to common shareholders $17,538 $64,538 $116,567 $185,218
================= =============== ================ ==============
Net income per common share
Basic $0.14 $0.53 $0.95 $1.58
================= =============== ================ ==============
Diluted $0.14 $0.53 $0.95 $1.58
================= =============== ================ ==============
Weighted average number of common shares outstanding
Basic 123,169,910 120,802,814 122,067,300 117,208,336
================= =============== ================ ==============
Diluted 123,330,645 120,994,191 122,265,351 117,439,248
================= =============== ================ ==============
Net income $21,186 $66,620 $127,512 $189,298
----------------- --------------- ---------------- --------------
Comprehensive income (loss)
Unrealized gain (loss) on available-for sale
securities (159,670) 86,852 (171,709) (40,655)
Less: reclassification adjustment for net gains
included in (32) (1,350) (12,047) (4,071)
net income
----------------- --------------- ---------------- --------------
Other comprehensive income (loss) (159,702) 85,502 (183,756) (44,726)
----------------- --------------- ---------------- --------------
Comprehensive income (loss) ($138,516) $152,122 ($56,244) $144,572
================= =============== ================ ==============
See notes to financial statements.
2
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005
(dollars in thousands, except per share data)
(UNAUDITED)
Accumulated
Common Additional Other
Preferred Stock Paid-In Comprehensive Comprehensive Retained Total
Stock Par Value Capital Income (Loss) Income (Loss) Earnings
-------- --------- --------- ------------- ------------- ------- ----------
BALANCE, JANUARY 1, 2005 $177,077 $1,213 $1,638,635 ($120,800) $4,345 $1,700,470
Net income $59,333 59,333
Other comprehensive income (loss) unrealized net loss
on securities,
net of reclassification adjustment (92,480) (92,480)
-------------
Comprehensive loss ($33,147) (33,147)
=============
Exercise of stock options 99 99
Proceeds from direct purchase and dividend reinvestment 177 177
Preferred dividend declared for the quarter ended March
31, 2005, $0.492188 per share (3,648) (3,648)
Common dividend declared for the quarter ended March
31, 2005, $0.45 per share (54,575) (54,575)
-------- -------- ----------- -------------- ------- ----------
BALANCE, MARCH 31, 2005 $177,077 $1,213 $1,638,911 ($213,280) $5,455 $1,609,376
Net income $46,993 46,993
Other comprehensive income (loss) unrealized net gain
on securities, net of
reclassification adjustment 68,427 68,427
-------------
Comprehensive income $115,420 115,420
=============
Reduction in estimated legal cost of preferred
offering 11 11
Exercise of stock options 154 154
Proceeds from direct purchase and dividend reinvestment 149 149
Proceeds from equity shelf offering 13 23,133 23,146
Preferred dividend declared for the quarter ended June
30, 2005, $0.492188 per share (3,648) (3,648)
Common dividend declared for the quarter ended June 30,
2005, $0.36 per share (44,120) (44,120)
-------- -------- ----------- -------------- ------- ----------
BALANCE, JUNE 30, 2005 $177,088 $1,226 $1,662,347 ($144,853) $4,680 $1,700,488
Net income $21,186 21,186
Other comprehensive income (loss) unrealized net gain
on securities, net of
reclassification adjustment (159,702) (159,702)
-------------
Comprehensive income ($138,516) (138,516)
=============
Proceeds from direct purchase and dividend reinvestment 114 114
Proceeds from equity shelf offering 11 16,991 17,002
Preferred dividend declared for the quarter ended
September 30, 2005, $0.492188 per
share (3,648) (3,648)
Common dividend declared for the quarter ended
September 30, 2005, $0.13 per share (16,080) (16,080)
-------- -------- ----------- -------------- ------- ----------
BALANCE, SEPTEMBER 30, 2005 $177,088 $1,237 $1,679,452 ($304,555) $6,138 $1,559,360
======== ======== =========== ============== ======= ==========
See notes to financial statements.
3
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(UNAUDITED)
For the Quarter For the Quarter For the Nine For the Nine
Ended Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
----------------- ----------------- ----------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 21,186 $ 66,620 $ 127,512 $ 189,298
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of Mortgage- Backed Securities
premiums and discounts, net 43,722 39,692 122,452 137,334
Amortization of intangibles 194 56 366 74
Gain on sale of Mortgage-Backed Securities (32) (1,350) (12,047) (4,071)
Stock option expense -- -- 56 307
Market value adjustment on long-term repurchase
agreement (616) 631 (2,194) 108
Decrease (increase) in accrued interest
receivable, net of purchased interest 4,032 1,680 (2,924) (19,366)
Decrease (increase) in other assets 147 309 538 (878)
Increase in advisory and service fees receivable (245) 7 (2,220) (74)
Increase (decrease) in accrued interest payable 4,517 4,524 (1,550) 9,493
Increase in accounts payable 2,069 2,459 506 2,812
------------- ------------- ------------- -------------
Net cash provided by operating activities 74,974 114,628 230,495 315,037
------------- ------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (2,035,744) (2,365,948) (6,857,934) (10,898,374)
Purchase of agency debentures -- -- -- (250,000)
Proceeds from sale of Mortgage-Backed Securities 21,632 130,671 978,346 414,768
Proceeds from called agency debentures 130,000 345,000 130,000 595,000
Principal payments on Mortgage-Backed Securities 2,051,163 1,582,969 5,314,052 4,921,041
Cash from FIDAC transaction -- 2,526
------------- ------------- ------------- -------------
Net cash provided by (used in)
investing activities 167,051 (307,308) (435,536) (5,215,039)
------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from repurchase agreements 65,581,331 38,197,654 185,698,813 104,975,795
Principal payments on repurchase agreements (65,794,700) (37,960,601) (185,368,466) (100,409,722)
Proceeds from exercise of stock options -- -- 196 355
Proceeds from direct purchase and dividend
reinvestment 114 175 441 2,118
Net proceeds from common stock follow-on offerings -- -- -- 363,592
Net proceeds from preferred offering -- -- -- 102,708
Net proceeds from equity shelf program 17,002 17,479 40,148 37,530
Proceeds from actual cost and estimated on preferred 11 11
Dividends paid (47,768) (59,754) (170,271) (165,849)
------------- ------------- ------------- -------------
Net cash (used in) provided by
activities financi (244,010) 194,953 200,872 4,906,527
Net increase (decrease) in cash and cash equivalents (1,985) 2,273 (4,169) 6,525
Cash and cash equivalents, beginning of period 3,669 4,499 5,853 247
------------- ------------- ------------- -------------
Cash and cash equivalents, end of period $ 1,684 $ 6,772 $ 1,684 $ 6,772
============= ============= ============= =============
Supplemental disclosure of cash flow information:
Interest paid $ 150,526 $ 65,649 $ 404,344 $ 166,631
============= ============= ============= =============
Income taxes $ 2,842 $ 1,000 $ 7,775 $ 1,430
============= ============= ============= =============
Noncash financing activities:
Net change in unrealized loss on available-for-sale,
securities net of reclassification adjustment ($ 159,702) $ 85,502 ($ 183,756) ($ 44,726)
============= ============= ============= =============
Dividends declared, not yet paid $ 16,079 $ 60,618 $ 16,079 $ 60,618
============= ============= ============= =============
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on November 25, 1996. The Company commenced its operations of
purchasing and managing an investment portfolio of mortgage-backed securities on
February 18, 1997, upon receipt of the net proceeds from the private placement
of equity capital. An initial public offering was completed on October 14, 1997.
The Company acquired Fixed Income Discount Advisory Company ("FIDAC") on June 4,
2004 (See Note 2). FIDAC is a registered investment advisor and is a taxable
Real Estate Investment Trust ("REIT") subsidiary of the Company.
A summary of the Company's significant accounting policies follows:
Basis of Presentation - The accompanying unaudited consolidated financial
statements have been prepared in conformity with the instructions to Form 10-Q
and Article 10, Rule 10-01 of Regulation S-X for interim financial statements.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America
("GAAP"). The interim financial statements are unaudited; however, in the
opinion of the Company's management, all adjustments, consisting only of normal
recurring accruals, necessary for a fair statement of the financial positions,
results of operations, and cash flows have been included. These unaudited
financial statements should be read in conjunction with the audited financial
statements included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2004. The nature of the Company's business is such that the
results of any interim period are not necessarily indicative of results for a
full year.
The consolidated financial statements subsequent to June 4, 2004 include
the accounts of the Company and FIDAC. All material intercompany balances have
been eliminated. Certain reclassifications have been made to prior year
financial statements, where appropriate, to conform to the current year
presentation.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand
and money market funds.
Mortgage-Backed Securities and Agency Debentures - The Company invests
primarily in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). The Company also invests in agency debentures issued by Federal
Home Loan Bank ("FHLB"), Federal Home Loan Mortgage Corporation ("FHLMC"), and
Federal National Mortgage Association ("FNMA"). The Mortgage-Backed Securities
and agency debentures are collectively referred to herein as "Investment
Securities."
Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting
for Certain Investments in Debt and Equity Securities, requires the Company to
classify its Investment Securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Investment Securities until
maturity, it may, from time to time, sell any of its Investment Securities as
part of its overall management of its portfolio. Accordingly, SFAS No. 115
requires the Company to classify all of its Investment Securities as
available-for-sale. All assets classified as available-for-sale are reported at
estimated fair value, based on market prices provided by certain dealers who
make markets in these financial instruments, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity.
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market concerns
warrant such evaluation. Consideration is given to (1) the length of time and
the extent to which the fair value has been lower than carrying value, (2) the
financial condition and near-term prospects of the issuer, and (3) the intent
and ability of the Company to retain its investment in the issuer for a period
of time sufficient to allow for any anticipated recovery in fair value.
Unrealized losses on Investment Securities that are considered other than
temporary, as measured by the amount of decline in fair value attributable to
factors other than temporary, are recognized in income and the cost basis of the
Investment Securities is adjusted. There were no such adjustments for the three
or nine months ended September 30, 2005 or 2004.
5
SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
requires disclosure of the fair value of financial instruments for which it is
practicable to estimate that value. The fair value of Mortgage-Backed Securities
and agency debentures available-for-sale and futures contracts is equal to their
carrying value presented in the balance sheet. The fair value of cash and cash
equivalents, accrued interest receivable, receivable for mortgage-backed
securities sold, receivable for advisory fees, repurchase agreements, and
payable for mortgage-backed securities purchased, dividends payable, accounts
payable, and accrued interest payable, generally approximates cost as of
September 30, 2005 and December 31, 2004, due to the short term nature of these
financial instruments.
Interest income is accrued based on the outstanding principal amount of the
Investment Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Investment Securities are amortized into
interest income over the projected lives of the securities using the interest
method. The Company's policy for estimating prepayment speeds for calculating
the effective yield is to evaluate historical performance, consensus prepayment
speeds, and current market conditions.
Investment Securities transactions are recorded on the trade date.
Purchases of newly issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gain and losses on sale of
Investment Securities are determined on the specific identification basis.
Credit Risk - The Company has limited its exposure to credit losses on its
portfolio of Investment Securities by only purchasing securities issued by
FHLMC, FNMA, Government National Mortgage Association ("GNMA"), or FHLB. The
payment of principal and interest on the FHLMC and FNMA Mortgage-Backed
Securities are guaranteed by those respective agencies, and the payment of
principal and interest on the GNMA Mortgage-Backed Securities are backed by the
full faith and credit of the U.S. government. All of the Company's Investment
Securities have an actual or implied "AAA" rating.
