<PAGE>
================================================================================
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
______________________
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ TO
______________
Commission File No. 001-13709
______________________
ANWORTH MORTGAGE ASSET CORPORATION
(Exact name of Registrant as specified in its charter)
MARYLAND 52-2059785
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1299 Ocean Avenue, #200
Santa Monica, CA 90401
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 394-0115
______________________
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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
--- ---
As of September 30, 1998, 2,328,000 shares of Common Stock, $0.01 par value per
share were issued and outstanding.
______________________
================================================================================
<PAGE>
INDEX
-----
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
Part I. Financial Information
- ------- ---------------------
Item 1. Financial Statements
Balance Sheet at September 30, 1998........................................ 3
Statements of Operations for the three months ended September 30,
1998 and for the period March 17, 1998 (Commencement of Operations)
to September 30, 1998...................................................... 4
Statement of Stockholders'Equity for the three months and six months
ended September 30, 1998................................................... 5
Statements of Cash Flows for the three months ended September 30,
1998 and for the period March 17, 1998 (Commencement of Operations)
to September 30, 1998...................................................... 6
Notes to the Financial Statements.......................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 11
Part II. Other Information
- -------- -----------------
Item 1. Legal Proceedings ......................................................... 19
Item 2. Changes in Securities...................................................... 19
Item 3. Defaults upon Senior Securities............................................ 19
Item 4. Submission of Matters to a Vote of Security Holders........................ 19
Item 5. Other Information.......................................................... 19
Item 6. Exhibits and Reports on Form 8-K........................................... 19
Signatures............................................................................ 20
</TABLE>
Page 2
<PAGE>
ANWORTH MORTGAGE ASSET CORPORATION
Balance Sheet
September 30, 1998
<TABLE>
<S> <C>
Assets
Mortgage backed securities $ 202,335,000
Other marketable securities 305,000
Cash and cash equivalents 4,162,000
Accrued interest receivable 1,499,000
Prepaid expenses and other 45,000
-----------------
$ 208,346,000
=================
Liabilities and Stockholders Equity
Liabilities
Reverse repurchase agreements $ 178,913,000
Payable for purchase of mortgage-backed securities 10,120,000
Accrued interest payable 1,272,000
Dividends payable 233,000
Accrued expenses and other 185,000
-----------------
190,723,000
-----------------
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share;
authorized 20,000,000 shares;
no shares issued and outstanding -
Common stock; par value $.01 per share;
authorized 100,000,000 shares; 2,328,000
shares issued and outstanding 23,000
Additional paid in capital, net 18,971,000
Accumulated other comprehensive income, unrealized
gain (loss) on available for sale securities (1,407,000)
Retained earnings 36,000
-----------------
17,623,000
-----------------
$ 208,346,000
=================
</TABLE>
See notes to financial statements.
Page 3
<PAGE>
ANWORTH MORTGAGE ASSET CORPORATION
Statements of Operations
<TABLE>
<CAPTION>
Period from
March 17, 1998
Three Months (Commencement of
Ended Operations) to
September 30, 1998 September 30, 1998
<S> <C> <C>
Interest and dividend income net of
amortization of premium $ 2,978,000 $ 5,851,000
Interest expense 2,611,000 4,971,000
------------- -------------
Net interest income $ 367,000 $ 880,000
Expenses:
Management fee 46,000 99,000
Incentive fee - 2,000
Other expense 77,000 161,000
------------- -------------
Net Income $ 244,000 $ 618,000
============= =============
Basic and diluted earnings per share $ 0.10 $ 0.27
============= =============
Average number of shares outstanding 2,328,000 2,309,913
============= =============
</TABLE>
See notes to financial statements.
Page 4
<PAGE>
ANWORTH MORTGAGE ASSET CORPORATION
Statement of Stockholders' Equity
Three Months and Six months Ended September 30, 1998
<TABLE>
<CAPTION>
Common Additional Accumulated Total
Stock Paid-in Other Comprehensive Retained Comprehensive
Par Value Capital Income Earnings Income Total
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1998 $22,001 $17,892,999 $ 16,482 $17,931,482
Issuance of common stock 1,279 1,069,244 1,070,523
Available-for-sale securities,
Fair value adjustment (756,827) (756,827) (756,827)
Net income 357,372 357,372 357,372
Dividends declared-
$0.15 per share (349,200) (349,200)
-------------------------------------------------------------------------------------------
Balance, June 30, 1998 $23,280 $18,962,243 $ (756,827) $ 24,654 $(399,455) $18,253,350
==========
Issuance of common stock -
Adjustment to Offer Expenses 8,822 8,822
Available-for-sale securities,
Fair value adjustment (650,420) (650,420) (650,420)
Net income 244,204 244,204 244,204
Dividends declared-
$0.10 per share (232,800) (232,800)
-------------------------------------------------------------------------------------------
Balance, September 30, 1998 $23,280 $18,971,065 $(1,407,247) $ 36,058 $(406,216) $17,623,156
==========
</TABLE>
See notes to financial statements.
