<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY MORTGAGE MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1500 HARBOR BOULEVARD
WEEHAWKEN, NEW JERSEY
(Address of principal executive offices)
07087
(Zip Code)
(201) 223-1900
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of The Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
(1) Yes X No
--- ---
(2) Yes No X
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of stock, as of the last practicable date:
Shares of Common Stock, 12,713,900, ($.01 par value), outstanding as of November
10, 1997
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ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheet - September 30, 1997 1
Statement of Operations for the quarter ended September
30, 1997 and for the period February 18, 1997
(Commencement of Operations) through September 30, 1997 2
Statement of Stockholders' Equity for the period February
18, 1997 (Commencement of Operations) through September 30, 1997 3
Statement of Cash Flows for the period February 18, 1997
(Commencement of Operations) through September 30, 1997 4
Notes to Financial Statements 5-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22-23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
SIGNATURES 24
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC.
BALANCE SHEET
SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 11,152
Receivable for Mortgage-Backed Securities sold 44,057,061
Mortgage-Backed Securities - Net 368,853,807
Accrued interest receivable 2,109,622
Other assets 238,813
------------
Total assets $415,270,455
============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements $372,291,014
Payable for Mortgage-Backed Securities purchased 6,405,861
Accrued interest payable 2,394,179
Dividends payable 678,204
Accounts payable 156,767
------------
Total liabilities 381,926,025
------------
STOCKHOLDERS' EQUITY:
Common stock: par value $.01 per share;
100,000,000 authorized, 3,767,800
shares issued and outstanding 37,678
Additional paid-in capital 33,832,226
Unrealized losses on Mortgage-Backed Securities (1,172,243)
Retained earnings 646,769
------------
Total stockholders' equity 33,344,430
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $415,270,455
============
See notes to financial statements.
1
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ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF OPERATIONS
JULY 1, 1997 FEBRUARY 18,
THROUGH 1997 THROUGH
SEPTEMBER 30, SEPTEMBER 30,
1997 1997
- --------------------------------------------------------------------------------
INTEREST INCOME:
Mortgage-Backed Securities $6,123,442 $12,601,604
Money market account 15 30,760
---------- -----------
Total interest income 6,123,457 12,632,364
INTEREST EXPENSE:
Repurchase agreements 5,126,089 10,274,906
---------- -----------
NET INTEREST INCOME 997,368 2,357,458
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES 429,400 659,265
GENERAL AND ADMINISTRATIVE EXPENSES 227,245 477,141
---------- ----------
NET INCOME $1,199,523 $2,539,582
========== ==========
NET INCOME PER SHARE $0.32 $0.68
===== =====
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 3,739,170 3,704,194
========= =========
See notes to financial statements.
2
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ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON ADDITIONAL
STOCK PAID-IN UNREALIZED RETAINED
PAR VALUE CAPITAL LOSS EARNINGS TOTAL
<S> <C> <C> <C> <C> <C>
BALANCE,
FEBRUARY 18, 1997 $ 800 $ 11,200 $ - $ (209) $ 11,791
Issuance of common stock
from private placement 36,000 32,943,904 - - 32,979,904
Issuance of common stock
from private placement 878 877,122 878,000
Available for sale securities -
Fair value adjustment - - (1,172,243) - (1,172,243)
Net income - - - 2,539,582 2,539,582
Dividends declared -
$0.51 per weighted
average share (1,892,604) (1,892,604)
BALANCE
SEPTEMBER 30, 1997 $37,678 $33,832,226 $(1,172,243) $ 646,769 $33,344,430
======= =========== =========== =========== ===========
</TABLE>
3
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ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF CASH FLOWS
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS) THROUGH
SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,539,582
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of mortgage premiums and discounts, net 1,302,859
Gain on sale of Mortgage-Backed Securities (659,265)
Increase in accrued interest receivable (2,109,622)
Increase in other assets (237,362)
Increase in accrued interest payable 2,394,179
Increase in accrued expenses and other liabilities 156,546
----------
Net cash provided by operating activities 3,386,917
----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (537,583,640)
Proceeds from sale of Mortgage-Backed Securities 95,963,096
Principal payments on Mortgage-Backed Securities 33,299,701
Purchase of furniture (1,451)
------------
Net cash used in investing activities (408,322,294)
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 1,563,478,126
Principal payments on repurchase agreements (1,191,187,112)
Net proceeds from private placement equity offering 32,979,904
Net proceeds from direct offering 878,000
Dividends paid (1,214,400)
--------------
Net cash provided by financing activities 404,934,518
--------------
NET INCREASE IN CASH AND CASH EQUIVALENTS (859)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,011
--------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $11,152
==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $7,880,727
==============
NONCASH FINANCING ACTIVITIES:
Unrealized losses on available-for-sale securities, net $1,172,243
==============
Dividends declared, not yet paid $678,204
==============
4
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ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE PERIOD FEBRUARY 18, 1997 (COMMENCEMENT OF OPERATIONS) THROUGH
SEPTEMBER 30, 1997
- --------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in Maryland
on November 25, 1996. The Company commenced its operations of purchasing and
managing an investment portfolio of primarily adjustable-rate Mortgage-Backed
Securities on February 18, 1997, upon receipt of the net proceeds from the
private placement of equity capital (see Note 5).
A summary of the Company's significant accounting policies follows:
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on hand
and money market funds. The carrying amounts of cash equivalents
approximates their value.
MORTGAGE-BACKED SECURITIES - The Company invests primarily in mortgage pass-
through certificates, collateralized mortgage obligations and other mortgage-
backed securities representing interests in or obligations backed by pools of
mortgage loans (collectively, "Mortgage-Backed Securities").
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company
to classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. Although the Company generally
intends to hold most of its Mortgage-Backed Securities until maturity, it
may, from time to time, sell any of its Mortgage-Backed Securities as part of
its overall management of its balance sheet. This flexibility requires the
Company to classify all of its Mortgage-Backed Securities as available-for-
sale. All assets classified as available-for-sale are reported at fair
value, with unrealized gains and losses excluded from earnings and reported
as a separate component of stockholders' equity.
Unrealized losses on Mortgage-Backed Securities that are considered other
than temporary, as measured by the amount of decline in fair value
attributable to factors other than temporary, are recognized in income and
the cost basis of the Mortgage-Backed Securities is adjusted.