Repurchase Agreements - The Company finances the acquisition of its
Investment Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements.
Income Taxes - The Company has elected to be taxed as a REIT and intends to
comply with the provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), with respect thereto. Accordingly, the Company will not be subjected to
federal income tax to the extent of its distributions to shareholders and as
long as certain asset, income and stock ownership tests are met. The Company and
FIDAC have made a joint election to treat FIDAC as a taxable REIT subsidiary. As
such, FIDAC is taxable as a domestic C corporation and subject to federal and
state and local income taxes based upon its taxable income.
Use of Estimates - The preparation of financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Intangible assets - The Company's acquisition of FIDAC was accounted for
using the purchase method. Under the purchase method, net assets and results of
operations of acquired companies are included in the consolidated financial
statements from the date of acquisition. In addition, the cost of FIDAC was
allocated to the assets acquired, including identifiable intangible assets, and
the liabilities assumed based on their estimated fair values at the date of
acquisition. The excess of cost over the fair value of the net assets acquired
was recognized as goodwill.
Recent Accounting Pronouncements - In March 2004, the Emerging Issues Task
Force, or "EITF", reached a consensus on Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments. This
Issue provides clarification with respect to the meaning of other-than-temporary
impairment and its application to investments classified as either
available-for-sale or held-to-maturity under SFAS No. 115, and investments
accounted for under the cost method or the equity method. Certain provisions of
this Issue have been deferred to a later date. This Issue is not expected to
have a significant impact on the Company's financial statements when adopted.
6
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123 (Revised 2004) - Share-Based Payment ("SFAS No. 123R"). SFAS
123R, which replaces SFAS No. 123, requires the Company to measure and recognize
in the financial statements the compensation cost relating to share-based
payment transactions. The compensation cost should be reassured based on the
fair value of the equity instruments issued. SFAS No. 123R is effective for the
Company on January 1, 2006. The adoption of SFAS No. 123R is not expected to
have a significant impact on the Company's financial statements.
2. FIXED INCOME DISCOUNT ADVISORY COMPANY
On December 31, 2003, the Company entered into a merger agreement with
FIDAC. At the annual meeting of the Company's shareholders held on May 27, 2004,
shareholders voted to approve the merger. The merger closed before the opening
of business on June 4, 2004. The merger was accounted for using the purchase
method of accounting in accordance with SFAS No. 141. Accordingly, the
consolidated balance sheets as of September 30, 2005 and December 31, 2004
include the effects of the merger and the Company's application of the purchase
method of accounting. Additionally, the consolidated statements of operations
and of cash flows for the nine months ended September 30, 2004 include the
results of the Company and FIDAC for the period from June 4, 2004 to September
30, 2004. The consolidated statements of operation and of cash flows for the
quarter ended September 30, 2004 include a full quarter of results of operations
of the Company and FIDAC.
Upon completion of the merger and pursuant to the merger agreement, FDC
Merger Sub, Inc. ("Merger Sub"), the Company's wholly-owned subsidiary created
solely for the purpose of effectuating the merger, merged with and into FIDAC.
As a result of the merger, Merger Sub ceased to exist, and FIDAC is the
surviving corporation and operates as the Company's wholly-owned taxable REIT
subsidiary. At the time of the merger, each FIDAC shareholder received
approximately 2,935 shares of the Company's common stock for each share of FIDAC
stock the shareholder owned and has the right to receive additional shares of
the Company's common stock in the future, based on FIDAC achieving specific
performance goals. FIDAC's shareholders may also receive additional shares of
our common stock as an earn-out in 2005 and 2006 worth up to $49,500,000 if
FIDAC meets specific performance goals under the merger agreement. We cannot
calculate how many shares we will issue under the earn-out provisions since that
will vary depending upon whether and the extent to which FIDAC achieves specific
performance goals. Even if FIDAC achieves specific performance goals for a
fiscal year, the number of additional shares to be issued to the FIDAC
shareholders will vary depending on our average share price for the first 20
trading days of the following fiscal year.
The value of the shares of the Company's common stock issued to the FIDAC
shareholders immediately upon the consummation of the acquisition was fixed at
$40,500,000 based upon the closing price of the Company's common stock on
December 31, 2003, and was paid on June 4, 2004 by delivering 2,201,080 shares
of the Company's common stock.
The total amount of goodwill represents the purchase price in excess of the
fair value of the net assets acquired. Under SFAS No. 142, "Goodwill and Other
Intangible Assets," goodwill is not amortized, but tested at least annually for
impairment. Certain customer relationships are deemed by the Company to have an
indefinite life based on a lack of attrition history and management's
expectation of continued service to FIDAC clients and, accordingly, are not
being amortized. Instead, they are required to be tested at least annually for
impairment. FIDAC trademark and non-compete agreements are considered intangible
assets subject to amortization over their estimated life of three years and one
year, respectively. For the quarter ended September 30, 2005, amortization
expense related to these intangibles was $194,000 A deferred tax liability of
$37,000 arising from the temporary difference between the book and tax basis
relating to these amortizable intangible is included in "Other liabilities" in
the Statements of Financial Condition as of September 30, 2005 and December 31,
2004, respectively.
7
A summary of the fair values of the net assets acquired is as follows:
(dollars in thousands)
Cash and cash equivalents $2,526
Receivable for advisory fees and services 1,564
Other assets 591
Customer relationships 15,613
FIDAC trademark 250
Non-compete agreements 140
Goodwill 22,905
Accounts payable (748)
----------------------------
Total fair value of net assets, including acquisition cost $42,841
============================
8
3. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of September 30, 2005 and December 31, 2004,
which are carried at their fair value:
Government Total
Federal Home Loan Federal National National Mortgage Mortgage-Backed
Mortgage Corporation Mortgage Association Association Securities
September 30, 2005 ------------------- --------------------- -------------------- ------------------
(dollars in thousands)
Mortgage-Backed Securities, gross $6,263,055 $11,964,950 $391,567 $18,619,572
Unamortized discount (1,102) (1,167) (67) (2,336)
Unamortized premium 121,479 251,011 5,831 378,321
------------------- --------------------- -------------------- ------------------
Amortized cost 6,383,432 12,214,794 397,331 18,995,557
Gross unrealized gains 3,523 2,583 2 6,108
Gross unrealized losses (93,012) (207,431) (3,837) (304,280)
------------------- --------------------- -------------------- ------------------
Estimated fair value $6,293,943 $12,009,946 $393,496 $18,697,385
=================== ===================== ==================== ==================
Gross Unrealized Gross Unrealized Estimated Fair
Amortized Cost Gain Loss Value
------------------- --------------------- -------------------- ------------------
(dollars in thousands)
Adjustable rate $12,683,449 $5,947 ($190,162) $12,499,234
Fixed rate 6,312,108 161 (114,118) 6,198,151
------------------- --------------------- -------------------- ------------------
Total $18,995,557 $6,108 ($304,280) $18,697,385
=================== ===================== ==================== ==================
Government Total
Federal Home Loan Federal National National Mortgage Mortgage-Backed
Mortgage Corporation Mortgage Association Association Securities
December 31, 2004 ------------------- --------------------- --------------------- -----------------
(dollars in thousands)
Mortgage-Backed Securities, gross $6,063,131 $12,061,462 $604,310 $18,728,903
Unamortized discount (171) (843) (109) (1,123)
Unamortized premium 130,211 288,217 8,528 426,956
------------------- --------------------- --------------------- -----------------
Amortized cost 6,193,171 12,348,836 612,729 19,154,736
Gross unrealized gains 11,534 9,905 1,582 23,021
Gross unrealized losses (39,429) (97,890) (2,052) (139,371)
------------------- --------------------- --------------------- -----------------
Estimated fair value $6,165,276 $12,260,851 $612,259 $19,038,386
=================== ===================== ===================== =================
Gross Unrealized Gross Unrealized Estimated Fair
Amortized Cost Gain Loss Value
------------------- --------------------- --------------------- -----------------
(dollars in thousands)
Adjustable rate $13,833,122 $20,713 ($93,796) $13,760,039
Fixed rate 5,321,614 2,308 (45,575) 5,278,347
------------------- --------------------- --------------------- -----------------
Total $19,154,736 $23,021 ($139,371) $19,038,386
=================== ===================== ===================== =================
9
Actual maturities of mortgage-backed securities are generally shorter than
stated contractual maturities. Actual maturities of the Company's
mortgage-backed securities are affected by the contractual lives of the
underlying mortgages, periodic payments of principal, and prepayments of
principal. The following table summarizes the Company's mortgage-backed
securities on September 30, 2005 and December 31, 2004 according to their
estimated weighted-average life classifications:
September 30, 2005 December 31, 2004
---------------------------------------------------------------------
Amortized Amortized
Fair Value Cost Fair Value Cost
Weighted-Average Life (dollars in thousands)
- ----------------------------------------------------------------------------------------------------------------------
Less than one year $ 128,539 $ 130,858 $ 357,135 $ 359,433
Greater than one year and less than five years
14,197,332 14,422,896 14,623,143 14,705,212
Greater than or equal to five years 4,371,514 4,441,803 4,058,108 4,090,091
----------------- ---------------- ---------------- -----------------
Total $18,697,385 $18,995,557 $19,038,386 $19,154,736
================= ================ ================ =================
The weighted-average lives of the mortgage-backed securities at September
30, 2005 and December 31, 2004 in the table above are based upon data provided
through subscription-based financial information services, assuming constant
principal prepayment rates to the reset date of each security. The prepayment
model considers current yield, forward yield, steepness of the yield curve,
current mortgage rates, mortgage rates of the outstanding loans, loan age,
margin and volatility.
Mortgage-Backed Securities with a carrying value of $7.3 billion were in a
continuous unrealized loss position over 12 months at September 30, 2005 in the
amount of $166.5 million. Mortgage-Backed Securities with a carrying value of
$11.7 billion were in a continuous unrealized loss position for less than 12
months at September 30, 2005 in the amount of $137.8 million. Mortgage-Backed
Securities with a carrying value of $2.2 billion were in a continuous unrealized
loss position over 12 months at December 31, 2004 in the amount of $34.1
million. Mortgage-Backed Securities with a carrying value of $13.1 billion were
in a continuous unrealized loss position for less than 12 months at December 31,
2004 in the amount of $105.3 million. The decline in value of these securities
is solely due to increases in interest rates. All of the Mortgage-Backed
Securities are "AAA" rated or carry an implied "AAA" rating. These investments
are not considered other-than-temporarily impaired since the Company currently
has the ability and intent to hold the investments for a period of time to
maturity, if necessary, sufficient for a forecasted market price recovery up to
or beyond the cost of the investments. Also, the Company is guaranteed payment
on the par value of the securities. If, however, for liquidity or other reasons,
the Company determined to sell a portion of its securities which are in an
unrealized loss position, it would realize those losses. In addition, such a
sale may require the Company to record all of the unrealized losses on its
entire portfolio as a realized loss even though it did not sell those
securities.
The adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every nine
months) and lifetime caps. The weighted average lifetime cap was 10.3% at
September 30, 2005 and 10.1% December 31, 2004.
