FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission File Number 001-13937
ANTHRACITE CAPITAL, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 13-3978906
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
345 Park Avenue, New York, New York 10154
--------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number including area code): (212) 409-3333
NOT APPLICABLE
----------------------------------------------------
(Former name, former address, and former fiscal year
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
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
As of November 13, 1998, 19,985,098 shares of voting common stock
($.001 par value) were outstanding.
ANTHRACITE CAPITAL, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
Item 1. Interim Financial Statements.................................3
Statement of Financial Condition
At September 30, 1998 (Unaudited)............................3
Statements of Operations
For the Three Months Ended September 30, 1998
and For the Period March 24, 1998 (Commencement
of Operations) Through September 30, 1998 (Unaudited)........4
Statement of Changes in Stockholders' Equity
For the Period March 24, 1998 (Commencement
of Operations) Through September 30, 1998 (Unaudited)........5
Statement of Cash Flows
For the Period March 24, 1998 (Commencement
of Operations)Through September 30, 1998 (Unaudited).........6
Notes to Financial Statements................................7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................20
Part II - OTHER INFORMATION
Item 1. Legal Proceedings...........................................32
Item 2. Changes in Securities and Use of Proceeds...................32
Item 3. Defaults Upon Senior Securities.............................32
Item 4. Submission of Matters to a Vote of Security Holders.........32
Item 5. Other Information...........................................32
Item 6. Exhibits and Reports on Form 8-K............................32
SIGNATURES
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Anthracite Capital, Inc.
Statement of Financial Condition
September 30, 1998 (Unaudited)
(in thousands, except per share amounts)
- -----------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 6,624
Securities available for sale, at fair value:
Subordinated commercial mortgage-backed
securities (CMBS) $ 312,519
Other securities 727,771 1,040,290
---------
Commercial mortgage loan, net 36,410
Receivable for securities sold 50,662
Principal and interest receivable 26,788
Other assets 203
-----------
Total Assets $ 1,160,977
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Short-term borrowings:
Secured by pledge of subordinated CMBS $ 163,516
Secured by pledge of other securities
or loans 757,068 $ 920,584
---------
Distributions payable 7,195
Hedging instruments, at fair value 5,340
Accrued interest payable 3,729
Accrued expenses, payables and other
liabilities 2,758
-----------
Total Liabilities 939,606
===========
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, par value $0.001 per
share; 100,000 shares authorized;
no shares issued --
Common stock, par value $0.001 per
share; 400,000 shares authorized;
21,365 shares issued 21
Additional paid-in capital 296,920
Accumulated other comprehensive
income (loss) (58,770)
Distributions in excess of earnings (957)
Treasury stock, at cost (1,380 shares) (15,843)
-----------
Total Stockholders' Equity 221,371
Total Liabilities and Stockholders' Equity $ 1,160,977
===========
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc.
Statements of Operations (Unaudited)
(in thousands, except per share amounts)
- ----------------------------------------------------------------------------
For the Period
March 24, 1998
For the Three (Commencement of
Months Ended Operations) Through
September 30, 1998 September 30, 1998
----------------------------------------
Interest Income:
Securities available for sale $ 19,318 $ 30,209
Commercial mortgage loan 408 408
Cash and cash equivalents 63 216
-------- --------
Total interest income 19,789 30,833
-------- --------
Expenses:
Interest 11,708 16,090
Management fee 1,374 2,244
Other expenses 244 482
Foreign currency loss 32 32
-------- --------
Total expenses 13,358 18,848
-------- --------
Gain on Sale of Securities 22 22
-------- --------
Net Income 6,453 12,007
-------- --------
Unrealized Loss on Securities:
Unrealized holding loss arising
during period (61,295) (58,748)
Less: reclassification adjustment
for gains included in net income (22) (22)
-------- --------
Comprehensive Loss $(54,864) $(46,763)
======== ========
Net income per share:
Basic $ 0.31 $ 0.57
Diluted $ 0.31 $ 0.57
Weighted average number of shares
outstanding:
Basic 20,562 20,980
Diluted 20,562 20,980
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc.
Statement of Changes in Stockholders' Equity
For the Period March 24, 1998 (Commencement of Operations)
Through September 30, 1998 (Unaudited)
(in thousands, except per share amounts)
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Accumulated
Common Additional Other Distributions Treasury Total
Stock, Paid-In Comprehensive In Excess Stock, Stockholders'
Par Value Capital Income (Loss) Of Earnings At Cost Equity
--------- ---------- ------------- ------------- ---------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 24, 1998 $ $ 200 $ - $ - $ - $ 200
Issuance of common stock 21 296,951 - - - 296,972
Net income - - - 173 - 173
Change in net unrealized
gain (loss) on securities
available for sale and
interest rate swaps - - 2 - - 2
--------- ---------- ------------- ------------- ---------- -------------
Balance at March 31, 1998 21 297,151 2 173 - 297,347
--------- ---------- ------------- ------------- ---------- -------------
Net income - - - 5,381 - 5,381
Change in net unrealized
gain (loss) on securities
available for sale and
interest rate swaps - - 2,545 - - 2,545
Distributions declared
($0.27 per share) - - - (5,769) - (5,769)
Cost of Dividend
Reinvestment and Stock
Purchase Plan offering - (30) - - - (30)
Redemption of common stock - (200) - - - (200)
--------- ---------- ------------- ------------- ---------- ------------
Balance at June 30, 1998 21 296,921 2,547 (215) - 299,274
--------- ---------- ------------- ------------- ---------- ------------
Net income - - - 6,453 - 6,453
Change in net unrealized
gain (loss) on securities
available for sale and
interest rate swaps, net of
reclassification adjustment - - (61,317) - - (61,317)
Distributions declared
($0.36 per share) - - - (7,195) - (7,195)
Redemption of common stock - (1) - - - (1)
Purchase of treasury stock - - - - (15,843) (15,843)
--------- ---------- ------------- ------------- ---------- ------------
Balance at September 30, 1998 $ 21 $ 296,920 $ (58,770) $ (957) $ (15,843) $ 221,371
========= ========== ============= ============= ========== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc.
Statement of Cash Flows
For the Period March 24, 1998 (Commencement of Operations)
Through September 30, 1998 (Unaudited)
(in thousands)
- -----------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 12,007
Adjustments to reconcile net income to net cash
provided by operating activities:
Premium amortization (discount accretion), net 6,557
Noncash portion of net foreign currency loss (gain) (920)
Net gain on sale of securities (22)
Increase in interest receivable (13,230)
Increase in other assets (203)
Increase in accrued interest payable 3,729
Increase in accrued expenses, payables and other
liabilities 2,758
------------
Net cash provided by operating activities 10,676
------------
Cash flows from investing activities:
Purchase of securities available for sale (1,241,091)
Purchase of commercial mortgage loan (35,131)
Principal payments received on securities available
for sale 53,395
Proceeds from sales of securities available
for sale 73,524
Increase in receivable for securities sold (50,662)
------------
Net cash used in investing activities (1,199,965)
------------
Cash flows from financing activities:
Increase in net short-term borrowings 920,584
Proceeds from issuance of common stock, net of
offering costs 296,972
Distributions on common stock (5,769)
Purchase of treasury stock (15,843)
Other common stock transactions (231)
------------
Net cash provided by financing activities 1,195,713
------------
Net increase in cash and cash equivalents 6,424
Cash and cash equivalents, beginning of period 200
------------
Cash and cash equivalents, end of period $ 6,624
============
Supplemental disclosure of cash flow information:
Interest paid $ 12,361
============
Noncash financing activities:
Net change in unrealized gain on securities
available for sale and interest rate swaps $ (58,770)
============
Distributions declared, not yet paid $ 7,195
============
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc.
Notes to Financial Statements
(Dollars in thousands, except per share amounts)
--------------------------------------------------------------------------
Note 1 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. Accordingly, they do
not include all of the information and footnotes required by generally
accepted accounting principles ("GAAP") for complete financial
statements.
