UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 June 30, 2003
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: 1-13991
MFA MORTGAGE INVESTMENTS, INC.
(Exact name of registrant as specified in its charter)
Maryland 13-3974868
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
350 Park Avenue, 21st Floor, New York, New York 10022
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 207-6400
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes |X| No |_|
54,117,105 shares of the registrant's Common Stock, $0.01 par value, were
outstanding as of July 25, 2003.
INDEX
Page
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PART I
Financial Information
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of June 30, 2003
(Unaudited) and December 31, 2002..................................... 1
Consolidated Statements of Operations (Unaudited) for the Three and Six
Months Ended June 30, 2003 and June 30, 2002.......................... 2
Consolidated Statements of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2003 (Unaudited).................... 3
Consolidated Statements of Cash Flows (Unaudited) for the Six Months
Ended June 30, 2003 and June 30, 2002................................. 4
Consolidated Statements of Comprehensive Income (Unaudited) for the Six
Months Ended June 30, 2003 and June 30, 2002.......................... 5
Notes to the Consolidated Financial Statements (Unaudited).............. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations......................................................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............. 23
Item 4. Controls and Procedures................................................. 25
PART II
Other Information
Item 1. Legal Proceedings....................................................... 26
Item 4. Submission of Matters to Vote of Securities Holders..................... 26
Item 6. Exhibits and Reports on Form 8-K........................................ 26
SIGNATURES...................................................................... 28
MFA MORTGAGE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, December 31,
(In Thousands, Except Share and per Share Amounts) 2003 2002
----------- -----------
(Unaudited)
Assets:
Mortgage backed securities ("MBS") (Note 4) $ 4,186,943 $ 3,485,319
Cash and cash equivalents 57,348 64,087
Restricted cash -- 39
Accrued interest and dividends receivable 21,668 19,472
Interest rate cap agreements (Note 5) 195 1,108
Equity interest in real estate investments (Note 6) 4,160 3,806
Real estate (Note 6) 21,720 21,986
Goodwill, net 7,189 7,189
Prepaid and other assets 1,477 853
----------- -----------
$ 4,300,700 $ 3,603,859
=========== ===========
Liabilities:
Repurchase agreements (Note 7) $ 3,821,619 $ 3,185,910
Accrued interest payable 9,896 14,299
Mortgages payable on real estate 16,248 16,337
Dividends payable 15,279 14,952
Accrued expenses and other liabilities 3,314 1,161
----------- -----------
3,866,356 3,232,659
----------- -----------
Commitments and contingencies (Note 8) -- --
Stockholders' Equity:
Common stock, $.01 par value; 375,000,000 shares authorized;
54,117,105 and 46,270,855 issued and outstanding at June 30,
2003 and December 31, 2002, respectively 541 463
Additional paid-in capital 426,881 359,359
Accumulated deficit (10,050) (12,417)
Accumulated other comprehensive income (Note 11) 16,972 23,795
----------- -----------
434,344 371,200
----------- -----------
$ 4,300,700 $ 3,603,859
=========== ===========
The accompanying notes are an integral part of the financial statements.
1
MFA MORTGAGE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
-------- -------- -------- --------
(In Thousands, Except per Share Amounts) (Unaudited)
Interest and Dividend Income:
MBS income $ 30,642 $ 30,148 $ 62,707 $ 56,786
Corporate debt securities income -- 289 -- 610
Dividend income -- -- -- 39
Interest income on temporary cash investments 148 273 271 528
-------- -------- -------- --------
Total Interest and Dividend Income 30,790 30,710 62,978 57,963
-------- -------- -------- --------
Interest Expense on Repurchase Agreements 14,700 15,247 29,667 28,730
-------- -------- -------- --------
Net Interest and Dividend Income 16,090 15,463 33,311 29,233
-------- -------- -------- --------
Other Income (Loss):
Income from equity interests in real estate 579 132 479 191
Revenue from operations of real estate 794 -- 1,221 --
Net gain (loss) on sale securities 334 (166) 334 248
Other-than-temporary impairment on investment
securities -- -- -- (3,474)
-------- -------- -------- --------
Total Other Income/(Loss) 1,707 (34) 2,034 (3,035)
-------- -------- -------- --------
Operating and Other Expense:
Compensation and benefits 929 534 1,880 1,353
Real estate operating expense 485 -- 832 --
Mortgage interest on real estate 297 -- 500 --
Other general and administrative 679 738 1,382 1,131
-------- -------- -------- --------
Total Operating and Other Expense 2,390 1,272 4,594 2,484
-------- -------- -------- --------
Net Income $ 15,407 $ 14,157 $ 30,751 $ 23,714
======== ======== ======== ========
Income per Share:
Net income per share - basic $ 0.30 $ 0.37 $ 0.63 $ 0.65
Weighted average shares outstanding - basic 51,217 38,294 48,780 36,520
Net income per share - diluted $ 0.30 $ 0.37 $ 0.63 $ 0.65
Weighted average shares outstanding - diluted 51,283 38,415 48,836 36,643
The accompanying notes are an integral part of the financial statements.
2
MFA MORTGAGE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Six Months Ended
June 30, 2003
------------------
(Unaudited)
(In Thousands, Except per Share Amounts)
Common Stock (Par Value $.01):
Balance at December 31, 2002 $ 463
Issuance of common stock in capital market transactions 77
Issuance of common stock for option exercises and
stock based compensation 1
---------
Balance at June 30, 2003 541
---------
Additional Paid-in Capital:
Balance at December 31, 2002 359,359
Issuance of common shares, net of expenses 67,114
Exercise of common stock options 408
---------
Balance at June 30, 2003 426,881
---------
Accumulated Deficit:
Balance at December 31, 2002 (12,417)
Net income 30,751
Cash dividends declared ($.56 per share year to date) (28,384)
---------
Balance at June 30, 2003 (10,050)
---------
Accumulated Other Comprehensive Income:
Balance at December 31, 2002 23,795
Unrealized loss on MBS during period, net (5,937)
Unrealized loss on interest rate cap agreements (886)
---------
Balance at June 30, 2003 16,972
---------
Total Stockholders' Equity $ 434,344
=========
The accompanying notes are an integral part of the financial statements.
3
MFA MORTGAGE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
(In Thousands) 2003 2002
----------- -----------
(Unaudited)
Cash Flows From Operating Activities:
Net income $ 30,751 $ 23,714
Adjustments to reconcile net income to net cash
provided by operating activities:
Net gain on sale of portfolio investments (334) (248)
Other than temporary impairment recognized on corporate debt securities -- 3,474
Amortization of purchase premiums on investments 20,172 11,582
Amortization of premium cost for interest rate cap agreements 27 --
Increase in interest receivable (2,196) (6,519)
Increase in prepaid and other assets and other (624) (762)
Decrease in accrued expenses and other liabilities 2,153 1,814
(Decrease) increase in accrued interest payable (4,403) 310
----------- -----------
Net cash provided by operating activities 45,546 33,365
----------- -----------
Cash Flows From Investing Activities:
Principal payments on MBS 919,247 536,492
Proceeds from sale of MBS 24,295 4,540
Proceeds from sale of corporate debt securities -- 908
Proceeds from sale of corporate equity securities -- 3,839
Net distributions received on real estate equity investments 42 131
Principal amortization of mortgage principal of consolidated subsidiaries (89) --
Depreciation and amortization on real estate of consolidated subsidiaries 206 --
Purchases of MBS (1,671,277) (1,994,987)
----------- -----------
Net cash used by investing activities (727,576) (1,449,077)
----------- -----------
Cash Flows From Financing Activities:
Decrease in restricted cash 39 38,500
Purchase of interest rate cap agreements -- (2,872)
Net increase in borrowings under repurchase agreements 635,709 1,263,288
Net proceeds from common stock offering 67,191 146,995
Dividends paid (28,057) (18,616)
Proceeds from exercise of stock options 409 329
----------- -----------
Net cash provided by financing activities 675,291 1,427,624
----------- -----------
Net (decrease) increase in cash and cash equivalents (6,739) 11,912
Cash and cash equivalents at beginning of period 64,087 58,533
----------- -----------
Cash and cash equivalents at end of period $ 57,348 $ 70,445
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest $ 34,070 $ 28,420
=========== ===========
The accompanying notes are an integral part of the financial statements.
4
MFA MORTGAGE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Six Months Ended
June 30,
(In Thousands) 2003 2002
-------- --------
(Unaudited)
Net income $ 30,751 $ 23,714
Other Comprehensive Income:
Unrealized holding losses arising during the period, net (5,937) (2,443)
Unrealized holding losses on interest rate cap
agreements arising during the period, net (886) (902)
-------- --------
Comprehensive Income $ 23,928 $ 20,369
======== ========
The accompanying notes are an integral part of the financial statements.
5
MFA MORTGAGE INVESTMENTS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
MFA Mortgage Investments, Inc. (the "Company") was incorporated in
Maryland on July 24, 1997 and began operations on April 10, 1998.
On April 10, 1998, the Company and three partnerships, America First
Participating/Preferred Equity Mortgage Fund Limited Partnership ("PREP Fund
1"), America First PREP Fund 2 Limited Partnership ("PREP Fund 2"), and America
First PREP Fund 2 Pension Series Limited Partnership ("Pension Fund" and,
together with PREP Fund 1 and PREP Fund 2, the "PREP Funds"), consummated a
merger transaction whereby the pre-existing net assets and operations of PREP
Fund 1 and PREP Fund 2 and a majority interest in the Pension Fund were
contributed to the Company in exchange for 9,035,084 shares of the Company's
common stock (the "1998 Merger"). The 1998 Merger was accounted for using the
purchase method of accounting in accordance with generally accepted accounting
principles ("GAAP"). PREP Fund 1 was deemed to be the acquirer of PREP Fund 2
and Pension Fund under the purchase method. Accordingly, the 1998 Merger
resulted, for financial accounting purposes, in the effective purchase by PREP
Fund 1 of all the Beneficial Unit Certificates ("BUCs") of PREP Fund 2 and 99%
of the BUCs of Pension Fund. In December 1999, Pension Fund was liquidated and
dissolved and, as a result, the Company directly acquired 99% of the assets of
Pension Fund. The remaining assets, consisting solely of cash, were distributed
to the holders of Pension Fund BUCs who elected to remain in place following the
1998 Merger. As the surviving entity for financial accounting purposes, the
assets and liabilities of PREP Fund 1 were recorded by the Company at their
historical cost and the assets and liabilities of PREP Fund 2 and Pension Fund
were adjusted to fair value. The excess of the fair value of the Company's
common stock issued over the fair value of net assets acquired was recorded as
goodwill.