During the quarter ended September 30, 2005, the Company realized $32,000
in net gains from sales of Mortgage-Backed Securities. During the quarter ended
September 30, 2004, the Company realized $1.4 million in net gains from sales of
Mortgage-Backed Securities.
10
4. AGENCY DEBENTURES
The Company owns callable agency debentures totaling $265.0 million par
value, which were issued by FHLMC, FNMA, and FHLB. All of the Company's agency
debentures are classified as available-for-sale. The agency debentures had
carrying values of $258.6 million and $390.5 million at September 30, 2005 and
December 31, 2004, respectively. The agency debentures were in a continuous
unrealized loss position over 12 months at September 30, 2005 in the amount of
$6.4 million. The debentures with a carrying value of $390.5 million were in a
continuous unrealized loss position for less than 12 months at December 31, 2004
in the amount of $4.5 million. All of the agency debentures carry an implied
"AAA" rating. These investments are not considered other-than-temporarily
impaired since the Company has the ability and intent to hold the investments
for a period of time to maturity, if necessary, sufficient for a forecasted
market price recovery up to or beyond the cost of the investments. Also, the
Company is guaranteed payment on the par value of the agency debentures.
5. REPURCHASE AGREEMENTS
The Company had outstanding $17.0 billion and $16.7 billion of repurchase
agreements with weighted average borrowing rates of 3.69% and 2.46%, and
weighted average remaining maturities of 74 days and 111 days as of September
30, 2005 and December 31, 2004, respectively. Investment securities pledged as
collateral under these repurchase agreements had an estimated fair value of
$17.9 billion and $17.4 billion at September 30, 2005 and December 31, 2004,
respectively.
At September 30, 2005 and December 31, 2004, the repurchase agreements had
the following remaining maturities:
September 30, 2005 December 31, 2004
(dollars in thousands)
---------------------------------------------------------
Within 30 days $14,056,652 $13,059,810
30 to 59 days 1,231,574 1,598,069
60 to 89 days - -
90 to 119 days - -
Over 120 days 1,750,000 2,050,000
---------------------------------------------------------
Total $17,038,226 $16,707,879
=========================================================
6. OTHER LIABILITIES
In 2001, the Company entered into a repurchase agreement maturing in July
2004. This repurchase agreement provided the buyer the right to extend its
maturity date, in whole or in part, in three-month increments up to July 2006.
The buyer has continuously exercised its right to extend the maturity date, and
the agreement is currently set to mature in July 2006. The repurchase agreement
has a principal amount of $100,000,000, and is included in repurchase agreements
in the statements of financial condition. The Company accounts for the extension
option as a separate interest rate floor liability carried at fair value. The
initial fair value of $1.2 million allocated to the extension option resulted in
a similar discount on the repurchase agreement borrowings that is being
amortized over the initial term of three years using the effective yield method.
At September 30, 2005 and December 31, 2004, the fair value of this interest
rate floor was $469,000 and $2.7 million, respectively, and is included in other
liabilities in the Statements of Financial Condition.
7. PREFERRED STOCK AND COMMON STOCK
During the quarter ended September 30, 2005, the Company declared dividends
to common shareholders totaling $16.1 million or $0.13 per share, which were
paid on October 27, 2005. During the quarter ended September 30, 2005, the
Company declared dividends to preferred shareholders totaling $3.6 million or
$0.492188 per share, which were paid on September 30, 2005. In addition, the
Company sold 7,153 common shares through the dividend reinvestment and direct
purchase program for $114,000 during the quarter ended September 30, 2005.
During the quarter ended September 30, 2005, the Company raised $17.0 million in
the Equity Shelf Program by issuing 1,122,947 common shares. During the quarter
ended September 30, 2004, the Company declared dividends to common shareholders
totaling $60.6 million or $0.50 per share, which were paid on October 27, 2004.
During the quarter ended September 30, 2004, the Company declared dividends to
preferred shareholders totaling $2.1 million or $0.492188 per share, which were
paid on September 30, 2004.
11
During the nine months ended September 30, 2005, 2,381,550 common shares of
the Company's common stock were issued through the Equity Shelf Program for net
proceeds of $40.1 million. During the nine months ended September 30, 2005,
16,128 options were exercised under the long-term compensation plan for an
aggregate exercise price of $253,000. Also 24,253 common shares were sold
through the dividend reinvestment and direct purchase program for $440,000. On
January 21, 2004 the Company entered into an underwriting agreement pursuant to
which the Company raised net proceeds of approximately $363.6 million in equity
in an offering of 20,700,000 shares of common stock. On March 31, 2004, the
Company raised approximately $102.9 million in net proceeds through an offering
of 4,250,000 shares of 7.875% Series A Cumulative Redeemable Preferred Stock,
which settled on April 5, 2004. During the nine months ended September 30, 2004,
2,103,525 shares of the Company's common stock were issued through the Equity
Shelf Program for net proceeds of $37.5 million. During the nine months ended
September 30, 2004, 40,250 options were exercised under the long-term
compensation plan for an aggregate exercise price of $662,000. In addition, the
Company sold 116,760 common shares through the dividend reinvestment and direct
purchase program for $2.1 million for the nine months ended September 30, 2004.
8. NET INCOME PER COMMON SHARE
The following table presents a reconciliation of the earnings and shares
used in calculating basic and diluted EPS for the quarters ended September 30,
2005 and 2004.
For the Quarters Ended For the Nine Months Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
(dollars and shares in thousands)
-------------------------------------------------------------------------
Net income $21,186 $66,620 $127,512 $189,298
Less: Preferred stock dividend 3,648 2,082 10,945 4,080
-------------------------------------------------------------------------
Net income available to common
shareholders $17,538 $64,538 $116,567 $185,218
-------------------------------------------------------------------------
Weighted average shares of common
stock outstanding-basic 123,170 120,803 122,067 117,208
Add: Effect of dilutive stock options 161 191 198 231
-------------------------------------------------------------------------
Weighted average shares of common
stock outstanding-diluted 123,331 120,994 122,265 117,439
=========================================================================
Options to purchase 1,250,775 shares and 621,775 shares of common stock
were outstanding and considered anti-dilutive as their exercise price exceeded
the average stock price for the quarter and nine months ended September 30, 2005
respectively.
Options to purchase 10,000 shares and 12,500 of common stock were
outstanding and considered anti-dilutive as their exercise price exceeded the
average stock price for each of the quarters and nine months ended September 30,
2004 respectively.
9. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and non-employee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including non-qualified options as well as incentive stock
options as defined under Section 422 of the Code. The Incentive Plan authorizes
the granting of options or other awards for an aggregate of the greater of
500,000 shares or 9.5% of the diluted outstanding shares of the Company's common
stock.
12
The following table sets forth activity relating to the Company's stock options
awards:
For the Nine Months Ended
2005 2004
-----------------------------------------------------------------
Weighted
Number of Average Number of Weighted Average
Shares Exercise Price Shares Exercise Price
- ---------------------------------------- ------------ ----------------- --------------- ------------------
Options outstanding at the beginning
of period 1,645,721 $15.66 1,063,259 $14.28
Granted 6,250 18.26 639,750 17.39
Exercised (16,128) 12.21 (40,250) 8.81
Expired (33,750) 17.87 - -
------------ ----------------- --------------- ------------------
Options outstanding at the end of
period 1,602,093 $15.66 1,662,759 $15.61
============ ================= =============== ==================
The following table summarizes information about stock options outstanding at
September 30, 2005:
Weighted Average
Weighted Average Remaining Contractual
Range of Exercise Prices Options Outstanding Exercise Price Life (Years)
- ------------------------------- ----------------------- ------------------------ ---------------------------
$7.94-$19.99 1,592,093 $15.63 7.2
$20.00-$29.99 10,000 20.53 2.2
----------------------- ------------------------ ---------------------------
1,602,093 $15.66 7.2
======================= ======================== ===========================
The Company accounts for the Incentive Plan under the intrinsic value
method in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. There would be no impact on reported basic and diluted earnings
per share, if the Company had applied the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.
10. INCOME TAXES
The Company has elected to be taxed as a REIT under the Code. In connection
with the Company's merger with FIDAC effective June 4, 2004, the Company and
FIDAC made a joint election to treat FIDAC as a taxable REIT subsidiary under
the Code. As a REIT, the Company is not subject to Federal income tax on
earnings distributed to its shareholders. Most states recognize REIT status as
well. The Company has decided to distribute the majority of its income and
retain a portion of the permanent difference between book and taxable income
arising from Section 162(m) of the Code pertaining to employee remuneration.
During the quarter ended September 30, 2005, the Company recorded $2.9
million of income tax expense for income attributable to FIDAC, its taxable REIT
subsidiary, and the portion of earnings retained based on Code Section 162(m)
limitations. During the quarter ended September 30, 2005, the Company recorded
$438,000 of income tax expense for a portion of earnings retained based on
Section 162(m) limitations.
11. INTEREST RATE RISK
The primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company's control. Changes in the general level of
interest rates can affect net interest income, which is the difference between
the interest income earned on interest-earning assets and the interest expense
13
incurred in connection with the interest-bearing liabilities, by affecting the
spread between the interest-earning assets and interest-bearing liabilities.
Changes in the level of interest rates also can affect the value of the
Investment Securities and the Company's ability to realize gains from the sale
of these assets. A decline in the value of the Investment Securities pledged as
collateral for borrowings under repurchase agreements could result in the
counterparties demanding additional collateral pledges or liquidation of some of
the existing collateral to reduce borrowing levels. Liquidation of collateral at
losses could have adverse accounting impacts, as discussed in Note 3.
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although the Company has not done so to
date, the Company may seek to mitigate the potential impact on net income of
periodic and lifetime coupon adjustment restrictions in the portfolio of
Investment Securities by entering into interest rate agreements such as interest
rate caps and interest rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate by balancing assets purchased at a premium
with assets purchased at a discount. To date, the aggregate premium exceeds the
aggregate discount on the Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce net income
compared to what net income would be absent such prepayments.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Special Note Regarding Forward-Looking Statements
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be based on historical facts
and are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements which are
based on various assumptions, (some of which are beyond our control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or the
negative of those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to, changes in interest rates, changes in yield curve, changes in
prepayment rates, the availability of mortgage backed securities for purchase,
the availability of financing and, if available, the terms of any financing and
risks associated with the investment advisory business of FIDAC, including the
removal by FIDAC's clients of assets FIDAC manages, FIDAC's regulatory
requirements, and competition in the investment advisory business. For a
discussion of the risks and uncertainties which could cause actual results to
differ from those contained in the forward-looking statements, see our 2004 Form
10-K. We do not undertake, and specifically disclaim any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
Overview
We are a real estate investment trust that owns and manages a portfolio of
mortgage-backed securities and agency debentures. Our principal business
objective is to generate net income for distribution to our stockholders from
the spread between the interest income on our investment securities and the
costs of borrowing to finance our acquisition of investment securities and from
dividends we receive from FIDAC, which earns investment advisory fee income.
FIDAC is our wholly-owned subsidiary, and is a registered investment advisor
that generates advisory and service fee income.
We are primarily engaged in the business of investing, on a leveraged
basis, in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed
Securities"). We also invest in Federal Home Loan Bank ("FHLB"), Federal Home
14
Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage Association
("FNMA") debentures. The Mortgage-Backed Securities and agency debentures are
collectively referred to herein as "Investment Securities."