In the opinion of management, the accompanying financial statements
contain all adjustments, consisting of normal and recurring accruals,
necessary for a fair presentation of the financial condition of
Anthracite Capital, Inc. (the "Company") at September 30, 1998, the
results of its operations for the three months ended September 30, 1998
and for the period March 24, 1998 (commencement of operations) through
September 30, 1998, and the changes in its stockholders' equity and its
cash flows for the period March 24, 1998 (commencement of operations)
through September 30, 1998. Operating results for the period ended
September 30, 1998 are not necessarily indicative of the results that may
be expected for any other interim periods or the period ended December
31, 1998.
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the dates of the statements of financial condition and
revenues and expenses for the periods covered. Actual results could
differ from those estimates and assumptions.
Note 2 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Maryland in November 1997 and commenced
operations on March 24, 1998. The Company's principal business activity
is to invest in a diversified portfolio of multifamily, commercial and
residential mortgage loans, mortgage-backed securities and other real
estate related assets in the U.S. and non-U.S. markets
A summary of the Company's significant accounting policies follows:
Cash and Cash Equivalents
All highly liquid investments with original maturities of three months or
less are considered to be cash equivalents.
Securities Available for Sale
The Company's mortgage-backed securities, mortgage-related securities and
certain other securities are designated as assets available for sale
because the Company may dispose of them prior to maturity. Securities
available for sale are carried at estimated fair value with the net
unrealized gains or losses reported as a component of accumulated other
comprehensive income in stockholders' equity. Unrealized losses on
securities that reflect a decline in value which is judged by management
to be other than temporary, if any, are charged to earnings. At
disposition the realized net gain or loss is included in earnings on a
specific identification basis. The amortization of premiums and accretion
of discounts are computed using the effective yield method after
considering actual and estimated prepayment rates, if applicable. Actual
prepayment experience is periodically reviewed and effective yields are
recalculated when differences arise between prepayments originally
anticipated and amounts actually received plus anticipated future
prepayments.
Commercial Mortgage Loan
The Company purchases and originates certain commercial mortgage loans to
be held as long-term investments. Loans held for investment are recorded
at cost at the date of purchase. Premiums and discounts related to these
loans are amortized over their estimated lives using the effective
interest method. Any origination fee income, application fee income and
costs associated with originating or purchasing commercial mortgage loans
have been deferred and the net amount is added to the basis of the loans
on the statement of financial condition. The Company recognizes
impairment on the loans when it is probable that the Company will not be
able to collect all amounts due according to the contractual terms of the
loan agreement. The Company measures impairment based on the present
value of expected future cash flows discounted at the loan's effective
interest rate or the fair value of the collateral if the loan is
collateral dependent.
Hedging Instruments
As part of its asset/liability management activities, the Company enters
into interest rate swap agreements and forward currency exchange
contracts in order to hedge interest rate and foreign currency exposures
or to modify the interest rate or foreign currency characteristics of
related items in its statement of financial condition.
Revenues and expenses from interest rate swap agreements are recognized
as a net adjustment to interest expense. During the term of the interest
rate swap agreements, changes in fair value are recognized on the
statement of financial condition as hedging instruments at fair value and
included among assets (if there is a net unrealized gain) or among
liabilities (if there is an unrealized loss). A corresponding amount is
included as a component of accumulated other comprehensive income in
stockholders' equity. In the event that interest rate swap agreements are
terminated, the associated gain or loss is deferred over the remaining
term of the agreement, provided that the underlying hedged item still
exists.
Revenues and expenses from forward currency exchange contracts are
recognized as a net adjustment to foreign currency gain or loss. During
the term of the forward currency exchange contracts, changes in fair
value are recognized on the statement of financial condition as hedging
instruments at fair value and included among assets (if there is a net
unrealized gain) or among liabilities (if there is an unrealized loss). A
corresponding amount is included as a component of net foreign currency
gain or loss in the statement of operations.
The Company is exposed to credit loss in the event of nonperformance by
any other party to the Company's interest rate swap agreements or forward
currency exchange contracts. However, the Company does not anticipate
nonperformance by any counterparty.
Foreign Currencies
Assets and liabilities denominated in foreign currencies are translated
at the exchange rate in effect on the date of the statement of financial
condition. Revenues, costs, and expenses denominated in foreign
currencies are translated at average rates of exchange prevailing during
the period. Foreign currency gains and losses resulting from this process
are recognized in the statement of operations.
Net Income Per Share
Net income per share is computed in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share, and
is calculated on the basis of the weighted average number of common
shares outstanding during each period plus the additional dilutive effect
of common stock equivalents. The dilutive effect of outstanding stock
options is calculated using the treasury stock method. For the three
months ended September 30, 1998 and for the period March 24, 1998 to
September 30, 1998, all outstanding stock options were antidilutive.
Income Taxes
The Company intends to elect to be taxed as a Real Estate Investment
Trust ("REIT") and to comply with the provisions of the Internal Revenue
Code of 1986, as amended, with respect thereto. Accordingly, the Company
will 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.
Income Recognition
Income and expenses are recorded on the accrual basis of accounting.
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, requires the Company to
classify items of "other comprehensive income", such as unrealized gains
and losses on securities available for sale, by their nature in a
financial statement and display the accumulated balance of other
comprehensive income separately from retained earnings and additional
paid-in capital in the stockholders' equity section of the statement of
financial condition. In accordance with SFAS No. 130, cumulative
unrealized gains and losses on securities available for sale and interest
rate swaps are classified as accumulated other comprehensive income in
stockholders' equity and current period unrealized gains and losses are
included as a component of comprehensive income.
Note 3 SECURITIES AVAILABLE FOR SALE
The Company's securities available for sale are carried at estimated fair
value. The amortized cost and estimated fair value of securities
available for sale at September 30, 1998 are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial mortgage-backed securities
("CMBS") interests:
Investment grade rated senior interest only $ 98,654 $7,027 $ 91,627
interests
Non-investment grade rated subordinated 313,109 31,217 281,892
interests
Non-rated subordinated interests 38,953 8,326 30,627
----------------------------------------------------
Total CMBS interests 450,716 46,570 404,146
----------------------------------------------------
Single-family residential mortgage-backed
securities ("residential MBS") interests:
Agency adjustable rate 197,981 833 197,148
Agency fixed rate 55,128 $ 198 51 55,275
Agency interest only 13,787 6,018 7,769
Investment grade rated private issuer fixed rate 317,947 2,823 320,770
----------------------------------------------------
Total residential MBS interests 584,843 3,021 6,902 580,962
----------------------------------------------------
Agency insured project loans 27,969 208 28,177
Investment grade rated asset backed securities 14,718 1,181 13,537
Non-investment grade rated non-U.S. sovereign
securities 15,833 2,365 13,468
====================================================
Total securities available for sale $1,094,079 $3,229 $57,018 $1,040,290
====================================================
</TABLE>
At September 30, 1998, an aggregate of $987,730 in estimated fair value
of the Company's securities available for sale was pledged to secure its
short-term borrowings.
The aggregate estimated fair value by underlying credit rating of the
Company's securities available for sale at September 30, 1998 is as
follows:
Estimated
Security Rating Fair Value Percentage
-------------------------------------------------------------------
Agency and agency insured securities $ 288,369 27.7%
AAA 412,397 39.6
BBB 13,537 1.3
BB+ 28,098 2.7
BB 40,165 3.9
BB- 63,457 6.1
B+ 8,849 0.9
B 103,774 10.0
B- 35,489 3.4
CCC 15,528 1.5
Not rated 30,627 2.9
========================
Total securities available for sale $1,040,290 100.0%
========================
As of September 30, 1998, the mortgage loans underlying the CMBS
interests held by the Company were secured by properties of the types and
at the locations identified below:
Property Type Percentage (1) Geographic Location Percentage (1)
-----------------------------------------------------------------------
Retail 28.6% California 13.3%
Multifamily 27.0 Texas 10.3
Office 16.4 New York 9.6
Lodging 9.9 Florida 6.8
Other 18.1 Illinois 5.6
Other (2) 54.4
--------------- ---------------
Total 100.0% Total 100.0%
=============== ===============
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No other individual state comprises more than 5% of the total.
