UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2006
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 of (IRS Employer
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 a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |X| Accelerated filer |_| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
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 May 5, 2006
Common Stock, $.01 par value 162,916,656
ANNALY MORTGAGE MANAGEMENT, INC. AND SUBSIDIARY
FORM 10-Q
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Financial Condition-March 31, 2006 (Unaudited) and December 31, 2005 1
Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) for the
quarters ended March 31, 2006 and 2005 2
Consolidated Statement of Stockholders' Equity (Unaudited) for the quarter ended March 31, 2006 3
Consolidated Statements of Cash Flows (Unaudited) for the quarters ended March 31, 2006 and 2005 4
Notes to Consolidated Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 31
Item 4. Controls and Procedures 32
Part II. OTHER INFORMATION
33
Item 1. Legal Proceedings
33
Item 1A. Risk Factors
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 35
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except for share data)
March 31, DECEMBER 31,
2006 2005
(UNAUDITED)
------------------------
ASSETS
Cash and cash equivalents $ 2,403 $ 4,808
Mortgage-Backed Securities, at fair value 16,176,348 15,929,864
Receivable for Mortgage-Backed Securities sold 139,491 13,449
Accrued interest receivable 75,092 71,340
Receivable for advisory and service fees 3,805 3,497
Intangible for customer relationships, net 13,851 15,183
Goodwill 22,966 23,122
Interest rate swaps, at fair value 36,470 -
Other assets 2,281 2,159
------------------------
Total assets $16,472,707 $16,063,422
========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements $14,629,883 $13,576,301
Payable for Mortgage-Backed Securities purchased 354,312 933,051
Accrued interest payable 37,738 27,994
Dividends payable 13,607 12,368
Other liabilities - 305
Accounts payable 3,238 8,837
Interest rate swaps, at fair value - 543
------------------------
Total liabilities 15,038,778 14,559,399
------------------------
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock: 7,637,500
authorized, 7,412,500 shares issued and outstanding 177,088 177,088
Common stock: par value $.01 per share; 500,000,000 authorized; and
123,701,656, 123,684,931; shares issued and outstanding,
respectively 1,237 1,237
Additional paid-in capital 1,679,904 1,679,452
Accumulated other comprehensive loss (249,459) (207,117)
Accumulated deficit (174,841) (146,637)
------------------------
Total stockholders' equity 1,433,929 1,504,023
------------------------
Total liabilities and stockholders' equity $16,472,707 $16,063,422
========================
See notes to financial statements.
1
PART I.
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(dollars in thousands, except per share amounts)
For the For the
Quarter Ended Quarter Ended
March 31, 2006 March 31, 2005
-------------------------------
Interest income $194,882 $176,289
Interest expense 167,512 113,993
-------------------------------
Net interest income 27,370 62,296
-------------------------------
Other (loss) income:
Investment advisory and service fees 6,997 6,309
(Loss) gain on sale of Mortgage-Backed Securities (7,006) 580
Impairment of intangible for customer relationships (1,148) -
Loss on other-than-temporarily impaired securities (26,730) -
-------------------------------
Total other (loss) income (27,887) 6,889
-------------------------------
Expenses:
Distribution fees 1,170 1,610
General and administrative expenses 7,177 6,664
-------------------------------
Total expenses 8,347 8,274
-------------------------------
Net (loss) income before income taxes (8,864) 60,911
Income taxes 2,085 1,578
-------------------------------
Net (loss) income (10,949) 59,333
Dividends on preferred stock 3,648 3,648
-------------------------------
Net (loss) income (related) available to common shareholders ($14,597) $55,685
===============================
Net (loss) income per share (related) available to common shareholders:
Basic ($0.12) $0.46
===============================
Diluted ($0.12) $0.46
===============================
Weighted average number of common shares outstanding:
Basic 123,693,851 121,270,867
===============================
Diluted 123,693,851 121,564,320
===============================
Net (loss) income ($10,949) $59,333
-------------------------------
Comprehensive loss:
Unrealized loss on available-for-sale securities (113,091) (91,900)
Unrealized gain on interest rate swaps 37,013 -
Reclassification adjustment for net losses (gains) included in
net loss or income 33,736 (580)
-------------------------------
Other comprehensive loss (42,342) (92,480)
-------------------------------
Comprehensive loss ($53,291) ($33,147)
===============================
See notes to financial statements.
2
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE QUATER ENDED MARCH 31, 2006
(dollars in thousands, except per share data)
(UNAUDITED)
Additional Accumulated
Common Paid-In Other
Preferred Stock Comprehensive Accumulated
Stock Par Value Capital Income (Loss) Deficit Total
------------------------------------------------------------------
------------------------------------------------------------------
BALANCE, JANUARY 1, 2006 $177,088 $1,237 $1,679,452 ($207,117) ($146,637) $1,504,023
Net loss (10,949)
Other comprehensive loss (42,342)
Comprehensive loss (53,291)
Option expense 293 293
Exercise of stock options 159 159
Preferred dividend declared, $0.492188 per share (3,648) (3,648)
Common dividend declared, $0.11 per share (13,607) (13,607)
------------------------------------------------------------------
BALANCE, MARCH 31, 2006 $177,088 $1,237 $1,679,904 ($249,459) ($174,841)$1,433,929
==================================================================
See notes to financial statements.
3
PART I
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(UNAUDITED)
For the Quarter For the Quarter
Ended Ended
March 31, 2006 March 31, 2005
------------------------------------
Cash flows from operating activities:
Net (loss) income ($10,949) $59,333
Adjustments to reconcile net (loss) gain to net cash provided by
operating activities:
Amortization of Mortgage- Backed Securities premiums and
discounts, net 15,793 36,067
Amortization of intangibles 205 55
Loss (gain) on sale of Mortgage-Backed Securities 7,006 (580)
Loss on other-than-temporarily impaired securities 26,730 -
Stock option expense 316 -
Market value adjustment on long-term repurchase agreement (148) (1,250)
Impairment of intangible 1,148 -
(Increase) decrease in accrued interest receivable, net of
purchased interest (4,621) 455
Increase in other assets (142) (54)
Increase in advisory and service fees receivable (308) (524)
Increase (decrease) in accrued interest payable 9,744 (1,951)
Decrease in accounts payable (5,600) (4,016)
------------------------------------
Net cash provided by operating activities 39,174 87,535
------------------------------------
Cash flows from investing activities:
Purchase of Mortgage-Backed Securities (3,273,966) (2,361,872)
Proceeds from sale of Mortgage-Backed Securities 1,071,781 85,946
Principal payments on Mortgage-Backed Securities 1,122,905 1,518,228
------------------------------------
Net cash used in investing activities (1,079,280) (757,698)
------------------------------------
Cash flows from financing activities:
Proceeds from repurchase agreements 52,762,754 57,259,546
Principal payments on repurchase agreements (51,709,172) (56,528,815)
Proceeds from exercise of stock options 136 99
Proceeds from direct purchase and dividend reinvestment - 177
Dividends paid (16,017) (64,280)
------------------------------------
Net cash provided by financing activities 1,037,701 666,727
Net decrease in cash and cash equivalents (2,405) (3,436)
Cash and cash equivalents, beginning of period 4,808 5,853
------------------------------------
Cash and cash equivalents, end of period $2,403 $2,417
====================================
Supplemental disclosure of cash flow information:
Interest paid $177,256 $115,944
====================================
Income taxes $2,339 $1,578
====================================
------------------------------------
Noncash financing activities:
Net change in unrealized loss on available-for-sale securities
and interest rate swaps, net of reclassification adjustment ($42,342) ($92,480)
====================================
Dividends declared, not yet paid $13,607 $54,575
====================================
See notes to financial statements.
