UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- ------
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 001-11914
THORNBURG MORTGAGE ASSET CORPORATION
(Exact name of Registrant as specified in its Charter)
MARYLAND 85-0404134
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
119 E. MARCY STREET
SANTA FE, NEW MEXICO 87501
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (505) 989-1900
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1) Yes X No
(2) Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common Stock ($.01 par value) 16,435,079 as of May 5, 1997
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION ------
Item 1. Financial Statements
Balance Sheets at March 31, 1997 and December 31, 1996... 3
Statements of Operations for the three months ended
March 31, 1997 and March 31, 1996......................... 4
Statement of Shareholders' Equity for the three months
ended March 31, 1997...................................... 5
Statements of Cash Flows for the three months ended
March 31, 1997 and March 31, 1996......................... 6
Notes to Financial Statements............................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................... 23
Item 2. Changes in Securities .................................... 23
Item 3. Defaults Upon Senior Securities .......................... 23
Item 4. Submission of Matters to a Vote of Security Holders....... 23
Item 5. Other Information......................................... 23
Item 6. Exhibits and Reports on Form 8-K.......................... 23
SIGNATURES ....................................................... 24
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THORNBURG MORTGAGE ASSET CORPORATION
<TABLE>
BALANCE SHEETS
(In thousands, except share data)
<CAPTION>
March 31, 1997 December 31, 1996
---------------- -----------------
<S> <C> <C>
ASSETS
ARM securities (Notes 2 and 3) $ 3,217,621 $ 2,727,875
Cash and cash equivalents 25,996 3,693
Accrued interest receivable 29,716 23,563
Prepaid expenses and other 512 227
------------- -------------
$ 3,273,845 $ 2,755,358
============= =============
LIABILITIES
Reverse repurchase agreements (Note 3) $ 2,936,179 $ 2,459,132
Other borrowings (Note 3) 13,394 14,187
Payable for securities purchased - 32,683
Accrued interest payable 21,531 18,747
Dividends payable (Note 6) 9,076 7,299
Accrued expenses and other 1,572 1,112
------------- -------------
2,981,752 2,533,160
SHAREHOLDERS' EQUITY (Note 6)
Preferred stock: par value $.01 per
share; 2,760,000 shares authorized;
9.68% Cumulative Convertible Series A,
2,760,000 and none issued and
outstanding, respectively 65,809 -
Common stock: par value $.01 per share;
47,240,000 shares authorized,
16,321,578 and 16,219,241 shares issued
and outstanding, respectively 163 162
Additional paid-in-capital 235,205 233,177
Available-for-sale securities:
Unrealized gain (loss) (Note 2) (13,564) (15,807)
Realized deferred hedging gain 4,137 4,541
Retained earnings 343 125
------------- -------------
292,093 222,198
------------- -------------
$ 3,273,845 $ 2,755,358
============= =============
</TABLE>
See Notes to Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
<TABLE>
STATEMENTS OF OPERATIONS
(In thousands, except share data)
<CAPTION>
Three Months Ended
March 31,
------------------------
1997 1996
----------- ----------
<S> <C> <C>
Interest income from ARM securities and cash $ 49,000 $ 32,702
Interest expense on borrowed funds (37,668) (26,512)
--------- ---------
Net interest income 11,332 6,190
--------- ---------
Realized gain (loss) on:
Sale of ARM securities (Note 2) 4 13
Provision for credit losses on
ARM securities (Note 2) (190) -
Management fee (Note 7) (811) (359)
Performance fee (Note 7) (857) (588)
Other operating expenses (184) (125)
---------- ----------
NET INCOME $ 9,294 $ 5,131
========= =========
Net income $ 9,294 $ 5,131
Dividend on preferred stock (1,242) -
--------- --------
Net income available to common shareholders $ 8,052 $ 5,131
========= =========
Net income per common share $ 0.49 $ 0.42
========= =========
Average number of common shares outstanding 16,311,344 12,334,847
========== ==========
</TABLE>
See Notes to Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
<TABLE>
STATEMENTS OF SHAREHOLDERS' EQUITY
Three Months Ended March 31, 1997
(In thousands, except share data)
<CAPTION>
Available-for-Sale Securities
-----------------------------
Additional Realized
Preferred Common Paid-in Unrealized Deferred Gain Retained
Stock Stock Capital Gain (Loss) From Hedging Earnings Total
Balance, --------- -------- ---------- ------------- -------------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
December 31, 1996 $ - $ 162 $ 233,177 $ (15,807) $ 4,541 $ 125 $ 222,198
Series A preferred stock
issued, net of issuance
cost (Note 5) 65,809 - - - - - 65,809
Issuance of common
stock (Note 5) - 1 2,028 - - - 2,029
Available-for-Sale Sec:
Fair value adjustment,
net of amortization - - - 2,243 - - 2,243
Deferred gain on sale
of hedges, net of
amortization - - - - (404) - (404)
Net income - - - - - 9,294 9,294
Dividends declared on
preferred stock -
$0.45 per share - - - - - (1,242) (1,242)
Dividends declared on
common stock -
$0.48 per share - - - - - (7,834) (7,834)
Balance, ------- ------- --------- ----------- ------------ ------- --------
March 31, 1997 $ 65,809 $ 163 $ 235,205 $ (13,564) $ 4,137 $ 343 $ 292,093
======= ======= ========= =========== ============= ======= ========
</TABLE>
See Notes to Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
<TABLE>
STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
Three Months Ended
March 31,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