At September 30, 1998, none of the mortgage loans underlying the CMBS
interests held by the Company were delinquent more than thirty days.
The CMBS interests held by the Company consist of senior interest only
and subordinated securities collateralized by adjustable and fixed rate
commercial and multifamily mortgage loans. The residential MBS interests
held by the Company consist of adjustable rate, fixed rate and interest
only residential pass-through or mortgage-backed securities
collateralized by adjustable and fixed rate single-family residential
mortgage loans. Agency residential MBS were issued by Federal Home Loan
Mortgage Corporation (FHLMC), Federal National Mortgage Association
(FNMA) or Government National Mortgage Corporation (GNMA). Private issuer
residential MBS were issued by entities other than FHLMC, FNMA or GNMA.
The agency insured project loans held by the Company consist of
participation interests in mortgage loans guaranteed by the Federal
Housing Administration (FHA). The asset backed securities held by the
Company consist of pass-through securities collateralized by manufactured
housing installment sale contracts. The non-U.S. sovereign securities
held by the Company consist of unsecured floating rate notes issued by a
foreign government. The Company's securities available for sale are
subject to credit, interest rate and/or prepayment risks.
The yield to maturity on the Company's CMBS interests and residential MBS
interests depends on, among other things, the rate and timing of
principal payments (including prepayments, repurchases, defaults and
liquidations), the pass-through rate and interest rate fluctuations. The
subordinated CMBS interests owned by the Company provide credit support
to the more senior interests of the related commercial securitization.
Cash flow from the mortgages underlying the CMBS interests generally is
allocated first to the senior interests, with the most senior interest
having a priority entitlement to cash flow. Then, any remaining cash flow
is allocated generally among the other CMBS interests in order of their
relative seniority. To the extent there are defaults and unrecoverable
losses on the underlying mortgages, resulting in reduced cash flows, the
most subordinated CMBS interest will bear this loss first. To the extent
there are losses in excess of the most subordinated interest's stated
entitlement to principal and interest, then the remaining CMBS interests
will bear such losses in order of their relative subordination.
As of September 30, 1998 the anticipated weighted average unleveraged
yield to maturity of the Company's subordinated CMBS interests for GAAP
purposes was 9.68% per annum. The Company's anticipated yields to
maturity on its subordinated CMBS interests are based upon a number of
assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of these include interest
payment shortfalls due to delinquencies on the underlying mortgage loans,
and the timing and magnitude of credit losses on the mortgage loans
underlying the subordinated CMBS that are a result of the general
condition of the real estate market (including competition for tenants
and their related credit quality) and changes in market rental rates. As
these uncertainties and contingencies are difficult to predict and are
subject to future events which may alter these assumptions, no assurance
can be given that the anticipated yields to maturity, discussed above and
elsewhere, will be achieved.
The agency adjustable rate residential MBS held by the Company are
subject to periodic and lifetime caps that limit the amount such
securities' interest rates can change during any given period and over
the life of the loan. At September 30, 1998, the average periodic cap on
the agency adjustable rate residential MBS was 1.9% per annum and the
average lifetime cap was equal to 12.3%.
Agency interest only residential MBS are held primarily to reduce the
interest rate sensitivity of the Company's portfolio of securities
available for sale.
At September 30, 1998, the unamortized net discount on securities
available for sale (excluding interest only securities) was $202,621,
which represented 17.1% of the then remaining face amount of such
securities. In May 1998, $16,750 face amount of U.S. Treasury securities
were sold for proceeds net of termination costs on the related hedge of
$17,133, which equaled the approximate amortized cost of such securities.
During the three months ended September 30, 1998, $16,368 notional amount
of agency interest only residential MBS interests, $50,410 face amount of
investment grade rated private issuer fixed rate residential MBS
interests and $3,000 face amount of non-investment grade rated non-U.S.
sovereign securities were sold for total proceeds of $73,524, which
exceeded the total amortized cost of such securities by $22.
The Company sold a substantial portion of its portfolio of securities
available for sale subsequent to September 30, 1998. See Note 12.
Note 4 COMMERCIAL MORTGAGE LOAN
On August 26, 1998, the Company along with a syndicate of other lenders
originated a loan secured by a second lien on five luxury hotels in
London, England and vicinity. The loan has a five-year maturity and may
be prepaid at any time. The loan is denominated in pounds sterling and
bears interest at a rate based upon the London Interbank Offered Rate
(LIBOR). The Company's investment in the loan is carried at amortized
cost. The amortized cost, estimated fair value and certain additional
information with respect to the Company's investment in the loan at
September 30, 1998 (at the exchange rate in effect on that date) are
summarized as follows:
Interest Principal Unamortized Amortized
Rate Balance Discount Cost
-----------------------------------------------
11.43% $36,501 $91 $36,410
At September 30, 1998, the entire principal balance of the Company's
investment in the loan was pledged to secure line of credit borrowings
included in short-term borrowings. The loan was current in payment status
at September 30, 1998.
Note 5 COMMON STOCK
The Company was initially capitalized with the sale of 13,333 shares of
common stock on March 5, 1998, for a total of $200. In April and July
1998, the Company redeemed all such shares from its initial stockholder
in two transactions at the then current market price of such shares, or
approximately $201 in the aggregate. The redeemed shares were retired.
The Company received commitments on March 23, 1998 for the purchase, in
private placements, of 1,365,198 shares of common stock at $13.95 per
share for a total of $19,045. The sale of these shares was consummated at
the time of the closing of the Company's initial public offering.
On March 27, 1998, the Company completed its initial public offering of
common stock. The Company issued 20,000,000 shares of common stock at a
price of $15 per share and received proceeds of $279,000, net of
underwriting discounts and commissions. Offering costs in connection with
the public offering amounting to $1,073 have been charged against the
proceeds of the offering.
In June 1998, the Company registered with the Securities and Exchange
Commission up to 2,000,000 shares of common stock in connection with a
new Dividend Reinvestment and Stock Purchase Plan (the "Plan"). The Plan
allows investors the opportunity to purchase additional shares of the
Company's common stock through the reinvestment of the Company's
dividends, optional cash payments and initial cash investments. Offering
costs in connection with the establishment of the Plan amounting to $30
have been charged against additional paid-in capital. As of September 30,
1998, no shares had been issued under the Plan.
In July 1998, the Board of Directors of the Company approved the
repurchase of up to 10% of the then outstanding number of shares of the
Company's common stock. In September 1998, the Board of Directors
approved the repurchase of an additional 2,000,000 shares of the
Company's common stock. Pursuant to these repurchase authorizations, the
Company repurchased 1,380,100 shares of its common stock for $15,843 in
open market transactions during the three months ended September 30,
1998. Such purchases were made at an average price per share of $11.43
(excluding commissions). The remaining number of shares authorized for
repurchase is 2,756,419.
On June 15, 1998, the Company declared distributions to its stockholders
totaling $5,769 or $0.27 per share, which were paid on July 15, 1998 to
stockholders of record on June 30, 1998. On September 2, 1998, the
Company declared distributions to its stockholders totaling $7,195 or
$0.36 per share, which were paid on October 15, 1998 to stockholders of
record on September 30, 1998. For Federal income tax purposes, all
distributions paid to date are expected to be ordinary income to the
Company's stockholders.
