<PAGE>
EXPLANATORY NOTE
On September 28, 1999, Annaly Mortgage Management, Inc. ("we" or "us") filed
with the Securities and Exchange Commission a prospectus supplement pursuant to
Rule 424(b) under the Securities Act. As a result of electronic transmission
errors beyond our control, certain pages from the prospectus supplement were not
filed with the Commission.
In accordance with Rule 103 of Regulation S-T, we are correcting this error by
filing a complete version of the prospectus supplement. The information in the
attached prospectus supplement is provided as of September 27, 1999 and has not
been updated since that date. This filing is being made solely for the purpose
of filing the information omitted from the prior filing.
We have not sold any shares pursuant to the attached prospectus supplement.
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus supplement is not complete and may be +
+changed. This prospectus supplement is not an offer to sell securities and is +
+not soliciting an offer to buy these securities in any jurisdiction where the +
+offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED SEPTEMBER 27, 1999
PROSPECTUS SUPPLEMENT
(To Prospectus Dated September 16, 1999)
5,000,000 Shares
ANNALY MORTGAGE MANAGEMENT, INC.
COMMON STOCK
This is a public offering of shares of common stock of Annaly Mortgage
Management, Inc. All of the shares of common stock offered for sale in this
prospectus supplement are being issued and sold by us.
Our common stock is traded on the New York Stock Exchange under the symbol
"NLY". On , 1999, the last reported sale price of our common stock on the
New York Stock Exchange was $ per share.
See "Risk Factors" beginning on page S-6 of this prospectus supplement and
page 5 of the accompanying prospectus to read about certain factors you should
consider before buying shares of our common stock.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus supplement. Any representation to the
contrary is a criminal offense.
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Public offering price........................................... $ $
Underwriting discounts.......................................... $ $
Proceeds, before expenses, to us................................ $ $
</TABLE>
The underwriters may, under certain circumstances, purchase up to an
additional 750,000 shares of our common stock from us at the public offering
price less the underwriting discount.
The underwriters expect to deliver the shares against payment in New York,
New York on , 1999.
You should rely only on the information contained or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We
have not, and the underwriters have not, authorized anyone to provide you with
information that is different from that contained in this prospectus supplement
and the accompanying prospectus. We are offering to sell the common stock only
in jurisdictions where offers and sales are permitted. The information
contained in this prospectus supplement and the accompanying prospectus is
accurate only as of the respective dates of this prospectus supplement and the
accompanying prospectus.
Friedman Billings Ramsey
Schroder & Co. Inc.
Tucker Anthony Cleary Gull
The date of this Prospectus Supplement is September , 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Prospectus Supplement
- ---------------------
<S> <C>
PROSPECTUS SUPPLEMENT SUMMARY...................................... S-1
RISK FACTORS....................................................... S-6
USE OF PROCEEDS.................................................... S-7
DIVIDEND POLICY.................................................... S-7
PRICE RANGE OF COMMON STOCK........................................ S-7
CAPITALIZATION..................................................... S-8
SELECTED FINANCIAL DATA............................................ S-9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.............................................. S-10
BUSINESS STRATEGY.................................................. S-22
MANAGEMENT......................................................... S-36
UNDERWRITING....................................................... S-37
LEGAL MATTERS...................................................... S-38
EXPERTS............................................................ S-38
INDEX TO FINANCIAL STATEMENTS...................................... F-1
Prospectus
- ----------
ABOUT THIS PROSPECTUS.............................................. 3
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995................... 3
ABOUT ANNALY MORTGAGE MANAGEMENT, INC.............................. 3
RISK FACTORS....................................................... 5
USE OF PROCEEDS.................................................... 11
DESCRIPTION OF STOCK............................................... 12
FEDERAL INCOME TAX CONSIDERATIONS.................................. 16
PLAN OF DISTRIBUTION............................................... 24
EXPERTS............................................................ 25
LEGAL MATTERS...................................................... 25
WHERE YOU CAN FIND MORE INFORMATION................................ 25
INCORPORATION OF CERTAIN DOCUMENT BY REFERENCE..................... 26
</TABLE>
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
PROSPECTUS SUPPLEMENT SUMMARY
The following summary highlights selected information from this prospectus
supplement and the prospectus and may not contain all of the information that is
important to you. We encourage you to read this prospectus supplement and the
prospectus, as well the information which is incorporated by reference in this
prospectus, in their entireties. You should carefully consider the factors set
forth under "Risk Factors" in this prospectus supplement and the prospectus.
Unless otherwise specified, the information in this prospectus supplement
assumes that the underwriters do not exercise the over-allotment option
described herein under "Underwriting."
THE COMPANY
Background
We own and manage a portfolio of mortgage-backed securities, including
mortgage pass-through certificates, collateralized mortgage obligations (or
CMOs) and other securities representing interests in or obligations backed by
pools of mortgage loans. Our principal business objective is to generate net
income for distribution to our stockholders from the spread between the interest
income on our mortgage-backed securities and the costs of borrowing to finance
our acquisition of mortgage-backed securities. We have elected to be taxed as a
real estate investment trust (or REIT) under the Internal Revenue Code.
Therefore, substantially all of our assets consist of qualified REIT real estate
assets (of the type described in Section 856(c)(6)(B) of the Internal Revenue
Code). We commenced operations on February 18, 1997. We are self-advised and
self-managed.
We have financed our purchases of mortgage-backed securities with the net
proceeds of equity offerings and borrowings under repurchase agreements whose
interest rates adjust based on changes in short-term market interest rates. We
plan to finance additional purchases of mortgage-backed securities with the
proceeds of this offering, future offerings and future borrowings.
Assets
Under our capital investment policy, at least 75% of our total assets must
be comprised of high-quality mortgage-backed securities and short-term
investments. High quality securities means securities (1) that are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) that are unrated but are guaranteed by the
United States government or an agency of the United States government, or (3)
that are unrated but are determined by us to be of comparable quality to rated
high quality mortgage-backed securities.
The remainder of our assets, comprising not more than 25% of our total
assets, may consist of other qualified REIT real estate assets which are unrated
or rated less than high quality but which are at least "investment grade" (rated
"BBB" or better by Standard & Poor's Corporation (S&P) or the equivalent by
another nationally recognized rating agency) or, if not rated, are determined by
us to be of comparable credit quality to an investment which is rated "BBB" or
better.
We may acquire mortgage-backed securities backed by single-family
residential mortgage loans as well as securities backed by loans on multi-
family, commercial or other real estate-related properties. To date, all of the
mortgage-backed securities that we have acquired have been backed by single-
family residential mortgage loans.
To date, all of the securities that we have acquired have been agency
mortgage-backed securities which, although not rated, carry an implied "AAA"
rating. Agency mortgage-backed securities are mortgage-backed securities for
which a government agency or federally chartered corporation, such as the
Federal Home Loan Mortgage Corporation (or FHLMC), the Federal National Mortgage
Association (or FNMA) or the Government National Mortgage Association (or GNMA),
guarantees payments of principal or interest on the securities. Agency mortgage-
backed securities consist of agency pass-through certificates and CMOs issued or
guaranteed by an agency. Pass-through certificates provide for a pass-through of
the monthly interest and principal payments made by the borrowers on the
underlying mortgage loans. CMOs divide a pool of mortgage loans into multiple
tranches with different principal and interest payment characteristics.
S-1
<PAGE>
At June 30, 1999, approximately 40% of our mortgage-backed securities were
adjustable-rate pass-though certificates, approximately 36% of our mortgage-
backed securities were fixed-rate pass-through certificates or CMOs, and
approximately 24% of our mortgage-backed securities were CMO floaters. Our
adjustable-rate pass-through certificates are backed by adjustable-rate mortgage
loans and have coupon rates which adjust over time, subject to interest rate
caps and lag periods, in conjunction with changes in short-term interest rates.
CMO floaters are tranches of mortgage loans where the interest rates on the CMO
floaters adjust in conjunction with changes in short-term interest rates. CMO
floaters may be backed by fixed-rate mortgage loans or, less often, by
adjustable-rate mortgage loans. In this prospectus supplement, except where the
context indicates otherwise, we use the term "adjustable-rate securities" or
"adjustable-rate mortgage-backed securities" to refer to adjustable-rate pass-
through certificates and CMO floaters. At June 30, 1999, the weighted average
yield on our portfolio of earning assets was 6.21%, and the weighted average
term to next rate adjustment was 11 months.
We intend to continue to invest in adjustable-rate pass-through
certificates, fixed-rate mortgage-backed securities and CMO floaters. Although
we have not done so to date, we may also invest on a limited basis in mortgage
derivative securities representing the right to receive interest only or a
disproportionately large amount of interest. We have not and will not invest in
real estate mortgage investment conduit (or REMIC) residuals, other CMO
residuals or any mortgage-backed securities, such as inverse floaters, which
have imbedded leverage as part of their structural characteristics.
Borrowings
We attempt to structure our borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
correspond generally to the interest rate adjustment indices and periods of our
adjustable-rate mortgage-backed securities. However, periodic rate adjustments
on our borrowings are generally more frequent than rate adjustments on our
mortgage-backed securities. At June 30, 1999, the weighted average cost of
funds for all of our borrowings was 4.87%, the weighted average original term to
next rate adjustment of these borrowings was 72 days, and the weighted average
term to next rate adjustment of these borrowings was 24 days.
We generally expect to maintain a ratio of debt-to-equity of between 8:1
and 12:1, although the ratio may vary from time to time depending upon market
conditions and other factors that our management deems relevant. For purposes
of calculating this ratio, our equity is equal to the value of our investment
portfolio on a mark-to-market basis, less the book value of our obligations
under repurchase agreements and other collateralized borrowings. At June 30,
1999, our ratio of debt-to-equity was 11.8:1.
Hedging
To the extent consistent with our election to qualify as a REIT, we may
enter into hedging transactions to attempt to protect our mortgage-backed
securities and related borrowings against the effects of major interest rate
changes. This hedging would be used to mitigate declines in the market value of
our mortgage-backed securities during periods of increasing or decreasing
interest rates and to limit or cap the rates on our borrowings. These
transactions would be entered into solely for the purpose of hedging interest
rate or prepayment risk and not for speculative purposes. To date, we have not
entered into any hedging transactions.
Compliance With REIT and Investment Company Requirements
We constantly monitor our mortgage-backed securities and the income from
these securities and, to the extent we enter into hedging transactions in the
future, will monitor income from our hedging transactions as well, so as to
ensure at all times that we maintain our qualification as a REIT and our exempt
status under the Investment Company Act.
S-2
<PAGE>
Management
Our executive officers are:
. Michael A.J. Farrell, Chairman of the Board and Chief Executive
Officer
. Timothy J. Guba, President and Chief Operating Officer
. Wellington J. St. Claire, Vice Chairman of the Board and Chief
Investment Officer
. Kathryn F. Fagan, Chief Financial Officer and Treasurer
Messrs. Farrell and Guba and Ms. St. Claire have an average of 17 years
experience in the investment banking and investment management industries where,
in various capacities, they have each managed portfolios of mortgage-backed
securities, arranged collateralized borrowings and utilized hedging techniques
to mitigate interest rate and other risk within fixed-income portfolios. Ms.
Fagan is a certified public accountant and, prior to becoming our Chief
Financial Officer and Treasurer, served as Chief Financial Officer and
Controller of a publicly owned savings and loan association. Since 1994,
Messrs. Farrell and Guba and Ms. St. Claire have managed Fixed Income Discount
Advisory Company (or FIDAC), a registered investment advisor which, at June 30,
1999, managed, assisted in managing or supervised approximately $1.4 billion in
gross assets for a wide array of clients, of which, at that date, approximately
$450 million was managed on a discretionary basis.
Management's duties on behalf of FIDAC's clients may create conflicts of
interest if members of management are presented with corporate opportunities
that may benefit both us and clients for which FIDAC acts as investment advisor.
In the event that an investment opportunity arises, the investment will be
allocated to another entity or us by determining the entity or account for which
the investment is most suitable. In making this determination, our management
will consider the investment strategy and guidelines of each entity or account
with respect to acquisition of assets, leverage, liquidity and other factors
which management determines appropriate. See pages 9 and 10 of the
accompanying prospectus for more details regarding potential conflicts of
interest.
Distributions
To maintain our qualification as a REIT, we must distribute substantially
all of our taxable income to our stockholders for each year. We have done this
in the past and intend to continue to do so in the future. We also have
declared and paid regular quarterly dividends in the past and intend to do so in
the future. We have adopted a dividend reinvestment plan to enable holders of
common stock to reinvest dividends automatically in additional shares of common
stock.
S-3
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by us 5,000,000 shares/(1)/
Common stock to be outstanding
after the offering................................... 17,898,082 shares/(1)(2)(3)/
Use of proceeds...................................... We intend to use the proceeds of
this offering to purchase
mortgage-backed securities. We
then intend to increase our
investment assets by borrowing
against these mortgage-backed
securities and using the proceeds
to acquire additional
mortgage-backed securities.
New York Stock Exchange symbol....................... NLY
</TABLE>
_________________
(1) Assumes no exercise of the underwriters' over-allotment option.
(2) Based upon the number of shares outstanding as of September 22, 1999.
Includes 89,919 shares of common stock issued on July 27, 1999, 735 shares
issued on August 30, 1999 and 109,880 shares issued on August 31, 1999
pursuant to our dividend reinvestment and share purchase plan.
(3) Does not include 552,136 shares of common stock issuable upon the exercise
of options granted pursuant to our Long-Term Stock Incentive Plan.
RISK FACTORS
You should carefully consider all of the information set forth in this
prospectus supplement and in the accompanying prospectus. In particular, you
should evaluate the risk factors involved in connection with an investment in
our common stock and the impact from various events that could adversely affect
our business. See "Risk Factors" in this prospectus supplement and the
prospectus.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this prospectus supplement, the
prospectus and in the information incorporated by reference in this prospectus
supplement and the prospectus may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
information may involve known and unknown risks, uncertainties and other
factors, including those set forth under the caption "Risk Factors" in this
prospectus supplement and the accompanying prospectus, that may cause our actual
results, performance or achievements to be materially different from any future
results, performance or achievements expressed or implied by such forward-
looking statements.
S-4
<PAGE>
SUMMARY FINANCIAL INFORMATION
(dollars in thousands, except for per share data)
The financial data set forth below should be read in conjunction with our
financial statements and related notes and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
prospectus supplement.
<TABLE>
<CAPTION>
At or At or At or At or
For the Six For the Six For the Year For the Period
Months Months Ended February 18, 1997
Ended Ended June December (inception) to
June 30, 1999 30, 1998 31, 1999 December 31, 1997
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Statement of Operations Data:
Days in period 181 181 365 317
Interest income $ 44,280 $ 43,841 $ 89,986 $ 24,713
Interest expense 34,017 36,491 75,735 19,677
------------------------------------------------------------------------------
Net interest income $ 10,263 $ 7,350 $ 14,251 $ 5,036
Gain on sale of mortgage-backed securities 90 1,723 3,344 735
General and administrative expenses
(G&A expenses) 1,171 978 2,106 852
Net income $ 9,182 $ 8,095 $ 15,489 $ 4,919
==============================================================================
Net income per average share $ 0.72 $ 0.64 $ 1.22 $ 0.83
Dividends declared per average share $ 0.68 $ 0.64 $ 1.21 $ 0.79
Balance Sheet Data:
Mortgage-backed securities, net $ 1,474,104 $ 1,566,188 $ 1,520,289 $ 1,161,779
Total assets 1,481,962 1,628,922 1,527,352 1,167,740
Repurchase agreements 1,344,740 1,416,268 1,280,510 918,869
Total liabilities 1,368,370 1,497,777 1,401,481 1,032,654
Stockholders' equity 113,592 131,145 125,871 135,086
Number of common shares outstanding 12,697,548 12,757,674 12,648,424 12,713,900
Other Data:
Average total assets $ 1,510,687 $ 1,433,517 $ 1,499,875 $ 476,855
Average borrowings 1,377,908 1,304,153 1,360,040 404,140
Average equity 123,112 133,089 131,265 61,096
Yield on average interest earning assets for
the period (1) 5.89% 6.13% 6.16% 6.34%
Cost of funds on average interest bearing
liabilities for the period (1) 4.94% 5.60% 5.57% 5.61%
Interest rate spread 0.95% 0.53% 0.59% 0.73%
Efficiency ratio (G&A expenses/net interest
income) 11.41% 13.31% 14.78% 16.92%
Annualized Financial Ratios: (1)
Net interest margin 1.36% 1.02% 0.95% 1.22%
G&A expenses as a percentage of average
assets 0.15% 0.14% 0.14% 0.21%
G&A expenses as a percentage of average equity 1.90% 1.47% 1.60% 1.61%
Return on average assets 1.22% 1.13% 1.03% 1.19%
Return on average equity 14.92% 12.16% 11.80% 9.27%
</TABLE>
_______________
(1) Ratios for the six months ended June 30, 1999 and 1998 and for the period
February 18, 1997 (inception) to December 31, 1997 have been annualized.
S-5
<PAGE>
RISK FACTORS
You should carefully evaluate the risk factors involved in an investment in
our common stock and the impact from various events that could adversely affect
our business. These risk factors are described in detail commencing on page 5
of the accompanying prospectus. It is important that you carefully review and
consider these risk factors, together with the other information in this
prospectus supplement and the accompanying prospectus, in determining whether to
invest in our common stock.
. If the interest payments on our borrowings increase relative to the
interest we earn on our mortgage-backed securities, it may adversely affect our
profitability
- Differences in timing of interest rate adjustments on our mortgage-
backed securities and our borrowings may adversely affect our
profitability
- Interest rate caps on our mortgage-backed securities may adversely
affect our profitability
- Because we acquire fixed-rate securities, an increase in interest
rates may adversely affect our profitability
. An increase in prepayment rates may adversely affect our profitability
. An increase in interest rates may adversely affect our book value
. Our strategy involves significant leverage
- Our leverage may cause substantial losses
- Our leverage may cause margin calls and defaults and force us to sell
assets under adverse market conditions
- Liquidation of collateral may jeopardize our REIT status
- We may exceed our target leverage ratios
- We may not be able to achieve our optimal leverage
- We may incur increased borrowing costs which would adversely affect
our profitability
. If we are unable to renew our borrowings at favorable rates, our
profitability may be adversely affected
. We have not used derivatives to mitigate our interest rate and prepayment
risks
. Our investment strategy may involve credit risk
. Because of competition, we may not be able to acquire mortgage-backed
securities at favorable yields
. We are dependent on our key personnel
. Some of our officers and employees have potential conflicts of interest
- Some of our directors and officers have ownership interests in our
affiliates that create potential conflicts of interest
- Our officers and employees manage assets for other clients
. We and our shareholders are subject to certain tax risks
- Our failure to qualify as a REIT would have adverse tax consequences
- We have certain distribution requirements
- We are also subject to other tax liabilities
. Loss of our Investment Company Act exemption would adversely affect us
. Issuances of large amounts of our stock could cause our share price to
decline
. We may change our investment policies without stockholder approval
. We are subject to the year 2000 risk
S-6
<PAGE>
USE OF PROCEEDS
We intend to use the proceeds of this offering to purchase mortgage-backed
securities. We then intend to increase our investment assets by borrowing
against these mortgage-backed securities and using the proceeds to acquire
additional mortgage-backed securities.
DIVIDEND POLICY
We intend to distribute substantially all of our taxable income with
respect to each year (which does not ordinarily equal net income as calculated
in accordance with GAAP) to our stockholders to comply with the REIT provisions
of the Internal Revenue Code. We intend to declare regular quarterly dividends.
We intend that any taxable income remaining after the distribution of the final
regular quarterly dividend each year will be distributed together with the first
regular quarterly dividend payment of the following taxable year or in a prior
special dividend distribution. Our dividend policy may be revised at the
discretion of our Board of Directors. Any distributions that we will make will
be at the discretion of our Board of Directors and will depend on our taxable
earnings, our financial condition, maintenance of our REIT status and other
factors that our Board of Directors deems relevant.
The level of quarterly dividends is based on a number of factors and should
not be deemed indicative of taxable income for the quarter in which declared or
future quarters or of income calculated in accordance with GAAP. All dividends
that we declare following the closing of this offering will be payable to
holders of the common stock, subject to the terms of any other class of capital
stock that we may issue in the future.
Distributions to stockholders will generally be subject to tax as ordinary
income, although a portion of these distributions may be designated by us as
capital gain or may constitute a tax-free return of capital. We do not intend
to declare dividends that would result in a return of capital. We will annually
furnish to each of our stockholders a statement setting forth distributions paid
during the preceding year and their characterization as ordinary income, capital
gains or return of capital.
We have adopted a dividend reinvestment plan to enable our stockholders to
have their dividends reinvested automatically in additional shares of our common
stock.
PRICE RANGE OF COMMON STOCK
Our common stock trades on the New York Stock Exchange under the symbol
"NLY."
The following table sets forth the high and low sale prices of our common
stock for the periods indicated, as reported by the New York Stock Exchange, and
per share dividend distributions we made for the periods indicated.
<TABLE>
<CAPTION>
Price Dividend
-----
High Low Distributions
---- --- -------------
<S> <C> <C> <C>
1997
Fourth Quarter (beginning October 8, 1997)........................... $12-13/16 $ 10 $0.220
1998
First Quarter........................................................ 11-3/4 10 0.320
Second Quarter....................................................... 11-5/16 8-11/16 0.320
Third Quarter........................................................ 9 6-3/4 0.270
Fourth Quarter....................................................... 9 6-1/8 0.315
1999
First Quarter........................................................ 10-1/4 7-15/16 0.330
Second Quarter....................................................... 11-3/8 9-5/16 0.350
Third Quarter (through _______ ___)..................................
</TABLE>
On _______________, 1999, the last reported sale price of our common stock
was ________ per share.
S-7
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999, on
an actual and as adjusted basis to give effect to the sale of the shares of
common stock offered by this prospectus supplement. You should read this table
in conjunction with "Use of Proceeds," "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our financial statements and
related notes included elsewhere in this prospectus supplement.
Our capitalization, at June 30, 1999, and as adjusted to reflect the sale
of the 5,000,000 shares of common stock that we are offering under this
prospectus supplement, is as follows:
<TABLE>
<CAPTION>
As Adjusted for the
Actual (1) Offering (1) (2)
---------- ----------------
<S> <C> <C>
Common Stock, par value $0.01 per share:
Authorized - 100,000,000 shares
Outstanding - 12,697,548 (as adjusted $ 128,071 (3) $ 178,071 (3)
17,697,548 shares)........................................
Additional Paid in Capital.......................................... 132,966,180
Accumulated other comprehensive income.............................. (19,428,328) (19,428,328)
Shares repurchased at cost (109,600 shares) (903,163) (903,163)
Retained earnings................................................... 829,147 829,147
------------- ------------
Total........................................................ $113,591,907
============= ============
</TABLE>
_______________
(1) Does not include 552,136 shares of common stock issuable upon the exercise
of options granted pursuant to our Long-Term Stock Incentive Plan.
(2) Assumes no exercise of the underwriters' over-allotment option.
(3) Includes 109,600 shares repurchased by us.
S-8
<PAGE>
SELECTED FINANCIAL DATA
(dollars in thousands, except for per share data)
The following selected financial data is derived from our unaudited
financial statements for the six months ended June 30, 1999 and 1998 and our
audited financial statements for the year ended December 31, 1998 and the period
from February 18, 1997 (inception) to December 31, 1997. The selected financial
data should be read in conjunction with the more detailed information contained
in our financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere in
this prospectus supplement.
<TABLE>
<CAPTION>
At or For
At or At or At or the Period
For the Six For the Six For the Year February 18, 1997
Months Ended Months Ended Ended December (inception) to
June 30, 1999 June 30, 1998 31, 1998 December 31, 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Statement of Operations Data:
Days in period 181 181 365 317
Interest income $ 44,280 $ 43,841 $ 89,986 $ 24,713
Interest expense 34,017 36,491 75,735 19,677
------------------------------------------------------------------------------
Net interest income $ 10,263 $ 7,350 $ 14,251 $ 5,036
Gain on sale of mortgage-backed securities 90 1,723 3,344 735
General and administrative expenses
(G&A expenses) 1,171 978 2,106 852
------------------------------------------------------------------------------
Net income $ 9,182 $ 8,095 $ 15,489 $ 4,919
==============================================================================
Net income per average share $ 0.72 $ 0.64 $ 1.22 $ 0.83
Dividends declared per average share $ 0.68 $ 0.64 $ 1.21 $ 0.79
Balance Sheet Data:
Mortgage-backed securities, net $ 1,474,104 $ 1,566,188 $ 1,520,289 $ 1,161,779
Total assets 1,481,962 1,628,922 1,527,352 1,167,740
Repurchase agreements 1,344,740 1,416,268 1,280,510 918,869
Total liabilities 1,368,370 1,497,777 1,401,481 1,032,654
Stockholders' equity 113,592 131,145 125,871 135,086
Number of common shares outstanding 12,697,548 12,757,674 12,648,424 12,713,900
Other Data:
Average total assets $ 1,510,687 $ 1,433,517 $ 1,499,875 $ 476,855
Average borrowings 1,377,908 1,304,153 1,360,040 404,140
Average equity 123,112 133,089 131,265 61,096
Yield on average interest earning assets for the 5.89% 6.13% 6.16% 6.34%
period (1)
Cost of funds on average interest bearing 4.94% 5.60% 5.57% 5.61%
liabilities for the period (1)
Interest rate spread 0.95% 0.53% 0.59% 0.73%
Efficiency ratio (G&A expenses/net interest 11.41% 13.31% 14.78% 16.92%
income)
Annualized Financial Ratios: (1)
Net interest margin 1.36% 1.02% 0.95% 1.22%
G&A expenses as a percentage of average 0.15% 0.14% 0.14% 0.21%
assets
G&A expenses as a percentage of average equity 1.90% 1.47% 1.60% 1.61%
Return on average assets 1.22% 1.13% 1.03% 1.19%
Return on average equity 14.92% 12.16% 11.80% 9.27%
</TABLE>
______________
(1) Ratios for the six months ended June 30, 1999 and 1998 and for the period
February 18, 1997 (inception) to December 31, 1997 have been annualized.
S-9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a real estate investment trust that owns and manages a portfolio of
mortgage-backed securities. Our principal business objective is to generate net
income for distribution to our stockholders from the spread between the interest
income on our mortgage-backed securities and the costs of borrowing to finance
our acquisition of mortgage-backed securities.
We commenced operations on February 18, 1997 upon the consummation of a
private placement. We completed our initial public offering on October 14,
1997.
The 317-day period ended December 31, 1997 was a short operating period and
not a full twelve months. Also, average assets for the period ended December
31, 1997 totaled $476.9 million, whereas average assets for the year ended
December 31, 1998 totaled $1.5 billion. As a result, the comparison of net
income for the period ended February 18, 1997 and the year ended December 31,
1998 may show changes that may not be indicative of future periods.