From the time of its inception through January 1, 2002, the Company was
externally managed by America First Mortgage Advisory Corporation (the
"Advisor") pursuant to an advisory agreement between the parties. As an
externally managed company, the Company had no employees of its own and relied
on the Advisor to conduct its business and operations.
On January 1, 2002 the Company acquired its external advisor through a
merger (the "Advisor Merger") and as a result, became self-advised commencing
January 1, 2002. For accounting purposes, the Advisor Merger was not considered
the acquisition of a "business" for purposes of applying Accounting Principles
Board ("APB") Opinion No. 16, "Business Combinations" as superceded by Financial
Accounting Standards ("FAS") 141, "Business Combinations" and, therefore, the
market value of the common stock issued, valued as of the consummation of the
Advisor Merger, in excess of the fair value of the net tangible assets acquired
was charged to operating income rather than capitalized as goodwill.
On August 13, 2002, the Company changed its name from America First
Mortgage Investments, Inc. to MFA Mortgage Investments, Inc.
2. Summary of Significant Accounting Policies
(a) Basis of Presentation
The accompanying interim unaudited financial statements have been prepared
according to the rules and regulations of the Securities and Exchange Commission
("SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with GAAP have been condensed or
omitted according to such rules and regulations, although management believes
that the disclosures are adequate to make the information presented not
misleading. The financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2002. In the opinion of management,
all normal and recurring adjustments necessary to present fairly the financial
position at June 30, 2003 and results of operations for all periods presented
have been made. The results of operations for the three and six month period
ended June 30, 2003 should not be construed as indicative of the results to be
expected for the full year.
The financial statements are prepared on the accrual basis of accounting
in accordance with GAAP. 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
6
reporting period. Actual results could differ from those estimates.
(b) MBS, Corporate Debt Securities and Corporate Equity Securities
Statement of FAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities", requires that investments in securities be designated as
either "held-to-maturity", "available-for-sale" or "trading" at the time of
acquisition. Securities that are designated as held-to-maturity are carried at
their amortized cost. Securities designated as available-for-sale are carried at
fair value with unrealized gains and losses excluded from earnings and reported
in other comprehensive income.
Although the Company generally intends to hold most of its MBS until
maturity, it may, from time to time, sell any of its MBS as part of the overall
management of its business. The available-for-sale designation provides the
Company with the flexibility to sell its MBS in order to act on potential future
market opportunities, changes in economic conditions to ensure future liquidity
and to meet other general corporate purposes, as they arise. (See Note 2e.)
Gains or losses on the sale of investment securities are based on the
specific identification method.
The Company's adjustable rate assets are comprised primarily of adjustable
rate MBS ("ARM-MBS") issued or guaranteed as to principal or interest by an
agency of the U.S. government or a federally chartered corporation, such as
Government National Mortgage Association ("Ginnie Mae"), Fannie Mae or Federal
Home Loan Mortgage Corporation ("Freddie Mac"). Included in the Company's
ARM-MBS are hybrid MBS that have a fixed interest rate for an initial period,
not to exceed five years at the time of purchase, converting to a one year
adjustable rate for the remaining loan term to maturity. As of June 30, 2003,
the Company's MBS portfolio had a weighted average term to prepayment or
repricing of 17.6 months, assuming a 15% prepayment rate. The 15% CPR is applied
in order to reflect, to some extent, the prepayment characteristics inherent in
the Company's interest-earning assets and interest bearing liabilities.
Interest income is accrued based on the outstanding principal balance of
the investment securities and their contractual terms. Premiums and discounts
associated with the purchase of investment securities are amortized into
interest income over the lives of the securities using the effective yield
method, adjusted for actual prepayment activity.
During 2002, the Company liquidated its remaining portfolio of corporate
debt and equity securities. The Company's corporate debt securities were
comprised of non-investment grade, high yield bonds. The Company had taken an
impairment charge of $3,474,000 on certain of its corporate debt securities
during the first quarter of 2002. The Company had no investments in corporate
debt securities at June 30, 2003 or December 31, 2002. (See Note 3d.)
(c) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid
investments with original maturities of three months or less. The carrying
amount of cash equivalents approximates their fair value.
(d) Restricted Cash
Restricted cash represents amounts of cash held with certain lending
institutions with which the Company has repurchase agreements. Such amounts may
be used to make principal and interest payments on the related repurchase
agreements.
(e) Credit Risk
The Company limits its exposure to credit losses on its investment
portfolio by requiring that at least 50% of its investment portfolio consist of
MBS that are issued or guaranteed as to principal or interest by an agency of
the U.S. Government or a federally chartered corporation, such as Ginnie Mae,
Fannie Mae and Freddie Mac (collectively, "Agency MBS"). Pursuant to its
operating policies, the remainder of the Company's assets may be investments in:
(i) multi-family apartment properties; (ii) investments in limited partnerships,
real estate investment trusts or preferred stock of a real estate related
corporations or; (iii) other fixed-income instruments. As of June 30, 2003,
94.2% of the Company's assets consisted of Agency MBS and receivables, 3.6% were
MBS rated "AAA" by at least one nationally recognized rating agency ("Rating
Agency" or "Rating Agencies") and 1.3% were cash and cash equivalents; combined
these assets comprised 99.1% of the Company's total assets.
Other-than-temporary losses on investment securities, whether designated
as available-for-sale or held-to-maturity, as measured by the amount of decline
in fair value attributable to factors that are considered to be
other-than-temporary, are charged against income resulting in an adjustment of
the cost basis of such securities. The
7
following are among, but not all, the factors considered in determining whether
and to what extent an other-than-temporary impairment exists: (i) the expected
cash flow from the investments; (ii) whether there has been an
other-than-temporary deterioration of the credit quality of the underlying
mortgages, debtor, or the company in which equity interests are held; (iii) the
credit protection available to the related mortgage pool for MBS; (iv) any other
market information available, including analysts assessments and statements,
public statements and filings made by the debtor, counterparty or other relevant
party issuing or otherwise securing the particular security; (v) management's
internal analysis of the security considering all known relevant information at
the time of assessment; and (vi) the magnitude and duration of historical
decline in market prices. Because management's assessments are based on factual
information as well as subjective information available at the time of
assessment, the determination as to whether an other-than-temporary decline
exists and, if so, the amount considered impaired is also subjective and,
therefore, constitutes material estimates, that are susceptible to a significant
change. As of June 30, 2003 and December 31, 2002, the Company had no assets on
which an impairment charge had been made.
(f) Equity Interests in Real Estate
At June 30, 2003, the Company's equity interests in real estate consisted
of certain non-consolidated investments accounted for under the equity method,
which were comprised of investments in three limited partnerships owning real
estate. The Company acquired certain of these investments as part of the 1998
Merger. One of the properties underlying the equity interests in the limited
partnerships that the Company received in the 1998 Merger was subsequently
exchanged for another property through a non-taxable exchange, known for tax
purposes as a "Section 1031 Exchange", and is held as a long-term investment. As
of June 30, 2003, the Company was in the process of negotiating the sale of its
50% limited partner interest in Gold Key Venture, the limited partnership which
holds Laurel Park Apartments, and the general partner of the limited partnership
holding the Harmony Bay Apartments property was in the process of negotiating a
sales agreement related to such property.
One of these investments has a zero carrying value and is generating
operating losses after depreciation. On this investment, earnings are recorded
only to the extent distributions are received. Such investment has not been
reduced below zero through recognition of allocated investment losses since the
Company has no legal obligation to provide additional cash support to the
underlying property partnerships as it is not the general partner, nor has it
indicated any commitment to provide this support. (See Note 6b.)
(g) Real Estate
Real estate is comprised of two multi-family real estate properties owned
indirectly by the Company's wholly-owned subsidiary Retirement Centers
Corporation ("RCC"). On October 1, 2002, the Company purchased 100% of the
voting common stock of RCC. (See Note 3b.) Prior to the Company's October 1,
2002 purchase of RCC's voting common stock, the Company held only the preferred
stock of RCC and accounted for its investment in RCC under the equity method of
accounting. Subsequent to October 1, 2002, RCC became a wholly-owned subsidiary
of the Company and, as such, was consolidated on a prospective basis. RCC is
consolidated with its subsidiaries, which hold properties known as "The
Greenhouse" and "Lealand Place", both of which were acquired through a Section
1031 Exchange. (See Note 6a.)
The properties, capital improvements and other assets held in connection
with these investments are carried at cost, net of accumulated depreciation and
amortization, not to exceed fair value. Depreciation and amortization are
computed using the straight line method over the useful life of the related
asset. Maintenance, repairs and minor improvements are charged to expense in the
period incurred, while capital improvements are capitalized and depreciated over
their useful life. The Company intends to hold its investments in such
properties as long-term investments.
(h) Repurchase Agreements
The Company finances the acquisition of its MBS at short-term borrowing
rates through the use of repurchase agreements. Under these repurchase
agreements, the Company sells securities to a lender and agrees to repurchase
those securities in the future for a price that is higher than the original
sales price. The difference between the sale price the Company receives and the
repurchase price the Company pays represents interest paid to the lender.
Although structured as a sale and repurchase obligation, a repurchase agreement
operates as a financing under which the Company effectively pledges its
securities as collateral to secure a loan which is equal in value to a specified
percentage of the market value of the pledged collateral. The Company retains
beneficial ownership of the pledged collateral, including the right to
distributions. At the maturity of a repurchase agreement, the Company is
required to repay the loan and concurrently receives back its pledged collateral
from the lender or, upon mutual consent with the lender, the Company may renew
such agreement at the then prevailing financing rate. These repurchase
8
agreements may require the Company to pledge additional assets to the lender in
the event the market value of the existing pledged collateral declines. Through
June 30, 2003, the Company did not have any margin calls on its repurchase
agreements that it was not able to satisfy with either cash or additional
pledged collateral.
