UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended:
September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to __________________
Commission file number: 1-13447
LASER MORTGAGE MANAGEMENT, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 22-3535916
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
51 JOHN F. KENNEDY PARKWAY
SHORT HILLS, NEW JERSEY 07078
(Address of principal executive offices)
(Zip Code)
(973) 912-8770
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
documents and reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days:
Yes X No ___
Indicate the number of shares outstanding of each of the issuer's
classes of stock, as of the last practicable date: 18,466,199 shares of common
stock, $0.001 par value, outstanding as of November 12, 1998.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION...............................................3
Item 1. Financial Statements......................................3
Balance Sheet at September 30, 1998 (Unaudited) and
December 31, 1997................................3
Statement of Operations for the Three Months Ended
September 30, 1998 (Unaudited) and Nine Months
Ended September 30, 1998 (Unaudited)............5
Statement of Stockholders's Equity for the Nine Months
Ended September 30, 1998 (Unaudited)..............7
Statement of Cash Flows for the Nine Months Ended
September 30, 1998 (Unaudited)...................10
Notes to Financial Statements for the Nine Months
Ended September 30, 1998 (Unaudited).............11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............21
PART II. OTHER INFORMATION...................................................36
Item 1. Legal Proceedings..........................................36
Item 2. Changes in Securities and Use of Proceeds..................36
Item 3. Defaults Upon Senior Securities............................36
Item 4. Submission of Matters to a Vote of Security Holders None
Item 5. Other Information..........................................36
Item 6. Exhibits and Reports on Form 8-K...........................36
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
LASER MORTGAGE MANAGEMENT, INC.
BALANCE SHEET AT SEPTEMBER 30, 1998 DECEMBER 31, 1997
(UNAUDITED)
- - -------------------------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 24,674,797 $ 82,626,526
Receivable for securities sold -- 67,208,943
Investment in securities at fair value 2,215,192,770 3,616,733,170
Investment in mortgage loans at amortized cost 9,246,381 --
Accrued interest receivable 16,431,875 21,170,369
Margin deposits 62,396,863 5,500,000
----------------- ---------------
Total assets $ 2,327,942,686 $ 3,793,239,008
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements $ 2,029,801,000 $ 2,747,060,588
Payable for securities purchased 68,465,077 747,594,232
Accrued interest payable 5,566,582 8,348,831
Interest rate swaps at fair value 42,075,000 3,114,900
Dividends payable 7,022,096 2,602,600
Accounts payable 386,334 1,756,187
Payable to Manager 143,556 327,850
----------------- -----------------
Total liabilities 2,153,459,645 3,510,805,188
----------------- -----------------
STOCKHOLDERS' EQUITY:
Common stock: par value $.001 per share;
100,000,000 shares authorized, 20,094,999 and 20,019,999
shares issued, respectively 20,095 20,020
Additional paid-in capital 282,886,975 281,840,175
Accumulated other comprehensive (loss) income (16,830,704) 603,821
Distributions in excess of net loss (75,873,276) (30,196)
Treasury stock at cost (1,615,800 shares) (15,720,049) --
---------------- ---------------
Total stockholders' equity 174,483,041 282,433,820
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,327,942,686 $ 3,793,239,008
================= =================
</TABLE>
See notes to financial statements.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS
FOR THE
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
(UNAUDITED) (UNAUDITED)
- - ---------------------------------------------------------------------------------------------------------------------
INTEREST INCOME:
<S> <C> <C>
Mortgage loans and securities $ 48,934,346 $ 161,334,678
Cash and cash equivalents 1,035,186 3,457,713
-------------- --------------
Total interest income 49,969,532 164,792,391
-------------- --------------
INTEREST EXPENSE:
Repurchase agreements 43,412,378 139,691,623
-------------- --------------
NET INTEREST INCOME 6,557,154 25,100,768
LOSS ON SALE OF SECURITIES (21,990,909) (20,725,108)
IMPAIRMENT LOSS ON INTEREST-ONLY
SECURITIES (22,412,673) (51,030,419)
GENERAL AND ADMINISTRATIVE EXPENSES 1,662,319 5,994,629
--------------- ---------------
NET LOSS $ (39,508,747) $ (52,649,388)
================= ===============
Unrealized loss on securities:
Unrealized holding loss arising during period (27,199,052) (38,159,633)
Add: reclassification adjustment for losses included in
net loss 21,990,909 20,725,108
----------------- ----------------
Other comprehensive loss (5,208,143) (17,434,525)
----------------- ----------------
Comprehensive loss $ 44,716,890) $ (70,083,913)
================= ================
NET LOSS PER SHARE:
Basic $ ( 2.10) $ ( 2.68)
================= ================
Diluted $ ( 2.10) $ ( 2.68)
================= ================
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING:
Basic 18,788,275 19,623,221
================== ================
Diluted 18,788,275 19,623,221
================== ================
</TABLE>
See notes to financial statements.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
- - -----------------------------------------------------------------------------------------------------------------------------------
Accumulated Dividends
Common Additional Comprehensive Other In Treasury
Stock Paid-in Income Comprehensive Excess Stock
Par Capital (Loss) Income of Net Income at Cost Total
Value (Loss) (Loss)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
DECEMBER 31, 1997 $ 20,020 $ 281,840,175 - $ 603,821 $ (30,196) - $282,433,820
Comprehensive income (loss)
Net income - - 8,529,653 - 8,529,653 - 8,529,653
Other comprehensive loss
Unrealized loss on
securities, net of
reclassification adjustment - - (14,190,050) (14,190,050) - - (14,190,050)
------------
Comprehensive loss - - $(5,660,397) - - -
Common stock issued 25 365,600 - - - 365,625
Dividends declared -
$0.43 per share - - - (8,619,350) - (8,619,350)
--------- ------------ ------------ ------------ ---------- ------------
BALANCE, MARCH 31, 1998 $20,045 $282,205,775 $(13,586,229) $ (119,893) $ - $268,519,698
========= ============ ============= ============== ========== ============
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) (CONTINUED)
- - ----------------------------------------------------------------------------------------------------------------------------------
Accumulated Dividends
Common Additional Comprehensive Other In Treasury
Stock Paid-in Income Comprehensive Excess Stock
Par Capital (Loss) Income of Net Income at Cost Total
Value (Loss) (Loss)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
MARCH 31, 1998 $ 20,045 $ 282,205,775 $ - $(13,586,229) $ (119,893) $ - $ 268,519,698
Comprehensive income (loss)
Net loss - - (21,670,294) - (21,670,294) - (21,670,294)
Other comprehensive income (loss)
Unrealized gains on
securities, net of
reclassification adjustment - - 1,963,668 1,963,668 - - 1,963,668
-------------
Comprehensive loss - - $(19,706,626) - - - -
=============
Repurchase of common stock - - - - (6,395,134) (6,395,134)
Common stock issued 25 406,225 - - - 406,250
Dividends declared -
$0.38 per share - - - (7,626,600) - (7,626,600)
------- -------------- ---------------- ----------- -------- -----------
BALANCE,
JUNE 30, 1998 $20,070 $282,612,000 $(11,622,561) $(29,416,787)$(6,395,134) $235,197,588
========= ================ ============== ============= ============ =============
</TABLE>
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
<TABLE>
<CAPTION>
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) (CONCLUDED)
- - -----------------------------------------------------------------------------------------------------------------------------------
Accumulated Dividends
Common Additional Comprehensive Other In Treasury
Stock Paid-in Income Comprehensive Excess Stock
Par Capital (Loss) Income of Net at Cost Total
Value (Loss) Income
(Loss)
BALANCE,
<S> <C> <C> <C> <C> <C> <C>
JUNE 30, 1998 $20,070 $282,612,000 $(11,622,561) $(29,416,787) $ (6,395,134) $235,197,588
Comprehensive loss
Net loss - - (39,508,747) - (39,508,747) - (39,508,747)
Other comprehensive loss
Unrealized losses on
securities, net of
reclassification adjustment - - (5,208,143) (5,208,143) - - (5,208,143)
-------------
Comprehensive loss - - $(44,716,890) - - - -
Repurchase of common stock - - - - (9,324,915) (9,324,915)
Common stock issued 25 274,975 - - - 275,000
Dividends declared
- $0.38 per share - - - (6,947,742) - (6,947,742)
----------- -------------- ----------- ----------- ------------ -----------
BALANCE,
SEPTEMBER 30, 1998 $20,095 $282,886,975 $(16,830,704) $(75,873,276) $(15,720,049) $174,483,041
=========== =============== ============= ============= ============= ============
Unrealized holding losses
arising during period $ (38,159,633)
Add: reclassification
adjustment for losses
included in net loss 20,725,108
-------------
Net unrealized losses on $ (17,434,525)
securities ================
</TABLE>
See notes to financial statements.
<PAGE>
<TABLE>
<CAPTION>
LASER MORTGAGE MANAGEMENT, INC.
STATEMENT OF CASH FLOWS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998 (UNAUDITED)
- - -----------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C>
Net loss $ (52,649,388)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of mortgage premiums and discounts, net 14,318,262
Impairment loss on interest-only securities 51,030,419
Loss on sale of securities 20,725,108
Decrease in accrued interest receivable 4,738,494
Increase in margin deposits (56,896,863)
Decrease in accrued interest payable (2,782,249)
Decrease in accounts payable (1,554,147)
----------------
Net cash used in operating activities (23,070,364)
----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities (2,989,589,332)
Purchase of mortgage loans (11,912,075)
Proceeds from sale of securities 3,477,020,779
Principal payments on securities 240,306,221
----------------
Net cash provided by investing activities 715,825,593
----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements 33,414,807,277
Principal payments on repurchase agreements (34,132,066,865)
Net payments from issuance (repurchase) of common stock (14,673,174)
Dividends paid (18,774,196)
----------------
Net cash used in financing activities (750,706,958)
----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (57,951,729)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 82,626,526
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 24,674,797
================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Interest paid $ 142,473,872
Noncash financing activities:
Net change in unrealized loss on available-for-sale securities $ (17,434,525)
=================
Dividends declared, not yet paid $ 7,022,096
=================
</TABLE>
See notes to financial statements.