4
ANNALY MORTGAGE MANAGEMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTER ENDED MARCH 31, 2006 AND 2005
(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. 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, 2005. 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 include the accounts of the Company
and FIDAC. All material intercompany balances have been eliminated.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand
and money market funds.
Mortgage-Backed Securities - The Company invests in mortgage pass-through
certificates, collateralized mortgage obligations and other mortgage-backed
securities representing interests in or obligations backed by pools of mortgage
loans (collectively, "Mortgage-Backed Securities").
Statement of Financial Accounting Standards ("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. The loss on other-than-temporarily impaired
securities was $26.7 million for the quarter ended March 31, 2006. There was no
impairment loss recognized during the quarter ended March 31, 2005.
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 and service fees, repurchase
agreements, and payable for mortgage-backed securities purchased, dividends
payable, accounts payable, and accrued interest payable, generally approximates
cost as of March 31, 2006 and December 31, 2005, 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.
Derivative Financial Instruments/Hedging Activity- The Company hedges
interest rate risk through the use of derivative financial instruments,
comprised of interest rate caps and interest rate swaps (collectively, "Hedging
Instruments"). The Company accounts for Hedging Instruments in accordance with
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
("SFAS 133") as amended and interpreted. The Company carries all Hedging
Instruments at their fair value, as assets, if their fair value is positive, or
as liabilities, if their fair value is negative. As the Company's interest rate
swaps are designated as "cash flow hedges," the change in the fair value of any
such derivative is recorded in other comprehensive income or loss for hedges
that qualify as effective. The ineffective amount of all Hedging Instruments, if
any, is recognized in earnings each quarter. To date, the Company has not
recognized any change in the value of its interest rate swaps in earnings as a
result of the hedge or a portion thereof being ineffective.
Upon entering into hedging transactions, the Company documents the
relationship between the Hedging Instruments and the hedged liability. The
Company also documents its risk-management policies, including objectives and
strategies, as they relate to its hedging activities. The Company assesses, both
at inception of a hedge and on an on-going basis, whether or not the hedge is
"highly effective," as defined by SFAS 133. The Company discontinues hedge
accounting on a prospective basis with changes in the estimated fair value
reflected in earnings when (i) it is determined that the derivative is no longer
effective in offsetting cash flows of a hedged item (including hedged items such
as forecasted transactions); (ii) it is no longer probable that the forecasted
transaction will occur; or (iii) it is determined that designating the
derivative as a Hedging Instrument is no longer appropriate.
When the Company enters into an interest rate swap, it agrees to pay a
fixed rate of interest and to receive a variable interest rate, generally based
on the London Interbank Offered Rate ("LIBOR"). The Company's interest rate
swaps are designated as cash flow hedges against the benchmark interest rate
risk associated with the Company's borrowings.
All changes in the unrealized gains/losses on any interest rate swap are
recorded in accumulated other comprehensive income or loss and are reclassified
to earnings as interest expense is recognized on the Company's hedged
borrowings. If it becomes probable that the forecasted transaction, which in
this case refers to interest payments to be made under the Company's short-term
borrowing agreements, will not occur by the end of the originally specified time
period, as documented at the inception of the hedging relationship, then the
related gain or loss in accumulated other comprehensive income or loss would be
reclassified to income or loss.
Realized gains and losses resulting from the termination of an interest
rate swap are initially recorded in accumulated other comprehensive income or
loss as a separate component of stockholders' equity. The gain or loss from a
terminated interest rate swap remains in accumulated other comprehensive income
or loss until the forecasted interest payments affect earnings. If it becomes
probable that the forecasted interest payments will not occur, then the entire
gain or loss would be recognized in earnings.
6
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, or GNMA. The payment of principal and interest on the FHLMC and
FNMA Mortgage-Backed Securities are guaranteed by those respective agencies, and
the payment of principal and interest on the GNMA Mortgage-Backed Securities are
backed by the full faith and credit of the U.S. government. 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. Intangible assets are valued for impairment charges.
During the quarter ended March 31, 2006, the Company recorded $1.1 million in
impairment losses. During the quarter ended March 31, 2005, the Company did not
have impairment losses
Recent Accounting Pronouncements - 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 reassessed based on the fair value of the equity instruments
issued. We adopted SFAS No. 123R effective January 1, 2006 under the modified
prospective transition method. Accordingly, prior period amounts have not been
restated. Under this application, the Company is required to record compensation
expense for all awards granted or modified on or after January 1, 2006 and for
the unvested portion of all outstanding awards that remain outstanding at the
date of adoption. The adoption of SFAS No. 123R resulted in incremental
stock-based compensation expense of $293,000 and insignificant impact on basic
and diluted net loss per share for the quarter ended March 31, 2006.
We elected to recognize compensation expense on a straight-line basis over
the requisite service period for the entire award (that is, over the requisite
service period of the last separately vesting portion of the award). We estimate
fair value using the Black-Scholes valuation model. Assumptions used to estimate
the compensation expense are determined as follows:
o Expected term (estimated time of outstanding) is estimated using the
historical exercise behavior of employees
o Expected volatility is measured using the weighted average of
historical daily changes in the market price of our common stock over
the expected term of the award
7
o Expected dividend yield is based on projected dividend yield over the
expected term of the award
o Risk-free interest rate is equivalent to the implied yield on
zero-coupon U.S. Treasury bonds with a remaining maturity equal to the
expected term of the awards; and,
o Forfeitures are based substantially on the history of cancellations of
similar awards granted by the Company in prior years.
Prior to the adoption of SFAS No. 123R, we used the intrinsic value method
prescribed in APB 25 and also followed the disclosure requirements of SFAS No.
123, as amended by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" ("SFAS No. 148"), which required certain disclosures
on a pro forma basis as if the fair value method had been followed for
accounting for such compensation. The reported and pro forma net loss per share
for the quarter ended March 31, 2006 in the table below are the same since
stock-based compensation expense is calculated under the provisions of SFAS No.
123R. These amounts for the quarter ended March 31, 2006 are included only to
provide the detail for a comparative presentation to the prior period.
For the Quarter For the Quarter
Ended March 31, Ended March 31,
2006 2005
---------------------------------------
Net loss income related to common shareholders, as reported ($14,597) $55,685
Add: Total stock-based compensation expense included in reported net loss 293
---------------------------------------
Deduct: Total stock-based employee compensation expense determined under
fair value intrinsic method (293) (36)
---------------------------------------
Pro-forma net (loss) income related to common shareholders ($14,597) $55,685
=======================================
Net (loss) income per share related to common shareholders, as reported
Basic ($0.12) $0.46
=======================================
Diluted ($0.12) $0.46
=======================================
Pro-forma net (loss) income per share related to common shareholders
Basic ($0.12) $0.46
=======================================
Diluted ($0.12) $0.46
=======================================
The FASB has added an item to its current proposed amendment relating to
the accounting treatment under SFAS 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities, a replacement of FASB
Statement 125, of transactions where assets purchased from a particular
counterparty are financed via a repurchase agreement with the same counterparty.
Currently, the Company records such assets and the related financing in the
consolidated statement of financial condition, and the corresponding interest
income and interest expense in the Company's consolidated statement of
operations and comprehensive (loss) income. For assets representing
available-for-sale investment securities, as in the Company's case, any change
in fair value is reported through other comprehensive income under SFAS No. 115,
with the exception of impairment losses, which are recorded in the consolidated
statement of operations and comprehensive (loss) income as realized losses.
However, a transaction where assets are acquired from and financed under a
repurchase agreement with the same counterparty may not qualify for a sale
treatment by a seller under the interpretation of SFAS 140, which would require
the seller to continue to carry such sold assets on their books based on their
"continuing involvement" with such assets. Depending on the ultimate outcome of
the EITF deliberations, the result may be that the Company would be precluded
from recording the assets purchased in the transaction described above as well
as the related financing in the Company's consolidated statement of financial
condition and would instead be treating the Company's net investment in such
assets as a derivative.