Under our capital investment policy, at least 75% of our total assets must
be comprised of high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) are unrated but are guaranteed by the United
States government or an agency of the United States government, or (3) are
unrated but are determined by us to be of comparable quality to rated
high-quality Mortgage-Backed Securities.
The remainder of our assets, comprising not more than 25% of our total
assets, may consist of other qualified REIT real estate assets which are unrated
or rated less than high quality, but which are at least "investment grade"
(rated "BBB" or better by Standard & Poor's Corporation ("S&P") or the
equivalent by another nationally recognized rating agency) or, if not rated,
determined by us to be of comparable credit quality to an investment which is
rated "BBB" or better.
We may acquire Mortgage-Backed Securities backed by single-family
residential mortgage loans as well as securities backed by loans on
multi-family, commercial or other real estate-related properties. To date, all
of the Mortgage-Backed Securities that we have acquired have been backed by
single-family residential mortgage loans.
We have elected to be taxed as a REIT for federal income tax purposes.
Pursuant to the current federal tax regulations, one of the requirements of
maintaining our status as a REIT is that we must distribute at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain) to our stockholders, subject to
certain adjustments.
The results of our operations are affected by various factors, many of
which are beyond our control. The results of our operations primarily depend on,
among other things, the amount of our net interest income, the market value of
our assets and the supply of and demand for such assets. Our net interest
income, which includes the amortization of purchase premiums, varies primarily
as a result of changes in interest rates, borrowing costs and prepayment speeds,
the behavior of which involves various risks and uncertainties. Prepayment
speeds, as reflected by the Constant Prepayment Rate, or CPR, and interest rates
vary according to the type of investment, conditions in financial markets,
competition and other factors, none of which can be predicted with any
certainty. In general, as prepayment speeds on our Mortgage-Backed Securities
portfolio increase, related purchase premium amortization increases, thereby
reducing the net yield on such assets. Since changes in interest rates may
significantly affect our activities, our operating results depend, in large
part, upon our ability to effectively manage interest rate risks and prepayment
risks while maintaining our status as a REIT.
The following table presents the CPR experienced on our Mortgage-Backed
Securities portfolio, on an annualized basis, for the following quarterly
periods :
Quarter Ended CPR
- ------------- ---
September 30, 2005 28%
June 30, 2005 27%
March 31, 2005 25%
December 31, 2004 27%
September 30, 2004 25%
We believe that the CPR in future periods will depend, in part, on changes
in and the level of market interest rates across the yield curve, with higher
CPRs expected during periods of declining interest rates and lower CPRs expected
during periods of rising interest rates.
We have reduced contractual maturities on borrowings, such that our
weighted average contractual maturity on our repurchase agreements was 137 days
at September 30, 2005, as compared to 211 days at December 31, 2004.
The table below provides quarterly information regarding our average
balances, interest income, interest expense, yield on assets, cost of funds and
net interest income for the following quarterly periods presented.
15
Yield on
Average Average
Investment Total Interest Average Balance Total Average Net
Securities Interest Earning of Repurchase Interest Cost of Interest
Held (1) Income Assets Agreements Expense Funds Income
--------------------------------------------------------------------------------------
(ratios for the quarters have been annualized, dollars in thousands)
Quarter Ended September 30, 2005 $18,906,350 $177,474 3.75% $17,672,690 $155,043 3.51% $22,431
Quarter Ended June 30, 2005 $18,918,577 $171,595 3.63% $17,658,408 $133,758 3.03% $37,837
Quarter Ended March 31, 2005 $18,798,200 $176,289 3.75% $17,756,241 $113,993 2.57% $62,296
- -------------------------------------------------------------------------------------------------------------------------
Quarter Ended December 31, 2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791
Quarter Ended September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038
(1) Does not reflect unrealized gains/(losses).
We continue to explore alternative business strategies, alternative
investments and other strategic initiatives to complement our core business
strategy of investing, on a leveraged basis, in high quality Investment
Securities. No assurance, however, can be provided that any such strategic
initiative will or will not be implemented in the future.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported in our financial statements. These
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. In preparing the financial
statements, management is required to make various judgments, estimates and
assumptions that affect the reported amounts. Changes in these estimates and
assumptions could have a material effect on our financial statements. The
following is a summary of our policies most affected by management's judgments,
estimates and assumptions. These policies have not changed during 2005.
Market valuation of Investment Securities: All assets classified as
available-for-sale are reported at fair value, based on market prices. Although
we generally intend to hold most of our Investment Securities until maturity, we
may, from time to time, sell any of our Investment Securities as part our
overall management of our portfolio. Accordingly, we are required to classify
all of our Investment Securities as available-for-sale. Our policy is to obtain
market values from at least three independent sources and record the market
value of the securities based on the average of the three. Management evaluates
securities for other-than-temporary impairment at least on a quarterly basis,
and more frequently when economic or market concerns warrant such evaluation.
Consideration is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. The investments with unrealized losses are
not considered other-than-temporarily impaired since the Company has the ability
and intent to hold the investments for a period of time, to maturity if
necessary, sufficient for a forecasted market price recovery up to or beyond the
cost of the investments. Unrealized losses on Investment Securities that are
considered other than temporary, as measured by the amount of decline in fair
value attributable to factors other than temporary, are recognized in income and
the cost basis of the Investment Securities is adjusted. There were no such
adjustments for the quarters ended September 30, 2005 and 2004. If in the future
management determines an impairment to be other-than-temporary, we may need to
realize a loss that would have an impact on future income. The realization of
such a loss may require the Company to record all of the unrealized losses on
its entire portfolio as a realized loss even though it did not sell those
securities. In addition, if for liquidity or other reasons, the Company
determined to sell a portion of its securities which are in an unrealized loss
position, it would realize those losses, and such a sale may require the Company
to record all of the unrealized losses on its entire portfolio as a realized
loss even though it did not sell those securities.
Interest income: Interest income is accrued based on the outstanding
principal amount of the Investment Securities and their contractual terms.
Premiums and discounts associated with the purchase of the Investment Securities
16
are amortized into interest income over the projected lives of the securities
using the interest method. Our policy for estimating prepayment speeds for
calculating the effective yield is to evaluate historical performance, street
consensus prepayment speeds, and current market conditions. If our estimate of
prepayments is incorrect, we may be required to make an adjustment to the
amortization or accretion of premiums and discounts that would have an impact on
future income.
Repurchase Agreements: We finance the acquisition of our Investment
Securities through the use of repurchase agreements. Repurchase agreements are
treated as collateralized financing transactions and are carried at their
contractual amounts, including accrued interest, as specified in the respective
agreements.
Income Taxes: We have elected to be taxed as a Real Estate Investment Trust
("REIT") and intend to comply with the provisions of the Internal Revenue Code
of 1986, as amended (the "Code"), with respect thereto. Accordingly, the Company
will not be subjected to federal income tax to the extent of its distributions
to shareholders and as long as certain asset, income and stock ownership tests
are met. The Company and FIDAC have made a joint election to treat FIDAC as a
taxable REIT subsidiary. As such, FIDAC is taxable as a domestic C corporation
and subject to federal and state and local income taxes based upon its taxable
income.
Results of Operations: For the Quarters and Nine Months Ended September 30, 2005
and 2004
Net Income Summary
For the quarter ended September 30, 2005, our net income was $21.2 million,
or $0.14 basic earnings per share available for common shareholders, as compared
to $66.6 million, or $0.53 basic earnings per average share, for the quarter
ended September 30, 2004. We attribute the decrease in total net income for the
quarter ended September 30, 2005, from the quarter ended September 30, 2004 to
the decline in net interest income. Even with the increased asset base from
September 30, 2004 to September 30, 2005, the decrease in total net income share
was primarily due to the decline in the interest rate spread from 1.56% to
0.24%. The increase in cost of funding from 1.80% for the quarter ended
September 30, 2004 to 3.51% for the quarter ended September 30, 2005 was only
partially offset by the increase in yield on assets of 3.36% for the quarter
ended September 30, 2004 to 3.75% for the quarter ended September 30, 2005. For
the quarter ended September 30, 2005, gain on sale of Mortgage-Backed Securities
was $32,000 as compared to $1.4 million for the quarter ended September 30,
2004. For the quarter ended September 30, 2005, net investment advisory and
service fees totaled $8.5 million, as compared to $3.8 million for the quarter
ended September 30, 2004. The net investment advisory and service fees increased
substantially, but did not offset the effect of the decline in the interest rate
spread. Dividends for the quarter ended September 30, 2005, were $0.13 per share
of common stock, or $16.0 million in total, and 0.492188 per share of preferred
stock, or $3.7 million in total. Dividends per share for the quarter ended
September 30, 2004 were $0.50 per share of common stock, or $60.6 million in
total. Our return on average equity was 5.20% for the quarter ended September
30, 2005 compared to 16.59% for the quarter ended September 30, 2004.
For the nine months ended September 30, 2005, our net income was $127.5
million, or $0.95 basic earnings per share, as compared to $189.3 million, or
$1.58 basic earnings per average share available to common shareholders, for the
nine months ended September 30, 2004. We attribute the decrease in net income
for the nine months ended September 30, 2005 from the nine months ended
September 30, 2004 to the decrease in net interest income. Even with the
substantial increase in gain on sale of mortgage-backed securities and net
investment advisory and service fees, the decline in interest rate spread of 91
basis points resulted in the decline of net income for the nine months ended
September 30, 2005. For the nine months ended September 30, 2005, gain on sale
of Mortgage-Backed Securities was $12.0 million, as compared to $4.1 million for
the nine months ended September 30, 2004. For the nine months ended September
30, 2005, net investment advisory and service fees totaled $20.7 million, as
compared to $5.0 million for the nine months ended September 30, 2004. Dividends
per share for the nine months ended September 30, 2005, were $0.94 per share of
common stock, or $114.8 million in total and $1.476564 per share of preferred
stock or $10.9 million in total. Dividends per share for the nine months ended
September 30, 2004 were $1.48 per share, or $177.2 million in total and $0.96
per share of preferred stock or $4.1 million in total. Our return on average
equity was 10.35% for the nine months ended September 30, 2005 and 16.42% for
the nine months ended September 30, 2004. The decline in the return on average
equity resulted from the decline in net interest income that was only partial
offset by an increase in net advisory fee income and gains on the sale of
Mortgage-Backed Securities.