<PAGE>
LASER MORTGAGE MANAGEMENT, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
LASER Mortgage Management, Inc. (the "Company") was incorporated in
Maryland on September 3, 1997. The Company commenced its operations on November
26, 1997 (see Note 5).
BASIS OF PRESENTATION - The accompanying unaudited financial
statements have been prepared in conformity with the instructions to Form 10-Q
and Article 10, Rule 10-01 of Regulation S-X for interim financial statements.
The interim financial statements for the three- and nine-month periods are
unaudited; however, in the opinion of the Company's management, all adjustments,
consisting only of normal recurring accruals, necessary for a fair statement of
the results of operations have been included. These unaudited financial
statements should be read in conjunction with the audited financial statements
included in the Company's Annual Report on Form 10-K for the period ended
December 31, 1997. The nature of the Company's business is such that the results
of any interim period are not necessarily indicative of results for a full year.
Prior period financial statements have been reclassified, where appropriate, to
conform to the 1998 presentation.
A summary of the Company's significant accounting policies follows:
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on
hand and overnight repurchase agreements. The carrying amounts of cash
equivalents approximates their value.
INVESTMENTS - The Company invests primarily in mortgage-backed
securities and mortgage loans. The mortgage-backed securities include mortgage
pass-through certificates, collateralized mortgage obligations and other
securities representing interests in, or obligations backed by, pools of
mortgage loans (collectively, "Mortgage Securities"). The Company also invests
in other debt and equity securities ("Other Securities" and, together with
Mortgage Securities, "Securities"). The mortgage loans are secured by first or
second liens on single-family residential, multi-family residential, commercial
or other real property ("Mortgage Loans" and, together with Securities,
"Investments").
Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities (SFAS 115), requires the
Company to classify its securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Securities until maturity, it may,
from time to time, sell any of its Securities as part of its overall management
of its balance sheet. Accordingly, this flexibility requires the Company to
classify all of its Securities as available-for-sale. All Securities classified
as available-for-sale are reported at fair value, with unrealized gains and
losses reported as a separate component of stockholders' equity within
accumulated other comprehensive income (loss).
Unrealized losses on Securities that are considered
other-than-temporary, as measured by the amount of decline in fair value
attributable to factors other than temporary factors, are recognized in income
and the cost basis of the Securities is adjusted. Other-than-temporary
unrealized losses are based on management's assessment of various factors
affecting the expected cash flow from the Securities, including the level of
interest rates, an other-than-temporary deterioration of the credit quality of
the underlying mortgages and/or the credit protection available to the related
mortgage pool and a significant change in the prepayment characteristics of the
underlying collateral.
The Company's Mortgage Loans are held as long-term investments and are
carried at their unpaid principal balance, net of unamortized discount or
premium.
Interest income is accrued based on the outstanding principal or
notional amount of the Investments and their contractual terms. Premiums and
discounts associated with the purchase of the Investments are amortized into
interest income over the lives of the Investments using the effective yield
method.
Investment transactions are recorded on the date the Investments 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
Investment transactions are determined on the specific identification basis.
INTEREST RATE SWAPS - In a simple interest rate swap, one investor
pays a floating rate of interest on a notional principal amount and receives a
fixed rate of interest on the same notional principal amount for a specified
period of time. Alternatively, an investor may pay a fixed rate and receive a
floating rate. Interest rate swaps were conceived as asset/liability management
tools and are used for various hedging activities. In more complex interest rate
swaps, the notional principal amount may decline (or amortize) over time.
During the term of the interest rate swap, changes in value are
recognized on the balance sheet as interest rate swaps at fair value and
included among assets (if there is a net unrealized gain) or among liabilities
(if there is a net unrealized loss). A corresponding amount is included in
accumulated other comprehensive income (loss) as a component of stockholders'
equity. When the interest rate swap is terminated, the Company intends to defer
the gain or loss equal to the difference between the proceeds from (or cost of)
the closing transaction and the Company's basis in the contract, if any.
However, since the appreciation on the hedged mortgage securities was
insufficient to offset the hedging loss, the Company has taken the loss in the
current period rather than amortizing such loss over the life of the contract.
During the term of an interest rate swap, the Company is generally required to
provide collateral to the counterparty in an amount equal to the sum of an
agreed-upon percentage of the notional principal amount and the Company's
unrealized loss in value (if any) of the interest rate swap. The amount of such
collateral appears on the balance sheet as margin deposits.
The Company is exposed to credit loss in the event of nonperformance
by the other party to the interest rate swap. However, the Company does not
anticipate nonperformance by any counterparty.
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 should not be subjected to Federal income tax to the
extent of its distributions to stockholders 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 the Company 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.
COMPREHENSIVE INCOME - The Company has adopted SFAS No. 130, Reporting
Comprehensive Income. This statement 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 (such as unrealized gains or losses on securities) that
historically has not been recognized in the calculation of net income.
2. AVAILABLE-FOR-SALE INVESTMENTS
The following table sets forth the fair value of the Company's
Securities, excluding interest-only securities ("IOs"), as of September 30, 1998
and December 31, 1997:
SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
Non-Agency
Agency Fixed/
Fixed/ Agency Floating
Floating Fixed Emerging Non- Principal Rate
Rate Rate Market Mortgage Mortgage Only Mortgage
Mortgage Pass- Bonds Subordinates Subordinates Securities Securities Total
Securities Throughs
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities, $118,294,078 $1,767,936,92 $27,310,000 $142,165,277 $27,055,388 $57,015,501 $36,678,475 $2,176,455,645
principal amount
Unamortized discount (292,532) (5,783,876) (1,869,028) (28,995,997) (1,151,221) (10,243,302) (540,386) (48,876,342)
Unamortized premium 923,816 10,372,219 430,193 253,230 217,404 - 132,994 12,329,856
---------- ---------- ---------- ------------ ----------- ------------ ----------- -------------
Amortized cost 118,925,362 1,772,525,269 25,871,165 113,422,510 26,121,571 46,772,199 36,271,083 2,139,909,159
Gross unrealized gains 2,399,954 40,856,867 - - - 5,626,158 113,709 48,996,688
Gross unrealized losses - (49,783) (5,660,401) (11,369,832) (2,600,586) - (1,451,391) (21,131,993)
Estimated fair value $121,325,316 $1,813,332,35 $20,210,764 $102,052,678 $23,520,985 $52,398,357 $34,933,401 $2,167,773,854
============ ============= =========== ============= =========== =========== =========== ==============
</TABLE>
DECEMBER 31, 1997
<TABLE>
<CAPTION>
Non-Agency
Fixed/
Agency Floating
Fixed Emerging Non- Principal Rate
Rate Market Mortgage Mortgage Only Mortgage
Pass-Throughs Bonds Subordinates Subordinates Securities Securities Total
<S> <C> <C> <C> <C> <C> <C> <C>
Securities, $ 3,286,896,621 $ 52,221,550 $ 58,399,966 $ 10,000,000 57,788,134 $ 9,754,000 $3,475,060,271
principal amount
Unamortized discount (14,104,395) (3,915,578) (10,416,934) (44,194) (23,718,298) (6,150) (52,205,549)
Unamortized premium 28,075,718 415,210 297,872 - - - 28,788,800
-------------- ------------ -------------- ------------ ------------- ------------ ---------------
Amortized cost 3,300,867,944 48,721,182 48,280,904 9,955,806 34,069,836 9,747,850 3,451,643,522
Gross unrealized gains 12,208,264 54,033 240,088 3,569 2,217,185 56 14,723,195
Gross unrealized losses (182,202) (274,504) (532,520) - (115,961) - (1,105,187)
-------------- ------------ -------------- ------------- ------------- -------------- --------------
Estimated fair value $3,312,894,006 48,500,711 $47,988,472 $9,959,375 $36,171,060 $ 9,747,906 $3,465,261,530
============== ============ =============== ============= ============= ================ ==============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
The fair value of the Company's IOs as of September 30, 1998 and
December 31, 1997 are summarized as follows:
SEPTEMBER 30, 1998
Residential Commercial Floating Total
Rate
<S> <C> <C> <C> <C>
Securities, notional amount $235,258,731 $545,742,208 $259,104,251 $1,040,105,190
Amortized cost, after 4,925,730 34,344,476 10,769,108 50,039,314
provision for impairment
Gross unrealized gains - - - -
Gross unrealized losses - (2,620,398) - (2,620,398)
----------------- --------------- --------------- ---------------
Estimated fair value $4,925,730 $31,724,078 $10,769,108 $ 47,418,916
================= =============== =============== ===============
DECEMBER 31, 1997
Residential Commercial Floating Total
Rate
<S> <C> <C> <C> <C>
Securities, notional amount $201,685,139 $373,650,000 $399,260,556 $ 974,595,695
Amortized cost 57,545,769 22,965,348 80,859,810 161,370,927
Gross unrealized gains - 32,494 5,093 37,587
Gross unrealized losses (3,153,808) (51,639) (6,731,427) (9,936,874)
------------ -------------- --------------- ---------------
Estimated fair value $54,391,961 $22,946,203 $74,133,476 $151,471,640
============== =============== =============== ===============
</TABLE>
The following table sets forth a historical reconciliation of the Company's
activities with respect to IOs:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
March 31, June 30, September 30,
1998 1998 1998
<S> <C> <C> <C>
Securities, beginning notional amount 974,595,695 943,163,085 1,185,413,736
Acquisitions, notional amount 126,210,955 334,600,020 -
Disposals, notional amount (129,442,016) (62,336,949) (111,874,185)
Paydowns, notional amount (28,201,549) (30,012,420) (33,434,361)
-------------- --------------- ---------------
Securities, ending notional amount 943,163,085 1,185,413,736 1,040,105,190
============= =============== ===============
Amortized cost, beginning 161,370,927 128,526,212 90,853,884
Acquisitions, at cost 9,311,100 15,048,458 -
Dispositions, at cost (37,282,413) (18,142,073) (16,181,945)
Amortization of premium (4,873,402) (5,960,967) (2,219,952)
Permanent impairment - (28,617,746) (22,412,673)
Amortized cost, ending 128,526,212 90,853,884 50,039,314
============= =============== ================
</TABLE>
FASB Statement No. 107, Disclosures About Fair Value of Financial
Instruments, defines the fair value of a financial instrument as the amount at
which the instrument could be exchanged in a current transaction between willing
parties, other than in a forced or liquidation sale.