This potential change in accounting treatment would not affect the economic
substance of the transactions but would affect how the transactions would be
reported in the Company's financial statements. The Company's cash flows,
liquidity and ability to pay a dividend would be unchanged, and the Company does
8
not believe the Company's taxable income or net equity would be affected. If the
Company were to change the current accounting treatment for these transactions,
total assets and total liabilities would each be reduced by approximately $1.7
billion.
9
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of March 31, 2006 and December 31, 2005,
which are carried at their fair value:
Government Total
Federal Home Loan Federal National National Mortgage Mortgage-Backed
Mortgage Corporation Mortgage Association Association Securities
March 31, 2006 ---------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed Securities, gross $5,661,286 $10,317,987 $309,575 $16,288,848
Unamortized discount (8,268) (39,093) (57) (47,418)
Unamortized premium 84,800 131,400 4,646 220,846
---------------------------------------------------------------------------------
Amortized cost 5,737,818 10,410,294 314,164 16,462,276
Gross unrealized gains 3,402 1,529 69 5,000
Gross unrealized losses (109,253) (176,860) (4,815) (290,928)
---------------------------------------------------------------------------------
Estimated fair value $5,631,967 $10,234,963 $309,418 $16,176,348
=================================================================================
Estimated Fair
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Value
---------------------------------------------------------------------------------
(dollars in thousands)
Adjustable rate $7,907,701 $4,986 ($122,589) $7,790,098
Fixed rate 8,554,575 14 (168,339) 8,386,250
---------------------------------------------------------------------------------
Total $16,462,276 $5,000 ($290,928) $16,176,348
=================================================================================
Government Total
Federal Home Loan Federal National National Mortgage Mortgage-Backed
Mortgage Corporation Mortgage Association Association Securities
December 31, 2005 ---------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed Securities, gross $5,689,898 $9,881,672 $344,231 $15,915,801
Unamortized discount (4,043) (17,345) (62) (21,450)
Unamortized premium 92,228 144,726 5,133 242,087
---------------------------------------------------------------------------------
Amortized cost 5,778,083 10,009,053 349,302 16,136,438
Gross unrealized gains 3,174 1,853 - 5,027
Gross unrealized losses (80,733) (124,330) (6,538) (211,601)
---------------------------------------------------------------------------------
Estimated fair value $5,700,524 $9,886,576 $342,764 $15,929,864
=================================================================================
Estimated Fair
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Value
---------------------------------------------------------------------------------
(dollars in thousands)
Adjustable rate $9,844,261 $3,973 ($120,480) $9,727,754
Fixed rate 6,292,177 1,054 (91,121) 6,202,110
---------------------------------------------------------------------------------
Total $16,136,438 $5,027 ($211,601) $15,929,864
=================================================================================
10
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 March 31, 2006 and December 31, 2005 according to their estimated
weighted-average life classifications:
March 31, 2006 December 31, 2005
-------------------------------------------------------------------------------
Fair Value Amortized Cost Fair Value Amortized Cost
Weighted-Average Life (dollars in thousands)
- ----------------------------------------------------------------------------------------------------------------------
Less than one year $ 136,843 $ 139,132 $ 508,851 $ 514,560
Greater than one year and less than
five years 9,885,317 10,081,491 12,648,106 12,824,736
Greater than or equal to five years 6,154,188 6,241,653 2,772,907 2,797,142
-------------------------------------------------------------------------------
Total $16,176,348 $16,462,276 $15,929,864 $16,136,438
===============================================================================
The weighted-average lives of the Mortgage-Backed Securities at March 31,
2006 and December 31, 2005 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 $5.3 billion were in a
continuous unrealized loss position over 12 months at March 31, 2006 in the
amount of $142.4 million. Mortgage-Backed Securities with a carrying value of
$8.4 billion were in a continuous unrealized loss position for less than 12
months at March 31, 2006 in the amount of $148.5 million. Mortgage-Backed
Securities with a carrying value of $4.6 billion were in a continuous unrealized
loss position over 12 months at December 31, 2005 in the amount of $111.1
million. Mortgage-Backed Securities with a carrying value of $8.4 billion were
in a continuous unrealized loss position for less than 12 months at December 31,
2005 in the amount of $100.5 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. Also, the Company
is guaranteed payment on the par value of the securities.
With the continued increase in the Federal Funds rate during the fourth
quarter of 2005 and first quarter of 2006, management determined during that it
did not intend to hold certain of its securities until maturity and would
reposition a portion of its assets. The Company recorded an impairment charge of
$83.1 million for these securities during the fourth quarter of 2005 and an
additional charge of $17.8 million during the first quarter of 2006 due to
further declines in the fair value of those securities that had not yet been
sold. In addition, during the first quarter of 2006, additional securities were
identified as being other-than-temporarily impaired, and a charge of $8.9
million was recorded to write them down to fair value. The remaining 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 or to
maturity, if necessary, sufficient for a forecasted market price recovery up to
or beyond the cost of the investments.
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 March
31, 2006 and 10.3% December 31, 2005.
During the quarter ended March 31, 2006, the Company realized $7.0 million
in net loss from sales of Mortgage-Backed Securities. During the quarter ended
March 31, 2005 the Company realized $580,000 in net gains from sales of
Mortgage-Backed Securities.
11
3. REPURCHASE AGREEMENTS
The Company had outstanding $14.6 billion and $13.6 billion of repurchase
agreements with weighted average borrowing rates of 4.51% and 4.16%, and
weighted average remaining maturities of 69 days and 79 days as of March 31,
2006 and December 31, 2005, respectively. Investment securities pledged as
collateral under these repurchase agreements had an estimated fair value of
$15.5 billion and $14.3 billion at March 31, 2006 and December 31, 2005,
respectively.
At March 31, 2006 and December 31, 2005, the repurchase agreements had the
following remaining maturities:
March 31, 2006 December 31, 2005
(dollars in thousands)
-------------------------------------------------------------
Within 30 days $12,308,173 $10,575,945
30 to 59 days 21,710 1,250,356
60 to 89 days - -
90 to 119 days 200,000 -
Over 120 days 2,100,000 1,750,000
-------------------------------------------------------------
Total $14,629,883 $13,576,301
=============================================================
The Company had an amount at risk greater than 10% of the equity of the
Company with the following counterparty.
Weighted Average Days
Amount at risk(1) to Maturity
(dollars in thousands)
-----------------------------------------------------------------
UBS Securities LLC $258,087 114
Deutsche Bank Securities Inc. $208,026 54
(1) Equal to the sum of fair value of securities sold plus accrued interest
income minus the sum of repurchase agreements plus accrued interest
expense.
The Company has entered into three structured repurchase agreements, which
provide the buyer with the right to extend their maturity dates. The repurchase
agreements totaled $550.0 million and the market value of the option to extend
is $3.1 million.
4. INTEREST RATE SWAPS
In connection with the Company's interest rate risk management process, the
Company hedges a portion of its interest rate risk by entering into derivative
financial instrument contracts. To date, such instruments are comprised of
interest rate swaps, which in effect modify the cash flows on repurchase
agreements. The use of interest rate swaps creates exposure to credit risk
relating to potential losses that could be recognized if the counterparties to
these instruments fail to perform their obligations under the contracts. In the
event of a default by the counterparty, the Company could have difficulty
obtaining its assets pledged as collateral for swaps. The Company does not
anticipate any defaults by its counterparties.
The Company's swaps are used to lock-in the fixed swap rate related to a
portion of its current and anticipated future 30-day term repurchase agreements.
For the quarter ended March 31, 2006, the Company's swaps increased the cost of
interest expense on repurchase agreements by $1.5 million.