The Company's repurchase agreements generally range from one month to 36
months in duration; however, the Company is not precluded from entering into
repurchase agreements with longer durations. Should a counterparty to a
repurchase agreement decide not to renew the agreement at maturity, the Company
must either refinance elsewhere or be in a position to satisfy the
obligation(s). If, during the term of a repurchase agreement, a lender should
file for bankruptcy, the Company might experience difficulty recovering its
pledged assets and may have an unsecured claim against the lender's assets for
the difference between the amount loaned to the Company and the fair value of
the collateral pledged to such lender. To reduce this risk, the Company enters
into repurchase agreements only with financially sound institutions whose
holding or parent company's long-term debt rating is "A" or better as determined
by at least one nationally recognized Rating Agency, where applicable. The
Company will not enter into repurchase agreements with a lender without the
specific approval of the Company's Board of Directors, if the minimum criterion
is not met. In the event an existing lender is downgraded below "A", the Company
will seek board approval before entering into additional repurchase agreements
with that lender. The Company generally seeks to diversify its exposure by
entering into repurchase agreements with at least four separate lenders with a
maximum loan from any lender of no more than three times the Company's
stockholders' equity. As of June 30, 2003, the Company had repurchase agreements
with 13 separate lenders with a maximum net exposure (the difference between the
amount loaned to the Company and the fair value of the security pledged by the
Company as collateral) to a single lender of $72.6 million. (See Note 7.)
(i) Earnings per Common Share ("EPS")
Basic EPS is computed by dividing net income by the weighted average
number of shares of common stock outstanding during the period. Diluted EPS is
computed by dividing net income by the weighted-average common shares and common
equivalent shares outstanding during the period. For the diluted EPS
calculation, the weighted average common shares and common equivalent shares
outstanding include the average number of shares of common stock outstanding
adjusted for the dilutive effect of unexercised stock options using the treasury
stock method. Under the treasury stock method, common equivalent shares are
calculated assuming that all dilutive common stock equivalents are exercised and
the proceeds are used to buy back shares of the Company's outstanding common
stock at the average market price during the reported period. No common share
equivalents are included in the computation of any diluted per share amount for
a period in which a net operating loss is reported. (See Note 10.)
(j) Comprehensive Income
The Company's consolidated statements of comprehensive income include all
changes in Stockholders' Equity with the exception of additional investments by
or dividends to stockholders. Such comprehensive income for the Company includes
net income and the change in net unrealized holding gains (losses) on
investments and certain derivative instruments. (For accumulated comprehensive
income, see Note 11.)
(k) Federal Income Taxes
The Company has elected to be taxed as a real estate investment trust
("REIT") under the provisions of the Internal Revenue Code of 1986, as amended
(the "Code"), and the corresponding provisions of state law. The Company expects
to operate in a manner that will enable it to continue to be taxed as a REIT. As
such, no provision for current or deferred income taxes has been made in the
accompanying consolidated financial statements.
(l) Derivative Financial Instruments - Interest Rate Cap Agreements
In accordance with FAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," ("FAS 133") as amended by FAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities" ("FAS 138"), a
derivative which is designated as a hedge is recognized as an asset/liability
and measured at fair value. In order for the Company's interest rate cap
agreements ("Cap Agreements" or "Caps") to qualify for hedge accounting, upon
entering into the Cap Agreement, the Company must anticipate that the hedge will
be highly "effective", as defined by FAS 133, in limiting the Company's cost
beyond the Cap threshold on its matching (on an aggregate basis) anticipated
repurchase agreements during the active period of the Cap. As long as the hedge
remains effective, changes in fair value of the Cap Agreements are included in
other comprehensive income. Upon the Cap Agreement active period commencing, the
premium paid to enter into the Cap Agreement is amortized and reflected in
interest expense. The periodic amortization of the premium expense is based on
an estimated allocation of the premium, determined at inception of the hedge,
for the monthly components on a fair value basis. Payments
9
received in connection with the Cap Agreement will be reported as a reduction to
interest expense. If it is determined that a Cap Agreement is not effective, the
premium would be reduced and a corresponding charge made to interest expense,
for the ineffective portion of the Cap Agreement. The maximum cost related to
the Company's Caps is limited to the original purchase price. In order to limit
credit risk associated with purchased Caps, the Company only purchases Caps from
financial institutions rated "A" or better by one of the Rating Agencies. Income
generated by Caps, if any, would be presented as an off-set to interest expense
on the hedged liabilities.
In order to continue to qualify for and to apply hedge accounting, Caps
are monitored on a quarterly basis to determine whether they continue to be
effective or, if prior to the commencement of the active period, whether it is
expected that the Cap will continue to be effective. If during the term of the
Cap Agreement, the Company determines that a Cap is not effective or that a Cap
is not expected to be effective, the ineffective portion of the Cap will no
longer qualify for hedge accounting and, accordingly, subsequent changes in its
fair value will be reflected in earnings.
At June 30, 2003, the Company had 11 Cap Agreements, which are derivative
instruments as defined by FAS 133 and FAS 138, with an aggregate notional amount
of $310 million. The Company utilizes Caps for the purpose of managing interest
rate risk and does not anticipate entering into derivative transactions for
speculative or trading purposes. As of June 30, 2003, there were unrealized
losses of $3.8 million on the Company's Caps. (See Note 5.)
(m) Adoption of New Accounting Standards
On January 1, 2003, the Company adopted FAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("FAS 148"). FAS 148,
amends FAS No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), by
providing alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, FAS 148 amends the disclosure requirements of Statement 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The Company will record option expense for
options granted subsequent to January 1, 2003, in accordance with FAS 123, as
amended by FAS 148. The adoption of FAS 148 did not have an impact on the
Company as all outstanding options were fully vested and no new options have
been granted since the adoption of FAS 148. However, the future effect of FAS
148 will be based on, among other things, the underlying terms of any future
grants of stock-based compensation.
(n) New Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46 "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires consolidation by the
primary beneficiary of all variable interest entities. FIN 46 became effective
immediately for investments in all variable interest entities acquired after
February 1, 2003 and for previously held investments beginning with the first
interim period beginning after June 15, 2003. FIN 46 applies to certain of the
Company's equity investments in real estate in which it has a majority interest
as a limited partner but has not historically consolidated because it does not
have effective control under the terms of the respective partnership agreements.
(See Note 6.) Accordingly, the Company will consolidate such investments as
required by FIN 46 beginning with the third quarter of calendar 2003. The
application of FIN 46 will not have a material impact on the Company's
consolidated financial statements.
(o) Reclassifications
Certain prior period amounts have been reclassified to conform to the
current period presentation.
3. Related Parties
(a) Property Management
Until his retirement from the Company's Board of Directors on March 10,
2003, Michael B. Yanney was the Chairman of the Board of the Company as well as
the Chairman of America First Companies LLC ("AFC"). America First Properties
Management Company L.L.C. (the "Property Manager"), a wholly owned subsidiary of
AFC, has and continues to provide property management services for the
multi-family properties in which the Company holds an investment interest. The
Property Manager receives a management fee equal to a stated percentage of the
gross revenues generated by these properties, ranging from 3.5% to 4% of gross
revenues, which are considered market rates for such services. The Property
Manager was paid fees of approximately $85,000 and $183,000 for the quarter and
year to date period ended June 30, 2003, respectively, and $105,000 and $214,000
for the quarter and year to date period ended June 30, 2002, respectively, for
managing these properties.
(b) Investment in Retirement Centers Corporation
10
From 1998 thorough September 30, 2002, the Company held all of the
non-voting preferred stock, representing 95% of the ownership and economic
interest, in Retirement Centers Corporation ("RCC"), an entity formed following
the 1998 Merger, which indirectly holds two multi-family properties. Through
September 30, 2002, Mr. Gorin, the Company's Executive Vice President, Chief
Financial Officer and Treasurer, held all of the voting common stock of RCC,
representing a 5% economic interest and 100% controlling interest in RCC.
On October 1, 2002, the Company purchased 100% of the voting common stock
held by Mr. Gorin for $260,000. The purchase price was based on the estimated
value of the underlying properties, as determined by independent appraisers, net
of the related mortgage indebtedness. As a result of the purchase of this voting
common stock, RCC become a wholly-owned subsidiary of the Company. (See Note 6.)
(c) Investments in Certain Corporate Debt Securities
Prior to the Company liquidating its corporate debt securities portfolio
in 2002, the Company held the corporate debt securities of RCN Corporation
("RCN"), which were purchased between February 1999 and August 2000, and Level 3
Corporation ("Level 3"), which were purchased between August 1998 and August
2000. Mr. Yanney, who retired as Chairman and as a member of the Company's Board
of Directors on March 6, 2003, was on the board of directors of both RCN and
Level 3 at the time the Company purchased and sold these securities. One of the
Company's Directors, W. David Scott, is the son of the Chairman of both Level 3
and RCN.
4. Mortgage Backed Securities
As of June 30, 2003 and December 31, 2002, all of the Company's MBS were
classified as available-for-sale and, as such, were carried at their estimated
fair value, as determined by obtaining several market quotes from investment
banks that trade such securities. The following table presents the carrying
value of the Company's MBS as of June 30, 2003 and December 31, 2002.
June 30, December 31,
2003 2002
---------- -----------
(In Thousands)
Fannie Mae Certificates $2,263,569 $1,901,621
Ginnie Mae Certificates 4,207 5,577
Freddie Mac Certificates 1,763,536 1,450,675
Non-agency "AAA" rated 155,631 127,446
---------- ----------
$4,186,943 $3,485,319
========== ==========
At June 30, 2003 and December 31, 2002, the Company's portfolio of MBS
consisted of pools of ARM-MBS with carrying values of approximately $4.18
billion and $3.47 billion, respectively, and fixed rate MBS with carrying values
of approximately $6.6 million and $6.8 million, respectively.
Agency MBS: Although not rated, Agency MBS carry an implied "AAA" rating.