Operating Activities:
Net Income $ 9,294 $ 5,131
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 4,359 3,293
Net (gain) loss from investing activities 186 (13)
Change in assets and liabilities:
Accrued interest receivable (6,152) 1,606
Prepaid expenses and other (285) (117)
Accrued interest payable 2,784 (1,084)
Accrued expenses and other 460 291
--------- ---------
Net cash provided by operating activities 10,646 9,107
--------- ---------
Investing Activities:
Available-for-sale securities:
Purchase of ARM securities (670,565) (205,970)
Proceeds on sales of ARM securities 633 6,574
Principal payments on ARM securities 127,054 106,813
Held-to-maturity securities:
Principal payments on ARM securities 18,140 30,842
Purchase of interest rate cap agreements (398) (234)
---------- ----------
Net cash provided by (used in)
investing activities (525,136) (61,975)
---------- ----------
Financing Activities:
Net borrowings from reverse
repurchase agreements 477,047 46,430
Net borrowings from (repayments of)
other borrowings (793) 7,804
Proceeds from preferred stock issued 65,809 -
Proceeds from common stock issued 2,029 3,618
Dividends paid (7,299) (4,632)
---------- ----------
Net cash provided by (used in)
financing activities 536,793 53,220
----------- ----------
Net increase (decrease) in cash and
cash equivalents 22,303 352
Cash and cash equivalents at beginning of period 3,693 3,660
--------- ---------
Cash and cash equivalents at end of period $ 25,996 $ 4,012
========= =========
</TABLE>
Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.
See Notes to Financial Statements
<PAGE>
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their value.
ADJUSTABLE-RATE MORTGAGE SECURITIES
The Company's policy is to classify each of its assets as
available-for-sale as they are purchased and then monitor each asset
for a period of time, generally six to twelve months, prior to
making a determination whether the asset will be classified as
held-to-maturity. Management has made the determination that certain
adjustable-rate mortgage ("ARM") securities are available-for-sale
in order to be prepared to respond to potential future opportunities
in the market, to sell ARM securities in order to optimize the
portfolio's total return and to retain its ability to respond to
economic conditions that require the Company to sell assets in order
to maintain an appropriate level of liquidity. Management
re-evaluates the classification of the ARM securities on a quarterly
basis. All ARM securities classified as held-to-maturity are carried
at the fair value of the security at the time the designation is
made and any fair value adjustment to the cost basis as of the date
of the classification is amortized into interest income as a yield
adjustment. All ARM securities designated available-for-sale are
reported at fair value, with unrealized gains and losses excluded
from earnings and reported as a separate component of shareholders'
equity.
Premiums and discounts associated with the purchase of the ARM
securities are amortized into interest income over the lives of the
securities using the effective yield method adjusted for the effects
of estimated prepayments.
ARM securities transactions are recorded on the date the ARM
securities are purchased or sold. Purchases of new issue ARM
securities are recorded when all significant uncertainties regarding
the characteristics of the securities are removed, generally shortly
before settlement date. Realized gains and losses on ARM securities
transactions are determined on the specific identification basis.
CREDIT RISK
The Company has limited its exposure to credit losses on its
portfolio of ARM securities by only purchasing ARM securities that
have some form of credit enhancement and are either guaranteed by an
agency of the federal government or have an investment grade rating
at the time of purchase, or the equivalent, by at least one of two
nationally recognized rating agencies, Moody's or Standard & Poor's
(the "Rating Agencies"). The Company also limits its exposure to
credit losses by limiting its investment in investment grade
securities that are rated A, or equivalent, or BBB, or equivalent,
("Other Investments") to no more than 30% of the portfolio and
currently has less than 5% of its portfolio invested in Other
Investments. Other Investments generate a higher yield, believed to
be commensurate with the additional credit risk of such investments.
The Company monitors the delinquencies and losses on the underlying
mortgages of its ARM securities and, if the credit performance of
the underlying mortgage loans is not as good as expected, makes a
provision for possible credit losses at a level deemed appropriate
by management to provide for known losses as well as unidentified
potential future losses in its ARM securities portfolio. The
provision is based on management's assessment of numerous factors
affecting its portfolio of ARM securities including, but not limited
to, current and projected economic conditions, delinquency status,
credit losses to date on underlying mortgages and remaining credit
protection. The provision is made by reducing the cost basis of the
individual security for the decline in fair value which is other
than temporary and the amount of such write-down is recorded as a
realized loss, thereby reducing earnings. Provisions for credit
losses do not reduce taxable income and therefore do not affect the
dividends paid by the Company to shareholders in the period the
provisions are taken. Actual losses realized by the Company do
reduce taxable income in the period the actual loss is realized and
would affect the dividends paid to shareholders for that tax year.
