<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, 1998
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)
<TABLE>
<S> <C>
MARYLAND 22-3479661
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)
</TABLE>
12 EAST 41ST STREET, SUITE 700
NEW YORK, NEW YORK
(Address of principal executive offices)
10017
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No _____
-----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of stock, as of the last practicable date:
Class Outstanding November 13, 1998
Common Stock, $.01 par value 12,648,074
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
<S> <C>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Balance Sheets - December 31, 1997 and September 30, 1998 (Unaudited) 1
Statements of Operations (Unaudited) for the quarters ended September 30, 1997 and 1998 2
Statements of Operations (Unaudited) for the period February 18, 1997 to September 30,
1997 and the nine months ended September 30, 1998 3
Statement of Stockholders' Equity (Unaudited) for the nine months ended September 30, 1998 4
Statements of Cash Flows (Unaudited) for the quarters ended September 30, 1997 and 1998 5
Statements of Cash Flows (Unaudited) for the period February 18, 1997 through September 30,
1997 and the nine months ended September 30, 1998 6
Notes to Financial Statements (Unaudited) 7-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13-25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
</TABLE>
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
1998 (UNAUDITED) 1997
-----------------------------------
<S> <C> <C>
ASSETS
CASH AND CASH EQUIVALENTS $ 137,521 $ 511,172
MORTGAGE-BACKED SECURITIES,
At fair value 1,483,195,158 1,161,779,192
RECEIVABLE FOR MORTGAGE-BACKED SECURITIES SOLD 106,717,843 0
ACCRUED INTEREST RECEIVABLE 7,538,267 5,338,861
OTHER ASSETS 230,207 111,257
-----------------------------------
TOTAL ASSETS $1,597,818,996 $1,167,740,482
===================================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements $1,450,381,000 $ 918,869,000
Payable for Mortgage-Backed Securities purchased 0 105,793,723
Accrued interest payable 13,437,440 4,992,447
Dividends payable 3,414,980 2,797,058
Accounts payable 244,033 201,976
-----------------------------------
Total liabilities 1,467,477,453 1,032,654,204
-----------------------------------
STOCKHOLDERS' EQUITY:
Common stock: par value $.01 per share;
100,000,000 authorized; 12,757,674 and 12,713,900
shares issued and outstanding, respectively 127,577 127,139
Additional paid-in capital 132,768,779 132,705,765
Accumulated other comprehensive income (2,104,717) 2,023,751
Treasury stock at cost (109,600 shares) (903,163) 0
Retained earnings 453,067 229,623
-----------------------------------
Total stockholders' equity 130,341,543 135,086,278
-----------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,597,818,996 $1,167,740,482
===================================
</TABLE>
See notes to financial statements.
1
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER ENDED FOR THE QUARTER ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
---------------------------------------------
<S> <C> <C>
INTEREST INCOME:
Mortgage-Backed Securities $ 24,008,528 $ 6,123,442
Money market account 39 15
---------------------------------------------
Total interest income 24,008,567 6,123,457
INTEREST EXPENSE:
Repurchase agreements 20,765,301 5,126,089
---------------------------------------------
NET INTEREST INCOME 3,243,266 997,368
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES 993,630 429,400
GENERAL AND ADMINISTRATIVE EXPENSES 528,240 227,245
---------------------------------------------
NET INCOME 3,708,656 1,199,523
---------------------------------------------
OTHER COMPREHENSIVE INCOME
Unrealized gain (loss) on available-for-sale securities 799,319 (444,082)
Less: reclassification adjustment for gains included in net income (993,630) (429,400)
---------------------------------------------
Other comprehensive loss (194,311) (873,482)
---------------------------------------------
COMPREHENSIVE INCOME $ 3,514,345 $ 326,041
=============================================
NET INCOME PER SHARE:
Basic $ 0.29 $ 0.32
=============================================
Diluted $ 0.29 $ 0.31
=============================================
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 12,704,194 3,739,170
=============================================
Diluted 12,785,765 3,822,470
=============================================
</TABLE>
2
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
FOR THE NINE FEBRUARY 18,
MONTHS ENDED 1997 THROUGH
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
-------------------------------------------------
<S> <C> <C>
INTEREST INCOME:
Mortgage-Backed Securities $67,849,165 $12,601,604
Money market account 76 30,760
-------------------------------------------------
Total interest income 67,849,241 12,632,364
INTEREST EXPENSE:
Repurchase agreements 57,256,355 10,274,906
-------------------------------------------------
NET INTEREST INCOME 10,592,886 2,357,458
GAIN ON SALE OF MORTGAGE-BACKED SECURITIES 2,716,589 659,265
GENERAL AND ADMINISTRATIVE EXPENSES 1,506,139 477,141
-------------------------------------------------
NET INCOME 11,803,336 2,539,582
-------------------------------------------------
OTHER COMPREHENSIVE INCOME
Unrealized loss on available-for-sale securities (1,411,879) (512,978)
Less: reclassification adjustment for gains included in net income (2,716,589) (659,265)
-------------------------------------------------
Other comprehensive loss (4,128,468) (1,172,243)
-------------------------------------------------
COMPREHENSIVE INCOME $ 7,674,868 $ 1,367,339
=================================================
NET INCOME PER SHARE:
Basic $0.93 $0.68
=================================================
Diluted $0.91 $0.67
=================================================
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic 12,729,673 3,704,194
=================================================
Diluted 13,028,970 3,787,494
=================================================
</TABLE>
See notes to financial statements.