Interest income is accrued based on the outstanding principal amount of the
Mortgage-Backed Securities and their contractual terms. Premiums and
discounts associated with the purchase of the Mortgage-Backed Securities are
amortized into interest income over the lives of the securities using the
effective yield method.
Mortgage-Backed Securities transactions are recorded on the date the
securities are purchased or sold. Purchases of newly issued securities are
recorded when all significant uncertainties regarding the characteristics of
the securities are removed, generally shortly before settlement date.
Realized gains and losses on Mortgage-Backed Securities transactions are
determined on the specific identification basis.
5
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CREDIT RISK - At September 30, 1997, the Company has limited its exposure to
credit losses on its portfolio of Mortgage-Backed Securities by only
purchasing securities from Federal Home Loan Mortgage Corporation ("FHLMC"),
Federal National Mortgage Association ("FNMA"), or Government National
Mortgage Association ("GNMA"). The payment of principal and interest on the
FHLMC and FNMA Mortgage-Backed Securities is guaranteed by those respective
agencies and the payment of principal and interest on the GNMA Mortgage-
Backed Securities is backed by the full-faith-and-credit of the U.S.
government. At September 30, 1997, all of the Company's Mortgage-Backed
Securities have an implied "AAA" rating.
INCOME TAXES - The Company will elect to be taxed as a Real Estate Investment
Trust ("REIT") and intends to comply with the provisions of the Internal
Revenue Code of 1986, as amended (the "Code") with respect thereto.
Accordingly, the Company will not be subjected to Federal income tax to the
extent of its distributions to shareholders and as long as certain asset,
income and stock ownership tests are met.
NET INCOME PER SHARE - Net income per share is computed by dividing net
income by the weighted average number of common shares and common share
equivalents (e.g., stock options), if dilutive, outstanding during the
period. The Company had no dilutive common stock equivalents outstanding
during the period.
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
RECENT ACCOUNTING PRONOUNCEMENTS-In February 1997, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting No. 128,
Earnings Per Share (SFAS No. 128). SFAS No. 128 supersedes APB Opinion No.
15, Earnings Per Share, and specifies the computation, presentation and
disclosure requirements for earnings per share (EPS) for entities with
publicly held common stock or potential common stock. SFAS No. 128 will
replace Primary EPS and Fully diluted EPS with Basic EPS and Diluted EPS,
receptively. SFAS No. 128 will require dual presentation of Basic EPS and
Diluted EPS on the face of the income statement for all entities with complex
capital structures. SFAS No. 128 also will require a reconciliation of the
numerator and denominator of the Basic EPS to the numerator and denominator
of the Diluted EPS computation. SFAS NO. 128 will be effective for financial
statements for periods ending after December 15, 1997
In February 1997, the FASB issued SFAS No. 129, Disclosure of Information
about Capital Structure. This statement establishes standards for disclosing
information about an entity's capital structure.
On June 30, 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. This statement requires companies to classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement
of financial position.
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The Company intends to comply with the requirements of these statements which
are effective for periods ending after December 15, 1997. The company has
determined that these statements will not result in material changes to the
Company's financial position and results of operations.
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of September 30, 1997, which are carried
at their fair value:
<TABLE>
<CAPTION>
FEDERAL FEDERAL GOVERNMENT
HOME LOAN NATIONAL NATIONAL TOTAL
MORTGAGE MORTGAGE MORTGAGE MORTGAGE
CORPORATION ASSOCIATION ASSOCIATION ASSETS
<S> <C> <C> <C> <C>
Mortgage-Backed
Securities, gross $32,141,035 $262,678,619 $65,726,026 $360,545,680
Unamortized discount (1,836) (115,095) - (116,931)
Unamortized premium 602,691 7,304,629 1,689,981 9,597,301
----------- ------------ ----------- ------------
Amortized cost 32,741,890 269,868,153 67,416,007 370,026,050
Gross unrealized gains 19,722 221,618 21,827 263,167
Gross unrealized losses (91,715) (1,062,723) (280,972) (1,435,410)
----------- ------------ ----------- ------------
Estimated fair value $32,669,897 $269,027,048 $67,156,862 $368,853,807
=========== ============ =========== ============
</TABLE>
At September 30, 1997, all investments in Mortgage-Backed Securities consist
of securities backed by mortgage loans secured by single-family residential
housing. All of the securities acquired, as of September 30, 1997, are
securitized by either FHLMC, FNMA or GNMA.
The adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every six
months) and lifetime caps. At September 30, 1997, the weighted average
lifetime cap is 11%.
During the period ended September 30, 1997, the Company realized $659,265 in
gains from sales of Mortgage-Backed Securities. There were no losses on
sales of Mortgage-Backed Securities during the period.
3. REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance most of its
Mortgage-Backed Securities. The repurchase agreements are secured by the
market value of the Company's Mortgage-Backed Securities and bear interest
rates that have historically moved in close relationship to LIBOR.
As of September 30, 1997, the Company had outstanding $372,291,014 of
repurchase agreements with a weighted average borrowing rate of 5.63% and a
weighted average remaining maturity of 48 days. At September 30, 1997,
Mortgage-Backed Securities actually pledged have estimated fair value of
$353,264,531.
7
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At September 30, 1997, the repurchase agreements had the following remaining
maturities:
Within 30 days $182,839,014
30 to 89 days 57,584,000
90 days 131,868,000
--------------
$372,291,014
==============
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at September 30, 1997. FASB Statement
No. 107, Disclosures About Fair Value of Financial Instruments, defines the
fair value of a financial instrument as the amount at which the instrument
could be exchanged in a current transaction between willing parties, other
than in a forced or liquidation sale:
CARRYING FAIR
AMOUNT VALUE
Mortgage-Backed Securities $370,026,050 $368,853,807
The fair values of the Company's Mortgage-Backed Securities are based on
market prices provided by certain dealers who make markets in these financial
instruments. The fair values reported reflect estimates and may not
necessarily be indicative of the amounts the Company could realize in a
current market exchange. Cash and cash equivalents, interest receivable,
repurchase agreements and other liabilities are reflected in the financial
statements at their amortized cost, which approximates their fair value
because of the short-term nature of these instruments.