<PAGE>
INTEREST RATE CAP AGREEMENTS
The Company purchases interest rate cap agreements (the "Cap
Agreements") to limit the Company's risks associated with the
lifetime or maximum interest rate caps of its ARM securities should
interest rates rise above specified levels. The Cap Agreements, in
effect, reduce the effect of the lifetime cap feature so that the
yield on the ARM securities will continue to rise in high interest
rate environments as the Company's cost of borrowings also continue
to rise.
The Cap Agreements classified as a hedge against held-to-maturity
securities are initially carried at their fair value as of the time
the Cap Agreements and the related securities are designated as
held-to-maturity with an adjustment to equity for any unrealized
gains or losses at the time of the designation. Any adjustment to
equity is thereafter amortized into interest income as a yield
adjustment in a manner consistent with the amortization of any
premium or discount. The Cap Agreements that are classified as a
hedge against available-for-sale securities are carried at fair
value with unrealized gains and losses reported as a separate
component of equity, consistent with the reporting of such
securities. The carrying value of the Cap Agreements are included in
ARM securities on the balance sheet. The amortization of the
carrying value of the Cap Agreements is included in interest income
as a contra item (i.e. expense) and, as such, reduces interest
income over the lives of the Cap Agreements.
Realized gains and losses resulting from the termination of the Cap
Agreements that are hedging assets classified as held-to-maturity
are deferred as an adjustment to the carrying value of the related
assets and are amortized into interest income over the terms of the
related assets. Realized gains and losses resulting from the
termination of such agreements that are hedging assets classified as
available-for-sale are initially reported in a separate component of
equity, consistent with the reporting of those assets, and are
thereafter amortized as a yield adjustment.
INTEREST RATE SWAP AGREEMENTS
The Company enters into interest rate swap agreements in order to
manage its interest rate exposure when financing its ARM assets.
Revenues and expenses from the interest rate swap agreements are
accounted for on an accrual basis and recognized as a net adjustment
to interest expense.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment
Trust ("REIT") and intends to comply with the provisions of the
Internal Revenue Code of 1986, as amended (the "Code") with respect
thereto. Accordingly, the Company will not be subject to Federal
income tax to the extent of its distributions to shareholders and as
long as certain asset, income and stock ownership tests are met.
NET INCOME PER SHARE
Net income 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.
<PAGE>
NOTE 2. ADJUSTABLE-RATE MORTGAGE SECURITIES AND INTEREST RATE CAP AGREEMENTS
Investments in ARM securities consist of mortgage certificates secured
by ARM loans primarily on single-family residential housing.
The following table pertains to the Company's ARM securities classified
as available-for-sale as of March 31, 1997 and December 31, 1996, which
are carried at their fair value (dollars in thousands):
Available-for-Sale
---------------------------------
March 31, 1997 December 31, 1996
-------------- -----------------
Amortized cost basis $ 2,789,424 $ 2,282,991
Allowance for losses (1,162) (990)
------------- ------------
Amortized cost, net 2,788,262 2,282,001
------------ ------------
Gross unrealized gains 9,023 7,686
Gross unrealized losses (21,571) (22,408)
------------- ------------
Fair value $ 2,775,714 $ 2,267,279
============ ============
During the quarter ended March 31, 1997, the Company realized $4,000 in
gains on the sale of $629,000 of ARM securities which were classified
as available-for-sale.
As of March 31, 1997, the Company had reduced the cost basis of its ARM
securities due to potential future credit losses (other than temporary
declines in fair value) in the amount of $1,162,000, including a
provision for credit losses of $190,000 during the quarter ended March
31, 1997. At this time, the Company is providing for potential future
credit losses on three securities that have an aggregate carrying value
of $17.9 million, which represent less than 0.6% of the Company's total
portfolio of ARM securities. All three of these securities are
performing and have varying degrees of remaining credit support that
mitigates the Company's exposure to potential future credit losses.
The following table pertains to the Company's ARM securities classified
as held-to-maturity as of March 31, 1997 and December 31, 1996, which
are carried at their amortized cost basis (dollars in thousands):
Held-to-Maturity
-------------------------------------
March 31, 1997 December 31, 1996
---------------- -------------------
Amortized cost basis $ 441,907 $ 460,596
Gross unrealized gains 5,617 4,169
Gross unrealized losses (3,722) (4,306)
------------ ------------
Fair value $ 443,802 $ 460,459
============ ============
As of March 31, 1997, the Company had $19.5 million of commitments to
purchase ARM securities.
The average effective yield on the ARM securities owned, including the
amortization of the net premium paid for the ARM securities and the Cap
Agreements, was 6.65% as of March 31, 1997 and 6.64% as of December 31,
1996.