The fair values of the Company's Investments are based on prices
provided by dealers who make markets in these financial instruments. The fair
values reported reflect estimates and may not necessarily be indicative of the
amounts the Company could realize in a current market exchange. Cash and cash
equivalents, interest receivable, repurchase agreements and other liabilities
are reflected in the financial statements at their fair value because of the
short-term nature of these instruments.
During the nine months ended September 30, 1998, the Company wrote
down (took a permanent impairment charge of $51,030,419) its floating-rate and
residential IOs which had an amortized cost greater than their market value. All
of the Company's floating-rate and residential IOs were written down to their
estimated fair market value, and such writedown is reflected in the Company's
statement of operations.
Most of the IOs were LIBOR floating rate IOs and were purchased in the
fourth quarter of 1997. They were acquired to balance duration in the Company's
portfolio. This investment was made based on the Company's evaluation of the
then-current prepayments and shape of the yield curve, and the relative values
of similar investments.
In evaluating the impairment charge on the IOs, the Company employs
current estimates of future prepayments that are obtained from independent
sources. For IOs collateralized by fixed-rate pass-through mortgage securities
issued by FNMA, GNMA and FHLMC (collectively, "Agency Fixed Rate
Pass-Throughs"), the Company utilized the median lifetime projection prepayment
speeds compiled and reported by Bloomberg L.P. from a survey of leading dealers
in the mortgage market. For "private label" IOs (collateralized by
non-government agency mortgage securities), the Company employs prepayment
estimates from at least one independent dealer. The prepayment estimates
typically take into consideration the current level and shape of the yield
curve.
As a result of the substantial decline in interest rates since the
purchase of the IOs, current estimates of prepayment speeds significantly exceed
the original prepayment speed estimates.
At the end of the first quarter of 1998, the majority of the Company's
IOs were floating rate IOs. Floating rate IOs are unique securities in that the
interest payments on these securities increase as one-month LIBOR increases. Due
to this characteristic of option value, floating rate IOs trade at much lower
yields than fixed rate IOs. At the end of the second and third quarters of 1998,
in light of the continued flat yield curve, low levels of LIBOR and faster than
expected prepayment rates actually occurring for an extended period of time, the
Company decided that the impairment in market value was other than temporary.
3. MORTGAGE LOANS
The following table pertains to the Company's Mortgage Loans as of
September 30, 1998 which are carried at their amortized cost:
Total
Mortgage Loans, principal amount $ 8,899,132
Unamortized discount -
Unamortized premium 347,249
---------------
Amortized cost $ 9,246,381
================
As of September 30, 1998, the amortized cost of the Mortgage Loans approximated
their fair value.
4. REPURCHASE AGREEMENTS
The Company has entered into repurchase agreements to finance most of
its Investments. The repurchase agreements are collateralized by the market
value of the Company's Investments and bear interest rates that generally move
in close relation to one-month LIBOR.
As of September 30, 1998, the Company had outstanding $2,029,801,000
of repurchase agreements with a weighted average borrowing rate of 5.79% and a
weighted average remaining maturity of 411 days. At September 30, 1998,
Investments actually pledged had an estimated fair value of $2,129,104,195.
At September 30, 1998, the repurchase agreements had the following
remaining maturities:
Within 30 days $ 1,508,002,656
30 to 90 days 21,798,344
Greater than 90 days 500,000,000
--------------------
$ 2,029,801,000
=====================
At September 30, 1998, $500,000,000 of the Company's Securities were
subject to a repurchase agreement with a broker-dealer with a term of five years
ending March 10, 2003. The borrowing rate of this repurchase agreement is
three-month LIBOR plus 61.5 basis points and is capped at 6.365%.
5. COMMON STOCK
SALES OF COMMON STOCK - The Company's common stock was sold through
several transactions as follows:
The Company was initially capitalized with the sale of 6,000 shares of
common stock on September 2, 1997, for a total of $15,005.
The Company received commitments on September 15, 1997 for the
purchase, in a private placement, of 1,014,000 shares of common stock, at $15.00
per share, for a total of $15,210,000 from certain officers, directors, proposed
directors, employees and affiliates of the Company and LASER Advisers Inc. (the
"Manager"). The sale of these shares was consummated at the time of the closing
of the public offering.
The Company received commitments on November 7, 1997 from several
mutual funds under common management (the "Funds") for the purchase, in a
private placement, of 3,333,333 shares of common stock, at $15.00 per share, for
a total of $49,999,995. The sale of these shares was consummated at the time of
the closing of the public offering.
The Company has been informed by the Manager that a fund affiliated
with the Manager entered into a total rate of return swap with a broker-dealer
which provides that the affiliated fund bear the economic benefit and risk of
directly holding 666,666 shares of the Company's common stock for a total of
$9,999,990. Such shares of common stock were sold by the Company to such
broker-dealer in a private placement without registration under Section 4(2) of
the Securities Act of 1933.
15,000,000 shares of common stock were sold through a public offering
for $225,000,000. Syndication costs of $18,364,795 were deducted from the gross
proceeds of the offerings.
On each of January 2, 1998, April 1, 1998 and July 1, 1998, 25,000
shares (75,000 shares in the aggregate) of common stock were issued as deferred
stock awards to certain employees of the Company.
DIVIDENDS - During the three months ended September 30, 1998, the
Company declared distributions to stockholders totaling $0.38 per share, which
were paid on October 30, 1998. During the three months ended June 30, 1998, the
Company declared distributions to stockholders totaling $0.38 per share, which
were paid on July 31, 1998. During the three months ended March 31, 1998, the
Company declared dividends to stockholders totaling $0.43 per share, which were
paid on April 30, 1998.
STOCK REPURCHASES - In March 1998, the Board of Directors of the
Company approved the repurchase of up to $20 million of the Company's common
stock. In June 1998, the Board of Directors increased the amount of common stock
authorized to be repurchased to $30 million. Pursuant to this repurchase
program, the Company repurchased 979,100 shares of its common stock for $9.3
million in open market transactions at their prevailing market prices during the
three months ended September 30, 1998. Such purchases were made at a weighted
average price per share of $9.484 (excluding commissions). The total number of
shares repurchased by the Company as of September 30, 1998 was 1,615,800. The
repurchased shares have been returned to the Company's authorized but unissued
shares of common stock as treasury shares.
6. TRANSACTIONS WITH AFFILIATES
The Company has a management agreement (the "Management Agreement")
with the Manager pursuant to which the Manager, subject to the supervision of
the Company's Board of Directors, formulates operating strategies for the
Company, oversees the acquisition of Investments by the Company, arranges for
various types of financing for the Company, monitors the performance of the
Company's Investments and provides certain administrative and managerial
services in connection with the Company's operations. For its performance of
these services, the Manager receives a quarterly base management fee of
$225,000, payable monthly. As of October 1, 1998, the Board of Directors
decreased the base management fee from 1% of Average Stockholders' Equity.
The Manager also receives a quarterly incentive fee in an amount equal
to 20% of the Net Income of the Company for the preceding fiscal quarter in
excess of the amount that would produce an annualized Return on Average
Stockholders' Equity for such fiscal quarter equal to the Ten-Year U.S. Treasury
Rate plus 1%. For such calculations, the "Net Income" of the Company means the
taxable income of the Company, within the meaning of the Code, less capital
gains and capital appreciation included in taxable income, but before the
Manager's incentive fee and before deduction of dividends paid.
For purposes of both the management and incentive fee calculations,
Average Stockholders' Equity means, for any period, stockholders' equity,
calculated in accordance with GAAP, excluding any mark-to-market adjustments of
the investment portfolio. The Company and the Manager have agreed that the
provision for impairment charge on the IOs in the Company's portfolio is not a
mark-to-market adjustment for purposes of these calculations. For the three
months ended September 30, 1998 management fees amounted to $590,984 and
incentive fees were $(34,757) and are included in General and Administrative
Expenses. The Manager will be reimbursed for certain out-of-pocket expenses
incurred on behalf of the Company.
7. 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 the
Basic EPS to the numerator and denominator of Basic EPS and Diluted EPS
computation. There are no differences between Basic EPS and Diluted EPS.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
Loss Shares Per-Share Loss Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
<S> <C> <C> <C> <C> <C> <C>
Basic EPS $ (39,508,747) 18,788,275 $ (2.10) $ (52,649,388) 19,623,221 $ (2.68)
============== ============= ========= ============= ============ =======
Diluted EPS $ (39,508,747) 18,788,275 $ (2.10) $(52,649,388) 19,623,221 $ (2.68)
=============== ============= ======== ============== ============== ========
</TABLE>
The Company has deferred common stock totaling 65,000 shares reserved
for issuance. The receipt of the stock is contingent upon the holder's continued
employment or service. The deferred common stock has been awarded and does not
have an exercise or strike price. Such shares were not included in Diluted EPS
as the Company has a loss from operations and including such amounts would be
anti-dilutive.