Note 6 TRANSACTIONS WITH AFFILIATES
The Company has entered into a Management Agreement (the "Management
Agreement") with BlackRock Financial Management, Inc. (the "Manager"), a
majority owned indirect subsidiary of PNC Bank Corp. ("PNC") and the
employer of certain directors and officers of the Company, under which
the Manager manages the Company's day-to-day operations, subject to the
direction and oversight of the Company's Board of Directors. The Company
will pay the Manager an annual base management fee equal to a percentage
of the Average Invested Assets of the Company as further defined in the
Management Agreement. The base management fee is equal to 1% per annum of
the Average Invested Assets rated less than BB- or not rated, 0.75% of
Average Invested Assets rated BB- to BB+, and 0.35% of Average Invested
Assets rated above BB+.
The Company accrued $1,374 and $2,244 in base management fees in
accordance with the terms of the Management Agreement for the three
months ended September 30, 1998 and for the period March 24, 1998 through
September 30, 1998, respectively. During the three months ended September
30, 1998, the Company paid the $870 in Management Fees that had accrued
for the period March 24, 1998 through June 30, 1998. The remaining amount
payable for base management fees is included in accrued expenses,
payables and other liabilities in the statement of financial condition.
During the three months ended September 30, 1998, the Company reimbursed
the Manager $134 for costs and expenses incurred on behalf of the Company
in accordance with the terms of the Management Agreement.
The Company will also pay the Manager, as incentive compensation, an
amount equal to 25% of the Funds from Operations of the Company plus
gains (minus losses) from debt restructuring and sales of property,
before incentive compensation, in excess of the amount that would produce
an annualized Return on Equity equal to 3.5% over the Ten-Year U.S.
Treasury Rate as further defined in the Management Agreement. For
purposes of the incentive compensation calculation, equity is generally
defined as proceeds from issuance of common stock before underwriting
discounts and commissions and other costs of issuance.
The Company did not accrue for or pay the Manager any incentive
compensation for the three months ended September 30, 1998 or for the
period March 24, 1998 through September 30, 1998.
The Company may also grant stock options to the Manager, directors,
officers and any key employees of the Company, directors, officers and
key employees of the Manager and to any other individual or entity
performing services for the Company. Options granted during the three
months ended September 30, 1998 and during the period March 24, 1998
through September 30, 1998 are disclosed in Note 7.
The Company received a commitment from PNC Investment Corp., a wholly
owned indirect subsidiary of PNC, on March 23, 1998 for the purchase, in
a private placement, of 648,352 shares of common stock at $13.95 per
share for a total of $9,045. The sale of these shares was consummated at
the time of the closing of the Company's initial public offering.
During the three months ended September 30, 1998, the Company purchased,
in private placements, 11 classes of subordinated CMBS interests for a
total of $142,855 in two securitization transactions in which PNC Bank,
N.A. ("PNC Bank"), a wholly owned subsidiary of PNC, and/or Midland Loan
Services, Inc. ("Midland"), a wholly owned indirect subsidiary of PNC,
participated as sellers of a portion of the commercial mortgage loans
underlying the CMBS interests.
The Company accrued $1,121 and $1,226 with respect to due diligence costs
incurred on behalf of the Company by PNC Bank and Midland for the three
months ended September 30, 1998 and for the period March 24, 1998 through
September 30, 1998, respectively. During the three months ended September
30, 1998, the Company paid PNC Bank and Midland $606 of such costs. The
remaining amount payable to PNC Bank and Midland for such costs is
included in accrued expenses, payables and other liabilities in the
statement of financial condition.
Note 7 STOCK OPTIONS
The Company has adopted a stock option plan (the "1998 Stock Option
Plan") that provides for the grant of both qualified incentive stock
options that meet the requirements of Section 422 of the Code, and
non-qualified stock options, stock appreciation rights and dividend
equivalent rights. Stock options may be granted to the Manager,
directors, officers and any key employees of the Company, directors,
officers and key employees of the Manager and to any other individual or
entity performing services for the Company.
The exercise price for any stock option granted under the 1998 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. Each option
must terminate no more than ten years from the date it is granted.
Subject to anti-dilution provisions for stock splits, stock dividends and
similar events, the 1998 Stock Option Plan authorizes the grant of
options to purchase an aggregate of up to 2,470,453 shares of common
stock.
On March 27, 1998, pursuant to the 1998 Stock Option Plan, options to
purchase 1,313,967 shares of the Company's common stock were granted to
certain officers, directors and employees of the Company and the Manager
and options to purchase 324,176 shares of the Company's common stock were
granted to PNC Investment Corp. The exercise price of these options is
$15 per share. The remaining contractual life of each option is
approximately 9.5 years. The options vest in four equal installments on
March 27, 1999, March 27, 2000, March 27, 2001 and March 27, 2002.
In addition to the options granted pursuant to the 1998 Stock Option
Plan, on March 27, 1998 options to purchase 246,544 shares of the
Company's common stock were granted to certain officers, directors and
employees of the Company and the Manager. The exercise price of these
options is $13.95 per share. The remaining contractual life of each
option is approximately 0.5 years. The options became exercisable on
September 30, 1998.
No options were granted, exercised or forfeited during the three months
ended September 30, 1998. No options were exercised or forfeited during
the period March 24, 1998 through September 30,1998.
Note 8 SHORT-TERM BORROWINGS
At September 30, 1998, the Company's short-term borrowings consisted of
line of credit borrowings and reverse repurchase agreements.
On August 21, 1998, the Company entered into a Master Assignment
Agreement and related Note, which provide financing for the Company's
investments. The agreement, which is with Merrill Lynch Mortgage Capital
Inc., permits the Company to borrow up to $400,000 and terminates August
20, 1999. The agreement requires assets to be pledged as collateral,
which may consist of rated CMBS interests, rated residential MBS
interests, residential and commercial mortgage loans, and certain other
assets. Outstanding borrowings against this line of credit bear interest
at a LIBOR based rate.
The Company has entered into reverse repurchase agreements to finance
most of its securities available for sale that are not financed under its
line of credit. The reverse repurchase agreements are collateralized by
most of the Company's securities available for sale and bear interest
rates that have historically moved in close relationship to LIBOR.
Certain information with respect to the Company's short-term borrowings
at September 30, 1998 is summarized as follows:
<TABLE>
<CAPTION>
Reverse Total
Line of Repurchase Short-Term
Credit Agreements Borrowings
---------------------------------------
<S> <C> <C> <C>
Outstanding borrowings $78,967 $841,617 $ 920,584
Weighted average borrowing rate 7.20% 6.09% 6.18%
Weighted average remaining maturity 324 days 47 days 70 days
Estimated fair value of assets pledged $114,905 $908,961 $1,023,866
</TABLE>
At September 30, 1998, $27,103 of borrowings outstanding under the line
of credit were denominated in pounds sterling.
At September 30, 1998, the Company's short-term borrowings had the
following remaining maturities:
Reverse Total
Line of Repurchase Short-Term
Credit Agreements Borrowings
---------------------------------------
Within 30 days - $549,823 $549,823
30 to 59 days - 106,728 106,728
Over 59 days $78,967 185,066 264,033
=======================================
$78,967 $841,617 $920,584
=======================================
Under the line of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
market value. A reduction in the value of its pledged assets will require
the Company to provide additional collateral or fund margin calls. From
time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.
The Company repaid a substantial portion of its borrowings under reverse
repurchase agreements subsequent to September 30, 1998. See Note 12.
Note 9 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the amortized cost and estimated fair values
of the Company's financial instruments at September 30, 1998:
Estimated
Amortized Fair
Cost Value
------------------------
Assets
Securities available for sale $1,094,079 $1,040,290
Commercial mortgage loan $ 36,410 $ 36,136
Liabilities
Hedging instruments - $ 5,340
SFAS 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 value of the Company's securities available for sale, commercial
mortgage loan and hedging instruments are based on market prices provided
by certain dealers who make markets in these financial instruments. The
fair values reported reflect estimates and may not necessarily be
indicative of the amounts the Company could realize in a current market
exchange. For securities available for sale that were sold subsequent to
September 30, 1998 (see Note 12), the actual sale price was used as the
fair value at September 30, 1998, if such sale price was lower that the
market prices obtained from dealers at September 30, 1998. The carrying
amounts of all other asset and liability accounts in the statements of
financial condition approximate fair value because of the short-term
nature of these accounts.