As of March 31, 1997 and December 31, 1996, the Company had purchased
Cap Agreements with a remaining notional amount of $2.538 billion and
$2.266 billion, respectively. The notional amount of the Cap Agreements
purchased decline at a rate that is expected to approximate the
amortization of the ARM securities. Under these Cap Agreements, the
Company will receive cash payments should either the three-month or
six-month London InterBank Offer Rate ("LIBOR") increase above the
contract rates of the Cap Agreements which range from 7.50% to 13.00%
and average approximately 10.17%. The Company's ARM securities
portfolio had an average lifetime interest rate cap of 11.60% as of
March 31, 1997. The initial aggregate notional amount of the Cap
Agreements will decline to approximately $1.760 billion over the period
of the agreements, which expire between 1999 and 2001. The Company
purchased these Cap Agreements by incurring a one-time fee, or premium.
The premium is amortized, or expensed, over the lives of the Cap
Agreements and reduces the interest income on the Company's ARM
securities during the period of amortization. The Company has credit
risk to the extent that the counterparties to the Cap Agreements do not
perform their obligations under the Cap Agreements. If one of the
counterparties does not perform, the Company would not receive the cash
to which it would otherwise be entitled under the conditions of the Cap
Agreement. In order to mitigate this risk and to achieve competitive
pricing, the Company has entered into Cap Agreements with five
different counterparties, three of which are rated AAA, two of which
are rated AA.
NOTE 3. REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS
The Company has entered into reverse repurchase agreements to finance
most of its ARM securities. The reverse repurchase agreements 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.
As of March 31, 1997, the Company had outstanding $2.936 billion of
reverse repurchase agreements with a weighted average borrowing rate of
5.61% and a weighted average remaining maturity of 3.6 months. As of
March 31, 1997, $1.261 billion of the Company's borrowings were
variable-rate term reverse repurchase agreements with original
maturities that range from three months to two years. The interest
rates of these term reverse repurchase agreements are indexed to either
the one, three or six-month LIBOR rate and reprice accordingly. The
reverse repurchase agreements at March 31, 1997 were collateralized by
ARM securities with a carrying value of $3.086 billion, including
accrued interest.
At March 31, 1997, the reverse repurchase agreements had the following
remaining maturities (dollars in thousands):
Within 30 days $ 1,121,132
30 to 90 days 818,483
90 days to one year 824,604
Over one year 171,960
-----------
$ 2,936,179
===========
As of March 31, 1997, the Company had entered into eight interest rate
swap agreements having an aggregate notional balance of $1.040 billion
and a weighted average remaining term of 6.0 months. In accordance with
these agreements, the Company will pay a fixed rate of interest during
the term of these agreements and receive a payment that varies monthly
with the one-month LIBOR rate. As a result of entering into these
agreements, the Company has reduced the interest rate variability of
its cost to finance its ARM securities by increasing the average period
until the next repricing of its borrowings from 44 days to 103 days.
The Company has a line of credit agreement which provides for
short-term borrowings of up to $25 million collateralized by the
Company's principal and interest receivables. As of March 31, 1997,
there was no balance outstanding under this agreement.
As of March 31, 1997, the Company had financed a portion of its
portfolio of interest rate cap agreements with $13.4 million of other
borrowings which require quarterly or semi-annual payments until the
year 2000. These borrowings have a weighted average fixed rate of
interest of 7.91% and have a weighted average remaining maturity of 2.8
years. The other borrowings financing cap agreements at March 31, 1997
were collateralized by ARM securities with a carrying value of $17.0
million, including accrued interest. The aggregate maturities of these
other borrowings are as follows (dollars in thousands):
1997 $ 3,376
1998 4,509
1999 4,877
2000 632
----------
$ 13,394
==========
During the quarter ended March 31, 1997, the total cash paid for
interest was $36.9 million.
<PAGE>
NOTE 4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at March 31, 1997 and
December 31, 1996. FASB Statement No. 107, Disclosures About Fair Value
of Financial Instruments, defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties, other than in a forced
or liquidation sale (dollars in thousands):
<TABLE>
<CAPTION>
March 31, 1997 December 31, 1996
------------------------ ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Assets:
ARM securities $ 3,211,632 $ 3,216,165 $ 2,689,727 $ 2,692,521
Cap agreements 5,989 3,351 5,465 2,535
Liabilities:
Other borrowings 13,394 13,637 14,187 14,744
Swap agreements 57 (571) (7) 440
</TABLE>
The above carrying amounts for assets are combined in the balance sheet
under the caption ARM securities. The carrying amount for assets
categorized as available-for-sale is their fair value whereas the
carrying amount for assets held-to-maturity is their amortized cost.
The fair values of the Company's ARM securities and cap agreements are
based on market prices provided by certain dealers who make markets in
these financial instruments. The fair value of the Company's long-term
debt and interest rate swap agreements, which are off-balance sheet
financial instruments, are based on market values provided by dealers
who are familiar with the terms of the long-term debt and swap
agreements. The fair values reported reflect estimates and may not
necessarily be indicative of the amounts the Company could realize in a
current market exchange. Cash and cash equivalents, interest
receivable, reverse repurchase agreements and other liabilities are
reflected in the financial statements at their amortized cost, which
approximates their fair value because of the short-term nature of these
instruments.