17
Net Income Summary
------------------
(ratios for the quarter have been annualized, dollars in the thousands, except for per share data)
--------------------------------------------------------------------------------------------------
Quarter Quarter Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
-------------------------------------------------------------------
Interest income $177,474 $138,970 $525,358 $375,545
Interest expense 155,043 70,173 402,794 176,124
-------------------------------------------------------------------
Net interest income 22,431 68,797 122,564 199,421
Investment advisory and service fees 10,945 4,811 26,923 6,369
Gain on sale of Mortgage-Backed
Securities 32 1,350 12,047 4,071
Distribution fees (2,414) (1,024) (6,151) (1,322)
General and administrative expenses (6,455) (6,159) (19,919) (17,167)
-------------------------------------------------------------------
Income before income taxes 24,539 67,775 135,464 191,372
Income taxes 3,353 1,155 7,952 2074
-------------------------------------------------------------------
Net income 21,186 66,620 127,512 189,298
Dividends on preferred stock 3,648 2,082 10,945 4,080
-------------------------------------------------------------------
Net income available to common
shareholders $17,538 $64,538 $116,567 $185,218
===================================================================
Weighted average number of basic common
shares outstanding 123,169,910 120,802,814 122,067,300 117,208,336
Weighted average number of diluted
common shares outstanding 123,330,645 120,994,191 122,265,351 117,439,248
Basic net income per common share $0.14 $0.53 $0.95 $1.58
Diluted net income per common share $0.14 $0.53 $0.95 $1.58
Average total assets $19,389,755 $17,788,296 $19,389,238 $16,726,393
Average total equity $1,629,724 $1,606,051 $1,642,423 $1,512,477
Annualized return on average assets 0.44% 1.50% 0.88% 1.51%
Annualized return on average equity 5.20% 16.59% 10.35% 16.69%
Interest Income and Average Earning Asset Yield
We had average earning assets of $18.9 billion and $16.6 billion for the
quarters ended September 30, 2005 and 2004, respectively. Our primary source of
income for the quarters ended September 30, 2005 and 2004 was interest income. A
portion of our income was generated by gains on the sales of our Mortgage-Backed
Securities and net income from FIDAC. Our interest income was $177.5 million for
the quarter ended September 30, 2005 and $139.0 million for the quarter ended
September 30, 2004. The yield on average investment securities increased from
3.36% for the quarter ended September 30, 2004 to 3.75% for the quarter ended
September 30, 2005. Our average earning asset balance increased by $2.3 billion
and interest income increased by $38.5 million for the quarter ended September
30, 2005 as compared to the quarter ended September 30, 2004. The increase was
the direct result of the increased asset base and increase in weighted average
yield. The average coupon rate at September 30, 2005 was 4.79%, as compared to
4.44% at September 30, 2004. The prepayment speeds increased to 28% CPR for the
quarter ended September 30, 2005 from 25% CPR for the quarter ended September
30, 2004. The increase in coupon rates, which was only partially offset by
higher prepayment speeds, resulted in an increase in yield of 39 basis points.
18
We had average earning assets of $18.9 billion and $15.9 billion for the
nine months ended September 30, 2005 and 2004, respectively. Our interest income
was $525.4 million for the nine months ended September 30, 2005 and $375.5
million for the nine months ended September 30, 2004. The yield on average
investment securities increased from 3.15% for the nine months ended September
30, 2004, to 3.71% for the nine months ended September 30, 2005. Our average
earning asset balance increased by $3.0 billion and interest income increased by
$149.9 million for the nine months ended September 30, 2005 as compared to the
nine months ended September 30, 2004. The increase in interest income for the
nine months ended September 30, 2005, when compared to the nine months ended
September 30, 2004, resulted from the increased asset base and the increase in
weighted average yield.
The table below shows our average balance of interest earning assets, our
yield on average earning assets and our interest income for the quarters ended
September 30, 2005, June 30, 2005, March 31, 2005, the year ended December 31,
2004, and the four quarters in 2004.
Average Earning Asset Yield
---------------------------
(ratios for the quarters have been annualized, dollars in thousands)
--------------------------------------------------------------------
Average
Average Yield on Constant
Investment Investment Prepayment Interest
Securities Securities Rate Income
---------- ---------- ---- ------
Quarter Ended September 30, 2005 $18,906,350 3.71% 28% $177,474
Quarter Ended June 30, 2005 $18,918,577 3.63% 27% $171,595
Quarter Ended March 31, 2005 $18,798,200 3.75% 25% $176,289
- -----------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $16,399,184 3.25% 29% $532,328
Quarter Ended December 31, 2004 $17,932,449 3.50% 27% $156,783
Quarter Ended September 30, 2004 $16,562,971 3.36% 25% $138,970
Quarter Ended June 30, 2004 $16,649,072 2.94% 33% $122,234
Quarter Ended March 31, 2004 $14,452,245 3.16% 31% $114,341
- -----------------------------------------------------------------------------------------------------
The CPR increased to 28% for the quarter ended September 30, 2005, as
compared to 25% for the quarter ended September 30, 2004. The total amortization
of premium and discount on Investment Securities for the quarters ended
September 30, 2005, and 2004 was $43.7 million and $39.7 million, respectively.
Interest Expense and the Cost of Funds
We anticipate that our largest expense will be the cost of borrowed funds.
We had average borrowed funds of $17.7 billion and total interest expense of
$155.0 million for the quarter ended September 30, 2005. We had average borrowed
funds of $15.6 billion and total interest expense of $70.1 million for the
quarter ended September 30, 2004. Our average cost of funds was 3.51% for the
quarter ended September 30, 2005 and 1.80% for the quarter ended September 30,
2004. The cost of funds rate increased by 171 basis points and the average
borrowed funds increased by $2.1 billion for the quarter ended September 30,
2005 when compared to the quarter ended September 30, 2004. Interest expense for
the quarter increased by $84.9 million due to the substantial increase in the
average repurchase balance and weighted average cost of funds rate. Our average
cost of funds was 0.03% below average one-month LIBOR and 0.40% below average
six-month LIBOR for the quarter ended September 30, 2005. Our average cost of
funds was 0.21% above average one-month LIBOR and 0.17% below average six-month
LIBOR for the quarter ended September 30, 2004.
We had average borrowed funds of $17.7 billion and total interest expense
of $402.8 million for the nine months ended September 30, 2005. We had average
borrowed funds of $15.0 billion and total interest expense of $176.1 million for
the nine months ended September 30, 2004. Our average cost of funds was 3.03%
for the nine months ended September 30, 2005 and 1.56% for the nine months ended
September 30, 2004. The cost of funds rate increased 1.47% and the average
borrowed funds increased by $2.7 billion for the nine months ended September 30,
2005 when compared to the nine months ended September 30, 2004. Interest expense
for the nine months increased by $226.7 million, due to the substantial increase
in the average repurchase balance and a 147 basis point increase in the average
funding rate.
19
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, 2005, June 30, 2005, March 31, 2005, the year ended December
31, 2004 and the four quarters in 2004.
Average Cost of Funds
---------------------
(ratios for the quarters have been annualized, dollars in thousands)
--------------------------------------------------------------------
Average One- Average Cost
Month LIBOR Average Cost of Funds
Average Average Relative to of Funds Relative to
Average Average One- Six- Average Relative to Average
Borrowed Interest Cost of Month Month Six-Month Average One- Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR Month LIBOR LIBOR
-----------------------------------------------------------------------------------------
Quarter Ended September 30, 2005 $17,672,690 $155,043 3.51% 3.54% 3.91% (0.37%) (0.03%) (0.40%)
Quarter Ended June 30, 2005 $17,658,408 $133,758 3.03% 3.05% 3.43% (0.38%) (0.02%) (0.40%)
Quarter Ended March 31, 2005 $17,756,241 $113,993 2.57% 2.58% 3.02% (0.44%) (0.01%) (0.45%)
- ---------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $15,483,118 $270,116 1.74% 1.50% 1.80% (0.30%) 0.24% (0.06%)
Quarter Ended December 31, 2004 $16,896,216 $93,992 2.23% 2.14% 2.48% (0.34%) 0.09% (0.25%)
Quarter Ended September 30, 2004 $15,568,691 $70,173 1.80% 1.59% 1.97% (0.38%) 0.21% (0.17%)
Quarter Ended June 30, 2004 $15,880,353 $55,648 1.40% 1.15% 1.54% (0.39%) 0.25% (0.14%)
Quarter Ended March 31, 2004 $13,587,211 $50,303 1.48% 1.10% 1.18% (0.08%) 0.38% 0.30%
Net Interest Income
Our net interest income, which equals interest income less interest
expense, totaled $22.4 million for the quarter ended September 30, 2005 and
$68.8 million for the quarter ended September 30, 2004. Our net interest income
decreased because the interest rate spread decreased, even though our asset base
increased. Our net interest spread, which equals the yield on our average assets
for the period less the average cost of funds for the period, was 0.24% for the
quarter ended September 30, 2005 as compared to 1.56% for the quarter ended
September 30, 2004. This 132 basis point decrease was a result of the increase
in the cost of funding for the quarter ended September 30, 2005 to 3.51% from
1.80% for the quarter ended September 30, 2004. The increase in cost of funds
was only partially offset by the increase in yield on assets, which increased to
3.75% for the quarter ended September 30, 2005, as compared to 3.36% for the
quarter ended September 30, 2004.
Our net interest income totaled $122.6 million for the nine months ended
September 30, 2005 and $199.4 million for the nine months ended September 30,
2004. Our net interest income decreased because of the decline in interest rate
spread. Our net interest spread, which equals the yield on our average assets
for the period less the average cost of funds for the period, was 0.68% for the
nine months ended September 30, 2005 as compared to 1.59% for the quarter ended
September 30, 2004.
The table below shows our interest income by earning asset type, average
earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
quarters ended September 30, 2005, June 30, 2005, March 31, 2005 the year ended
December 31, 2004, and the four quarters in 2004.
20
Net Interest Income
-------------------
(ratios for the quarters have been annualized, dollars in thousands)
--------------------------------------------------------------------
Yield on
Average Average Average Net
Investment Total Interest Balance of Average Net Interest
Securities Interest Earning Repurchase Interest Cost of Interest Rate
Held Income Assets Agreements Expense Funds Income Spread
------------------------------------------------------------------------------------------
Quarter Ended September 30, 2005 $18,906,350 $177,474 3.75% $17,672,690 $155,043 3.51% $22,431 0.24%
Quarter Ended June 30, 2005 $18,918,577 $171,595 3.63% $17,658,408 $133,758 3.03% $37,837 0.60%
Quarter Ended March 31, 2005 $18,798,200 $176,289 3.75% $17,756,241 $113,993 2.57% $62,296 1.18%
- -------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $16,399,184 $532,328 3.25% $15,483,118 $270,116 1.74% $262,212 1.51%
Quarter Ended December 31, 2004 $17,932,449 $156,783 3.50% $16,896,216 $93,992 2.23% $62,791 1.27%
Quarter Ended September 30, 2004 $16,562,971 $138,970 3.36% $15,568,691 $70,173 1.80% $68,797 1.56%
Quarter Ended June 30, 2004 $16,649,072 $122,234 2.94% $15,880,353 $55,648 1.40% $66,586 1.54%
Quarter Ended March 31, 2004 $14,452,245 $114,341 3.16% $13,587,211 $50,303 1.48% $64,038 1.68%
Investment Advisory and Service Fees
FIDAC is a registered investment advisor which generally receives annual
net investment advisory fees of approximately 10 to 20 basis points of the gross
assets it manages, assists in managing or supervises. At September 30, 2005,
FIDAC had under management approximately $2.9 billion in net assets and $26.8
billion in gross assets, compared to $1.7 billion in net assets and $13.9
billion in gross assets at September 30, 2004. Investment advisory and service
fees for the quarter ended September 30, 2005 and September 30, 2004 totaled
$8.5 and $3.8 million respectively, net of fees paid to third parties pursuant
to distribution service agreements for facilitating and promoting distribution
of shares of FIDAC's clients. At September 30, 2005, net assets under management
increased by $1.2 billon and gross assets under management increased by $12.9
billion, when compared to September 30, 2004.