Note 10 HEDGING INSTRUMENTS
At September 30, 1998, the Company's hedging instruments included an
interest rate swap transaction and a forward currency exchange contract.
The Company has entered into an interest rate swap transaction with a
notional amount of $70,000. Under the interest rate swap agreement, the
Company will receive quarterly payments of interest based on three-month
LIBOR and will remit semi-annual payments based on a fixed interest rate
of approximately 6.19%, in each case based upon a notional balance of
$70,000. The swap became effective on May 19, 1998 and has a stated
termination date of May 19, 2008. In certain circumstances, the Company
may be required to provide collateral to secure its obligations under the
interest rate swap agreement, or may be entitled to receive collateral
from the counterparty to the swap agreement. At September 30, 1998, no
collateral was required under the interest rate swap agreement. At
September 30, 1998, the interest rate payable to the Company by the
counterparty to the swap transaction was approximately 5.69%. The Company
terminated this swap transaction subsequent to September 30, 1998. See
Note 12.
The Company has entered into a forward currency exchange contract
pursuant to which it has agreed to exchange (pound)5,758 (pounds
sterling) for $9,337 (U.S. dollars) on March 31, 1999. In certain
circumstances, the Company may be required to provide collateral to
secure its obligations under the forward currency exchange contract, or
may be entitled to receive collateral from the counterparty to the
forward currency exchange contract. At September 30, 1998, no collateral
was required under the forward currency exchange contract.
The following table presents the amortized cost and estimated fair values
of the Company's hedging instruments at September 30, 1998:
Estimated
Amortized Fair
Cost Value
----------------------
Interest rate swap $ - $(4,981)
Forward currency exchange contract - (359)
======================
Total hedging instruments $ - $(5,340)
======================
Note 11 COMMITMENTS AND CONTINGENCIES
At September 30, 1998, the Company had a commitment outstanding to
originate a $35,000 floating rate commercial real estate construction
loan secured by a second mortgage. Funding of the commitment is subject
to satisfaction by the borrower of various closing conditions. The
Company received a $175 commitment fee relating to the commitment, which
has been deferred and included in accrued expenses, payables and other
liabilities. The fee will be added to the basis of the related loan when
it is funded.
Note 12 SUBSEQUENT EVENTS
Subsequent to September 30, 1998, the Company sold certain of its
securities available for sale at their carrying value of approximately
$622,000 and terminated its interest rate swap. These transactions
resulted in a realized loss of approximately $21,000. The proceeds from
the sale were used primarily to repay the Company's borrowings under
reverse repurchase agreements and to increase its cash position. Of the
securities sold, approximately $95,000 were acquired subsequent to
September 30, 1998, and accordingly, are not included in the pro forma
effects described below.
Had these transactions occurred on September 30, 1998, the pro forma
effect on the September 30, 1998 statement of financial condition would
be a decrease in total assets from $1,160,977 to approximately $660,000,
a decrease in total liabilities from $936,606 to approximately $436,000.
Total stockholders' equity would remain the same. The decrease in total
assets would be a result paying for the termination of the interest rate
swap and selling: all of the Company's agency adjustable rate residential
MBS interests, agency interest only residential MBS interests, investment
grade rated asset backed securities and non-investment grade rated
non-U.S. sovereign securities; substantially all of the Company's
investment grade rated senior interest only CMBS interests, agency fixed
rate residential MBS interests and agency insured project loans; and a
substantial portion of the Company's investment grade rated private
issuer fixed rate residential MBS interests. The decrease in liabilities
would be a result of repaying the reverse repurchase agreement borrowings
that financed the securities sold and terminating the interest rate swap.
Had these transactions occurred on September 30, 1998, the pro forma
effect on the statement of operations for the three months ended
September 30, 1998 would be a decrease in net income from $6,453 to a net
loss of approximately $(13,547) and a decrease in net income per share
from $0.31 to a net loss per share of approximately $(0.66), and for the
period March 24, 1998 through September 30, 1998 would be a decrease in
net income from $12,007 to a net loss of approximately $(7,993) and a
decrease in net income per share from $0.57 to a net loss per share of
approximately $(0.38), in each case as a result of the realized loss on
the sale of the securities.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General: The Company was organized in November 1997 to invest in a
diversified portfolio of multifamily, commercial and residential mortgage
loans, mortgage-backed securities and other real estate related assets in
the U.S. and non-U.S. markets. The Company expects to generate income for
distribution to its stockholders primarily from the net earnings derived
from its investments in real estate related assets. The Company intends
to operate in a manner that permits it to maintain its status as a REIT
for Federal income tax purposes.
In March 1998, the Company received $297.0 million of net proceeds from
the initial public offering of 21,365,198 shares of its common stock. As
of September 30, 1998, the Company had invested, net of repayments to
date, $1.2 billion to acquire its initial portfolio of securities
available for sale and its commercial mortgage loan.
The following discussion should be read in conjunction with the Interim
Financial Statements and related Notes included in Item 1 hereof. Dollar
amounts are expressed in thousands, other than per share amounts.
Market Conditions: The third quarter of 1998 can be characterized as one
of the most dramatic periods of credit spread widening in recent history.
Economic uncertainty in Asia and Russia caused uneasiness among investors
and a flight to quality - investors sold off holdings of credit-sensitive
securities in favor of Treasuries. This caused credit spreads to widen
substantially and Treasury yields to fall.
These factors combined to cause a significant decline in the market value
of the Company's investment portfolio. The Company's holdings of
subordinated commercial mortgage-backed securities ("CMBS") were
particularly affected, inasmuch as they represent the first classes in a
securitization transaction to be affected by credit losses. The
unrealized gain (loss) on the Company's holdings of subordinated CMBS
declined from $3,012 at June 30, 1998 to $(39,543) at September 30, 1998.
These declines have occurred despite the Company's belief that there has
been no fundamental change in the credit quality of the underlying loans.
The fall in Treasury yields during the three months ended September 30,
1998 resulted in a further "inversion" of the yield curve, that is, the
excess of short-term interest rates over long-term interest rates became
more pronounced during such period. Average one-month LIBOR for the three
months ended September 30, 1998 was 5.62% and for the period March 24,
1998 through September 30, 1998 was 5.64%. The average ten-year U.S.
Treasury yield for the three months ended September 30, 1998 was 5.20%
and for the period March 24, 1998 through September 30, 1998 was 5.40%.
The excess of one-month LIBOR over the ten-year U.S. Treasury yield was
0.12% on March 24, 1998, 0.22% on June 30, 1998 and 0.96% on September
30, 1998.
The Company's earnings depend, in part, on the relationship between
long-term interest rates and short-term interest rates. The Company's
investments bear interest at fixed rates determined by reference to the
yields of medium- or long-term U.S. Treasury securities or at adjustable
rates determined by reference (with a lag) to the yields on various
short-term instruments. The Company's borrowings bear interest rates that
have historically moved in close relationship to LIBOR. To the extent
that interest rates on the Company's borrowings increase without an
offsetting increase in the interest rates earned on the Company's
investments, the Company's earnings could be negatively affected.
Recent Events: To respond to reduced liquidity in the financing markets
and spread widening in the credit-sensitive sectors of the debt markets,
the Company sold approximately $622,000 in market value of assets since
September 30, 1998. The proceeds from these sales were applied primarily
to reduce the Company's borrowings under reverse repurchase agreements
and to increase its cash position. As a result of these transactions, the
Company's debt to equity ratio has declined from approximately 4.2 to 1
at September 30, 1998 to approximately 2.0 to 1 currently.