Agency MBS are issued or guaranteed as to principal or interest by an agency of
the U.S. government or a federally chartered corporation, such as Fannie Mae,
Ginnie Mae or Freddie Mac.
Non-Agency "AAA": Non-Agency "AAA" MBS are privately issued certificates
that are backed by pools of single-family and multi-family mortgage loans.
Non-Agency "AAA" MBS are rated as such by one of the Rating Agencies. "AAA" is
the highest rating given by bond Rating Agencies and indicates the relative
security of the investment. These securities are not guaranteed by the U.S.
Government or any of its agencies or any federally chartered corporation.
11
The following table presents the components of the carrying value of the
Company's MBS as of June 30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
----------- -----------
(In Thousands)
Principal balance $ 4,066,098 $ 3,382,275
Unamortized premium 100,053 76,333
Unaccreted discount (2) (20)
Gross unrealized gains 24,143 27,154
Gross unrealized losses (3,349) (423)
----------- -----------
Carrying value/estimated fair value $ 4,186,943 $ 3,485,319
=========== ===========
5. Interest Rate Cap Agreements
As of June 30, 2003, the Company had 11 Caps with an aggregate notional
amount of $310.0 million purchased to hedge against increases in interest rates
on $310.0 million of the Company's current and anticipated future 30-day term
repurchase agreements. The Caps had an amortized cost of $4,017,000 and a fair
value of $195,000 at June 30, 2003, resulting in an unrealized loss of
$3,822,000, which is included as a component of accumulated other comprehensive
income. Pursuant to the Cap terms, the Company will receive monthly payments
from the Cap Agreement counterparty, if the 30-day London Interbank Offered Rate
("LIBOR") increases above the rate specified in the Cap Agreement during the
effective term of the Cap.
The Company's counterparties for the Cap Agreements are financial
institutions whose holding or parent company's long-term debt rating is "A" or
better, as determined by at least one of the Rating Agencies, where applicable.
In the unlikely event of a default by the counterparty, the Company would not
receive payments provided for under the terms of the Cap Agreement and could
incur a loss for up to the premium paid upon entering into the Cap Agreement.
Weighted Estimated
Average Weighted Fair
Active Average LIBOR Notional Unamortized Value/Carrying Gross
Period Strike Rate(1) Amount Premium Value Unrealized Loss
--------- -------------- -------- ----------- -------------- ---------------
(Dollars in Thousands)
Months until active:
Currently active 19 Months 5.75% $ 50,000 $ 320 $ -- $ (320)
Within six months 18 Months 4.63 200,000 2,872 33 (2,839)
Six to nine months N/A N/A -- -- -- --
Nine to 12 months 18 Months 3.25 60,000 825 162 (663)
12 to 24 months N/A N/A -- -- -- --
--------- ---- -------- -------- -------- --------
Weighted
Average/Total 18 Months 4.54% $310,000 $ 4,017 $ 195 $ (3,822)
========= ==== ======== ======== ======== ========
(1) The rate at which payments would become due to the Company under the terms
of the Cap Agreement. N/A - Not applicable
6. Equity Interests in Real Estate Investments and Real Estate
Equity interests in real estate investments and real estate consisted of
the following as of June 30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
------- -----------
(In Thousands)
Real estate $21,720 $21,986
Equity interests in real estate 4,160 3,806
------- -------
$25,880 $25,792
======= =======
12
(a) Real Estate /Retirement Centers Corporation
RCC was formed as a separate taxable corporation to hold certain
properties acquired in the 1998 Merger, primarily retirement/assisted living
properties, the operations of which, if held directly, would be incompatible
with the Company's maintaining compliance with the REIT provisions of the Code.
Such assets have since been sold and the proceeds reinvested in multi-family
apartment properties currently held by RCC. On October 1, 2002, the Company
purchased the voting common stock of RCC. Prior to this purchase, the Company
held the non-voting preferred stock and accounted for its investment in RCC
under the equity method. Upon acquiring the controlling interest in RCC, the
Company changed from the equity method of accounting for this investment to
consolidating RCC, reflecting the assets and liabilities and results of
operations of RCC on a prospective basis.
As of June 30, 2003 and December 31, 2002, RCC owned: (i) The Greenhouse,
a 127 unit multi-family apartment property located in Omaha Nebraska, which was
acquired on January 12, 2000, and (ii) an 88.3% undivided interest in Lealand
Place, a 192-unit apartment property located in Lawrenceville, Georgia, which
was acquired on January 18, 2001. The Company also indirectly owned the
remaining 11.7% undivided interest in Lealand Place. In December 2000, the
Company loaned Greenhouse Holding LLC (which directly owns The Greenhouse)
$437,000 to fund building renovations, which remained outstanding as of June 30,
2003.
The summary results of real estate reflect the operations of RCC, as
consolidated with its subsidiaries that own two multi-family properties, for the
three- and six-month periods ended June 30, 2003, were as follows:
Three Months Six Months
------------ ----------
(Thousands) Ended June 30, 2003
Revenue from operations of real estate $ 794 $ 1,221
Interest expense for mortgages on real estate (297) (500)
Other real estate operations expense (485) (832)
------- -------
$ 12 $ (111)
======= =======
(b) Equity Interests in Real Estate
As of June 30, 2003, the Company held limited partner interests in three
limited partnerships, which had an aggregate of $24.8 million of non-recourse
mortgage loans secured by the underlying investment properties. These mortgages
have non-recourse provisions, subject to customary non-recourse exceptions, such
that they are generally secured to the extent of the collateral mortgaged
property. Prior to October 1, 2002, the Company held 100% of the non-voting
preferred stock of RCC which represented a 95% economic interest, as such, the
net assets of RCC were included in equity interests in real estate and income
recognized under the equity method.
The Company holds a 99% limited partner interest in Morrowood Associates,
Ltd., whose sole asset is a 264-unit property known as Morrowood Townhomes. On
April 16, 2003, Morrowood Townhomes was sold. As a result of the sale of the
property and subsequent distributions from the limited partnership, the Company
realized a gain of $621,000 during the second quarter of 2003.
13
7. Repurchase Agreements
As of June 30, 2003, the Company had outstanding balances of $3.82 billion
repurchase agreements with a weighted average borrowing rate of 1.49% and a
weighted average remaining maturity of 8.9 months. The following table presents
the Company's repurchase agreements by contractual maturity.
June 30,
2003
-----------
(In Thousands)
Within 30 days $ 537,418
31 to 90 days 539,795
91 days 6 months 608,655
6 to 12 months 1,396,820
12 to 18 months 486,931
18 to 24 months 18,000
24 to 36 months 234,000
-----------
$ 3,821,619
===========
The repurchase agreements are collateralized by the Company's MBS which
had a carrying value of approximately $4.19 billion. The Company's repurchase
agreements generally bear interest at rates that are LIBOR-based.
8. Commitments and Contingencies
At June 30, 2003, the Company had a commitment to purchase a $25.2 million
Freddie Mac issued ARM-MBS at a price of 102.5% of par value. Such purchase
settled on July 1, 2003.
9. Stockholders' Equity
(a) Dividends/Distributions
The following table presents dividends declared by the Company from
January 1, 2002 through June 30, 2003:
Dividend
Declaration Date Record Date Payment Date per Share
- ---------------- ----------- ------------ ---------
2003
- ----
May 20, 2003 June 30, 2003 July 31, 2003 $ 0.280
March 13, 2003 March 28, 2003 April 30, 2003 0.280
2002
- ----
December 19, 2002 December 30, 2002 January 24, 2003 0.320 (1)
September 12, 2002 September 30, 2002 October 30, 2002 0.320 (1)
June 12, 2002 June 28, 2002 July 30, 2002 0.300 (2)
March 12, 2002 March 28, 2002 April 30, 2002 0.300 (2)
(1) Includes a special dividend of $0.04 per share.
(2) Includes a special dividend of $0.02 per share.
(b) Shelf Registration
On September 25, 2001, the Company filed a registration statement on Form
S-3 with the SEC under the Securities Act of 1933, as amended (the "Act"), with
respect to an aggregate of $300,000,000 of common stock and/or preferred stock
that may be sold by the Company from time to time pursuant to Rule 415 under the
Act. On October 8, 2001, the SEC declared this registration statement effective.
As of June 30, 2003, the Company had $8.7 million available under this shelf
registration statement.
On June 27, 2003, the Company filed a registration statement on Form S-3
with the SEC under the Act, with respect to an aggregate of $500.0 million of
common stock and/or preferred stock that may be sold by the Company from time to
time pursuant to Rule 415 under the Act. On July 8, 2003, the SEC declared this
registration statement effective. As of June 30, 2003, the Company had the
entire $500.0 million available under this shelf registration statement.
14
(c) Stock Repurchase Plan
Since implementing the stock repurchase program during the fourth quarter
of 1999, through June 30, 2003, the Company had repurchased and retired 378,221
shares at an aggregate cost of $1,924,000. The Company has not repurchased any
of its Common Stock since December 2000.
10. EPS Calculation
The following table presents the reconciliation between basic and diluted
shares outstanding used in calculating basic and diluted EPS for the three and
six months ended June 30, 2003 and 2002:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
------ ------ ------ ------
(In Thousands)
Weighted average shares outstanding - basic 51,217 38,294 48,780 36,520
Add effect of assumed shares issued under
treasury stock method for stock options 66 121 56 123
------ ------ ------ ------
Weighted average shares outstanding - diluted 51,283 38,415 48,836 36,643
====== ====== ====== ======
11. Accumulated Other Comprehensive Income
Accumulated other comprehensive income at June 30, 2003 and December 31,
2002 was as follows:
June 30, December 31,
2003 2002
-------- --------
(In Thousands)
Unrealized gains on available-for-sale:
MBS $ 24,143 $ 27,155
Unrealized losses on available for sale:
MBS (3,349) (423)
-------- --------
20,794 26,732
-------- --------
Hedging Instruments:
Unrealized depreciation on interest rate cap agreements (3,822) (2,937)
-------- --------
Accumulated other comprehensive income $ 16,972 $ 23,795
======== ========
12. 1997 Stock Option Plan and Employment Agreements
(a) 1997 Stock Option Plan
The Company's Second Amended and Restated 1997 Stock Option Plan (the
"1997 Plan") authorizes the granting of options to purchase an aggregate of up
to 1,400,000 shares of the Company's common stock. The Plan authorizes the
Compensation Committee of the Board of Directors, or the entire Board of
Directors if no such committee exists, to grant incentive stock options
("ISOs"), as defined under section 422 of the Code, non-qualified stock options
("NQSOs") and dividend equivalent rights ("DERs") to eligible persons. The
exercise price for any options granted to eligible persons under the 1997 Plan
shall not be less than the fair market value of the common stock on the day of
the grant. As of June 30, 2003, the Company had 560,000 options outstanding, all
of which were fully vested with a weighted average strike price of $8.57. At
June 30, 2003, there were 580,000 common stock options and 895,000 DERs
available for grant under the 1997 Plan.