Gains and Losses on Sales of Mortgage-Backed Securities
For the quarter ended September 30, 2005, we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $151.6 million for an
aggregate gain of $32,000. For the quarter ended September 30, 2004 we sold
Mortgage-Backed Securities with an aggregate historical amortized cost of $129.3
million for an aggregate gain of $1.4 million. For the nine months ended
September 30, 2005, we sold Mortgage-Backed Securities with an aggregate
historical amortized cost of $1.1 billion for an aggregate gain of $12.0
million. For the nine months ended September 30, 2004, we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $279.3 million for an
aggregate gain of $4.1 million. The difference between the sale price and the
historical amortized cost of our Mortgage-Backed Securities will be a realized
gain or a realized loss, and will increase or decrease income accordingly. We do
not expect to sell assets on a frequent basis, but may from time to time sell
existing assets to acquire assets, which our management believes might have
higher risk-adjusted returns as part of our asset/liability management strategy.
In addition, in certain circumstances we may record all of the unrealized losses
on our entire portfolio as a realized loss even though we did not sell those
securities. See "Critical Accounting Policies" above.
General and Administrative Expense
General and administrative ("G&A") expenses were $6.5 million for the
quarter ended September 30, 2005 and $6.2 million for the quarter ended
September 30, 2004. G&A expenses as a percentage of average assets were 0.13%
and 0.14% for the quarters ended September 30, 2005 and September 30, 2004
respectively. G&A expenses as a percentage of average equity were 1.58% and
1.53% on an annualized basis for the quarters ended September 30, 2005 and
September 30, 2004, respectively. The increase in G&A expenses of $300,000 for
the quarter ended September 30, 2005, was primarily the result of increased
salaries and directors' and officers' insurance.
G&A expenses were $20.0 million for the nine months ended September 30,
2005 and $17.2 million for the nine months ended September 30, 2004. G&A
expenses as a percentage of average assets was 0.14% and 0.14% on an annualized
21
basis for the nine months ended September 30, 2005 and 2004, respectively. G&A
expenses as a percentage of average equity was 1.62% and 1.51% on an annualized
basis for the nine months ended September 30, 2005 and 2004, respectively.
The table below shows our total G&A expenses as compared to average total
assets and average equity for the quarter ended September 30, 2005, June 30,
2005, March 31, 2005, the year ended December 31, 2004, and the four quarters in
2004.
G&A Expenses and Operating Expense Ratios
-----------------------------------------
(ratios for the quarters have been annualized, dollars in thousands)
--------------------------------------------------------------------
Total G&A Total G&A
Total G&A Expenses/Average Expenses/Average
Expenses Assets (annualized) Equity (annualized)
-------- ------------------- -------------------
Quarter Ended September 30, 2005 $6,455 0.13% 1.58%
Quarter Ended June 30, 2005 $6,800 0.14% 1.64%
Quarter Ended March 31, 2005 $6,664 0.14% 1.61%
-------------------------------------------------------------------------------------------
Year Ended December 31, 2004 $24,029 0.14% 1.55%
Quarter Ended December 31, 2004 $6,862 0.14% 1.63%
Quarter Ended September 30, 2004 $6,159 0.14% 1.53%
Quarter Ended June 30, 2004 $5,643 0.13% 1.39%
Quarter Ended March 31, 2004 $5,365 0.15% 1.63%
Net Income and Return on Average Equity
Our net income was $21.2 million for the quarter ended September 30, 2005
and $66.6 million for the quarter ended September 30, 2004. Our annualized
return on average equity was 5.20% for the quarter ended September 30, 2005 and
16.59% for the quarter ended September 30, 2004. Our net income was $127.5
million for the nine months ended September 30, 2005 and $189.3 million for the
nine months ended September 30, 2004. Our return on average equity was 10.35%
for the nine months ended September 30, 2005 and 16.69% for the nine months
ended September 30, 2004. We attribute the decrease in net income and return on
average equity to the interest rate spread compression for the quarter and nine
months. The decline in spread income was only partially offset by the increase
in gains on sales of Mortgage-Backed Securities and increase in net advisory and
service fees. The table below shows our net interest income, investment advisory
and service fees, gain on sale of Mortgage-Backed Securities, G&A expenses, and
income taxes each as a percentage of average equity, and the return on average
equity for the quarter ended September 30, 2005, June 30, 2005, March 31, 2005,
the year ended December 31, 2004, and the four quarters in 2004.
Components of Return on Average Equity
--------------------------------------
(ratios for the quarters have been annualized)
----------------------------------------------
Gain on Sale
of Mortgage-
Net Investment Backed G&A Income
Net Interest Advisory and Securities/ Expenses/ Taxes/ Return on
Income/Average Service Fees/ Average Average Average Average
Equity Average Equity Equity Equity Equity Equity
----------------------------------------------------------------------------------
Quarter Ended September 30, 2005 5.50% 2.09% 0.01% 1.58% 0.82% 5.20%
Quarter Ended June 30, 2005 9.15% 1.82% 2.76% 1.64% 0.73% 11.36%
Quarter Ended March 31, 2005 15.06% 1.13% 0.14% 1.61% 0.38% 14.34%
- ------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2004 16.92% 0.62% 0.34% 1.55% 0.29% 16.04%
Quarter Ended December 31, 2004 14.95% 1.10% 0.27% 1.63% 0.57% 14.12%
Quarter Ended September 30, 2004 17.13% 0.94% 0.34% 1.53% 0.29% 16.59%
Quarter Ended June 30, 2004 16.44% 0.31% 0.52% 1.39% 0.12% 15.76%
Quarter Ended March 31, 2004 18.05% - 0.17% 1.63% - 16.59%
22
Financial Condition
Investment Securities
All of our Mortgage-Backed Securities at September 30, 2005 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by single-family
mortgage loans. All of the mortgage assets underlying these Mortgage-Backed
Securities were secured with a first lien position on the underlying
single-family properties. All our Mortgage-Backed Securities were FHLMC, FNMA or
GNMA mortgage pass-through certificates or collateralized mortgage obligations,
which carry an actual or implied "AAA" rating. We mark-to-market all of our
Mortgage Backed Securities to fair value.
All of our agency debentures are callable and carry an implied "AAA"
rating. We mark-to-market all of our agency debentures to fair value.
We accrete discount balances as an increase in interest income over the
life of Investment Securities purchased at a discount and we amortize premium
balances as a decrease in interest income over the life of the Investment
Securities purchased at a premium. At September 30, 2005 and December 31, 2004,
we had in our statement of financial condition a total of $2.3 million and $1.1
million, respectively, of unamortized discount (which is the difference between
the remaining principal value and current historical amortized cost of our
Investment Securities acquired at a price below principal value) and a total of
$378.3 million and $409.9 million, respectively, of unamortized premium (which
is the difference between the remaining principal value and the current
historical amortized cost of our Investment Securities acquired at a price above
principal value).
We received mortgage principal repayments of $2.1 billion for the quarter
ended September 30, 2005 and $1.6 billion for the quarter ended September 30,
2004. The overall prepayment speed for the quarter ended September 30, 2005
increased to 28%, as compared to 25% for the quarter ended September 30, 2004,
due to increase in refinancing activity. Given our current portfolio
composition, if mortgage principal prepayment rates were to increase over the
life of our Mortgage-Backed Securities, all other factors being equal, our net
interest income would decrease during the life of these Mortgage-Backed
Securities as we would be required to amortize our net premium balance over a
shorter time period. Similarly, if mortgage principal prepayment rates were to
decrease over the life of our Mortgage-Backed Securities, all other factors
being equal, our net interest income would increase during the life of these
Mortgage-Backed Securities, as we would amortize our net premium balance over a
longer time period.
The table below summarizes our Investment Securities at September 30, 2005,
June 30, 2005, March 31, 2005, December 31, 2004, September 30, 2004, June 30,
2004, and March 31, 2004.
Investment Securities
---------------------
(dollars in thousands)
----------------------
Amortized Fair Weighted
Principal Amortized Cost/Principal Value/Principal Average
Amount Net Premium Cost Amount Fair Value Amount Yield
----------- ----------- ----------- ----------- ----------- ----------- -----------
At September 30, 2005 $18,884,571 $375,985 $19,260,557 101.99% $18,956,001 101.38% 3.96%
At June 30, 2005 $19,300,333 $401,356 $19,701,690 102.08% $19,556,836 101.33% 3.78%
At March 31, 2005 $18,887,801 $416,542 $19,304,343 102.21% $19,091,063 101.08% 3.61%
- --------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $19,123,902 $425,792 $19,549,694 102.23% $19,428,895 101.59% 3.43%
At September 30, 2004 $17,893,902 $409,115 $18,303,017 102.29% $18,211,030 101.77% 3.36%
At June 30, 2004 $16,914,635 $384,648 $17,299,283 102.27% $17,121,795 101.22% 3.04%
At March 31, 2004 $17,662,596 $412,563 $18,075,159 102.34% $18,079,598 102.36% 2.72%
The tables below set forth certain characteristics of our Investment
Securities. The index level for adjustable-rate Investment Securities is the
weighted average rate of the various short-term interest rate indices, which
determine the coupon rate.
23
Adjustable-Rate Investment Securities Characteristics
-----------------------------------------------------
(dollars in thousands)
----------------------
Weighted Weighted Principal Amount
Weighted Weighted Weighted Average Average at Period End as
Average Average Average Term to Weighted Asset % of Total
Principal Coupon Index Net Next Average Yield Investment
Amount Rate Level Margin Adjustment Lifetime Cap (annualized) Securities
----------- ----------- --------- --------- ----------- ----------- ----------- -----------
At September 30, 2005 $12,437,763 4.56% 2.82% 1.74% 23 months 10.26% 3.91% 65.86%
At June 30, 2005 $12,934,382 4.43% 2.61% 1.82% 24 months 10.30% 3.69% 67.02%
At March 31, 2005 $13,464,087 4.29% 2.50% 1.79% 22 months 10.06% 3.46% 71.28%
- -------------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $13,544,872 4.23% 2.45% 1.78% 24 months 10.12% 3.24% 70.83%
At September 30, 2004 $12,645,118 4.12% 2.34% 1.78% 25 months 10.12% 3.06% 70.67%
At June 30, 2004 $11,806,171 3.95% 2.19% 1.76% 29 months 10.07% 2.73% 69.80%
At March 31, 2004 $13,059,967 3.90% 2.20% 1.70% 30 months 9.77% 2.91% 73.94%
Fixed-Rate Investment Securities Characteristics
------------------------------------------------
(dollars in thousands)
----------------------
Principal
Amount at
Weighted Weighted Period End as %
Average Coupon Average of Total
Principal Rate Asset Yield Investment
Amount (annualized) (annualized) Securities
----------- -------------- --------------- -----------------
At September 30, 2005 $6,446,808 5.23% 4.06% 34.14%
At June 30, 2005 $6,365,952 5.22% 3.96% 32.98%
At March 31, 2005 $5,423,714 5.31% 3.99% 28.72%
- --------------------------------------------------------------------------------------------
At December 31, 2004 $5,579,030 5.24% 3.89% 29.17%
At September 30, 2004 $5,248,784 5.19% 4.08% 29.33%
At June 30, 2004 $5,108,464 5.15% 3.77% 30.20%
At March 31, 2004 $4,602,629 5.53% 3.41% 26.06%
The following tables provide information on adjustable-rate investment
securities by index at September 30, 2005 and December 31, 2004.