12
The table below presents information about the Company's swaps, all of
which were active at March 31, 2006.
Notional Amount Weighted Weighted Estimated Fair
(dollars in Average Pay Average Value/Carrying Value
thousands) Rate Receive Rate (dollars in thousands)
March 31, 2006 $ 2,764,000 4.85% 4.75% $ 36,470
5. PREFERRED STOCK AND COMMON STOCK
During the quarter ended March 31, 2006, the Company declared dividends to
common shareholders totaling $13.6 million or $0.11 per share, which were paid
on April 27, 2006. During the quarter ended March 31, 2006, the Company declared
dividends to preferred shareholders totaling $3.6 million or $0.492188 per
share, which were paid on March 31, 2006. During the quarter ended March 31,
2006, 16,725 options were exercised under the long-term compensation plan for an
aggregate exercise price of $159,000.
During the quarter ended March 31, 2005, the Company declared dividends to
common shareholders totaling $54.6 million or $0.45 per share, which were paid
on April 27, 2005. During the quarter ended March 31, 2005, the Company declared
dividends to preferred shareholders totaling $3.6 million or $0.492188 per
share, which were paid on March 31, 2005. During the quarter ended March 31,
2005, 5,500 options were exercised under the long-term compensation plan for an
aggregate exercise price of $99,000. Also 9,198 common shares were sold through
the dividend reinvestment and direct purchase program for $178,000.
6. NET (LOSS) 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 March 31, 2006
and 2005.
For the Quarters Ended
March 31, 2006 March 31, 2005
-------------------------------------------------
(dollars in thousands)
-------------------------------------------------
Net (loss) income ($10,949) $59,333
Less: Preferred stock dividend 3,648 3,648
-------------------------------------------------
Net income (related) available to common shareholders ($14,597) $55,685
-------------------------------------------------
Weighted average shares of common stock outstanding 123,694 121,271
Add: Effect of dilutive stock options - 293
-------------------------------------------------
Weighted average shares of common
stock outstanding-diluted 123,694 121,564
=================================================
Because the Company had a net loss related to common shareholders, options
to purchase 3,047,868 shares of common stock were considered anti-dilutive for
the quarter ended March 31, 2006. For the quarter ended March 31, 2005, the
Company had options to purchase 12,500 shares that were considered
anti-dilutive.
7. 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, up to ceiling of 8,932,921 shares. Stock options are issued at the
current market price on the date of grant, subject to an immediate or four year
vesting in four equal installments with a contractual term of 5 or 10 years. The
grant date fair value is calculated using the Black-Scholes option valuation
model.
13
The following table sets forth activity relating to the Company's stock
options awards:
For the Quarters Ended March 31,
2006 2005
-----------------------------------------------------------------
Weighted
Number of Average Number of Weighted Average
Shares Exercise Price Shares Exercise Price
- ----------------------------------------------------------------------------------------------------------
Options outstanding at the beginning
of period 2,333,593 $16.10 1,645,721 $15.66
Granted 731,000 11.72 - -
Exercised (16,725) 8.21 (5,500) 17.97
Forfeited - - - -
Expired - - - -
------------ ----------------- --------------- ------------------
Options outstanding at the end of
period 3,047,868 $15.09 1,640,221 $15.65
Options exercisable at the end of
period 831,181 $14.02 542,634 $11.47
============ ================= =============== ==================
The weighted average remaining contractual term was approximately 8.1 years
for stock options outstanding and approximately 5.7 years for stock options
exercisable as of March 31, 2006. The weighted average grant-date fair value of
options granted during the quarter ended March 31, 2006 was $1.76. There were no
options granted during the quarter ended March 31, 2005. The total intrinsic
value (the excess of the market price over the exercise price) was $1.2 million
for stock options outstanding and exercisable as of March 31, 2006. The total
intrinsic value for stock options exercised during the quarter ended March 31,
2006 and 2005 was $63,000 and $9,000, respectively. There were no options vested
during the quarter ended March 31, 2006 or 2005. The amount of cash received
from the exercise of stock options was $136,000 during the quarter ended March
31, 2006 and $99,000 for the quarter ended March 31, 2005. As of March 31, 2006,
there was approximately $3.7 million of total unrecognized compensation cost
related to nonvested share-based compensation awards. That cost is expected to
be recognized over a weighted average period of 3.2 years.
The following table summarizes information about stock options outstanding
at March 31, 2006:
Weighted Weighted
Weighted Average Average
Range of Exercise Prices Average Remaining Weighted Remaining
Exercise Contractual Average Contractual
Total Price on Life (Years) Total Exercise Life (Years)
Options Total on Total Options Price on on
Outstanding Outstanding Outstanding Exercisable Exercisable Exercisable
- ----------------------------------------------------------------------------------------------------------------------
$7.94-$19.99 3,037,868 $15.08 8.10 821,181 $13.94 5.79
$20.00-$29.99 10,000 20.53 1.74 10,000 20.53 1.74
-------------------------------------------------------------------------------------------
3,047,868 $15.09 8.08 831,181 $14.02 5.74
===========================================================================================
8. INCOME TAXES
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 March 31, 2006, the Company recorded $1.6 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 March 31, 2006, the Company recorded
$471,000 of income tax expense for a portion of earnings retained based on
Section 162(m) limitations.
14
During the quarter ended March 31, 2005, the Company recorded $1.2 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 March 31, 2005, the Company recorded
$425,000 of income tax expense for a portion of earnings retained based on
Section 162(m) limitations.
9. LEASE COMMITMENTS
The Company has a noncancelable lease for office space, which commenced in
May 2002 and expires in December 2009.
The Company's aggregate future minimum lease payments are as follows:
Total per Year
(dollars in thousands)
------------------------
2006 $ 398
2007 532
2008 532
2009 532
------------------------
Total remaining lease payments $1,994
========================
10. 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
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.
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. 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. As of March 31, 2006 and
December 31, 2005, the Company entered into interest rate swaps to pay a fixed
rate and receive a floating rate of interest, with total notional amount of $2.8
billion and $479.0 million, respectively.
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.
11. CONTINGENCIES
From time to time, the Company is involved in various claims and legal
actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a material
effect on the Company's consolidated financial statements.
15
12. SUBSEQUENT EVENTS
On April 6, 2006, the Company entered into an underwriting agreement
pursuant to which it sold 39,215,000 shares of its common stock for net proceeds
before expenses of approximately $437,737,438. On April 6, 2006, the Company
entered into a second underwriting agreement pursuant to which it sold 4,600,000
shares of its 6% Series B Cumulative Convertible Preferred Stock for net
proceeds before expenses of approximately $111,550,000. Each of these
transactions settled on April 12, 2006.
16
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 Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. 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 financings,
changes in the market value of our assets, changes in business conditions and
the general economy, 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, changes in governmental regulations affecting our business, and our
ability to maintain our classification as a REIT for federal income tax
purposes. 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 most recent Annual Report on Form 10-K and any subsequent Quarterly
Reports on Form 10-Q. 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. 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.
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").
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. In addition, we may directly or indirectly invest part of
this remaining 25% of our assets in other types of securities, including without
limitation, unrated debt, equity or derivative securities, to the extent
consistent with our REIT qualification requirements.
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.
17
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. Our results of operations primarily depend on,
among other things, the level 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 reflects the amortization of purchase premiums and accretion of
discounts, 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. The CPR
on our Mortgage Backed Securities portfolio averaged 18% and 25% for the
quarters ended March 31, 2006 and 2005, respectively. 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.
During the fourth quarter of 2005, the Company sold certain assets and
began purchasing assets in the current rate environment. This continued during
the first quarter of 2006. With the federal funds interest rate continuing to
rise through the first quarter of 2006, the Company sold lower yielding assets
and began replacing them with higher yielding assets. The Company took these
actions because it determined that certain assets that were purchased in the
much lower interest rate environment of 2003 and 2004 were unlikely to recover
to their amortized cost basis and were not providing attractive returns on a
cash flow basis.