3
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE PERIOD ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
COMMON ADDITIONAL OTHER
STOCK PAID-IN TREASURY COMPREHENSIVE RETAINED COMPREHENSIVE
PAR VALUE CAPITAL STOCK INCOME EARNINGS INCOME
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1997 $127,139 $132,705,765 $ 229,623 $ 2,023,751
Comprehensive income:
Net income $ 4,708,150 4,708,150
Other comprehensive income
Unrealized gains (losses) on securities,
net of reclassification adjustment (4,112,308) (4,112,308)
-------------
Comprehensive income $ 595,842
=============
Exercise of stock options 438 193,262
Additional cost of Initial Public Offering (130,248)
Dividends declared for the quarter ended
March 31, 1998 - $0.32 per average share (4,082,456)
--------------------------------------- ---------------------------
BALANCE, MARCH 31, 1998 $127,577 $132,768,779 $ - $ 855,317 $(2,088,557)
--------------------------------------- ---------------------------
Comprehensive income:
Net income $ 3,386,530 3,386,530
Other comprehensive income
Unrealized gains (losses) on
securities,
net of reclassification adjustment 178,151 178,151
-------------
Comprehensive income $ 3,564,681
=============
Dividends declared for the quarter ended
June 30, 1998 - $0.32 per average share (4,082,456)
--------------------------------------- ---------------------------
BALANCE, JUNE 30, 1998 $127,577 $132,768,779 $ - $ 159,391 $(1,910,406)
--------------------------------------- ---------------------------
Comprehensive income:
Net income $ 3,708,656 3,708,656
Other comprehensive income
Unrealized gains (losses) on
securities,
net of reclassification adjustment (194,311) (194,311)
-------------
Comprehensive income $ 3,514,345
=============
Stock buyback (903,163)
Dividends declared for the quarter ended
September 30, 1998 - $0.27 per average share (3,414,980)
--------------------------------------- ---------------------------
BALANCE, SEPTEMBER 30, 1998 $127,577 $132,768,779 $ (903,163) $ 453,067 $(2,104,717)
======================================= ===========================
DISCLOSURE OF RECLASSIFICATION AMOUNT:
Unrealized holding losses arising during period $ (1,411,879)
Less: reclassification adjustment for gains included in net income (2,716,589)
-------------
Net unrealized losses on securities $ (4,128,468)
=============
</TABLE>
See notes to financial statements.
4
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
FOR THE QUARTER FOR THE QUARTER
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,199,523 $ 3,708,656
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of mortgage premiums and discounts, net 680,180 2,239,747
Gain on sale of Mortgage-Backed Securities (429,400) (993,630)
(Increase) decrease in accrued interest receivable (164,045) 41,076
(Increase) decrease in other assets (228,617) 14,394
(Decrease) increase in accrued interest payable (10,045) 2,537,065
Increase in accounts payable 129,132 117,600
------------------------------------------
Net cash provided by operating activities 1,176,728 7,664,908
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (119,167,540) (241,286,923)
Proceeds from sale of Mortgage-Backed Securities 53,091,067 83,224,377
Principal payments on Mortgage-Backed Securities 19,639,368 121,339,783
------------------------------------------
Net cash used in investing activities (46,437,105) (36,722,763)
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 778,218,036 2,288,511,000
Principal payments on repurchase agreements (732,914,112) (2,254,398,000)
Purchase of Treasury Stock (903,163)
Proceeds from direct offering 878,000
Dividends paid (938,400) (4,082,456)
------------------------------------------
Net cash provided by financing activities 45,243,524 29,127,381
------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (16,853) 69,526
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 28,005 67,995
------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,152 $ 137,521
==========================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 5,136,134 $ 18,318,236
==========================================
NONCASH FINANCING ACTIVITIES:
Net unrealized losses on available-for-sale securities $ (1,172,243) $ (2,104,717)
==========================================
Dividends declared, not yet paid $ 678,204 $ 3,414,980
==========================================
</TABLE>
See notes to financial statements.
5
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
FEBRUARY 18, 1997 FOR THE NINE
THROUGH MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998
----------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,539,582 $ 11,803,336
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of mortgage premiums and discounts, net 1,302,859 6,093,183
Gain on sale of Mortgage-Backed Securities (659,265) (2,716,589)
Increase in accrued interest receivable (2,109,622) (2,199,406)
Increase in other assets (238,813) (118,950)
Increase in accrued interest payable 2,394,179 8,444,993
Increase in accounts payable 156,546 42,056
---------------------------------------------------------
Net cash provided by operating activities 3,385,466 21,348,623
---------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities (537,583,640) (1,203,070,837)
Proceeds from sale of Mortgage-Backed Securities 95,963,096 308,163,885
Principal payments on Mortgage-Backed Securities 33,299,701 353,474,359
---------------------------------------------------------
Net cash used in investing activities (408,320,843) (541,432,593)
---------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 1,563,478,126 7,530,044,000
Principal payments on repurchase agreements (1,191,187,112) (6,998,532,000)
Proceeds from exercise of stock options 193,700
Proceeds from private placement of equity capital 32,979,904
Net proceeds from direct offering 878,000
Additional cost of inital public offering (130,248)
Purchase of Treasury Stock (903,163)
Dividends paid (1,214,400) (10,961,970)
---------------------------------------------------------
Net cash provided by financing activities 404,934,518 519,710,319
---------------------------------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (859) (373,651)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,011 511,172
---------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,152 $ 137,521
=========================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 7,880,727 $ 48,811,362
=========================================================
NONCASH FINANCING ACTIVITIES:
Net unrealized losses on available-for-sale securities $ (1,172,243) $ (2,104,717)
=========================================================
Dividends declared, not yet paid $ 678,204 $ 3,414,980
========================================================
</TABLE>
See notes to financial statements.
6
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
- -------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Mortgage Management, Inc. (the "Company") was incorporated in Maryland
on November 25, 1996. The Company commenced its operations of purchasing and
managing Mortgage-Backed Securities on February 18, 1997, upon receipt of the
net proceeds from the private placement of equity capital. On July 31, 1997,
the Company received additional proceeds from a direct offering to officers
and directors. An initial public offering was completed on October 14, 1997.