5. COMMON STOCK
During the period the Company completed a private placement of equity
capital. The Company received net proceeds of $32,979,904 from an issuance
of 3,600,000 shares of common stock. The Company received additional
proceeds of $878,000 from an issuance of 87,800 shares of common stock upon
the closing of a direct offering to certain directors, officers, and
employees of the Company on July 31, 1997.
During the Company's period ending September 30, 1997, the Company declared
dividends to shareholders totaling $1,892,604, or $.51 per weighted average
share, of which $1,214,400, or $.33 per share was paid during the period and
$678,204, or $.18 per share was paid on October 23, 1997. For Federal income
tax purposes, $.06 of the dividend is long-term capital gains and all other
dividends paid for the period is ordinary income to the Company's
stockholders.
6. LONG TERM STOCK INCENTIVE PLAN
The Company has adopted a Long Term Stock Incentive Plan for executive
officers, key employees and nonemployee directors (the "Incentive Plan").
The Incentive Plan authorizes the Compensation Committee of the Board of
Directors to grant awards, including incentive stock options as defined
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under section 422 of the Code ("ISOs") and options not so qualified
("NQSOs"). The Incentive Plan authorizes the granting of options or other
awards for an aggregate of the greater of 500,000 shares or 5% of the
outstanding shares of the Company's common stock.
Information regarding options is as follows:
Number of Weighted
Shares Average
Represented Excercise
By Options Price
Granted (311,000 ISOs,37,500, NQSOs) 345,500 $ 642
Exercised - -
Expired - -
------- -----
Outstanding, end period 348,500 $6.42
======= =====
Information regarding exercise prices and contractual life:
OPTIONS OUTSTANDING
-------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
RANGE OF OPTIONS CONTRACTUAL EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YRS.) PRICE
$4.00 208,250 3.7 $4.00
10.00 140,250 3.6 10.00
$4.00-$10.00 348,500 3.9 $6.42
============ ======= === =====
The vesting periods for the options are as f ollows: 7,500 options vested as
of June 26, 1997. The remainder of the options will vest in four equal
annual installments beginning in 1998 and ending in 2001.
7. SUBSEQUENT EVENT
The Company raised additional estimated net capital of $99,088,476 after
underwriting fees and expenses, on October 14, 1997 upon the consummation of
the public offering of an aggregate of 8,946,100 shares at $12.00 per share.
9
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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.
SAFE HARBOR STATEMENT
Certain statements contained herein are not, and certain statements contained
in future filings by the Company with the Securities and Exchange Commission, in
the Company's press releases or in the Company's other public or shareholder
communications may not be, based on historical facts and are "Forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements which are based on various assumptions
(some of which are beyond the Company's control), may be identified by reference
to a future period or periods, or by the use of forward-looking terminology,
such as "may," "will," "believe," "expect," "anticipate," "continue," or similar
terms or variations on those terms, or the negative of those terms. Actual
results could differ materially from those set forth in forward-looking
statements due to a variety of factors, including, but not limited to, changes
in interest rates, changes in yield curve, changes in prepayment rates, the
availability of Mortgage-Backed Securities for purchase, the availability of
financing and, if available, the terms of any such financing. For a discussion
of the risks and uncertainties which could cause actual results to differ from
those contained in the forward-looking statements, see "Risk Factors" commencing
on page 12 of the Company's Prospectus dated October 8, 1997. The Company does
not undertake, and specifically disclaims any obligation, to publicly release
the result of any revisions which may be made to any forward-looking statements
to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
OVERVIEW
The Company is a real estate investment trust ("REIT") which acquires and
manages a portfolio of mortgage-backed securities ("Mortgage-Backed Securities")
which can be readily financed. The Company commenced operations on February 18,
1997 upon the closing of the sale by the Company of 3,600,000 shares of common
stock of the Company ("Common Stock") in an offering exempt from registration
under the Securities Act of 1933, as amended (the "Securities Act") and state
securities law (the "Private Placement"). Mortgage-Backed Securities acquired by
the Company from time to time may include mortgage-pass through certificates,
collateralized mortgage obligations and other securities representing interests
in or obligations backed by pools of mortgage loans. At September 30, 1997, all
of the Mortgage-Backed Securities held by the Company were "Agency
Certificates." Agency Certificates consist of mortgage participation
certificates issued by the Federal Home Loan Mortgage Corporation, Pass-Through
Certificates issued by the Federal National Mortgage Association, and fully
modified Pass-Through Certificates guaranteed by the Government National
Mortgage Association.
The Company received additional proceeds of $878,000 upon the closing on
July 31, 1997 of the sale of an aggregate of 87,800 shares of Common Stock to
certain directors, officers and employees of the Company. The Company received
additional proceeds of approximately $99.1 million after deducting the
underwriters' discount and estimated expenses of the offering, on October 14,
1997, upon the consummation of the Company's public offering of 8,946,100 shares
at a price to the public of $12 per share.
10
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The Company's principal business is to generate net income for distribution
to stockholders from the spread between the interest income on its Mortgage-
Backed Securities and the costs of borrowing to finance its acquisition of
Mortgage-Backed Securities. Since its commencement of operations on February
18, 1997, the Company has been in the process of building its balance sheet by
acquiring Mortgage-Backed Securities. Therefore, the operating results of the
Company reflected in the financial statements included in this Form 10-Q should
be interpreted in light of this growth process and are not necessarily
representative of what they may be in the future.
The Company will seek to generate growth in earnings and dividends per share
in a variety of ways, including through (i) issuing new Common Stock and
increasing the size of the balance sheet when opportunities in the market for
Mortgage-Backed Securities are likely to allow growth in earnings per share,
(ii) seeking to improve productivity by increasing the size of the balance sheet
at a rate faster than the rate of increasing operating expenses, (iii)
continually reviewing the mix of Mortgage-Backed Security types on the balance
sheet in an effort to improve risk-adjusted returns, and (iv) attempting to
improve the efficiency of the Company's balance sheet structure through the
issuance of uncollateralized subordinated debt, preferred stock and other forms
of capital, to the extent management deems such issuances appropriate.