NOTE 5. COMMON AND PREFERRED STOCK
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share
pursuant to its Registration Statement on Form S-3 declared effective
in December 1996. Net proceeds from this issuance totaled $65.8
million. Upon completion of this issuance of preferred stock, the
Company had $173 million of its securities registered for future sale
under this registration statement.
During the quarter ended March 31, 1997, the Company issued 102,337
shares of common stock under its dividend reinvestment and stock
purchase plan and received net proceeds of $2.0 million.
In October 1995, the Company entered into a Sales Agency Agreement with
PaineWebber Incorporated. In accordance with the Sales Agency
Agreement, PaineWebber agreed to sell, at the direction and discretion
of the Company, up to 1,174,969 additional shares of the Company's
common stock. During 1997, the Company has not sold any shares under
this Sales Agency Agreement.
On March 14, 1997, the Company declared a first quarter dividend of
$0.48 per common share which was paid on April 10, 1997 to common
shareholders of record as of March 31, 1997. Additionally, the Company
declared a dividend of $0.45 per share to the shareholders of the
Series A 9.68% Cumulative Convertible Preferred Stock for the partial
period of January 24, 1997 (date of issuance) through March 31, 1997
which was also paid on April 10, 1997 to preferred shareholders of
record as of March 31, 1997. For federal income tax purposes such
dividends are ordinary income to the Company's common and preferred
shareholders.
<PAGE>
NOTE 6. STOCK OPTION PLAN
The Company has a Stock Option Plan and Incentive Plan (the "Plan")
which authorizes the granting of options to purchase an aggregate of up
to 1,800,000 shares, but not more than 5% 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"), Stock Appreciation Rights ("SARs"), and
Phantom Stock Rights ("PSRs"). The exercise price for any options
granted under the Plan may not be less than 100% of the fair market
value of the shares of the common stock at the time the option is
granted. Options become exercisable six months after the date granted
and will expire ten years after the date granted, except options
granted in connection with an offering of convertible preferred stock,
in which case such options become exercisable if and when the
convertible preferred stock is converted into common stock.
During the quarter ended March 31, 1997, there were 115,920 options
granted to buy common shares at an exercise price of $20 in conjunction
with the issuance of the Series A 9.68% Cumulative Convertible
Preferred Stock along with 28,980 DERs. In that these options and DERs
were granted in conjunction with the issuance of convertible preferred
stock, neither the options nor the DERs will be vested by the
recipients until the convertible preferred shares are converted into
common shares. As of March 31, 1997, the Company had 742,666 options
outstanding at exercise prices of $9.375 to $20 per share, 613,413 of
which were exercisable. The weighted average exercise price of the
options outstanding is $16.21 per share. There were no options
exercised during the first quarter of 1997.
NOTE 7. TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement (the "Agreement") with Thornburg
Mortgage Advisory Corporation ("the Manager"). Under the terms of this
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 Agreement provides for an annual review by the unaffiliated
directors of the Board of Directors of the Manager's performance under
the Agreement.
The Company pays the Manager an annual base management fee based on
average shareholders' equity, adjusted for liabilities that are not
incurred to finance assets ("Average Shareholders' Equity" or "Average
Net Invested Assets" as defined in the Agreement) payable monthly in
arrears as follows: 1.1% of the first $300 million of Average
Shareholders' Equity, plus 0.8% of Average Shareholders' Equity above
$300 million.
For the quarters ended March 31, 1997 and 1996, the Company paid the
Manager $811,000 and $359,000, respectively, in base management fees in
accordance with the terms of the Agreement.
The Manager is also entitled to earn performance based compensation in
an amount equal to 20% of the Company's annualized net income, before
performance based compensation, above an annualized Return on Equity
equal to the ten year U.S. Treasury Rate plus 1%. For purposes of the
performance fee calculation, equity is generally defined as proceeds
from issuance of common stock before underwriter's discount and other
costs of issuance, plus retained earnings. For the quarters ended March
31, 1997 and 1996, the Company paid the Manager $857,000 and $588,000,
respectively, in performance based compensation in accordance with the
terms of the Agreement.
Thornburg Securities Corporation, an affiliate of the Manager, was an
underwriter in the January 1997 public offering of the Company's
Preferred Stock. Thornburg Securities Corporation was not the lead
underwriter and did not participate in any negotiations of the
underwriters' compensation or the terms of either offering.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Report on Form 10-Q contains forward-looking statements which are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Investors are cautioned that all forward-looking statements
involve risks and uncertainties including, without limitation, risks related to
future interest rates, prepayment rates and the timing of new programs. For
additional information regarding these and other risks, reference is made to the
Company's Prospectus Supplement dated January 20, 1997.
GENERAL
Thornburg Mortgage Asset Corporation (the "Company") is a specialized financial
institution that primarily invests in adjustable-rate mortgage ("ARM")
securities, thereby indirectly providing capital to the single family
residential housing market. ARM securities represent interests in pools of ARM
loans, which often include guarantees or other credit enhancements against
losses from loan defaults. While the Company is not a bank or savings and loan,
its business purpose, strategy, method of operation and risk profile are best
understood in comparison to such institutions. The Company leverages its equity
capital using borrowed funds, invests in ARM securities and seeks to generate
income based on the difference between the yield on its ARM securities portfolio
and the cost of its borrowings. The corporate structure of the Company differs
from most lending institutions in that 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 shareholders without paying federal
or state income tax at the corporate level.