Results of Operations: For the Six Months Ended June 30, 1999 and 1998, and the
Year ended December 31, 1998 and the Period February 18, 1997 (inception)
through December 31, 1997
Net Income Summary
For the six months ended June 30, 1999, our GAAP net income was $9.2
million, or $0.72 basic earnings per average share, as compared to $8.1 million,
or $0.64 basic earnings per average share, for the six months ended June 30,
1998. We compute our GAAP net income per share by dividing net income by the
weighted average number of shares of outstanding common stock during the period,
which was 12,677,718 for the six months ended June 30, 1999 and 12,742,623 for
the six months ended June 30, 1998. Dividends per weighted average number of
shares outstanding for the six months ended June 30, 1999 was $0.68 per share,
or $8.6 million in total. Dividends per weighted average number of shares
outstanding for the six months ended June 30, 1998 was $0.64 per share, or $8.2
million in total. Our return on average equity was 14.92% on an annualized
basis for the six months ended June 30, 1999 and 12.16% on an annualized basis
for the six months ended June 30, 1998.
Taxable Income and GAAP Income
For the six months ended June 30, 1999 and 1998, our income as calculated
for tax purposes (taxable income) differed from income as calculated according
to GAAP (GAAP income). Our taxable income for the six months ended June 30,
1999 was approximately $9.5 million, or $0.75 per share, as compared to taxable
income of $8.0 million, or $0.63 per share, for the six months ended June 30,
1998. The differences were in the calculations of premium and discount
amortization, gains on sale of mortgage-backed securities, and general and
administrative expenses.
The distinction between taxable income and GAAP income is important to our
stockholders because dividends are declared on the basis of taxable income.
While we do not pay taxes so long as we satisfy the requirements for exemption
from taxation pursuant to the REIT provisions of the Internal Revenue Code, each
year we complete a corporate tax form on which taxable income is calculated as
if we were to be taxed. This taxable income level determines the amount of
dividends we can pay out over time. The table below presents the major
differences between our GAAP and taxable income for the six months ended June
30, 1999 and 1998, the year ended December 31, 1998, and the period ended
December 31, 1997.
S-10
<PAGE>
Taxable Income
--------------
<TABLE>
<CAPTION>
Taxable General Taxable Taxable Gain
& Mortgage on Sale of
GAAP Net Administrative Amortization Securities Taxable Net
Income Differences Differences Differences Income
------ ----------- ----------- ----------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
For the Six Months Ended
June 30, 1999 $ 9,182 $2 $ 328 ($1) $ 9,511
For the Six Months Ended
June 30, 1998 $ 8,095 $3 $ 302 ($394) $ 8,006
- --------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $15,489 $6 $ 959 $ 23 $16,477
For the Period Ended
December 31, 1997 $ 4,919 $3 ($92) $ 54 $ 4,884
</TABLE>
Interest Income and Average Earning Asset Yield
We had average earning assets of $1.5 billion for the six months ended June
30, 1999 and $1.4 billion for the six months ended June 30, 1998. Our primary
source of income for the six months ended June 30, 1999 and 1998 was interest
income. A portion of our income was generated by gains on the sales of our
mortgage-backed securities. Our interest income was $44.3 million for the six
months ended June 30, 1999 and $43.8 million for the six months ended June 30,
1998. Our yield on average earning assets was 5.89% and 6.13% for the same
respective periods. Our average earning asset balance increased by $74.6 million
for the six months ended June 30, 1999 as compared to the six months ended June
30, 1998 and the yield decreased by 0.24%. Interest income increased for the six
months ended June 30, 1999 over the same period in 1998, even though the yield
decreased by 0.24% because the earning assets increased significantly. The table
below shows our average balance of cash equivalents and mortgage-backed
securities, the yields we earned on each type of earning assets, our yield on
average earning assets and our interest income for the six months ended June 30,
1999 and 1998, the year ended December 31, 1998, and the period ended December
31, 1997.
Average Earning Asset Yield
---------------------------
<TABLE>
<CAPTION>
Average Yield on
Amortized Average
Cost of Yield on Amortized Cost Yield on
Average Mortgage- Average Average of Mortgage- Average
Cash Backed Earning Cash Backed Earning Interest
Equivalents Securities Assets Equivalents Securities Assets Income
----------- ---------- ------ ----------- ---------- ------ ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
For the Six Months Ended June 30, 1999 $ 2 $1,503,649 $1,503,651 4.16% 5.89% 5.89% $44,280
For the Six Months Ended June 30, 1998 $ 2 $1,429,028 $1,429,030 4.40% 6.13% 6.13% $43,841
- -----------------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1998 $ 2 $1,461,789 $1,461,791 4.32% 6.16% 6.16% $89,986
For the Period Ended December 31, 1997 $30 $ 448,276 $ 448,306 4.20% 6.34% 6.34% $24,713
</TABLE>
The constant prepayment rate (or CPR) on our mortgage-backed securities for
the six months ended June 30, 1999 was 22% and for the six months ended June 30,
1998 was 21%. CPR is an assumed rate of prepayment for our mortgage-backed
securities, expressed as an annual rate of prepayment relative to the
outstanding principal balance of our mortgage-backed securities. CPR does not
purport to be either a historical description of the prepayment experience of
our mortgage-backed securities or a prediction of the anticipated rate of
prepayment of our mortgage-backed securities.
S-11
<PAGE>
Principal prepayments had a negative effect on our earning asset yield
for the six months ended June 30, 1999 and 1998 because we adjust our rates of
premium amortization and discount accretion monthly based upon the effective
yield method, which takes into consideration changes in prepayment speeds.
Interest Expense and the Cost of Funds
We anticipate that our largest expense will be the cost of borrowed
funds. We had average borrowed funds of $1.4 billion and total interest expense
of $34.0 million for the six months ended June 30, 1999. We had average borrowed
funds of $1.3 billion and total interest expense of $36.5 million for the six
months ended June 30, 1998. Our average cost of funds was 4.94% for the six
months ended June 30, 1999 and 5.60% for the six months ended June 30, 1998. The
cost of funds rate declined 0.66% for the six months ended June 30, 1999 when
compared to the six months ended June 30, 1998; consequently, interest expense
decreased by 7% for the same time period.
With our current asset/liability management strategy, changes in our
cost of funds are expected to be closely correlated with changes in short-term
LIBOR, although we may choose to extend the maturity of our liabilities at any
time. Our average cost of funds was 0.02% below one-month LIBOR for the six
months ended June 30, 1999 and 0.05% below one-month LIBOR for the six months
ended June 30, 1998. We generally have structured our borrowings to adjust with
one-month LIBOR because we believe that one-month LIBOR may continue to be lower
than six-month LIBOR in the present interest rate environment. During the six
months ended June 30, 1999, average one-month LIBOR, which was 4.96%, was 0.16%
lower than average six-month LIBOR, which was 5.12%. During the six months ended
June 30, 1998, average one-month LIBOR, which was 5.65%, was 0.07% lower than
average six-month LIBOR, which was 5.72%.
The table below shows our average borrowed funds and average cost of
funds as compared to average one- and average six-month LIBOR for the six months
ended June 30, 1999 and June 30, 1998, the year ended December 31, 1998, and
period ended December 31, 1997.
Average Cost of Funds
---------------------
<TABLE>
<CAPTION>
Average One-
Month LIBOR
Average Average Average Relative to
Borrowed Interest Average Cost One-Month Six-Month Average Six-
Funds Expense of Funds LIBOR LIBOR Month LIBOR
----------- ------------- --------------- ----------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
For the Six Months Ended
June 30, 1999 $ 1,377,908 $ 34,017 4.94% 4.96% 5.12% (0.16%)
For the Six Months Ended
June 30, 1998 $ 1,304,153 $ 36,491 5.60% 5.65% 5.72% (0.07%)
- ----------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $ 1,360,040 $ 75,735 5.57% 5.57% 5.54% 0.03%
For the Period Ended
December 31, 1997 $ 404,140 $ 19,677 5.61% 5.67% 5.87% (0.20%)
<CAPTION>
Average Cost
of Funds Average Cost of
Relative to Funds Relative
Average One- to Average Six-
Month LIBOR Month LIBOR
----------------- ----------------------
<S> <C> <C>
For the Six Months Ended
June 30, 1999 (0.02%) (0.18%)
For the Six Months Ended
June 30, 1998 (0.05%) (0.12%)
- ------------------------------------------------------------------------
For the Year Ended - 0.03%
December 31, 1998
For the Period Ended
December 31, 1997 (0.06%) (0.26%)
</TABLE>
Net Interest Rate Agreement Expense
We have not entered into any interest rate agreements to date. As part of
our asset/liability management process, we may enter into interest rate
agreements such as interest rate caps, floors or swaps. These agreements would
be entered into with the intent to reduce interest rate or prepayment risk and
would be designed to provide us income and capital appreciation in the event of
certain changes in interest rates. However, even after entering into these
agreements, we would still be exposed to interest rate and prepayment risks. We
review the need for interest rate agreements on a regular basis consistent with
our capital investment policy.
S-12
<PAGE>
Net Interest Income
Our net interest income, which equals interest income less interest
expense, totaled $10.3 million for the six months ended June 30, 1999 and $7.4
million for the six months ended June 30, 1998. Our net interest income
increased because of lower funding costs for the period. This increase was
partially offset by lower yields on assets. Our net interest spread, which
equals the yield on our average assets for the period less the average cost of
funds for the period, was 0.95% for the six months ended June 30, 1999 compared
to 0.53% for the six months ended June 30, 1998. This 0.42% increase in spread
income is reflected in the $2.9 million increase in net interest income. Net
interest margin, which equals net interest income divided by average interest
earning assets, was 1.36% on an annualized basis for the six months ended June
30, 1999 and 1.02% on an annualized basis for the six months ended June 30,
1998. The principal reason that annualized net interest margin exceeded net
interest spread is that average interest earning assets exceeded average
interest bearing liabilities. A portion of our assets is funded with equity
rather than borrowings. We did not have any interest rate agreement expenses
for the six months ended June 30, 1999 and 1998.
The table below shows our interest income by earning asset type, average
earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of funds, and net interest income for the
six months ended June 30, 1999 and 1998, the year ended December 31, 1998, and
the period ended December 31, 1997.
GAAP Net Interest Income
<TABLE>
<CAPTION>
Average
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>
(dollars in thousands)
For the Six Months Ended
June 30, 1999 $ 1,503,649 $ 44,280 $ 2 - $ 44,280 5.89% $ 1,377,908
For the Six Months Ended
June 30, 1998 $ 1,429,028 $ 43,841 $ 2 - $ 43,841 6.13% $ 1,304,153
- ------------------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $ 1,461,789 $ 89,986 $ 2 - $ 89,986 6.16% $ 1,360,040
For the Period Ended
December 31, 1997 $ 448,276 $ 24.682 $ 30 $ 31 $ 24,713 6.34% $ 404,140
<CAPTION>
Average Net
Interest Cost of Interest
Expense Funds Income
--------- ------------- ----------
<S> <C> <C> <C>
For the Six Months Ended
June 30, 1999 $ 34,017 4.94% $ 10,263
For the Six Months Ended
June 30, 1998 $ 36,491 5.60% $ 7,350
- --------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $ 75,735 5.57% $ 14,251
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 six months ended June 30, 1999, we sold mortgage-backed securities
with an aggregate historical amortized cost of $48.1 million for an aggregate
gain of $90,413. For the six months ended June 30, 1998, we sold mortgage-
backed securities with an aggregate historical amortized cost of $223.2 million
for an aggregate gain of $1.7 million. As stated above, our gain on the sale of
assets declined substantially. For the six months ended June 30, 1999, there
was a greater emphasis on spread income and not gains. The difference between
the sale price and the historical amortized cost of our mortgage-backed
securities is a realized gain and increases income accordingly. We do not
expect to sell assets on a frequent basis, but may from time to time sell
existing assets to move into new assets which our management believes might have
higher risk-adjusted returns or to manage our balance sheet as part of our
asset/liability management strategy.
S-13
<PAGE>
Credit Losses
We have not experienced credit losses on our mortgage-backed securities to
date. We have limited our exposure to credit losses on our mortgage-backed
securities by purchasing only securities, issued or guaranteed by FNMA, FHLMC or
GNMA, which, although not rated, carry an implied "AAA" rating.
General and Administrative Expenses
G&A expenses were $1.2 million for the six months ended June 30, 1999 and
$1.0 million for the six months ended June 30, 1998. Taxable G&A expenses were
approximately $2,000 and $3,000 less than for GAAP purposes for the six months
ended June 30, 1999 and 1998, respectively. G&A expenses increased as a
percentage of average assets to 0.15% for the six months ended June 30, 1999
compared to 0.14% for the same period in the previous year. This increase was
primarily attributable to an increase of $160,000 in cash compensation and
benefits expense.
GAAP G&A Expenses and Operating Expense Ratios
----------------------------------------------
<TABLE>
<CAPTION>
Cash Total G&A Total G&A
Compensation Other Total Expenses/Average Expenses/Average
and Benefits G&A G&A Assets Equity
Expense Expenses Expenses (annualized) (annualized)
---------------- ------------- ----------- ------------------- ---------------------
<S> <C> <C> <C> <C> <C>
(dollars in thousands)
For the Six Months Ended
June 30, 1999 $ 671 $ 500 $ 1,171 0.15% 1.90%
For the Six Months Ended
June 30, 1998 $ 511 $ 467 $ 978 0.14% 1.47%
- ---------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $ 1,210 $ 896 $ 2,106 0.14% 1.60%
For the Period Ended
December 31, 1997 $ 492 $ 360 $ 852 0.21% 1.61%
</TABLE>
Net Income and Return on Average Equity
Our net income was $9.2 million for the six months ended June 30, 1999 and
$8.1 million for the six months ended June 30, 1998. Our return on average
equity was 14.92% on an annualized basis for the six months ended June 30, 1999
and 12.16% on an annualized basis for the six months ended June 30, 1998. The
increase in net income is a direct result of an increase in spread income. As
previously mentioned, the substantial decline in interest expense was the
primary reason that our earnings increased. The table below shows our net
interest income, gain on sale of mortgage-backed securities and G&A expenses
each as a percentage of average equity, and the return on average equity for the
six months ended June 30, 1999 and June 30, 1998, the year ended December 31,
1998 and the period ended December 31, 1997.
Components of Return on Average Equity
--------------------------------------
(Ratios for the Six Months Ended June 30, 1999 and 1998 and the Period ended
December 31, 1997 are annualized)
<TABLE>
<CAPTION>
Gain on Sale of
Net Interest Mortgage-Backed G&A Return on
Income/Average Securities/Average Expenses/Average Average
Equity Equity Equity Equity
------------------ ---------------------- ------------------- --------------
<S> <C> <C> <C> <C>
For the Six Months Ended June 30, 1999 16.67% 0.15% 1.90% 14.92%
For the Six Months Ended June 30, 1998 11.05% 2.58% 1.47% 12.16%
- ------------------------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 1998 10.85% 2.55% 1.60% 11.80%
For the Period Ended December 31, 1997 9.49% 1.39% 1.61% 9.27%
</TABLE>
S-14
<PAGE>
Dividends and Taxable Income
We have elected to be taxed as a REIT under the Internal Revenue Code.
Accordingly, we have distributed substantially all of our taxable income for
each year since inception to our stockholders, including income resulting from
gains on sales of our mortgage-backed securities. From inception through June
30, 1999, earned taxable income exceeded dividend declarations by $2.1 million,
or $0.16 per share, based on the number of shares of common stock outstanding at
period end.
Dividend Summary
----------------
<TABLE>
<CAPTION>
Weighted
Average
Common Taxable Net Dividends Cumulative
Taxable Shares Income Per Declared Per Total Dividend Pay-out Undistributed
Net Income Outstanding Share Share Dividends out Ratio Taxable Income
------------ -------------- -------------- -------------- ----------- ---------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
(dollars in thousands, except per share data)
For the Six Months Ended
June 30, 1999 $ 9,511 12,677,718 $ 0.75 $ 0.68 $ 8,634 90.8% $ 2,111
For the Six Months Ended
June 30, 1998 $ 8,006 12,742,623 $ 0.63 $ 0.64 $ 8,164 101.9% $ 36
- -----------------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 1998 $ 16,477 12,709,116 $ 1.30 $ 1.21 $ 15,437 93.7% $ 1,234
For the Period Ended
December 31, 1997 $ 4,884 5,952,123 $ 0.82 $ 0.79 $ 4,690 96.0% $ 194
</TABLE>
Financial Condition
Mortgage-Backed Securities
All of our mortgage-backed securities at June 30, 1999 were adjustable-rate
or fixed-rate mortgage-backed securities backed by single-family mortgage loans.
All of the mortgage assets underlying these mortgage-backed securities were
secured with a first lien position on the underlying single-family properties.
All our mortgage-backed securities were FHLMC, FNMA or GNMA mortgage pass-
through certificates or CMOs, which carry an implied "AAA" rating. We mark-to-
market all of our earning assets at liquidation value.
We accrete discount balances as an increase in interest income over the
life of discount mortgage-backed securities and we amortize premium balances as
a decrease in interest income over the life of premium mortgage-backed
securities. At June 30, 1999 and 1998, we had on our balance sheet a total of
$1.0 million and $648,066, respectively, of unamortized discount (which is the
difference between the remaining principal value and current historical
amortized cost of our mortgage-backed securities acquired at a price below
principal value) and a total of $26.0 million and $27.2 million, respectively,
of unamortized premium (which is the difference between the remaining principal
value and the current historical amortized cost of our mortgage-backed
securities acquired at a price above principal value).
We received mortgage principal repayments of $235.8 million for the six
months ended June 30, 1999 and $232.1 million for the six months ended June 30,
1998. Given our current portfolio composition, if mortgage principal prepayment
rates were to increase over the life of our mortgage-backed securities, all
other factors being equal, our net interest income would decrease during the
life of these mortgage-backed securities as we would be required to amortize our
net premium balance into income over a shorter time period. Similarly, if
mortgage principal prepayment rates were to decrease over the life of our
mortgage-backed securities, all other factors being equal, our net interest
income would increase during the life of these mortgage-backed securities as we
would amortize our net premium balance over a longer time period.
S-15
<PAGE>
The table below summarizes our mortgage-backed securities at June 30, 1999
and 1998, December 31, 1998, and December 31, 1997.
Mortgage-Backed Securities
--------------------------
<TABLE>
<CAPTION>
Amortized Estimated Fair Weighted
Net Amortized Cost/Principal Estimated Fair Value/Principal Average
Principal Value Premium Cost Value Value Value Yield
----------------- ---------- ------------ -------------- --------------- ----------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
At June 30, 1999 $1,468,547 $24,985 $1,493,532 101.70% $1,474,104 100.38% 6.21%
At June 30, 1998 $1,541,520 $26,532 $1,568,052 101.72% $1,566,188 101.60% 6.50%
- ------------------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $1,502,414 $24,278 $1,526,692 101.62% $1,520,289 101.19% 6.43%
At December 31, 1997 $1,138,365 $21,390 $1,159,755 101.88% $1,161,779 102.06% 6.57%
</TABLE>
The tables below set forth certain characteristics of our mortgage-backed
securities. 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 Value
Weighted Weighted at Period End
Average Weighted Weighted Average Term Weighted Weighted as % of Total
Principal Coupon Average Index Average Net to Next Average Average Asset Mortgage-Backed
Value Rate Level Margin Adjustment Lifetime Cap Yield Securities
---------- ---------- -------------- ----------- ------------- ------------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(dollars in thousands)
At June 30, 1999 $ 941,559 6.67% 4.96% 1.71% 11 months 11.00% 5.84% 64.12%
At June 30, 1998 $1,140,518 6.86% 5.20% 1.66% 15 months 10.42% 6.46% 73.98%
- ----------------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $1,030,654 6.84% 5.18% 1.66% 12 months 10.63% 6.42% 68.60%
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 Weighted of Total
Average Average Mortgage-Backed
Principal Value Coupon Rate Asset Yield Securities
------------------ ------------------ -------------- -------------------------
<S> <C> <C> <C> <C>
(dollars in thousands)
At June 30, 1999 $526,988 6.58% 6.88% 35.88%
At June 30, 1998 $401,002 6.82% 6.65% 26.02%
-------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $471,760 6.55% 6.47% 31.40%
At December 31, 1997 $143,712 7.50% 7.08% 12.62%
</TABLE>
S-16
<PAGE>
At June 30, 1999, June 30, 1998, December 31, 1998 and December 31, 1997,
we held mortgage-backed securities with coupons linked to the one-year and
three-year Treasury Indices, one-month LIBOR and the six-month CD rate. At June
30, 1999 and December 31, 1998, we also held mortgage-backed securities with
coupons linked to the five-year Treasury Index. The tables below segments our
adjustable-rate mortgage-backed securities by type of adjustment index, coupon
adjustment frequency and annual and lifetime cap adjustment as of those dates.
Adjustable-Rate Mortgage-Backed Securities by Index
---------------------------------------------------
June 30, 1999
-------------
<TABLE>
<CAPTION>
1-Year 3-Year 5-Year
One-Month Six-Month Treasury Treasury Treasury
LIBOR CD Rate Index Index Index
------------ ------------ --------------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 mo. 36 mo. 60 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 18 mo. 16 mo. 14 mo.
Weighted Average Annual Period Cap None 1.00% 1.70% 1.79% 1.33%
Weighted Average Lifetime Cap at June 30,
1999 9.13% 11.05% 12.02% 13.17% 11.62%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at June 30, 1999 23.85% 3.16% 30.14% 6.17% 0.80%
</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. 12 mo. 36 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 32 mo. 9 mo.
Weighted Average Annual Period Cap None 1.00% 2.00% 2.00%
Weighted Average Lifetime Cap at June 30,
1998 9.15% 10.93% 11.73% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at June 30, 1998 36.24% 4.63% 32.99% 0.12%
</TABLE>
Adjustable-Rate Mortgage-Backed Securities by Index
---------------------------------------------------
December 31, 1998
-----------------
<TABLE>
<CAPTION>
1-Year 3-Year 5-Year
One-Month Six-Month Treasury Treasury Treasury
LIBOR CD Rate Index Index Index
------------ ------------ --------------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
Weighted Average Adjustment Frequency 1 mo. 6 mo. 12 mo. 36 mo. 60 mo.
Weighted Average Term to Next Adjustment 1 mo. 3 mo. 23 mo. 9 mo. 2 mo.
Weighted Average Annual Period Cap None 1.00% 1.83% 2.00% 2.00%
Weighted Average Lifetime Cap at December
31, 1998 9.16% 11.04% 11.76% 13.07% 11.57%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at December 31,
1998 29.60% 3.73% 33.33% 1.62% 0.32%
</TABLE>
S-17
<PAGE>
Adjustable-Rate Mortgage-Backed Securities by Index
---------------------------------------------------
December 31, 1997
-----------------
<TABLE>
<CAPTION>
1-Year 3-Year
One-Month Six-Month CD Treasury Treasury
LIBOR Rate 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. 4 mo. 46 mo. 12 mo.
Weighted Average Annual Period Cap None 2.00% 1.95% 2.00%
Weighted Average Lifetime Cap at December
31, 1998 9.21% 10.88% 11.75% 14.16%
Mortgage Principal Value as Percentage of
Mortgage-Backed Securities at December 31,
1998 30.94% 7.81% 48.45% 0.18%
</TABLE>
Interest Rate Agreements
Interest rate agreements are assets that are carried on a balance sheet at
estimated liquidation value. We have not entered into any interest rate
agreements since our inception.
Borrowings
To date, our debt has consisted entirely of borrowings collateralized by a
pledge of our mortgage-backed securities. These borrowings appear on our
balance sheet as repurchase agreements. At June 30, 1999, we had established
uncommitted borrowing facilities in this market with twenty-three lenders in
amounts which we believe are in excess of our needs. All of our mortgage-backed
securities are currently accepted as collateral for these borrowings. However,
we limit our borrowings, and thus our potential asset growth, in order to
maintain unused borrowing capacity and thus increase the liquidity and strength
of our balance sheet.
For the six months ended June 30, 1999 and 1998, the term to maturity of
our borrowings ranged from one day to one year, with a weighted average original
term to maturity of 72 days for the six months ended June 30, 1999 and 90 days
for the six months ended June 30, 1998. At June 30, 1999, the weighted average
cost of funds for all of our borrowings was 4.87% and the weighted average term
to next rate adjustment was 24 days. At June 30, 1998, the weighted average
cost of funds for all of our borrowings was 5.58% and the weighted average term
to next rate adjustment was 42 days.
Liquidity
Liquidity, which is our ability to turn non-cash assets into cash, allows
us to purchase additional mortgage-backed securities and to pledge additional
assets to secure existing borrowings should the value of our pledged assets
decline. Potential immediate sources of liquidity for us include cash balances
and unused borrowing capacity. Unused borrowing capacity will vary over time as
the market value of our mortgage-backed securities varies. Our balance sheet
also generates liquidity on an on-going basis through mortgage principal
repayments and net earnings held prior to payment as dividends. Should our
needs ever exceed these on-going sources of liquidity plus the immediate sources
of liquidity discussed above, we believe that our mortgage-backed securities
could in most circumstances be sold to raise cash. The maintenance of liquidity
is one of the goals of our capital investment policy. Under this policy, we
limit asset growth in order to preserve unused borrowing capacity for liquidity
management purposes.
Stockholders' Equity
We use "available-for-sale" treatment for our mortgage-backed securities;
we carry these assets on our balance sheet at estimated market value rather than
historical amortized cost. Based upon this "available-for-sale" treatment, our
equity base at June 30, 1999 was $113.6 million, or $8.95 per share. If we had
used historical
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<PAGE>
amortized cost accounting, our equity base at June 30, 1999 would have been
$133.0 million, or $10.48 per share. Our equity base at June 30, 1998 was $131.1
million, or $10.28 per share. If we had used historical amortized cost
accounting, our equity base at June 30, 1998 would have been $133.0 million, or
$10.43 per share.
With our "available-for-sale" accounting treatment, unrealized fluctuations
in market values of assets do not impact our GAAP or taxable income but rather
are reflected on our balance sheet by changing the carrying value of the asset
and stockholders' equity under "Accumulated Other Comprehensive Income." By
accounting for our assets in this manner, we hope 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, our book value and
book value per share are likely to fluctuate far more than if we used historical
amortized cost accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may not be
meaningful.
The table below shows unrealized gains and losses on the mortgage-backed
securities in our portfolio.