Page 5
<PAGE>
ANWORTH MORTGAGE ASSET CORPORATION
Statements of Cash Flows
<TABLE>
<CAPTION>
Period from
March 17, 1998
Three Months (Commencement of
Ended Operations) to
September 30, 1998 September 30, 1998
<S> <C> <C>
Operating Activities:
Net income $ 244,000 $ 617,000
Adjustments to reconcile net income to
net cash provided by operating activites:
Amortization 551,000 893,000
Decrease (increase) in accrued interest receivable (17,000) (1,507,000)
Decrease (increase) in deferred organization expense 27,000 (37,000)
Increase (decrease) in accrued interest payable (515,000) 1,273,000
Increase (decrease) in accrued expenses and other 79,000 187,000
----------------- ----------------
Net cash provided by operating activities 369,000 1,426,000
Investing Activities:
Available-for-sale securities:
Purchases (14,310,000) (231,125,000)
Principal payments 17,454,000 36,302,000
----------------- ----------------
Net cash (used in) investing activities 3,144,000 (194,823,000)
Financing Activities:
Net borrowings from reverse repurchase agreements (8,539,000) 178,904,000
Proceeds from common stock issued, net - 19,003,000
Dividends paid (349,000) (349,000)
----------------- ----------------
Net cash provided by financing activities (8,888,000) 197,558,000
----------------- ----------------
Net increase (decrease) in cash and cash equivalents (5,375,000) 4,161,000
Cash and cash equivalents at beginning of period 9,537,000 1,000
----------------- ----------------
Cash and cash equivalents at end of period $ 4,162,000 $ 4,162,000
================= ================
</TABLE>
See notes to financial statements.
Page 6
<PAGE>
ANWORTH MORTGAGE ASSET CORPORATION
NOTES TO FINANCIAL STATEMENTS
September 30, 1998
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Anworth Mortgage Asset Corporation (the "Company") was incorporated in Maryland
on October 20, 1997. The Company commenced its operations of purchasing and
managing an investment portfolio of primarily adjustable-rate mortgage-backed
securities on March 17, 1998, upon completion of its initial public offering of
the Company's common stock.
A summary of the company's significant accounting policies follows:
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Therefore, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation have been
included. The condensed Balance Sheet as of September 30, 1998 and the
condensed Statements of Operations and Cash Flows for the period ended September
30, 1998 and related notes are unaudited. As such, the operating results for
the quarter ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the calendar year ending December 31, 1998.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of twelve months or less. The carrying amount of cash
equivalents approximates their fair market value.
MORTGAGE BACKED SECURITIES
The Company invests primarily in adjustable-rate mortgage pass-through
certificates and hybrid adjustable-rate mortgage-backed securities ("ARM"
securities). Hybrid ARM securities have an initial interest rate that is fixed
for a certain period, usually three to five years, and then adjusts annually for
the remainder of the term of the loan.
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to
classify its investments as either trading investments, available-for-sale
investments or held-to-maturity investments. It is the Company's policy to
Page 7
<PAGE>
classify each of its ARM securities as available-for-sale and then to monitor
the security's performance over time before making a final determination as to
the permanent classification. At this time all of the Company's ARM securities
are classified as available-for-sale. All assets that are classified as
available-for-sale are carried at fair value, with unrealized gains and losses
included in Other Comprehensive Income, a component of Stockholders' Equity.
Interest income is accrued based on the outstanding principal amount of the ARM
securities and their contractual terms. Premiums associated with the purchase
of ARM securities are amortized into interest income over the estimated lives of
the asset using the effective yield method.
ARM securities are recorded on the date the securities are purchased or sold.
CREDIT RISK
At September 30, 1998 the company has limited its exposure to credit losses on
its portfolio of ARM securities by purchasing primarily securities from Federal
Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage
Association ("FNMA"). The payment of principal and interest on the FHLMC and
FNMA ARM securities are guaranteed by those respective agencies. At September
30, 1998, all of the Company's ARM securities have an implied "AAA" rating.
Also, at September 30, 1998, the Company had a position in REIT Preferred Stock,
fair value approximately $305,000; the credit rating on this position is B1.
INCOME TAXES
The Company intends to elect to be taxed as a Real Estate Investment Trust and
to comply with the provisions of the Internal Revenue Code with respect thereto.
Accordingly, the Company will not be subject to Federal income tax to the extent
that its distributions to stockholders satisfy the REIT requirements.