The Company's mortgage securities portfolio may consist of either agency or
privately issued (generally publicly registered) mortgage pass-through
securities, multiclass pass-through securities, collateralized mortgage
obligations ("CMOs") or short-term investments that either mature within one
year or have an interest rate that reprices within one year.
The Company's investment policy is to invest at least 70% of total assets in
High Quality adjustable and variable rate mortgage securities and short-term
investments. High Quality means:
(1)securities that are unrated but are guaranteed by the U.S. Government
or issued or guaranteed by an agency of the U.S. Government;
(2)securities which are rated within one of the two highest rating
categories by at least one of either Standard & Poor's Corporation or
Moody's Investors Service, Inc. (the "Rating Agencies"); or
(3)securities that are unrated or whose ratings have not been updated but are
determined to be of comparable quality (by the rating standards of at
least one of the Rating Agencies) to a High Quality rated mortgage
security, as determined by the Manager (as defined below) and approved by
the Company's Board of Directors.
The remainder of the Company's ARM portfolio, comprising not more than 30% of
total assets, may consist of Other Investment assets, which may include:
(1)adjustable or variable rate pass-through certificates, multi-class
pass-through certificates or CMOs backed by loans on single-family,
multi-family, commercial or other real estate-related properties so long
as they are rated at least Investment Grade at the time of purchase.
"Investment Grade" generally means a security rating of BBB or Baa or
better by at least one of the Rating Agencies;
(2)ARM loans secured by first liens on single-family residential properties,
generally underwritten to "A" quality standards, and acquired for the
purpose of future securitization; or
(3)a limited amount, currently $20 million as authorized by the Board of
Directors, of less than investment grade classes of ARM securities that
are created as a result of the Company's loan acquisition and
securitization efforts.
Since inception, the Company has generally invested less than 15% of its total
assets in Other Investment assets. The Company believes that, due to recent
changes in the mortgage industry and the current real estate environment, a
strategy to selectively increase its investment in Other Investment assets can
provide attractive benefits to the Company such that the total return of these
investments would be commensurate with their higher risk and not significantly
affect the Company's overall high quality portfolio. The Company's ARM
securities portfolio is currently comprised of less than 5% of Other Investment
assets and, therefore, the Company may increase its investment in Other
Investment assets, specifically classes of multiclass pass-throughs, which may
benefit from future credit rating upgrades as senior classes of these securities
pay off, or have the potential to increase in value as a result of the
appreciation of underlying real estate values. The Company may also begin to
acquire ARM loans for the purpose of future securitization into ARM securities
for the Company's investment portfolio. The Company believes that its strategy
to increase its investment in Other Investment assets and to securitize ARM
loans that it acquires will provide the Company with higher yielding investments
and give the Company greater control over the types of ARM securities originated
and held in its investment portfolio. In pursuing this strategy the Company will
likely have to accept a higher degree of credit risk than it has in the past.
However, the Company remains committed to maintaining a high level of credit
quality, consistent with its objectives of avoiding substantial credit risk, and
providing an attractive return on equity.
The Company does not invest in REMIC residuals or other CMO residuals and,
therefore does not create excess inclusion income or unrelated business taxable
income for tax exempt investors. Therefore, the Company is a mortgage REIT
eligible for purchase by tax exempt investors, such as pension plans, profit
sharing plans, 401(k) plans, Keogh plans and Individual Retirement Accounts
("IRAs").
FINANCIAL CONDITION
At March 31, 1997, the Company held total assets of $3.274 billion, $3.218
billion of which consisted of ARM securities, as compared to $2.755 billion and
$2.728 billion, respectively, at December 31, 1996. Since commencing operations,
the Company has purchased only ARM securities which have been either backed by
agencies of the U.S. government or privately-issued (generally publicly
registered) mortgage securities, most of which are rated AA or higher by at
least one of the Rating Agencies. At March 31, 1997, 95.2% of the assets held by
the Company were High Quality assets as compared with the Company's investment
policy of investing at least 70% of its total assets in High Quality ARM
securities and cash and cash equivalents. All of the ARM securities currently
owned by the Company are in the form of adjustable-rate pass-through
certificates.
The following table presents a schedule of ARM securities owned at March 31,
1997 and December 31, 1996 classified by High Quality and Other Investment
assets and further classified by type of issuer and by ratings categories.