Granted DERs on the ISOs have vested on the same basis as the options and
granted DERs on NQSOs became fully vested one year following the date of grant.
Dividends are paid on vested DERs only to the extent of ordinary income. DERs
are not entitled to distributions representing a return of capital. Dividends
paid on DERs on ISOs are charged to stockholders' equity when declared and
dividends paid on DERs on NQSOs are charged to earnings when declared. For the
six months ended June 30, 2003 and 2002, the Company recorded charges of
$252,000 and $285,000, respectively, to stockholders' equity (included in
dividends paid or accrued) associated with the DERs on ISOs and an expense of
$1,400 and $1,875, respectively, associated with DERs on NQSOs. At June 30,
2003, the Company had 452,500 DERs outstanding, all of which were fully vested.
15
The ISOs granted to the executive officers of the Company, who were also
employees of the Advisor, were accounted for under the fair value method
established under FAS 123, resulting in option related expenses recognized over
the vesting period. Management used the Black-Scholes valuation model to
determine the option expense. Since the Company commenced operations in 1998,
the Company applied assumptions consistent with activity of a comparable peer
group of companies including an estimated option life, a volatility rate, a risk
free rate and a current dividend yield for the 1998 and 1999 grants (or 0% if
the related DERs are issued).
Effective January 1, 2002, the status of the employees of the Advisor
changed such that they became employees of the Company, resulting in a change in
status of these individuals. Accordingly, the unvested options outstanding as of
January 1, 2002 were treated as newly granted options to employees and accounted
for under the APB 25, with the difference between the fair market value of the
Company's common stock and option price expensed over the remaining vesting
period of approximately seven months. The Company did not incur any expense for
stock options during the quarter or year-to-date periods ended June 30, 2003, as
all options had vested during 2002 and no subsequent grants were made; for the
six months ended June 30, 2002, the Company recognized $48,000 of employee
related compensation expense for stock options.
NQSOs were granted to the Company's directors as consideration for the
performance of their duties as directors. The Company treated the directors as
employees for purposes of applying FAS 123 and, in accordance with its policy,
accounted for the NQSOs under APB 25, as described earlier, with no expense
recognized for the NQSOs, as the exercise price at the time of grant was equal
to the market value of the stock.
(b) Employment Agreements
On March 12, 2002, the Board of Directors adopted new compensation plans
for Messrs. Zimmerman, Gorin and Freydberg that took effect on August 1, 2002.
Under their employment agreements, salaries to be paid to Messrs. Zimmerman,
Gorin, and Freydberg will be equal to 0.25%, 0.20% and 0.20%, respectively, of
the Company's tangible net worth, which will be calculated on a semi-annual
basis on each June 30 and December 31. In the event that the Company's
annualized return on equity for any given six-month period were to fall below
10%, the salaries to be paid to Messrs. Zimmerman, Gorin and Freydberg with
respect to the following six-month period would be adjusted downward to equal
(i) 0.2375%, 0.19% and 0.19%, respectively, of the Company's tangible net worth
if its annualized return on equity was between 10% and 5% and (ii) 0.225%, 0.18%
and 0.18%, respectively, of the Company's tangible net worth if its annualized
return on equity was less than 5%. Notwithstanding the foregoing, the annual
base salaries payable to Messrs. Zimmerman, Gorin and Freydberg pursuant to the
new compensation plan will in no event exceed $1,000,000, $750,000 and $750,000,
respectively. For the six month period ended June 30, 2003, Messrs. Zimmerman,
Gorin and Freydberg had base salaries of approximately $451,000, $361,000 and
$361,000, respectively. On October 1, 2002, the Company entered into an
employment agreement with Ms. Teresa Covello, the Company's Senior Vice
President, Controller and Chief Accounting Officer, that provides for, among
other things, a base salary of $140,000.
(c) Deferred Compensation Plans
On December 19, 2002, the Company's Board of Directors adopted the MFA
Mortgage Investments, Inc. 2003 Nonemployee Directors' Deferred Compensation
Plan and the MFA Mortgage Investments, Inc. Senior Officers Deferred Bonus Plan
(collectively, the "Deferred Plans"). Directors and senior officers of the
Company may elect to defer a percentage of their compensation under the Deferred
Plans for compensation earned subsequent to December 31, 2002. The Deferred
Plans are intended to provide non-employee Directors and Senior Officers of the
Company with an opportunity to defer up to 100% of certain compensation, as
defined in the Deferred Plans, while at the same time aligning such individual's
interests with the interests of the stockholders. Amounts deferred are
considered to be converted into "stock units" of the Company, which do not
represent stock of the Company, but rather the right to receive a cash payment
equal to the fair market value of an equivalent number of shares of the common
stock. Deferred accounts increase or decrease in value as would equivalent
shares of the common stock and are settled in cash at the termination of the
deferral period, based on the value of the stock units at that time. The
Deferred Plans are non-qualified plans under the Employee Retirement Income
Security Act and are not funded. Prior to the time that the deferred accounts
are settled, participants are unsecured creditors of the Company.
The Deferred Plans are intended to be non-qualified deferred compensation
plans under the provisions of the Code. At the time a participant's deferral of
compensation is made, it is intended that such participant will not recognize
income for federal income tax purposes, nor will the Company receive a deduction
until such time that the compensation is actually distributed to the
participant.
16
13. Subsequent Events
On July 15, 2003, the Company filed a post-effective amendment to its
registration statement relating to the MFA Mortgage Investment, Inc. Discount
Waiver, Direct Stock Purchase and Dividend Reinvestment Plan (the "DRIP"),
pursuant to which the Company may offer for sale up to 3.0 million authorized
but unissued shares of its common stock to participants in the DRIP. On July 24,
2003, this registration statement was declared effective by the SEC.
17
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion should be read in conjunction with the financial
statements and notes thereto included in Item 1 of this Quarterly Report on Form
10-Q as well as in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
General
MFA Mortgage Investments, Inc., a self-advised mortgage REIT, is primarily
engaged in the business of investing, on a leveraged basis, in ARM-MBS. Included
in the Company's portfolio of ARM-MBS are hybrid MBS that have a fixed interest
rate for five years or less at the time of purchase and then convert to a
one-year adjustable-rate for the remaining loan term. The Company's MBS
portfolio consists primarily of ARM-MBS issued or guaranteed as to principal or
interest by an agency of the U.S. government or a federally chartered
corporation, such as Ginnie Mae, Fannie Mae or Freddie Mac (collectively
referred to as "Agency Securities"), and, to a lesser extent, high quality
ARM-MBS, rated in one of the two highest rating categories by at least one
nationally recognized Rating Agency. The Company's investment strategy also
provides for the acquisition of multi-family housing properties, investments in
REIT securities and other securities. The Company's principal business objective
is to generate net income for distribution to its stockholders, resulting from
the spread between the interest and other income it earns on its investments and
the cost of financing such investments.
The Company has 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 its status as a REIT is that the Company must
distribute at least 90% of its annual taxable net income to its stockholders,
subject to certain adjustments.
The Company was incorporated in Maryland on July 24, 1997 and began
operations on April 10, 1998 when it merged with the PREP Funds. As a result of
the 1998 Merger, PREP Fund 1 and PREP Fund 2 were merged directly into the
Company and Pension Fund became a partnership subsidiary of the Company. In
December 1999, Pension Fund was liquidated and dissolved and, as a result, the
Company acquired approximately 99% of the assets of Pension Fund. The remaining
assets, consisting solely of cash, were distributed to the holders of Pension
Fund securities who elected to remain in place following the 1998 Merger. As a
result of the 1998 Merger, the Company issued a total of 9,035,084 shares of its
common stock to the former partners of the PREP Funds.
Following the completion of the 1998 Merger through December 31, 2001, the
Company was externally advised and managed REIT. As such, the Company had no
employees and relied entirely on the Advisor to perform all of the duties that
are generally performed by internal management. Pursuant an agreement with the
Advisor, the Advisor provided the day-to-day management and administrative
functions for the Company's operations for a fee, which was calculated on a
quarterly basis. The Advisor was a subsidiary of AFC.
On January 1, 2002, as a result of the Advisor Merger, the Company became
a self-advised REIT. In connection with the Advisor Merger, the employees of the
Advisor became employees of the Company and the Company assumed the employment
contracts of these individuals. The Company also acquired all of the tangible
and intangible business assets of the Advisor.
Since June 2001, the Company has significantly increased its asset base by
investing, on a leveraged basis, additional equity capital raised through public
offerings of the Company's common stock. As a result, the Company has
experienced growth in interest income, interest expense and net interest income.
The Company's total assets were $4.30 billion at June 30, 2003 and $3.60 billion
at December 31, 2002. As of June 30, 2003, 99.2% of the Company's assets
consisted of MBS and related receivables issued or guaranteed by an agency of
the U.S. government or a federally chartered corporation, other MBS rated "AAA"
by Standard & Poor's Corporation and cash. The Company has indirect interests in
three multi-family properties and indirect controlling interests in two
multi-family properties, these five properties contain a total of 1,209 rental
units. Three of these apartment properties are located in Georgia, one is
located in North Carolina and one is located in Nebraska. The Company is
currently in the process of marketing certain of these property interests;
however, there can be no assurance that the Company will be able to consummate a
transaction involving such interests at any particular time or on any particular
terms. During the quarter ended June 30, 2003, a 264 unit apartment complex
known as Morrowood Townhouses, located in Morrow, Georgia, was sold for
approximately $7.2 million, resulting in the Company realizing a gain of
$621,000.