EARNINGS PER SHARE
Earnings per share is computed by dividing net income by the weighted average
number of common shares and common share equivalents (e.g., stock options), if
dilutive, outstanding during the period.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
NOTE 2. MORTGAGE BACKED SECURITIES
Page 8
<PAGE>
The following table pertains to the Company's ARM securities classified as
available-for-sale as of September 30, 1998, which are carried at their fair
value:
<TABLE>
<CAPTION>
Federal Federal
Home Loan National Other Total
Mortgage Mortgage ARM ARM
Corporation Association Assets Assets
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Amortized Cost ($000's) $50,748 $142,879 $0 $193,627
Unrealized gains (losses) (362) (1,093) 0 (1,455)
------------------------------------------------------------------------------
Fair value $50,386 $141,786 $0 $192,172
------------------------------------------------------------------------------
</TABLE>
In addition, at September 30, 1998 the Company held a position in a preferred
stock and a position in a fixed-rate agency mortgage backed security, which had
fair values of $305,000 and $10,164,000 respectively. The following table
summarizes the Company's securities as of September 30, 1998 at their fair
value:
<TABLE>
<CAPTION>
Fixed REIT
ARM Rate Preferred
Securities MBS Stock Total
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Amortized Cost ($000's) $193,627 $10,120 $299 $204,046
Unrealized gains (losses) (1,455) 44 6 (1,405)
------------------------------------------------------------------------------
Fair value $192,172 $10,164 $305 $202,641
------------------------------------------------------------------------------
</TABLE>
NOTE 3. REVERSE REPURCHASE AGREEMENTS
The Company has entered into reverse repurchase agreements to finance most of
its ARM securities. The reverse repurchase agreements are short-term borrowings
that are secured by the market value of the Company's ARM securities and bear
interest rates that have historically moved in close relationship to LIBOR.
At September 30, 1998, the repurchase agreements had the following remaining
maturities:
<TABLE>
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Within 59 days $115,887,000
60 to 89 days 0
90 to 119 days 15,444,000
Over 120 days 47,582,191
----------------
$178,913,191
----------------
</TABLE>
NOTE 4. INITIAL PUBLIC OFFERING
On March 12, 1998 the Company completed its initial public offering of common
stock, $0.01 par value. The Company issued 2,200,000 shares of common stock at
a price of $9 per share and received net proceeds of $18,414,000, net of
underwriting discount of $0.63 per share. Offering costs in connection with the
public offering, including the underwriting discount and other expenses, which
totaled $491,000, have been charged against the proceeds of the offering.
Page 9
<PAGE>
During the third quarter the Company adjusted additional paid in capital to
reflect the difference between the estimated $500,000 and actual expenses,
generating an $8,000 addition to paid in capital during the quarter. Prior to
March 17, 1998, the Company had no operations other than activities relating to
its organization, registration under the Securities Act of 1933 and the issuance
of 100 shares of its common stock to its initial shareholder.
The company granted the underwriters of the initial public offering of the
Company's common stock a 30-day option to purchase additional shares of common
stock solely to cover over-allotments, if any, at the public offering price of
$9 per share. On April 14, 1998, the underwriters purchased an additional
127,900 shares under the terms of this option. As a result, the Company
received additional net proceeds of $1,070,523, net of the underwriting discount
of $0.63 per share, on April 14, 1998, which is reflected in the accompanying
financial statements.
NOTE 5. TRANSACTIONS WITH AFFILIATES
The Company entered into a Management Agreement (the "Agreement") with Anworth
Mortgage Advisory Corporation (the "Manager"), effective March 12, 1998. Under
the terms of the Agreement, the Manager, subject to the supervision of the
Company's Board of Directors, is responsible for the management of the day-to-
day operations of the Company and provides all personnel and office space.
The Company pays the Manager an annual base management fee equal to 1% of the
first $300 million of Average Net Invested Assets (as defined in the Agreement),
plus 0.8% of the portion above $300 million (the "Base Management
Compensation").
In addition to the Base Management Compensation, the Manager shall receive as
incentive compensation for each fiscal quarter an amount equal to 20% of the Net
Income of the Company, before incentive compensation, for such fiscal quarter in
excess of the amount that would produce an annualized Return on Equity
(calculated by multiplying the Return on Equity for such fiscal quarter by four)
equal to the Ten-Year U.S. Treasury Rate for such fiscal quarter plus 1% (the
"Incentive Management Compensation").
For the quarter ended September 30, 1998, the Company paid the Manager $46,000
in base management fee and paid no incentive compensation.
The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock
Option and Awards Plan (the "Stock Option Plan") which authorizes the grant of
options to purchase an aggregate of up to 300,000 of the outstanding shares of
the company's Common Stock. The plan authorizes the Board of Directors, or a
committee of the Board of Directors, to grant incentive stock options ("ISOs")
as defined under section 422 of the Internal Revenue Code of 1986, as amended,
options not so qualified ("NQSOs"), dividend equivalent rights ("DERs") and
stock appreciation rights ("SARs"). The exercise price for any option granted
under the Stock Option Plan may not be less than 100% of the fair market value
of the shares of Common Stock at the time the option is granted. As of
September 30, 1998, the Company had granted 148,000 options at an exercise price
of $9 per share and 136,000 DERs. Options granted to officers become
Page 10
<PAGE>
exercisable at a rate of 33.3% each year following their date of grant. Options
granted to directors become exercisable six months after their date of grant.