Adjustable-Rate Investment Securities by Index
----------------------------------------------
September 30, 2005
------------------
National
Six- 11th Financial Monthly
One- Six- Twelve Month 12-Month District Average Six- 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Mortgage MonthCD Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Rate Rate Index Index Index Index Funds
----------------------------------------------------------------------------------------------------------
Weighted Average
Term to Next
Adjustment 1 mo. 43 mo. 29 mo. 5 mo. 2 mo. 1 mo. 19 mo. 2 mo. 19 mo. 11 mo. 22 mo. 35 mo. 1 mo.
Weighted Average
Annual Period Cap 7.47% 2.00% 2.03% 1.00% 0.78% 0.00% 2.00% 1.00% 1.92% 2.00% 2.02% 1.96% 0.00%
Weighted Average
Lifetime Cap at
September 30, 2005 8.21% 10.76% 10.21% 13.03% 10.85% 12.08% 10.88% 11.73% 10.42% 11.94% 12.43% 12.51% 13.39%
Investment
Principal Amount as
Percentage of
Investment
Securities at
September 30, 2005 4.81% 5.88% 27.46% 0.01% 0.27% 0.83% 0.01% 0.04% 25.57% 0.01% 0.30% 0.05% 0.62%
24
Adjustable-Rate Investment Securities by Index
----------------------------------------------
December 31, 2004
-----------------
National
Six- 11th Financial Monthly
One- Six- Twelve Month 12-Month District Average 1-Year 2-Year 3-Year 5-Year Federal
Month Month Month Auction Moving Cost of Mortgage Six-Month Treasury Treasury Treasury Treasury Cost of
Libor Libor Libor Average Average Funds Rate CD Rate Index Index Index Index Funds
--------------------------------------------------------------------------------------------------------------
Weighted Average Term
to Next Adjustment 1 mo. 27 mo. 34 mo. 2 mo. 1 mo. 0 mo. 5 mo. 3 mo. 25 mo. 10 mo. 17 mo. 31 mo. 0 mo.
Weighted Average
Annual
Period Cap 8.01% 1.07% 2.18% 1.00% 0.17% 0.82% 2.00% 1.00% 1.86% 2.00% 2.00% 2.00% 2.00%
Weighted Average
Lifetime Cap at
December 31, 2004 8.88% 9.86% 10.08% 13.03% 10.65% 12.13% 10.58% 11.66% 10.31% 11.92% 12.96% 12.59% 13.39%
Investment Principal
Value as Percentage
of Investment
Securities at
December 31, 2004 8.67% 2.50% 22.96% 0.01% 0.22% 0.98% 0.01% 0.05% 34.31% 0.01% 0.25% 0.07% 0.79%
Borrowings
To date, our debt has consisted entirely of borrowings collateralized by a
pledge of our Investment Securities. These borrowings appear on our balance
sheet as repurchase agreements. At September 30, 2005, we had established
uncommitted borrowing facilities in this market with 30 lenders in amounts which
we believe are in excess of our needs. All of our Investment Securities are
currently accepted as collateral for these borrowings. However, we limit our
borrowings, and thus our potential asset growth, in order to maintain unused
borrowing capacity and thus increase the liquidity and strength of our financial
condition.
For the quarter ended September 30, 2005, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 137 days. For the quarter ended September 30, 2004, the term
to maturity of our borrowings ranged from one day to three years, with a
weighted average original term to maturity of 215 days. At September 30, 2005,
the weighted average cost of funds for all of our borrowings was 3.69% and the
weighted average term to next rate adjustment was 74 days. At September 30,
2004, the weighted average cost of funds for all of our borrowings was 1.99% and
the weighted average term to next rate adjustment was 109 days.
Liquidity
Liquidity, which is our ability to turn non-cash assets into cash, allows
us to purchase additional investment securities and to pledge additional assets
to secure existing borrowings should the value of our pledged assets decline.
Our potential immediate sources of liquidity include cash balances and unused
borrowing capacity. Unused borrowing capacity will vary over time as the market
value of our investment securities varies. Liquidity is also generated on an
on-going basis through mortgage principal repayments and net earnings retained
prior to payment as dividends. Should our needs ever exceed these on-going
sources of liquidity plus the immediate sources of liquidity discussed above, we
believe that in most circumstances our investment securities could be sold to
raise cash. The maintenance of liquidity is one of the goals of our capital
investment policy. Under this policy, we limit asset growth in order to preserve
unused borrowing capacity for liquidity management purposes.
Borrowings under our repurchase agreements increased by $1.4 billion to
$17.0 billion at September 30, 2005, from $15.6 billion at September 30, 2004.
This increase in leverage was facilitated by the increase in our equity capital
as a result of the issuance of common stock primarily through public offerings
during 2004.
We anticipate that, upon repayment of each borrowing under a repurchase
agreement, we will use the collateral immediately for borrowing under a new
repurchase agreement. We have not at the present time entered into any
25
commitment agreements under which the lender would be required to enter into a
new repurchase agreement during a specified period of time, nor do we presently
plan to have liquidity facilities with commercial banks.
Under our repurchase agreements, we may be required to pledge additional
assets to our repurchase agreement counterparties (i.e., lenders) in the event
the estimated fair value of the existing pledged collateral under such
agreements declines and such lenders demand additional collateral (a "margin
call"), which may take the form of additional securities or cash. Similarly, if
the estimated fair value of investment securities increase due to changes in
market interest rates or market factors, lenders may release collateral back to
the Company. Specifically, margin calls result from a decline in the value of
the Mortgage-Backed Securities securing our repurchase agreements, prepayments
on the mortgages securing such Mortgage-Backed Securities and to changes in the
estimated fair value of such Mortgage-Backed Securities generally due to
principal reduction of such Mortgage-Backed Securities from scheduled
amortization and resulting from changes in market interest rates and other
market factors. Through September 30, 2005, we did not have any margin calls on
our repurchase agreements that we were not able to satisfy with either cash or
additional pledged collateral. However, should prepayment speeds on the
mortgages underlying our Mortgage-Backed Securities and/or market interest rates
suddenly increase, margin calls on our repurchase agreements could result,
causing an adverse change in our liquidity position. If for liquidity or other
reasons, we determined to sell a portion of our securities which are in an
unrealized loss position, we would realize those losses. In addition, such a
sale may require us to record all of the unrealized losses on our entire
portfolio as a realized loss even though we did not sell those securities.
The following table summarizes the effect on our liquidity and cash flows
from contractual obligations at September 30, 2005.
(dollars in thousands)
--------------------
Within One One to Three to More than Total
Year Three Five Five Years
Years Years
--------------------------------------------------------------
Repurchase agreements $15,388,226 $1,650,000 - - $17,038,226
Long-term operating lease obligations 522 1,065 666 - 2,253
Employment contracts 10,667 - - - 10,667
--------------------------------------------------------------
Total $15,399,415 $1,651,065 $666 - $17,051,146
==============================================================
Stockholders' Equity
During the quarter ended September 30, 2005, the Company declared dividends
to common shareholders totaling $16.1 million or $0.13 per share, which were
paid on October 27, 2005. During the quarter ended September 30, 2005, the
Company declared dividends to preferred shareholders totaling $3.6 million or
$0.492188 per share, which were paid on September 30, 2005. The Company sold
7,153 common shares through the dividend reinvestment and direct purchase
program for $114,000 during the quarter ended September 30, 2005. During the
quarter ended September 30, 2005, the Company raised $17.0 million in the Equity
Shelf Program by issuing 1,122,947 common shares. During the quarter ending
September 30, 2004, the Company declared dividends to shareholders totaling
$60.6 million or $0.50 per share, which was paid on October 27, 2004. During the
quarter ended September 30, 2004, the Company declared dividends to preferred
shareholders totaling $2.1 million or $0.49 per share, which were paid on
September 30, 2004. During the quarter ended September 30, 2004, 1,076,125
shares were issued through the Equity Shelf Program resulting in net proceeds of
$17.5 million. During the quarter ended September 30, 2004, 50 options were
exercised under the long-term compensation plan for an aggregate exercise price
of $432. In addition, the Company sold 10,818 common shares through the dividend
reinvestment and direct purchase program for $175,000 during the quarter ended
September 30, 2004. During the quarter ended June 30, 2004, 2,201,080 common
shares were issued under the terms of the FIDAC merger agreement.
During the nine months ended September 30, 2005, 2,381,550 shares of the
Company's common stock were issued through the Equity Shelf Program for net
proceeds of $40.1 million. During the nine months ended September 30, 2005,
26
16,128 options were exercised under the long-term compensation plan at $253,000.
Also, 24,253 common shares were sold through the dividend reinvestment and
direct purchase program at $440,000. On January 21, 2004 the Company entered
into an underwriting agreement pursuant to which the Company raised net proceeds
of approximately $363.6 million in equity in an offering of 20,700,000 shares of
common stock. On March 31, 2004, the Company raised approximately $102.9 million
in net proceeds through an offering of 4,250,000 shares of 7.875% Series A
Cumulative Redeemable Preferred Stock, which settled on April 5, 2004. During
the nine months ended September 30, 2004, 2,103,525 shares of the Company's
common stock were issued through the Equity Shelf Program for net proceeds of
$37.5 million. During the nine months ended September 30, 2004, 40,250 options
were exercised under the long-term compensation plan for an aggregate exercise
price of $662,000. In addition, the Company sold 116,760 common shares through
the dividend reinvestment and direct purchase program for $2.1 million for the
nine months ended September 30, 2004.
The FIDAC acquisition was completed on June 4, 2004. We issued 2,201,080
common shares to the shareholders of FIDAC, based on the December 31, 2003
closing price of $18.40. We continue to operate as a self-managed and
self-advised real estate investment trust, with FIDAC operating as our
wholly-owned taxable REIT subsidiary. FIDAC's shareholders may also receive
additional shares of our common stock as an earn-out in 2005and 2006 worth up to
$49,500,000 if FIDAC meets specific performance goals under the merger
agreement. We cannot calculate how many shares we will issue under the earn-out
provisions since that will vary depending upon whether and the extent to which
FIDAC achieves specific performance goals. Even if FIDAC achieves specific
performance goals for a fiscal year, the number of additional shares to be
issued to the FIDAC shareholders will vary depending on our average share price
for the first 20 trading days of the following fiscal year.
With our "available-for-sale" accounting treatment, unrealized fluctuations
in market values of assets do not impact our GAAP or taxable income but rather
are reflected on our balance sheet by changing the carrying value of the asset
and stockholders' equity under "Accumulated Other Comprehensive Income (Loss)."
As a result of this mark-to-market accounting treatment, our book value and
book value per share are likely to fluctuate far more than if we used historical
amortized cost accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may not be
meaningful.
The table below shows unrealized gains and losses on the Investment
Securities in our portfolio.