For the three months ended September 30, 1998, options to purchase
298,000 shares were outstanding during the period and were anti-dilutive because
the strike price ($15.00) was greater than the average daily market price of the
Company's common stock for the quarter ($8.594). Therefore, these options were
excluded from Diluted EPS.
For the nine months ended September 30, 1998, options to purchase
298,000 shares were outstanding during the period and were anti-dilutive because
the strike price ($15.00) was greater than the average daily market price of the
Company's common stock for the period ($12.959). Therefore, these options were
excluded from Diluted EPS.
8. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a Long-Term Stock Incentive Plan for
directors, executive officers, and key employees (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the Board of Directors
to grant awards, including deferred stock, 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 778,000 shares and 400,000 deferred shares of the Company's common
stock.
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" for the options. 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 loss per share would have been
increased to the pro forma amounts indicated below:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
Net loss - as reported $(39,508,747) $(52,649,388)
Net loss - pro forma $(39,514,521) $(52,666,709)
Loss per share - as reported $(2.10) $(2.68)
Loss per share - pro forma $(2.10) $(2.68)
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 three months and nine months ended September
30, 1998: dividend yield of 11.47%; expected volatility of 18%; risk-free
interest rate of 5.82%; and expected lives of ten years.
The following table summarizes information about stock options
outstanding:
Weighted
Average Weighted
Range of Remaining Average
Exercise Options Contractual Exercise
Prices Outstanding Life Price
(Yrs.)
$ 15.00 298,000 9.2 $ 15.00
====== ============= =========== ==========
The options become exercisable at the rate of 25% on each of January
2, 1998, January 2, 1999, January 2, 2000 and January 2, 2001, subject to the
holder's continued employment or service. During the third quarter of 1998,
480,000 stock options have terminated.
The compensation expense for the 140,000 shares of deferred stock will
be amortized over a four-year period.
9. INTEREST RATE SWAPS
As of September 30, 1998, the Company is a party to interest rate
swaps with original notional amounts as stated below. Under these agreements,
the Company receives a floating rate and pays a fixed rate. These swaps are
cancelable at the option of the Company on the fifth anniversary of their
respective effective dates.
<PAGE>
Non-Amortizing
Notional
Amount Fixed Floating Termination Unrealized
(in Rate Rate Date Loss in
thousands) Value
$550,000 7.4100% 1-month LIBOR 1/10/13 $(42,075,000)
============
During the three-months ended September 30, 1998, the Company
terminated interest rate swaps with notional amounts totaling $485,000,000 and
incurred a realized loss of $25,782,250, which is included in loss on sale of
securities in the statement of operations.
10. TAXABLE INCOME AND CAPITAL LOSSES IN EXCESS OF CAPITAL GAINS
For the quarter ended September 30, 1998, income as calculated for tax
purposes ("taxable income") is estimated at approximately $5.3 million, or $0.28
per weighted average share, and capital losses in excess of capital gains are
estimated at approximately $22.7 million, or $1.21 per weighted average share.
For the nine-month period ended September 30, 1998, taxable income is estimated
at approximately $18.0 million, or $0.92 per weighted average share, and capital
losses in excess of capital gains are estimated at approximately $21.1 million
or $1.08 per weighted average share. Capital losses in excess of capital gains
are eligible to be carried forward to future tax years to offset capital gains.
Taxable income was different from income (loss) as calculated according to
generally accepted accounting principles ("GAAP income (loss)") as a result of,
among other things, differing treatment of losses on securities transactions and
interest rate swaps, permanent impairment writedowns on IOs and a differing
treatment of premium and discount amortization.
11. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133")
was issued and is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. SFAS No. 133 generally requires that entities recognize all
derivative financial instruments as assets or liabilities, measured at fair
value, and include in earnings the changes in the fair value of such assets and
liabilities. SFAS No. 133 also provides that changes in the fair value of assets
or liabilities being hedged with recognized derivative instruments be recognized
and included in earnings. The Company has not yet completed its evaluation of
SFAS No. 133, and therefore, at this time, cannot predict what, if any, effect
its adoption will have on the Company's financial condition or results of
operations.
12. SUBSEQUENT EVENTS
On October 2, 1998, the Company's Board of Directors authorized its
financial advisor, Lehman Brothers Inc., to promptly solicit offers to acquire
the Company or all, or substantially all, of its assets. To date, Lehman
Brothers Inc., after soliciting offers to acquire the Company, has not received
any firm bids. Lehman Brothers Inc. is continuing to solicit bids on behalf of
the Company.
Also on October 2, 1998, the Company's Board of Directors engaged
BlackRock Financial Management, Inc. ("BlackRock") as its consultant to review
the Company's portfolio and to make recommendations designed to reduce the
portfolio's susceptibility to basis and interest rate risk and to create
additional liquidity.
BlackRock has recommended that the Manager delever the Company's
portfolio by selling certain Securities. From September 30, 1998 through October
31, 1998, the Company sold approximately $1.1 billion of Securities (agency
fixed/floating rate mortgage securities, agency fixed rate pass-through
certificates, emerging market securities, interest-only securities,
principal-only securities and interest rate swaps).
The Manager has determined the Company's net asset value as of October
31, 1998 to be between $7.50 and $8.00 per share. The net asset value as of such
date reflects sales of Securities completed through October 31, 1998.
*****
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion should be read in conjunction with the
Company's financial statements and notes thereto.
FORWARD-LOOKING STATEMENTS
"Safe Harbor" statement under the Private Securities Litigation Reform
Act of 1995: Statements in this discussion regarding the Company and its
business, which are not historical facts, are "forward-looking statements" that
involve risks and uncertainties. Risks and uncertainties, which could cause
results to differ from those discussed in the forward-looking statements herein,
are listed in the Company's Annual Report filed on Form 10-K.
GENERAL
The Company was organized in September 1997 and commenced operations
on November 26, 1997. The Company's day-to-day operations are managed by the
Manager, subject to the supervision of the Board of Directors. The Manager and
its investment professionals have no prior experience in managing a REIT, and
specialize in managing investments in Mortgage Securities for institutions and
other sophisticated investors.
The Company seeks to generate net income for distribution to
stockholders from the spread between the interest income earned on its
investment portfolio and the costs of borrowing to finance the portfolio. The
Company's results of operations are affected by various factors, many of which
are beyond the control of the Company, including the availability of
opportunities for the acquisition of Investments, the level and volatility of
interest rates, conditions in the financial markets and other economic
conditions.
The Company has elected to qualify as a REIT under the Code and, as
such, is required to distribute at least 95% of its taxable income annually,
subject to certain adjustments. Cash for such distributions is expected to be
generated from the Company's operations, although the Company also may borrow
funds to make distributions.
The Company may experience high volatility in net interest income from
quarter to quarter and year to year, primarily as a result of fluctuations in
interest rates, borrowing costs, reinvestment opportunities and prepayment
rates. Because changes in interest rates may significantly affect the Company's
activities, the operating results of the Company will depend, in large part,
upon the ability of the Company to manage its interest rate, prepayment and
credit risks, while effectively maintaining its status as a REIT.
RECENT DEVELOPMENTS
On October 2, 1998, the Company's Board of Directors authorized its
financial advisor, Lehman Brothers Inc., to promptly solicit offers to acquire
the Company or all, or substantially all, of its assets. To date, Lehman
Brothers Inc., after soliciting offers to acquire the Company, has not received
any firm bids. Lehman Brothers Inc. is continuing to solicit bids on behalf of
the Company.
Also on October 2, 1998, the Company's Board of Directors engaged
BlackRock Financial Management, Inc. ("BlackRock") as its consultant to review
the Company's portfolio and to make recommendations designed to reduce the
portfolio's susceptibility to basis and interest rate risk and to create
additional liquidity.
BlackRock has recommended that the Manager delever the Company's
portfolio by selling certain Securities. From September 30, 1998 through October
31, 1998, the Company sold approximately $1.1 billion of Securities (agency
fixed/floating rate mortgage securities, agency fixed rate pass-through
certificates, emerging market securities, interest-only securities,
principal-only securities and interest rate swaps).
The Manager has determined the Company's net asset value as of October
31, 1998 to be between $7.50 and $8.00 per share. The net asset value as of such
date reflects sales of Securities completed through October 31, 1998.
Pursuant to the Company's stock repurchase program, to date the
Company has repurchased 1,633,800 shares of its common stock for $15.7 million
in open market transactions at their prevailing market prices. Such purchases
were made at a weighted average price per share of $9.63 (excluding commission
costs). The repurchased shares have been returned to the Company's authorized
but unissued shares of common stock as treasury shares.
RESULTS OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 1998 AND FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 1998
NET LOSS SUMMARY
For the quarter ended September 30, 1998, the Company suffered a net
loss before giving effect to charges relating to the permanent impairment of
certain Interest-Only Securities ("IOs") of $(17.1 million), or $(0.91) per
weighted average share. After giving effect to the impairment charges of $(22.4
million), or $(1.19) per weighted average share, the Company had a net loss of
$(39.5 million), or $(2.10) per weighted average share, for the quarter ended
September 30, 1998. Net loss per share is computed by dividing net loss by the
weighted average number of shares of common stock outstanding, which was
18,788,275 for the quarter. Distributions were $0.37 per weighted average share,
$7.0 million in total. Return on average equity was (18.06)% on an unannualized
basis (after giving effect to the impairment charges), for the quarter ended
September 30, 1998.