A summary of the Company's significant accounting policies follows:
BASIS OF PRESENTATION - The accompanying unaudited financial statements have
been prepared in conformity with the instructions to Form 10-Q and Article
10, Rule 10-01 of Regulation S-X for interim financial statements. The
interim financial statements for the three and nine month periods are
unaudited; however, in the opinion of the Company's management, all
adjustments, consisting only of normal recurring accruals, necessary for a
fair statement of the results of operations have been included. These
unaudited financial statements should be read in conjunction with the audited
financial statements included in the Company's Annual Report on form 10-K for
the period ended December 31, 1997. The nature of the Company's business is
such that the results of any interim period are not necessarily indicative of
results for a full year.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents 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. Accordingly, this flexibility
requires the Company to classify all of its Mortgage-Backed Securities as
available-for-sale. All assets classified as available-for-sale are reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of stockholders' equity.
Unrealized losses on Mortgage-Backed Securities that are considered other
than temporary, as measured by the amount of decline in fair value
attributable to factors other than temporary, are recognized in income
7
<PAGE>
and the cost basis of the Mortgage-Backed Securities is adjusted. There were
no such adjustments for the period ended December 31, 1997 and the nine
months ended September 30, 1998.
Interest income is accrued based on the outstanding principal amount of the
Mortgage-Backed Securities and their contractual terms. Premiums and
discounts associated with the purchase of the Mortgage-Backed Securities are
amortized into interest income over the lives of the securities using the
effective yield method.
Mortgage-Backed Securities transactions are recorded on the date the
securities are purchased or sold. Purchases of newly issued securities are
recorded when all significant uncertainties regarding the characteristics of
the securities are removed, generally shortly before settlement date.
Realized gains and losses on Mortgage-Backed Securities transactions are
determined on the specific identification basis.
CREDIT RISK - At September 30, 1998, the Company has limited exposure to
credit losses on its portfolio of Mortgage-Backed Securities by only
purchasing securities from Federal Home Loan Mortgage Corporation ("FHLMC"),
Federal National Mortgage Association ("FNMA"), or Government National
Mortgage Association ("GNMA"). The payment of principal and interest on the
FHLMC and FNMA Mortgage-Backed Securities are guaranteed by those respective
agencies and the payment of principal and interest on the GNMA Mortgage-
Backed Securities are backed by the full-faith-and-credit of the U.S.
government.
INCOME TAXES - The Company has elected to be taxed as a Real Estate
Investment Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") with respect thereto.
Accordingly, the Company will not be subjected to Federal income tax to the
extent of its distributions to shareholders and as long as certain asset,
income and stock ownership tests are met.
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
8
<PAGE>
2. MORTGAGE-BACKED SECURITIES
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of December 31, 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 $273,119,008 $691,081,916 $174,164,513 $1,138,365,437
Unamortized discount (3,619) (110,567) - (114,186)
Unamortized premium 2,848,376 14,532,363 4,123,451 21,504,190
------------ ------------ ------------ --------------
Amortized cost 275,963,765 705,503,712 178,287,964 1,159,755,441
Gross unrealized gains 376,485 1,948,068 928,453 3,253,006
Gross unrealized losses (115,190) (802,801) (311,264) (1,229,255)
------------ ------------ ------------ --------------
Estimated fair value $276,225,060 $706,648,979 $178,905,153 $1,161,779,192
============ ============ ============ ==============
</TABLE>
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of September 30, 1998, 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
Mortgage-Backed
<S> <C> <C> <C> <C>
Securities, gross $417,101,660 $875,488,645 $168,465,774 $1,461,056,079
Unamortized discount (156,372) (815,822) - (972,194)
Unamortized premium 9,056,444 13,271,602 2,887,945 25,215,991
---------------------------------------------------------------------
Amortized cost 426,001,732 887,944,425 171,353,719 1,485,299,876
Gross unrealized gains 95,900 4,952,420 2,011,321 7,059,641
Gross unrealized losses (4,101,210) (4,505,385) (557,764) (9,164,359)
---------------------------------------------------------------------
Estimated fair value $421,996,422 $888,391,460 $172,807,276 $1,483,195,158
=====================================================================
</TABLE>
9
<PAGE>
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.
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.
The adjustable rate Mortgage-Backed Securities may be limited by periodic
caps (generally interest rate adjustments are limited to no more than 1%
every six months) and lifetime caps. At December 31, 1997, the weighted
average lifetime cap was 10.8%. At September 30, 1998, the weighted average
lifetime cap was 10.4%.
During the nine months ended September 30, 1998, the Company realized
$2,716,589 in gains from sales of Mortgage-Backed Securities. There were no
losses on sales of Mortgage-Backed Securities for the nine months ended
September 30, 1998.
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 December 31, 1997, the Company had outstanding $918,869,000 of
repurchase agreements with a weighted average borrowing rate of 6.16% and a
weighted average remaining maturity of 16 days. At December 31, 1997,
Mortgage-Backed Securities actually pledged had an estimated fair value of
$936,859,658. As of September 30, 1998, the Company had outstanding
$1,450,381,000 of repurchase agreements with a weighted average borrowing
rate of 5.59% and a weighted average remaining maturity of 29 days. At
September 30, 1998, Mortgage-Backed Securities actually pledged had an
estimated fair value of $1,458,669,073.