The Company incurred a financial statement (GAAP) realized loss on the
investments sold and termination of its interest rate swap since
September 30, 1998 of approximately $21,000. As a result, the Company
expects to record a GAAP loss for the fourth quarter of 1998. In
addition, the reduction in the Company's balance sheet will cause future
net interest income from investments to be lower than previously
expected. The Company anticipates that the decline in future net interest
income under current market conditions could be in the range of 20 to 30
percent below the level posted in the third quarter.
Depending on market conditions, the Company may sell the remainder of its
securities available for sale other than subordinated CMBS over the next
several quarters. The Company does not anticipate that such sales, were
they to occur, would have a significant additional effect on its
stockholders' equity or earnings.
Funds From Operations: Most industry analysts, including the Company,
consider FFO an appropriate supplementary measure of operating
performance of a REIT. In general, FFO adjusts net income for non-cash
charges such as depreciation, certain amortization expenses and gains or
losses from debt restructuring and sales of property. However, FFO does
not represent cash provided by operating activities in accordance with
GAAP and should not be considered an alternative to net income as an
indication of the results of the Company's performance or to cash flows
as a measure of liquidity.
In 1995, the National Association of Real Estate Investment Trusts
("NAREIT") established new guidelines clarifying its definition of FFO
and requested that REITs adopt this new definition beginning in 1996. The
Company computes FFO in accordance with the definition recommended by
NAREIT. The Company believes that the exclusion from FFO of gains or
losses from sales of property was not intended to address gains or losses
from sales of securities as it applies to the Company. Accordingly, the
Company includes gains or losses from sales of securities in its
calculation of FFO.
The Company's FFO for the three months ended September 30, 1998 was
$6,453, or $0.31 per share (basic and diluted), and for the period March
24, 1998 through September 30, 1998 was $12,007, or $0.57 per share
(basic and diluted), which was the same as its reported GAAP net income
for such periods.
Results of Operations
Net income for the three months ended September 30, 1998 was $6,453, or
$0.31 per share (basic and diluted), and for the period March 24, 1998
through September 30, 1998 was $12,007, or $0.57 per share (basic and
diluted).
Interest Income: The following tables sets forth information regarding
the total amount of income from interest-earning assets and the resultant
average yields. Information is based on daily average balances during the
reported periods.
<TABLE>
<CAPTION>
For the Three Months Ended September 30, 1998
--------------------------------------------------
Interest Average Annualized
Income Balance Yield
---------------- ---------------- ----------------
<S> <C> <C> <C>
Securities available for sale $ 19,318 $1,047,990 7.31%
Commercial mortgage loan 408 14,462 11.19
Cash and cash equivalents 63 4,436 5.61
================ ================ ================
Total $ 19,789 $1,066,888 7.36%
================ ================ ================
For the Period March 24, 1998
Through September 30, 1998
--------------------------------------------------
Interest Average Annualized
Income Balance Yield
---------------- ---------------- ----------------
Securities available for sale $ 30,209 $ 789,280 7.31%
Commercial mortgage loan 408 6,966 11.19
Cash and cash equivalents 216 7,413 5.57
================ ================ ================
Total $ 30,833 $ 803,659 7.33%
================ ================ ================
</TABLE>
The Company sold a substantial portion of its portfolio of securities
available for sale subsequent to September 30, 1998 and, as a result, the
amount of the Company's interest income for comparable periods in the
near future is likely to be significantly less than the amounts reported
above. See "Recent Events" above and Note 12 to the Interim Financial
Statements included in Item 1 hereof.
Expenses: The following tables set forth information regarding the total
amount of interest expense from short-term borrowings (including the net
amount payable under the interest rate swap agreement allocated pro rata
to each category of short-term borrowings) and the resultant average
yields. Information is based on daily average balances during the
reported periods.
<TABLE>
<CAPTION>
For the Three Months Ended September 30, 1998
--------------------------------------------------
Interest Average Annualized
Expense Balance Yield
---------------- ---------------- ----------------
<S> <C> <C> <C>
Reverse repurchase agreements $11,460 $ 763,529 5.96%
Line of credit borrowings 248 11,118 8.81
---------------- ---------------- ----------------
Total $ 11,708 $ 774,647 6.00%
================ ================ ================
For the Period March 24, 1998
Through September 30, 1998
--------------------------------------------------
Interest Average Annualized
Expense Balance Yield
---------------- ---------------- ----------------
Reverse repurchase agreements $ 15,842 $ 515,965 5.87%
Line of credit borrowings 248 5,355 8.85
---------------- ---------------- ----------------
Total $ 16,090 $ 521,320 5.90%
================ ================ ================
</TABLE>
The Company repaid a substantial portion of its borrowings under reverse
repurchase agreements subsequent to September 30, 1998 and, as a result,
the amount of the Company's interest expense for comparable periods in
the near future is likely to be significantly less than the amounts
reported above. See "Recent Events" above and Note 12 to the Interim
Financial Statements included in Item 1 hereof.
Management fees of $1,374 for the three months ended September 30, 1998
and $2,244 for the period March 24, 1998 through September 30, 1998 were
comprised solely of the base management fee paid to the Manager for such
periods (as provided pursuant to the management agreement between the
Manager and the Company), as the Manager earned no incentive fee for such
periods. Other expenses of $244 for the three months ended September 30,
1998 and $482 for the period March 24, 1998 through September 30, 1998
were comprised of accounting agent fees, custodial agent fees, directors'
fees, insurance premiums and other miscellaneous expenses. The foreign
currency loss of $32 for the three months ended September 30, 1998 and
for the period March 24, 1998 through September 30, 1998 relates to the
Company's net investment in a commercial mortgage loan denominated in
pounds sterling.
Net Interest Margin: Net interest margin is annualized net interest
income divided by the average daily balance of interest-earning assets.
Net interest income is total interest income less interest expense
(including the net amount payable under the interest rate swap
agreement). Net interest margin was 3.00% for the three months ended
September 30, 1998 and 3.51% for the period March 24, 1998 through
September 30, 1998.
Distributions Declared and Distributions in Excess of Earnings: On June
15, 1998, the Company declared distributions to its stockholders totaling
$5,769 or $0.27 per share. These distributions were paid on July 15, 1998
to stockholders of record on June 30, 1998. On September 2, 1998, the
Company declared distributions to its stockholders totaling $7,195 or
$0.36 per share. These distributions were paid on October 15, 1998 to
stockholders of record on September 30, 1998. Distributions paid to date
covered the Company's undistributed tax basis income for the period March
24, 1998 through September 30, 1998. As a result of these distributions,
the Company incurred distributions in excess of earnings of $957 as of
September 30, 1998. For Federal income tax purposes, all distributions
paid to date are expected to be ordinary income to the Company's
stockholders.
Tax Basis Income and GAAP Net Income: Net income as calculated for tax
purposes (tax basis income) was $7,421, or $0.36 per share (basic and
diluted), for the three months ended September 30, 1998 and $13,246, or
$0.63 per share (basic and diluted), for the period March 24, 1998
through September 30, 1998, compared to net income as calculated in
accordance with generally accepted accounting principles (GAAP) of
$6,453, or $0.31 per share (basic and diluted), for the three months
ended September 30, 1998 and $12,007, or $0.57 per share (basic and
diluted), for the period March 24, 1998 through September 30, 1998.
Differences between tax basis income and GAAP net income arise for
various reasons. For example, in computing income from its subordinated
CMBS interests for GAAP purposes, the Company takes into account
estimated credit losses on the underlying loans whereas for tax basis
income purposes, only actual credit losses are taken into account. Loan
commitment fees are recognized over the life of the related loan for GAAP
purposes but are included in tax basis income upon receipt. In addition,
certain general and administrative expenses may differ due to differing
treatment of the deductibility of such expenses for tax basis income.
Also, differences could arise in the treatment of premium and discount
amortization on the Company's securities available for sale.