We have lengthened contractual maturities on our borrowings during the
first quarter of 2006 through the use of structured repurchase agreements, such
that our weighted average contractual maturity on our repurchase agreements was
162 days at March 31, 2006, as compared to 159 days at March 31, 2005.
Structured repurchase agreements give the lender the right to extend the term of
the repurchase agreement.
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.
Yield on
Average Average Average
Investment Total Interest Balance of Total Average Net
Securities Interest Earning 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 March 31, 2006 $16,590,859 $194,882 4.70% $15,296,893 $167,512 4.38% $27,370
Quarter Ended December 31, 2005 $17,551,868 $179,688 4.10% $16,547,972 $165,766 4.01% $13,922
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
- ---------------------------------------------------------------------------------------------------------------------
(1) Does not reflect unrealized gains/(losses).
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
- ------------- ---
March 31, 2006 18%
December 31, 2005 28%
September 30, 2005 28%
June 30, 2005 27%
March 31, 2005 25%
18
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 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; the policies have not changed during 2006.
Market Valuation and Impairment 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 independent sources. 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. Investments with unrealized losses are not
considered other-than-temporarily impaired if 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. Other-than-temporary
impaired losses on securities totaled $26.7 million at March 31, 2006. There
were no such adjustments at March 31, 2005.
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
are amortized or accreted 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.
19
Income Taxes: We have elected to be taxed as a Real Estate Investment Trust
(or REIT) and intend to comply with the provisions of the Internal Revenue Code
of 1986, as amended (or 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 Ended March 31, 2006 and 2005
Net Income Summary
For the quarter ended March 31, 2006, our net loss was $10.9 million, or
$0.12 net loss per average share related to common shareholders, as compared to
net income of $59.3 million, or $0.46 net income per average share available to
common shareholders, for the quarter ended March 31, 2005. We attribute the
decrease in total net income for the quarter ended March 31, 2006 from the
quarter ended March 31, 2005 to the decline in net interest income and to
impairment charges related to certain securities and intangibles. The decrease
in total net income per share was primarily due to the decline in the interest
rate spread from 1.18% to 0.32%. The increase in cost of funding from 2.57% for
the quarter ended March 31, 2005 to 4.38% for the quarter ended March 31, 2006
was only partially offset by the increase in yield on assets of 3.75% for the
quarter ended March 31, 2005 to 4.70% for the quarter ended March 31, 2006. For
the quarter ended March 31, 2006, the loss on sale of Mortgage-Backed Securities
was $7.0 million as compared to a $580,000 gain on sale of Mortgage-Backed
Securities for the quarter ended March 31, 2005. Losses on
other-than-temporarily impaired securities totaled $26.7 million and impairment
of intangibles totaled $1.1 million for the quarter ended March 31, 2006. There
were no impairment charges for the quarter ended March 31, 2005. For the quarter
ended March 31, 2006, net investment advisory and service fees totaled $5.8
million, as compared to $4.7 million for the quarter ended March 31, 2005. The
net investment advisory and service fees increased substantially, but did not
offset the effect of the decline in the interest rate spread, realized losses
and impairment losses. Dividends for the quarter ended March 31, 2006 were $0.11
per share of common stock, or $13.6 million in total, and $0.492188 per share of
preferred stock, or $3.6 million in total. Dividends per share for the quarter
ended March 31, 2005 were $0.45 per share of common stock, or $54.6 million in
total. Our return on average equity was (2.98%) for the quarter ended March 31,
2006 compared to 14.34% for the quarter ended March 31, 2005.
Net Income Summary
------------------
(ratios for the quarter have been annualized, dollars in the thousands, except for per share data)
--------------------------------------------------------------------------------------------------
Quarter Quarter
Ended Ended
March 31, March 31,
2006 2005
--------------------------------------
Interest income $194,882 $176,289
Interest expense 167,512 113,993
--------------------------------------
Net interest income 27,370 62,296
Investment advisory and service fees 6,997 6,309
(Loss) gain on sale of Mortgage-Backed Securities (7,006) 580
Distribution fees (1,170) (1,610)
General and administrative expenses (7,177) (6,664)
Impairment of intangible for customer relationships (1,148) -
Loss on other-than-temporarily impaired securities (26,730) -
--------------------------------------
Income (loss) before income taxes (8,864) 60,911
Income taxes 2,085 1,578
--------------------------------------
Net (loss) income (10,949) 59,333
Dividends on preferred stock 3,648 3,648
--------------------------------------
Net (loss) income (related) available to common shareholders
($14,597) $55,685
======================================
Weighted average number of basic common shares outstanding 123,693,851 121,270,867
Weighted average number of diluted common shares outstanding 123,693,851 121,564,320
Basic net (loss) income (related) available to common share ($0.12) $0.46
Diluted net (loss) income (related) available to common share ($0.12) $0.46
Average total assets $16,268,064 $19,388,721
Average total equity $1,468,976 $1,654,923
Annualized return on average assets (0.27%) 1.22%
Annualized return on average equity (2.98%) 14.34%
20
Interest Income and Average Earning Asset Yield
We had average earning assets of $16.6 billion and $18.8 billion for the
quarters ended March 31, 2006 and 2005, respectively. Our primary source of
income for the quarters ended March 31, 2006 and 2005 was interest income. Our
interest income was $194.9 million for the quarter ended March 31, 2006 and
$176.3 million for the quarter ended March 31, 2005. The yield on average
investment securities increased from 3.75% for the quarter ended March 31, 2005
to 4.70% for the quarter ended March 31, 2006. Our average earning asset balance
decreased by $2.2 billion and interest income increased by $18.6 million for the
quarter ended March 31, 2006 as compared to the quarter ended March 31, 2005.
The average coupon rate at March 31, 2006 was 5.22% as compared to 4.58% at
March 31, 2005. The prepayment speeds decreased to 18% CPR for the quarter ended
March 31, 2006 from 25% CPR for the quarter ended March 31, 2005. The increase
in coupon rates and reduction in prepayment speeds, resulted in an increase in
yield.
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 $15.3 billion and total interest expense of
$167.5 million for the quarter ended March 31, 2006. We had average borrowed
funds of $17.8 billion and total interest expense of $114.0 million for the
quarter ended March 31, 2005. Our average cost of funds was 4.38% for the
quarter ended March 31, 2006 and 2.57% for the quarter ended March 31, 2005. The
cost of funds rate increased by 181 basis points and the average borrowed funds
decreased by $2.5 billion for the quarter ended March 31, 2006 when compared to
the quarter ended March 31, 2005. Even though the average repurchase balance
decreased by $2.5 billion for the quarter ended March 31, 2006, interest expense
for the quarter increased by $53.5 million due to the substantial increase in
the cost of funds interest rate. Our average cost of funds was 0.17% below
average one-month LIBOR and 0.46% below average six-month LIBOR for the quarter
ended March 31, 2006. Our average cost of funds was 0.01% below average
one-month LIBOR and 0.45% below average six-month LIBOR for the quarter ended
March 31, 2005.
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 March 31, 2006, the year ended December 31, 2005 and the four quarters in
2005.