At December 31, 1997 and September 30, 1998, the repurchase agreements had
the following remaining maturities:
<TABLE>
<CAPTION>
December 31, 1997 September 30, 1998
------------------------------------------------------
<S> <C> <C>
Within 30 days $ 590,960,000 $ 999,339,000
30 to 59 days 51,776,000 327,705,000
60 to 89 days -
90 to 119 days 103,391,000 32,806,000
Over 120 days 172,742,000 90,531,000
------------------------ ---------------------------
$ 918,869,000 $1,450,381,000
======================== ===========================
</TABLE>
10
<PAGE>
4. COMMON STOCK
Options were exercised during the nine month period. The number of stock
options exercised was 43,774, with a total amount paid of $193,700. Also,
during the quarter 109,600 shares of common stock were acquired in the
Company's Stock Buyback Program, at a cost of $903,163. At September 30,
1998 total shares outstanding less treasury stock totaled 12,648,074
During the Company's quarter ending March 31, 1998, the Company declared
dividends to shareholders totaling $4,082,456, or $.32 per weighted average
share which was paid on April 20, 1998. During the Company's quarter ending
June 30, 1998, the Company declared dividends to shareholders totaling
$4,082,456, or $.32 per weighted average share which was paid on July 27,
1998. During the Company's quarter ending September 30, 1998, the Company
declared dividends to shareholders totaling $3,414,980, or $.27 per weighted
average share which was paid on October 12, 1998. For Federal income tax
purposes dividends paid for the nine month period is ordinary income to the
Company stockholders.
5. EARNINGS PER SHARE (EPS)
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No. 128),
which requires dual presentation of Basic EPS and Diluted EPS on the face of
the income statement for all entities with complex capital structures
SFAS No. 128 also requires a reconciliation of the numerator and denominator
of Basic EPS and Diluted EPS computation. The reconciliation is as follows:
<TABLE>
<CAPTION>
FOR THE PERIOD ENDED
DECEMBER 31, 1997
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
---------------------- ---------------------- ----------------
<S> <C> <C> <C>
Net income $11,803,336
---------------------
Basic EPS 11,803,336 12,729,673 $0.93
================
Effect of dilutive securities:
Dilutive stock options 299,297
----------------------------------------------
Diluted EPS $11,803,336 13,028,970 $0.91
===================== ===================== ================
</TABLE>
Options to purchase 446,434 shares were outstanding and dilutive at period
end, as the exercise price (between $4.00 and $8.13) was less than the
average stock price for the nine months of $9.82. Options to purchase
147,676 shares of stock were outstanding and are not considered dilutive. The
exercise price (between $10.00 and $11.25) was greater than the average stock
price for the nine months of $9.82.
11
<PAGE>
6. COMPREHENSIVE INCOME
The Company adopted FASB Statement no. 130, Reporting Comprehensive Income,
Statement no. 130 requires the reporting of comprehensive income in addition
to net income from operations. Comprehensive income is a more inclusive
financial reporting methodology that includes disclosure of certain financial
information that historically has not been recognized in the calculation of
net income. The Company at September 30, 1998 held securities classified as
available-for-sale, which have unrealized losses of $2,104,717.
7. LEASE COMMITMENTS
The Corporation's aggregate future minimum lease payments are as follows:
<TABLE>
<S> <C>
1998 $ 67,787
1999 92,804
2000 95,299
2001 97,868
2002 100,515
2003 and thereafter 582,406
----------
$1,036,679
==========
</TABLE>
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act
of 1995: Statements in this discussion regarding the Company and its business
which are not historical facts are "forward-looking statements" that involve
risks and uncertainties. For a discussion of such risks and uncertainties,
which could cause actual results to differ from those contained in the forward-
looking statements, see "Risk Factors" in the Company's Form 10-K for the year
ended December 31, 1997.
OVERVIEW
The Company is a real estate investment trust ("REIT") which acquires and
manages Mortgage-Backed Securities which can be readily financed. The Company
commenced operations on February 18, 1997 upon the closing of the Private
Placement, which resulted in proceeds to the Company of $33 million. The
Company received additional proceeds of $878,000 upon the closing of the Direct
Offering on July 31, 1997. The Company's initial public offering was completed
on October 14, 1997 raising net proceeds of $99.0 million. During the third
quarter of 1998, the Company initiated a stock buy back program. At September
30, 1998 109,600 shares were repurchased at a cost of $903,163.
The Company's principal business objective 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 the 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) continually reviewing the mix of Mortgage-Backed Security types on the
balance sheet in an effort to improve risk-adjusted returns, and (iii)
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.
RESULTS OF OPERATIONS The Company's 1997 fiscal year commenced with the start
of operations on February 18, 1997 and concluded on December 31, 1997. The 317-
day period from February 18, 1997 to December 31, 1997 is referred to herein as
"the period ended 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. The quarters ended September 30, 1997, March 31, 1998, June 30, 1998 and
September 30, 1998 are their calendar equivalents.
NET INCOME SUMMARY
For the quarter ended September 30, 1998, net income, as calculated
according to Generally Accepted Accounting Principles ("GAAP"), was $3,708,656,
or $0.29 basic earnings per share, as compared to the quarter ended September
30, 1997 of $1,199,523, or $0.32 basic earnings per share. Taxable earnings per
share for the quarter ended September 30, 1998 was $3,937,459, or $0.31 per
average share. For the nine months ended September 30, 1998, GAAP net income
was $11,803,336 or $0.93 basic per average share, as compared to the period
ended September 30, 1997 of $2,539,582, or $0.68 basic per average share.
Taxable income for the nine months ended September 30, 1998 was $12,338,096 or
$0.97 basic per average share. Net income per share is computed by dividing net
income by the weighted average number of shares of outstanding Common Stock
during the nine month period, which was 12,729,673 and 12,704,194 for the
quarter. Dividends per weighted average number of shares outstanding for the
quarter were $0.27 per share, $3,414,980 in total. Return on average equity was
11.31% on an annualized basis.
13
<PAGE>
Comparing net income for the period February 18, 1997 through September 30,
1997 to the nine months ended September 30, 1998 may be deceptive. The 225-day
period ended September 30, 1997 is a shortened operating period and not a full
nine months. Secondly, at September 30, 1997 the Company's asset base was
substantially lower than at September 30, 1998. The reason for the asset size
difference is twofold. First, the Company was in an asset acquisition period.
Additionally, the Company's capital base was only $32 million, as compared to
$130 million at September 30, 1998.
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. The Company seeks to increase net income as
a percentage of equity consistent with its Capital Investment Policy.