<TABLE>
ARM SECURITIES BY ISSUER AND CREDIT RATING
(amounts in thousands)
<CAPTION>
March 31, 1997 December 31, 1996
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $1,956,986 60.8% $1,474,842 54.1%
Privately Issued:
AAA/Aaa Rating 262,962 8.2 260,031 9.5
AA/Aa Rating 847,394 26.3 862,727 31.6
--------- -------- --------- --------
Total Privately Issued 1,110,356 34.5 1,122,758 41.1
--------- -------- --------- --------
Total High Quality 3,067,342 95.3 2,597,600 95.2
--------- -------- --------- --------
OTHER INVESTMENT:
Privately Issued:
A Rating 127,051 4.0 106,531 3.9
BBB/Baa Rating 13,808 0.4 14,017 0.5
BB/Ba Rating 9,420 0.3 9,727 0.4
--------- -------- --------- --------
Total Other Investment 150,279 4.7 130,275 4.8
--------- -------- --------- --------
Total ARM Securities $3,217,621 100.0% $2,727,875 100.0%
========= ======== ========= =======
</TABLE>
As of March 31, 1997, the Company had reduced the cost basis of its ARM
securities due to potential future credit losses (other than temporary declines
in fair value) in the amount of $1,162,000, including a provision for credit
losses of $190,000 recorded during the quarter ended March 31, 1997. During the
first quarter of 1997, the Company realized actual credit losses of $18,000 on
one senior class of a multi-class pass-through security that is secured by
single family loans. However, it is possible that these losses will be
reimbursed at some future date if future deposits to a reserve fund credit
enhancement account exceed future loss experience. Although the Company limits
its exposure to credit losses by acquiring primarily securities that are rated
AA or better, the Company also invests in Other Investments that generally have
a higher yield than securities rated AA or better, currently less than 5% of the
Company's total assets, which are more likely to experience credit losses from
time to time. The Company believes that the total return on the Other
Investments purchased by the Company provides a yield that is commensurate with
the added credit exposure. The Company's analysis of losses on loans underlying
certain ARM securities owned by the Company relative to the remaining credit
support protecting the Company from credit losses indicates that there is the
possibility of future losses. At this time, the Company is providing for
potential future losses on three securities that have an aggregate carrying
value of $17.9 million, which is less than 0.6% of the Company's total portfolio
of ARM securities. All three of these securities are performing and have varying
degrees of remaining credit support that mitigates the Company's exposure to
potential future credit losses.
The following table classifies the Company's portfolio of ARM securities by type
of interest rate index.
<TABLE>
ARM SECURITIES BY INDEX
(amounts in thousands)
<CAPTION>
March 31, 1997 December 31, 1996
----------------------- -----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------- --------- ------------ ---------
<S> <C> <C> <C> <C>
INDEX:
One-month LIBOR $ 10,902 0.3% $ 10,646 0.4%
Six-month LIBOR 1,219,121 37.9 1,252,884 45.9
Six-month Certificate of Deposit 70,027 2.2 69,348 2.6
Six-month Constant Maturity Treasury 44,840 1.4 8,841 0.3
One-year Constant Maturity Treasury 1,645,794 51.1 1,238,892 45.4
11th District Cost of Funds 226,937 7.1 147,264 5.4
----------- ------- ----------- -------
$ 3,217,621 100.0% $ 2,727,875 100.0%
=========== ======= =========== =======
</TABLE>
The portfolio had a current weighted average coupon of 7.53% at March 31, 1997.
If the portfolio were "fully indexed," the weighted average coupon would be
7.93%, based upon the current composition of the portfolio and the applicable
indices at March 31, 1997.
At March 31, 1997, the current yield of the ARM securities portfolio was 6.64%.
The current yield includes the impact of the amortization of applicable premiums
and discounts, the cost of hedging, the amortization of the deferred gains from
hedging activity and the impact of principal payment receivables.
As a result of issuing the Series A 9.68% Cumulative Convertible Preferred
Stock, which provided the Company with net proceeds of $65.8 million of
additional shareholders' equity during the quarter ended March 31, 1997, the
Company purchased $670.6 million of ARM securities, 97% of which were High
Quality assets. The Company also sold $629,000 of High Quality ARM securities
for a net gain of $4,000 during the quarter ended March 31, 1997.
For the quarter ended March 31, 1997, the Company's mortgage securities paid
down at an approximate average annualized constant prepayment rate of 22%, which
was close to long-term expectations. In the event that actual prepayment
experience exceeds expectations due to sustained increased prepayment activity,
the Company would have to amortize its premiums over a shorter time period,
resulting in a reduced yield to maturity on the Company's ARM securities.
Conversely, if actual prepayment experience is 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 monitors its prepayment
experience on a monthly basis in order to adjust the amortization of the net
premium, as appropriate.
The fair value of the Company's portfolio of ARM securities increased during the
quarter ended March 31, 1997. As of March 31, 1997, the Company's portfolio of
ARM securities available-for-sale, including the applicable Cap Agreements, had
a net unrealized loss of $12.5 million, or 0.45% of the securities
available-for-sale, as compared to a net unrealized loss of $14.7 million or
0.65% of the securities available-for-sale, as of December 31, 1996.