The Capital Investment Policy is the policy established by the Company,
including a majority of the Independent Directors, establishing guidelines for
management relating to asset acquisitions, credit risk management, capital and
leverage, interest rate risk management and prepayment risk management . Under
the Capital Investment Policy adopted by the Company (the "Capital Investment
Policy"), at least 75% of the Company's total assets will be comprised of "High
Quality" Mortgage-Backed Securities and "High Quality" short-term investments.
The term "High Quality" means securities (i) which are rated within one of the
two highest rating categories by at least one of the nationally recognized
rating agencies, (ii) that are unrated but are either guaranteed by the United
States government or an agency of the United States government, or (iii) that
are unrated or whose ratings have not been updated but are determined to be of
comparable quality to rated High Quality Mortgage-Backed Securities on the basis
of credit enhancement features that meet the High Quality credit criteria
approved by the Company's Board of Directors. The remainder of the Company's
assets, comprising not more than 25% of total assets, may consist of other
qualified REIT real estate assets which are unrated or rated less than High
Quality but which are at least "investment grade" (rated "BBB" or better by
Standard & Poor's Corporation or the equivalent by another nationally recognized
rating organization or, if not rated, are determined by the Company to be of
comparable credit quality to an investment which is rated "BBB" or better.
Mortgage-Backed Securities acquired by the Company from time to time may
include, but will not be limited to, Mortgage-Backed Securities backed by
single-family residential mortgage loans and Mortgage-Backed Securities backed
by loans on multi-family, commercial or other real estate-related properties.
RESULTS OF OPERATIONS: FOR THE QUARTER ENDED SEPTEMBER 30, 1997 AND THE
PERIOD FROM FEBRUARY 18, 1997 TO SEPTEMBER 30, 1997
The Company's 1997 fiscal year commenced with the start of operations on
February 18, 1997 and will conclude December 31, 1997. The 225 day period from
February 18, 1997 to September 30, 1997 is referred to herein as "the period
ended September 30, 1997."
NET INCOME SUMMARY
For the quarter ended September 30, 1997, net income was $1,199,523, or $0.32
per weighted average share. For the period ended September 30, 1997, net income
was $2,539,582 or $0.68 per weighted average share. Net income per share is
computed by dividing net income by the weighted average number of
11
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shares of Common Stock outstanding, which were 3,739,170 for the quarter and
3,704,194 for the period. Dividends per share were $0.51 per weighted average
share, $1,891,604 in total. Taxable income did not differ from GAAP income for
the period. Return on average equity was 12.37% on an annualized basis, for the
period ended September 30, 1997.
Management's policy is to focus on income and expense measures as a
percentage of equity rather than as a percentage of assets. Therefore,
improvements in asset-based measures such as net interest margin or operating
expenses as a percentage of assets do not necessarily translate into improved
stockholder returns. Improvements in net interest income or operating expenses
as a percentage of equity, however, indicate that the Company is effectively
utilizing its equity capital base.
TAXABLE INCOME AND GAAP INCOME
For the period ended September 30, 1997, income as calculated for tax
purposes (taxable income) did not differ from income as calculated according to
generally accepted accounting principles (GAAP income). However, such amounts
could differ in the future for various reasons. For example, the Company may
take credit provisions which would affect GAAP income whereas only actual credit
losses are deducted in calculating taxable income. In addition, general and
administrative expenses may differ due to differing treatment of leasehold
amortization, certain stock option expenses and other items. As of September
30, 1997, the Company had not taken credit provisions because all of the
Mortgage-Backed Securities acquired by the Company through September 30, 1997
had been Agency Certificates which, although not rated, carry an implied "AAA"
rating.
The distinction between taxable income and GAAP income is important to the
Company's stockholders because dividends are declared on the basis of taxable
income. While the Company does not pay taxes so long as it satisfies the
requirements fro exemption from taxation pursuant to the REIT Provisions of the
Code, each year the Company completes a corporate tax form wherein taxable
income is calculated as if the Company were to be taxed. This taxable income
level determines the amount of dividends the Company can pay out over time.
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
The Company had average earning assets of $383.6 million for the quarter
ended September 30, 1997 and $316.2 million for the period ended September 30,
1997. The Company's primary source of income for the period ended September
30, 1997 was interest income. A portion of income was generated by gains on
sales of Mortgage-Backed Securities. Interest income was $6.1 million for the
quarter ended September 30, 1997 and $12.6 million for the period ended
September 30, 1997. The yield on average earning assets was 6.33% for the
quarter ended September 30, 1997 and 6.46% for the period ended September 30,
1997. The table below shows, for the quarter ended and the period ended
September 30, 1997, the Company's average balance of cash equivalents and
Mortgage-Backed Securities, the yields earned on each type of earning assets,
the yield on average earning assets and interest income.
12
<PAGE>
AVERAGE EARNING ASSET YIELD
(dollars in thousands)
<TABLE>
<CAPTION>
Yield on
Average Average
Amortized Amortized
Cost of Yield on Cost of Yield on
Average Mortgage- Average Average Mortgage- Average
Cash Backed Earning Cash Backed Earning Interest
Equivalents Securities Assets Equivalents Securities Assets Income
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended September 30, 1997 $2 $383,556 $383,558 3.26% 6.33% 6.33% $6,123
For the Period Ended September 30, 1997 $76 $316,245 $316,321 4.60% 6.46% 6.46% $12,632
</TABLE>
The Constant Prepayment Rate (or "CPR") on the Company's portfolio of
Mortgage-Backed Securities for the period ended September 30, 1997 was 17%.
"CPR" means an assumed rate of prepayment for the Company's Mortgage-Backed
Securities, expressed as an annual rate of prepayment relative to the
outstanding principal balance of the Company's Mortgage-Backed Securities. This
CPR does not purport to be either a historical description of the prepayment
experience of the Company's Mortgage-Backed Securities or a prediction of the
anticipated rate of prepayment of the Company's Mortgage-Backed Securities.
Since a large portion of the Company's assets was purchased at a premium to par
value and only a small portion of the Company's assets was purchased at a
discount to par value, the premium balance in the Company's portfolio is
substantially higher than the discount balance. Principal prepayments had a
negative effect on the Company's earning asset yield for the period ended
September 30, 1997 because the Company adjusts its rate of premium amortization
and discount accretion monthly based on actual payments received.