NET INCOME SUMMARY
------------------
<TABLE>
<CAPTION>
Quarter Ended Nine months ended
September 30, 1998 September 30, 1998
(dollars in thousands, (dollars in thousands,
except except
per share amounts) per share amounts)
----------------------- -----------------------
<S> <C> <C>
Interest Income $ 24,008 $ 67,849
Interest Expense 20,765 57,256
----------- -----------
Net Interest Income 3,243 10,593
Gain on Sale of Mortgage-Backed Securities 994 2,717
General and Administrative Expenses 528 1,506
----------- -----------
Net Income $ 3,709 $ 11,803
================================================
Average Number of Outstanding Shares 12,704,194 12,729,673
Basic Net Income Per Share $ 0.29 $ 0.93
Diluted Net Income Per Share $ 0.29 $ 0.91
Average Total Assets $ 1,554,123 $ 1,473,719
Average Equity $ 131,148 $ 132,442
Annualized Return on Average Assets .95% 1.07%
Annualized Return on Average Equity 11.31% 11.88%
</TABLE>
TAXABLE INCOME AND GAAP INCOME
For the quarter ended September 30, 1998, income as calculated for tax
purposes (taxable income) differed from income as calculated according to
generally accepted accounting principles (GAAP income). The differences were in
the calculations of premium amortization and general and administrative
expenses. For the period February 18, 1997 through September 30, 1997 there
were no differences between GAAP and taxable income.
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 for 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.
The table below presents the major differences between GAAP and taxable income
for the Company
14
<PAGE>
TAXABLE INCOME
--------------
<TABLE>
<CAPTION>
GAAP Net Taxable General & Taxable Mortgage Taxable Gain on Taxable Net
Income Administrative Amortization Sale of Securities Income
Differences Differences Differences
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $3,709 $ 228 $3,937
For the Quarter Ended $3,766
June 30, 1998 $3,387 $2 $ 376
For the Quarter Ended
March 31, 1998 $4,708 $1 ($74) $4,635
For the Period Ended $4,919 $3 ($92) $54 $4,884
December 31, 1997
</TABLE>
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
The Company had average earning assets of $1,543.0 million for the quarter
ended September 30, 1998. The Company's primary source of income for the nine
months ended September 30, 1998 was interest income. A portion of income was
generated by gains on sales of Mortgage-Backed Securities. Interest income was
$24,009 million for the quarter ended September 30, 1998. The yield on average
earning assets was 6.22% for the same period. The table below shows 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.
AVERAGE EARNING ASSET YIELD
---------------------------
<TABLE>
<CAPTION>
Average Yield on
Amortized Cost Average
Average of Mortgage- Average Yield on Amortized Cost
Cash Backed Earning Average Cash of Mortgage-
Equivalents Securities Assets Equivalents Backed Securities
----------- ------------ ------ ----------- -----------------
(dollars in thousand)
<S> <C> <C> <C> <C> <C>
For the Quarter Ended September 30, 1998 $ 2 $1,543,010 $1,543,012 4.20% 6.22%
For the Quarter Ended June 30, 1998 $ 2 $1,568,022 $1,568,024 4.35% 6.13%
For the Quarter Ended March 31, 1998 $ 2 $1,307,088 $1,307,090 4.45% 6.15%
For the Period Ended December 31, 1997 $30 $ 448,276 $ 448,306 4.20% 6.34%
Yield on
Average
Earning Interest
Assets Income
------ ------
<S> <C> <C>
For the Quarter Ended September 30, 1998 6.22% $24,009
For the Quarter Ended June 30, 1998 6.13% $23,762
For the Quarter Ended March 31, 1998 6.15% $20,079
For the Period Ended December 31, 1997 6.34% $24,713
</TABLE>
The Constant Prepayment Rate (or "CPR") on the Company's portfolio of
Mortgage-Backed Securities for the quarter ended September 30, 1998 was 21%.
"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 quarter ended
September 30, 1998 because the Company adjusts its rates of premium amortization
and discount accretion monthly based on actual payments received.
15
<PAGE>
INTEREST EXPENSE AND THE COST OF FUNDS
The Company anticipates that its largest expense will usually be the cost
of borrowed funds. The Company had average borrowed funds of $1,460.6 million
and total interest expense of $20.8 million for the quarter ended September 30,
1998. Interest expense for the quarter ended September 30, 1997 was $5.1
million. The average cost of funds was 5.59% for the quarter ended September
30, 1998. 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, 1998. 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 quarter ended September 30,
1998, average one-month LIBOR, which was 5.62%, was 0.01% lower than average
six-month LIBOR, which was 5.63%.
The table below shows the Company's average borrowed funds and average cost
of funds as compared to average one- and average six-month LIBOR.
<TABLE>
<CAPTION>
AVERAGE COST OF FUNDS
---------------------
Average
One-Month Average Cost Average Cost
LIBOR of Funds of Funds
Average Average Relative to Relative to Relative to
Average Average One- Six- Average Average Average
Borrowed Interest Cost of Month Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
-------- -------- -------- ------- ------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $1,460,612 $20,765 5.68% 5.62% 5.63% (0.01%) 0.06% 0.05%
For the Quarter Ended
June 30, 1998 $1,440,822 $20,178 5.60% 5.66% 5.75% (0.09%) (0.06%) (0.15%)
For the Quarter Ended
March 31, 1998 $1,167,483 $16,313 5.59% 5.64% 5.68% (0.04%) (0.05%) (0.09%)
For the Period Ended
December 31, 1997 $ 404,140 $19,677 5.61% 5.67% 5.87% (0.20%) (0.06%) (0.26%)
</TABLE>
Net Interest Rate Agreement Expense
The Company did not enter into any interest rate agreements to date. As
part of its asset/liability management process, the Company may enter into
interest rate agreements such as interest rate caps, floors and swaps. These
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. The Company reviews the need for interest
rate agreements on a regular basis consistent with its Capital Investment
Policy.