Unrealized Gains and Losses
---------------------------
(dollars in thousands)
<TABLE>
<CAPTION>
At December 31, At December 31,
At June 30, 1999 At June 30, 1998 1998 1997
----------------------------------------- -------------------------------------
<S> <C> <C> <C> <C>
Unrealized Gain $ 1,744 $ 2,826 $ 3,302 $ 3,253
Unrealized Loss (21,172) (4,736) (9,706) (1,229)
----------------------------------------- -------------------------------------
Net Unrealized Loss (19,428) (1,910) (6,404) 2,024
========================================= =====================================
Net Unrealized Loss as % of
Mortgage-Backed Securities
Principal Value (1.32%) (0.12%) (0.43%) 0.18%
Net Unrealized Loss as % of Mortgage-Backed
Securities Amortized Cost (1.30%) (0.12%) (0.42%) 0.17%
</TABLE>
Unrealized changes in the estimated net market value of mortgage-backed
securities have one direct effect on our potential earnings and dividends:
positive market-to-market changes increase our equity base and allow us to
increase our borrowing capacity while negative changes tend to limit borrowing
capacity under our capital investment policy. A very large negative change in
the net market value of our mortgage-backed securities might impair our
liquidity position, requiring us to sell assets with the likely result of
realized losses upon sale. "Unrealized Losses on Available for Sale Securities"
was $19.4 million, or 1.30% of the amortized cost of our mortgage-backed
securities at June 30, 1999. "Unrealized Losses on Available for Sale
Securities" was $1.9 million or 0.12% of the amortized cost of our mortgage-
backed securities at June 30, 1998.
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<PAGE>
The table below shows our equity capital base as reported and on a
historical amortized cost basis at June 30, 1999, June 30, 1998, December 31,
1998 and December 31, 1997. Issuances of common stock, the level of GAAP
earnings as compared to dividends declared, and other factors influence our
historical cost equity capital base. The GAAP reported equity capital base is
influenced by these factors plus changes in the "Net Unrealized Losses on Assets
Available for Sale" account.
<TABLE>
<CAPTION>
Stockholders' Equity
--------------------
GAAP
Historical Net Unrealized Reported Historical GAAP Reported
Amortized Cost Gains on Assets Equity Base Amortized COST Equity (Book
Equity Base Available for Sale (Book Value) Equity Per Share Value) Per Share
--------------------------------------------------------------------------------------------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
At June 30, 1999 $ 133,020 ($19,428) $ 113,592 $ 10.48 $ 8.95
At June 30, 1998 $ 133,055 ($1,910) $ 131,145 $ 10.43 $ 10.28
- ------------------------------------------------------------------------------------------------------------------------
At December 31, 1998 $ 132,275 ($6,404) $ 125,871 $ 10.46 $ 9.95
At December 31, 1997 $ 133,062 $2,024 $ 135,086 $ 10.47 $ 10.62
</TABLE>
Leverage
Our debt-to-GAAP reported equity ratio at June 30, 1999 and June 30, 1998
was 11.8:1 and 10.8:1, respectively. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to-GAAP reported equity ratio is determined under our
capital investment policy. Should our actual debt-to-equity ratio increase
above the target level due to asset acquisition or market value fluctuations in
assets, we will cease to acquire new assets. Our management will, at that time,
present a plan to our Board of Directors to bring us back to our target debt-to-
equity ratio; in many circumstances, this would be accomplished in time by the
monthly reduction of the balance of our mortgage-backed securities through
principal repayments.
Asset/Liability Management and Effect of Changes in Interest Rates
We continually review our asset/liability management strategy with respect
to interest rate risk, mortgage prepayment risk, credit risk and the related
issues of capital adequacy and liquidity. We seek attractive risk-adjusted
stockholder returns while maintaining a strong balance sheet.
We seek to manage the extent to which our net income changes as a function
of changes in interest rates by matching adjustable-rate assets with variable-
rate borrowings. In addition, although we have not done so to date, we may seek
to mitigate the potential impact on net income of periodic and lifetime coupon
adjustment restrictions in our portfolio of 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. We will seek to mitigate the effect of changes in the mortgage
principal repayment rate by balancing assets we purchase at a premium with
assets we purchase at a discount. To date, the aggregate premium exceeds the
aggregate discount on our mortgage-backed securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
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<PAGE>
Status of Year 2000 Compliance
We have made an ongoing effort to protect against the year 2000 risk. The
year 2000 risk arises because certain computer programs have been written using
two digits rather than four to define the applicable years. Consequently, date-
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in system failures or miscalculations causing
disruptions of operations.
We have engaged a consultant to assist us in protecting against the year
2000 risk. With the assistance of the consultant, we have reviewed the ability
of our computers and computer programs to recognize properly and handle dates in
the year 2000 and have completed upgrades, as appropriate. In addition, we have
reviewed all the date fields embedded in our internally developed spreadsheets,
databases and other programs and have determined that these programs are using
four-digit years in reference to dates. Therefore, we believe that all of our
equipment and internal systems are year 2000 compliant. To date, we have
incurred minimal costs to become year 2000 compliant.
We believe that most of our exposure to year 2000 issues involves the
readiness of third parties. Each third party is subject to the year 2000 risk.
We have surveyed pertinent third parties for their compliance. As a result of
communications with these third parties, we believe that they are spending the
appropriate and necessary resources to try to identify year 2000 issues and to
resolve them or mitigate their impact to the best of their ability as they are
identified.
S-21
<PAGE>
BUSINESS STRATEGY
General
Our principal business objective is to generate income for distribution to
our stockholders, primarily from the net cash flows on our mortgage-backed
securities. Our net cash flows result primarily from the difference between the
interest income on our mortgage-backed security investments and our borrowing
costs on our mortgage-backed securities. To achieve our business objective and
generate dividend yields, our strategy is:
. to purchase mortgage-backed securities, the majority of which we expect
to have adjustable interest rates based on changes in short-term market
interest rates;
. to acquire mortgage-backed securities that we believe:
- we have the necessary expertise to evaluate and manage;
- we can readily finance;
- are consistent with our balance sheet guidelines and risk management
objectives; and
- provide attractive investment returns in a range of scenarios;
. to finance purchases of mortgage-backed securities with the proceeds of
equity offerings and, to the extent permitted by our capital investment
policy, to utilize leverage to increase potential returns to
stockholders through borrowings (primarily under repurchase agreements);
. to attempt to structure our borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate
basis, generally correspond to the interest rate adjustment indices and
interest rate adjustment periods of our adjustable-rate mortgage-backed
securities;
. to seek to minimize prepayment risk by structuring a diversified
portfolio with a variety of prepayment characteristics and through other
means; and
. to issue new equity or debt and increase the size of our balance sheet
when opportunities in the market for mortgage-backed securities are
likely to allow growth in earnings per share.
We believe we are able to obtain cost efficiencies through our facilities-
sharing arrangement with FIDAC and by virtue of our management's experience in
managing portfolios of mortgage-backed securities and arranging collateralized
borrowings. We will strive to become even more cost-efficient over time by:
. seeking to raise additional capital from time to time in order to
increase our ability to invest in mortgage-backed securities;
. striving to lower our effective borrowing costs over time by seeking
direct funding with collateralized lenders, rather than using financial
intermediaries, and investigating the possibility of using commercial
paper and medium term note programs;
. improving the efficiency of our balance sheet structure by investigating
the issuance of uncollateralized subordinated debt, preferred stock and
other forms of capital; and
. utilizing information technology to the fullest extent possible in our
business, including to improve our ability to monitor the performance of
our mortgage-backed securities and to lower our operating costs.
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<PAGE>
Mortgage-Backed Securities
General
To date, all of the mortgage-backed securities that we have acquired have
been agency mortgage-backed securities which, although not rated, carry an
implied "AAA" rating. Agency mortgage-backed securities are mortgage-backed
securities where a government agency or federally chartered corporation, such as
FHLMC, FNMA or GNMA, guarantees payments of principal or interest on the
securities. Agency mortgage-backed securities consist of agency pass-through
certificates and CMOs issued or guaranteed by an agency.
Even though we have only acquired securities with an implied "AAA" rating
so far, under our capital investment policy we have the ability to acquire
securities of lower quality. Under our policy, at least 75% of our total assets
must be high quality mortgage-backed securities and short-term investments.
High quality securities means securities (1) that are rated within one of the
two highest rating categories by at least one of the nationally recognized
rating agencies, (2) that are unrated but are guaranteed by the United States
government or an agency of the United States government, or (3) that are unrated
or whose ratings have not been updated but that our management determines are of
comparable quality to rated high quality mortgage-backed securities.
Under our capital investment policy, the remainder of our assets,
comprising not more than 25% of total assets, may consist of mortgage-backed
securities and 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 S&P or the equivalent by another nationally recognized rating
organization) or, if not rated, are by our determination of comparable credit
quality to an investment which is rated "BBB" or better. We intend to structure
our portfolio to maintain a minimum weighted average rating (including our
deemed comparable ratings for unrated mortgage-backed securities) of our
mortgage-backed securities of at least single "A" under the S&P rating system
and at the comparable level under the other rating systems.
Our allocation of investments among the permitted investment types may vary
from time-to-time based on the evaluation by our Board of Directors of economic
and market trends and our perception of the relative values available from these
types of investments, except that in no event will our investments that are not
high quality exceed 25% of our total assets.
We acquire only those mortgage-backed securities that we believe we have
the necessary expertise to evaluate and manage, that are consistent with our
balance sheet guidelines and risk management objectives and that we believe we
can readily finance. Since we generally hold the mortgage-backed securities we
acquire until maturity, we generally do not seek to acquire assets whose
investment returns are attractive in only a limited range of scenarios. We
believe that future interest rates and mortgage prepayment rates are very
difficult to predict. Therefore, we seek to acquire mortgage-backed securities
which we believe will provide acceptable returns over a broad range of interest
rate and prepayment scenarios.
Our mortgage-backed securities consist of pass-through certificates and
collateralized mortgage obligations (or CMOs) issued or guaranteed by FHLMC,
FNMA or GNMA. We have not and will not invest in REMIC residuals, other CMO
residuals or mortgage-backed securities, such as inverse floaters, which have
imbedded leverage as part of their structural characteristics.
Description of Mortgage-Backed Securities
The mortgage-backed securities that we acquire provide funds for mortgage
loans made primarily to residential homeowners. Our securities generally
represent interests in pools of mortgage loans made by savings and loan
institutions, mortgage bankers, commercial banks and other mortgage lenders.
These pools of mortgage loans are assembled for sale to investors (like us) by
various government, government-related and private organizations.
Mortgage-backed securities differ from other forms of traditional debt
securities, which normally provide for periodic payments of interest in fixed
amounts with principal payments at maturity or on specified call dates.
Instead, mortgage-backed securities provide for a monthly payment, which
consists of both interest and principal. In
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<PAGE>
effect, these payments are a "pass-through" of the monthly interest and
principal payments made by the individual borrower on the mortgage loans, net of
any fees paid to the issuer or guarantor of the securities. Additional payments
result from prepayments of principal upon the sale, refinancing or foreclosure
of the underlying residential property, net of fees or costs which may be
incurred. Some mortgage-backed securities, such as securities issued by GNMA,
are described as "modified pass-through." These securities entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
certain fees, regardless of whether or not the mortgagors actually make mortgage
payments when due.
The investment characteristics of pass-through mortgage-backed securities
differ from those of traditional fixed-income securities. The major differences
include the payment of interest and principal on the mortgage-backed securities
on a more frequent schedule, as described above, and the possibility that
principal may be prepaid at any time due to prepayments on the underlying
mortgage loans or other assets. These differences can result in significantly
greater price and yield volatility than is the case with traditional fixed-
income securities.
The occurrence of mortgage prepayments is affected by various factors
including the level of interest rates, general economic conditions, the age of
the mortgage loan, the location of the property and other social and demographic
conditions. Generally prepayments on mortgage-backed securities increase during
periods of falling mortgage interest rates and decrease during periods of rising
mortgage interest rates. We may reinvest prepayments at higher or lower
interest rates than the original investment, thus affecting the yield of our
investments.
To the extent mortgage-backed securities are purchased at a premium, faster
than expected prepayments would result in a faster than expected amortization of
the premium paid. Conversely, if these securities were purchased at a discount,
faster than expected prepayments would accelerate our recognition of income.
CMOs may allow for shifting of prepayment risk from slower-paying tranches
to faster-paying tranches. This is in contrast to mortgage pass-through
certificates where all investors share equally in all payments, including all
prepayments, on the underlying mortgages.
FHLMC Certificates
FHLMC is a privately-owned government-sponsored enterprise created pursuant
to an Act of Congress on July 24, 1970. The principal activity of FHLMC
currently consists of the purchase of mortgage loans or participation interests
in these loans and the resale of the loans and participations in the form of
guaranteed mortgage-backed securities. FHLMC guarantees to each holder of FHLMC
certificates the timely payment of interest at the applicable pass-through rate
and ultimate collection of all principal on the holder's pro rata share of the
unpaid principal balance of the related mortgage loans, but does not guarantee
the timely payment of scheduled principal of the underlying mortgage loans. The
obligations of FHLMC under our guarantees are solely those of FHLMC and are not
backed by the full faith and credit of the United States. If FHLMC were unable
to satisfy these obligations, distributions to holders of FHLMC certificates
would consist solely of payments and other recoveries on the underlying Mortgage
Loans and, accordingly, monthly distributions to holders of FHLMC certificates
would be affected by delinquent payments and defaults on such Mortgage Loans.
FHLMC certificates may be backed by pools of single-family mortgage loans
or multi-family mortgage loans. These underlying mortgage loans may have
original terms to maturity of up to 40 years. FHLMC certificates may be issued
under cash programs (composed of mortgage loans purchased from a number of
sellers) or guarantor programs (composed of mortgage loans purchased from one
seller in exchange for participation certificates representing interests in the
mortgage loans purchased).
FHLMC certificates may pay interest at a fixed rate or an adjustable rate.
The interest rate paid on adjustable-rate FHLMC certificates (or FHLMC ARMs)
adjusts periodically within 60 days prior to the month in which the interest
rates on the underlying mortgage loans adjust. The interest rates paid on
certificates issued under FHLMC's standard ARM programs adjust in relation to
the Treasury index. Other specified indices used in FHLMC ARM programs include
the 11th District Cost of Funds Index published by the Federal Home Loan Bank of
San Francisco, LIBOR and other indices. Interest rates paid on fully-indexed
FHLMC ARM certificates equal the applicable index rate plus a specified number
of basis points. The majority of series of FHLMC ARM certificates issued to
date have evidenced pools of mortgage loans with monthly, semi-annual or annual
interest adjustments.
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<PAGE>
Adjustments in the interest rates paid are generally limited to an annual
increase or decrease of either 100 or 200 basis points and to a lifetime cap of
500 or 600 basis points over the initial interest rate. Certain FHLMC programs
include mortgage loans which allow the borrower to convert the adjustable
mortgage interest rate to a fixed rate. Adjustable-rate mortgages which are
converted into fixed-rate mortgage loans are repurchased by FHLMC or by the
seller of the loan to FHLMC at the unpaid principal balance of the loan plus
accrued interest to the due date of the last adjustable rate interest payment.
FNMA Certificates
FNMA is a privately-owned, federally-chartered corporation organized and
existing under the Federal National Mortgage Association Charter Act. FNMA
provides funds to the mortgage market primarily by purchasing home mortgage
loans from local lenders, thereby replenishing their funds for additional
lending. FNMA guarantees to the registered holder of a FNMA certificate that it
will distribute amounts representing scheduled principal and interest on the
mortgage loans in the pool underlying the FNMA certificate, whether or not
received, and the full principal amount of any such mortgage loan foreclosed or
otherwise finally liquidated, whether or not the principal amount is actually
received. The obligations of FNMA under its guarantees are solely those of FNMA
and are not backed by the full faith and credit of the United States. If FNMA
were unable to satisfy its obligations, distributions to holders of FNMA
certificates would consist solely of payments and other recoveries on the
underlying mortgage loans and, accordingly, monthly distributions to holders of
FNMA certificates would be affected by delinquent payments and defaults on these
mortgage loans.
FNMA certificates may be backed by pools of single-family or multi-family
mortgage loans. The original terms to maturities of the mortgage loans
generally do not exceed 40 years. FNMA certificates may pay interest at a fixed
rate or an adjustable rate. Each series of FNMA ARM certificates bears an
initial interest rate and margin tied to an index based on all loans in the
related pool, less a fixed percentage representing servicing compensation and
FNMA's guarantee fee. The specified index used in different series has included
the Treasury Index, the 11th District Cost of Funds Index published by the
Federal Home Loan Bank of San Francisco, LIBOR and other indices. Interest
rates paid on fully-indexed FNMA ARM certificates equal the applicable index
rate plus a specified number of basis points. The majority of series of FNMA
ARM certificates issued to date have evidenced pools of mortgage loans with
monthly, semi-annual or annual interest rate adjustments. Adjustments in the
interest rates paid are generally limited to an annual increase or decrease of
either 100 or 200 basis points and to a lifetime cap of 500 or 600 basis points
over the initial interest rate. Certain FNMA programs include mortgage loans
which allow the borrower to convert the adjustable mortgage interest rate of the
ARM to a fixed rate. Adjustable-rate mortgages which are converted into fixed-
rate mortgage loans are repurchased by FNMA or by the seller of the loans to
FNMA at the unpaid principal of the loan plus accrued interest to the due date
of the last adjustable rate interest payment. Adjustments to the interest rates
on FNMA ARM certificates are typically subject to lifetime caps and periodic
rate or payment caps.
GNMA Certificates
GNMA is a wholly owned corporate instrumentality of the United States
within the Department of Housing and Urban Development (or HUD). The National
Housing Act of 1934 authorizes GNMA to guarantee the timely payment of the
principal of and interest on certificates which represent an interest in a pool
of mortgages insured by the Federal Housing Administration (or FHA) or partially
guaranteed by the Department of Veterans Affairs and other loans eligible for
inclusion in mortgage pools underlying GNMA certificates. Section 306(g) of the
Housing Act provides that the full faith and credit of the United States is
pledged to the payment of all amounts which may be required to be paid under any
guaranty by GNMA.
At present, most GNMA certificates are backed by single-family mortgage
loans. The interest rate paid on GNMA certificates may be a fixed rate or an
adjustable rate. The interest rate on GNMA certificates issued under GNMA's
standard ARM program adjusts annually in relation to the Treasury index.
Adjustments in the interest rate are generally limited to an annual increase or
decrease of 100 basis points and to a lifetime cap of 500 basis points over the
initial coupon rate.
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<PAGE>
Single-Family and Multi-Family Privately-Issued Certificates
Single-family and multi-family privately-issued certificates are pass-
through certificates that are not issued by one of the agencies and that are
backed by a pool of conventional single-family or multi-family mortgage loans.
These certificates are issued by originators of, investors in, and other owners
of mortgage loans, including savings and loan associations, savings banks,
commercial banks, mortgage banks, investment banks and special purpose "conduit"
subsidiaries of these institutions.
While agency pass-through certificates are backed by the express obligation
or guarantee of one of the agencies, as described above, privately-issued
certificates are generally covered by one or more forms of private (i.e., non-
governmental) credit enhancements. These credit enhancements provide an extra
layer of loss coverage in the event that losses are incurred upon foreclosure
sales or other liquidations of underlying mortgaged properties in amounts that
exceed the equity holder's equity interest in the property. Forms of credit
enhancements include limited issuer guarantees, reserve funds, private mortgage
guaranty pool insurance, over-collateralization and subordination.
Subordination is a form of credit enhancement frequently used and involves
the issuance of classes of senior and subordinated mortgage-backed securities.
These classes are structured into a hierarchy to allocate losses on the
underlying mortgage loans and also for defining priority of rights to payment of
principal and interest. Typically, one or more classes of senior securities are
created which are rated in one of the two highest rating levels by one or more
nationally recognized rating agencies and which are supported by one or more
classes of mezzanine securities and subordinated securities that bear losses on
the underlying loans prior to the classes of senior securities. Mezzanine
securities, as used in this prospectus, refers to classes that are rated below
the two highest levels but no lower than a single "B" level under the S&P rating
system (or comparable level under other rating systems) and are supported by one
or more classes of subordinated securities which bear realized losses prior to
the classes of mezzanine securities. Subordinated securities, as used in this
prospectus, refers to any class that bears the "first loss" from losses from
underlying mortgage loans or that is rated below a single "B" level (or, if
unrated, we deem it to be below that level). In some cases, only classes of
senior securities and subordinated securities are issued. By adjusting the
priority of interest and principal payments on each class of a given series of
senior-subordinated mortgage-backed securities, issuers are able to create
classes of mortgage-backed securities with varying degrees of credit exposure,
prepayment exposure and potential total return, tailored to meet the needs of
sophisticated institutional investors.
Collateralized Mortgage Obligations and Multi-Class Pass-Through Securities
We may also invest in collateralized mortgage obligations (or CMOs) and
multi-class pass-through securities. CMOs are debt obligations issued by special
purpose entities that are secured by mortgage-backed certificates, including, in
many cases, certificates issued by government and government-related guarantors,
including, GNMA, FNMA and FHLMC, together with certain funds and other
collateral. Multi-class pass-through securities are equity interests in a trust
composed of mortgage loans or other mortgage-backed securities. Payments of
principal and interest on underlying collateral provide the funds to pay debt
service on the CMO or make scheduled distributions on the multi-class pass-
through securities. CMOs and multi-class pass-through securities may be issued
by agencies or instrumentalities of the U.S. Government or by private
organizations. The discussion of CMOs in the following paragraphs is similarly
applicable to multi-class pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," is issued at a specific
coupon rate (which, as discussed below, may be an adjustable rate subject to a
cap) and has a stated maturity or final distribution date. Principal prepayments
on collateral underlying a CMO may cause it to be retired substantially earlier
than the stated maturity or final distribution date. Interest is paid or accrues
on all classes of a CMO on a monthly, quarterly or semi-annual basis. The
principal and interest on underlying mortgages may be allocated among the
several classes of a series of a CMO in many ways. In a common structure,
payments of principal, including any principal prepayments, on the underlying
mortgages are applied to the classes of the series of a CMO in the order of
their respective stated maturities or final distribution dates, so that no
payment of principal will be made on any class of a CMO until all other classes
having an earlier stated maturity or final distribution date have been paid in
full.
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<PAGE>
Other types of CMO issues include classes such as parallel pay CMOs, some
of which, such as planned amortization class CMOs (or PAC bonds), provide
protection against prepayment uncertainty. Parallel pay CMOs are structured to
provide payments of principal on certain payment dates to more than one class.
These simultaneous payments are taken into account in calculating the stated
maturity date or final distribution date of each class which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC bonds generally require payment of a
specified amount of principal on each payment date so long as prepayment speeds
on the underlying collateral fall within a specified range. PAC bonds are always
parallel pay CMOs with the required principal payment on the securities having
the highest priority after interest has been paid to all classes.
Other types of CMO issues include targeted amortization class CMOs (or TAC
bonds), which are similar to PAC bonds. While PAC bonds maintain their
amortization schedule within a specified range of prepayment speeds, TAC bonds
are generally targeted to a narrow range of prepayment speeds or a specified
prepayment speed. TAC bonds can provide protection against prepayment
uncertainty since cash flows generated from higher prepayments of the underlying
mortgage-related assets are applied to the various other pass-through tranches
so as to allow the TAC bonds to maintain their amortization schedule.
A CMO may be subject to the issuer's right to redeem the CMO prior to its
stated maturity date, which may have the effect of diminishing the anticipated
return on our investment. Privately-issued CMOs are supported by private credit
enhancements similar to those used for privately-issued certificates and are
often issued as senior-subordinated mortgage-backed securities. We will only
acquire CMOs or multi-class pass-through certificates that constitute debt
obligations or beneficial ownership in grantor trusts holding mortgage loans, or
regular interests in REMICs, or that otherwise constitute qualified REIT real
estate assets under the Internal Revenue Code (provided that we have obtained a
favorable opinion of our tax advisor or a ruling from the IRS to that effect).
Adjustable-Rate Mortgage Pass-Through Certificates and Floating Rate
Mortgage-Backed Securities (or "Floaters")
Most of the mortgage pass-through certificates we acquire are adjustable-
rate mortgage pass-through certificates. This means that their interest rates
may vary over time based upon changes in an objective index, such as:
. LIBOR or the London Interbank Offered Rate. The interest rate that
banks in London offer for deposits in London of U.S. dollars.
. Treasury Index. A monthly or weekly average yield of benchmark U.S.
Treasury securities, as published by the Federal Reserve Board.
. CD Rate. The weekly average of secondary market interest rates on six-
month negotiable certificates of deposit, as published by the Federal
Reserve Board.
These indices generally reflect short-term interest rates. The underlying
mortgages for adjustable-rate mortgage pass-through certificates are adjustable-
rate mortgage loans (or ARMs).
We also acquire "floating rate CMOs" or "floaters." One or more tranches of
a CMO may have coupon rates that reset periodically at a specified increment
over an index such as LIBOR. These adjustable-rate tranches are sometime known
as "floating-rate CMOs" or "floaters" and may be backed by fixed or adjustable-
rate mortgages. To date, fixed-rate mortgages have been more commonly utilized
for this purpose.
Adjustable-rate mortgage pass-through certificates and floating-rate CMOs
are typically issued with lifetime caps on the coupon rate. These caps, similar
to the caps on ARMs, represent a ceiling beyond which the coupon rate on an
adjustable-rate mortgage pass-through certificate or a floating-rate CMO may not
increase regardless of increases in the interest rate index on which the
adjustable-rate mortgage pass-through certificate or floating-rate CMO is based.
There are two main categories of indices for adjustable-rate mortgage pass-
through certificates and floaters: (1) those based on U.S. Treasury securities,
and (2) those derived from calculated measures such as a cost of funds
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index or a moving average of mortgage rates. Commonly utilized indices include
the one-year Treasury note rate, the three-month Treasury bill rate, the six-
month Treasury bill rate, rates on long-term Treasury securities, the 11th
District Federal Home Loan Bank Costs of Funds Index, the National Median Cost
of Funds Index, one-month or three-month LIBOR, the prime rate of a specific
bank, or commercial paper rates. Some indices, such as the one-year Treasury
rate, closely mirror changes in market interest rate levels. Others, such as the
11th District Home Loan Bank Cost of Funds Index, tend to lag changes in market
interest rate levels. We seek to diversify our investments in adjustable-rate
mortgage pass-through certificates and floaters among a variety of indices and
reset periods so that we are not at any one time unduly exposed to the risk of
interest rate fluctuations. In selecting adjustable-rate mortgage pass-through
certificates and floaters for investment, we will also consider the liquidity of
the market for the different mortgage-backed securities.
We believe that adjustable-rate mortgage pass-through certificates and
floaters are particularly well-suited to our investment objective of high
current income, consistent with modest volatility of net asset value, because
the value of adjustable-rate mortgage pass-through certificates and floaters
generally remains relatively stable as compared to traditional fixed-rate debt
securities paying comparable rates of interest. While the value of adjustable-
rate mortgage pass-through certificates and floaters, like other debt
securities, generally varies inversely with changes in market interest rates
(increasing in value during periods of declining interest rates and decreasing
in value during periods of increasing interest rates), the value of adjustable-
rate mortgage pass-through certificates and floaters should generally be more
resistant to price swings than other debt securities because the interest rates
on these securities move with market interest rates.