Unrealized Gains and Losses
---------------------------
(dollars in thousands)
At At At At At At
September 30, June 30, March 31, December 31, September 30 June 30
2005 2005 2005 2004 2004 2004
--------------- ------------- --------------- -------------- --------------- -----------
Unrealized Gain $6,109 $ 7,956 $23,683 $23,021 $24,788 $ 27,603
Unrealized Loss (310,664) (152,809) (236,963) (143,821) (116,775) (205,092)
--------------- ------------- --------------- -------------- --------------- -----------
Net Unrealized Gain ($304,555) ($144,853) ($213,280) ($120,800) (91,987) ($177,489)
(Loss)
=============== ============= =============== ============== =============== ===========
Net Unrealized Gain (Loss)
as % of Investment
Securities' Principal Amount (1.61%) (0.75%) (1.13%) (0.63%) (0.51%) (1.05%)
Net Unrealized Gain (Loss)
as % of Investment
Securities' Amortized Cost (1.58%) (0.74%) (1.11%) (0.62%) (0.50%) (1.03%)
Mortgage-Backed Securities with a carrying value of $7.3 billion were in a
continuous unrealized loss position over 12 months at September 30, 2005 in the
amount of $166.5 million. Mortgage-Backed Securities with a carrying value of
$11.7 billion were in a continuous unrealized loss position for less than 12
months at September 30, 2005 in the amount of $137.8 million. Mortgage-Backed
Securities with a carrying value of $2.2 billion were in a continuous unrealized
loss position over 12 months at December 31, 2004 in the amount of $34.1
million. Mortgage-Backed Securities with a carrying value of $13.1 billion were
in a continuous unrealized loss position for less than 12 months at December 31,
2004 in the amount of $105.3 million. The decline in value of these securities
is solely due to increases in interest rates. All of the Mortgage-Backed
Securities are "AAA" rated or carry an implied "AAA" rating. These investments
27
are not considered other-than-temporarily impaired since the Company has the
ability and intent to hold the investments for a period of time to maturity, if
necessary, sufficient for a forecasted market price recovery up to or beyond the
cost of the investments. Also, the Company is guaranteed payment on the par
value of the securities. If, however, for liquidity or other reasons, the
Company determined to sell a portion of its securities which are in an
unrealized loss position, it would realize those losses. In addition, such a
sale may require the Company to record all of the unrealized losses on its
entire portfolio as a realized loss even though it did not sell those
securities.
The debentures with a carrying value of $390.5 million were in a continuous
unrealized loss position for less than 12 months at December 31, 2004 in the
amount of $4.5 million. All of the agency debentures carry an implied "AAA"
rating. These investments are not considered other-than-temporarily impaired
since the Company has the ability and intent to hold the investments for a
period of time to maturity, if necessary, sufficient for a forecasted market
price recovery up to or beyond the cost of the investments. Also, the Company is
guaranteed payment on the par value of the agency debentures.
As discussed above, because we use "available-for-sale" treatment for our
Investment Securities, we carry these assets on our balance sheet at estimated
market value rather than historical amortized cost. Based upon this
"available-for-sale" treatment, our common equity base at September 30, 2005 was
$1.4 billion, or a book value of $11.18 per common share. If we had used
historical amortized cost accounting, our common equity base at September 30,
2005 would have been $1.7 billion, or $13.64 per common share. Our equity base
at December 31, 2004 was $1.7 billion, or $12.56 per share. If we had used
historical amortized cost accounting, our equity base at December 31, 2004 would
have been $1.8 billion, or $13.56 per share.
The table below shows our equity capital base as reported and on a
historical amortized cost basis at September 30,2005, June 30, 2005, March 31,
2005, December 31, 2004, September 30, 2004, June 30, 2004 and March 31,2004.
Issuances of common stock, the level of earnings as compared to dividends
declared, and other factors influence our historical cost equity capital base.
The reported equity capital base is influenced by these factors plus changes in
the "Unrealized Net Gains (Losses) on Assets Available for Sale" account.
Stockholders' Equity
--------------------
7.875% Series Net Unrealized
A Cumulative Gains (Losses) Reported Reported Common
Redeemable Historical on Assets Common Stock Historical Stock Equity
Preferred Stock Common Stock Available for Equity Base Common Stock (Book Value) Per
Equity Base Sale (Book Value) Equity Per Share Share
-----------------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
At September 30 ,2005 $177,088 $1,686,827 ($304,555) $1,382,272 $13.64 $11.18
At June 30, 2005 $177,088 $1,668,253 (144,853) $1,523,400 $13.61 $12.43
At March 31, 2005 $177,077 $1,645,579 ($213,280) $1,432,299 $13.57 $11.81
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 2004 $177,077 $1,821,270 ($120,800) $1,700,470 $13.56 $12.56
At September 30, 2004 $102,708 $1,648,869 ($91,987) $1,556,882 $13.60 $12.84
At June 30, 2004 $102,708 $1,627,292 ($177,489) $1,449,803 $13.54 $12.07
At March 31, 2004 $102,870 $1,581,218 $4,500 $1,585,718 $13.42 $13.45
Leverage
Our debt-to-reported equity ratio at September 30, 2005 and September 30,
2004 was 10.9:1 and 9.4:1 respectively. We generally expect to maintain a ratio
of debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to-equity ratio is determined under our capital investment
policy. Should our actual debt-to-equity ratio increase above the target level
due to asset acquisition or market value fluctuations in assets, we will cease
28
to acquire new assets. Our management will, at that time, present a plan to our
Board of Directors to bring us back to our target debt-to-equity ratio; in many
circumstances, this would be accomplished over time by the monthly reduction of
the balance of our Mortgage-Backed Securities through principal repayments.
Asset/Liability Management and Effect of Changes in Interest Rates
We continually review our asset/liability management strategy with respect
to interest rate risk, mortgage prepayment risk, credit risk and the related
issues of capital adequacy and liquidity. We seek attractive risk-adjusted
stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a function
of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although we have not done so to date, we
may seek to mitigate the potential impact on net income of periodic and lifetime
coupon adjustment restrictions in our portfolio of Investment Securities by
entering into interest rate agreements such as interest rate caps and interest
rate swaps.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
Inflation
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends based upon our net income as
calculated for tax purposes; in each case, our activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
Other Matters
We calculate that our qualified REIT assets, as defined in the Code, were
100% of our total assets at September 30, 2005 and September 30, 2004, as
compared to the Code requirement that at least 75% of our total assets be
qualified REIT assets. We also calculate that 97% and 95% of our revenue
qualifies for the 75% source of income test, and 100% of our revenue qualifies
for the 95% source of income test, under the REIT rules for the quarters ended
September 30, 2005 and September 30, 2004 respectively. We also met all REIT
requirements regarding the ownership of our common stock and the distribution of
our net income. Therefore, as of September 30, 2005 and September 30, 2004, we
believe that we qualified as a REIT under the Code.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act. If we were
to become regulated as an investment company, then our use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
"primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate" (qualifying
interests). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, we must maintain at least 55% of our assets directly
in qualifying interests. In addition, unless certain mortgage securitites
represent all the certificates issued with respect to an underlying pool of
mortgages, the Mortgage-Backed Securities may be treated as securities separate
from the underlying mortgage loans and, thus, may not be considered qualifying
interests for purposes of the 55% requirement. We calculate that as of September
30, 2005 and December 31, 2004 we were in compliance with this requirement.
29
ITEM. 3 QUANTITATIVE AND QUALITIATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and
other factors beyond our control. Changes in the general level of interest rates
can affect our net interest income, which is the difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing liabilities. Changes in
the level of interest rates also can affect the value of our Mortgage-Backed
Securities and our ability to realize gains from the sale of these assets. We
may utilize a variety of financial instruments; including interest rate swaps,
caps, floors and other interest rate exchange contracts, in order to limit the
effects of interest rates on our operations. If we use these types of
derivatives to hedge the risk of interest-earning assets or interest-bearing
liabilities, we may be subject to certain risks, including the risk that losses
on a hedge position will reduce the funds available for payments to holders of
securities and that the losses may exceed the amount we invested in the
instruments. To date, we have not purchased any hedging instruments.
Our profitability and the value of our portfolio may be adversely affected
during any period as a result of changing interest rates. The following table
quantifies the potential changes in net interest income and portfolio value
should interest rates go up or down 25, 50, and 75 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, 2005 and various estimates regarding prepayment and all activities
are made at each level of rate shock. Actual results could differ significantly
from these estimates.
Projected Percentage Change in Projected Percentage Change in
Change in Interest Rate Net Interest Income Portfolio Value
- ---------------------------------- ---------------------------------- -----------------------------------
- -75 Basis Points 43.16% 0.62%
- -50 Basis Points 30.21% 0.46%
- -25 Basis Points 15.96% 0.25%
Base Interest Rate - -
+25 Basis Points (19.20%) (0.30%)
+50 Basis Points (39.10%) (0.65%)
+75 Basis Points (56.11%) (1.05%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. We attempt to control risks
associated with interest rate movements. Methods for evaluating interest rate
risk include an analysis of our interest rate sensitivity "gap", which is the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of falling interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
30
The following table sets forth the estimated maturity or repricing of our
interest-earning assets and interest-bearing liabilities at September 30, 2005.
The amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except adjustable-rate loans, and securities are included in the
period in which their interest rates are first scheduled to adjust and not in
the period in which they mature. The interest rate sensitivity of our assets and
liabilities in the table could vary substantially if based on actual prepayment
experience.
More than 1
Year to 3 3 Years and
Within 3 Months 4-12 Months Years Over Total
--------------------------------------------------------------------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $2,079,798 $2,888,249 $7,883,862 $6,032,662 $18,884,571
Rate Sensitive Liabilities:
Repurchase Agreements 15,288,226 100,000 1,650,000 - 17,038,226
--------------------------------------------------------------------------
Interest rate sensitivity gap ($13,208,428) $2,788,249 $6,233,862 $6,032,662 $1,846,345
==========================================================================
Cumulative rate sensitivity gap ($13,208,428) ($10,420,179) ($4,186,315) $1,846,345
==========================================================================
Cumulative interest rate sensitivity gap as a
percentage of total rate-sensitive assets (70%) (55%) (22%) 10%
Our analysis of risks is based on management's experience, estimates,
models and assumptions. These analyses rely on models which utilize estimates of
fair value and interest rate sensitivity. Actual economic conditions or
implementation of investment decisions by our management may produce results
that differ significantly form the estimates and assumptions used in our models
and the projected results shown in the above tables and in this report. These
analyses contain certain forward-looking statements and are subject to the safe
harbor statement set forth under the heading, "Special Note Regarding
Forward-Looking Statements."
ITEM 4. CONTROLS AND PROCEDURES
Our management, including our Chief Executive Officer (the "CEO") and Chief
Financial Officer (the "CFO"), reviewed and evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15(e) of the Securities Exchange Act) as of the end of the period
covered by this quarterly report. Based on that review and evaluation, the CEO
and CFO have concluded that our current disclosure controls and procedures, as
designed and implemented, (1) were structured to ensure that material
information regarding Annaly and its sole subsidiary is made known to our
management, including our CEO and CFO, by our employees and (2) were effective
in providing reasonable assurance that information the Company must disclose in
its periodic reports under the Securities Exchange Act is recorded, processed,
summarized and reported within the time periods prescribed by the SEC's rules
and forms. There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date of their evaluation. There were no significant material weaknesses
identified in the course of such review and evaluation and, therefore, we have
taken no corrective measures.
During the nine months ended September 30, 2005, no change occurred in our
internal control over financial reporting that materially effected, or is likely
to materially effect, our internal control over financial reporting.
31
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
The exhibits required by this item are set forth on the Exhibit Index attached
hereto.
Exhibit Number Exhibit Description
31.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32
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 4, 2005 By: /s/ Michael A.J. Farrell
-------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief Executive Officer,
President and authorized officer of registrant)
Dated: November 4, 2005 By: /s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
(Chief Financial Officer and Treasurer and
principal financial and chief accounting officer)
33