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense,
totaled $3.2 million for the quarter ended September 30, 1998 and $997,368 for
the quarter 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 0.54% for the quarter ended
16
<PAGE>
September 30, 1998. Net interest margin, which equals net interest income
divided by average total assets, was .83% on an annualized basis. Taxable net
interest income was $228,422 greater than GAAP net interest income because of
differing premium amortization. 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 are funded with equity
rather than borrowings. The Company did not have any interest rate agreement
expenses for the quarter ended September 30, 1998
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, 1998, June 30, 1998, March 31, 1998, and the period
ended December 31, 1997.
<TABLE>
<CAPTION>
GAAP Net Interest Income
------------------------
(dollars in thousands)
Amortized
Cost of Interest Yield on
Mortgage- Income on Interest Average Average
Backed Mortgage- Average Income on Total Interest Balance of
Securities Backed Cash Cash Interest Earning Repurchase
Held Securities Equivalents Equivalents Income Assets Agreements
---------- ---------- ----------- ----------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $1,543,010 $24,009 $ 2 $24,009 6.22% 1,460,612
For the Quarter Ended
June 30, 1998 $1,568,022 $23,762 $ 2 $23,762 6.13% $1,440,822
For the Quarter Ended
March 31, 1998 $1,307,088 $20,079 $ 2 $20,079 6.15% $1,167,483
For the Period Ended
December 31, 1997 $ 448,276 $24,682 $30 $31 $24,713 6.34% $ 404,140
Average Net
Interest Cost of Interest
Expense Funds Income
--------- ------- ---------
<S> <C> <C> <C>
For the Quarter Ended
September 30, 1998 20,765 5.68% 3,244
For the Quarter Ended
June 30, 1998 $ 20,178 5.60% $3,584
For the Quarter Ended
March 31, 1998 $ 16,313 5.59% $3,765
For the Period Ended
December 31, 1997 $ 19,677 5.61% $5,036
</TABLE>
GAINS AND LOSSES ON SALES OF MORTGAGE-BACKED SECURITIES
For the quarter ended September 30, 1998, the Company sold Mortgage-Backed
Securities with an aggregate historical amortized cost of $82.2 million for an
aggregate gain of $993,630 million. During the quarter ended September 30, 1997
the Company sold Mortgage-Backed Securities with a historical amortized cost of
$52.7 million for an aggregate gain of $429,400. 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, 1998, 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.
17
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses ("operating expense" or "G&A expense")
were $528,240 for the quarter ended September 30, 1998 and $227,245 for the
quarter ended September 30, 1997. Taxable G&A expenses were $380 less than for
GAAP purposes for the quarter ended September 30, 1998.
GAAP G&A EXPENSE AND OPERATING EXPENSE RATIOS
---------------------------------------------
<TABLE>
<CAPTION>
Total G&A Total G&A
Cash Comp and Expense/Average Expense/Average
Benefits Other G&A Total G&A Assets Equity
Expense Expense Expense (annualized) (annualized)
---------------- --------- --------- ------------------------ ------------------------
<S> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $318 $210 $528 0.13% 1.61%
For the Quarter Ended
June 30, 1998 $252 $242 $494 0.13% 1.50%
For the Quarter Ended
March 31, 1998 $259 $225 $484 0.15% 1.44%
For the Period Ended
December 31, 1997 $492 $360 $852 0.21% 1.61%
</TABLE>
NET INCOME AND RETURN ON AVERAGE EQUITY
Net income was $3.7 million in the quarter ended September 30, 1998.
Return on average equity was 11.31% on an annualized basis. The table below
shows, on an annualized basis, 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 Securities/ G&A
Income/Average Average Expense/Average Return on Average
Equity Equity Equity Equity
-------------- --------------- --------------- -----------------
<S> <C> <C> <C> <C>
For the Quarter Ended September 30, 1998
(on an annualized basis) 9.89% 3.03% 1.61% 11.31%
For the Quarter Ended June 30, 1998
(on an annualized basis) 10.92% 1.90% 1.50% 10.32%
For the Quarter March 31, 1998
(on an annualized basis) 11.18% 4.23% 1.44% 13.97%
For the Period Ended December 31, 1997
(on an annualized basis) 9.49% 1.39% 1.61% 9.27%
</TABLE>
DIVIDENDS AND TAXABLE INCOME
The Company has elected to be taxed as a REIT under the Code. 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
18
<PAGE>
Mortgage-Backed Securities. Through September 30, 1998, earned taxable income
exceeded dividend declarations by $952,984, or $0.07 per share, based on the
number of shares of Common Stock outstanding at period end.
DIVIDEND SUMMARY
----------------
<TABLE>
<CAPTION>
Weighted Cumulative
Taxable Average Common Taxable Net Dividends Dividend Undistributed
Net Shares Income Declared Total Pay-out Taxable
Income Outstanding Per Share Per Share Dividends Ratio Income
-------- -------------- ---------- --------- --------- -------- -------------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $3,937 12,704,194 $0.31 $0.27 $3,415 83.74% $952
For the Quarter Ended
June 30, 1998 $3,765 12,757,674 $0.29 $0.32 $4,082 108.39% $430
For the Quarter Ended
March 31, 1998 $4,635 12,727,405 $0.36 $0.32 $4,082 88.07% $747
For the Period Ended $4,884 5,952,123 $0.82 $0.79 $4,690 96. 0% $194
December 31, 1997
</TABLE>
FINANCIAL CONDITION
MORTGAGE-BACKED SECURITIES
All of the Company's Mortgage-Backed Securities at September 30, 1998 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, 1998, all the Company's
Mortgage-Backed Securities were Agency Certificates, which carry a S&P "AAA"
rating or 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 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, 1998, the Company had on its balance sheet a total
of $972,194 of unamortized discount (which is the difference between the
remaining principal value and current historical amortized cost of Mortgage-
Backed Securities acquired at a price below principal value) and a total of
$25.2 million of 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 $121.3 million for the quarter
ended September 30, 1998. Given the Company's current portfolio composition, if
mortgage principal prepayment 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 period.