For the nine months ended September 30, 1998, the Company had a net
loss before giving effect to charges relating to the impairment of certain IOs
of $(1.6 million), or $(0.08) per weighted average share. After giving effect to
the impairment charges of $(51.0 million), or $(2.60) per weighted average
share, for the nine-month period ended September 30, 1998, the Company had a net
loss of $(52.6 million), or $(2.68) per weighted average share. The weighted
average number of shares of common stock outstanding for the nine-month period
was 19,623,221. Distributions were $1.18 per weighted average share, $23.2
million in total. Return on average equity was (20.60)% on an unannualized basis
(after giving effect to the impairment charges), for the nine-month period ended
September 30, 1998.
During the third quarter of 1998, the Company's net income declined as
a result of losses incurred in sales of securities and a reduction in the income
from its Mortgage Securities due to a reduced investment portfolio and
increasing prepayments. In the third quarter of 1998, the Company realized a
loss of $(22.0 million) or $(1.17) per weighted average share on sales of
securities and terminations of interest rate swaps. These sales were made in
response to a difficult credit environment, as the Company raised cash in order
to meet increased margin requirements.
Most of the IOs were LIBOR floating rate IOs and were purchased in the
fourth quarter of 1997. They were acquired to balance duration in the Company's
portfolio. This investment was made based on the Company's evaluation of the
then-current prepayments and shape of the yield curve, and the relative values
of similar investments.
In evaluating the impairment charge on the IOs, the Company employs
current estimates of future prepayments that are obtained from independent
sources. For IOs collateralized by fixed-rate pass-through mortgage securities
issued by FNMA, GNMA and FHLMC (collectively, "Agency Fixed Rate
Pass-Throughs"), the Company utilized the median lifetime projection prepayment
speeds compiled and reported by Bloomberg L.P. from a survey of leading dealers
in the mortgage market. For "private label" IOs (collateralized by
non-government agency mortgage securities), the Company employs prepayment
estimates from at least one independent dealer. The prepayment estimates
typically take into consideration the current level and shape of the yield
curve.
As a result of the substantial decline in interest rates since the
purchase of the IOs, current estimates of prepayment speeds significantly exceed
the original prepayment speed estimates.
At the end of the first quarter of 1998, the majority of the Company's
IOs were floating rate IOs. Floating rate IOs are unique securities in that the
interest payments on these securities increase as one-month LIBOR increases. Due
to this characteristic of option value, floating rate IOs trade at much lower
yields than fixed rate IOs. At the end of the second and third quarters of 1998,
in light of the continued flat yield curve, low levels of LIBOR and faster than
expected prepayment rates actually occurring for an extended period of time, the
Company decided that the impairment in market value was other than temporary.
TAXABLE INCOME AND GAAP INCOME (LOSS)
For the quarter ended September 30, 1998, income as calculated for tax
purposes ("taxable income") is estimated at approximately $5.3 million, or $0.28
per weighted average share, and capital losses in excess of capital gains are
estimated at approximately $22.7 million, or $1.21 per weighted average share.
For the nine-month period ended September 30, 1998, taxable income is estimated
at approximately $18.0 million, or $0.92 per weighted average share, and capital
losses in excess of capital gains are estimated at approximately $21.1 million
or $1.08 per weighted average share. Capital losses in excess of capital gains
are eligible to be carried forward to future tax years to offset capital gains.
Taxable income was different from income (loss) as calculated according to
generally accepted accounting principles ("GAAP income (loss)") as a result of,
among other things, differing treatment of losses on securities transactions and
interest rate swaps, permanent impairment writedowns on IOs and a differing
treatment of premium and discount amortization.
Taxable income and GAAP income (loss) could also differ for other
reasons. For example, the Company may take credit provisions which would affect
GAAP income whereas only actual credit losses are deducted in calculating
taxable income. In addition, G & A Expenses may differ due to differing
treatment of leasehold amortization, certain stock option expenses and other
items. As of September 30, 1998, the Company had not taken credit provisions
because 91% of Investments held by the Company at September 30, 1998 are
Mortgage Securities issued by government agencies.
The distinction between taxable income and GAAP income (loss) is
important to the Company's stockholders because dividends or distributions are
declared on the basis of taxable income. While the Company does not pay taxes so
long as it satisfies the requirements for exemption from taxation pursuant to
Sections 856 through 860 of the Code, each year the Company completes a
corporate tax form wherein taxable income is calculated as if the Company were
to be taxed. This taxable income level helps to determine the amount of
dividends the Company intends to pay out over time.
INTEREST INCOME AND AVERAGE EARNING ASSET YIELD
The Company had average earning assets of $3,156 million and $3,478
million for the quarter and nine-month period ended September 30, 1998,
respectively. The table below shows, for the quarter and nine-month period ended
September 30, 1998, the Company's average balance of cash equivalents, loans and
securities, the yields earned on each type of earning assets, the yield on
average earning assets and interest income.
AVERAGE EARNING ASSET YIELD
(dollars in thousands)
<TABLE>
<CAPTION>
Yield Yield on Yield on
Average on Average Average
Average Amortized Average Average Amortized Interest
Cash Cost of Earning Cash Cost of Earning Interest
Equivalents Securities Assets Equivalents Securities Assets Income
<S> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $ 25,969 $3,129,845 $3,155,814 5.61% 6.60% 6.59% $ 49,970
For the Nine Months Ended
September 30, 1998 52,599 3,478,359 $3,425,760 5.78% 6.68% 6.67% $164,792
</TABLE>
INTEREST EXPENSE AND THE COST OF FUNDS
The Company had average borrowed funds of $2,969 million and total
interest expense of $43 million for the quarter ended September 30, 1998. The
average cost of funds was 5.72% for the same period. For the nine-month period
ended September 30, 1998, the Company had average borrowed funds of $3,240
million and total interest expense of $140 million with an average cost of funds
of 5.69%. The Company believes that its largest expense will usually be the cost
of borrowed funds. Interest expense is calculated in the same manner for tax and
GAAP purposes. With the Company's current asset/liability management strategy,
changes in the Company's cost of funds are expected to be closely correlated
with changes in one-month LIBOR, although the Company may choose to extend the
maturity of its liabilities at any time, subject to the lender's consent. The
Company's average cost of funds was 0.05% above one-month LIBOR for the nine
months ended September 30, 1998 and 0.10% above one-month LIBOR for the three
months ended September 30, 1998. The Company generally has structured its
borrowings to adjust with one-month LIBOR. During the quarter ended September
30, 1998, average one-month LIBOR, which was 5.62%, was 0.01% lower than average
six-month LIBOR, which was 5.63%.
The table below shows, for the quarter and nine-month period ended
September 30, 1998, the Company's average borrowed funds and average cost of
funds as compared to average one and six-month LIBOR.
<TABLE>
<CAPTION>
AVERAGE COST OF FUNDS
(dollars in thousands)
Average Average
Average Cost Cost
One-Month of of
LIBOR Funds Funds
Relative Relative Relative
to to to
Average Average Average Average Average Average Average
Borrowed Interest Cost of One-Month Six-Month Six-Month One-Month Six-Month
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $ 2,969,455 $ 43,412 5.72% 5.62% 5.63% -0.01% 0.10% 0.09%
For the Nine-Months Ended
September 30, 1998 3,240,113 $139,692 5.69% 5.64% 5.68% -0.04% 0.05% 0.01%
</TABLE>
The Company believes that the continuation of current trends in the
financial markets (including the continued flat yield curve, the dislocation in
the market for fixed-income securities, the tightening of credit available for
investment in securities and the increased risk of interest rate sensitive
prepayment on mortgages) will have an adverse effect upon the Company's
earnings. The continued flat yield curve maintains financing costs at a
relatively high level compared to the income of securities. The dislocation in
the fixed-income securities market and the increased risk of prepayments, which
primarily affect the value of the Company's portfolio, together with the
tightening of credit available for investment in securities, adversely affects
the Company's ability to employ leverage profitably.
INTEREST RATE SWAPS
During the quarter and nine-month period ended September 30, 1998, the
Company had outstanding interest rate swaps with the original notional amounts
stated below. Under these swap agreements, the Company receives a floating rate
from its swap counterparty and pays a fixed rate to its swap counterparty. As
part of its asset/liability management process, the Company may enter into
interest rate agreements such as interest rate caps, floors and swaps. These
agreements are entered into to reduce interest rate risk and would be designed
to provide income and capital appreciation to the Company in the event of
certain changes in interest rates.
<TABLE>
<CAPTION>
INTEREST RATE SWAP TERMS
(dollars in thousands)
Average
Notional Fixed Floating Net
Amount Rate Rate Income
<S> <C> <C> <C> <C>
For the Quarter Ended
September 30, 1998 $ 550,000 7.41% 5.65% $ (3,857)
For the Nine Months Ended $
September 30, 1998 $ 550,000 7.41% 5.65% $ (12,312)
</TABLE>
During the three-months ended September 30, 1998, the Company
terminated interest rate swaps with notional amounts totaling $485 million and
incurred a realized loss of $25.8 million which is included in loss on sale of
securities in the statement of operations. Since the appreciation on the hedged
mortgage securities was insufficient to offset the hedging loss and the overall
position in mortgage securities was reduced, the Company has taken the loss in
the current period rather than amortizing such loss over the life of the
contract. Interest rate swaps are carried on the balance sheet at fair value. At
September 30, 1998, there were $42.1 million in unrealized losses on interest
rate swaps.
At October 31, 1998, the Company did not have any interest rate swaps
outstanding. In October 1998, the Company realized a $34.8 million loss on the
termination of its interest rate swaps which will be recognized in the fourth
quarter of 1998.
The Company entered into approximately $1,035.0 million of interest
rate swaps for hedging purposes. The interest rate swaps were used to hedge two
interest rate risks for the Company. As interest rates increase, the value of
the interest rate swaps should increase to hedge the decline in asset values.