INTEREST EXPENSE AND THE COST OF FUNDS
The Company had average borrowed funds of $357.2 million and total
interest expense of $5.1 million for the quarter ended September 30, 1997. The
average cost of funds was 5.69% for the same period. The Company had average
borrowed funds of $285.2 million and total interest expense of $10.3 million for
the period ended September 30, 1997. The average cost of funds was 5.84% for
the same period. The Company anticipates that its largest expense will usually
be the cost of borrowed funds. Interest expense is calculated in the same
manner for GAAP and tax purposes.
With the Company's current asset/liability management strategy, changes in
the Company's cost of funds are expected to be closely correlated with changes
in short-term LIBOR, although the Company may choose to extend the maturity of
its liabilities at any time. The Company's average cost of funds was 0.06%
above one-month LIBOR for the quarter ended September 30, 1997. The Company's
average cost of funds was 0.10% above one-month LIBOR for the period ended
September 30, 1997. The Company generally has structured its borrowings to
adjust with one-month LIBOR because the Company believes that one-month LIBOR
may continue to be lower than six-month LIBOR in the present interest rate
environment. During the period ended September 30, 1997, average one-month
LIBOR, which was 5.64%, was 0.17% lower than average six month LIBOR, which was
5.81%.
The table below shows, for the quarter ended and the period ended September
30, 1997, the Company's average borrowed funds and average cost of funds as
compared to average one and six-month LIBOR.
13
<PAGE>
AVERAGE COST OF FUNDS
(dollars in thousands)
<TABLE>
<CAPTION>
Average Average Average
One-Month Cost of Cost of
LIBOR Funds Funds
Relative to Relative to Relative to
Average Average Average Average Average Six- Average Average
Borrowed Interest Cost of One-Month Six-Month Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended September 30, 1997 $357,205 $5,126 5.69% 5.63% 5.81% (0.18%) 0.06% (0.12%)
For the Period Ended September 30, 1997 $285,219 $10,275 5.84% 5.64% 5.81% (0.17%) 0.10% 0.03%
</TABLE>
NET INTEREST RATE AGREEMENT EXPENSE
For the period ended September 30, 1997, the Company did not enter into any
interest rate agreements. As part of its asset/liability management process,
the Company may enter into interest rate agreements such as interest rate caps,
floors and swaps. The agreements would be entered into to reduce interest rate
risk and would be designed to provide income and capital appreciation to the
Company in the event of certain changes in interest rates. While the Company has
determined, based upon the current interest rate environment and other relevant
factors, that it would not be economically advantageous, at present, for the
Company to enter into interest rate agreements, the Company may enter into such
agreements in the future.
NET INTEREST INCOME
Interest income, which equals interest income less interest expense, totaled
$997,367 for the quarter ended September 30, 1997, and $2.3 million for the
period ended September 30, 1997. Net interest spread, which equals the yield
on the Company's average assets for the period less the average cost of funds
for the period, was 0.64% for the quarter ended September 30, 1997 and 0.62% for
the period ended September 30, 1997. Net interest margin, which equals net
interest income divided by average total assets, was 1.16% on an annualized
basis, for the period ended September 30, 1997. The principal reason that
annualized net interest margin exceeded net interest spread is that average
assets exceeded average liabilities. A portion of the Company's assets is
funded with equity rather than borrowings. The Company did not have any
interest rate agreement expenses for the period ended September 30, 1997.
The table below shows interest income by earning asset type, average earning
assets by type, total interest income, interest expense, average repurchase
agreements, average cost of funds, and net interest income for the quarter ended
September 30, 1997 and the period ended September 30, 1997.
14
<PAGE>
NET INTEREST INCOME
(dollars in thousands)
<TABLE>
<CAPTION>
Average
Amortized
Cost of Interest Yield on
Mortgage- Income on Interest Average Average
Backed Mortgaged- Average Income on Total Interest Balance of Average Net
Securities Backed Cash Cash Interest Earning Repurchase Interest Cost of Interest
Held Securities Equivalents Equivalents Income Assets Agreements Expense Funds Income
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1997 $383,556 $6,123 $2 - $6,123 6.33% $357,205 $5,126 5.69% $997
For the Period Ended
September 30, 1997 $316,245 $12,602 $76 $31 $12,632 6.46% $285,219 $10,275 5.84% $2,357
</TABLE>
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the quarter ended September 30, 1997, the Company sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $64.8 million for an
aggregate gain of $429,400. For the period ended September 30, 1997, the
Company sold Mortgage-Backed Securities with an aggregate historical amortized
cost of $139.4 million for an aggregate gain of $659,265. The difference
between the sale price and the historical amortized cost of the Mortgage-Backed
Securities is a realized gain and increased income accordingly. The Company
does not expect to sell assets on a frequent basis, but may from time to time
sell existing assets to move into new assets which management believes might
have higher risk-adjusted returns or to manage its balance sheet as part of
management's asset/liability management strategy.
CREDIT EXPENSES
The Company has not experienced credit losses on its portfolio of Mortgage-
Backed Securities to date, but losses may be experienced in the future. At
September 30, 1997, the Company had limited its exposure to credit losses on its
portfolio of Mortgage-Backed Securities by purchasing only Agency Certificates
which, although not rated, carry an implied "AAA" rating.
GENERAL AND ADMINISTRATIVE EXPENSES
General and Administrative expenses ("operating expense" or "G&A expense")
was $227,245 for the quarter ended September 30, 1997 and $477,141 for the
period ended September 30, 1997. There were no differences in the calculation
of G&A expense for taxable and GAAP income purposes.
G&A EXPENSE RATIOS
(dollars in thousands)
<TABLE>
<CAPTION>
Total G&A Total G&A
Cash Expense/ Expense/
Comp and Other Total Average Average Efficiency
Benefits G&A G&A Assets Equity Ratio
Expense Expense Expense (annualized) (annualized) (annualized)
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
For the Quarter Ended September 30, 1997 $99 $128 $227 0.22% 2.68% 22.78%
For the Period Ended September 30, 1997 $239 $238 $477 0.24% 2.32% 20.24%
</TABLE>
The Company expects G&A expense to increase following the Offering. The
Company hired a new employee, on October 15, 1997, to expand the Company's
capabilities with respect to acquiring and monitoring its portfolio of
Mortgage-Backed Securities. In addition, certain compensation expenses will
increase commensurate with growth in the Company's equity base. Despite these
increases in operating expenses, management believes that the Company's
operating expenses over time are likely to grow at a slower rate than its asset
or equity base and thus management believes that the Company's operating expense
ratios are likely to continue to improve over time.