The table below summarizes the Company's Mortgage-Backed Securities at
September 30, 1998, June 30, 1998 March 31, 1998 and December 31, 1997.
19
<PAGE>
MORTGAGE-BACKED SECURITIES
--------------------------
<TABLE>
<CAPTION>
Estimated
Amortized Estimated Fair Value/ Weighted
Principal Net Amortized Cost/Principal Fair Principal Average
Value Premium Cost Value Value Value Yield
-------------- -------- ---------- -------------- ----------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
At September 30, 1998 $1,461,056 $24,244 $1,485,300 101.66% $1,483,195 101.52% 6.49%
At June 30, 1998 $1,541,520 $26,532 $1,568,052 101.72% $1,566,188 101.60% 6.50%
At March 31, 1998 $1,495,670 $25,265 $1,520,935 101.70% $1,518,847 101.55% 6.51%
$1,138,365 $21,390 $1,159,755 101.88% $1,161,779 102.06% 6.57%
At December 31,
1997
</TABLE>
The tables below set forth certain characteristics of the Company's
Mortgage-Backed Securities at September 30, 1998, June 30, 1998, March 31, 1998
and December 31, 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.
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITY CHARACTERISTICS
--------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Weighted Value at
Weighted Weighted Average Weighted Weighted Period End as
Average Average Weighted Term to Average Average % of Mortgage-
Principal Coupon Index Average Net Next Lifetime Asset Backed
Value Rate Level Margin Adjustment Cap Yield Securities
---------- -------- --------- ----------- ---------- -------- -------- -------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
At September 30, 1998 $1,050,177 6.78% 5.20% 1.68% 13 months 10.42% 6.51% 71.88%
At June 30, 1998 $1,140,518 6.86% 5.20% 1.66% 15 months 10.42% 6.46% 73.98%
At March 31, 1998 $1,176,716 6.89% 5.45% 1.61% 12 months 10.00% 6.46% 78.68%
At December 31, 1997 $ 994,653 7.13% 5.52% 1.61% 22 months 10.78% 6.50% 87.38%
</TABLE>
FIXED-RATE MORTGAGE-BACKED SECURITY CHARACTERISTICS
---------------------------------------------------
<TABLE>
<CAPTION>
Principal Value as %
Weighted Average Weighted Average of Mortgage-Backed
Principal Value Coupon Rate Asset Yield Securities
------------------ ---------------- ----------------- --------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
At September 30, 1998 $410,879 6.69% 6.47% 28.12%
At June 30, 1998 $401,002 6.82% 6.65% 26.02%
At March 31, 1998 $318,954 6.85% 6.70% 21.32%
At December 31, 1997 $143,712 7.50% 7.08% 12.62%
</TABLE>
At September 30, 1998, June 30, 1998, March 31, 1998, and December 31,
1997, the Company held Mortgage-Backed Securities with coupons linked to the
one- and three-year Treasury Indices, one-month LIBOR and the six-month CD
20
<PAGE>
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
---------------------------------------------------
SEPTEMBER 30, 1998
------------------
<TABLE>
<CAPTION>
1-Year 3-Year
One-Month Six-Month Treasury Treasury
LIBOR CD Rate Index Index
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 20 mo. 36 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 14 mo. 9 mo.
Weighted Average Annual Period Cap None 1.00% 2.00% 2.00%
Weighted Average Lifetime Cap at
September 30, 1998 9.14% 10.95% 11.82% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
September 30, 1998 36.55% 4.44% 30.88% .01%
</TABLE>
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITIES BY INDEX
---------------------------------------------------
JUNE 30, 1998
-------------
<TABLE>
<CAPTION>
1-Year 3-Year
One-Month Six-Month Treasury Treasury
LIBOR CD Rate Index Index
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 43 mo. 36 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 32 mo. 13 mo.
Weighted Average Annual Period Cap None 1.00% 2.00% 2.00%
Weighted Average Lifetime Cap at
June 30, 1998 9.15% 10.92% 11.74% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
June 30, 1998 36.25% 4.64% 33.01% .08%
</TABLE>
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITIES BY INDEX
---------------------------------------------------
MARCH 31, 1998
--------------
<TABLE>
<CAPTION>
1-Year 3-Year
One-Month Six-Month Treasury Treasury
LIBOR CD Rate Index Index
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 45 mo. 36 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 31 mo. 12 mo.
Weighted Average Annual Period Cap None 2.00% 1.97% 2.00%
Weighted Average Lifetime Cap at
March 31, 1998 9.15% 10.88% 10.69% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at
March 31, 1998 36.29% 5.51% 36.75% .13%
</TABLE>
21
<PAGE>
ADJUSTABLE-RATE MORTGAGE-BACKED SECURITIES BY INDEX
---------------------------------------------------
DECEMBER 31, 1997
-----------------
<TABLE>
<CAPTION>
One-Month Six-Month 1-Year 3-Year
LIBOR CD Rate Treasury Treasury
----------------- --------------- Index Index
----------------- -----------------
<S> <C> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 mo. 36 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 6 mo. 12 mo.
Weighted Average Annual Period Cap None 2.00% 1.78% 2.00%
Weighted Average Lifetime Cap at
December 31, 1997 9.21% 10.88% 11.77% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at December 31, 30.94% 7.81% 48.45% .18%
1997
</TABLE>
The table below shows unrealized gains and losses on the Mortgage-Backed
Securities in the Company's portfolio.