These options will expire on March 11, 2008.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain information contained in this Quarterly Report on Form 10-Q constitutes
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Exchange Act, which can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negatives thereof or
other variations thereon or comparable terminology. Investors are cautioned that
all forward-looking statements involve risks and uncertainties including, but
not limited to, risks related to the future level and relationship of various
interest rates, prepayment rates and the timing of new programs. The statements
in the "Risk Factors" of the Company's Prospectus dated March 12, 1998
constitute cautionary statements identifying important factors, including
certain risks and uncertainties, with respect to such forward-looking statements
that could cause the actual results, performance or achievements of the Company
to differ materially from those reflected in such forward-looking statements.
GENERAL
Anworth Mortgage Asset Corporation (the "Company") was formed in October 1997 to
invest in mortgage assets, including mortgage pass-through certificates,
collateralized mortgage obligations, mortgage loans and other securities
representing interests in, or obligations backed by, pools of mortgage loans
which can be readily financed and short-term investments (collectively,
Mortgage-Backed Securities).
The Company's principal business objective is to generate net income for
distribution to stockholders from the spread between the interest income on its
Mortgage-Backed Securities and the costs of borrowing to finance its acquisition
of Mortgage-Backed Securities. The Company commenced operations on March 17,
1998 upon the closing of its initial public offering. Since that date the
Company has been in the process of deploying its capital and building its
balance sheet through the acquisition of mortgage assets and the financing of
those assets in the credit markets. The Company seeks to generate income
through its use of leverage and active management of the asset/liability yield
spread. The financial statements included in this quarterly report on Form 10-Q
should be interpreted in light of this growth process and are not necessarily
representative of what they may be in the future.
The Company will seek to generate growth in earnings and dividends per share in
a variety of ways, including through (i) issuing new Common Stock and increasing
the size of the balance sheet when opportunities in the market for
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Mortgage-Backed Securities are likely to allow growth in earnings per share,
(ii) seeking to improve productivity by increasing the size of the balance sheet
at a rate faster than the rate of increase in operating expenses, (iii)
continually reviewing the mix of Mortgage-Backed Security types on the balance
sheet in an effort to improve risk-adjusted returns, and (iv) attempting to
improve the efficiency of the Company's balance sheet structure through the
issuance of uncollateralized subordinated debt, preferred stock and other forms
of capital, to the extent management deems such issuances appropriate.
The Company is organized for tax purposes as a real estate investment trust
("REIT") and therefore generally passes through substantially all of its
earnings to stockholders without paying federal or state income tax at the
corporate level.
The Company's investment policy is to invest at least 70% of total assets in
"Primary" adjustable-rate Mortgage Securities and Short-Term Investments
(investments with an average life of one year or less). "Primary" as used
herein means either (i) securities that are rated within one of the two highest
rating categories by at least one of either Standard & Poor's or Moody's, or
(ii) securities that are unrated but are either obligations of the United States
or obligations guaranteed by the United States government or an agency or
instrumentality of the United States government.
The remainder of the Company's investment portfolio, comprising not more than
30% of its total assets, may consist of mortgage assets which are unrated, or,
if rated, are less than Primary, including (i) mortgage loans secured by first
liens on single-family (one-to-four units) residential properties, (ii) mortgage
securities backed by loans on single-family, multi-family, commercial or other
real estate-related properties which are rated at least Investment Grade (rated
at least "BBB" or "Baa" by Standard & Poor's or Moody's, respectively) or (as to
single-family and multi-family Mortgage Securities) the equivalent, if not
rated, (iii) fixed-rate mortgage assets, including the acquisition of such
assets for the purpose of being combined with hedging instruments to obtain
investment characteristics similar to adjustable-rate mortgage assets, and (iv)
other mortgage securities representing interests in, or secured by mortgages on,
real property. The Company may also generate qualified REIT income through
investment in other REITs.
The Company will generally not acquire inverse floaters, Remic residuals or
first loss subordinated bonds. The Company may acquire mortgage derivative
securities, including, but not limited to, interest only, principal only or
other mortgage securities that receive a disproportionate share of interest
income or principal, either as an independent stand-alone investment opportunity
or to assist in the management of prepayment and other risks, but only on a
limited basis due to the greater risk of loss associated with mortgage
derivative securities.