Accordingly, as interest rates change, the value of our shares should be
more stable than that of funds which invest primarily in securities backed by
fixed-rate mortgages or in other non-mortgage-backed debt securities, which do
not provide for adjustment in the interest rates in response to changes in
interest rates.
Adjustable-rate mortgage pass-through certificates and floaters typically
have caps, which limit the maximum amount by which the interest rate may be
increased or decreased at periodic intervals or over the life of the floater. To
the extent that interest rates rise faster than the allowable caps on the
adjustable-rate mortgage pass-through certificates and floaters, these
securities will behave more like fixed-rate securities. Consequently, interest
rate increases in excess of caps can be expected to cause these securities to
behave more like traditional debt securities than adjustable-rate securities
and, accordingly, to decline in value to a greater extent than would be the case
in the absence of these caps.
Adjustable-rate mortgage pass-through certificates and floaters, like other
mortgage-backed securities, differ from conventional bonds in that principal is
to be paid back over the life of the security rather than at maturity. As a
result, we receive monthly scheduled payments of principal and interest on these
securities and may receive unscheduled principal payments representing
prepayments on the underlying mortgages. When we reinvest the payments and any
unscheduled prepayments we receive, we may receive a rate of interest on the
reinvestment which is lower than the rate on the existing security. For this
reason, adjustable-rate mortgage pass-through certificates and floaters are less
effective than longer-term debt securities as a means of "locking in" longer-
term interest rates. Accordingly, adjustable-rate mortgage pass-through
certificates and floaters, while generally having less risk of price decline
during periods of rapidly rising rates than fixed-rate mortgage-backed
securities of comparable maturities, have less potential for capital
appreciation than fixed-rate securities during periods of declining interest
rates.
As in the case of fixed-rate mortgage-backed securities, to the extent
these securities are purchased at a premium, faster than expected prepayments
would result in a faster than expected amortization of the premium paid.
Conversely, if these securities were purchased at a discount, faster than
expected prepayments would accelerate our recognition of income.
As in the case of fixed-rate CMOs, floating-rate CMOs may allow for
shifting of prepayment risk from slower-paying tranches to faster-paying
tranches. This is in contrast to mortgage pass-through certificates where all
investors share equally in all payments, including all prepayments, on the
underlying mortgages.
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Other Floating Rate Instruments
We may also invest in structured floating-rate notes issued or guaranteed
by government agencies, such as FNMA and FHLMC. These instruments are typically
structured to reflect an interest rate arbitrage (i.e., the difference between
the agency's cost of funds and the income stream from specified assets of the
agency) and their reset formulas may provide more attractive returns than other
floating rate instruments. The indices used to determine resets are the same as
those described above.
Mortgage Loans
We may from time to time invest a small percentage of our assets directly
in single-family, multi-family or commercial mortgage loans. We expect that the
majority of these mortgage loans would be ARMs. The interest rate on an ARM is
typically tied to an index (such as LIBOR or the interest rate on Treasury
bills), and is adjustable periodically at specified intervals. These mortgage
loans are typically subject to lifetime interest rate caps and periodic interest
rate or payment caps. The acquisition of mortgage loans generally involves
credit risk. We may obtain credit enhancement to mitigate this risk; however,
there can be no assurances that we will able to obtain credit enhancement or
that credit enhancement would mitigate the credit risk of the underlying
mortgage loans.
Capital Investment Policy
Asset Acquisitions
Our capital investment policy provides that at least 75% of our total
assets will be comprised of high quality mortgage-backed securities and short-
term investments. The remainder of our assets (comprising not more than 25% of
total assets), may consist of mortgage-backed securities and 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) or, if not rated,
are determined by us to be of comparable credit quality to an investment which
is rated "BBB" or better.
Our capital investment policy requires that we structure our portfolio to
maintain a minimum weighted average rating (including our deemed comparable
ratings for unrated mortgage-backed securities) of our mortgage-backed
securities of at least single "A" under the S&P rating system and at the
comparable level under the other rating systems. To date, all of the mortgage-
backed securities we have acquired have been pass-through certificates or CMOs
issued or guaranteed by FHLMC, FNMA or GNMA which, although not rated, have an
implied "AAA" rating.
We intend to acquire only those mortgage-backed securities which we believe
we have the necessary expertise to evaluate and manage, which we can readily
finance and which are consistent with our balance sheet guidelines and risk
management objectives. Since we expect to hold our mortgage-backed securities
until maturity, we generally do not seek to acquire assets whose investment
returns are only attractive in a limited range of scenarios. We believe that
future interest rates and mortgage prepayment rates are very difficult to
predict and, as a result, we seek to acquire mortgage-backed securities which we
believe provide acceptable returns over a broad range of interest rate and
prepayment scenarios.
Among the asset choices available to us, our policy is to acquire those
mortgage-backed securities which we believe generate the highest returns on
capital invested, after considering,
. the amount and nature of anticipated cash flows from the asset,
. our ability to pledge the asset to secure collateralized borrowings,
. the increase in our capital requirement determined by our capital
investment policy resulting from the purchase and financing of the
asset, and
. the costs of financing, hedging, managing and reserving for the asset.
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Prior to acquisition, we assess potential returns on capital employed over the
life of the asset and in a variety of interest rate, yield spread, financing
cost, credit loss and prepayment scenarios.
We also give consideration to balance sheet management and risk
diversification issues. We deem a specific asset which we are evaluating for
potential acquisition as more or less valuable to the extent it serves to
increase or decrease certain interest rate or prepayment risks which may exist
in the balance sheet, to diversify or concentrate credit risk, and to meet the
cash flow and liquidity objectives our management may establish for our balance
sheet from time to time. Accordingly, an important part of the asset evaluation
process is a simulation, using our risk management model, of the addition of a
potential asset and our associated borrowings and hedges to the balance sheet
and an assessment of the impact this potential asset acquisition would have on
the risks in and returns generated by our balance sheet as a whole over a
variety of scenarios.
We focus primarily on the acquisition of adjustable-rate mortgage-backed
securities, including floaters. We have, however, purchased a significant amount
of fixed-rate mortgage-backed securities and may continue to do so in the future
if, in our view, the potential returns on capital invested, after hedging and
all other costs, would exceed the returns available from other assets or if the
purchase of these assets would serve to reduce or diversify the risks of our
balance sheet.
Although we have not yet done so, we may purchase the stock of mortgage
REITs or similar companies when we believe that these purchases would yield
attractive returns on capital employed. When the stock market valuations of
these companies are low in relation to the market value of their assets, these
stock purchases can be a way for us to acquire an interest in a pool of
mortgage-backed securities at an attractive price. We do not, however, presently
intend to invest in the securities of other issuers for the purpose of
exercising control or to underwrite securities of other issuers.
We may acquire newly-issued mortgage-backed securities, and also will seek
to expand our capital base in order to further increase our ability to acquire
new assets, when the potential returns from new investments appears attractive
relative to the return expectations of stockholders. We may in the future
acquire mortgage-backed securities by offering our debt or equity securities in
exchange for the mortgage-backed securities.
We generally intend to hold mortgage-backed securities for extended
periods. In addition, the REIT provisions of the Internal Revenue Code limit in
certain respects our ability to sell mortgage-backed securities. We may decide
to sell assets from time to time, however, for a number of reasons including to
dispose of an asset as to which credit risk concerns have arisen, to reduce
interest rate risk, to substitute one type of mortgage-backed security for
another, to improve yield or to maintain compliance with the 55% requirement
under the Investment Company Act, and generally to re-structure the balance
sheet when we deem advisable. Our Board of Directors has not adopted any policy
that would restrict management's authority to determine the timing of sales or
the selection of mortgage-backed securities to be sold.
We do not invest in principal-only interests in mortgage-backed securities,
residual interests, accrual bonds, inverse-floaters, two-tiered index bonds,
cash flow bonds, mortgage-backed securities with imbedded leverage or mortgage-
backed securities that would be deemed unacceptable for collateralized
borrowings, excluding shares in mortgage REITs.
As a requirement for maintaining REIT status, we will distribute to
stockholders aggregate dividends equaling at least 95% of our taxable income. We
will make additional distributions of capital when the return expectations of
the stockholders appear to exceed returns potentially available to us through
making new investments in mortgage-backed securities. Subject to the limitations
of applicable securities and state corporation laws, we can distribute capital
by making purchases of our own capital stock or through paying down or
repurchasing any outstanding uncollateralized debt obligations.
Our asset acquisition strategy may change over time as market conditions
change and as we evolves.
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Credit Risk Management
We have not taken on credit risk to date, but may do so in the future. In
that event, we will review credit risk and other risk of loss associated with
each investment and determine the appropriate allocation of capital to apply to
the investment under our capital investment policy. Our Board of Directors will
monitor the overall portfolio risk and determine appropriate levels of provision
for loss.
Capital and Leverage
We expect generally to maintain a debt-to-equity ration of between 8:1 and
12:1, although the ratio may vary from time to time depending upon market
conditions and other factors our management deems relevant, including the
composition of our balance sheet, haircut levels required by lenders, the market
value of our mortgage-backed securities in our portfolio and "excess capital
cushion" percentages (as described below) set by our Board of Directors from
time to time. For purposes of calculating this ratio, our equity (or capital
base) is equal to the value of our investment portfolio on a mark-to-market
basis less the book value of our obligations under repurchase agreements and
other collateralized borrowings. At June 30, 1999, our ratio of debt-to-equity
was 11.8:1.
Our goal is to strike a balance between the under-utilization of leverage,
which reduces potential returns to stockholders, and the over-utilization of
leverage, which could reduce our ability to meet our obligations during adverse
market conditions. Our capital investment policy limits our ability to acquire
additional assets during times when our debt-to-equity ratio exceeds 12:1. Our
capital base represents the approximate liquidation value of our investments and
approximates the market value of assets that we can pledge or sell to meet
over-collateralization requirements for our borrowings. The unpledged portion
of our capital base is available for us to pledge or sell as necessary to
maintain over-collateralization levels for our borrowings.
We are prohibited from acquiring additional assets during periods when our
capital base is less than the minimum amount required under our capital
investment policy, except as may be necessary to maintain REIT status or our
exemption from the Investment Company Act. In addition, when our capital base
falls below our risk-managed capital requirement, our management is required to
submit to our Board a plan for bringing our capital base into compliance with
our capital investment policy guidelines. We anticipate that in most
circumstances we can achieve this goal without overt management action through
the natural process of mortgage principal repayments. We anticipate that our
capital base is likely to exceed our risk-managed capital requirement during
periods following new equity offerings and during periods of falling interest
rates and that our capital base could fall below the risk-managed capital
requirement during periods of rising interest rates.
The first component of our capital requirements is the current aggregate
over-collateralization amount or "haircut" the lenders require us to hold as
capital. The haircut for each mortgage-backed security is determined by our
lenders based on the risk characteristics and liquidity of the asset. Haircut
levels on individual borrowings generally range from 3% for certain FHLMC, FNMA
or GNMA mortgage-backed securities to 20% for certain privately-issued mortgage-
backed securities. At June 30, 1999, the weighted average haircut level on our
securities was 4%. Should the market value of our pledged assets decline, we
will be required to deliver additional collateral to our lenders to maintain a
constant over-collateralization level on our borrowings.
The second component of our capital requirement is the "excess capital
cushion." This is an amount of capital in excess of the haircuts required by our
lenders. We maintain the excess capital cushion to meet the demands of our
lenders for additional collateral should the market value of our mortgage-backed
securities decline. The aggregate excess capital cushion equals the sum of
liquidity cushion amounts assigned under our capital investment policy to each
of our mortgage-backed securities. We assign excess capital cushions to each
mortgage-backed security based on our assessment of the mortgage-backed
security's market price volatility, credit risk, liquidity and attractiveness
for use as collateral by lenders. The process of assigning excess capital
cushions relies on our management's ability to identify and weigh the relative
importance of these and other factors. In assigning excess capital cushions, we
also give consideration to hedges associated with the mortgage-backed security
and any effect such hedges may have on reducing net market price volatility,
concentration or diversification of credit and other risks in the balance sheet
as a whole and the net cash flows that we can expect from the interaction of the
various components of our balance sheet.
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Our Board reviews on a periodic basis various analyses prepared by our
management of the risks inherent in our balance sheet, including an analysis of
the effects of various scenarios on our net cash flow, earnings, dividends,
liquidity and net market value. Should our Board determine that the minimum
required capital base set by our capital investment policy is either too low or
too high, our Board may raise or lower the capital requirement accordingly.
Our capital investment policy stipulates that at least 25% of the capital
base maintained to satisfy the excess capital cushion must be invested in AAA-
rated adjustable-rate mortgage-backed securities or assets with similar or
better liquidity characteristics.
A substantial portion of our borrowings are short-term or variable-rate
borrowings. Our borrowings are implemented primarily through repurchase
agreements, but in the future may also be obtained through loan agreements,
lines of credit, dollar-roll agreements (an agreement to sell a security for
delivery on a specified future date and a simultaneous agreement to repurchase
the same or a substantially similar security on a specified future date) and
other credit facilities with institutional lenders and issuance of debt
securities such as commercial paper, medium-term notes, CMOs and senior or
subordinated notes. We enter into financing transactions only with institutions
that we believe are sound credit risks and follow other internal policies
designed to limit our credit and other exposure to financing institutions.
We expect to continue to use repurchase agreements as our principal
financing device to leverage our mortgage-backed securities portfolio. We
anticipate that, upon repayment of each borrowing under a repurchase agreement,
we will use the collateral immediately for borrowing under a new repurchase
agreement. At present, we have entered into uncommitted facilities with 23
lenders for borrowings in the form of repurchase agreements. We have not at the
present time entered into any commitment agreements under which the lender would
be required to enter into new repurchase agreements during a specified period of
time, nor do we presently plan to have liquidity facilities with commercial
banks. We may, however, enter into such commitment agreements in the future. We
enter into repurchase agreements primarily with national broker-dealers,
commercial banks and other lenders which typically offer this type of financing.
We enter into collateralized borrowings only with financial institutions meeting
credit standards approved by our Board, and we monitor the financial condition
of these institutions on a regular basis.
A repurchase agreement, although structured as a sale and repurchase
obligation, acts as a financing under which we effectively pledge our mortgage-
backed securities as collateral to secure a short-term loan. Generally, the
other party to the agreement makes the loan in an amount equal to a percentage
of the market value of the pledged collateral. At the maturity of the repurchase
agreement, we are required to repay the loan and correspondingly receive back
our collateral. While used as collateral, the mortgage-backed securities
continue to pay principal and interest which are for our benefit. In the event
of our insolvency or bankruptcy, certain repurchase agreements may qualify for
special treatment under the Bankruptcy Code, the effect of which, among other
things, would be to allow the creditor under the agreement to avoid the
automatic stay provisions of the Bankruptcy Code and to foreclose on the
collateral agreement without delay. In the event of the insolvency or bankruptcy
of a lender during the term of a repurchase agreement, the lender may be
permitted, under applicable insolvency laws, to repudiate the contract, and our
claim against the lender for damages may be treated simply as an unsecured
creditor. In addition, if the lender is a broker or dealer subject to the
Securities Investor Protection Act of 1970, or an insured depository institution
subject to the Federal Deposit Insurance Act, our ability to exercise our rights
to recover our securities under a repurchase agreement or to be compensated for
any damages resulting from the lender's insolvency may be further limited by
those statutes. These claims would be subject to significant delay and, if and
when received, may be substantially less than the damages we actually incur.
Substantially all of our borrowing agreements require us to deposit
additional collateral in the event the market value of existing collateral
declines, which may require us to sell assets to reduce our borrowings. We have
designed our liquidity management policy to maintain a cushion of equity
sufficient to provide required liquidity to respond to the effects under our
borrowing arrangements of interest rate movements and changes in market value of
our mortgage-backed securities, as described above. However, a major disruption
of the repurchase or other market relied that we rely on for short-term
borrowings would have a material adverse effect on us unless we were able to
arrange alternative sources of financing on comparable terms.
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Our articles of incorporation and bylaws do not limit our ability to incur
borrowings, whether secured or unsecured.
Interest Rate Risk Management
To the extent consistent with our election to qualify as a REIT, we follow
an interest rate risk management program intended to protect our portfolio of
mortgage-backed securities and related debt against the effects of major
interest rate changes. Specifically, our interest rate risk management program
is formulated with the intent to offset the potential adverse effects resulting
from rate adjustment limitations on our mortgage-backed securities and the
differences between interest rate adjustment indices and interest rate
adjustment periods of our adjustable-rate mortgage-backed securities and related
borrowings.
Our interest rate risk management program encompasses a number of
procedures, including the following:
. we attempt to structure our borrowings to have interest rate
adjustment indices and interest rate adjustment periods that, on an
aggregate basis, generally correspond to the interest rate adjustment
indices and interest rate adjustment periods of our adjustable-rate
mortgage-backed securities; and
. we attempt to structure our borrowing agreements relating to
adjustable-rate mortgage-backed securities to have a range of
different maturities and interest rate adjustment periods (although
substantially all will be less than one year).
We adjust the average maturity adjustment periods of our borrowings on an
ongoing basis by changing the mix of maturities and interest rate adjustment
periods as borrowings come due and are renewed. Through use of these procedures,
we attempt to minimize the differences between the interest rate adjustment
periods of our mortgage-backed securities and related borrowings that may occur.
Although we have not done so to date, we may purchase from time to time
interest rate caps, interest rate swaps, interest rate collars, caps or floors,
"interest only" mortgage-backed securities and similar instruments to attempt to
mitigate the risk of the cost of our variable rate liabilities increasing at a
faster rate than the earnings on our assets during a period of rising interest
rates or to mitigate prepayment risk. We may hedge as much of the interest rate
risk as our management determines is in our best interests, given the cost of
the hedging transactions and the need to maintain our status as a REIT. This
determination may result in our electing to bear a level of interest rate or
prepayment risk that could otherwise be hedged when management believes, based
on all relevant facts, that bearing the risk is advisable.
We seek to build a balance sheet and undertake an interest rate risk
management program which is likely to generate positive earnings and maintain an
equity liquidation value sufficient to maintain operations given a variety of
potentially adverse circumstances. Accordingly, our hedging program addresses
both income preservation, as discussed above, and capital preservation concerns.
For capital preservation, we monitor our "duration." This is the expected
percentage change in market value of our assets that would be caused by a 1%
change in short and long-term interest rates. To monitor duration and the
related risks of fluctuations in the liquidation value of our equity, we model
the impact of various economic scenarios on the market value of our mortgage-
backed securities and liabilities. At June 30, 1999, we estimate that the
duration of our assets was 1%. We believe that our interest rate risk management
program will allow us to maintain operations throughout a wide variety of
potentially adverse circumstances. Nevertheless, in order to further preserve
our capital base (and lower our duration) during periods when we believe a trend
of rapidly rising interest rates has been established, we may decide to enter
into or increase hedging activities or to sell assets. Each of these actions may
lower our earnings and dividends in the short term to further our objective of
maintaining attractive levels of earnings and dividends over the long term.
We may elect to conduct a portion of our hedging operations through one or
more subsidiary corporations which would not be a qualified REIT subsidiary and
would be subject to Federal and state income taxes. To comply with the asset
tests applicable to us as a REIT, the value of the securities of the any taxable
subsidiary we hold must be limited to less than 5% of the value of our total
assets as of the end of each calendar quarter and we may not own more than 10%
of the voting securities of the taxable subsidiary. A taxable subsidiary would
not elect REIT status and would distribute any net profit after taxes to us and
its other stockholders. Any dividend income we receive
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from the taxable subsidiary (combined with all other income generated from our
assets, other than qualified REIT real estate assets) must not exceed 25% of our
gross income.
We believe that we have developed a cost-effective asset/liability
management program to provide a level of protection against interest rate and
prepayment risks. However, no strategy can completely insulate us from interest
rate changes and prepayment risks. Further, as noted above, the Federal income
tax requirements that we must satisfy to qualify as a REIT limit our ability to
hedge our interest rate and prepayment risks. We monitor carefully, and may have
to limit, our asset/liability management program to assure that we do not
realize excessive hedging income, or hold hedging assets having excess value in
relation to total assets, which would result in our disqualification as a REIT
or, in the case of excess hedging income, the payment of a penalty tax for
failure to satisfy certain REIT income tests under the Internal Revenue Code,
provided the failure was for reasonable cause. In addition, asset/liability
management involves transaction costs which increase dramatically as the period
covered by the hedging protection increases. Therefore, we may be unable to
hedge effectively our interest rate and prepayment risks.
Prepayment Risk Management
We seek to minimize the effects of faster or slower than anticipated
prepayment rates through structuring a diversified portfolio with a variety of
prepayment characteristics, investing in mortgage-backed securities with
prepayment prohibitions and penalties, investing in certain mortgage-backed
security structures which have prepayment protections, and balancing assets
purchased at a premium with assets purchased at a discount. We monitor
prepayment risk through periodic review of the impact of a variety of prepayment
scenarios on our revenues, net earnings, dividends, cash flow and net balance
sheet market value.
Future Revisions in Policies and Strategies
Our Board of Directors has established the investment policies and
operating policies and strategies set forth in this prospectus supplement. The
Board has the power to modify or waive these policies and strategies without the
consent of the stockholders to the extent that the Board determines that the
modification or waiver is in the best interests of our stockholders. Among other
factors, developments in the market which affect our policies and strategies or
which change our assessment of the market may cause our Board to revise our
policies and strategies.
Potential Acquisitions, Strategic Alliances and Other Investments
From time to time we have had discussions with other parties regarding
possible transactions including acquisitions of other businesses or assets,
investments in other entities, joint venture arrangements, or strategic
alliances, including a strategic alliance with Liberty Capital, a privately-held
financial services company headquartered in Ohio. To date, none of these
discussions have gone beyond the preliminary stage. We have also considered from
time to time entering into related businesses.
During 1998, we made an initial investment of $49,980 in Annaly
International Mortgage Management, Inc. Annaly International explores business
opportunities overseas, including the origination of mortgages. Annaly
International has not commenced operations beyond this exploratory stage. We now
own 24.99% of the equity of Annaly International in the form of non-voting
securities. The remaining equity of Annaly International is owned by FIDAC,
Michael A.J. Farrell, our Chairman and Chief Executive Officer, Timothy J. Guba,
our President and Chief Operating Officer, Wellington J. St. Claire, our Vice
Chairman and Chief Investment Officer, Kathryn F. Fagan, our Chief Operating
Officer, and other persons. Mr. Farrell is the sole shareholder of FIDAC.
During 1998, Annaly International made an initial investment of $20,400 in
Annaly.com, Inc. Annaly.com explores opportunities to acquire or originate
mortgages in the United States. Annaly.com has established a website at
http://www.annaly.com but has not commenced the acquisition or origination of
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mortgages. Annaly International owns 51% of the equity of Annaly.com. The
remaining equity of Annaly.com is owned by FIDAC I Partners, whose partners
include FIDAC and our executive officers.
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Prior to making our investment in Annaly International we consulted with
our tax advisors to ensure that the investment would not cause us to fail to
satisfy the asset and source of income tests applicable to us as a REIT. Prior
to making any additional equity investment in Annaly International or any other
equity investment, we will similarly consult with our tax advisors.
We may, from time to time, continue to explore possible acquisitions,
investments, joint venture arrangements and strategic alliances, as well as the
further development of the business of Annaly International or Annaly.com.
Dividend Reinvestment and Share Purchase Plan
We have recently adopted a dividend reinvestment and share purchase plan.
Under the dividend reinvestment feature of the plan, existing shareholders can
reinvest their dividends in additional shares of our common stock. Under the
share purchase feature of the plan, new and existing shareholders can purchase
shares of our common stock. We have filed a Form S-3 registration statement
registering 2,000,000 shares that may be issued under the plan.
Through September 22, 1999, we have issued an aggregate of 200,534 shares
of common stock under the share purchase feature of the plan. All of these
shares were issued at a discount of 2%. We have not yet issued any shares under
the dividend reinvestment feature of the plan.
Legal Proceedings
There are no material pending legal proceedings to which we are a party or
to which any of our property is subject.
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MANAGEMENT
Our Board of Directors currently consists of eight members. Our Board of
Directors is divided into three classes of directors, with three directors in
each class. At each annual meeting of our stockholders, one class of directors
is elected for a three-year term. The terms of the Class I directors expire at
the annual meeting of our stockholders to be held in 2000, the terms of the
Class II directors expire at the annual meeting of our stockholders to be held
in 2001 and the terms of the Class III directors expire at the annual meeting of
our stockholders to be held in 2002. As a result of the resignation of John S.
Grace as a director on August 30, 1999, we now have one vacancy on our Board.
The following table sets forth the name and position(s) held with us of
each of our officers and directors:
Name Position(s) Held
- ---- ----------------
Michael A.J. Farrell Chairman of the Board, Chief Executive Officer and
Director (1)(6)
Timothy J. Guba President, Chief Operating Officer and Director
(2)(6)
Wellington J. St. Claire Vice Chairman of the Board, Chief Investment Officer
and Director (3)
Kathryn F. Fagan Chief Financial Officer and Treasurer
Jennifer A. Stephens Secretary
Kevin P. Brady Director (2)(4)
Spencer I. Browne Director (1)(5)
Jonathan D. Green Director (3)(4)
John A. Lambiase Director (3)(4)(5)
Donnell A. Segalas Director (2)(5)
_____________________
(1) Class I Director
(2) Class II Director
(3) Class III Director
(4) Member of the Audit Committee
(5) Member of the Compensation Committee
(6) Member of the Nominating Committee
S-36
<PAGE>
UNDERWRITING
Friedman, Billings, Ramsey & Co. Inc. is acting as representative of the
underwriters. Subject to the terms and conditions contained in a purchase
agreement, we have agreed to sell to each underwriter, and each underwriter
severally has agreed to purchase from us, the number of shares set forth
opposite its name below. In the purchase agreement, the underwriters have
agreed, subject to the terms and conditions set forth therein, to purchase and
pay for all of these shares if any shares are purchased.
Underwriter Number of Shares
- ----------- ----------------
Friedman, Billings, Ramsey & Co., Inc...................
Schroder & Co. Inc......................................
Tucker Anthony Cleary Gull, Inc.........................
Total..............................................
The representative has advised us that the underwriters propose to offer
the common stock to the public at the public offering price set forth on the
cover of this prospectus supplement and to certain dealers at such price less a
concession of not in excess of $_____ per share. The underwriters may allow, and
these dealers may reallow, a discount not in excess of $_____ per share to
certain other dealers. After this offering, the public offering price,
concession and discount may change. This change will not reduce the proceeds to
be received by us as set forth on the cover page of this prospectus.
We have granted to the underwriters an option, exercisable during the
30-day period after the date of this prospectus supplement, to purchase up to
750,000 additional shares of common stock at the price set forth on the cover
page of this prospectus, less the underwriting discount. If the underwriters
exercise this option, each of the underwriters will have a firm commitment to
purchase from us a number of additional shares proportionate to the
underwriter's initial commitment in whole or in part as shown in the above
table. If purchased, the additional shares will be sold by the underwriters on
the same terms as described above.