UNREALIZED GAINS AND LOSSES
---------------------------
<TABLE>
<CAPTION>
At September 30, At June 30, At March 31, At December 31,
1998 1998 1997 1997
(dollars in (dollars in (dollars in (dollars in
thousands) thousands) thousands) thousands)
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Unrealized Gain $ 7,060 $ 2,826 $ 2,622 $ 3,253
Unrealized Loss (9,164) (4,736) (4,710) (1,229)
Net Unrealized Gain (Loss) (2,104) (1,910) (2,088) 2,024
Net Unrealized Gain (Loss) as % of Mortgage-Backed
Securities Principal Value 0.14% 0.12% 0.14% 0.20%
Net Unrealized Gain (Loss) as % of Mortgage-Backed
Securities Amortized Cost 0.14% 0.12% 0.14% 0.20%
</TABLE>
INTEREST RATE AGREEMENTS
Interest rate agreements are assets that are carried on a balance sheet at
estimated liquidation value. At September 30, 1998, there were no interest rate
agreements on the Company's balance sheet.
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, 1998, the Company had established uncommitted borrowing facilities in this
market with twenty-three 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 while increasing the liquidity and strength of its
balance sheet.
For the quarter ended September 30, 1998, the term to maturity of the
Company's borrowings has ranged from one day to one year, with a weighted
average original term to maturity of 88 days and a weighted average remaining
maturity of
22
<PAGE>
29 days at September 30, 1998. Many of the Company's borrowings have a cost of
funds which adjust 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, 1998,
the weighted average cost of funds for all of the Company's borrowings was 5.59%
and the weighted average term to next rate adjustment was 29 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. The maintenance of liquidity is
one of the goals of the Company's Capital Investment Policy. Under this policy,
asset growth is limited in order to preserve unused borrowing capacity for
liquidity management purposes.
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, 1998 was $131.0
million, or $10.30 per share. If the Company had used historical amortized
cost accounting, the Company's equity base at September 30, 1998 would have been
$133.0 million, or $10.47 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
asset and reflecting the change in stockholders' equity under "Accumulated Other
Comprehensive Income." 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 accounting. As a result, comparisons
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 will tend to limit borrowing capacity under the Company's Capital
Investment Policy. A very large negative change 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 $2.1 million, or 0.14% of the amortized cost of Mortgage-Backed Securities
at September 30, 1998.
The table below shows the Company's equity capital base as reported and on
a historical amortized cost basis at September 30, 1998, June 30, 1998, March
31, 1998 and December 31, 1997. Issuances of Common Stock, the level of GAAP
earnings as compared to dividends declared, and other factors influence the
historical cost equity capital base. The GAAP reported equity capital base is
influenced by these factors plus changes in the "Net Unrealized Gains (Losses)
on Assets Available for Sale" account.
23
<PAGE>
STOCKHOLDERS' EQUITY
--------------------
<TABLE>
<CAPTION>
Historical Net Unrealized GAAP Historical GAAP Reported
Amortized Cost Gains (Losses) on Reported Amortized Cost Equity (Book
Equity Base Assets Available Equity Base Equity Per Share Value) Per Share
------------------ --------- ------------------ -----------------
for Sale (Book Value)
-------- --------------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
At September 30, 1998 $132,446 ($2,105) $130,342 $10.47 $10.30
At June 30, 1998 $133,055 ($1,910) $131,145 $10.43 $10.28
At March 31, 1998 $133,751 ($2,088) $131,663 $10.48 $10.32
At December 31, 1997 $133,063 $2,024 $135,087 $10.47 $10.62
</TABLE>
LEVERAGE
The Company's debt-to-GAAP reported equity ratio at September 30, 1998 was
11.1:1. The Company generally expects to maintain a ratio of debt-to-equity of
between 8:1 and 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.
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.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate 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
24
<PAGE>
Company's activities and balance sheet are measured with reference to historical
cost or fair market value without considering inflation.
OTHER MATTERS
The Company calculated its qualified REIT Assets, as defined in the
Internal Revenue Code of 1986, as amended (the "Code"), to be 99.5% of is total
assets, as compared to the Code requirement that at least 75% of its total
assets must be qualified REIT Assets. The Company also calculates that 96.2%
of its revenue qualifies for the 75% source of income test and 100% of its
revenue qualifies for the 95% source of income test under the REIT rules. The
Company also met all REIT requirements regarding the ownership of its common
stock and the distributions of its net income. Therefore, as of September 30,
1998, the Company believes that it qualified as a REIT under the provisions of
the Code.
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act of
1940. If the Company were to become regulated as an investment company, then
the Company's use of leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" ("Qualifying Interests"). Under current interpretation of the
staff of the Commission, in order to qualify for this exemption, the Company
must maintain at least 55% of its assets directly in Qualifying Interests. In
addition, unless certain mortgage securitites represent all the certificates
issued with respect to an underlying pool of mortgages, such mortgage securities
may be treated as securities separate from the underlying mortgage loans and,
thus, may not be considered Qualifying Interests for purposes of the 55%
requirement. As of September 30, 1998, the Company calculates that it is in
compliance with this requirement.
25
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 1 - Financial Data Schedule
(b) Reports
None
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY MORTGAGE MANAGEMENT, INC.
Dated: November 13, 1998 By:/s/ Michael A.J. Farrell
-------------------------
Michael A.J. Farrell
Chairman of the Board and Chief Executive
Officer
(authorized officer of registrant)
Dated: November 13, 1998 By:/s/ Kathryn F. Fagan
---------------------
Kathryn F. Fagan
Chief Financial Officer and Treasurer
(principal accounting officer)
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1998 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 137
<SECURITIES> 1,483,195
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,597,737
<PP&E> 82
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,597,819
<CURRENT-LIABILITIES> 1,467,477
<BONDS> 0
0
0
<COMMON> 131,993
<OTHER-SE> (1,652)
<TOTAL-LIABILITY-AND-EQUITY> 1,597,819
<SALES> 0
<TOTAL-REVENUES> 24,009
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 528
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20,765
<INCOME-PRETAX> 3,709
<INCOME-TAX> 0
<INCOME-CONTINUING> 3,709
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,709
<EPS-PRIMARY> 0.29
<EPS-DILUTED> 0.29
</TABLE>