15
<PAGE>
NET INCOME AND RETURN ON AVERAGE EQUITY
Net income was $1.2 million for the quarter ended September 30, 1997. For the
period ended September 30, 1997, net income was $2.5 million. Return on average
equity for the period ended September 30, 1997, was 12.37% on an annualized
basis. The table below shows, on an annualized basis, for the quarter ended and
the period ended September 30, 1997, the Company's net interest income, gain on
sale of Mortgage-Backed Securities and G&A expense each as a percentage of
average equity, and the return on average equity.
COMPONENTS OF RETURN ON AVERAGE EQUITY
<TABLE>
<CAPTION>
Gain on Sale of
Mortgage-Backed
Net Interest Income/ Securties/ Average G&A Expense/ Return on Average
Average Equity Equity Average Equity Equity
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
For the Quarter Ended September 30, 1997 11.76% 5.06% 2.68% 14.14%
For the Period Ended September 30, 1997 11.48% 3.21% 2.32% 12.37%
</TABLE>
DIVIDENDS AND TAXABLE INCOME
The Company will elect to be taxed as a REIT under the Internal Revenue Code
of 1986, as amended. Accordingly, the Company intends to distribute
substantially all of its taxable income for each year to stockholders, including
income resulting from gains on sales of Mortgage-Backed Securities. On a
cumulative basis through September 30, 1997, earned taxable income exceeded
dividend declarations by $646,978, or $0.17 per share, based on the number of
shares of Common Stock outstanding at period end.
DIVIDEND SUMMARY
(dollars in thousands)
<TABLE>
<CAPTION>
Weighted Taxable Dividend Per Cumulative
Taxable Average Net Weighted Dividend Undistributed
Net Common Income Average Total Pay-Out Taxable
Income Shares Per Share Share Dividends Ratio Income
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended September 30, 1997 $1,200 3,739,170 $0.32 $0.18 $678 56.5%
For the Period Ended September 30, 1997 $2,539 3,704,194 $0.68 $0.51 $1,892 74.5% $647
</TABLE>
FINANCIAL CONDITION
MORTGAGE-BACKED SECURITIES
All of the Company's Mortgage-Backed Securities at September 30, 1997 were
adjustable-rate or fixed-rate Mortgage-Backed Securities backed by Single-Family
Mortgage Loans. All of the mortgage assets underlying such Mortgage-Backed
Securities were secured with a first lien position with respect to the
underlying single-family properties. At September 30, 1997, all the Company's
Mortgage-Backed Securities were Agency Certificates which carry an implied "AAA"
rating. All of the Company's earning assets are marked-to-market at liquidation
value.
Discount balances are accreted as an increase in interest income over the
life of discount
16
<PAGE>
Mortgage-Backed Securities and premium balances are amortized as a decrease in
interest income over the life of premium Mortgage-Backed Securities. At
September 30, 1997, the Company had on it's balance sheet $116,931 total
unamortized discount (which is the difference between the remaining principal
value and the current historical amortized cost of Mortgage-Backed Securities
acquired at a price below principal value) and $9.6 million total unamortized
premium (which is the difference between the remaining principal value and the
current historical amortized cost of Mortgage-Backed Securities acquired at a
price above principal value).
Mortgage principal repayments received were $33.3 million for the period
ended September 30, 1997, which equals a CPR of 17%. Given the Company's
current portfolio composition, if mortgage principal repayment rates increase
over the life of the Mortgage-Backed Securities comprising the current
portfolio, all other factors being equal, the Company's net interest income
should decrease during the life of such Mortgage-Backed Securities as the
Company will be required to amortize its net premium balance into income over a
shorter time period. Similarly, if mortgage principal prepayment rates decrease
over the life of such Mortgage-Backed Securities, all other factors being
equal, the Company's net interest income should increase during the life of
such Mortgage-Backed Securities as the Company will amortize its net premium
balance over a longer time.
The table below summarizes the Company's Mortgage-Backed Securities at
September 30, 1997.
MORTGAGE-BACKED SECURITIES
(dollars in thousands)
<TABLE>
<CAPTION>
Amortized Estimated
Cost Fair Value
Principal Net Amortized Principal Estimated Principal Weighted
Value Premium Cost Value Fair Value Value Average Yield
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
At September 30, 1997 $360,546 $9,480 $370,026 102.63% $368,854 102.30% 6.58%
</TABLE>
During the period ended September 30, 1997, the Company's Mortgage-Backed
Securities consisted solely of Agency Certificates. However, the Company may
purchase other types of Mortgage-Backed Securities in the future.
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITY CHARACTERISTICS
(dollars in thousands)
<TABLE>
<CAPTION>
Weighted Principal Value
Average at Period End
Weighted Term to Weighted as % of
Average Weighted Weighted Next Average Weighted Mortgage-
Principal Coupon Average Average Coupon Lifetime Average Backed
Value Rate Index Level Net Margin Adjustment Cap Asset Yield Securities
------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
At September 30, 1997 $350,221 7.26% 5.48% 1.78% 1 11.30% 6.56% 97.14%
</TABLE>
The tables below set forth certain characteristics of the Company's Mortgage-
Backed Securities at September 30, 1997. The index level for adjustable-rate
Mortgage-Backed Securities is the weighted average rate of the various short-
term interest rate indices which determine the coupon rate.
17
<PAGE>
FIXED-RATE MORTGAGE-BACKED SECURITY CHARACTERISTICS
(dollars in thousands)
<TABLE>
<CAPTION>
Principal Value as %
Weighted Average Weighted Average of Mortgage- Backed
Principal Value coupon Rate Asset Yield Securities
---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At September 30, 1997 $10,325 8.00% 7.30% 2.86%
</TABLE>
At September 30, 1997, the Company held Mortgage-Backed Securities with
coupons linked to the one- year Treasury Index, one month LIBOR and the six-
month CD rate. The table below segments the Company's adjustable-rate Mortgage-
Backed Securities by type of adjustment index, coupon adjustment frequency and
annual and lifetime cap adjustment.