The swaps also serve to fix interest expense by increasing cash flow as LIBOR
increases which offsets the Company's increased interest expense. By using
interest rate swaps to fix liability expense, the Company attempted to preserve
both value and income as interest rates fluctuate. The interest rate swaps also
serve an additional hedging purpose. Since swap spreads and mortgage spreads
tend to be highly correlated, a decrease in the value of the Company's mortgage
securities due to a widening in mortgage spreads should be offset by the
increased value of the interest rate swaps if the change in mortgage spreads is
due to a change in swap spreads.
NET INTEREST INCOME
Net interest income, which equals interest income less interest
expense, totaled $6.6 million and $25.1 million for the quarter and nine-month
period ended September 30, 1998, respectively. Net interest rate spread, which
equals the yield on the Company's interest earning assets (excluding cash) less
the average cost of funds for the period was 0.88% and 0.99% for the quarter and
the nine-month period ended September 30, 1998, respectively.
The table below shows interest income by earning asset type, average
earning assets by type, total interest income, interest expense, average
repurchase agreements, average cost of
funds, and net interest income for the quarter and nine-month period ended
September 30, 1998.
<TABLE>
<CAPTION>
NET INTEREST INCOME
(dollars in thousands)
Yield
Average Interest Net on Average
Amortized Interest Income Income Average Balance Average
Cost Income Average on on Total Interest of Cost Net
of on Cash Cash Contractual Interest Earnings Repurchase Interest of Interest
Investment Investments Equivalents Equivalent Commitments Income Assets Agreements Expense Funds Income
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
For the $3,129,845 $ 52,792 $25,969 $1,034 $ (3,857) $ 49,969 6.59% $ 2,969,455 $43,412 5.72% $ 6,557
Quarter Ended
September
30, 1998
For the Nine
Months Ended $3,425,760 $ 173,647 $52,599 $3,458 $(12,312) $164,793 6.67% $ 3,240,113 $ 139,692 5.69% $25,101
September
30, 1998
</TABLE>
LOSSES ON SALES OF SECURITIES
For the quarter ended September 30, 1998, the Company sold Securities
with an aggregate historical amortized cost of $1.2 billion for an aggregate
loss of $22.0 million. For the nine-month period ended September 30, 1998, the
Company sold Securities with an aggregate historical amortized cost of $3.4
billion for a net loss of $20.7 million. The difference between the sale price
and the historical amortized cost of the Securities is a realized loss and
reduced net income accordingly.
CREDIT CONSIDERATIONS
The Company has not experienced credit losses on its investment
portfolio to date, but losses may be experienced in the future. At September 30,
1998, the Company had limited its exposure to credit losses on its portfolio by
holding 91% of its Investments in Mortgage Securities issued by FNMA, GNMA and
FHLMC (including IOs, fixed/floating rate mortgage securities, fixed rate
pass-through mortgage securities and principal-only mortgage securities).
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses ("operating expense" or "G&A
expense") were $1.7 million and $6.0 million for the quarter and the nine-month
period ended September 30, 1998, respectively, consisting of management fees
paid to the Manager of $590,984 and $2.0 million, incentive fees payable to the
Manager of $(34,757) and $1.4 million and professional and other miscellaneous
fees. There were no differences in the calculation of G&A expense for taxable
and GAAP income purposes. The "Efficiency Ratio" is the G&A expense divided by
the net interest income.
<TABLE>
<CAPTION>
G&A EXPENSE RATIOS
(dollars in thousands)
Total Total
G&A G&A
Expense/ Expense/
Deferred Other Total Average Average Efficiency
Management Incentive Stock G&A G&A Assets Equity Ratio
Fee Fee Expense Expense Expense (Annualized) (Annualized) (Annualized)
For the Quarter
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ended $ 591 $ (35) $ 275 $ 831 $ 1,662 0.20% 3.01% 25.35%
September 30, 1998
For the Nine
Months Ended
September 30, 1998 $ 1,991 $1,414 $ 1,047 $ 1,542 $ 5,994 0.21% 3.14% 23.88%
</TABLE>
NET LOSS AND RETURN ON AVERAGE EQUITY
Net losses were $(39.5) million and $(52.6) million for the quarter
and nine-month period ended September 30, 1998, respectively. Return on average
equity for the quarter and nine- month period ended September 30, 1998, was
(18.06)% and (20.60)% on an unannualized basis, respectively. The table below
shows, on an unannualized basis, for the quarter and nine-month period ended
September 30, 1998, the Company's net interest income, gain on sale of
securities and G&A expense each as a percentage of average equity, and the
return on average equity.
<TABLE>
<CAPTION>
COMPONENTS OF RETURN ON AVERAGE EQUITY
Net Loss Impairment
Interest on Sale Loss on Return
Income/ of Interest-Only G&A on
Average Securities Securities Expense/ Average
Equity Average Equity Equity
Equity
<S> <C> <C> <C> <C> <C>
For the Quarter Ended September 30, 1998 3.00% (10.05)% (10.25)% 0.76% (18.06%)
For the Nine Months Ended September 30, 1998 9.82% (8.11)% (19.97)% 2.34% (20.60%)
</TABLE>
DISTRIBUTIONS AND TAXABLE INCOME
The Company has elected to be taxed as a REIT under the Code.
Accordingly, the Company intends to distribute substantially all of its taxable
income for each year to stockholders, including income resulting from gains on
sales of securities. For the nine months ended September 30, 1998, distribution
declarations exceeded estimated taxable income by approximately $5.1 million or
$0.26 per share, based on the weighted average number of shares of common stock
outstanding during the period.
DISTRIBUTION SUMMARY
(dollars in thousands)
<TABLE>
<CAPTION>
Distributions
Estimated Distribution in
Extimate Weightec Taxable Per Excess of
Table Average Net Weighted Distribution Estimated
Net Common Income Average Total Pay-Out Taxable
Income Shares Per Share Distribution Ratio Income
Share
<S> <C> <C> <C> <C> <C> <C> <C>
For the Nine Months Ended $18,046 19,623,221 $ 0.92 $ 1.18 $ 23,194 128.5% $ (5,148)
September 30, 1998
</TABLE>
FINANCIAL CONDITION
Investments
At September 30, 1998, the Company's Investments consisted of: $121.3
million fixed/floating rate mortgage securities issued by government agencies
("Agency Fixed/Floating Rate Mortgage Securities"); $1,813.3 million fixed rate
pass-through mortgage securities issued by government agencies ("Agency Fixed
Rate Pass-Throughs"); $20.2 million emerging market sovereign debt securities
("Emerging Market Bonds"); $102.1 million subordinate mortgage securities
("Mortgage Subordinates"); $23.5 million other rated and unrated debt
securities, including collateralized bond obligations, bank loans and
collateralized loan obligations ("Non-Mortgage Subordinates"); $52.4 million
principal-only mortgage securities ("Principal-Only Securities"); $34.9 million
fixed/floating rate mortgage securities issued by non-governmental entities
("Non-Agency Fixed/Floating Rate Mortgage Securities"); $47.4 million IOs; and
$9.2 million Mortgage Loans.
At December 31, 1997, the Company's Investments consisted of: $3,312.9
million Fixed Rate Agency Pass-Throughs; $48.5 million Emerging Market Bonds;
$48.0 million Mortgage Subordinates; $10.0 million Non-Mortgage Subordinates;
$36.2 million Principal-Only Securities; $151.5 million IOs; and $9.7 million
Non-Agency Fixed/Floating Rate Mortgage Securities.
The Company's investment portfolio has been reduced since December 31,
1997 through amortization, prepayments and selected sales.
Discount balances are accreted as an increase in interest income over
the life of discount investments and premium balances are amortized as a
decrease in interest income over the life of premium investments. At September
30, 1998, the Company had on its balance sheet (excluding IOs) $48.9 million
total unamortized discount (which is the difference between the remaining
principal value and the current historical amortized cost of investments
acquired at a price below principal value) and $12.7 million unamortized premium
(which is the difference between the remaining principal amount and the current
historical amortized cost of investments acquired at a price above principal
value). The Company also had $50.0 million unamortized premium on IOs.
Mortgage principal repayments received were $240.3 million for the
period ended September 30, 1998. Given the Company's current portfolio
composition, if mortgage principal repayment rates increase over the life of the
Mortgage Securities comprising the current portfolio, all other factors being
equal, the Company's net interest income should decrease during the life of such
Mortgage Securities as the Company will be required to amortize its net premium
balance into income over a shorter time period. Similarly, if mortgage principal
prepayment rates decrease over the life of such Mortgage Securities, all other
factors being equal, the Company's net interest income should increase during
the life of such Mortgage Securities as the Company will amortize its net
premium balance over a longer time.
The table below summarizes the Company's Investments at September 30, 1998.
<TABLE>
<CAPTION>
SECURITIES (EXCLUDING IOs)
(dollars in thousands)
Weighted
Estimated
Amortized Fair Value
Cost to to Average
Principal Net Amortized Principal Estimated Principal Life
Amount Discount Cost Amount Fair Value Amount (Years)
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $ 2,176,456 $ (36,547) $ 2,139,909 98.32% $ 2,167,774 99.60% 6.0
</TABLE>
<TABLE>
<CAPTION>
MORTGAGE LOANS
(dollars in thousands)
Amortized Estimated Weighted
Cost to Estimated Fair Value Average
Principal Net Amortized Principal Fair to Principal Life
Amount Premium Cost Amount Value Amount (Years)
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $ 8,899 $ 347 $ 9,246 103.90% $ 9,246 103.90% 2.6
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
IO SECURITIES
Amortized Estimated Weighted
Cost to Fair Value Average
Notional Net Amortized Notional Estimated to Notional Life
Amount Premium Cost (1) Amount Fair Value Amount (Years)
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1998 $1,040,105 $50,039 $50,039 4.81% $47,419 4.56% 7.6
</TABLE>
The table below shows unrealized gains and losses on the Securities in the
Company's portfolio at September 30, 1998.