FINANCIAL CONDITION
At September 30, 1998, the Company held total assets of $208 million, consisting
of $192 million of ARM securities, $10 million of fixed-rate agency mortgage-
backed securities and $.3 million of REIT preferred stock. At September 30,
1998, 95% of the qualified real estate assets held by the Company were Primary
assets. Of the ARM securities owned by the Company, 85%
Page 12
<PAGE>
were adjustable-rate pass-through certificates which reset at least once a year.
The remaining 15% were new origination 3/1 and 5/1 hybrid ARMS. Hybrid ARM
securities have an initial interest rate that is fixed for a certain period,
usually three to five years, and then adjust annually for the remainder of the
term of the loan.
The following table presents a schedule of ARM securities owned at September 30,
1998 classified by type of issuer.
ARM SECURITIES BY ISSUER
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Agency Carrying Portfolio
Value Percentage
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
FNMA $141,786 74
- ----------------------------------------------------------------------------------------------------------
FHLMC 50,386 26
- ----------------------------------------------------------------------------------------------------------
Total Portfolio $192,172 100
==========================================================================================================
</TABLE>
The following table classifies the Company's portfolio of ARM securities by type
of interest rate index.
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Index Carrying Portfolio
Value Percentage
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Six-month LIBOR 16,413 8.5%
- ----------------------------------------------------------------------------------------------------------
Six-month Certificate of
Deposit 9,734 5.1%
- ----------------------------------------------------------------------------------------------------------
One-year Constant
Maturity Treasury 159,127 83.0%
- ----------------------------------------------------------------------------------------------------------
Cost of Funds Index 6,898 3.4%
- ----------------------------------------------------------------------------------------------------------
192,172 100.0%
==========================================================================================================
</TABLE>
The ARM portfolio had a weighted average coupon of 6.95% at September 30, 1998.
The weighted average three-month constant prepayment rate ("CPR") of the
Company's MBS portfolio was 31% as of September 30, 1998. At September 30, 1998
the unamortized net premium paid for the mortgage-backed securities was
$5,184,000.
The Company analyzes its mortgage-backed securities and the extent to which
prepayments impact the yield of the securities. When actual prepayments exceed
expectations, the Company amortizes the premiums paid on mortgage assets over a
shorter time period, resulting in a reduced yield to maturity on the Company's
mortgage assets. Conversely, if actual prepayments are less than the assumed
constant prepayment rate, the premium would be amortized over a longer time
period, resulting in a higher yield to maturity. The Company
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<PAGE>
monitors its yield expectations versus its actual prepayment experience on a
monthly basis in order to adjust the amortization of the net premium.
The fair value of the Company's portfolio of mortgage backed securities was
$1.407 million less than the amortized cost of the securities, resulting in a
negative adjustment of 0.69% of the amortized cost of the portfolio as of
September 30, 1998. This price decline reflects the possibility of increased
future prepayments which would have the effect of shortening the average life of
the Company's ARM securities and decreasing their yield and market value.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
For the quarter ended September 30, 1998, the Company's net income was $244,000,
or $0.10 per share (basic and diluted EPS), based on an average of 2,328,000
shares outstanding. Net interest income for the quarter totaled $367,000. Net
interest income is comprised of the interest income earned on mortgage
investments less interest expense from borrowings. During the third quarter of
1998, the Company incurred operating expenses of $123,000, consisting of a base
management fee of $46,000 and other operating expenses of $77,000.
The Company's return on average equity was 1.28% or, on an annualized basis,
5.22%, for the quarter ended September 30, 1998. The table below shows the
components of return on average equity.
COMPONENTS OF RETURN ON AVERAGE EQUITY (1)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
Net Interest
For the Quarter Income/ G&A Expense/(2)// Net Income/
Ended Equity Equity Equity
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Jun 30, 1998 2.52% 0.65% 1.87%
- -------------------------------------------------------------------------------------------------------------
Sep 30, 1998 1.92% 0.64% 1.28%
- -------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Average equity excludes unrealized gain (loss) on available-for-sale ARM
securities.
(2) Excludes performance fees.
The following table shows the Company's average balances of cash equivalents and
mortgage assets, the yields earned on each type of earning assets, the yield on
average earning assets and interest income.
Page 14
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Yield on
Average Average
Amortized Yield on Amortized Yield on
Average Cost of Average Average Cost of Average
Cash Mortgage Earning Cash Mortgage Earning Interest
in thousands Equivalents Assets Assets Equivalents Assets Assets Income
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
For the quarter ended
June 30, 1998 $7,956 $166,855 $174,811 5.32 6.34 6.30 $2,799
- -----------------------------------------------------------------------------------------------------------------------------
For the quarter ended
September 30, 1998 $7,087 $190,773 $197,860 5.35 5.94 5.91 $2,970
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
The table below shows the Company's average borrowed funds and average cost of
funds as compared to average one- and average three-month LIBOR.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Average Average Average
One-month Cost of Cost of
LIBOR Funds Funds
Average Average Relative Relative Relative
Average Average One- Three- to Average to Average to Average
Borrowed Interest Cost of Month Month Three-month One-month Three-month
in thousands Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
For the quarter ended
June 30, 1998 $157,605 $2,318 5.61% 5.66% 5.69% (0.03%) (0.05%) (0.08%)
- -----------------------------------------------------------------------------------------------------------------------------
For the quarter ended
Sept 30, 1998 $182,880 $2,611 5.60% 5.62% 5.62% 0.00% (0.02%) (0.02%)
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
As of September 30, 1998, the yield on the Company's total assets, including the
impact of the amortized of premiums and discounts, was 5.84%. The Company's
weighted average cost of borrowed funds at September 30, 1998, was 5.60%.