21
Average Cost of Funds
---------------------
(ratios for the quarters have been annualized, dollars in thousands)
--------------------------------------------------------------------
Average
Average Average Cost of
One-Month Cost of Funds
LIBOR Funds Relative
Relative Relative to
Average Average Average Average to Average to Average Average
Borrowed Interest Cost of One-Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
----- ------- ----- ----- ----- ----- ----- -----
Quarter Ended March 31, 2006 $15,296,893 $167,512 4.38% 4.55% 4.84% (0.29%) (0.17%) (0.46%)
- ----------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005 $17,408,828 $568,560 3.27% 3.33% 3.72% (0.39%) (0.06%) (0.45%)
Quarter Ended December 31, 2005 $16,547,972 $165,766 4.01% 4.10% 4.46% (0.36%) (0.09%) (0.45%)
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%)
Net Interest Income
Our net interest income, which equals interest income less interest
expense, totaled $27.4 million for the quarter ended March 31, 2006 and $62.3
million for the quarter ended March 31, 2005. Our net interest income decreased
because the interest rate spread decreased. 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 0.32% for the quarter ended March 31, 2006 as compared
to 1.18% for the quarter ended March 31, 2005. This 86 basis point decrease was
a result of the increase in the cost of funding for the quarter ended March 31,
2006 to 4.38% from 2.57% for the quarter ended March 31, 2005. The increase in
cost of funds was only partially offset by the increase in yield on assets,
which increased to 4.70% for the quarter ended March 31, 2006, as compared to
3.75% for the quarter ended March 31, 2005.
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 March 31, 2006 the year ended December 31, 2005, and the four
quarters in 2005.
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 March 31, 2006 $16,590,859 $194,882 4.70% $15,296,893 $167,512 4.38% $27,370 0.32%
- --------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005 $18,543,749 $705,046 3.80% $17,408,827 $568,560 3.27% $136,486 0.53%
Quarter Ended December
31, 2005 $17,551,868 $179,688 4.10% $16,547,972 $165,766 4.01% $13,922 0.09%
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%
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 March 31, 2006 FIDAC
had under management approximately $2.0 billion in net assets and $16.9 billion
in gross assets, compared to $2.3 billion in net assets and $18.6 billion in
gross assets at March 31, 2005. Investment advisory and service fees for the
quarter ended March 31, 2006 and March 31, 2005 totaled $5.8 million and $4.7
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. Gross assets under management will vary from time to time
because of changes in the amount of net assets FIDAC manages as well as changes
in the amount of leverage used by the various funds and accounts FIDAC manages.
At March 31, 2006 net assets under management decreased by $300 million and
gross assets under management decreased by $1.7 billion, when compared to March
31, 2005. In addition, during the first quarter of 2006, FIDAC was notified that
an additional $127 million in net assets would be removed from its management
although FIDAC would continue to receive advisory fees on these assets until
June 1, 2006.
22
Gains and Losses on Sales of Mortgage-Backed Securities
For the quarter ended March 31, 2006, we sold Mortgage-Backed Securities
with a carrying value of $1.2 billion for an aggregate loss of $7.0 million,
which had previously been classified as other-than-temporarily impaired
securities. For the quarter ended March 31, 2005 we sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $85.4 million for an
aggregate gain of $580,000. During the fourth quarter of 2005, we determined
that certain assets purchased in a much lower interest rate environment of 2003
and 2004 were unlikely to receive their amortized cost basis, and commenced
selling these assets. The rebalancing, which continued from the fourth quarter
of 2005, was done with the objective of improving future financial performance.
The difference between the sale price and the carrying value 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 new
assets, which our management believes might have higher risk-adjusted returns as
part of our asset/liability management strategy.
Impairment of intangible for customer relationships
During the quarter ended March 31, 2006 we terminated an investment
advisory agreement. The expected cash flows from the contract were valued as an
intangible for customer relationships on June 4, 2004, the date of the
acquisition of FIDAC.The value of $1.1 million was deemed to be impaired and
written off in the quarter ended March 31, 2006.
Loss on other-than-temporarily impaired securities
During the first quarter of 2006, the Company reviewed each of its
securities to determine if an other-than-temporary impairment charge would be
necessary. It was determined for certain securities that were in an unrealized
loss position, the Company did not intend to hold them 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. Approximately $368.7 million face amount
of securities were classified as other-than-temporarily impaired, with an
approximate loss of $8.9 million. Securities that had previously been determined
to be other-than-temporarily impaired continued to decline in value and we
recorded a $17.8 million additional loss for these securities. The total loss on
other-than-temporarily impaired securities totaled $26.7 million for the quarter
ended March 31, 2006.
General and Administrative Expense
General and administrative ("G&A") expenses were $7.2 million for the
quarter ended March 31, 2006 and $6.7 million for the quarter ended March 31,
2005. G&A expenses as a percentage of average assets were 0.18% and 0.14% for
the quarters ended March 31, 2006 and March 31, 2005 respectively. G&A expenses
as a percentage of average equity were 1.95% and 1.61% on an annualized basis
for the quarters ended March 31, 2006 and March 31, 2005 respectively. The
increase in G&A expenses of $513,000 for the quarter ended March 31, 2006 was
the primary result of an increase in compensation expense from the adoption of
SFAS 123R, payroll taxes, and printing and mailing of the annual reports.
The table below shows our total G&A expenses as compared to average total
assets and average equity for the quarter ended March 31, 2006, the year ended
December 31, 2005, and the four quarters in 2005.
23
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 March 31, 2006 $7,177 0.18% 1.95%
---------------------------------------------------------------------------------------------------------
Year Ended December 31, 2005 $26,278 0.14% 1.63%
Quarter Ended December 31, 2005 $6,359 0.14% 1.66%
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%
Net Income and Return on Average Equity
Our net loss was $10.9 million for the quarter ended March 31, 2006 and net
income of $59.3 million for the quarter ended March 31, 2005. Our annualized
return on average equity was (2.98%) for the quarter ended March 31, 2006 and
14.34% for the quarter ended March 31, 2005. We attribute the decrease in net
income and return on average equity to the interest rate spread compression for
the quarter and the realized and unrealized losses on securities during the
quarter. The decline in spread income totaled $34.9 million. Losses realized
during our rebalancing of our portfolio totaled $7.0 million. Unrealized losses
on other-than-temporarily-impaired securities totaled $26.7 million The table
below shows our net interest income, net investment advisory and service fees,
(loss) gain on sale of Mortgage-Backed Securities, loss on other than
temporarily impaired securities, G&A expenses, and income taxes each as a
percentage of average equity, and the return on average equity for the quarter
ended March 31, 2006, the year ended December 31, 2005, and the four quarters in
2005.
Components of Return on Average Equity
--------------------------------------
(Ratios for the four quarters in 2005 have been annualized)
-----------------------------------------------------------
(Loss) gain
Net on Sale of
Net Investment Mortgage- Loss on
Interest Advisory and Backed other-than- G&A Income Impairment of Return
Income/ Service Securities/ temporarily Expenses/ Taxes/ intangible on
Average Fees/Average Average impaired Average Average for customer Average
Equity Equity Equity securities Equity Equity relationships Equity
--------------------------------------------------------------------------------------------
For the Quarter
Ended March
31, 2006 7.45% 1.59% (1.91%) (7.28%) (1.95%) (0.57%) (0.31%) (2.98%)
- -----------------------------------------------------------------------------------------------------------
For the Year
Ended December
31, 2005 8.45% 1.71% (3.30%) (5.15%) 1.63% 0.67% (0.57%)
For the Quarter
Ended December
31, 2005 3.64% 1.79% (17.05%) (21.70%) 1.66% 0.73% (35.71%)
For the Quarter
Ended
September 30,
2005 5.50% 2.09% 0.01% - 1.58% 0.82% 5.20%
For the Quarter
Ended June 30,
2005 9.15% 1.82% 2.76% - 1.64% 0.73% 11.36%
For the Quarter
Ended March
31, 2005 15.06% 1.13% 0.14% - 1.61% 0.38% 14.34%
Financial Condition
Investment Securities
All of our Mortgage-Backed Securities at March 31, 2006 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.
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 March 31, 2006 and December 31, 2005, we
had in our statement of financial condition a total of $47.4 million and $21.5,
respectively, of unamortized discount and a total of $220.8 million and $242.1
million, respectively, of unamortized premium.