UNREALIZED GAINS AND LOSSES
At September
30, 1998
(dollars in thousands)
Unrealized Gain $ 48,997
Unrealized Loss (65,828)
Net Unrealized Loss (16,831)
Net Unrealized Loss as % of
Investments Principal/Notional -0.52%
Amount
Net Unrealized Loss as % of Investments -0.77%
Amortized Cost
BORROWINGS
To date, the Company's debt has consisted entirely of borrowings
collateralized by a pledge of the Company's Investments. These borrowings appear
on the balance sheet as repurchase agreements. At September 30, 1998, the
Company had established uncommitted borrowing facilities in this market with
twenty lenders. Substantially all of the Company's Investments are currently
accepted as collateral for such borrowings. The Company has not established, and
currently does not intend to establish, permanent lines of credit. The Company
has obtained, and believes it will be able to continue to obtain, short-term
financing in amounts and at interest rates consistent with the Company's
financing objectives. At September 30, 1998, the Company had bororowings
outstanding from eight lenders. Such borrowings are generally short-term (7-day
or 30-day term) and may not be renewed by the lender at its discretion. At
October 31, 1998, the Company had borrowings outstanding from eight lenders.
Certain lenders have reduced the funds available to the Company for certain less
liquid securities.
For the quarter ended September 30, 1998, the term to maturity of the
Company's borrowings has ranged from one day to five years, with a weighted
average remaining maturity of 411 days at September 30, 1998. At September 30,
1998, the Company had outstanding $2,029.8 million of repurchase agreements.
Approximately $600 million of the Company's borrowings have a cost of funds
which adjusts monthly based on a fixed spread over or under one-month LIBOR. At
September 30, 1998, the weighted average cost of funds for all of the Company's
borrowings was 5.79%. At September 30, 1998, Investments actually pledged had an
estimated fair value of $2,129.1 million.
At September 30, 1998, $500.0 million of the Company's Agency Fixed Rate
Pass- Throughs were subject to a repurchase agreement with a broker-dealer with
a term of five years ending March 10, 2003. The borrowing rate of this
repurchase agreement is three-month LIBOR plus 61.5 basis points and is capped
at 6.365%.
LIQUIDITY
Liquidity, which is the Company's ability to turn non-cash assets into
cash, allows the Company to purchase additional securities and to pledge
additional assets to secure existing borrowings should the value of pledged
assets decline. Potential immediate sources of liquidity for the Company include
cash balances and unused borrowing capacity. Unused borrowing capacity will vary
over time as the market value of the Company's securities varies. The Company's
balance sheet also generates liquidity on an on-going basis through mortgage
principal repayments and net earnings held prior to payment as dividends. Should
the Company's needs ever exceed these on-going sources of liquidity plus the
immediate sources of liquidity discussed above, management believes that the
Company's securities could in most circumstances be sold to raise cash; however,
if the Company is forced to liquidate Mortgage Assets that qualify as qualified
real estate assets to repay borrowings, there can be no assurance that it will
be able to maintain its REIT status.
Current trends in the financial markets (including the dislocation in
the market for fixed- income securities, the tightening of credit available for
investment in securities and the decrease in value of mortgage securities due to
prepayment risk) have had an adverse effect on the Company's ability to borrow
funds and may continue to have such an effect. To address concerns with respect
to possible decreased liquidity, the Company has begun to delever its portfolio
and sell Securities. From September 30, 1998 through October 31, 1998, the
Company has sold approximately $1.1 billion of Securities (agency fixed/floating
rate mortgage securities, agency fixed rate pass-through certificates, emerging
market securities, interest-only securities, principal-only securities and
interest rate swaps).
STOCKHOLDERS' EQUITY
The Company uses "available-for-sale" treatment for its Securities; these
assets are carried on the balance sheet at estimated market value rather than
historical amortized cost. Based upon such "available-for-sale" treatment, the
Company's equity base at September 30, 1998 was $174.5 million, or $9.44 per
share. If the Company had used historical amortized cost accounting, the
Company's equity base at September 30, 1998 would have been $191.3 million, or
$10.35 per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in market values of assets do not impact GAAP net income or taxable
income but rather are reflected on the balance sheet by changing the carrying
value of the assets and reflecting the change in stockholders' equity under
"Accumulated Other Comprehensive Income (Loss)" and in the statement of
operations under "Other Comprehensive Loss." By accounting for its assets in
this manner, the Company hopes to provide useful information to stockholders and
creditors and to preserve flexibility to sell assets in the future without
having to change accounting methods.
As a result of this mark-to-market accounting treatment, the book value and
book value per share of the Company are likely to fluctuate far more than if the
Company used historical amortized cost accounting. As a result, comparison with
companies that use historical cost accounting for some or all of their balance
sheet may be misleading.
Unrealized changes in the estimated net market value of Securities have one
direct effect on the Company's potential earnings and dividends: positive
market-to-market changes will increase the Company's equity base and allow the
Company to increase its borrowing capacity while negative changes in the net
market value of the Company's Securities might impair the Company's liquidity
position, requiring the Company to sell assets with the likely result of
realized losses upon sale. "Accumulated Other Comprehensive Income (Loss)" was
$(16.8) million, or (0.77)% of the amortized cost of Securities at September 30,
1998.
The table below shows the Company's equity capital base as reported and on
a historical amortized cost basis at September 30, 1998. The historical cost
equity basis is influenced by issuances of Common Stock, the level of GAAP
earnings as compared to dividends declared, and other factors. The GAAP reported
equity base is influenced by these factors plus changes in the "Accumulated
Other Comprehensive Income" account.
STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Net Unrealized GAAP Historical GAAP
Historical Losses on Reported Amortized Reported
Amortized Assets Equity Cost Equity
Cost Equity Available Base Equity (Book Value
Base for Sale (Book Value) Per Share Per Sale)
<S> <C> <C> <C> <C> <C>
At September 30, 1998 $ 191,314 $ (16,831) $ 174,483 $ 10.35 $ 9.44
</TABLE>
CAPITAL AND LEVERAGE POLICIES
The Company's operations are highly leveraged. Initially, the Company
financed its acquisition of Investments through proceeds of its initial public
offering and several private placements, and currently finances acquisitions
primarily by borrowing against or "leveraging" its existing portfolio and using
the proceeds to acquire additional Investments. The Company's target for its
equity-to-assets ratio depends on market conditions and other factors deemed
relevant by the Manager, subject to the review of the Company's Board of
Directors. Currently, the Company has been delevering, thereby increasing its
equity-to-assets ratio. At September 30, 1998, the Company's equity-to-assets
ratio was 7.50%. At October 31, 1998, the Company's equity-to-assets ratio was
approximately 12.0%. The equity-to-assets ratio is total stockholders' equity as
a percentage of total assets. For purposes of calculating the equity-to-assets
ratio, the Company's total assets include the value of the Company's investment
portfolio on a marked-to- market-basis. For purchased Investments, the Company
obtains market quotes for its Investments from independent broker-dealers that
make markets in securities similar to those in the Company's portfolio. The
Company's total stockholders' equity, for purposes of this calculation, equals
the Company's stockholders' equity determined in accordance with GAAP.
The Board of Directors has discretion to deviate from or change the
Company's indebtedness policy at any time. However, the Company intends to
maintain an adequate capital base to protect against interest rate environments
in which the Company's financing and hedging costs might exceed interest income
from its Investments. These conditions could occur, for example, when, due to
interest rate fluctuations, interest income on the Company's Investments (which
occur during periods of rapidly rising interest rates or during periods when the
Mortgage Loans in the portfolio are prepaying rapidly) lags behind interest rate
increases in the Company's variable rate borrowings. The Company enters into
hedging transactions in an effort to protect its assets and liabilities, such
hedging transactions include interest rate swaps, IOs, the purchase or sale of
interest rate collars, caps or floors and options.
INFLATION
Virtually all of the Company's assets and liabilities are financial in
nature. As a result, interest rates are expected to influence the Company's
performance more directly than inflation.
While changes in interest rates do not necessarily correlate with inflation
rates or changes in inflation rates, interest rates ordinarily increase during
periods of high or increasing inflation and decrease during periods of low or
declining inflation. Accordingly, management believes that the Company's
financial condition or results of operations will be influenced by inflation to
the extent interest rates are affected by inflation.
YEAR 2000 COMPLIANCE
The Company is substantially dependent upon the Manager's information
technology infrastructure. The Manager uses a significant number of computer
software programs and operating systems in its internal operations relating to
the management of the Company and its portfolio. The year 2000 issue is the
result of computer programs being written using two digits rather than four to
define the applicable year and impacts both information technology ("IT") and
non-IT systems. Any of the Company's or the Manager's computer programs that
have time- sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. This could cause the Company to incur expenses and
the risk and potential expense of any disruptions that may be caused by the
software's impaired functioning as the year 2000 approaches and by the
modification or replacement of such software.
The Manager will bear the costs associated with determining whether its
systems are year 2000 compliant and the costs of any necessary modifications or
replacements. The Manager has advised the Company that the Manager has reviewed
its computer systems in order to evaluate necessary modifications for year 2000
compliance. The Manager does not anticipate any material difficulties in
achieving year 2000 compliance with respect to the Manager's computer systems.
The Company has completed the process of identifying its IT systems that
are not year 2000 compliant. As the Company does not use any proprietary
software in its operations, the Company does not foresee any material issues or
costs associated with year 2000 compliance. The Company is currently in the
process of assessing its non-IT systems for year 2000 compliance.
The ability of third parties with whom the Company transacts business to
address adequately their year 2000 compliance is beyond the Company's control.
The Company has not started the process of contacting vendors and others with
whom the Company does significant business to determine their year 2000
compliance status and the extent to which the Company could be affected by any
third party year 2000 compliance issues. There can be no assurance that the
systems of other companies with whom the Company does business or on which the
Manager's systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Manager's
systems, would not have a material adverse effect on the Company.