The Company pays the Manager an annual base management fee, generally based on
average net invested assets, as defined in the Management Agreement, payable
monthly in arrears as follows: 1.0% of the first $300 million of Average Net
Invested Assets, plus 0.8% of the portion above $300 million.
In order for the Manager to earn a performance fee, the rate of return on the
stockholders' investment, as defined in the Management Agreement, must exceed
the average ten-year U.S. Treasury rate during the quarter plus 1%. During the
third quarter of 1998, the Manager earned no performance fee. During the third
quarter of 1998, the Company's return on common equity was 1.28% or, on an
annualized basis, 5.22%. The ten-year U.S. Treasury rate for the corresponding
period was 5.24%.
Page 15
<PAGE>
The following table shows operating expenses as a percent of total assets:
ANNUALIZED OPERATING EXPENSE RATIOS
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
Management Fee & Total G&A
For The Other Expenses/ Performance Fee/ Expenses/
Quarter Ended Total Assets Total Assets Total Assets
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Jun 30, 1998 0.23% 0.00% 0.23%
- ----------------------------------------------------------------------------------------------------
Sep 30,1998 0.24% 0.00% 0.24%
- ----------------------------------------------------------------------------------------------------
</TABLE>
The Company did not enter into any interest rate agreements to date. As part of
its asset/liability management process, the Company may enter into interest rate
agreements such as interest rate caps, floors and swaps. These agreements would
be entered into to reduce interest rate risk and would be designed to offset the
effects of certain changes in interest rates. The Company reviews the need for
interest rate agreements on a regular basis consistent with its Capital
Investment Policy.
The Company has not experienced credit losses on its portfolio of ARM securities
to date, but losses may be experienced in the future. At September 30, 1998,
the Company had limited its exposure to credit losses on its portfolio of ARM
securities by purchasing only Agency Certificates, which, although not rated,
carry an implied "AAA" rating.
COMMON DIVIDEND
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. Since the Company, as a REIT, pays its dividends
based on taxable earnings, the dividends may at times be more or less than
reported earnings.
On September 29, 1998 the Company declared a dividend of $0.10 per share payable
on October 9, 1998 to holders of record as of October 6, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarter ended September 30, 1998
consisted of reverse repurchase agreements, which totaled $179 million at
September 30, 1998. The Company's other significant source of funds for the
quarter ended September 30, 1998 consisted of payments of principal and interest
from its ARM securities portfolio in the amount of $17.5 million. In the
future, the Company expects its primary sources of funds will consist of
borrowed funds under reverse repurchase agreement transactions with one- to
twelve-month maturities and of monthly payments of principal and interest on its
ARM securities portfolio. The Company's liquid assets generally consist of
unpledged ARM assets, cash and cash equivalents.
The borrowings incurred during the quarter ended September 30, 1998 had a
weighted average interest cost during the quarter of 5.60%. As of September 30,
1998, all of the Company's reverse repurchase agreements were fixed-rate term
reverse repurchase agreements with original maturities that range from three
months to one year. The Company has borrowing arrangements with ten different
financial institutions and on September 30, 1998, had borrowed funds
Page 16
<PAGE>
under reverse repurchase agreements with six of these firms. Because the Company
borrows money based on the fair value of its ARM securities and because
increases in short-term interest rates can negatively impact the valuation of
ARM securities, the Company's borrowing ability could be limited and lenders may
initiate margin calls in the event short-term interest rates increase or the
value of the Company's ARM securities declines for other reasons. During the
quarter ended September 30, 1998, the Company had adequate cash flow, liquid
assets and unpledged collateral with which to meet its margin requirements
during the period. Subsequent to September 30, 1998, in the wake of the Long
Term Capital Management difficulties, the Company found that the amount of
excess collateral required on reverse repurchase agreements rose by
approximately one percent.
In its efforts to maintain sufficient access to sources of short term liquidity,
the Company has begun discussions with the Adviser concerning the Adviser's
periodically providing short term working capital loans on an unsecured basis.