24
We received mortgage principal repayments of $1.1 billion for the
quarter ended March 31, 2006 and $1.5 billion for the quarter ended March 31,
2005. The overall prepayment speed for the quarter ended March 31, 2006
decreased to 18%, as compared to 25% for the quarter ended March 31, 2005, due
to the decline 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 March 31, 2006,
December 31, 2005, September 30, 2005, June 30, 2005, and March 31, 2005.
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 March 31, 2006 $16,288,848 $173,428 $16,462,276 101.06% $16,176,348 99.31% 5.03%
- --------------------------------------------------------------------------------------------------------------------
At December 31, 2005 $15,915,801 $220,637 $16,136,438 101.39% $15,929,864 100.09% 4.68%
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%
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 of securities.
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 March 31, 2006 $7,785,082 4.99% 4.36% 1.66% 20 months 10.27% 5.07% 47.79%
- -------------------------------------------------------------------------------------------------------------------------
At December 31, 2005 $9,699,133 4.76% 3.12% 1.64% 22 months 10.26% 4.74% 60.94%
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%
Fixed-Rate Investment Securities Characteristics
------------------------------------------------
(dollars in thousands)
----------------------
Principal
Amount at
Weighted Weighted Period End as %
Average Average Asset of Total
Principal Coupon Rate Yield Investment
Amount (annualized) (annualized) Securities
------ ------------ ------------ ----------
At March 31, 2006 $8,503,766 5.43% 4.99% 52.21%
- ---------------------------------------------------------------------------------------------
At December 31, 2005 $6,216,668 5.37% 4.60% 39.06%
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%
25
The following tables provide information on adjustable-rate Investment
Securities by index at March 31, 2006 and December 31, 2005.
Adjustable-Rate Investment Securities by Index
----------------------------------------------
March 31, 2006
--------------
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
LiborLibor Libor Average Average Funds Rate Rate Index Index Index Index Funds
-------------------------------------------------------------------------------------------------------
Weighted Average
Term to Next
Adjustment 1 mo.41 mo. 26 mo. 5 mo. 1 mo. 1 mo. 15 mo. 2 mo. 17 mo. 18 mo. 19 mo. 33 mo. 1 mo.
Weighted Average
Annual Period
Cap 7.24% 2.00% 2.00% 1.00% 0.17% 0.00% 2.00% 1.00% 1.89% 2.00% 2.02% 1.96% 0.00%
Weighted Average
Lifetime Cap at
March 31, 2006 7.93%10.85%10.27% 12.98% 10.62% 12.08% 10.90%11.74% 10.64% 11.93% 13.13 % 12.50% 13.40%
Investment
Principal Amount
as Percentage of
Investment
Securities at
March 31, 2006 6.17% 5.47%17.17% 0.01% 0.17% 0.87% 0.01% 0.03% 16.97% 0.01% 0.23% 0.06% 0.62%
Adjustable-Rate Investment Securities by Index
----------------------------------------------
December 31, 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
LiborLibor Libor Average Average Funds Rate Rate Index Index Index Index Funds
-------------------------------------------------------------------------------------------------------
Weighted Average
Term to
Next Adjustment 1 mo.42 mo. 22 mo. 2 mo. 2 mo. 1 mo. 17mo. 3 mo. 18 mo. 14 mo. 21 mo. 34 mo. 1 mo.
Weighted Average
Annual
Period Cap 7.29% 2.00% 2.00% 1.00% 0.16% 0.00% 2.00% 1.00% 1.90% 2.00% 2.03% 1.96% 0.00%
Weighted Average
Lifetime
Cap at December
31, 2005 7.98%10.78%10.33% 13.03% 10.61% 12.07% 10.90%11.74% 10.54% 11.93% 13.12 % 12.51% 13.40%
Investment
Principal Value
as Percentage of
Investment
Securities at
December 31,
2005 6.33% 6.42%24.46% 0.01% 0.19% 0.94% 0.01% 0.03% 21.55% 0.01% 0.25% 0.06% 0.68%
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 March 31, 2006, 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 March 31, 2006, the term to maturity of our
borrowings ranged from one day to three years, with a weighted average original
term to maturity of 162 days. For the quarter ended March 31, 2005, the term to
maturity of our borrowings ranged from one day to three years, with a weighted
average original term to maturity of 159 days. At March 31, 2006, the weighted
average cost of funds for all of our borrowings was 4.38% and the weighted
average term to next rate adjustment was 69 days. At March 31, 2005, the
weighted average cost of funds for all of our borrowings was 2.78% and the
weighted average term to next rate adjustment was 94 days.
26
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 to our shareholders. 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 decreased by $2.8 billion to
$14.6 billion at March 31, 2006 from $17.4 billion at March 31, 2005. The
decrease in our equity base and the process of re-positioning assets resulted in
lower borrowings at March 31, 2006, when compared to March 31, 2005.
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
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 the Mortgage-Backed Securities decreases due to
changes in market interest rates of market factors, lenders may release
collateral back to us. Specifically, margin calls result from a decline in the
value of the our 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 March 31, 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.
The following table summarizes the effect on our liquidity and cash flows
from contractual obligations at March 31, 2006.
One to Three to
Within One Three Five More than
Year Years Years Five Years Total
------------------------------------------------------------------------
(dollars in thousands)
----------------------
Repurchase agreements $13,029,883 $1,600,000 - - $14,629,883
Interest expense on repurchase
agreements 56,979 42,707 99,686
Long-term operating lease
obligations 530 1,596 - - 1,994
Employment contracts 15,196 2,533 - - 17,729
------------------------------------------------------------------------
Total $13,102,589 $1,646,836 - - $14,749,292
========================================================================
27
Stockholders' Equity
During the quarter ended March 31, 2006 the Company declared dividends to
common shareholders totaling $13.6 million or $0.11 per share, which were paid
on April 27, 2006. During the quarter ended March 31, 2006, the Company declared
dividends to preferred shareholders totaling $3.6 million or $0.492188 per
share, which were paid on March 31, 2006. During the quarter ended March 31,
2006, 16,725 options were exercised under the long-term compensation plan for an
aggregate exercise price of $159,000. During the quarter ended March 31, 2005,
the Company declared dividends to shareholders totaling $54.6 million or $0.45
per share, which was paid on April 27, 2005. During the quarter ended March 31,
2005, the Company declared dividends to preferred shareholders totaling $3.6
million or $0.492218 per share, which were paid on March 31, 2005. During the
quarter ended March 31, 2005, 5,500 options were exercised under the long-term
compensation plan for an aggregate exercise price of $98,835. In addition, the
Company sold 9,198 common shares through the dividend reinvestment and direct
purchase program for $177,613 during the quarter ended March 31, 2005.
On April 6, 2006, the Company entered into an underwriting agreement
pursuant to which it sold 39,215,000 shares of its common stock for net proceeds
before expenses of approximately $437,737,438. On April 6, 2006, the Company
entered into a second underwriting agreement pursuant to which it sold 4,600,000
shares of its 6% Series B Cumulative Convertible Preferred Stock for net
proceeds before expenses of approximately $111,550,000. Each of these
transactions settled on April 12, 2006.
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)."
The table below shows unrealized gains and losses on the Investment
Securities and interest rate swaps in our portfolio.