The purchase agreement contains covenants of indemnity between the
underwriters and us against certain civil liabilities, including liabilities
under the Securities Act and liabilities arising from breaches of
representations and warranties contained in the purchase agreement, or
contribution to payments which the underwriters may be required to make in
respect of liabilities under the Securities Act.
The following table shows the per share and total underwriting discount
that we will pay to the underwriters. The amounts are shown assuming both no
exercise and full exercise of the underwriters' over-allotment option.
Total Total
Without With
Per Share Option Option
--------- ------ ------
Public offering price......................
Underwriting discounts.....................
Proceeds, before expenses, to us...........
The common stock is being offered by the underwriters, subject to prior
sale, when, as and if issued to and accepted by them, subject to approval of
certain conditions by counsel to the underwriters and certain other conditions.
The underwriters reserve the right to withdraw, cancel or modify this offer and
to reject orders in whole or in part.
Each of our officers and directors has agreed with the representative, for
a period of 90 days after the date of this prospectus (the "Lock-Up Period"),
subject to certain exceptions, not to sell any shares of common stock or any
securities convertible into or exchangeable for shares of common stock owned by
the holders, without the prior
S-37
<PAGE>
written consent of the representative. However, the representative may, in its
sole discretion and at any time without notice, release all or any portion of
the securities subject to lock-up agreements. We have agreed that during the
Lock-Up Period, we will not, subject to certain exceptions, without the prior
written consent of the representative, issue, sell, contract to sell or
otherwise dispose of, any shares of common stock, any options or warrants to
purchase any shares of common stock or any securities convertible into,
exercisable or exchangeable for shares of common stock, other than the sale of
our shares in this offering, the issuance of common stock upon the exercise of
outstanding options and warrants, our issuance of options and shares under our
Long-Term Stock Incentive and our issuance of shares under our Dividend
Reinvestment and Share Purchase Plan.
Until the distribution of the common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters to
bid for and purchase the common stock. As an exception to these rules, the
representative is permitted to engage in certain transactions that stabilize the
price of the common stock. These transactions consist of bids or purchases for
the purpose of pegging, fixing or maintaining the price of the common stock.
If the underwriters create a short position in the common stock in
connection with this offering (i.e., if they sell more shares of common stock
than are set forth on the cover page of this prospectus supplement), the
representative may reduce that short position by purchasing common stock in the
open market. The representative may also elect to reduce any short position by
exercising all or part of the over-allotment option described above.
The representative may also impose a penalty bid on certain underwriters
and selling group members. This means that if the representative purchases
shares of common stock in the open market to reduce the underwriters' short
position or to stabilize the price of the common stock, it may reclaim the
amount of the selling concession from the underwriters and selling group members
who sold those shares as part of the offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of those purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it would
discourage resales of the security.
Neither we nor any of the underwriters make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above might have on the price of the common stock. In addition,
neither we nor any of the underwriters make any representation that the
representative will engage in these transactions or that these transactions,
once commenced, will not be discontinued without notice.
The representative may from time to time provide investment banking and
other financial services for us for which it will receive fees and commissions.
LEGAL MATTERS
The validity of the issuance of the shares of common stock offered hereby
will be passed upon for us by Morgan, Lewis & Bockius LLP. Certain legal matters
relating to this offering will be passed upon for the underwriters by Brown &
Wood LLP.
EXPERTS
Our financial statements in this prospectus from our Annual Report on Form
10-K for the period from February 18, 1997 (commencement of operations) through
December 31, 1997 and for the year ended December 31, 1998 have been audited by
Deloitte & Touche LLP, independent auditors, as stated in their report, and have
been so included in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.
S-38
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report.............................................. F-2
Financial Statements:
Balance Sheets--December 31, 1998 and December 31, 1997 (audited)....... F-3
Statements of Operations for the year ended December 31, 1998 and the
period February 18, 1997 (commencement of operations) through December
31, 1997 (audited)..................................................... F-4
Statements of Stockholders's Equity for the year ended December 31, 1998
and the period February 18, 1997 (commencement of operations) through
December 31, 1997 (audited)............................................ F-5
Statements of Cash Flows for the year ended December 31, 1998 and the
period February 18, 1997 (commencement of operations) through December
31, 1997 (audited)..................................................... F-6
Notes to Financial Statements (audited)................................. F-7
Balance Sheet--June 30, 1999 (unaudited)................................ F-14
Statements of Operations for the six months ended June 30, 1999 and 1998
(unaudited)............................................................ F-15
Statement of Stockholders' Equity for the six months ended June 30, 1999
(unaudited)............................................................ F-16
Statements of Cash Flows for the six months ended June 30, 1999 and 1998
(unaudited)............................................................ F-17
Notes to Interim Financial Statements (unaudited)....................... F-18
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Stockholders of
Annaly Mortgage Management, Inc.
We have audited the accompanying balance sheets of Annaly Mortgage
Management, Inc. (the "Company") as of December 31, 1998 and 1997, and the
related statements of operations, stockholders' equity and cash flows for the
year ended December 31, 1998 and the period February 18, 1997 (commencement of
operations) through December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provides a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at December 31, 1998 and 1997
and the results of its operations and its cash flows for the year ended
December 31, 1998 and the period February 18, 1997 (commencement of operations)
through December 31, 1997 in conformity with generally accepted accounting
principles.
February 5, 1999
Deloittle & Touche LLP
New York, New York
F-2
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
-------------- --------------
<S> <C> <C>
ASSETS
Cash and Cash Equivalents....................... $ 69,020 $ 511,172
Mortgage-Backed Securities--At fair value....... 1,520,288,762 1,161,779,192
Accrued Interest Receivable..................... 6,782,043 5,338,861
Other Assets.................................... 212,214 111,257
-------------- --------------
Total Assets.................................... $1,527,352,039 $1,167,740,482
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements......................... $1,280,510,000 $ 918,869,000
Payable for Mortgage-Backed Securities
purchased.................................... 111,921,205 105,793,723
Accrued interest payable...................... 5,052,626 4,992,447
Dividends payable............................. 3,857,663 2,797,058
Accounts payable.............................. 139,236 201,976
-------------- --------------
Total liabilities........................... 1,401,480,730 1,032,654,204
-------------- --------------
Stockholders' Equity:
Common stock: par value $.01 per share;
100,000,000 authorized, 12,758,024 and
12,713,900
shares issued and outstanding, respectively... 127,580 127,139
Additional paid-in capital.................... 132,770,175 132,705,765
Accumulated other comprehensive income
(loss)....................................... (6,404,275) 2,023,751
Treasury stock at cost (109,600 shares)....... (903,163) --
Retained earnings............................. 280,992 229,623
-------------- --------------
Total stockholders' equity.................. 125,871,309 135,086,278
-------------- --------------
Total Liabilities and Stockholders' Equity.. $1,527,352,039 $1,167,740,482
============== ==============
</TABLE>
See notes to financial statements.
F-3
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Period
February 18, 1997
For the (Commencement of
Year Ended Operations)
December Through December
31, 1998 31, 1997
----------- -----------------
<S> <C> <C>
Interest Income:
Mortgage-Backed Securities.................... $89,985,526 $24,682,353
Money market account.......................... 105 30,782
----------- -----------
Total interest income....................... 89,985,631 24,713,135
Interest Expense:
Repurchase agreements......................... 75,735,280 19,676,954
----------- -----------
Net Interest Income............................. 14,250,351 5,036,181
Gain on Sale of Mortgage-Backed Securities...... 3,344,106 735,303
General and Administrative Expenses............. 2,105,534 851,990
----------- -----------
Net Income...................................... 15,488,923 4,919,494
----------- -----------
Other Comprehensive Income (Loss):
Unrealized gain (loss) on available-for-sale
securities................................... (5,083,920) 2,759,054
Less: reclassification adjustment for gains
included in net income....................... (3,344,106) (735,303)
----------- -----------
Other comprehensive gain (loss)............... (8,428,026) 2,023,751
----------- -----------
Comprehensive Income............................ $ 7,060,897 $ 6,943,245
=========== ===========
Net Income Per Share:
Basic......................................... $ 1.22 $ 0.83
=========== ===========
Diluted....................................... $ 1.19 $ 0.80
=========== ===========
Average Number of Shares Outstanding:
Basic......................................... 12,709,116 5,952,123
=========== ===========
Diluted....................................... 13,020,648 6,168,531
=========== ===========
</TABLE>
See notes to financial statements.
F-4
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1998 AND THE PERIOD FEBRUARY 18, 1997
(COMMENCEMENT OF OPERATIONS) THROUGH DECEMBER 31, 1997
<TABLE>
<CAPTION>
Common Additional Other
Stock Paid-in Treasury Comprehensive Retained Comprehensive
Par Value Capital Stock Income Earnings Income Total
--------- ------------ --------- ------------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, FEBRUARY 18,
1997................... $ 800 $ 11,200 $ $ $ (209) $ $ 11,791
Net income............. $ 4,919,494 4,919,494
Other comprehensive
income:
Unrealized net losses
on securities, net of
reclassification
adjustment............ 2,023,751 2,023,751 6,943,245
-----------
Comprehensive income... $ 6,943,245
===========
Issuance of common
stock................. 126,339 132,694,565 132,820,904
Dividends declared for
the year ended
December 31, 1997,
$0.79 per average
share................. (4,689,662) (4,689,662)
-------- ------------ ------------ ----------- ------------
BALANCE, DECEMBER 31,
1997................... 127,139 132,705,765 229,623 2,023,751 135,086,278
-------- ------------ ------------ ----------- ------------
Net income............. $15,488,923 15,488,923
Other comprehensive
income:
Unrealized net losses
on securities, net of
reclassification
adjustment............ (8,428,026) (8,428,026)
-----------
Comprehensive income... $ 7,060,897 7,060,897
===========
Exercise of stock
options............... 441 194,658 195,099
Additional cost of
initial public
offering.............. (130,248) (130,248)
Stock buyback.......... (903,163) (903,163)
Dividends declared for
the year ended
December 31, 1998,
$1.22 per average
share................. (15,437,554) (15,437,554)
-------- ------------ --------- ------------ ----------- ------------
BALANCE, DECEMBER 31,
1998................... $127,580 $132,770,175 $(903,163) $ 280,992 $(6,404,275) $125,871,309
======== ============ ========= ============ =========== ============
Disclosure of
reclassification
amounts:
Unrealized holding
losses arising during
period................ $(5,083,920)
Less reclassification
adjustment of gains
included in net
income................ (3,344,106)
-----------
Net unrealized losses
on securities......... $(8,428,026)
===========
</TABLE>
See notes to financial statements.
F-5
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
February 18, 1997
For the Year (Commencement of
Ended Operations)
December 31, Through
1998 December 31, 1997
---------------- -----------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income............................... $ 15,488,923 $ 4,919,494
Adjustments to reconcile net income to
net cash provided by
operating activities:
Amortization of mortgage premiums and
discounts, net........................ 8,235,371 2,620,729
Depreciation of fixed assets........... 14,154 --
Gain on sale of Mortgage-Backed
Securities............................ (3,344,106) (735,303)
Increase in accrued interest
receivable............................ (1,443,182) (5,338,861)
Increase in other assets............... (115,112) (111,257)
Increase in accrued interest payable... 60,179 4,992,447
(Decrease) increase in accounts
payable............................... (62,740) 201,976
---------------- ---------------
Net cash provided by operating
activities.......................... 18,833,487 6,549,225
---------------- ---------------
Cash Flows From Investing Activities:
Purchase of Mortgage-Backed Securities... (1,420,592,798) (1,310,362,097)
Proceeds from sale of Mortgage-Backed
Securities.............................. 568,553,814 174,682,533
Principal payments on Mortgage-Backed
Securities.............................. 486,337,605 79,832,420
---------------- ---------------
Net cash used in investing
activities.......................... (365,701,379) (1,055,847,144)
---------------- ---------------
Cash Flows From Financing Activities:
Proceeds from repurchase agreements...... 11,506,566,000 3,498,546,390
Principal payments on repurchase
agreements.............................. (11,144,925,000) (2,579,677,390)
Proceeds from exercise of stock options.. 195,100 --
Proceeds from private placement equity
offering................................ -- 32,979,904
Net proceeds from public offering........ -- 98,962,999
Net proceeds from direct offering........ -- 878,000
Additional cost of initial public
offering................................ (130,248) --
Purchase of Treasury Stock............... (903,163) --
Dividends paid........................... (14,376,949) (1,892,604)
---------------- ---------------
Net cash provided by financing
activities.......................... 346,425,740 1,049,797,299
---------------- ---------------
Net Increase in Cash and Cash Equivalents.. (442,152) 499,380
Cash and Cash Equivalents, Beginning of
Period.................................... 511,172 11,792
---------------- ---------------
Cash and Cash Equivalents, End of Period... $ 69,020 $ 511,172
================ ===============
Supplemental Disclosure of Cash Flow
Information:
Interest paid............................ $ 48,811,362 $ 14,684,507
================ ===============
Noncash Financing Activities:
Net unrealized gain (loss) on available-
for-sale securities..................... $ (6,404,275) $ 2,023,751
================ ===============
Dividends declared, not yet paid......... $ 3,857,663 $ 2,797,058
================ ===============
</TABLE>
See notes to financial statements.
F-6
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1998 AND FOR THE PERIOD
FEBRUARY 18, 1997 THROUGH DECEMBER 31, 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 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:
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 and the cost basis of
the Mortgage-Backed Securities is adjusted. There were no such adjustments for
the years ended December 31, 1998 and 1997.
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 December 31, 1998 and 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 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. At December 31, 1998 and 1997, all of the Company's Mortgage-Backed
Securities have an implied "AAA" rating.
F-7
<PAGE>
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.
2. Mortgage-Backed Securities
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of December 31, 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
------------ ------------ ----------- --------------
<S> <C> <C> <C> <C>
Mortgage-Backed
Securities, gross...... $449,433,408 $955,650,670 $97,330,495 $1,502,414,573
Unamortized discount.... (184,996) (423,583) -- (608,579)
Unamortized premium..... 8,852,370 14,264,277 1,770,397 24,887,044
------------ ------------ ----------- --------------
Amortized cost.......... 458,100,782 969,491,364 99,100,892 1,526,693,038
Gross unrealized gains.. 659,557 2,092,119 549,900 3,301,576
Gross unrealized
losses................. (3,487,784) (5,692,759) (525,309) (9,705,852)
------------ ------------ ----------- --------------
Estimated fair value.... $455,272,555 $965,890,724 $99,125,483 $1,520,288,762
============ ============ =========== ==============
</TABLE>
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 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. The weighted average lifetime cap was 10.6% and
10.8% at December 31, 1998 and 1997, respectively.
During the year ended December 31, 1998, the Company realized $3,344,070 in
gains from sales of Mortgage-Backed Securities. Losses totaled $9,964 for the
year ended December 31, 1998. During the period ended December 31, 1997, the
Company realized $735,303 in gains from sales of Mortgage-Backed Securities.
There were no losses on sales of Mortgage-Backed Securities during the period
ended December 31, 1997.
F-8
<PAGE>
3. Repurchase Agreements
The Company had outstanding $1,280,510,000 and $918,869,000 of repurchase
agreements with a weighted average borrowing rate of 5.21% and 6.16% and a
weighted average remaining maturity of 29 days and 16 days as of December 31,
1998 and 1997, respectively. At December 31, 1998 and 1997, Mortgage-Backed
Securities actually pledged had an estimated fair value of $1,458,669,078 and
$936,859,658.
At December 31, 1998 and 1997, the repurchase agreements had the following
remaining maturities:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
--------------- ------------
<S> <C> <C>
Within 30 days............................. $ 1,222,542,000 $590,960,000
30 to 59 days.............................. 31,346,000 51,776,000
60 to 89 days.............................. 26,622,000 --
90 to 119 days............................. -- 103,391,000
Over 120 days.............................. -- 172,742,000
--------------- ------------
$ 1,280,510,000 $918,869,000
=============== ============
</TABLE>
4. Common Stock
During the period ended December 31, 1997, 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. The Company issued 9,006,100 shares
of common stock on October 14, 1997 during an initial public offering. Net
proceeds received in the offering were $98,832,751. During the year ended
December 31, 1998, 44,124 options were exercised at $195,099. Stock buybacks
during the year ended December 31, 1998 totaled 109,600 shares at a cost of
$903,163.
During the Company's year ending December 31, 1998, the Company declared
dividends to shareholders totaling $15,437,554, or $1.22 per weighted average
share, of which $11,579,891 was paid during the period and $3,857,663 was paid
on January 25, 1999. For Federal income tax purposes dividends paid for the
period is ordinary income to the Company stockholders.
During the period ended December 31, 1997, the Company declared dividends to
shareholders totaling $4,689,662, or $.79 per weighted average share, of which
$1,892,604 was paid during the period and $2,797,058 was paid on January 20,
1998. For Federal income tax purposes, dividends paid for the period are
ordinary income to the Company stockholders.
F-9
<PAGE>
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. For the year ended December 31, 1998, the
reconciliation is as follows:
<TABLE>
<CAPTION>
For the Year Ended
December 31, 1998
-----------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
<S> <C> <C> <C>
Net income.................................. $15,488,923
-----------
Basic EPS................................... 15,488,923 12,709,116 $1.22
=====
Effect of dilutive securities:
Dilutive stock options.................... 311,532
----------- ----------
Diluted EPS............................... $15,488,923 13,020,648 $1.19
=========== ========== =====
</TABLE>
Options to purchase 446,084 shares were outstanding during the period (Note
6) and were dilutive as the exercise price (between $4.00 and $8.13) was less
than the average stock price for the year for the Company of $9.36. Options to
purchase 147,676 shares of stock were outstanding and not considered dilutive.
The exercise price (between $10.00 and $11.28) was greater than the average
stock price for the year of $9.36.
For the period ending December 31, 1997, 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................................. $4,919,494
----------
Basic EPS.................................. 4,919,494 5,952,123 $0.83
=====
Effect of dilutive securities:
Dilutive stock options................... 216,408
---------- ---------
Diluted EPS.............................. $4,919,494 6,168,531 $0.80
========== ========= =====
</TABLE>
Options to purchase 348,500 shares were outstanding during the period (Note
6) and were dilutive as the exercise price (between $4.00 and $10.00) was less
than the average stock price for the period for the Company (between $11.00 and
$12.00).
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 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.
F-10
<PAGE>
The Company adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost for the Incentive Plan has been determined
based on the fair value at the grant date for awards consistent with the
provisions of SFAS No. 123. For the Company's pro forma net earnings, the
compensation cost will be amortized over the four-year vesting period of the
options. The Company's net earnings per share would have been reduced to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
For the Period Ending
------------------------
December December 31,
31, 1998 1997
----------- ------------
<S> <C> <C>
Net earnings--as reported...................... $15,488,925 $4,919,494
Net earnings--pro forma........................ 15,280,631 4,738,932
Earnings per share--as reported................ $ 1.22 $ 0.83
Earnings per share--pro forma.................. $ 1.20 $ 0.80
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in the year ended December 31, 1998: dividend yield
of 10%; expected volatility of 33%; risk-free interest rate of 5.56%; and
expected lives of seven years. For the period ended December 31, 1997, dividend
yield of 10%; expected volatility of 25%; risk-free interest rate of 6.07%; and
expected lives of four years.
Information regarding options is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price
-------- --------
<S> <C> <C>
Outstanding, January 1, 1998....................... 348,500 $6.42
Granted (242,884 ISOs, 46,500 NQSOs)............... 289,384 8.17
Exercised.......................................... (44,124) 4.34
Expired............................................ -- --
-------- -----
Outstanding, December 31, 1998..................... 593,760 $7.42
======== =====
Weighted average fair value of options granted
during the year (per share)....................... $ 1.99
========
</TABLE>
Information regarding options at December 31, 1997, is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Shares Price
-------- --------
<S> <C> <C>
Granted (311,000 ISOs, 37,500 NQSOs)................ 348,500 $6.42
Exercised........................................... -- --
Expired............................................. -- --
-------- -----
Outstanding, December 31, 1997...................... 348,500 $6.42
======== =====
Weighted average fair value of options granted
during the period (per share)...................... $ 2.07
========
</TABLE>
F-11
<PAGE>
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding
Weighted
Average
Remaining
Range of Options Contractual
Exercise Prices Outstanding Life (Yrs.)
--------------- ----------- -------------------
<S> <C> <C>
$ 4.00 166,626 3
$ 8.13 279,458 10
$ 8.94 7,500 4
$10.00 137,750 3
$11.25 2,426 4
-------
593,760 6.3
-------
</TABLE>
At December 31, 1998, 56,241 options were vested and not exercised.
7. 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 December 31, 1998 and 1997 held securities classified as available-
for-sale. At December 31, 1998, the net unrealized losses totaled $6,404,275
and at December 31, 1997 the net unrealized gains totaled $2,023,751.
8. Lease Commitments
The Corporation has a noncancelable lease for office space, which commenced
in April 1998 and expires in December 2007.
The Corporation's aggregate future minimum lease payments are as follows:
<TABLE>
<S> <C>
1999............................... $ 92,804
2000............................... 95,299
2001............................... 97,868
2002............................... 100,515
2003 and thereafter................ 582,406
---------
$ 968,892
---------
</TABLE>
9. Related Party Transaction
Included in "Other Assets" on the Balance sheet is an investment in Annaly
International Money Management, Inc. On June 24, 1998, the Company acquired
99,960 nonvoting shares, at a cost of $49,980. The officers and directors of
Annaly International Money Management Inc. are also officers and directors of
the Company.
F-12
<PAGE>
10. Summarized Quarterly Results (Unaudited)
The following is a presentation of the quarterly results of operations for
the year ended December 31, 1998.
<TABLE>
<CAPTION>
Quarters Ending
-----------------------------------------------
March 31, June 30, September December
1998 1998 30, 1998 31, 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Interest income from Mortgage-
Backed Securities and cash... $20,078,721 $23,761,953 $24,008,567 $22,136,390
Interest expense on repurchase
agreements................... 16,313,474 20,177,580 20,765,301 18,478,925
----------- ----------- ----------- -----------
Net interest income....... 3,765,247 3,584,373 3,243,266 3,657,465
Gain on sale of Mortgage-
Backed Securities............ 1,427,084 295,875 993,630 627,517
General and administrative
expenses..................... 484,181 493,718 528,240 599,185
----------- ----------- ----------- -----------
Net income.................... $ 4,708,150 $ 3,386,530 $ 3,708,656 $ 3,685,797
=========== =========== =========== ===========
Net income per share:
Basic....................... $ 0.37 $ 0.27 $ 0.29 $ 0.29
=========== =========== =========== ===========
Dilutive.................... $ 0.36 $ 0.26 $ 0.29 $ 0.29
=========== =========== =========== ===========
Average number of shares
outstanding:
Basic....................... 12,727,405 12,757,674 12,704,194 12,648,116
=========== =========== =========== ===========
Dilutive.................... 12,923,195 12,959,771 12,785,765 12,731,192
=========== =========== =========== ===========
</TABLE>
The following is a presentation of the quarterly results of operations for
the period February 18, 1997 (commencement of operations) through December 31,
1997.
<TABLE>
<CAPTION>
Quarters Ending
Period Ended ------------------------------------
March 31, June 30, September 30, December
1997 1997 1997 31, 1997
------------ ---------- ------------- -----------
<S> <C> <C> <C> <C>
Interest income from
Mortgage-Backed
Securities and cash..... $1,060,692 $5,448,215 $6,123,457 $12,080,771
Interest expense on
repurchase agreements... 713,120 4,435,697 5,126,089 9,402,048
---------- ---------- ---------- -----------
Net interest income.... 347,572 1,012,518 997,368 2,678,723
Gain on sale of Mortgage-
Backed Securities....... -- 229,865 429,400 76,038
General and
administrative
expenses................ 64,047 185,849 227,245 374,849
---------- ---------- ---------- -----------
Net income............... $ 283,525 $1,056,534 $1,199,523 $ 2,379,912
========== ========== ========== ===========
Net income per share:
Basic.................. $ 0.08 $ 0.28 $ 0.32 $ 0.21
========== ========== ========== ===========
Dilutive............... $ 0.07 $ 0.26 $ 0.29 $ 0.20
========== ========== ========== ===========
Average number of shares
outstanding............. 3,680,000 3,680,000 3,739,170 11,449,777
========== ========== ========== ===========
</TABLE>
* * * * * *
F-13
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
BALANCE SHEET
<TABLE>
<CAPTION>
June 30, 1999
--------------
(Unaudited)
<S> <C>
ASSETS
Cash and Cash Equivalents...................................... $ 52,402
Mortgage-Backed Securities, At fair value...................... 1,474,103,767
Accrued Interest Receivable.................................... 7,402,365
Other Assets................................................... 403,165
--------------
Total Assets............................................... $1,481,961,699
==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Repurchase agreements........................................ $1,344,740,000
Payable for Mortgage-Backed Securities purchased............. 9,987,500
Accrued interest payable..................................... 8,767,821
Dividends payable............................................ 4,444,142
Accounts payable............................................. 430,329
--------------
Total liabilities.......................................... 1,368,369,792
--------------
Stockholders' Equity:
Common stock: par value $.01 per share; 100,000,000
authorized;12,807,148 shares issued and outstanding......... 128,071
Additional paid-in capital................................... 132,966,180
Accumulated other comprehensive income....................... (19,428,328)
Treasury Stock at cost (109,600 shares)...................... (903,163)
Retained earnings............................................ 829,147
--------------
Total stockholders' equity................................. 113,591,907
--------------
Total Liabilities and Stockholders' Equity................. $1,481,961,699
==============
</TABLE>
See notes to financial statements.
F-14
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For The Six For The Six
Months Ended Months Ended
June 30, 1999 June 30, 1998
------------- -------------
(Unaudited)
<S> <C> <C>
Interest Income:
Mortgage-Backed Securities....................... $ 44,279,733 $43,840,637
Money market account............................. 138 37
------------ -----------
Total interest income.......................... 44,279,871 43,840,674
Interest Expense:
Repurchase agreements............................ 34,016,865 36,491,054
------------ -----------
Net Interest Income................................ 10,263,006 7,349,620
Gain on Sale of Mortgage-Backed Securities......... 90,413 1,722,959
General and Administrative Expenses................ 1,171,014 977,899
------------ -----------
Net Income......................................... 9,182,405 8,094,680
------------ -----------
Other Comprehensive Income
Unrealized loss on available-for-sale
securities...................................... (12,933,640) (2,211,198)
Less: reclassification adjustment for gains
included in net income.......................... (90,413) (1,722,959)
------------ -----------
Other comprehensive loss......................... (13,024,053) (3,934,157)
------------ -----------
Comprehensive Income............................... $ (3,841,648) $ 4,160,523
============ ===========
Net Income Per Share:
Basic............................................ $ 0.72 $ 0.64
============ ===========
Dilutive......................................... $ 0.71 $ 0.63
============ ===========
AVERAGE NUMBER OF SHARES OUTSTANDING
Basic............................................ 12,677,718 12,742,623
============ ===========
Dilutive......................................... 12,957,289 12,941,535
============ ===========
</TABLE>
See notes to financial statements.