A reconciliation of GAAP net income to tax basis income is as follows:
<TABLE>
<CAPTION>
For the Period
For the Three March 24, 1998
Months Ended Through
September 30, 1998 September 30, 1998
--------------------- -------------------
<S> <C> <C>
GAAP net income $ 6,453 $ 12,007
Subordinate CMBS interests income 628 771
differentials
Income from loan commitment fees 175 175
General and administrative expense
differences 148 276
Other 17 17
=================== ==================
Tax basis income $ 7,421 $ 13,246
=================== ==================
</TABLE>
Changes in Financial Condition
Securities Available for Sale: At September 30, 1998, an aggregate of
$53,789 in unrealized losses on securities available for sale was
included as a component of accumulated other comprehensive income in
stockholders' equity.
The Company's securities available for sale, which are carried at
estimated fair value, included the following at September 30, 1998:
Estimated
Security Description Fair Value Percentage
------------------------------------------------- ------------- -----------
Commercial mortgage-backed securities ("CMBS")
interests:
Investment grade rated senior interest only $ 91,627 8.8%
interests
Non-investment grade rated subordinated 281,892 27.1
interests
Non-rated subordinated interests 30,627 2.9
------------- -----------
Total CMBS interests 404,146 38.8
------------- -----------
Single-family residential mortgage-backed
securities ("residential MBS") interests:
Agency adjustable rate 197,148 19.0
Agency fixed rate 55,275 5.3
Agency interest only 7,769 0.8
Investment grade rated private issuer fixed rate 320,770 30.8
------------- -----------
Total residential MBS interests 580,962 55.9
------------- -----------
Agency insured project loans 28,177 2.7
Investment grade rated asset backed securities 13,537 1.3
Non-investment grade rated non-U.S. sovereign
securities 13,468 1.3
============= ===========
Total securities available for sale $1,040,290 100.0%
============= ===========
In May 1998, $16,750 face amount of U.S. Treasury securities were sold
for proceeds net of termination costs on the related hedge of $17,133,
which equaled the approximate amortized cost of such securities. During
the three months ended September 30, 1998, $16,368 notional amount of
agency interest only residential MBS interests, $50,410 face amount of
investment grade rated private issuer fixed rate residential MBS
interests and $3,000 face amount of non-investment grade rated non-U.S.
sovereign securities were sold for total proceeds of $73,524, which
exceeded the total amortized cost of such securities by $22.
The Company sold a substantial portion of its portfolio of securities
available for sale subsequent to September 30, 1998. See "Recent Events"
above and Note 12 to the Interim Financial Statements included in Item 1
hereof.
Short-Term Borrowings: To date, the Company's debt has consisted of line
of credit borrowings and reverse repurchase agreements, which have been
collateralized by a pledge of most of the Company's securities available
for sale and its commercial mortgage loan. The Company's financial
flexibility is affected by its ability to renew or replace on a
continuous basis its maturing short-term borrowings. To date, the Company
has obtained short-term financing in amounts and at interest rates
consistent with the Company's financing objectives.
Under the line of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
market value. A reduction in the value of its pledged assets will require
the Company to provide additional collateral or fund margin calls. From
time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.
The following tables set forth information regarding the Company's
short-term borrowings.
<TABLE>
<CAPTION>
For the Three Months Ended September 30, 1998
--------------------------------------------------
Average Maximum Range of
Balance Balance Maturities
---------------- ---------------- ----------------
<S> <C> <C> <C>
Reverse repurchase agreements $ 763,529 $ 841,617 1 to 180 days
Line of credit borrowings 11,118 78,967 324 to 359 days
---------------- ---------------- ----------------
Total $ 774,647 $ 920,584 1 to 359 days
================ ================ ================
For the Period March 24, 1998
Through September 30, 1998
--------------------------------------------------
Average Maximum Range of
Balance Balance Maturities
---------------- ---------------- ----------------
Reverse repurchase agreements $ 515,965 $ 841,617 1 to 180 days
Line of credit borrowings 5,355 78,967 324 to 359 days
---------------- ---------------- ----------------
Total $ 521,320 $ 920,584 1 to 359 days
================ ================ ================
</TABLE>
The Company repaid a substantial portion of its borrowings under reverse
repurchase agreements subsequent to September 30, 1998. See "Recent
Events" above and Note 12 to the Interim Financial Statements included in
Item 1 hereof.
Hedging instruments: At September 30, 1998, the Company's hedging
instruments included an interest rate swap transaction and a forward
currency exchange contract.
The Company has entered into an interest rate swap transaction with a
notional amount of $70,000. Under the interest rate swap agreement, the
Company will receive quarterly payments of interest based on three-month
LIBOR and will remit semi-annual payments based on a fixed interest rate
of approximately 6.19%, in each case based upon a notional balance of
$70,000. The swap became effective on May 19, 1998 and has a stated
termination date of May 19, 2008. In certain circumstances, the Company
may be required to provide collateral to secure its obligations under the
interest rate swap agreement, or may be entitled to receive collateral
from the counterparty to the swap agreement. At September 30, 1998, no
collateral was required under the interest rate swap agreement. At
September 30, 1998, the interest rate payable to the Company by the
counterparty to the swap transaction was approximately 5.69%. The Company
terminated this swap transaction subsequent to September 30, 1998. See
"Recent Events" above and Note 12 to the Interim Financial Statements
included in Item 1 hereof.
The Company has entered into a forward currency exchange contract
pursuant to which it has agreed to exchange (pound)5,758 (pounds
sterling) for $9,337 (U.S. dollars) on March 31, 1999. In certain
circumstances, the Company may be required to provide collateral to
secure its obligations under the forward currency exchange contract, or
may be entitled to receive collateral from the counterparty to the
forward currency exchange contract. At September 30, 1998, no collateral
was required under the forward currency exchange contract.
Hedging instruments are carried in the statement of financial condition
at estimated liquidation value. At September 30, 1998, an aggregate of
$4,981 in unrealized losses on the interest rate swap was included as a
component of accumulated other comprehensive income in stockholders'
equity. During the three months ended September 30, 1998 and during the
period March 24, 1998 through September 30, 1998, an aggregate of $359 in
losses on the forward currency exchange contract was included as a
component of foreign currency loss in the statement of operations.
Capital Resources and Liquidity: Liquidity is a measurement of the
Company's ability to meet potential cash requirements, including ongoing
commitments to repay borrowings, fund investments, loan acquisition and
lending activities and for other general business purposes. The primary
sources of funds for liquidity consist of short-term borrowings,
principal and interest payments on and maturities of securities available
for sale and the commercial mortgage loan, and proceeds from sales
thereof.
The Company's operating activities provided cash flows of $10,676 during
the period March 24, 1998 through September 30, 1998. During the
foregoing period cash flows from operating activities were used primarily
to purchase securities available for sale.
The Company's investing activities used cash flows totaling $1,199,965
during the period March 24, 1998 through September 30, 1998. During the
foregoing period, cash was used in investing activities primarily to
purchase securities available for sale.
The Company's financing activities provided $1,195,713 during the period
March 24, 1998 through September 30, 1998 and consisted primarily of net
borrowings under short-term borrowings and net proceeds from the issuance
of 21,365,198 shares of common stock.
Although the Company's portfolio of securities available for sale was
acquired at a net discount to the face amount of such securities, the
Company has received to date and expects to continue to receive
sufficient coupon income in cash from its portfolio to fund distributions
to stockholders as necessary to maintain its REIT status.
The Company's ability to execute its business strategy depends to a
significant degree on its ability to obtain additional capital. Factors
which could affect the Company's access to the capital markets, or the
costs of such capital, include changes in interest rates, general
economic conditions and perception in the capital markets of the
Company's business, covenants under the Company's current and future
credit facilities, results of operations, leverage, financial conditions
and business prospects. Except as discussed herein, management is not
aware of any other trends, events, commitments or uncertainties that may
have a significant effect on liquidity.
REIT Status: The Company intends to elect to be taxed as a REIT and to
comply with the provisions of the Internal Revenue Code of 1986, as
amended, with respect thereto. Accordingly, the Company will 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. The Company may, however, be subject to tax at normal
corporate rates on net income or capital gains not distributed.