Unrealized Gains and Losses
---------------------------
(dollars in thousands)
----------------------
At At At At At
March 31, December 31, September 30, June 30, March 31,
2006 2005 2005 2005 2005
-----------------------------------------------------------------------------
Unrealized gain $41,470 $5,027 $6,109 $ 7,956 $23,683
Unrealized loss (290,929) (211,601) (310,664) (152,809) (236,963)
-----------------------------------------------------------------------------
Net Unrealized loss ($249,459) ($206,574) ($304,555) ($144,853) ($213,280)
=============================================================================
Net unrealized loss as %
of Investment Securities
principal amount (1.53%) (1.30%) (1.61%) (0.75%) (1.13%)
Net unrealized loss as %
of Investment Securities'
Amortized Cost (1.52%) (1.28%) (1.58%) (0.74%) (1.11%)
Unrealized changes in the estimated net market value of investment
securities and interest rate swaps have one direct effect on our potential
earnings and dividends: positive mark-to-market changes increase our equity base
and allow us to increase our borrowing capacity while negative changes tend to
limit borrowing capacity under our capital investment policy. A very large
negative change in the net market value of our Investment Securities and
interest rate swaps may impair our liquidity position, requiring us to sell
assets with the likely result of realized losses upon sale. The net unrealized
gains (loss) on available for sale securities was ($249.5) million, or (1.52%)
of the amortized cost of our Investment Securities as of March 31, 2006 and
($206.6) million, or (1.28%) of the amortized cost of our investment securities
as of December 31, 2005.
Mortgage-Backed Securities with a carrying value of $5.3 billion were in a
continuous unrealized loss position over 12 months at March 31, 2006 in the
amount of $142.4 million. Mortgage-Backed Securities with a carrying value of
$8.5 billion were in a continuous unrealized loss position for less than 12
months at March 31, 2006 in the amount of $148.5 million. Mortgage-Backed
Securities with a carrying value of $4.6 billion were in a continuous unrealized
loss position over 12 months at December 31, 2005 in the amount of $111.1
million. Mortgage-Backed Securities with a carrying value of $8.4 billion were
in a continuous unrealized loss position for less than 12 months at December 31,
2005 in the amount of $100.5 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. Also, the Company
is guaranteed payment on the par value of the securities.
28
With the continued increase in the Federal Funds rate during the fourth
quarter of 2005 and first quarter of 2006, management determined during that it
did not intend to hold certain of its securities until maturity and would
reposition a portion of its assets. The Company recorded an impairment charge of
$83.1 million for these securities during the fourth quarter of 2005 and an
additional charge of $17.8 million during the first quarter of 2006 due to
further declines in the fair value of those securities that had not yet been
sold. In addition, during the first quarter of 2006, additional securities were
identified as being other-than-temporarily impaired, and a charge of $8.9
million was recorded to write them down to fair value. The remaining 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 or to
maturity, if necessary, sufficient for a forecasted market price recovery up to
or beyond the cost of the investments.
Leverage
Our debt-to-reported equity ratio at March 31, 2006 and March 31, 2005 was
10.2:1 and 10.8:1 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
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. At March 31, 2006, we entered into swap agreements with a total
notional amount of $2.8 billion. Pursuant to these swaps, we are required to pay
a weighted average pay rate of 4.85% and receive a floating rate based on one
month LIBOR. At December 31, 2005, we entered into swap agreements with a total
notional amount of $479.0 million. Pursuant to these swaps, we are required to
pay a weighted average pay rate of 4.88% and receive a floating rate based on
one month LIBOR. The interest rate swaps had not settled as of December 31,
2005. We may enter into similar derivative transactions by entering into
interest rate collars, caps or floors.
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.
29
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. Further, we have not guaranteed any obligations of
unconsolidated entities nor do we have any commitment or intent to provide
funding to any such entities. As such, we are not materially exposed to any
market, credit, liquidity or financing risk that could arise if we had engaged
in such relationships.
Capital Resources
At March 31, 2006, we had no material commitments for capital expenditures.
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
almost 100% of our total assets at March 31, 2006 and December 31, 2005 as
compared to the Code requirement that at least 75% of our total assets be
qualified REIT assets. We also calculate that 100% 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
March 31, 2006 and March 31, 2005 respectively. We also met all REIT
requirements regarding the ownership of our common stock and the distribution of
our net income. Therefore, as of March 31, 2006 and December 31, 2005 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 and at least 80% of our assets in qualifying interests
plus other real estate related assets. 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 March 31, 2006 and December 31, 2005 we were in compliance with this
requirement.
30
ITEM. 3 QUANTITATIVE AND QUALITATIVE 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. When 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.
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 March
31, 2006 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 51.82% 1.43%
- -50 Basis Points 30.37% 1.02%
- -25 Basis Points 13.56% 0.41%
Base Interest Rate - -
+25 Basis Points (14.22%) (0.48%)
+50 Basis Points (29.01%) (1.03%)
+75 Basis Points (44.21%) (1.65%)
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.
31
The following table sets forth the estimated maturity or repricing of our
interest-earning assets and interest-bearing liabilities at March 31, 2006. 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 3 Years and
Within 3 Months 4-12 Months Year to 3 Years Over Total
-----------------------------------------------------------------------------------
(dollars in thousands)
Rate Sensitive Assets:
Investment Securities $ 1,665,136 $ 1,900,713 $ 4,169,166 $ 8,553,833 $16,288,848
Rate Sensitive Liabilities:
Repurchase Agreements 12,529,863 1,250,000 850,000 - 14,629,883
-----------------------------------------------------------------------------------
Interest rate sensitivity gap ($10,864,727) $450,713 $3,319,166 $8,553,833 $1,658,985
===================================================================================
Cumulative rate sensitivity gap ($10,864,727) ($10,214,014) ($6,894,848) $1,658,985
===================================================================================
Cumulative interest rate
sensitivity gap as a percentage of
total rate-sensitive assets (67%) (63%) (42%) 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) and 15d-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 material
weaknesses identified in the course of such review and evaluation and,
therefore, we have taken no corrective measures.
32
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
From time to time, we are involved in various claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
our consolidated financial statements.
Item 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or future results. The
information presented below updates and should be read in conjunction with the
risk factors and information disclosed in that Form 10-K.
Our operations may be adversely affected if we are subject to the
Investment Company Act.
We rely on the exclusion provided by Section 3(c)(5)(C) of the Investment
Company Act of 1940, as amended (or Investment Company Act). Section 3(c)(5)(C),
as interpreted by the staff of the SEC, requires us to invest at least 55% of
our assets in "mortgages and other liens on and interests in real estate" (or
Qualifying Real Estate Assets) and at least 80% of our assets in Qualifying Real
Estate Assets plus real estate related assets. The assets that we acquire,
therefore, are limited by the provisions of the Investment Company Act and the
rules and regulations promulgated under the Investment Company Act. If the
Securities and Exchange Commission determines that any of these securities are
not qualifying interests in real estate or real estate related assets, adopts a
contrary interpretation with respect to these securities or otherwise believes
we do not satisfy the above exceptions, we could be required to restructure our
activities or sell certain of our assets. We may be required at times to adopt
less efficient methods of financing certain of our mortgage assets and we may be
precluded from acquiring certain types of higher-yielding mortgage assets. The
net effect of these factors will be to lower our net interest income. If we fail
to qualify for exemption from registration as an investment company, our ability
to use leverage would be substantially reduced, and we would not be able to
conduct our business as described. Our business will be materially and adversely
affected if we fail to qualify for this exemption.
Item 1. LEGAL PROCEEDINGS
From time to time, we are involved in various claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
our consolidated financial statements.
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
10.9 Amended and Restated Employment Agreement, dated as of
April 21, 2006, between the Registrant and Rose-Marie
Lyght.*
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.
33
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.
* Exhibit Number 10.9 is a management contract or compensatory plan required to
be filed as an exhibit to this Form 10-Q.
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: May 8, 2006 By: /s/ Michael A.J. Farrell
-------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief Executive
Officer, President and authorized officer
of registrant)
Dated: May 8, 2006 By: /s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
(Chief Financial Officer and Treasurer
and rincipal financial and chief
accounting officer)
35