18
The results of the Company's operations are affected by various factors,
many of which are beyond the control of the Company. The results of the
Company's operations primarily depend on, among other things, the level of its
net interest income, the market value of its assets and the supply of and demand
for such assets. The Company's net interest income, which reflects the
amortization of purchase premiums, varies primarily as a result of changes in
short-term interest rates, borrowing costs and prepayment rates, the behavior of
which involves various risks and uncertainties. Prepayment rates, as reflected
by the constant prepayment rate ("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. The CPR on the
Company's MBS portfolio averaged 37.08% for the quarter ended June 30, 2003. In
addition to these factors, borrowing costs are further affected by the Company's
creditworthiness. Since changes in interest rates may significantly affect the
Company's activities, the operating results of the Company depend, in large
part, upon its ability to effectively manage its interest rate and prepayment
risks while maintaining its status as a REIT. The Company also has risks
inherent in its other investments, comprised of interests in multi-family real
estate properties and hedging instruments. Because these investments represented
less than 1.0% of the Company's total assets at June 30, 2003, the risk related
to these assets is limited; nonetheless, these investments have the potential of
causing a material impact on the Company's operating performance in future
periods.
The Company continues to explore alternative business strategies,
alternative investments and other strategic initiatives to compliment the
Company's core business strategy of investing, on a leveraged basis, in high
quality ARM-MBS. No assurance, however, can be provided that any such strategic
initiative will or will not be implemented in the future.
Results Of Operations
Three Month Period Ended June 30, 2003 Compared to the Three Month Period Ended
June 30, 2002
Net income increased to $15.4 million for the three months ended June 30,
2003, reflecting basic and diluted earnings per share of $0.30, from $14.2
million, or basic and diluted earnings per share of $0.37, for the three months
ended June 30, 2002. Comparing the second quarter of 2003 to the second quarter
of 2002, the Company's core net revenue, comprised of net interest income,
increased by $627,000, or 4.1%, to $16.1 million for the 2003 quarter from $15.5
million for the 2002 quarter.
For the three months ended June 30, 2003, total interest and dividend
income, net of amortization of purchase premiums and accretion of purchase
discounts, increased minimally, by $80,000, or .3%, to $30.8 million from $30.7
million for the three months ended June 30, 2002. While the change in net
interest income was minimal comparing the two quarters, changes in the Company's
asset yield, investment volume and cost of borrowings changed significantly. The
Company experienced significant growth in its interest-earning assets and
interest-bearing liabilities as a result of investing and leveraging additional
equity capital raised by the Company during the first quarter of 2003.
The Company's average interest-earning assets for the three months ended
June 30, 2003 were $3.89 billion, as compared to $2.79 billion for the three
months ended June 30, 2002. However, during the second quarter of 2003, the
Company experienced a reduction in the net yield on interest-earning assets, as
faster prepayments resulted in accelerated amortization of purchase premiums.
This is reflected in the decrease in the yield on such MBS to 3.17% for the
second quarter of 2003 from 4.40% for the comparable 2002 quarter.
The Company's interest expense on borrowings (i.e., repurchase agreements)
decreased by $547,000, or 3.6%, to $14.7 million for the three months ended June
30, 2003, compared to $15.2 million for the second quarter of 2002, reflecting
the net impact of the significant decrease in the Company's cost of borrowings,
and an increase in borrowings. The average cost of borrowings decreased to 1.68%
for the 2003 quarter as compared to 2.42% for the second quarter of 2002. The
substantial increase in the Company's borrowings was the direct result of the
Company's May 2003 issuance of approximately 7.76 million shares of its common
stock in a public offering, which generated net proceeds of approximately $67.2
million; such proceeds were invested in additional ARM-MBS on a leveraged basis.
(See "Liquidity and Capital Resources", below.)
Since the Company's borrowings typically reprice faster than its
interest-earning assets, a declining interest rate environment would generally
be expected to benefit the Company. However, the acceleration of amortization of
purchase premiums on the MBS portfolio has been significant, as borrowers have
rapidly refinanced to historically low mortgage rates. During the second quarter
of 2003, the Company experienced an annualized CPR on its MBS portfolio of
37.1%, reaching a quarterly and historical high for the Company of 39.7% in May,
2003, compared to a
19
CPR of 29.2% for the second quarter of 2002. The impact of the significant
increase in prepayments and related premium amortization is reflected in the
Company's interest rate margin, (i.e., annualized net interest and dividend
income divided by average interest-earning assets) which was 1.65% for the 2003
quarter compared to 2.33% for the 2002 quarter and the net interest rate spread,
which compressed to 1.49% for the 2003 quarter from 1.98% for the 2002 quarter.
Total other income increased by $1.7 million for the three months ended
June 30, 2003, as compared to the second quarter of 2002. During the second
quarter of 2003, the Company realized income from equity interests in real
estate of $579,000, which reflects a gain of $621,000 resulting from the sale of
the underlying property held by a limited partnership in which the Company has
an interest. (See Note 6b to the Consolidated Financial Statements.) Excluding
the non-recurring gain, equity interests in real estate generated a net loss of
$42,000. The Company's investment interests in multi-family apartment
properties, which were acquired in the formation of the Company or through
subsequent tax-free exchanges of such properties, have declined, both in
absolute investment dollars and as a component of total assets. Given the
significant growth of the Company's MBS portfolio during 2002 and 2003, these
investments and their returns have generally become relatively insignificant to
the Company, as such investments represented less than 1% of total assets as of
June 30, 2003. However, gains and/or losses on the sale of these investments, if
any, could significantly impact the results of operations for future periods.
While the Company currently anticipates that it will continue to hold, for
investment purposes, three of its remaining indirect interests in these
properties, as such properties were obtained through tax-free transactions known
as section 1031 exchange. However, the Company is currently in the process of
marketing its limited partner interests in the remaining properties. The Company
does not expect the sale of such limited partner interests or the underlying
properties, if such sales occur, to have a material impact on future operations.
As part of the strategy of managing its portfolio, during the second
quarter of 2003, the Company sold $24.3 million of MBS all at a gain, resulting
in gross gains of $334,000. During the second quarter of 2002, the Company
realized a net loss of $166,000 comprised of gross gains and losses of $118,000
and $284,000, respectively. The Company does not maintain a trading portfolio,
nor does it currently expect to engage in trading in the future. The timing and
impact of future sales of MBS cannot be predicted.
During the second quarter of 2003, the Company had operating and other
expenses of $2.4 million, compared to $1.3 million for the second quarter of
2002. This $1.1 million period-over-period increase includes $782,000 of
mortgage interest and other expenses related to the real estate properties held
by RCC, which prior to October 1, 2002 were accounted for under the equity
method and reported as a net component of income from equity interests in real
estate. The remaining increase of $336,000 reflects a $395,000 increase in
compensation and benefits, primarily resulting from the additional staff hired
to meet the needs of the Company's growth as an internally managed Company. The
Company expects to hire additional officers which includes an in-house general
counsel during the second half of 2003, such hires are expected to increase the
cost of compensation and benefits, however, the timing and amount of such costs
are presently uncertain.
Total operating and other expense increased from $1.3 million to $2.4
million, of which $782,000 reflects the RCC's operating expenses as consolidated
with the Company. (For the 2002 period, RCC's expenses were included as a net
component of income from equity interests in real estate.) On a comparative
basis, excluding the consolidated expenses of RCC, total operating and other
expenses increased by $336,000, primarily reflecting the increase in the cost of
compensation and benefits related to additional hires as well as contractual
increases in base salaries. Other general and administrative expenses remained
fairly stable, declining $59,000, due to a reduction in professional fees.
Operating expenses (excluding the non-comparative consolidated expenses of RCC)
as a percentage of average total assets, on a annualized basis, improved to .16%
for the 2003 quarter, compared to .18% for the second quarter of 2002.
Six Month Period Ended June 30, 2003 Compared to the Six Month Period Ended June
30, 2002
Net income increased to $30.8 million for the six months ended June 30,
2003, reflecting basic and diluted earnings per share of $0.63, compared to net
income of $23.7 million, or $.65 per basic and diluted share, for the six months
ended June 30, 2002. During the first quarter of 2002, the Company recognized a
non-recurring charge of $3.5 million against its debt securities portfolio due
to an other-than-temporary decline in the market value of an issue of corporate
debt securities. This charge decreased earnings per share for the 2002 period by
$.09.
Comparing the first six months of 2003 to the comparable period in 2002,
the Company's core net revenue, comprised of net interest income, increased by
$4.1 million, or 14.0%, to $33.3 million for the 2003 period from
20
$29.2 million for the 2002 period. This increase in net interest income reflects
the net impact of significant growth in the Company's balance sheet and the
decrease in the net interest margin and spread. The declining interest rate
environment that has generally prevailed since 2001, while initially beneficial
to the Company, has ultimately led to the compression in margins and spreads, as
faster prepayments resulted in accelerating purchase premiums on the MBS
portfolio.
Interest and dividend income for the six-month period ended June 30, 2003
increased by $5.0 million, or 8.7%, from $58.0 million for the first half of
2002 to $63.0 million for the 2003 six month period. This change reflects the
significant growth in interest-earning assets, which were significantly offset
by the decrease in the net yield on such assets to 3.40% for the 2003 six month
period from 4.52% for the comparative 2002 period. For the 2003 period, the
Company experienced an annualized CPR of 35.0%, compared to a 28.4% CPR for the
2002 six month period. The increase in prepayments, as measured by the CPR,
resulted in accelerating amortization of purchase premiums, a significant
component in reducing in the net yield on the Company's MBS portfolio. Average
interest-earning assets increased to $3.70 billion for the 2003 six month period
from $2.62 billion for the six months ended June 30, 2002.