F-15
<PAGE>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Common Additional Other
Stock Par Paid-in Treasury Comprehensive Retained Comprehensive
Value Capital Stock Income Earnings Income Total
--------- ------------- ---------- ------------- ----------- ------------- -------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31,
1998................... $ 127,580 $ 132,770,175 $ (903,163) $ 280,992 $ (6,404,275) $ 125,871,309
Net income............. $ 4,318,456 4,318,456
Other comprehensive
income:
Unrealized net gains on
securities, net of
reclassification
adjustment............ 421,355 421,355
------------
Comprehensive income... $ 4,739,811 4,739,811
============
Exercise of stock
options............... 489 195,007 195,496
Dividends declared for
the quarter ended
March 31, 1999, $0.33
per average share..... (4,190,108) (4,190,108)
--------- ------------- ---------- ----------- ------------- -------------
BALANCE, MARCH 31,
1999................... $ 128,069 $ 132,965,182 $ (903,163) $ 409,340 $ (5,982,920) $126,616,508
Net income............. $ 4,863,949 4,863,949
Other comprehensive
income:
Unrealized net losses
on securities, net of
reclassification
adjustment (13,445,408) (13,445,408)
------------
Comprehensive income... $ (8,581,459) (8,581,459)
============
Exercise of stock
options............... 2 998 1,000
Dividends declared for
the quarter ended June
30, 1999, $0.35 per
average share......... (4,444,142) (4,444,142)
--------- ------------- ---------- ----------- ------------- -------------
BALANCE, JUNE 30,1999... $ 128,071 $ 132,966,180 $ (903,163) $ 829,147 $ (19,428,328) $ 113,591,907
========= ============= ========== =========== ============= =============
Disclosure of
reclassification
amount:
Unrealized holding
losses arising during
period................. $(12,933,640)
Less: reclassification
adjustment for gains
included in net
income................. (90,413)
------------
Net unrealized losses on
securities............. $(13,024,053)
============
</TABLE>
See notes to financial statements.
F-16
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For The Six For The Six
Months Ended Months Ended
June 30, 1999 June 30, 1998
--------------- ---------------
(Unaudited)
<S> <C> <C>
Cash Flows From Operating Activities:
Net income................................. $ 9,182,405 $ 8,094,680
Adjustments to reconcile net income to net
cash provided by
operating activities:
Amortization of mortgage premiums and
discounts, net.......................... 4,050,915 3,853,436
Gain on sale of Mortgage-Backed
Securities.............................. (90,413) (1,722,959)
Increase in accrued interest receivable.. (620,322) (2,240,482)
Increase in other assets................. (190,951) (133,344)
Increase in accrued interest payable..... 3,715,195 5,907,928
Increase (Decrease) in accounts payable.. 291,092 (75,544)
--------------- ---------------
Net cash provided by operating
activities............................ 16,337,921 13,683,715
--------------- ---------------
Cash Flows From Investing Activities:
Purchase of Mortgage-Backed Securities..... (356,751,056) (961,783,914)
Proceeds from sale of Mortgage-Backed
Securities................................ 48,212,366 224,939,508
Principal payments on Mortgage-Backed
Securities................................ 235,805,426 232,134,576
--------------- ---------------
Net cash used in investing activities.. (72,733,264) (504,709,830)
--------------- ---------------
Cash Flows From Financing Activities:
Proceeds from repurchase agreements........ 5,272,183,000 5,241,533,000
Principal payments on repurchase
agreements................................ (5,207,953,000) (4,744,134,000)
Proceeds from exercise of stock options.... 196,496 193,700
Additional cost of initial public
offering.................................. -- (130,248)
Dividends paid............................. (8,047,771) (6,879,514)
--------------- ---------------
Net cash provided by financing
activities............................ 56,378,725 490,582,938
--------------- ---------------
Net Increase in Cash and Cash Equivalents.... (16,618) (443,177)
Cash and Cash Equivalents, Beginning of
Period...................................... 69,020 511,172
--------------- ---------------
Cash and Cash Equivalents, End of Period..... $ 52,402 $ 67,995
=============== ===============
Supplemental Disclosure of Cash Flow
Information:
Interest paid.............................. $ 30,241,491 $ 30,493,126
=============== ===============
Noncash Financing Activities:
Net unrealized losses on available-for-sale
securities................................ $ (19,428,328) $ (1,910,407)
=============== ===============
Dividends declared, not yet paid........... $ 4,444,142 $ 4,082,456
=============== ===============
</TABLE>
See notes to financial statements.
F-17
<PAGE>
ANNALY MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
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. 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 six month period 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 financials statements should be read in
conjunction with the audited financial statements included in the Company's
Annual Report on form 10-K for the year ended December 31, 1998. 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 and the cost basis of
the Mortgage-Backed Securities is adjusted. There were no such adjustments for
the six months ended June 30, 1999.
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.
F-18
<PAGE>
Credit Risk. At June 30, 1999, 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. At June 30,
1999 and December 31, 1998, all of the Company's Mortgage-Backed Securities
have a "AAA" rating or an implied a "AAA" rating.
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.
2. Mortgaged-Backed Securities
The following table pertains to the Company's Mortgage-Backed Securities
classified as available-for-sale as of June 30, 1999, 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...... $424,033,991 $938,104,181 $106,408,686 $1,468,546,858
Unamortized discount.... (167,685) (867,438) -- (1,035,123)
Unamortized premium..... 8,489,757 15,666,584 1,864,019 26,020,360
------------ ------------ ------------ --------------
Amortized cost.......... 432,356,063 952,903,327 108,272,705 1,493,532,095
Gross unrealized gains.. 58,216 1,685,599 -- 1,743,815
Gross unrealized
losses................. (6,681,797) (12,136,017) (2,354,329) (21,172,143)
------------ ------------ ------------ --------------
Estimated fair value.... $425,732,482 $942,452,909 $105,918,376 $1,474,103,767
============ ============ ============ ==============
</TABLE>
During the six months ended June 30, 1999 and 1998, the Company realized
$90,413 and $1,722,959 in gains from sales of Mortgage-Backed Securities,
respectively. There were no losses on sales of Mortgage-Backed Securities for
the six months ended June 30, 1999 and 1998.
3. Repurchase Agreements
As of June 30, 1999, the Company had outstanding $1,344,740,000 of
repurchase agreements with a weighted average borrowing rate of 4.87% and a
weighted average remaining maturity of 24 days. At June 30, 1999, Mortgage-
Backed Securities actually pledged had an estimated fair value of
$1,419,675,628.
F-19
<PAGE>
At June 30, 1999, the repurchase agreements had the following remaining
maturities:
<TABLE>
<CAPTION>
June 30, 1999
---------------
<S> <C>
Within 30 days............... $ 1,177,751,000
30 to 59 days................ 45,453,000
60 to 89 days................ 41,254,000
90 to 119 days............... 54,752,000
120 days and over............ 25,530,000
---------------
$ 1,344,740,000
---------------
</TABLE>
4. Common Stock
Options were exercised during the six month period ending June 30, 1999
increasing the total number of shares outstanding to 12,697,548. The number of
stock options exercised was 49,124, with an aggregate purchase price of
$196,496.
During the Company's six months ending June 30, 1999, the Company declared
dividends to shareholders totaling $8,634,250, or $0.68 per weighted average
share, of which $4,444,142 was paid on July 28, 1999.
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. For the six months ended June 30, 1999 the
reconciliation is as follows:
<TABLE>
<CAPTION>
For the Six Months Ended
June 30, 1999
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
<S> <C> <C> <C>
Net income.................................. $9,182,405
----------
Basic EPS................................... 9,182,405 12,677,718 $0.72
Effect of dilutive securities:
Dilutive stock options.................... 279,571
---------- ---------- -----
Diluted EPS............................... $9,182,405 12,957,289 $0.71
========== ========== =====
</TABLE>
Options to purchase 404,460 shares were outstanding during the quarter were
dilutive, as the exercise price (between $4.00 and $8.94) was less than the
average stock price for the six month period for the Company of $9.80. Options
to purchase 147,676 shares of stock were outstanding during the period and are
not considered dilutive. The exercise price (between $10.00 and $11.25) was
greater than the average stock price for the six month period of $9.80.
For the six months ended June 30, 1998, the reconciliation is as follows:
<TABLE>
<CAPTION>
For the Six Months Ended
June 30, 1998
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------ ---------
<S> <C> <C> <C>
Net income.................................. $8,094,680
----------
Basic EPS................................... 8,094,680 12,742,623 $0.64
Effect of dilutive securities:
Dilutive stock options.................... 198,912
---------- ---------- -----
Diluted EPS............................... $8,094,680 12,941,535 $0.63
========== ========== =====
</TABLE>
F-20
<PAGE>
Options to purchase 312,226 shares were outstanding during the quarter and
were dilutive as the exercise price (between $4.00 and $10.00) was less than
the average stock price for the six month period for the Company of $10.66.
Options to purchase 2,426 shares of stock were outstanding and not considered
dilutive. The exercise price of $11.25 were greater than the average stock
price of for the quarter of $10.66.
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 June 30, 1999 held securities classified as available-for-sale. At
June 30, 1999, the net unrealized losses totaled $19,428,328.
7. Lease Commitments
The Corporation has non-cancelable lease for office space, which commenced
in April 1998 and expires in December 2007.
The Corporation's aggregate future minimum lease payments are as follows:
<TABLE>
<S> <C>
1999................................ 92,804
2000................................ 95,299
2001................................ 97,868
2002................................ 100,515
2003 through 2007................... 582,406
--------
Total lease obligation............ $968,892
========
</TABLE>
8. Related Party Transaction
Included in "Other Assets" on the Balance sheet is an investment in Annaly
International Money Management, Inc. On June 24, 1998, the Company acquired
99,960 nonvoting shares, at a cost of $49,980. The officers and directors of
Annaly International Money Management Inc. are also officers and directors of
the Company.
F-21
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[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
Prospectus
Annaly Mortgage Management, Inc.
12 East 41st Street, Suite 700
New York, New York 10017
(212-696-0100)
$200,000,000
Common Stock and Preferred Stock
By this prospectus, we may offer, from time to time, shares of our:
. common stock
. preferred stock
. any combination of the foregoing
We will provide specific terms of these securities in supplements to this
prospectus. You should read this prospectus and any supplement carefully before
you decide to invest.
This prospectus may not be used to consummate sales of these securities
unless it is accompanied by a prospectus supplement.
The New York Stock Exchange lists our common stock under the symbol "NLY".
To ensure we qualify as a real estate investment trust, no person may own
more than 9.8% of the outstanding shares of any class of our common stock or our
preferred stock, unless our Board of Directors waives this limitation.
Consider carefully the risk factors beginning on page 5 of this prospectus.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is September 16, 1999
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
ABOUT THIS PROSPECTUS.............................................. 3
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995................... 3
ABOUT ANNALY MORTGAGE MANAGEMENT, INC.............................. 3
RISK FACTORS....................................................... 5
USE OF PROCEEDS.................................................... 11
DESCRIPTION OF STOCK............................................... 12
FEDERAL INCOME TAX CONSIDERATIONS.................................. 16
PLAN OF DISTRIBUTION............................................... 24
EXPERTS............................................................ 25
LEGAL MATTERS...................................................... 25
WHERE YOU CAN FIND MORE INFORMATION................................ 25
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE.................... 26
</TABLE>
<PAGE>
ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we filed with the
SEC using a "shelf" registration process. Under this process, we may offer and
sell any combination of preferred stock and common stock in one or more
offerings up to a total dollar amount of $200,000,000. This prospectus provides
you with a general description of the securities we may offer. Each time we
offer to sell securities, we will provide a supplement to this prospectus that
will contain specific information about the terms of that offering. The
prospectus supplement may also add, update or change information contained in
this prospectus. You should read both this prospectus and any prospectus
supplement together with the additional information you may need to make your
investment decision.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR CAUTIONARY STATEMENT
This prospectus and the documents incorporated by reference herein contain
"forward-looking" statements, as defined in the Private Securities Litigation
Reform Act of 1995, that are based on our current expectations, estimates and
projections. Statements that are not historical facts, including statements
about our beliefs and expectations, are forward-looking statements. These
statements are not guarantees of future performance, events or results and
involve potential risks and uncertainties. Accordingly, our actual results may
differ from our current expectations, estimates and projections. We undertake no
obligation to update publicly any forward-looking statements, whether as a
result of new information, future events or otherwise.
Important factors that may impact our actual results include changes in
interest rates, changes in the yield curve, changes in prepayment rates, the
supply of mortgage-backed securities, our ability to obtain financing, the terms
of any financing and the other factors described in this prospectus under the
heading "Risk Factors."
ABOUT ANNALY MORTGAGE MANAGEMENT, INC.
General
We are a real estate investment trust (or REIT) organized under Maryland
law. We own, manage and finance a portfolio of mortgage-backed securities. We
seek to generate net income for our stockholders from the spread between the
interest income we earn on our portfolio of mortgage-backed securities and our
borrowing costs to finance our portfolio of mortgage-backed securities. We were
organized on November 25, 1996 and commenced operations on February 18, 1997. We
are self-advised and self-managed.
Assets
On June 30, 1999, all of the mortgage-backed securities we owned were
"agency certificates." Agency certificates are mortgage-backed securities where
a government agency or federally chartered corporation, such as FHLMC, FNMA or
GNMA, guarantees payments of principal or interest on the certificates. Although
not rated, these agency certificates carry an implied "AAA" rating.
. Freddie Mac is a common abbreviation that refers to the Federal Home
Loan Mortgage Corporation, a privately-owned government-sponsored
enterprise created pursuant to an act of Congress.
. Fannie Mae is a common abbreviation that refers to the Federal
National Mortgage Association, a privately-owned, federally-chartered
corporation organized under an act of Congress.
. Ginnie Mae is a common abbreviation that refers to the Government
National Mortgage Association, a wholly-owned instrumentality of the
United States within the Department of Housing and Urban Development.
3
<PAGE>
Even though we have only acquired AAA securities so far, under our capital
investment policy we have the ability to acquire securities of lower credit
quality. Under our policy:
. 75% of our investments must have a AA or higher rating by Standard &
Poor's Corporation (or S&P), or an equivalent rating by another nationally
recognized rating organization, or our management must determine that the
investments are of comparable credit quality to investments with these ratings;
. the remaining 25% of our investments must have a BBB or higher rating
by S&P, or an equivalent rating by another nationally recognized rating
organization, or our management must determine that the investments are of
comparable credit quality to investments with these ratings; securities with
ratings of BBB or higher are commonly referred to as "investment grade"
securities; and
. we seek to have a minimum weighted average rating for our portfolio of
at least A by S&P.
We acquire both adjustable-rate and fixed-rate mortgage-backed securities.
Adjustable-rate mortgage-backed securities have interest rates that adjust
periodically based upon changes in an objective index of short-term interest
rates, such as LIBOR or a Treasury index. On June 30, 1999, approximately 64%
of our mortgage-backed securities were adjustable-rate securities and
approximately 36% were fixed-rate securities.
Borrowings
We borrow money primarily through repurchase agreements using our mortgage-
backed securities as collateral. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 to 12:1, although the ratio may vary from time to
time depending upon market conditions and other factors our management deems
relevant. At June 30, 1999, our debt-to-equity ratio was 11.8:1.
We attempt to structure our borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
correspond generally to the interest rate adjustment indices and periods of our
adjustable-rate mortgage-backed securities. However, the interest rates on our
borrowings generally adjust more frequently than the interest rates on our
mortgage-backed securities. In addition, our fixed-rate mortgage-backed
securities do not provide for any periodic rate adjustments. Accordingly, we
could experience net losses or a decrease in net profits in a period of rising
interest rates.
Stock Listing
Our common stock is traded on the New York Stock Exchange under the symbol
"NLY."
Principal Executive Offices and Telephone Number
Our principal executive offices are located at 12 East 41st Street, Suite
700, New York, New York 10017. Our telephone number is (212) 696-0100.
4
<PAGE>
RISK FACTORS
An investment in our stock involves a number of risks. Before making an
investment decision, you should carefully consider all of the risks described in
this prospectus. If any of the risks discussed in this prospectus actually
occur, our business, financial condition and results of operations could be
materially adversely affected. If this were to occur, the trading price of our
common stock could decline significantly and you may lose all or part of your
investment.
If the interest payments on our borrowings increase relative to the interest we
earn on our mortgage-backed securities, it may adversely affect our
profitability
We earn money based upon the spread between the interest payments we earn
on our mortgage-backed security investments and the interest payments we must
make on our borrowings. If the interest payments on our borrowings increase
relative to the interest we earn on our mortgage-backed securities, our
profitability may be adversely affected.
The interest payments on our borrowings may increase relative to the
interest we earn on our adjustable-rate mortgage-backed securities for various
reasons discussed in this section.
. Differences in timing of interest rate adjustments on our mortgage-backed
securities and our borrowings may adversely affect our profitability
We rely primarily on short-term borrowings to acquire mortgage-backed
securities with long-term maturities. Accordingly, if short-term interest rates
increase, this may adversely affect our profitability.
Most of the mortgage-backed securities we acquire are adjustable-rate
securities. This means that their interest rates may vary over time based upon
changes in an objective index, such as:
. LIBOR or the London Interbank Offered Rate. The interest rate that
banks in London offer for deposits in London of U.S. dollars.
. Treasury Index. A monthly or weekly average yield of benchmark U.S.
Treasury securities, as published by the Federal Reserve Board.
. CD Rate. The weekly average of secondary market interest rates on six-
month negotiable certificates of deposit, as published by the Federal
Reserve Board.
These indices generally reflect short-term interest rates. On June 30,
1999, approximately 64% of our mortgage-backed securities were adjustable-rate
securities.
The interest rates on our borrowings similarly vary with changes in an
objective index. However, the interest rates on our borrowings generally adjust
more frequently than the interest rates on our adjustable-rate mortgage-backed
securities. For example, on June 30, 1999, our adjustable-rate mortgage-backed
securities had a weighted average term to next rate adjustment of 10 months,
while our borrowings had a weighted average term to next rate adjustment of 24
days. Accordingly, in a period of rising interest rates, we could experience a
decrease in net income or a net loss because the interest rates on our
borrowings adjust faster than the interest rates on our adjustable-rate
mortgage-backed securities.
. Interest rate caps on our mortgage-backed securities may adversely affect
our profitability
Our adjustable-rate mortgage-backed securities are typically subject to
periodic and lifetime interest rate caps. Periodic interest rate caps limit the
amount an interest rate can increase during any given period. Lifetime interest
rate caps limit the amount an interest rate can increase through maturity of a
mortgage-backed security. Our borrowings are not subject to similar
restrictions. Accordingly, in a period of rapidly increasing interest rates, we
could experience a decrease in net income or a net loss because the interest
rates on our borrowings could increase
5
<PAGE>
without limitation while the interest rates on our adjustable-rate mortgage-
backed securities would be limited by caps.
. Because we acquire fixed-rate securities, an increase in interest rates may
adversely affect our profitability
While the majority of our investments consist of adjustable-rate mortgage-
backed securities, we also invest in fixed-rate mortgage-backed securities. In
a period of rising interest rates, our interest payments could increase while
the interest we earn on our fixed-rate mortgage-backed securities would not
change. This would adversely affect our profitability. On June 30, 1999,
approximately 36% of our mortgage-backed securities were fixed-rate securities.
An increase in prepayment rates may adversely affect our profitability
The mortgage-backed securities we acquire are backed by pools of mortgage
loans. We receive payments, generally, from the payments that are made on these
underlying mortgage loans. When borrowers prepay their mortgage loans at rates
that are faster than expected, this results in prepayments that are faster than
expected on the mortgage-backed securities. These faster than expected
prepayments may adversely affect our profitability.
We often purchase mortgage-backed securities that have a higher interest
rate than the market interest rate at the time. In exchange for this higher
interest rate, we must pay a premium over the market value to acquire the
security. In accordance with accounting rules, we amortize this premium over the
term of the mortgage-backed security. If the mortgage-backed security is prepaid
in whole or in part prior to its maturity date, however, we must expense the
premium that was prepaid at the time of the prepayment. This adversely affects
our profitability. On June 30, 1999, approximately 87% of the mortgage-backed
securities we owned were acquired at a premium.
Prepayment rates generally increase when interest rates fall and decrease
when interest rates rise, but changes in prepayment rates are difficult to
predict. Prepayment rates also may be affected by conditions in the housing and
financial markets, general economic conditions and the relative interest rates
on fixed-rate and adjustable-rate mortgage loans.
We may seek to reduce prepayment risk by acquiring mortgage-backed
securities at a discount. If a discounted security is prepaid in whole or in
part prior to its maturity date, we will earn income equal to the amount of the
remaining discount. This will improve our profitability if the discounted
securities are prepaid faster than expected. On June 30, 1999, approximately 13%
of the mortgage-backed securities we owned were acquired at a discount.
While we seek to minimize prepayment risk to the extent practical, in
selecting investments we must balance prepayment risk against other risks and
the potential returns of each investment. No strategy can completely insulate us
from prepayment risk.
An increase in interest rates may adversely affect our book value
Increases in interest rates may negatively affect the market value of our
mortgage-backed securities. Our fixed-rate securities, generally, are more
negatively affected by these increases. In accordance with accounting rules, we
reduce our book value by the amount of any decrease in the market value of our
mortgage-backed securities. During the second quarter of 1999, rising interest
rates contributed to a decline in our book value from $9.97 per share at the
beginning of the quarter to $8.95 per share at the end of the quarter.
Our strategy involves significant leverage
We seek to maintain a ratio of debt-to-equity of between 8:1 and 12:1,
although our ratio may at times be above or below this amount. We incur this
leverage by borrowing against a substantial portion of the market value of our
mortgage-backed securities. By incurring this leverage, we can enhance our
returns. However, this leverage, which is fundamental to our investment
strategy, also creates significant risks.
6
<PAGE>
. Our leverage may cause substantial losses
Because of our significant leverage, we may incur substantial losses if our
borrowing costs increase. Our borrowing costs may increase for any of the
following reasons:
. short-term interest rates increase
. the market value of our mortgage-backed securities decreases
. interest rate volatility increases
. the availability of financing in the market decreases.
. Our leverage may cause margin calls and defaults and force us to
sell assets under adverse market conditions
Because of our leverage, a decline in the value of our mortgage-backed
securities may result in our lenders initiating margin calls. A margin call
means that the lender requires us to pledge additional collateral to re-
establish the ratio of the value of the collateral to the amount of the
borrowing. Our fixed-rate mortgage-backed securities generally are more
susceptible to margin calls as increases in interest rates tend to more
negatively affect the market value of fixed-rate securities.
If we are unable to satisfy margin calls, our lenders may foreclose on our
collateral. This could force us to sell our mortgage-backed securities under
adverse market conditions. Additionally, in the event of our bankruptcy, our
borrowings, which are generally made under repurchase agreements, may qualify
for special treatment under the Bankruptcy Code. This special treatment would
allow the lenders under these agreements to avoid the automatic stay provisions
of the Bankruptcy Code and to liquidate the collateral under these agreements
without delay.
. Liquidation of collateral may jeopardize our REIT status
To continue to qualify as a REIT, we must comply with requirements
regarding our assets and our sources of income. If we are compelled to liquidate
our mortgage-backed securities, we may be unable to comply with these
requirements, ultimately jeopardizing our status as a REIT. For further
discussion of these asset and source of income requirements, and the
consequences of our failure to continue to qualify as a REIT, please see the
"Federal Income Tax Considerations" section of this prospectus.
. We may exceed our target leverage ratios
We seek to maintain a ratio of debt-to-equity of between 8:1 and 12:1.
However, we are not required to stay within this leverage ratio. If we exceed
this ratio, the adverse impact on our financial condition and results of
operations from the types of risks described in this section would likely be
more severe.
. We may not be able to achieve our optimal leverage
We use leverage as a strategy to increase the return to our investors.
However, we may not be able to achieve our desired leverage for any of the
following reasons:
. we determine that the leverage would expose us to excessive risk
. our lenders do not make funding available to us at acceptable rates
. our lenders require that we provide additional collateral to cover our
borrowings.
7
<PAGE>
. We may incur increased borrowing costs which would adversely affect our
profitability
Currently, all of our borrowings are collateralized borrowings in the form
of repurchase agreements. If the interest rates on these repurchase agreements
increase, it would adversely affect our profitability.
Our borrowing costs under repurchase agreements generally correspond to
short-term interest rates such as LIBOR or a short-term Treasury index, plus or
minus a margin. The margins on these borrowings over or under short-term
interest rates may vary depending upon:
. the movement of interest rates
. the availability of financing in the market
. the value and liquidity of our mortgage-backed securities.
If we are unable to renew our borrowings at favorable rates, our profitability
may be adversely affected
Since we rely primarily on short-term borrowings, our ability to achieve
our investment objectives depends not only on our ability to borrow money in
sufficient amounts and on favorable terms, but also on our ability to renew or
replace on a continuous basis our maturing short-term borrowings. If we are not
able to renew or replace maturing borrowings, we would have to sell our assets
under possibly adverse market conditions.
We have not used derivatives to mitigate our interest rate and prepayment risks
Our policies permit us to enter into interest rate swaps, caps and floors
and other derivative transactions to help us mitigate our interest rate and
prepayment risks described above. However, we have determined in the past that
the cost of these transactions outweighs the benefits. In addition, we will not
enter into derivative transactions if we believe they will jeopardize our status
as a REIT. If we decide to enter into derivative transactions in the future,
these transactions may mitigate our interest rate and prepayment risks but
cannot insulate us from these risks.
Our investment strategy may involve credit risk
We may incur losses if there are payment defaults under our mortgage-backed
securities.
To date, all of our mortgage-backed securities have been agency
certificates which, although not rated, carry an implied "AAA" rating. Agency
certificates are mortgage-backed securities where Freddie Mac, Fannie Mae or
Ginnie Mae guarantees payments of principal or interest on the certificates.
Even though we have only acquired AAA securities so far, under our capital
investment policy we have the ability to acquire securities of lower credit
quality. Under our policy:
. 75% of our investments must have a AA or higher rating by Standard &
Poor's Corporation (or S&P), or an equivalent rating by a similar
nationally recognized rating organization, or our management must
determine that the investments are of comparable credit quality to
investments with these ratings;
. the remaining 25% of our investments must have a BBB or higher rating
by S&P, or an equivalent rating by a similar nationally recognized
rating organization, or our management must determine that the
investments are of comparable credit quality to investments with these
ratings; securities with ratings of BBB or higher are commonly
referred to as "investment grade" securities; and
. we seek to have a minimum weighted average rating for our portfolio of
at least A by S&P.