While the Adviser has as of the date of this filing made no firm commitment of
any amount, it has been agreed that any short term loan to the company would be
for a period of less than 90 days and at an interest rate equal to LIBOR. During
the fourth quarter, the Company expects to begin discussions with financial
institutions about obtaining other availability to short term loans on both a
secured and an unsecured basis.
STOCKHOLDERS' EQUITY
The Company uses "available-for-sale" treatment for its Mortgage-Backed
Securities; these assets are carried on the balance sheet at fair value rather
than historical amortized cost. Based upon such "available-for-sale" treatment,
the Company's equity base at September 30, 1998 was $17.6 million, or $7.57 per
share. If the Company had used historical amortized cost accounting, the
Company's equity base at September 30, 1998 would have been $19.0 million, or
$8.17 per share.
With the Company's "available-for-sale" accounting treatment, unrealized
fluctuations in fair values of assets do not impact GAAP or taxable income but
rather are reflected on the balance sheet by changing the carrying value of the
asset and reflecting the change in stockholders' equity under "Accumulated other
comprehensive income, unrealized gain (loss) on available for sale securities."
By accounting for its assets in this manner, the Company hopes to provide useful
information to stockholders and creditors and to preserve flexibility to sell
assets in the future without having to change accounting methods.
As a result of this mark-to-market accounting treatment, the book value and book
value per share of the Company are likely to fluctuate far more than if the
Company used historical amortized cost accounting. As a result, comparisons
with companies that use historical cost accounting for some or all of their
balance sheet may be misleading.
Changes in the fair value of Mortgage-Backed Securities have one direct effect
on the Company's potential earnings and dividends: positive mark-to-market
changes will increase the Company's equity base and allow the Company to
increase its borrowing capacity while negative changes will tend to limit
borrowing capacity under the Company's Capital Investment Policy. A very large
negative change in the fair value of the Company's Mortgage-Backed Securities
might impair the Company's liquidity position, requiring the Company to sell
assets with the likely result of realized losses upon sale. "Accumulated other
comprehensive income, unrealized gain (loss) on available for sale securities"
was $1.4 million, or 0.69% of the amortized cost of mortgage backed securities
at September 30, 1998.
Page 17
<PAGE>
EFFECTS OF INTEREST RATE CHANGES
The Company has invested in adjustable-rate mortgage securities. Adjustable-
rate mortgage assets are typically subject to periodic and lifetime interest
rate caps that limit the amount an adjustable-rate mortgage securities' interest
rate can change during any given period. Adjustable-rate mortgage securities
are also typically subject to a maximum interest rate payable. The Company
borrowings will not be subject to similar restrictions. Hence, in a period of
increasing interest rates, interest rates on its borrowings could increase
without limitation by caps, while the interest rates on its mortgage assets
could be so limited. This problem would be magnified to the extent the Company
acquires mortgage assets that are not fully indexed. Further, some adjustable-
rate mortgage assets may be subject to periodic payment caps that result in some
portion of the interest being deferred and added to the principal outstanding.
This could result in receipt by the Company of less cash income on its
adjustable-rate mortgage assets than is required to pay interest on the related
borrowings. These factors could lower the Company's net interest income or
cause a net loss during periods of rising interest rates, which would negatively
impact the Company's liquidity and its ability to make distributions to
stockholders.
The Company intends to fund the purchase of a substantial portion of its
adjustable-rate mortgage securities with borrowings that may have interest rates
based on indices and repricing terms similar to, but of somewhat shorter
maturities than, the interest rate indices and repricing terms of the mortgage
assets. Thus, the Company anticipates that in most cases the interest rate
indices and repricing terms of its mortgage assets and its funding sources will
not be identical, thereby creating an interest rate mismatch between assets and
liabilities. During periods of changing interest rates, such interest rate
mismatches could negatively impact the Company's net income, dividend yield and
the market price of the Common Stock.
Prepayments are the full or partial repayment of principal prior to the original
term to maturity of a mortgage loan and typically occur due to refinancing of
mortgage loans. Prepayment rates on mortgage securities vary from time to time
and may cause changes in the amount of the Company's net interest income.
Prepayments of adjustable-rate mortgage loans usually can be expected to
increase when mortgage interest rates fall below the then-current interest rates
on such loans and decrease when mortgage interest rates exceed the then-current
interest rate on such loans, although such effects are not predictable.
Prepayment experience also may be affected by the conditions in the housing and
financial markets, general economic conditions and the relative interest rates
on fixed-rate and adjustable-rate mortgage loans underlying mortgage securities.
The purchase prices of mortgage securities are generally based upon assumptions
regarding the expected amounts and rates of prepayments. Where slow prepayment
assumptions are made, the Company may pay a premium for mortgage securities. To
the extent such assumptions materially and adversely differ from the actual
amounts of prepayments, the Company's yield to maturity may decrease. Finally
in the event that the Company is unable to acquire new mortgage assets to
replace the prepaid mortgage assets, its financial condition, cash flows and
results of operations could be materially adversely affected.