The costs incurred by the Company to address year 2000 compliance have not
had, and are not anticipated to have, a material adverse effect on the Company's
business, financial condition, results of operations or ability to sustain
growth. The costs are based on management's best estimates, which were derived
using numerous assumptions of future events including the continued availability
of certain resources, third party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ from those plans.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 1998, there were no legal proceedings to which the Company
was a party or of which any of its properties were subject.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
On October 2, 1998, the Company's Board of Directors authorized its
financial advisor, Lehman Brothers Inc., to promptly solicit offers to acquire
the Company or all, or substantially all, of its assets. To date, Lehman
Brothers Inc., after soliciting offers to acquire the Company, has not received
any firm bids. Lehman Brothers Inc. is continuing to solicit bids on behalf of
the Company.
Also on October 2, 1998, the Company's Board of Directors engaged BlackRock
Financial Management, Inc. ("BlackRock") as its consultant to review the
Company's portfolio and to make recommendations designed to reduce the
portfolio's susceptibility to basis and interest rate risk and to create
additional liquidity.
BlackRock has recommended that the Manager delever the Company's portfolio
by selling certain Securities. From September 30, 1998 through October 31, 1998,
the Company has sold approximately $1.1 billion of Securities (agency
fixed/floating rate mortgage securities, agency fixed rate pass-through
certificates, emerging market securities, interest-only securities,
principal-only securities and interest rate swaps).
The Manager has determined the Company's net asset value as of October 31,
1998 to be between $7.50 and $8.00 per share. The net asset value as of such
date reflects sales of Securities completed through October 31, 1998.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 10.1 - Consulting Agreement dated as of October 2,
1998 between BlackRock Financial Management Inc.
and the Company
Exhibit 27.1 - Financial Data Schedule
(b) Reports
On August 3, 1998, the Company filed a Current Report on Form 8-K regarding
press releases issued by the Company announcing certain administrative changes
at LASER Advisers Inc. and the termination of Michael L. Smirlock as Chief
Executive Officer, President and Chairman of the Company.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
LASER MORTGAGE MANAGEMENT, INC.
Dated: November 16, 1998 By: /s/ Frederick N. Khedouri
-------------------------
Frederick N. Khedouri
President
(authorized officer of registrant)
Dated: November 16, 1998 By: /s/ Thomas G. Jonovich
-----------------------
Thomas G. Jonovich
Chief Financial Officer (principal
accounting officer)
<PAGE>
EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT
3.1 Articles of Incorporation of the Registrant
(Incorporated by reference to Exhibit 3.1 to the
Registration Statement on Form S-11 (File No.
333- 35673))
3.2 Bylaws of the Registrant (Incorporated by
reference to Exhibit 3.2 to the Registration
Statement on Form S-11 (File No. 333-35673))
10.1* Consulting Agreement dated as of October 2,
1998 between BlackRock Financial Management,
Inc. and the Company
27.1* Summary Financial Data
- - ----------
* Filed herewith.
Exhibit 10.1
October 2, 1998
BlackRock Financial Management, Inc.
345 Park Avenue
New York, New York 10154
Dear Sirs:
The undersigned (the "Company") hereby engages BlackRock Financial
Management, Inc. ("BlackRock") as a consultant to perform services on the terms
and conditions set forth below.
1. DUTIES. BlackRock shall, on a continuous basis, (i) monitor the
Company's securities portfolio and report to the Company's Board of Directors
(the "Board") on the portfolio's value, credit quality and susceptibility to
changes in interest rates and other factors BlackRock deems relevant, (ii)
review and report to the Board concerning the hedging strategy being employed by
the Company's investment adviser, LASER Advisers, Inc., (iii) recommend a
strategy or investment criteria designed to reduce the risk associated with the
portfolio, maximize the value of the portfolio and increase liquidity, (iv)
advise the Company in connection with the sale of portfolio securities, and (v)
perform such other consulting services as respects the Company's portfolio as
the Board, from time to time, may request. The Company is not engaging BlackRock
to manage any portion of its securities portfolio.
2. TERM. BlackRock's engagement hereunder shall commence as of the date
hereof and shall terminate on January 2, 1999, subject to renewal by the Company
by written notice to BlackRock for additional thirty-day periods thereafter.
3. COMPENSATION. For all services to be rendered to the Company during the
term of Agreement and any renewal, the Company agrees to pay BlackRock $200,000
per month, in arrears on the first business day of each month.
4. CONFIDENTIALITY. (a) BlackRock acknowledges that the information and
knowledge obtained in the course of its performance of the services requested
hereunder relating to the Company's business (the "Confidential Information")
are of a confidential nature. BlackRock shall, and shall ensure that its
employees, take all actions necessary and appropriate to preserve the
confidentiality of the Confidential Information and prevent (i) the disclosure
of the Confidential Information to any person other than employees of BlackRock
who have a need to know of it in order to perform their duties hereunder and
(ii) the use of Confidential Information other than in connection with the
performance of its duties hereunder.
(b) The foregoing provision shall not apply to Confidential Information
that BlackRock can prove (i) has been voluntarily disclosed to the public by the
Company, (ii) otherwise entered the public domain through lawful means, (iii)
was or is disclosed to the Company by a third party on a non-confidential basis
and which BlackRock reasonably believes is without a breach of an obligation of
confidentiality, (iv) was known by BlackRock prior to its receipt from the
Company, (v) was developed by BlackRock independently of any disclosures
previously made by the Company to BlackRock of such information, or (vi) is
required to be disclosed by BlackRock in connection with any judicial proceeding
involving the Company or BlackRock or any of its employees (whether or not such
proceeding involves third parties) relating to BlackRock's services for the
Company or this Agreement, provided that BlackRock first gives written detailed
notice thereof to the Company as soon as possible prior to such disclosure,
unless notice would be unlawful.
(c) BlackRock acknowledges that the improper use or disclosure of any
Confidential Information may cause irreparable damage, and that the Company
shall have the right to seek injunctive relief to prevent such unauthorized use
or disclosure, and to such damages as are occasioned by such unauthorized use or
disclosure.
5. INDEMNITY. BlackRock, acting in good faith, shall not be liable, and
shall be indemnified by the Company against any and all losses, damages, costs,
expenses (including reasonable attorney's fees), liabilities, claims and
demands, for any action, omission, information or recommendation in connection
with this Agreement, except in the case of BlackRock's actual misconduct
(including a breach of Section 4 or other breach of this Agreement), gross
negligence, willful violation of any applicable statute or reckless disregard
for its duties, provided, however, this limitation shall not act to relieve
BlackRock from any responsibility, obligation or duty BlackRock may have under
any federal securities act.
6. TRANSACTIONS WITH THE COMPANY. The Company recognizes that BlackRock or
one or more of its affiliates may desire to acquire all or a portion of the
Company's assets or engage in a merger or other combination with the Company.
Nothing in this Agreement shall limit the ability of BlackRock and its
affiliates to do so, provided that the provisions of Section 4 are complied
with.
7. ASSIGNMENT. BlackRock agrees not to assign this Agreement or the
obligations to be performed by it hereunder.
8. ENTIRE AGREEMENT. This Agreement constitutes the entire agreement
between the parties relating its subject matter, and supersedes any previous
understandings with respect thereto.
9. AMENDMENT. This Agreement may be amended only by a written instrument
executed by both of the parties hereto.
10. NOTICES. All notices, requests, demands and other communications
hereunder shall be in writing and shall be deemed to have been duly given when
delivered personally or mailed by certified mail, return receipt requested, or
overnight courier, to the address of the applicable party, except that notices
to the Company shall be sent to the attention of Mr. Frederick Khedouri, Bear,
Stearns & Co. Inc., 245 Park Avenue, New York, New York 10167, facsimile:
212-272-2295, with a copy to James R. Tanenbaum, Stroock & Stroock & Lavan LLP,
180 Maiden Lane, New York, New York 10038, facsimile: 212-806-6006. Any
correspondence to BlackRock can be sent to the attention of Henry Gabbay,
BlackRock Financial Management, Inc., 345 Park Avenue, New York, New York 10154.
11. SURVIVAL. The provisions of Sections 4, 5 and 6 and this Section 11
shall survive the termination of this Agreement.
12. GOVERNING LAW. This Agreement and the rights and obligations of the
parties hereto shall be construed in accordance with the internal laws of the
State of New York.
13. COUNTERPARTS. This Agreement may be executed counterparts, each of
which shall be deemed to be an original.
If you agree with the foregoing, please sign and return a copy of this
Agreement.
Sincerely,
LASER MORTGAGE MANAGEMENT, INC.
By: /S/ FREDERICK N. KHEDOURI
----------------------------
Name: Frederick N. Khedouri
Title: President
Agreed to and Accepted By:
BLACKROCK FINANCIAL MANAGEMENT, INC.
By: /S/ ROBERT KAPITO
--------------------
Name: Robert Kapito
Title: Vice Chairman
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1998 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH
</LEGEND>
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 87,072
<SECURITIES> 2,224,439
<RECEIVABLES> 16,432
<ALLOWANCES> 0
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<CURRENT-ASSETS> 2,327,943
<PP&E> 0
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<CURRENT-LIABILITIES> 2,153,460
<BONDS> 0
0
0
<COMMON> 267,188
<OTHER-SE> 92,704
<TOTAL-LIABILITY-AND-EQUITY> 2,327,943
<SALES> 0
<TOTAL-REVENUES> 5,566
<CGS> 0
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<OTHER-EXPENSES> 1,662
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<INTEREST-EXPENSE> 43,412
<INCOME-PRETAX> (39,509)
<INCOME-TAX> 0
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<NET-INCOME> (39,509)
<EPS-PRIMARY> (2.10)
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