If we acquire mortgage-backed securities of lower credit quality, we may
incur losses if there are defaults under those mortgage-backed securities or if
the rating agencies downgrade the credit quality of those mortgage-backed
securities.
8
<PAGE>
Because of competition, we may not be able to acquire mortgage-backed securities
at favorable yields
Our net income depends, in large part, on our ability to acquire mortgage-
backed securities at favorable spreads over our borrowing costs. In acquiring
mortgage-backed securities, we compete with other REITs, investment banking
firms, savings and loan associations, banks, insurance companies, mutual funds,
other lenders and other entities that purchase mortgage-backed securities, many
of which have greater financial resources than us. As a result, in the future,
we may not be able to acquire sufficient mortgage-backed securities at favorable
spreads over our borrowing costs.
We are dependent on our key personnel
We are dependent on the efforts of our key officers and employees,
including Michael A. J. Farrell, Chairman of the Board and Chief Executive
Officer, Timothy J. Guba, President and Chief Operating Officer, Wellington J.
St. Claire, Vice Chairman and Portfolio Manager, and Kathryn F. Fagan, Chief
Financial Officer. The loss of any of their services could have an adverse
effect on our operations. Although we have employment agreements with each of
them, we cannot assure you they will remain employed with us.
Some of our officers and employees have potential conflicts of interest
Some of our officers and employees have potential conflicts of interest
with us. The material potential conflicts are as follows:
. Our officers and employees manage assets for other clients
Messrs. Farrell and Guba, Ms. St. Claire and other officers and employees
are actively involved in managing mortgage-backed securities and other fixed
income assets for institutional clients through Fixed Income Discount Advisory
Company. FIDAC is a registered investment adviser that on June 30, 1999 managed,
assisted in managing or supervised approximately $650 million in gross assets
for a wide array of clients. Of that amount, FIDAC managed approximately $450
million of those gross assets on a discretionary basis. The U.S. Dollar Floating
Rate Fund is a fund managed by FIDAC. Mr. Farrell is a Director of the Floating
Rate Fund. These officers will continue to perform services for FIDAC, the
institutional clients and the Floating Rate Fund. Mr. Farrell is also the sole
shareholder of FIDAC.
These responsibilities may create conflicts of interest for these officers
and employees if they are presented with corporate opportunities that may
benefit us and the institutional clients and the Floating Rate Fund. Our
officers allocate investments among Annaly, the institutional clients and the
Floating Rate Fund by determining the entity or account for which the investment
is most suitable. In making this determination, our officers consider the
investment strategy and guidelines of each entity or account with respect to
acquisition of assets, leverage, liquidity and other factors that our officers
determine appropriate.
. Some of our directors and officers have ownership interests in our
affiliates that create potential conflicts of interest
Mr. Farrell, our Chairman and Chief Executive Officer, and our other
directors and officers, have direct and indirect ownership interests in our
affiliates that create potential conflicts of interest.
During 1998, we made an initial investment of $49,980 in Annaly
International Mortgage Management, Inc. Annaly International explores business
opportunities overseas, including the origination of mortgages. Annaly
International has not commenced operations beyond this exploratory stage. We own
24.99% of the equity of Annaly International in the form of non-voting
securities. The remaining equity of Annaly International is owned by FIDAC,
Michael A.J. Farrell, Timothy J. Guba, our President and Chief Operating
Officer, Wellington J. St. Claire, our Vice Chairman and Portfolio Manager,
Kathryn F. Fagan, our Chief Financial Officer, John S. Grace, one of our
directors, and other persons. Mr. Farrell is the sole shareholder of FIDAC.
During 1998, Annaly International made an initial investment of $20,400 in
Annaly.com, Inc. Annaly.com explores opportunities to acquire or originate
mortgages in the United States. Annaly.com has established a Web
9
<PAGE>
site at http://www.annaly.com but has not commenced the acquisition or
origination of mortgages. Annaly International owns 51% of the equity of
Annaly.com. The remaining equity of Annaly.com is owned by FIDAC.
Our management allocates rent and other office expenses between our
affiliates and us. These allocations may create conflicts of interest. Our
management currently allocates rent and other expenses 90% to Annaly and 10% to
FIDAC. Our audit committee must approve any change in these allocation
percentages. In addition, we may enter into agreements, such as technology
sharing or research agreements, with our affiliates in the future. These
agreements would present potential conflicts of interest. Our management will
obtain prior approval of our audit committee prior to entering into any
agreements with our affiliates.
We and our shareholders are subject to certain tax risks
. Our failure to qualify as a REIT would have adverse tax consequences
We believe that since 1997 we have qualified for taxation as a REIT for
federal income tax purposes. We plan to continue to meet the requirements for
taxation as a REIT. Many of these requirements, however, are highly technical
and complex. The determination that we are a REIT requires an analysis of
various factual matters and circumstances that may not be totally within our
control. For example, to qualify as a REIT, as least 95% of our gross income
must come from certain sources that are itemized in the REIT tax laws. We are
also required to distribute to stockholders at least 95% of our REIT taxable
income (excluding capital gains). Even a technical or inadvertent mistake could
jeopardize our REIT status. Furthermore, Congress and the IRS might make changes
to the tax laws and regulations, and the courts might issue new rulings that
make it more difficult or impossible for us to remain qualified as a REIT.
If we fail to qualify as a REIT, we would be subject to federal income tax
at regular corporate rates. Also, unless the IRS granted us relief under certain
statutory provisions, we would remain disqualified as a REIT for four years
following the year we first fail to qualify. If we fail to qualify as a REIT, we
would have to pay significant income taxes and would therefore have less money
available for investments or for distributions to our stockholders. This would
likely have a significant adverse effect on the value of our securities. In
addition, we would no longer be required to make any distributions to our
stockholders.
. We have certain distribution requirements
As a REIT, we must distribute 95% of our annual taxable income. The
required distribution limits the amount we have available for other business
purposes, including amounts to fund our growth. Also, it is possible that
because of the differences between the time we actually receive revenue or pay
expenses and the period we report those items for distribution purposes, we may
have to borrow funds on a short-term basis to meet the 95% distribution
requirement.
. We are also subject to other tax liabilities
Even if we qualify as a REIT, we may be subject to certain federal, state
and local taxes on our income and property. Any of these taxes would reduce our
operating cash flow.
Loss of Investment Company Act exemption would adversely affect us
We intend to conduct our business so as not to become regulated as an
investment company under the Investment Company Act. If we fail to qualify for
this exemption, our ability to use leverage would be substantially reduced and
we would be unable to conduct our business as described in this prospectus.
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. Under the current interpretation of the SEC staff,
in order to qualify for this exemption, we must maintain at least 55% of our
assets directly in these qualifying real estate interests. Mortgage-backed
securities that do not represent all the certificates issued with respect to an
underlying pool of mortgages may be treated as securities separate from the
underlying mortgage loans and, thus, may not qualify for purposes of the 55%
requirement. Therefore, our ownership of these mortgage-
10
<PAGE>
backed securities is limited by the provisions of the Investment Company Act. In
addition, in meeting the 55% requirement under the Investment Company Act, we
treat as qualifying interests mortgage-backed securities issued with respect to
an underlying pool as to which we hold all issued certificates. If the SEC or
its staff adopts a contrary interpretation, we could be required to sell a
substantial amount of our mortgage-backed securities, under potentially adverse
market conditions. Further, in order to insure that we at all times qualify for
the exemption from the Investment Company Act, we may be precluded from
acquiring mortgage-backed securities whose yield is somewhat higher than the
yield on mortgage-backed securities that could be purchased in a manner
consistent with the exemption. The net effect of these factors may be to lower
our net income.
Issuances of large amounts of our stock could cause our price to decline
As of August 26, 1999, 12,793,224 shares of our common stock were
outstanding. This prospectus may be used for the issuance of additional common
stock or shares of preferred stock that are convertible into common stock. If we
issue a significant number of shares of common stock or convertible preferred
stock in a short period of time, there could be a dilution of the existing
common stock and a decrease in the market price of the common stock.
We may change our policies without stockholder approval
Our Board of Directors and management determine all of our policies,
including our investment, financing and distribution policies. Although they
have no current plans to do so, they may amend or revise these policies at any
time without a vote of our stockholders. Policy changes could adversely affect
our financial condition, results of operations, the market price of our common
stock or our ability to pay dividends or distributions.
We are subject to the year 2000 risk
The year 2000 risk arises because certain computer programs have been
written using two digits rather than four to define the applicable years.
Consequently, date-sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in system failures or
miscalculations causing disruptions of operations. Our accounting software
vendor has certified that the software package we use is year 2000 compliant.;
however, we have not independently determined that this package is year 2000
compliant and we cannot assure you it is free of year 2000 risk.
We rely on third-party suppliers for a number of key services. If supplier
operations are interrupted due to the year 2000 risk, that interruption could
affect our operations. Although some of our suppliers have assured us that they
are year 2000 compliant, we cannot assure you that our vendors are free of year
2000 risk.
USE OF PROCEEDS
Unless otherwise indicated in an accompanying prospectus supplement, we
intend to use the net proceeds from any of the offered securities for the
purchase of mortgage-backed securities. We then intend to increase our
investment assets by borrowing against these mortgage-backed securities and
using the proceeds to acquire additional mortgage-backed securities.
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DESCRIPTION OF STOCK
General
Our authorized capital stock consists of 100 million shares of common
stock. Pursuant to our articles of incorporation, our Board has the right to
classify or reclassify any unissued shares of common stock into one or more
classes or series of common stock or preferred stock.
Common Stock
Voting
Each of our common stockholders is entitled to one vote for each share held
of record on each matter submitted to a vote of common stockholders.
Our bylaws provide that annual meetings of our stockholders will be held
each calendar year on the date determined by our President, and special meetings
may be called by a majority of our Board, our Chairman, a majority of our
independent directors, our President or generally by stockholders entitled to
cast at least 25% of the votes which all stockholders are entitled to cast at
the meeting. Our articles of incorporation may be amended in accordance with
Maryland law.
Dividends; Liquidation; Other Rights
Common stockholders are entitled to receive dividends when declared by our
Board of Directors out of legally available funds. The right of common
stockholders to receive dividends is subordinate to the rights of preferred
stockholders or other senior stockholders. If we have a liquidation,
dissolution or winding up, our common stockholders will share ratably in all of
our assets remaining after the payment of all of our liabilities and the payment
of all liquidation and other preference amounts to preferred stockholders and
other senior stockholders. Common stockholders have no preemptive or other
subscription rights, and there are no conversion rights, or redemption or
sinking fund provisions, relating to the shares of common stock.
Classification or Reclassification of Common Stock or Preferred Stock
Our articles of incorporation authorize our Board to reclassify any
unissued shares of common or preferred stock into other classes or series of
shares, to establish the number of shares in each class or series and to set the
preferences, conversion and other rights, voting powers, restrictions,
limitations and restrictions on ownership, limitations as to dividends or other
distributions, qualifications and terms or conditions of redemption for each
class or series.
Issuance of Preferred Stock
The following description sets forth general terms and provisions of the
preferred stock to which any prospectus supplement may relate. The statements
below describing the preferred stock are in all respects subject to and
qualified in their entirety by reference to our articles of incorporation, by-
laws and any articles supplementary to our articles of incorporation designating
terms of a series of preferred stock. The preferred stock, when issued, will be
fully paid and non-assessable. Because our Board has the power to establish the
preferences, powers and rights of each series of preferred stock, our Board may
afford the holders of any series of preferred stock preferences, powers and
rights, voting or otherwise, senior to the rights of common stockholders.
The rights, preferences, privileges and restrictions of each series of
preferred stock will be fixed by the articles supplementary relating to the
series. A prospectus supplement, relating to each series, will specify the
terms of the preferred stock, as follows:
- the title and stated value of the preferred stock;
- the number of shares offered, the liquidation preference per share and
the offering price of the shares;
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- the dividend rate(s), period(s) and payment date(s) or method(s) of
calculation applicable to the preferred stock;
- the date from which dividends on the preferred stock will accumulate,
if applicable;
- the procedures for any auction and remarketing for the preferred
stock;
- the provision for a sinking fund, if any, for the preferred stock;
- the provision for redemption, if applicable, of the preferred stock;
- any listing of the preferred stock on any securities exchange;
- the terms, if any, upon which the preferred stock will be convertible
into common stock, including the conversion price (or manner of
calculation) and conversion period;
- any other specific terms, preferences, rights, limitations or
restrictions of the preferred stock;
- a discussion of certain material federal income tax considerations
applicable to the preferred stock;
- the relative ranking and preferences of the preferred stock as to
dividend rights and rights upon the liquidation, dissolution or
winding-up of our affairs;
- any limitation on issuance of any series of preferred stock ranking
senior to or on a parity with the series of preferred stock as to
dividend rights and rights upon the liquidation, dissolution or
winding-up of our affairs; and
- any limitations on direct or beneficial ownership and restrictions on
transfer of the preferred stock, in each case as may be appropriate to
preserve our status as REIT.
Restrictions on Ownership and Transfer
To ensure that we meet the requirements for qualification as a REIT, our
articles of incorporation prohibit anyone from acquiring or holding, directly or
constructively, ownership of a number of shares of any class of our capital
stock in excess of 9.8% of the outstanding shares. For this purpose the term
"ownership" generally means either direct ownership or constructive ownership in
accordance with the constructive ownership provisions of section 544 of the
Internal Revenue Code.
The constructive ownership provisions of section 544 of the Internal
Revenue Code, generally attribute ownership of securities owned by a
corporation, partnership, estate or trust proportionately to its stockholders,
partners or beneficiaries; attribute ownership of securities owned by family
members to other members of the same family; and set forth rules as to when
securities constructively owned by a person are considered to be actually owned
for the application of such attribution provisions (i.e., "reattribution"). To
determine whether a person holds or would hold capital stock in excess of the
9.8% ownership limit, a person will be treated as owning not only shares of
capital stock actually owned, but also any shares of capital stock attributed to
that person under the attribution rules described above. Accordingly, a person
who individually owns less than 9.8% of the shares outstanding may nevertheless
be in violation of the 9.8% ownership limit.
Any transfer of shares of capital stock that would cause us to be
disqualified as a REIT or that would (a) create a direct or constructive
ownership of shares of capital stock in excess of the 9.8% ownership limit, or
(b) result in the shares of capital stock being beneficially owned (within the
meaning of section 856(a) of the Internal Revenue Code) by fewer than 100
persons (determined without reference to any rules of attribution), or (c)
result in us being "closely held" within the meaning of section 856(h) of the
Internal Revenue Code, will be null and void, and the intended transferee (the
"purported transferee") will acquire no rights to those shares. These
restrictions on transferability and ownership will not apply if our Board
determines that it is no longer in our best interests to continue to qualify as
a REIT.
Any purported transfer of shares of capital stock that would result in a
purported transferee owning (directly or constructively) shares of capital stock
in excess of the 9.8% ownership limit due to the unenforceability of the
transfer restrictions described above will constitute "excess securities."
Excess securities will be transferred by operation of law to a trust that we
will establish for the exclusive benefit of a charitable organization, until
such time as the trustee of the trust retransfers the excess securities. The
trustee will be a banking institution designated by us that is not affiliated
with the purported transferee or us. While the excess securities are held in
trust, the purported transferee will not be entitled to vote or to share in any
dividends or other distributions with respect to the securities. Subject to the
9.8% ownership limit, excess securities may be transferred by the trust to any
person (if such transfer would not result in excess securities) at a price not
to exceed the price paid by the purported transferee (or, if no
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consideration was paid by the purported transferee, the fair market value of the
excess securities on the date of the purported transfer), at which point the
excess securities will automatically cease to be excess securities.
Upon a purported transfer of excess securities, the purported transferee
shall cease to be entitled to distributions, voting rights and other benefits
with respect to the shares of capital stock except the right to payment of the
purchase price for the shares of capital stock on the retransfer of securities
as provided above. Any dividend or distribution paid to a purported transferee
on excess securities prior to our discovery that shares of capital stock have
been transferred in violation of our articles of incorporation shall be repaid
to us upon demand. If these transfer restrictions are determined to be void,
invalid or unenforceable by a court of competent jurisdiction, then the
purported transferee of any excess securities may be deemed, at our option, to
have acted as an agent on our behalf in acquiring the excess securities and to
hold the excess securities on our behalf.
All certificates representing shares of capital stock will bear a legend
referring to the restrictions described above.
Any person who acquires shares in violation of our articles of
incorporation, or any person who is a purported transferee such that excess
securities results, must immediately give written notice or, in the event of a
proposed or attempted transfer that would be void as set forth above, give at
least 15 days prior written notice to us of such event and shall provide us such
other information as we may request in order to determine the effect, if any, of
the transfer on our status as a REIT. In addition, every record owner of more
than 5.0% (during any period in which the number of record stockholders is 2,000
or more) or 1.0% (during any period in which the number of record stockholders
is greater than 200 but less than 2,000) or 1/2% (during any period in which the
number of record stockholders is 200 or less) of the number or value of our
outstanding shares must send us an annual written notice by January 31 stating
the name and address of the record owner and the number of shares held and
describing how the shares are held. Further, each stockholder is required to
disclose to us in writing information with respect to the direct and
constructive ownership of shares as the Board deems reasonably necessary to
comply with the REIT provisions of the Internal Revenue Code, to comply with the
requirements of any taxing authority or governmental agency or to determine any
such compliance.
Our Board may increase or decrease the 9.8% ownership limit. In addition,
to the extent consistent with the REIT provisions of the Internal Revenue Code,
our Board may, pursuant to our articles of incorporation, waive the 9.8%
ownership limit for a purchaser of our stock. In connection with any such
waiver, we may require that the stockholder requesting the waiver enter into an
agreement with us providing that we may repurchase shares from the stockholder
under certain circumstances to ensure compliance with the REIT provisions of the
Internal Revenue Code. The repurchase would be at fair market value as set forth
in the agreement between us and the stockholder. The consideration received by
the stockholder in the repurchase might be characterized as the receipt by the
stockholder of a dividend from us, and any stockholder entering into an
agreement with us should consult its tax advisor. At present, we do not intend
to waive the 9.8% ownership limit for any purchaser.
The provisions described above may inhibit market activity and the
resulting opportunity for the holders of our capital stock to receive a premium
for their shares that might otherwise exist in the absence of such provisions.
Such provisions also may make us an unsuitable investment vehicle for any person
seeking to obtain ownership of more than 9.8% of the outstanding shares of our
capital stock.
Classification of Board, Vacancies and Removal of Directors
Our by-laws provide for a staggered Board of Directors. Our by-laws provide
for nine directors divided into three classes, with terms of three years each.
The number of directors in each class and the expiration of each class term is
as follows:
<TABLE>
<S> <C> <C> <C>
Class 1 3 Directors Expires 2000
Class 2 3 Directors Expires 2001
Class 3 3 Directors Expires 2002
</TABLE>
At each annual meeting of our stockholders, successors of the class of
directors whose term expires at that meeting will be elected for a three-year
term and the directors in the other two classes will continue in office. A
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classified Board may delay, defer or prevent a change in control or other
transaction that might involve a premium over the then prevailing market price
for our common stock or other attributes that our stockholders may consider
desirable. In addition, a classified Board could prevent stockholders who do not
agree with the policies of our Board of Directors from replacing a majority of
the Board of Directors for two years, except in the event of removal for cause.
On August 30, 1999, John S. Grace, one of the Class 1 directors, resigned
from our Board, leaving one vacancy on our Board. Our by-laws provide that any
vacancy on our Board may be filled by a majority of the remaining directors. Any
individual so elected director will hold office for the unexplored term of the
director he or she is replacing. Our by-laws provide that a director may be
removed at any time only for cause upon the affirmative vote of at least two-
thirds of the votes entitled to be cast in the election of directors, but only
by a vote taken at a stockholder meeting. These provisions preclude stockholders
form removing incumbent directors, except for cause and upon a substantial
affirmative vote, and filling the vacancies created by such removal with their
own nominees.
Indemnification
Our articles of incorporation obligate us to indemnify our directors and
officers and to pay or reimburse expenses for them before the final disposition
of a proceeding to the maximum extent permitted by Maryland law. The
Corporations and Associations Article of the Annotated Code of Maryland (or the
Maryland General Corporation Law) permits a corporation to indemnify its present
and former directors and officers against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by them in connection with
any proceeding to which they may be made a party by reason of their service in
those or other capacities, unless it is established that (1) the act or omission
of the director or officer was material to the matter giving rise to the
proceeding and (a) was committed in bad faith, or (b) was the result of active
and deliberate dishonesty, or (2) the director or officer actually received an
improper personal benefit in money, property or services, or (3) in the case of
any criminal proceeding, the director or officer had reasonable cause to believe
that the act or omission was unlawful.
Limitation of Liability
The Maryland General Corporation Law permits the charter of a Maryland
corporation to include a provision limiting the liability of its directors and
officers to the corporation and its stockholders for money damages, except to
the extent that (1) it is proved that the person actually received an improper
benefit or profit in money, property or services, or (2) a judgment or other
final adjudication is entered in a proceeding based on a finding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. Our articles of incorporation provide for elimination of the
liability of our directors and officers to us or our stockholders for money
damages to the maximum extent permitted by Maryland law from time to time.
Maryland Business Combination Statute
The Maryland General Corporation Law establishes special requirements for
"business combinations" between a Maryland corporation and "interested
stockholders" unless exemptions are applicable. An interested stockholder is
any person who beneficially owns ten percent or more of the voting power of our
then-outstanding voting stock. Among other things, the law prohibits for a
period of five years a merger and other similar transactions between us and an
interested stockholder unless the Board approved the transaction prior to the
party becoming an interested stockholder. The five-year period runs from the
most recent date on which the interested stockholder became an interested
stockholder. The law also requires a supermajority stockholder vote for such
transactions after the end of the five-year period. This means that the
transaction must be approved by at least:
. 80% of the votes entitled to be cast by holders of outstanding voting
shares; and
. 66% of the votes entitled to be cast by holders of outstanding voting
shares other than shares held by the interested stockholder with whom
the business combination is to be effected.
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As permitted by the Maryland General Corporation Law, we have elected not
to be governed by the Maryland business combination statute. We made this
election by opting out of this statute in our articles of incorporation. If,
however, we amend our articles of incorporation to opt back in to the statute,
the business combination statute could have the effect of discouraging offers to
acquire us and of increasing the difficulty of consummating these offers, even
if our acquisition would be in our stockholders' best interests.
Maryland Control Share Acquisition Statute
Maryland law provides that "control shares" of a Maryland corporation
acquired in a "control share acquisition" have no voting rights except to the
extent approved by a stockholder vote. Two-thirds of the shares eligible to vote
must vote in favor of granting the "control shares" voting rights. "Control
shares" are shares of stock that, taken together with all other shares of stock
the acquiror previously acquired, would entitle the acquiror to exercise at
least 20% of the voting power in electing directors. Control shares do not
include shares of stock the acquiring person is entitled to vote as a result of
having previously obtained stockholder approval. A "control share acquisition"
means the acquisition of control shares, subject to certain exceptions.
If a person who has made (or proposes to make) a control share acquisition
satisfies certain conditions (including agreeing to pay expenses), he may compel
the Board of Directors to call a special meeting of stockholders to be held
within 50 days to consider the voting rights of the shares. If such a person
makes no request for a meeting, we have the option to present the question at
any stockholders' meeting.
If voting rights are not approved at a meeting of stockholders then we may
redeem any or all of the control shares (except those for which voting rights
have previously been approved) for fair value. We will determine the fair value
of the shares, without regard to voting rights, as of the date of either:
. the last control share acquisition; or
. any meeting where stockholders considered and did not approve voting
rights of the control shares.
If voting rights for control shares are approved at a stockholders' meeting
and the acquiror becomes entitled to vote a majority of the shares of stock
entitled to vote, all other stockholders may exercise appraisal rights. This
means that you would be able to redeem your stock back to us for fair value.
Under Maryland law, the fair value may not be less than the highest price per
share paid in the control share acquisition. Furthermore, certain limitations
otherwise applicable to the exercise of dissenters' rights would not apply in
the context of a control share acquisition.
The control share acquisition statute would not apply to shares acquired in
a merger, consolidation or share exchange if we were a party to the transaction.
The control share acquisition statute could have the effect of discouraging
offers to acquire us and of increasing the difficulty of consummating any such
offers, even if our acquisition would be in our stockholders' best interests.
Transfer Agent and Registrar
ChaseMellon Shareholder Services, L.L.C., 450 West 33rd Street, 15th Floor,
New York, New York 10001, is the transfer agent and registrar for our stock. Its
telephone number is (800) 851-9677.
FEDERAL INCOME TAX CONSIDERATIONS
The following discusses the material United States federal income tax
considerations that relate to our treatment as a REIT and that apply to an
investment in our stock. No assurance can be given that the conclusions set out
below would be sustained by a court if challenged by the IRS. This summary deals
only with stock that you hold as a "capital asset", which generally means
property that is held for investment. It does not address tax considerations
applicable to you if you are a person subject to special tax rules, such as:
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. a dealer or trader in securities;
. a financial institution;
. an insurance company;
. a stockholder that holds our stock as a hedge, part of a straddle,
conversion transaction or other arrangement involving more than one
position;
. a stockholder whose functional currency is not the United States
dollar; or
. a tax-exempt or foreign taxpayer, except to the extent discussed
below.
The discussion below is based upon the provisions of the United States
Internal Revenue Code of 1986 and regulations, rulings and judicial decisions
interpreting the Internal Revenue Code as of the date of this prospectus; any of
these authorities may be repealed, revoked or modified, perhaps with retroactive
effect, so as to result in federal income tax consequences different from those
discussed below.
The discussion set out below is intended only as a summary of the material
United States federal income tax consequences of our treatment as a REIT and of
an investment in our stock. We urge you to consult your own tax advisor as to
the tax consequences of an investment in our stock, including the application to
your particular situation of the tax considerations discussed below, as well as
the application of state, local or foreign tax laws. The statements of United
States tax law set out below are based on the laws in force and their
interpretation as of the date of this prospectus, and are subject to any changes
occurring after that date.
General
We have elected to become subject to tax as a REIT for federal income tax
purposes effective for our taxable year ending December 31, 1997. In the opinion
of Morgan, Lewis & Bockius LLP, commencing with our taxable year ended December
31, 1997, we have been organized in conformity with the requirements for
qualification and taxation as a REIT under the Internal Revenue Code, and our
method of operation enables us to meet the requirements for qualification and
taxation as a REIT. This opinion is based on factual assumptions and
representations relating to our organization and operations and factual
assumptions and representations relating to our continued efforts to comply with
the various REIT tests. Qualification as a REIT depends upon our ability to meet
on a continuing basis, through actual operating results, the various
qualification tests imposed under the Internal Revenue Code, and Morgan, Lewis &
Bockius LLP has not reviewed in the past, and may not review in the future, our
compliance with these tests.