YEAR 2000
The Company is subject to risks associated with the "Year 2000" problem, a term
which refers to uncertainties about the ability of various data processing
hardware and software to interpret dates correctly as we approach the Year 2000.
To address these risks the Company has implemented a plan whereby it will
evaluate its internal systems and, to a much larger extent, evaluate the
readiness of the systems used by the Company's External Counterparties. The
Company will develop contingency plans for implementation in the event of
failure of any systems on which its business relies.
Internal Systems - Currently, the Company uses a general ledger software
application to prepare its books and records, as well as spreadsheet software to
construct subsidiary ledgers. Throughout the fourth quarter of 1998 and into
the first and second quarters of 1999 the Company intends to create parallel
files within these applications to test these packages' ability to interpret the
year 2000 in various data fields on which calculations are made. In the event
that either application is found not to be Year 2000 compliant, the Company will
obtain replacement software from the suppliers.
To date, the Company has not incurred any additional expense in connection with
the evaluation of internal systems. Since the Company is externally managed,
the testing and potential software replacement referred to above should not
result in additional cost to the Company.
External Counterparties - The Company has implemented a plan of communicating
with its External Counterparties regarding the state of readiness of their Year
2000 plans. During the fourth quarter of 1998, the Company will compile a list
of these counterparties and will solicit information from each one regarding
their Year 2000 plans. Many of these counterparties are prominent broker-dealers
and investment banks or government mortgage agencies who are known by the
Company to be involved in Year 2000 review processes currently being performed
by securities industry regulators (such as the New York Stock Exchange or the
Securities and Exchange Commission) and self-regulatory organizations. The
Company intends to monitor the progress of each of these counterparties over the
course of the next three quarters and report to shareholders regarding progress
made by these counterparties.
Contingency Plans - During the second and third quarters of 1999, after
gathering data through the processes described above, the Company will develop
plans to address any potential failure in internal or external systems.
In its normal course of business the Company relies heavily on the accurate
functioning of many computer applications. The Company's ability to perform its
normal business functions depends heavily on the Company's ability to perform
mathematical calculations quickly and accurately and its ability to send and
receive funds quickly and accurately. While the Company believes that
completion of its Year 2000 Plan will reduce some of the uncertainty that
currently surrounds the Year 2000 problem, the Company acknowledges that Year
2000-related breakdowns in either the internal or external systems on which the
Company depends could cause significant disruptions in the Company's operations.
Page 18
<PAGE>
OTHER MATTERS
As of September 30, 1998, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
greater than 99.0% of its total assets, as compared to the Code requirement
that at least 75% of its total assets must be Qualified REIT Assets. The Company
also calculates that greater than 99.0% of its 1998 revenue for the quarter
ended September 30, 1998 qualifies for both the 75% source of income test and
the 95% source of income test under the REIT rules. The Company also met all
REIT requirements regarding the ownership of its common stock and the
distributions of its net income. Therefore, as of September 30, 1998, the
Company believes that it will continue to qualify as a REIT under the provisions
of the Code.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940, as
amended (the "Investment Company Act). If the Company were to become regulated
as an investment company, then the Company's use of leverage would be
substantially reduced. The Investment Company Act exempts entities that are
"primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate" ("Qualifying
Interests"). Under current interpretation of the staff of the SEC, in order to
qualify for this exemption, the Company must maintain at least 55% of its assets
directly in Qualifying Interests. In addition, unless certain mortgage
securities represent all of the certificates issued with respect to an
underlying pool of mortgages, such mortgage securities may be treated as
securities separate from the underlying mortgage loans and, thus, may not be
considered Qualifying Interests for purposes of the 55% requirement. The Company
calculates that it is in compliance with this requirement.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 1998, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
None
Page 19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized,
ANWORTH MORTGAGE ASSET CORPORATION
Dated: November 13, 1998
By: /s/ Lloyd McAdams
- -------------------------
Lloyd McAdams
President
(authorized officer of registrant)
Dated: November 13, 1998
By: /s/ Pamela J. Watson
- -------------------------
Pamela J. Watson,
Chief Financial Officer and Treasurer
(principal accounting officer)
Page 20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1998 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,162
<SECURITIES> 202,640
<RECEIVABLES> 1,499
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,705
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 208,346
<CURRENT-LIABILITIES> 190,723
<BONDS> 0
0
0
<COMMON> 18,994
<OTHER-SE> (1,407)
<TOTAL-LIABILITY-AND-EQUITY> 208,346
<SALES> 0
<TOTAL-REVENUES> 2,978
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 123
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,611
<INCOME-PRETAX> 244
<INCOME-TAX> 0
<INCOME-CONTINUING> 244
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 244
<EPS-PRIMARY> .10
<EPS-DILUTED> .10
</TABLE>