Investment Company Act: The Company 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"). Under the
Investment Company Act, a non-exempt entity that is an investment company
is required to register with the Securities and Exchange Commission
("SEC") and is subject to extensive, restrictive and potentially adverse
regulation relating to, among other things, operating methods,
management, capital structure, dividends and transactions with
affiliates. 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 by the staff of the SEC, to
qualify for this exemption, the Company, among other things, must
maintain at least 55% of its assets in Qualifying Interests. Pursuant to
such SEC staff interpretations, certain of the Company's interests in
agency pass-through and mortgage-backed securities and agency insured
project loans are Qualifying Interests. In general, the Company will
acquire subordinated interests in commercial mortgage-backed securities
("subordinated CMBS interests") only when such mortgage securities are
collateralized by pools of first mortgage loans, when the Company can
monitor the performance of the underlying mortgage loans through loan
management and servicing rights, and when the Company has appropriate
workout/foreclosure rights with respect to the underlying mortgage loans.
When such arrangements exist, the Company believes that the related
subordinated CMBS interests constitute Qualifying Interests for purposes
of the Investment Company Act. Therefore, the Company believes that it
should not be required to register as an "investment company" under the
Investment Company Act as long as it continues to invest primarily in
such subordinated CMBS interests and/or in other Qualifying Interests.
However, if the SEC or its staff were to take a different position with
respect to whether the Company's subordinated CMBS interests constitute
Qualifying Interests, the Company could be required to modify its
business plan so that either (i) it would not be required to register as
an investment company or (ii) it would comply with the Investment Company
Act and be able to register as an investment company. In such event, (i)
modification of the Company's business plan so that it would not be
required to register as an investment company would likely entail a
disposition of a significant portion of the Company's subordinated CMBS
interests or the acquisition of significant additional assets, such as
agency pass-through and mortgage-backed securities, which are Qualifying
Interests or (ii) modification of the Company's business plan to register
as an investment company, which would result in significantly increased
operating expenses and would likely entail significantly reducing the
Company's indebtedness (including the possible prepayment of the
Company's short-term borrowings), which could also require it to sell a
significant portion of its assets. No assurances can be given that any
such dispositions or acquisitions of assets, or deleveraging, could be
accomplished on favorable terms. Consequently, any such modification of
the Company's business plan could have a material adverse effect on the
Company. Further, if it were established that the Company were an
unregistered investment company, there would be a risk that the Company
would be subject to monetary penalties and injunctive relief in an action
brought by the SEC, that the Company would be unable to enforce contracts
with third parties and that third parties could seek to obtain recission
of transactions undertaken during the period it was established that the
Company was an unregistered investment company. Any such results would be
likely to have a material adverse effect on the Company.
New Accounting Pronouncement: In June of 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). This statement establishes accounting and reporting
standards for derivative instruments including certain derivative
instruments embedded in other contracts, and for hedging activities. It
requires that the Company recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as a hedge of the exposure to changes in
the fair value of a recognized asset or liability or a hedge of the
exposure to variable cash flows of a forecasted transaction. The
accounting for changes in the fair value of a derivative (e.g., through
earnings or outside of earnings, through comprehensive income) depends on
the intended use of the derivative and the resulting designation.
The Company is required to implement SFAS 133 by the end of the first
quarter of the year ending December 31, 2000. Company management is
evaluating the impact that this statement will have on its hedging
strategies and use of derivative instruments and is currently unable to
predict the effect, if any, it will have on the Company's financial
statements.
Forward-Looking Statements: Certain statements contained herein are not,
and certain statements contained in future filings by the Company with
the SEC, in the Company's press releases or in the Company's other public
or shareholder communications may not be, based on historical facts and
are "Forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements
which are based on various assumptions (some of which are beyond the
Company's control), may be identified by reference to a future period or
periods, or by the use of forward-looking terminology, such as "may,"
"will," "believe," "expect," "anticipate," "continue," or similar terms
or variations on those terms, or the negative of those terms. Actual
results could differ materially from those set forth in forward-looking
statements due to a variety of factors, including, but not limited to,
those related to the economic environment, particularly in the market
areas in which the Company operates, competitive products and pricing,
fiscal and monetary policies of the U.S. Government, changes in
prevailing interest rates, acquisitions and the integration of acquired
businesses, credit risk management, asset/liability management, the
financial and securities markets and the availability of and costs
associated with sources of liquidity. The Company does not undertake, and
specifically disclaims any obligation, to publicly release the result of
any revisions which may be made to any forward-looking statements to
reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
Year 2000 Readiness Disclosure: The Company is currently in the process
of evaluating its information technology infrastructure for Year 2000
compliance. Substantially all of the Company's information systems are
supplied by the Manager. The Manager has advised the Company that it is
currently evaluating whether such systems are Year 2000 compliant and
that it expects to incur costs of up to approximately $500 to complete
such evaluation and to make any modifications to its systems as may be
necessary to achieve Year 2000 compliance. The Manager has advised the
Company that it expects to have fully tested its systems for Year 2000
compliance by December 31, 1998. The Company may be required to bear a
portion of such costs incurred by the Manager in this regard. The Manager
has advised the Company that it does not anticipate any material
disruption in the operations of the Company as a result of any failure by
the Manager to achieve Year 2000 compliance. There can be no assurance
that the costs will not exceed the amount referred to above or that the
Company will not experience a disruption in operations.
The Manager has advised the Company that it is in the process of
evaluating the Year 2000 compliance of various suppliers of the Manager
and the Company. The Manager has advised the Company that it intends to
communicate with such suppliers to determine their Year 2000 compliance
status and the extent to which the Manager or the Company could be
affected by any supplier's Year 2000 compliance issues. To date, however,
the Manager has not received responses from all such suppliers with
respect to their Year 2000 compliance, and there can be no assurance that
the systems of such suppliers, who are beyond the Company's control, will
be Year 2000 compliant. In the event that any of the Company's
significant suppliers do not successfully and timely achieve Year 2000
compliance, the Company's business or operations could be adversely
affected. The Manager has advised the Company that it is in the process
of preparing a contingency plan for Year 2000 compliance by its
suppliers. There can be no assurance that such contingency plan will be
successful in preventing a disruption of the Company's operations.
The Company is designating this disclosure as its Year 2000 readiness
disclosure for all purposes under the Year 2000 Information and Readiness
Disclosure Act and the foregoing information shall constitute a Year 2000
statement for purposes of that Act.
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 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
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule (filed herewith)
(b) Reports on Form 8-K
None
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.
ANTHRACITE CAPITAL, INC.
Dated: November 13, 1998 By: /s/ Hugh R. Frater
------------------------------------
Name: Hugh R. Frater
Title: President and Chief Executive
Officer
(authorized officer of registrant)
Dated: November 13, 1998 By: /s/ Richard M. Shea
-------------------------------------
Name: Richard M. Shea
Title: Chief Operating Officer and Chief
Financial Officer
(principal accounting officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE SEPTEMBER 30, 1998 QUARTERLY REPORT ON FORM 10-Q AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH QUARTERLY
REPORT ON FORM 10-Q.
</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> 6,624
<SECURITIES> 1,076,700
<RECEIVABLES> 77,653
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,160,977
<CURRENT-LIABILITIES> 939,606
<BONDS> 0
0
0
<COMMON> 296,941
<OTHER-SE> (75,570)
<TOTAL-LIABILITY-AND-EQUITY> 1,160,977
<SALES> 0
<TOTAL-REVENUES> 19,789
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,650
<LOSS-PROVISION> (22)
<INTEREST-EXPENSE> 11,708
<INCOME-PRETAX> 6,453
<INCOME-TAX> 0
<INCOME-CONTINUING> 6,453
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,453
<EPS-PRIMARY> 0.31
<EPS-DILUTED> 0.31
</TABLE>