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITIES BY INDEX
<TABLE>
<CAPTION>
1-Year Treasury
One-Month LIBOR Six-Month CD Rate Index
----------------------------------------------------
<S> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 6 mo.
Weighted Average Annual; Period Cap none 2.00% 1.78%
Weighted Average Lifetime Cap 9.60% 11.06% 11.78%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities 16.71% 19.97% 60.46%
</TABLE>
The table below shows unrealized gains and losses on the Mortgage-Backed
Securities in the Company's portfolio at September 30, 1997.
UNREALIZED GAINS AND LOSSES
<TABLE>
<CAPTION>
At
September 30, 1997
----------------------
(dollars in thousands)
<S> <C>
Unrealized Gain $ 263
Unrealized Loss (1,435)
Net Unrealized Loss (1,172)
Net Unrealized Loss as % of Mortgage-Backed Securities Principal Value 0.33%
Net Unrealized Loss as % of Mortgage-Backed Securities Amortized Cost 0.32%
</TABLE>
INTEREST RATE AGREEMENTS
Interest rate agreements are assets that are carried on a balance sheet at
estimated liquidation value. At September 30, 1997, there were no interest rate
agreements on the Company's balance sheet.
18
<PAGE>
BORROWINGS
To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's Mortgage-Backed Securities. These
borrowings appear on the balance sheet as repurchase agreements. At September
30, 1997, the Company had established uncommitted borrowing facilities in this
market with nineteen lenders in amounts which the Company believes are in excess
of its needs. All of the Company's Mortgage-Backed Securities are currently
accepted as collateral for such borrowings. The Company, however, limits its
borrowings, and thus its potential asset growth, in order to maintain unused
borrowing capacity and thus increase the liquidity and strength of its balance
sheet.
For the period ended September 30, 1997, the term to maturity of the
Company's borrowings has ranged from one day to six months, with a weighted
average original term to maturity of 90 days and a weighted average remaining
maturity of 48 days at September 30, 1997. Many of the Company's borrowings
have a cost of funds which adjusts monthly based on a fixed spread over or under
one-month LIBOR or based on the daily Fed Funds rate. As a result, the average
term to the next rate adjustment for the Company's borrowings is typically
shorter than the term to maturity for the Company's Mortgage-Backed Securities.
At September 30, 1997, the weighted average cost of funds for all of the
Company's borrowings was 5.62% and the weighted average term to next rate
adjustment was 48 days.
LIQUIDITY
Liquidity, which is the Company's ability to turn non-cash assets into cash,
allows the Company to purchase additional Mortgage-Backed Securities and to
pledge additional assets to secure existing borrowings should the value of
pledged assets decline. Potential immediate sources of liquidity for the
Company include cash balances and unused borrowing capacity. Unused borrowing
capacity will vary over time as the market value of the Company's Mortgage-
Backed Securities varies. The Company's balance sheet also generates liquidity
on an on-going basis through mortgage principal repayments and net earnings held
prior to payment as dividends. Should the Company's needs ever exceed these on-
going sources of liquidity plus the immediate sources of liquidity discussed
above, management believes that the Company's Mortgage-Backed Securities could
in most circumstances be sold to raise cash.
STOCKHOLDERS' EQUITY
The Company uses "available-for-sale" treatment for its Mortgage-Backed
Securities; these assets are carried on the balance sheet at estimated market
value rather than historical amortized cost. Based upon such "available-for-
sale" treatment, the Company's equity base at September 30, 1997 was $33.3
million, or $8.85 per share. If the Company had used historical amortized cost
accounting, the Company's equity base at September 30, 1997 would have been
$34.5 million, or $9.16 per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact GAAP or taxable income but
rather are reflected on the balance sheet by changing the carrying value of the
assets and reflecting the change in stockholders' equity under "Net Unrealized
Losses on Assets Available of Sale." By accounting for its assets in this
manner, the Company hopes to provide useful information to stockholders and
creditors and to preserve flexibility to sell assets in the future without
having to change accounting methods.
As a result of this mark-to-market accounting treatment, the book value and
book value per share of the Company are likely to fluctuate far more than if the
Company used historical amortized cost
19
<PAGE>
accounting. As a result, comparison with companies that use historical cost
accounting for some or all of their balance sheet may be misleading.
Unrealized changes in the estimated net market value of Mortgage-Backed
Securities have one direct effect on the Company's potential earnings and
dividends: positive market-to-market changes will increase the Company's equity
base and allow the Company to increase its borrowing capacity while negative
changes in the net market value of the Company's Mortgage-Backed Securities
might impair the Company's liquidity position, requiring the Company to sell
assets with the likely result of realized losses upon sale. "Net Unrealized
Losses on Assets Available for Sale" was $1.2 million, or 0.32% of the amortized
cost of Mortgage-Backed Securities at September 30, 1997.
The table below shows the Company's equity capital base as reported and on a
historical amortized cost basis at September 30, 1997. The historical cost
equity basis is influenced by issuances of Common Stock, the level of GAAP
earnings as compared to dividends declared, and other factors. The GAAP
reported equity base is influenced by these factors plus changes in the "Net
Unrealized Losses on Assets Available for Sale" account.
STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
GAAP Reported
Net Unrealized GAAP Reported Historical Amortized Equity
Historical Amortized Losses on Assets Equity Base Cost Equity Per (Book Value Per
Cost Equity Base Available for Sale (Book Value) Share Share)
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
At September 30, 1997 $34,517 $1,172 $33,345 $9.16 $8.85
</TABLE>
LEVERAGE
The Company's debt-to-GAAP reported equity ratio at September 30, 1997 was
11:1. The Company generally expects to maintain a ratio of debt-to-equity of
between 8:1 to 12:1, although the ratio may vary from time to time based upon
various factors, including management's opinion of the level of risk of its
assets and liabilities, the Company's liquidity position, the level of unused
borrowing capacity and over-collateralization levels required by lenders when
the Company pledges assets to secure borrowings.