Interest expense increased by $937,000, or 3.3%, to $29.7 million for the
six months ended June 30, 2003, compared with $28.7 million for the first six
months of 2002. This change reflects the significant increase in borrowings,
which averaged $3.35 billion during the 2003 period, compared to $2.33 billion
for the 2002 period, significantly offset by a reduction in the cost of
borrowings to 1.78% for the first six months of 2003 from 2.48% for the first
six months of 2002.
The increase of $5.1 million in total other income/(loss) primarily
reflects the non-recurrence of the first quarter 2002 impairment charge of $3.5
million for the six months ended June 30, 2002, an $86,000 increase in gains on
sale of MBS and an increase in income from equity earnings in real estate of
$288,000. Income from equity earnings from real estate includes a $621,000
realized from the sale of real estate. (See Note 6b to the consolidated
financial statements included herein.) The consolidation of RCC on a prospective
basis commencing October 1, 2002, resulted in reporting RCC's gross revenue in
other income of $1.2 million; however, had the Company reported under the equity
method as accounted for during the 2002 period, the net results of RCC's
operations of ($111,000) would have been reported a as a component of income
from equity interests in real estate.
Total other general and administrative expense increased from $2.5 million
to $4.6 million, of which $1.3 million reflects the consolidation of RCC's
operating expenses. (For the 2002 period, RCC's expenses were included as a net
component of income from equity interests in real estate.) On a comparative
basis, excluding the consolidated expenses of RCC, total operating and other
expenses increased by $778,000, primarily reflecting the increase in the cost of
compensation and benefits related to additional hires as well as contractual
increases in base salaries. Other general and administrative expenses increased
by $251,000 reflecting the increase in operating overhead, related to the
Company's new corporate headquarters, which were occupied in August of 2002 and
the increased cost of corporate insurance, which the Company believes is in line
with general market trends. These increases were partially off-set by cost
savings experienced for professional fees. Operating expenses (excluding the
non-comparative consolidated expenses of RCC) as a percentage of average total
assets, on an annualized basis, improved to .17% for the 2003 six month period,
compared to .19% for the 2002 period.
Other operating expenses are expected to continue to increase over the
remainder of 2003 and into 2004, as incremental costs will be incurred by the
Company to comply with new rules promulgated by the SEC relating to the
Sarbanes-Oxley Act of 2002 and rules issued by the New York Stock Exchange
relating to corporate governance; such incremental costs are not, however,
presently expected to be significant to the Company. The Company expects to hire
additional officers which includes in-house general counsel during the second
half of 2003, such hires are expected to increase the cost of compensation and
benefits, however, the timing and amount of such costs are presently uncertain.
(See Note 13 to the Consolidated Financial Statements, herein.) As part of
monitoring the Company's profitability and effectiveness, management and the
Board of Directors will continue to assess the Company's staffing needs.
21
Liquidity And Capital Resources
The Company's principal sources of liquidity consist of borrowings under
repurchase agreements, principal payments received on its portfolio of MBS, cash
flows generated by operations and proceeds from capital market transactions. The
Company's most significant uses of cash include purchases of MBS and dividend
payments on the Company's common stock. In addition, the Company also uses cash
to fund operations, make purchases of hedging instruments and make such other
investments that it considers appropriate.
Borrowings under repurchase agreements were $3.82 billion as of June 30,
2003, and $3.19 billion as of December 31, 2002. At June 30, 2003, the Company's
repurchase agreements had a weighted average borrowing rate of 1.49%, on loan
balances of between $350,000 and $82.3 million. These agreements generally have
original terms to maturity ranging from one month to 36 months and fixed
interest rates that are typically based off of LIBOR. As previously disclosed,
the Company has extended the maturities on its repurchase agreements up to 36
months. To date, the Company has not had any margin calls on its repurchase
agreements that it was unable to satisfy with either cash or additional pledged
collateral.
During the second quarter of 2003, the Company issued 7.8 million shares
of its common stock in a public offering, raising net proceeds of $67.2 million,
which were invested, on a leveraged basis, in additional ARM-MBS. The Company
has an aggregate of $508.7 million remaining under its two effective shelf
registration statements. To the extent the Company raises additional equity
capital from future capital market transactions, the Company currently
anticipates using the net proceeds primarily to acquire additional MBS on a
leveraged basis. The Company may also consider acquiring additional interests in
multi-family properties and/or other investments consistent with its investment
strategies and operating policies. There can be no assurance, however, that the
Company will be able to raise additional equity capital at any particular time
or on any particular terms.
During the six months ended June 30, 2003, principal payments on MBS
generated cash of $919.2 million and operations provided $45.5 million in cash.
As part of its core investing activities, during the first six months of 2003,
the Company acquired $1.67 billion of MBS, all of which were either Agency or
"AAA" rated ARM-MBS. Other uses of funds during the six months ended June 30,
2003, included payments of $28.1 million for dividends on the Company's
outstanding common stock and DERs.
The Company's restricted cash balance represents cash held on deposit with
certain counterparties (i.e., lenders) to satisfy margin calls on repurchase
agreements. Margin calls result from the decline in the value of the MBS
securing repurchase agreements, generally due to principal reduction in the MBS
from scheduled amortization and prepayments on the underlying mortgages and
changes in the market value associated with changes in market interest rates and
other market factors. At the time a repurchase agreement rolls (i.e., matures),
the Company will apply the restricted cash against the repurchase agreement,
thereby reducing the borrowing. The Company believes it has adequate financial
resources to meet its obligations as they come due and to fund dividends
declared as well as to actively pursue its investment strategies. However,
should market interest rates suddenly spike, margin calls due to a decline in
the market value of the MBS collateralizing the Company's repurchase agreements
could result, causing an adverse change in the Company's liquidity position.
Other Matters
The Company at all times intends to conduct its business so as to not
become regulated as an investment company under the Investment Company Act of
1940, as amended (the "Investment Company Act"). If the Company were to become
regulated as an investment company, then, among other things, the Company's
ability to use 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 interest in real estate"
(i.e., "Qualifying Interest"). Under the current interpretation of the staff of
the SEC, in order to qualify for this exemption, the Company must maintain at
least 55% of its assets directly in Qualifying Interests. In addition, unless
certain mortgage securities represent an undivided interest in the entire pool
backing such mortgage securities (i.e., "whole pool" mortgage securities"), such
mortgage securities may be treated as securities separate from the underlying
mortgage loan and, thus, may not be considered Qualifying Interests for purposes
of the 55% exemption requirement. Accordingly, the Company monitors its
compliance with this requirement in order to maintain its exempt status. As of
June 30, 2003, the Company determined that it is in, and has maintained,
compliance with this requirement.
22
Inflation
Substantially all of the Company's assets and liabilities are financial in
nature. As a result, changes in interest rates and other factors impact our
performance far more than does inflation. Our financial statements are prepared
in accordance with GAAP and our dividends are based upon 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.
Forward Looking Statements
When used in this Quarterly Report on Form 10-Q, in future filings with
the SEC, or in press releases or other written or oral communications,
statements which are not historical in nature, including those containing words
such as "anticipate," "estimate," "should," "expect," "believe," "intend" and
similar expressions are intended to identify "forward-looking statements" for
purposes of Section 27A of the Act and Section 21E of the Securities Exchange
Act of 1934, as amended (the "1934 Act") and as such may involve known and
unknown risks, uncertainties and assumptions.
These forward-looking statements are subject to various risks and
uncertainties, including, but not limited to, those relating to: changes in the
prepayment rates on the mortgage loans securing the Company's MBS; changes in
short-term interest rates and the market value of the Company's MBS; changes in
government regulations affecting the Company's business; the Company's ability
to maintain its qualification as a REIT for federal income tax purposes; the
Company's ability to use borrowings to finance its assets; and risks associated
with investing in real estate, including changes in business conditions and the
general economy. These risks, uncertainties and factors could cause the
Company's actual results to differ materially from those projected in any
forward-looking statements it makes.
All forward-looking statements speak only as the date they are made and
the Company does not undertake, and specifically disclaims, any obligation to
update or revise any forward-looking statements to reflect events or
circumstances after the date of such statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company seeks to manage the interest rate, market value, liquidity,
prepayment and credit risks inherent in all financial institutions in a prudent
manner designed to insure the longevity of the Company while, at the same time,
seeking to provide an opportunity to stockholders to realize attractive total
rates of return through stock ownership of the Company. While the Company does
not seek to avoid risk, it does seek, to the best of its ability, to assume risk
that can be quantified from historical experience, to actively manage such risk,
to earn sufficient returns to justify the taking of such risks and to maintain
capital levels consistent with the risks it does undertake.
Interest Rate Risk
The Company primarily invests in ARM-MBS, which include the hybrid MBS
that have fixed rate coupons for a specified period, not to exceed five years,
and thereafter typically convert to a one-year adjustable interest rate coupon.
As of June 30, 2003, applying a 15% CPR, the weighted average term to repricing
or prepayment of the Company's ARM-MBS portfolio was 17.6 months and the
weighted average term to repricing on repurchase agreements was 8.1 months,
resulting in repricing gap of 9.5 months. The actual CPR experience of the
Company's ARM-MBS portfolio will, of course vary over time depending on the
interest rate environment, with its CPR expected to be higher during periods of
declining interest rates and to be lower during periods of rising interest
rates. As of June 30, 2003, based on contractual terms, (i.e. assuming no
prepayments) the Company's ARM-MBS portfolio had a weighted average term to
repricing of 21.4 months and repurchase agreements had a weighted average term
to repricing of 8.9 months; resulting in a 12.5 month contractual repricing gap.
The Company's debt obligations are generally repurchase agreements with terms of
three years or less. Upon contractual maturity or an interest reset date, these
borrowings are refinanced at then prevailing market rates.
The interest rates for most of the Company's adjustable rate assets are
dependent on the one-year constant maturity treasury ("CMT") rate, while debt
obligations, in the form of repurchase agreements, are generally dependent on
LIBOR. These indexes generally move in parallel, but there can be no assurance
that this will continue to occur.
23
The Company's adjustable rate investment assets and borrowings (i.e.
repurchase agreements) reset on various dates that differ for the specific asset
or obligation. In general, the repricing of the Company's debt obligations
occurs more quickly than the repricing of assets. Therefore, on average, the
Company's cost of borrowings may rise or fall more quickly than does its
earnings rate on the assets.