There can be no assurance, however, that we will qualify as a REIT in any
particular taxable year, given the highly complex nature of the rules governing
REITs, the ongoing importance of factual determinations and the possibility of
future changes in our circumstances. If we were not to qualify as a REIT in any
particular year, we would be subject to federal income tax as a regular domestic
corporation, and you would be subject to tax in the same manner as a stockholder
of a regular domestic corporation. In this event, we could be subject to a
potentially substantial income tax liability in respect of each taxable year
that we fail to qualify as a REIT, and the amount of earnings and cash available
for distribution to you and other stockholders could be significantly reduced or
eliminated. See "Failure to qualify" below.
REIT Qualification Requirements
The following is a brief summary of the material technical requirements
that we must meet on an ongoing basis in order to qualify, and remain qualified,
as a REIT under the Internal Revenue Code.
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Stock Ownership Tests
We must meet the following stock ownership tests:
(1) our capital stock must be transferable;
(2) our capital stock must be held by at least 100 persons during at least
335 days of a taxable year of 12 months (or during a proportionate
part of a taxable year of less than 12 months); and
(2) no more than 50% of the value of our capital stock may be owned,
directly or indirectly, by five or fewer individuals at any time
during the last half of the taxable year. In applying this test, the
Internal Revenue Code treats some entities as individuals.
Tax-exempt entities, other than private foundations and certain
unemployment compensation trusts, are generally not treated as individuals for
these purposes. The requirements of items (2) and (3) above do not apply to the
first taxable year for which we made an election to be taxed as a REIT. However,
these stock ownership requirements must be satisfied in each subsequent taxable
year. Our articles of incorporation provide restrictions regarding the transfer
of our shares in order to aid us in meeting the stock ownership requirements. In
addition, we are required under Treasury Department regulations to demand annual
written statements from the record holders of designated percentages of our
capital stock disclosing actual and constructive stock ownership and to maintain
permanent records showing the information we have received as to the actual and
constructive stock ownership and a list of those persons failing or refusing to
comply with our demand.
Asset Tests
We generally must meet the following asset tests at the close of each
quarter of each taxable year:
(a) at least 75% of the value of our total assets must consist of
Qualified REIT Real Estate Assets, government securities, cash and
cash items; and
(b) the value of securities that we hold (other than government
securities) may not exceed 25% of the value of our total assets, and
in addition, we may not hold securities of any one issuer that
constitute either
(1) 5% or more of the value of our total assets or
(2) 10% of the outstanding voting securities of the issuer.
"Qualified REIT Real Estate Assets" means pass-through certificates,
mortgage loans and other assets of the type described in Section 856(c)(5)(B) of
the Internal Revenue Code.
We, along with one or more other entities, may form and capitalize one or
more taxable subsidiaries that will engage in hedging activities, the creation
of mortgage-backed securities through securitization or other activities. In
order to ensure that we would not violate the more than 10% single issuer voting
stock limitation, we would own only non-voting preferred and common stock, and
the other entities would own all of the voting common stock. The value of our
investment in any of these subsidiaries would also be limited to less than 5% of
the value of our total assets at the end of each calendar quarter so that we can
also comply with the 5% of value, single-issuer asset limitation. The taxable
subsidiary would not elect REIT status and would distribute only net after-tax
profits to its stockholders, including us. We will consult with our tax advisor
to determine whether our activities or the formation and contemplated method of
operation of a subsidiary corporation would cause us to fail to satisfy the REIT
requirements.
Gross Income Tests
We generally must meet the following gross income tests for each taxable
year:
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(a) at least 75% of our gross income must be derived from the real estate
sources specified in the Internal Revenue Code, including interest
income and gain from the disposition of Qualified REIT Real Estate
Assets or "qualified temporary investment income," which is income
derived from "new capital" within one year of its receipt; and
(b) at least 95% of our gross income for each taxable year must be derived
from sources of income qualifying for the 75% gross income test
described in (a), dividends, interest, and gains from the sale of
stock or other financial instruments (including interest rate swap and
cap agreements, options, futures contracts, forward rate agreements or
similar financial instruments entered into to hedge variable rate debt
incurred to acquire Qualified REIT Real Estate Assets) not held for
sale in the ordinary course of business.
Distribution Requirement
We generally must distribute to our stockholders at least 95% of our REIT
taxable income before deductions of dividends paid and excluding net capital
gain. However, we may elect to retain, rather than distribute, our net long-term
capital gains and pay the tax on these gains, while our stockholders include
their proportionate share of the undistributed long-term capital gains in income
and receive a credit for their share of the tax that we pay.
Failure to Qualify
If we fail to qualify for taxation as a REIT in any taxable year and relief
provisions do not apply, we will be subject to tax, including any applicable
alternative minimum tax, on our taxable income at regular corporate rates.
Distributions to stockholders in any year in which we fail to qualify as a REIT
will not be deductible by us, nor will we be required to make distributions.
Unless entitled to relief under specific statutory provisions, we also will be
disqualified from taxation as a REIT for four taxable years following the year
during which qualification was lost. It is not possible to state whether in all
circumstances we would be entitled to such statutory relief.
Recent Developments
On August 4, 1999, Congress released the "Taxpayer Refund and Relief Act of
1999," a bill that is to be sent to the White House for President Clinton's
approval when Congress reconvenes in September. The bill would change the
restriction on the ability of the REIT to own securities of any issuer from the
current 10% of the voting securities of an issuer to 10% of the vote or value of
the securities of an issuer. President Clinton's proposed budget plan, released
earlier this year, included similar provisions. In addition, the bill would
allow REITs to own up to 100% of the stock of "taxable REIT subsidiaries."
Although a taxable REIT subsidiary would not be subject to the 10% vote or value
test, a taxable REIT subsidiary would otherwise be subject to the REIT asset
tests. If these provisions were to become law, we might have to change our
future or current ownership of subsidiaries in order to continue to qualify as a
REIT. Congress' Taxpayer Refund and Relief Act of 1999 does contain a transition
rule under which securities that a REIT has held on July 12, 1999 will not be
subject to this new limitation, assuming that the issuer of the securities does
not engage in a substantially new line of business or acquire a substantial
asset. This transition rule may exempt our ownership of 24.99% of the equity of
Annaly International from the bill's provisions if it were enacted as proposed.
The bill also contains a provision, among others, that would reduce a REIT's
annual distribution requirement from the current 95% of REIT taxable income to
90%.
Taxation of Annaly Mortgage Management
In any year in which we qualify as a REIT, we generally will not be subject
to federal income tax on that portion of our REIT taxable income or capital gain
that we distribute to our stockholders. We will, however, be subject to federal
income tax at normal corporate income tax rates upon any undistributed taxable
income or capital gain.
Notwithstanding our qualification as a REIT, we may also be subject to tax
in the following other circumstances:
. If we fail to satisfy either the 75% or the 95% gross income
test, but nonetheless maintain our qualification as a REIT
because we meet other requirements, we generally would be
subject to a
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100% tax on the greater of the amount by which we fail either
the 75% or the 95% gross income test multiplied by a fraction
intended to reflect our profitability.
. We will also be subject to a tax of 100% on net income derived
from any "prohibited transaction" which is, in general, a sale
or other disposition of property held primarily for sale to
customers in the ordinary course of business.
. If we have (1) net income from the sale or other disposition
of "foreclosure property" that is held primarily for sale to
customers in the ordinary course of business or (2) other non-
qualifying income from foreclosure property, it will be
subject to federal income tax at the highest corporate income
tax rate.
. If we fail to distribute during each calendar year at least
the sum of (1) 85% of our REIT ordinary income for such year,
(2) 95% of our REIT capital gain net income for such year and
(3) any undistributed amount of ordinary and capital gain net
income from the preceding taxable years, we would be subject
to a 4% federal excise tax on the excess of the required
distribution over the amounts actually distributed during the
taxable year.
. If we acquire any asset from a C corporation in a transaction
in which the basis of the asset is determined by reference to
the basis of the asset in the hands of a C corporation and we
recognize gain upon a disposition of such asset occurring
within 10 years of its acquisition, then we would be subject
to tax to the extent of any built-in gain at the highest
regular corporate rate.
. We also may be subject to the corporate alternative minimum
tax, as well as other taxes in situations not presently
contemplated.
If we fail to qualify as a REIT in any taxable year and the relief
provisions provided in the Internal Revenue Code do not apply, we would be
subject to federal income tax, including any applicable alternative minimum tax,
on our taxable income in that taxable year and all subsequent taxable years at
the regular corporate income tax rates. We would not be allowed to deduct
distributions to shareholders in these years, nor would we be required to make
them under the Internal Revenue Code. Further, unless entitled to the relief
provisions of the Internal Revenue Code, we also would be disqualified from re-
electing REIT status for the four taxable years following the year during which
we became disqualified.
We intend to monitor on an ongoing basis our compliance with the REIT
requirements described above. In order to maintain our REIT status, we will be
required to limit the types of assets that we might otherwise acquire, or hold
some assets at times when we might otherwise have determined that the sale or
other disposition of these assets would have been more prudent.
Taxation of Stockholders
Unless you are a tax-exempt entity, distributions that we make to you,
including constructive distributions, generally will be subject to tax as
ordinary income to the extent of our current and accumulated earnings and
profits as determined for federal income tax purposes. If the amount we
distribute to you exceeds your allocable share of current and accumulated
earnings and profits, the excess will be treated as a return of capital to the
extent of your adjusted basis in your stock, which will reduce your basis in
your stock but will not be subject to tax. If the amount we distribute to you
also exceeds your adjusted basis, this excess amount will be treated as a gain
from the sale or exchange of a capital asset. Distributions you receive, whether
characterized as ordinary income or as capital gain, are not eligible for the
corporate dividends received deduction.
Distributions that we designate as capital gain dividends generally will be
subject to tax as long-term capital gain to you, to the extent that the
distributions to you and the other shareholders do not exceed our actual net
capital gain for the taxable year. In the event that we realize a loss for the
taxable year, you will not be permitted to deduct any share of that loss.
Further, if we, or a portion of our assets, were to be treated as a taxable
mortgage pool, any "excess inclusion income" that is allocated to you could not
be offset by any net operating loss that you may have.
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Future Treasury Department regulations may require that you take into account,
for purposes of computing your individual alternative minimum tax liability,
some of our tax preference items.
Dividends that we declare during the last quarter of the calendar year and
actually pay to you during January of the following taxable year generally are
treated as if we had paid, and you had received, them on December 31 of the
calendar year and not on the date actually paid and received. In addition, we
may elect to treat other dividends distributed after the close of the taxable
year as having been paid during the taxable year, so long as they meet the
requirements described in the Internal Revenue Code, but you will be treated as
having received these dividends in the taxable year in which their distribution
is actually made.
If you sell or otherwise dispose of our stock, you will generally recognize
a capital gain or loss in an amount equal to the difference between the amount
realized and your adjusted basis in the stock, which gain or loss will be long-
term if you have held the stock for more than one year. Any loss that you
recognize on the sale or exchange of our stock that you have held for six months
or less generally will be treated as a long-term capital loss to the extent,
with respect to the stock, of (1) any long-term capital gain dividends that you
receive and (2) any long-term capital gain that we retain and the tax on which
you receive a credit.
If we do not qualify as a REIT in any year, distributions that we make to
you would be taxable in the same manner discussed above, except that:
. we would not be allowed to designate any distributions as capital gain
dividends;
. distributions would be eligible for the corporate dividends received
deduction;
. the excess inclusion income rules would not apply to you; and
. you would not receive any share of our tax preference items.
In this event, however, we could be subject to potentially substantial
federal income tax liability, and the amount of earnings and cash available for
distribution to you and other stockholders could be significantly reduced or
eliminated.
Information Reporting and Backup Withholding
We will report to our domestic stockholders and to the IRS the amount of
distributions that we pay, and the amount of tax that we withhold on these
distributions for each calendar year. Under the backup withholding rules, you
may be subject to backup withholding at a rate of 31% with respect to
distributions paid unless you:
. are a corporation or otherwise within an exempt category and
demonstrate this fact when required; or
. provide a taxpayer identification number, certify as to no loss of
exemption from backup withholding and otherwise comply with applicable
requirements of the backup withholding rules.
If you do not provide us with your correct taxpayer identification number,
then you may also be subject to penalties imposed by the IRS.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules will be refunded or credited against your United States
federal income tax liability, provided that you furnish the required information
to the IRS.
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Taxation of Tax-Exempt Entities
The discussion under this heading only applies to you if you are a tax-
exempt entity.
Subject to the discussion below regarding a "pension-held REIT,"
distributions received from us or gain realized on the sale of our stock will
not be taxable as unrelated business taxable income (UBTI), provided that:
. you have not incurred indebtedness to purchase or hold our stock;
. you do not otherwise use our shares in an unrelated trade or business;
and
. we, consistent with our present intent, do not hold a residual
interest in a REMIC that gives rise to "excess inclusion" income as
defined under section 860E of the Internal Revenue Code.
If we were to be treated as a "taxable mortgage pool," however, a
substantial portion of the dividends you receive may be subject to tax as UBTI.
In addition, a substantial portion of the dividends you receive may
constitute UBTI if we are treated as a "pension-held REIT" and you are a
"qualified pension trust" that holds more than 10% by value of our interests at
any time during a taxable year. For these purposes, a "qualified pension trust"
is any pension or other retirement trust that qualifies under section 401(a) of
the Internal Revenue Code. We would be treated as a "pension-held REIT" if (1)
we would not have qualified as a REIT but for the provisions of the Internal
Revenue Code which look through qualified pension trust stockholders to the
qualified pension trust's beneficiaries in determining stock ownership of a REIT
and (2) at least one qualified pension trust holds more than 25% of our stock by
value or one or more qualified pension trusts (each owning more than 10% of our
stock by value) hold in the aggregate more than 50% of our stock by value.
Assuming compliance with the ownership limit provisions set forth in our
articles of incorporation, it is unlikely that pension plans will accumulate
sufficient stock to cause us to be treated as a pension-held REIT.
If you are exempt from federal income taxation under sections 501(c)(7),
(c)(9), (c)(17), and (c)(20) of the Internal Revenue Code, then distributions
you receive may also constitute UBTI; we urge you to consult your tax advisor
concerning the applicable "set aside" and reserve requirements.
United States Federal Income Tax Considerations Applicable to Foreign Holders
The discussion under this heading applies to you only if you are not a U.S.
person. A U.S. person is a person who is:
. a citizen or resident of the United States;
. a corporation, partnership, or other entity created or organized in
the United States or under the laws of the United States or of any
political subdivision thereof;
. an estate whose income is includible in gross income for United States
Federal income tax purposes regardless of its source; or
. a trust, if (1) a court within the United States is able to exercise
primary supervision over the administration of the trust and one or
more U.S. persons have authority to control all substantial decisions
of the trust, or (2) the trust was in existence on August 26, 1996 and
has made an election to be treated as a U.S. person;
This discussion is only a brief summary of the United States federal tax
consequences that apply to you, which are highly complex, and does not consider
any specific facts or circumstances that may apply to you and your particular
situation. We urge you to consult your tax advisor regarding the United States
federal tax consequences
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of acquiring, holding and disposing of our stock, as well as any tax
consequences that may arise under the laws of any foreign, state, local or other
taxing jurisdiction.
Distributions
Except for distributions attributable to gain from the dispositions of real
property interests or designated as capital gains dividends, distributions you
receive from us generally will be subject, to the extent of our earnings and
profits, to withholding of United States federal income tax at the rate of 30%,
unless reduced or eliminated by an applicable tax treaty or unless the
distributions are treated as effectively connected with a United States trade or
business. If you wish to claim the benefits of an applicable tax treaty, you
may need to satisfy certification and other requirements, some of which will
change on January 1, 2001.
Distributions you receive that are in excess of our earnings and profits
will be treated as a tax-free return of capital to the extent of your adjusted
basis in your stock. If the amount of the distribution also exceeds your
adjusted basis, this excess amount will be treated as gain from the sale or
exchange of our stock as described below. If we cannot determine at the time we
make a distribution whether the distribution will exceed our earnings and
profits, the distribution will be subject to withholding at the same rate as
dividends. These withheld amounts, however, will be refundable or creditable
against your United States federal tax liability if it is subsequently
determined that the distribution was, in fact, in excess of our earnings and
profits. If you receive a dividend that is treated as being effectively
connected with your conduct of a trade or business within the United States, the
dividend will be subject to the United States federal income tax on net income
that applies to United States persons generally and may be subject to the branch
profits tax if you are a corporation.
Distributions that we make to you and designate as capital gains dividends,
other than those attributable to the disposition of a United States real
property interest, generally will not be subject to United States federal income
taxation, unless:
. your investment in our stock is effectively connected with your
conduct of a trade or business within the United States; or
. you are a nonresident alien individual who is present in the United
States for 183 days or more in the taxable year and other requirements
are met.
Distributions that are attributable to your disposition of United States
real property interests are subject to income and withholding taxes pursuant to
the Foreign Investment in Real Property Act of 1980 (FIRPTA), and may also be
subject to branch profits tax if you are a corporation that is not entitled to
treaty relief or exemption. However, because we do not expect to hold assets
that would be treated as "United States real property interests" as defined by
FIRPTA, the FIRPTA provisions should not apply to your investment in our stock.
Gain on Disposition
You generally will not be subject to United States federal income tax on
gain recognized on a sale or other disposition of our stock unless:
. the gain is effectively connected with your conduct of a trade or
business within the United States;
. you are a nonresident alien individual who holds our stock as a
capital asset and is present in the United States for 183 or more days
in the taxable year and other requirements are met; or
. you are subject to tax under the FIRPTA rules discussed below.
Gain that is effectively connected with your conduct of a trade or business
within the United States will be subject to the United States federal income tax
on net income that applies to United States persons generally and may be subject
to the branch profits tax if you are a corporation. However, these effectively-
connected gains will not be subject to withholding. We urge you to consult
applicable treaties, which may provide for different rules.
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Under FIRPTA, you may be subject to tax on gain recognized from your sale
or other disposition of our stock if we were to both (1) hold United States real
property interests and (2) fail to qualify as a "domestically-controlled REIT."
A REIT qualifies as "domestically-controlled" as long as less than 50% in value
of its shares of beneficial interest are held by foreign persons at all times
during the shorter of (1) the previous five years and (2) the period in which
the REIT is in existence. As mentioned above, we do not expect to hold any
United States real property interests. Furthermore, we will likely qualify as a
"domestically-controlled REIT," although no assurances can be provided because
our shares are publicly-traded.
State and Local Taxes
We and our stockholders may be subject to state or local taxation in
various jurisdictions, including those in which we or they transact business or
reside. The state and local tax treatment that applies to us and our
stockholders may not conform to the federal income tax consequences discussed
above. Consequently, we urge you to consult your own tax advisor regarding the
effect of state and local tax laws.
PLAN OF DISTRIBUTION
We may sell the securities offered pursuant to this prospectus and any
accompanying prospectus supplements to or through one or more underwriters or
dealers or we may sell the securities to investors directly or through agents.
Any underwriter or agent involved in the offer and sale of the securities will
be named in the applicable prospectus supplement. We may sell securities
directly to investors on our own behalf in those jurisdictions where we are
authorized to do so.
Underwriters may offer and sell the securities at a fixed price or prices,
which may be changed, at market prices prevailing at the time of sale, at prices
related to the prevailing market prices or at negotiated prices. We also may,
from time to time, authorize dealers or agents to offer and sell these
securities upon such terms and conditions as may be set forth in the applicable
prospectus supplement. In connection with the sale of any of these securities,
underwriters may receive compensation from us in the form of underwriting
discounts or commissions and may also receive commissions from purchasers of the
securities for whom they may act as agent. Underwriters may sell the securities
to or through dealers, and such dealers may receive compensation in the form of
discounts, concessions or commissions from the underwriters or commissions from
the purchasers for which they may act as agents.
Shares may also be sold in one or more of the following transactions: (a)
block transactions (which may involve crosses) in which a broker-dealer may sell
all or a portion of the shares as agent but may position and resell all or a
portion of the block as principal to facilitate the transaction; (b) purchases
by a broker-dealer as principal and resale by the broker-dealer for its own
account pursuant to a prospectus supplement; (c) a special offering, an exchange
distribution or a secondary distribution in accordance with applicable New York
Stock Exchange or other stock exchange rules; (d) ordinary brokerage
transactions and transactions in which a broker-dealer solicits purchasers; (e)
sales "at the market" to or through a market maker or into an existing trading
market, on an exchange or otherwise, for shares; and (f) sales in other ways not
involving market makers or established trading markets, including direct sales
to purchasers. Broker-dealers may also receive compensation from purchasers of
the shares which is not expected to exceed that customary in the types of
transactions involved.
Any underwriting compensation paid by us to underwriters or agents in
connection with the offering of these securities, and any discounts or
concessions or commissions allowed by underwriters to participating dealers,
will be set forth in the applicable prospectus supplement. Dealers and agents
participating in the distribution of the securities may be deemed to be
underwriters, and any discounts and commissions received by them and any profit
realized by them on resale of the securities may be deemed to be underwriting
discounts and commissions.
Underwriters, dealers and agents may be entitled, under agreements entered
into with us, to indemnification against and contribution toward certain civil
liabilities, including liabilities under the Securities Act. Unless otherwise
set forth in the accompanying prospectus supplement, the obligations of any
underwriters to purchase any
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of these securities will be subject to certain conditions precedent, and the
underwriters will be obligated to purchase all of the series of securities, if
any are purchased.
Underwriters, dealers and agents may engage in transactions with, or
perform services for, us and our affiliates in the ordinary course of business.
In connection with the offering of the securities hereby, certain
underwriters, and selling group members and their respective affiliates may
engage in transactions that stabilize, maintain or otherwise affect the market
price of the applicable securities. These transactions may include stabilization
transactions effected in accordance with Rule 104 of Regulation M promulgated by
the Securities and Exchange Commission pursuant to which these persons may bid
for or purchase securities for the purpose of stabilizing their market price.
The underwriters in an offering of securities may also create a "short
position" for their account by selling more securities in connection with the
offering than they are committed to purchase from us. In that case, the
underwriters could cover all or a portion of the short position by either
purchasing securities in the open market following completion of the offering of
these securities or by exercising any over-allotment option granted to them by
us. In addition, the managing underwriter may impose "penalty bids" under
contractual arrangements with other underwriters, which means that they can
reclaim from an underwriter (or any selling group member participating in the
offering) for the account of the other underwriters, the selling concession for
the securities that are distributed in the offering but subsequently purchased
for the account of the underwriters in the open market. Any of the transactions
described in this paragraph or comparable transactions that are described in any
accompanying prospectus supplement may result in the maintenance of the price of
the securities at a level above that which might otherwise prevail in the open
market. None of the transactions described in this paragraph or in an
accompanying prospectus supplement are required to be taken by any underwriters
and, if they are undertaken, may be discontinued at any time.
The common stock is listed on the New York Stock Exchange under the symbol
"NLY." The preferred stock will be new issues of securities with no established
trading market and may or may not be listed on a national securities exchange.
Any underwriters or agents to or through which securities are sold by us may
make a market in the securities, but these underwriters or agents will not be
obligated to do so and any of them may discontinue any market making at any time
without notice. No assurance can be given as to the liquidity of or trading
market for any shares of preferred stock.
EXPERTS
Deloitte & Touche LLP, independent auditors, have audited our financial
statements as of December 31, 1998 and 1997 and for the year ended December 31,
1998 and the period ended December 31, 1997, as set forth in their reports which
are incorporated in this prospectus by reference. Our financial statements are
incorporated by reference in reliance on Deloitte & Touche LLP's reports, given
on their authority as experts in accounting and auditing.
LEGAL MATTERS
The validity of the securities offered hereby is being passed upon for us
by Morgan, Lewis & Bockius LLP. The opinion of counsel described under the
heading "Federal Income Tax Considerations" is being rendered by Morgan, Lewis &
Bockius LLP. This opinion is subject to various assumptions and is based on
current tax law.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the Commission. You may inspect and copy such reports, proxy
statements and other information at the public reference facilities maintained
by the Commission at Room 1204, Judiciary Plaza, 450 Fifth Street, N.W,
Washington, D.C. 20549. Please call the Commission at 1-800-SEC-0330 for
further information. This material can also be obtained from the Commission's
worldwide web site at http://www.sec.gov. Our outstanding common stock is
listed on the NYSE
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under the symbol "NLY," and all such reports, proxy statements and other
information filed by us with the NYSE may be inspected at the NYSE's offices at
20 Broad Street, New York, New York 10005.
We have filed a registration statement, of which this prospectus is a part,
covering the securities offered hereby. As allowed by Commission rules, this
prospectus does not contain all the information set forth in the registration
statement and the exhibits, financial statements and schedules thereto. We refer
you to the registration statement, the exhibits, financial statements and
schedules thereto for further information. This prospectus is qualified in its
entirety by such other information.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The Commission allows us to "incorporate by reference" information into
this prospectus, which means that we can disclose important information to you
by referring you to another document filed separately with the Commission. The
information incorporated by reference is deemed to be part of this prospectus,
except for any information superseded by information in this prospectus. We have
filed the documents listed below with the Commission (File No. 1-13447) under
the Securities Exchange Act of 1934 (the "Exchange Act"), and these documents
are incorporated herein by reference:
. Our Annual Report on Form 10-K for the year ended December 31, 1998.
. Our Quarterly Reports on Form 10-Q for the quarters ended March 31,
1999 and June 30, 1999.
. Our Proxy Statement dated March 25, 1999.
. The description of our common stock included in our registration
statement on Form 8-A, as amended.
Any documents we file pursuant to Sections 13(a), 13(c), 14 or 15(d) of the
Exchange Act after the date of this prospectus and prior to the termination of
the offering of the securities to which this prospectus relates will
automatically be deemed to be incorporated by reference in this prospectus and
to be part hereof from the date of filing those documents. Any documents we file
pursuant to these sections of the Exchange Act after the date of the initial
registration statement that contains this prospectus and prior to the
effectiveness of the registration statement will automatically be deemed to be
incorporated by reference in this prospectus and to be part hereof from the date
of filing those documents.
Any statement contained in this prospectus or in a document incorporated by
reference shall be deemed to be modified or superseded for all purposes to the
extent that a statement contained in this prospectus or in any other document
which is also incorporated by reference modifies or supersedes that statement.
You may obtain copies of all documents which are incorporated in this
prospectus by reference (other than the exhibits to such documents which are not
specifically incorporated by reference herein) without charge upon written or
oral request to Investor Relations, at Annaly Mortgage Management, Inc., 12 East
41st Street, Suite 700, New York, New York, 10017, telephone number (212) 696-
0100.
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5,000,000 Shares
ANNALY MORTGAGE MANAGEMENT, INC.
Common Stock
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PROSPECTUS SUPPLEMENT
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FRIEDMAN BILLINGS RAMSEY
SCHRODER & CO. INC.
TUCKER ANTHONY CLEARY GULL
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