The target debt-to-GAAP reported equity ratio is determined under the
Company's Capital Investment Policy. Should the actual debt-to-equity ratio of
the Company increase above the target level due to asset acquisition and/or
market value fluctuations in assets, management will cease to acquire new
assets. Management will, at such time, present a plan to its Board of Directors
to bring the Company back to its target debt-to equity ratio; in many
circumstances, this would be accomplished in time by the monthly reduction of
the balance of Mortgage-Backed Securities through principal repayments.
ASSET/LIABILITY MANAGEMENT AND EFFECT OF CHANGES IN INTEREST RATES
Management continually reviews the Company's asset/liability management
strategy with respect to interest rate risk, mortgage prepayment risk, credit
risk and the related issues of capital adequacy and liquidity. The Company
seeks attractive risk-adjusted stockholder returns while maintaining a strong
balance sheet.
20
<PAGE>
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, although it has not done so to date, the
Company may seek to mitigate the potential impact on net income of periodic and
lifetime coupon adjustment restrictions in its portfolio of Mortgage-Backed
Securities by entering into interest rate agreements such as interest rate caps
and interest rate swaps. While the Company has determined, based upon the
current interest rate environment and other relevant factors, that it would not
be economically advantageous, at present, for the Company to enter into interest
rate agreements, the company may enter into such agreements in the future.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal prepayment rate from an economic point of view by balancing
assets purchased at a premium with assets purchased at a discount. To date, the
aggregate premium exceeds the aggregate discount on Mortgage-Backed Securities
in the Company's portfolio. As a result, prepayments, which result in the
expensing of unamortized premium, will reduce the Company's net income compared
to what net income would be absent such prepayments.
INFLATION
Virtually all of the Company's assets and liabilities are financial in
nature. As a result, interest rates and other factors drive the Company's
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates. The
Company's financial statements are prepared in accordance with GAAP and the
Company's dividends are determined by the Company's net income as calculated for
tax purposes; in each case, the Company's activities and balance sheet are
measured with reference to historical cost or fair market value without
considering inflation.
21
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 1997 there were no pending legal proceedings to which the
Company as a party or of which any of its property was subject.
Item 2. Changes in Securities and Use of Proceeds
Changes in Securities
---------------------
On July 31, 1997, the Company sold 87,800 shares of Common Stock to certain
directors, officers and employees of the Company at a price of $10.00 per share
of Common Stock or $878,000 in the aggregate. The foregoing shares were sold
without registration under the Securities Act in reliance on the exemption
provided by Section 4(2) thereof.
Use of Proceeds of Initial Public Offering
------------------------------------------
Effective Date of the Company's Registration Statements: October 7, 1997
(effective date of Post-Effective Amendment No. 1 to Registration Statements -
October 8, 1997)
Commission File Numbers: 333-32913 and 333-37391
Date the Offering Commenced: October 8, 1997
Names of Managing Underwriters: Friedman, Billings, Ramsey & Co., Inc.,
Sutro & Co. Incorporated and Tucker Anthony
Incorporated
Class of Securities Registered: Common Stock
Amount Registered and Sold: See below
The following table sets forth the amount and aggregate offering price of
securities registered and sold for the account of the Company and for the
accounts of the selling stockholders in the Offering:
For the Account of the Company
------------------------------
Amount registered - 8,946,100 shares
Aggregate price of offering amount registered - $107,353,200
Amount sold - 8,946,100 shares
Aggregate offering price of amount sold - $107,353,200
For the Accounts of the Selling Stockholders
--------------------------------------------
Amount registered - 845,000 shares
Aggregate price of offering amount registered - $10,140,000
Amount sold - 845,000
Aggregate offering price of amount sold - $10,140,000
Expenses:
22
<PAGE>
The expenses incurred for the Company's account in connection with the
Offering are as follows:
<TABLE>
<CAPTION>
<S> <C>
Underwriting Discounts and Commissions* $7,514,724
Finders Fees* $ 0
Expenses Paid to or for Underwriters** $ 0
Other Expenses** $ 750,000
Total Expenses** $8,264,724
</TABLE>
* Actual amount of expense
** Reasonable estimate for amount of expense
None of the expenses of the Offering consisted of direct or indirect payments to
(i) directors, officers, general partners of the Company or their associates,
(ii) persons owning 10 percent or more of any class of equity securities of the
Company, or (iii) affiliates of the Company.
Net Proceeds: The net offering proceeds to the Company from the Offering after
deducting the total expenses described above was $99,088,476. All of
the net proceeds of the Offering have been used to acquire Mortgage-
Backed Securities.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 10.1 - Form of Purchase Agreement between the Company and the
purchasers in the Direct Offering (incorporated by reference to
Exhibit 10.8 to the Company's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
Exhibit 27.1 - Financial Data Schedule
(b) Reports
None
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
ANNALY MORTGAGE MANAGEMENT
Dated: November 10, 1997 By:/s/ Michael A.J. Farrell
------------------------
Michael A.J. Farrell
Chairman of the Board and Chief
Executive Officer (authorized
officer of registrant)
Dated: November 10, 1997 By:/s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
Chief Financial Officer and
Treasurer (principal accounting
officer)
Exhibit Index
Exhibit No.
10.1 Form of Purchase Agreement between the Company and the purchasers in the
Direct Offering (incorporated by reference to Exhibit 10.8 to the
Company's Registration Statement on Form S-11 (Registration No. 333-
32913) filed with the Securities and Exchange Commission on August 5,
1997).
27.1 Financial Data Schedule
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1997 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> FEB-18-1997
<PERIOD-END> SEP-30-1997
<CASH> 11
<SECURITIES> 369,854
<RECEIVABLES> 46,167
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 415,268
<PP&E> 2
<DEPRECIATION> 0
<TOTAL-ASSETS> 415,268
<CURRENT-LIABILITIES> 381,926
<BONDS> 368,854
0
0
<COMMON> 33,870
<OTHER-SE> (525)
<TOTAL-LIABILITY-AND-EQUITY> 415,270
<SALES> 0
<TOTAL-REVENUES> 12,632
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 477
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10,275
<INCOME-PRETAX> 2,540
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,540
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,540
<EPS-PRIMARY> 0.68
<EPS-DILUTED> 0.68
</TABLE>