To a limited extent, the Company uses Cap Agreements as part of its
interest rate risk management. The notional amounts of these instruments are not
reflected in the Company's balance sheet. The Company's Caps, which are not
reflected in the gap amounts presented above, are intended to serve as a hedge
against future interest rate increases on the Company's repurchase agreements,
which are typically priced off of LIBOR. As of June 30, 2003, the Company had
$310.0 million of notional amount of Caps, with a weighted average strike rate
for the one-month LIBOR of 4.54%. (See Note 5 to the accompanying Consolidated
Financial Statements.)
Market Value Risk
Substantially all of the Company's investment securities are designated as
"available-for-sale" assets. As such, they are reflected at their estimated fair
value, with the difference between amortized cost and fair value reflected in
accumulated other comprehensive income, a component of stockholders' equity.
(See the Consolidated Statements of Comprehensive Income and Note 11 to the
accompanying Consolidated Financial Statements.) The market value of the
Company's MBS assets fluctuate primarily due to changes in interest rates and
other factors; however, given that these securities are issued or guaranteed as
to principal or interest by an agency of the U.S. government or a federally
chartered corporation or "AAA" rated, such fluctuations are generally not based
on the underlying credit worthiness.
Liquidity Risk
The primary liquidity risk of the Company arises from financing long-term
assets with shorter-term debt in the form of repurchase agreements. Although the
interest rate adjustments of these assets and liabilities are matched within the
Company's operating policies, maturities are not required to be, nor are they
matched.
The Company's assets which are pledged to secure repurchase agreements are
high-quality, liquid assets. As a result, the Company has not had difficulty
rolling over (i.e., renewing) these agreements as they mature. However, the
Company cannot give assurances that it will always be able to roll over its
repurchase agreements. At June 30, 2003, the Company had cash and cash
equivalents of $57.0 million available to meet margin calls on repurchase
agreements and for other corporate purposes.
Prepayment and Reinvestment Risk
As the Company receives repayments of principal on its MBS, premiums on
the corresponding securities are amortized against interest income, discounts on
MBS are accreted to income and increase interest income reported. Premiums arise
when the Company acquires a MBS at a price in excess of the principal balance of
the mortgages or par value if purchased at the original issue. Conversely,
discounts arise when the Company acquires a MBS at a price below the principal
balance of the mortgages, or par, if purchased at original issue. For financial
accounting purposes interest income is accrued based on the outstanding
principal balance of the investment securities and their contractual terms.
Purchase premiums on the Company's investment securities, currently comprised of
MBS, are amortized against interest income over the lives of the securities
using the effective yield method, adjusted for actual prepayment activity. In
general, an increase in the prepayment rate, as measure by the CPR, will
accelerate the amortization of purchase premiums, thereby reducing the
yield/interest income earned on such assets.
For tax accounting purposes, the purchase premiums are amortized based on
the asset yield at the purchase date. Therefore, on a tax basis, amortization of
premiums will differ from those reported for financial purposes under GAAP. At
June 30, 2003, the gross unamortized premium for ARM-MBS for financial
accounting purposes was $100.1 million (2.5% of the carrying value of MBS) while
the amount for federal tax purposes was estimated at $95.4 million.
In general, the Company believes it will be able to reinvest proceeds from
scheduled principal payments and prepayments at acceptable yields; however, no
assurances can be given that, should significant prepayments occur,
24
market conditions would be such that acceptable investments could be identified
and the proceeds reinvested.
Item 4. Controls and Procedures
A review and evaluation was performed by the Company's management,
including the Company's Chief Executive Officer (the "CEO") and Chief Financial
Officer (the "CFO"), of the effectiveness of the design and operation of the
Company's disclosure controls and procedures as of a date within 90 days prior
to the filing of this quarterly report. Based on that review and evaluation, the
CEO and CFO have concluded that the Company's current disclosure controls and
procedures, as designed and implemented, were effective. There have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect the Company's internal controls subsequent to the
date of their evaluation. There were no significant material weaknesses
identified in the course of such review and evaluation and, therefore, no
corrective measures were taken by the Company.
25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There are no material pending legal proceedings to which the Company is a
party or any of its assets are subject.
Item 4. Submission of Matters to Vote of Securities Holders.
The Company held its Annual Meeting of Stockholders on May 20, 2003 in New
York, New York (the "Meeting") for the purpose of (i) electing two directors as
the Class II Directors on its Board of Directors and (ii) ratifying the
appointment of Ernst & Young LLP as its auditors for 2003. The total shares
entitled to vote at the Meeting were 46,354,605, of which 43,249,382, or 93.3%,
were present in person or by proxy. The following sets forth the results of the
election of directors:
Name of Nominee For Withheld
--------------- --- --------
Michael L. Dahir 43,086,025 161,714
George H. Krauss 43,087,490 160,249
There was no solicitation in opposition to the foregoing nominees by
stockholders.
The ratification of the appointment of Ernst & Young LLP as independent
auditors for the Company for the fiscal year ending December 31, 2003 was
approved by the stockholders with 42,979,470 votes "For", 150,445 votes
"Against" and 117,824 votes "Abstained or Broker Non-Votes".
Further information regarding these matters is contained in the Company's
Proxy Statement, dated April 9, 2003.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
2.1 Agreement and Plan of Merger by and among the Registrant,
America First Participating/Preferred Equity Mortgage Fund Limited
Partnership, America First PREP Fund 2 Limited Partnership, America
First PREP Fund 2 Pension Series Limited Partnership and certain
other parties, dated as of July 29, 1997 (incorporated herein by
reference to Exhibit 2.1 of the Registration Statement on Form S-4
dated February 12, 1998, filed by the Registrant pursuant to the Act
(Commission File No. 333-46179)).
2.2 Agreement and Plan of Merger by and among the Registrant,
America First Mortgage Advisory Corporation ("AFMAC") and the
shareholders of AFMAC, dated September 24, 2001 (incorporated herein
by reference to Exhibit A of the Preliminary Proxy Statement dated
October 9, 2001, filed by the Registrant pursuant to the 1934 Act
(Commission File No. 1-13991)).
3.1 Amended and Restated Articles of Incorporation of the Registrant
(incorporated herein by reference to Form 8-K dated April 10, 1998,
filed by the Registrant pursuant to the 1934 Act (Commission File
No. 1-13991)).
3.2 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Registrant, dated August 6, 2002 (incorporated
herein by reference to Form 8-K, dated August 13, 2002, filed by the
Registrant pursuant to the 1934 Act (Commission File No. 1-13991))
3.3 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Registrant, dated August 16, 2002 (incorporated
herein by reference to Exhibit 3.3 of the Form 10-Q, dated September
30, 2002, filed by the Registrant pursuant to the 1934 Act
(Commission File No. 1-13991)).
3.4 Amended and Restated Bylaws of Registrant (incorporated herein
by reference to Form 8-K dated August 13, 2002, filed by the
Registrant pursuant to the 1934 Act (Commission File No. 1-13991)).
26
4.1 Specimen of Common Stock Certificate of the Company
(incorporated herein by reference to Exhibit 4.1 of the Registration
Statement on Form S-4, dated February 12, 1998, filed by the
Registrant pursuant to the Act (Commission File No. 333-46179)).
10.1 Employment Agreement of Stewart Zimmerman, dated August 1, 2002
(incorporated herein by reference to Exhibit 10.1 of the Form 10-Q,
dated September 30, 2002, filed by the Registrant pursuant to the
1934 Act (Commission File No. 1-13991)).
10.2 Employment Agreement of William S. Gorin, dated August 1, 2002
(incorporated herein by reference to Exhibit 10.2 of the Form 10-Q,
dated September 30, 2002, filed by the Registrant pursuant to the
1934 Act (Commission File No. 1-13991)).
10.3 Employment Agreement of Ronald A. Freydberg, dated August 1,
2002 (incorporated herein by reference to Exhibit 10.3 of the Form
10-Q dated September 30, 2002, filed by the Registrant pursuant to
the 1934 Act (Commission File No. 1-13991)).
10.4 Employment Agreement of Teresa D. Covello, dated October 1,
2002 (incorporated herein by reference to Exhibit 10.4 of the Form
10-K, dated December 31, 2002, filed by the Registrant pursuant to
the 1934 Act (Commission File No. 1-13991)).
10.5 Second Amended and Restated 1997 Stock Option Plan of the
Company (incorporated herein by reference to the Form 10-Q, dated
August 10, 2001, filed with the SEC pursuant to the 1934 Act
(Commission File No. 1-13991)).
10.7 MFA Mortgage Investments, Inc. Senior Officers Deferred
Compensation Plan, adopted December 19, 2002 (incorporated herein by
reference to Exhibit 10.7 of the Form 10-K, dated December 31, 2002,
filed by the Registrant pursuant to the 1934 Act (Commission File
No. 1-13991)).
10.8 MFA Mortgage Investments, Inc. 2003 Non-Employee Directors
Deferred Compensation Plan adopted December 19, 2002 (incorporated
herein by reference to Exhibit 10.8 of the Form 10-K, dated December
31, 2002, filed by the Registrant pursuant to the 1934 Act
(Commission File No. 1-13991)).
31.1 Certification of the 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 the Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
1. On April 29, 2003, the Registrant filed a Current Report on Form
8-K under Item 9, "Regulation FD Disclosure", under which the
Registrant's press release, dated April 23, 2003, announcing results
for the first quarter ended March 31, 2003 were furnished.
2. On May 1, 2003, the Registrant filed a Current Report on Form 8-K
disclosing certain information under item 5 "Other Events"
announcing the Company's public offering of common stock, which was
completed on May 5, 2003.
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SIGNATURES
Pursuant to the requirements 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.
Date: July 25, 2003 MFA MORTGAGE INVESTMENTS, INC.
By: /s/ Stewart Zimmerman
--------------------------------------------
Stewart Zimmerman
Chief Executive Officer and President
By: /s/ William S. Gorin
--------------------------------------------
William S. Gorin
Executive Vice President and Chief Financial
Officer/Treasurer
(Principal Accounting Officer)
28