The Company has purchased Cap Agreements in order to limit its exposure to risks
associated with the lifetime interest rate caps of its ARM securities should
interest rates rise above specified levels. The Cap Agreements act to reduce the
effect of the lifetime or maximum interest rate cap limitation. The Cap
Agreements purchased by the Company will allow the yield on the ARM securities
to continue to rise in a high interest rate environment just as the Company's
cost of borrowings would continue to rise, since the borrowings do not have any
interest rate cap limitation. At March 31, 1997, the Cap Agreements owned by the
Company had a remaining notional balance of $2.538 billion with an average final
maturity of 2.9 years, as compared to a remaining notional balance of $2.266
billion with an average final maturity of 3.0 years at December 31, 1996.
Pursuant to the terms of the Cap Agreements, the Company will receive cash
payments if the three-month or six-month LIBOR index increases above certain
specified levels which range from 7.50% to 13.00% and average approximately
10.17%. The expense of the Company's hedging activity amounted to $754,000 and
decreased the yield on the ARM securities portfolio by 0.14% during the quarter
ended March 31, 1997. In general market interest rates increase and decrease
when market interest rates decrease, helping to partially offset changes in the
fair value of the Company's ARM securities. At March 31, 1997 the fair value of
the Cap Agreements was $3.4 million, $10.3 million less than the amortized cost
of the Cap Agreements. The following table presents information about the
Company's Cap Agreement portfolio as of March 31, 1997:
<TABLE>
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
<CAPTION>
Hedged Weighted Cap Agreement Weighted
ARM Securities Average Notional Average
Balance (1) Life Cap Balance (2) Strike Price Remaining Term
---------------- ---------- -------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
$ 395,510,000 9.57% $ 398,547,000 7.50% 3.0 Years
130,116,000 10.36 139,212,000 8.50 2.9
273,676,000 10.13 365,126,000 9.00 2.8
128,385,000 10.83 114,866,000 9.50 2.7
254,113,000 11.04 175,000,000 10.00 4.9
410,127,000 11.51 363,810,000 10.50 3.0
224,278,000 12.00 221,826,000 11.00 2.0
316,076,000 12.57 50,000,000 11.50 2.9
437,640,000 12.93 467,831,000 12.00 2.6
182,187,000 13.54 141,697,000 12.50 3.3
130,594,000 14.11 100,000,000 13.00 2.9
------------ ------- ------------ -------- ------
$ 2,882,702,000 11.60% $2,538,015,000 10.17% 2.9 Years
============= ======= ============= ========= ======
<FN>
(1) 90% of the ARM securities' balance which approximates the financed portion.
(2) Subsequent to March 31, 1997, the Company purchased additional
Cap Agreements in order to hedge ARM securities purchased in the
quarter ended March 31, 1997. The Company purchased $35 million with a
strike price of 10.50%, $250 million with a strike price of 11.50% and
$60 million with a strike price of 12.50%
</FN>
</TABLE>
As of March 31, 1997, the Company had entered into eight interest rate swap
agreements having an aggregate notional balance of $1.040 billion and a weighted
average remaining term of six months. In accordance with these agreements, the
Company will pay a fixed rate of interest during the term of these agreements
and receive a payment that varies monthly with the one-month LIBOR Index. As of
March 31, 1997, the average cost of the Company's borrowings was 5.67%, which
includes the impact of the interest rate swap agreements. As a result of
entering into these agreements the Company extended the weighted average term to
the next re-pricing date of its borrowing from 44 days to 103 days.
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share pursuant to
an effective Registration Statement. Net proceeds from this issuance totaled
$65.8 million. Primarily as a result of the issuance of the preferred stock, the
Company's shareholders' equity, excluding the fair value adjustment for assets
held as available-for sale, has grown to $305.7 million as of March 31, 1997
from $238.0 million as of December 31, 1996. As of March 31, 1997, the Company's
ratio of shareholders' equity to assets, excluding the fair value adjustment for
assets held as available-for sale, was 9.30% as compared to 8.59% as of December
31, 1996.
<PAGE>
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1997
For the quarter ended March 31, 1997, the Company's net income was $9,294,000 as
compared to $5,131,000 for the quarter ended March 31, 1996. Net income
available to common shareholders, after the 9.68% dividend to preferred
shareholders, increased to $8,052,000 or $0.49 per common share based on
weighted average common shares of 16,311,344 from $5,131,000 or $0.42 per common
share based on weighted average common shares of 12,334,847 for the quarter
ended March 31, 1996. This is an increase in net income available to common
shareholders per common share of 17% despite an increase in the weighted average
common shares outstanding of 32%. Net interest income for the quarter totaled
$11,332,000 as compared to $6,190,000 for the same period in 1995, an increase
of 83%. Net interest income is comprised of the interest income earned on
mortgage investments and cash less interest expense from borrowings. During the
first quarter of 1997, the Company recorded a gain on the sale of ARM securities
of $4,000 as compared to $13,000 during the first quarter of 1996. Additionally,
during the first quarter of 1997, the Company reduced earnings and the carrying
value of its ARM securities by $190,000 for projected credit losses. For the
quarter ended March 31, 1997, the Company incurred operating expenses of
$1,852,000 consisting of a base management fee of $811,000, a performance based
fee of $857,000 and other operating expenses of $184,000. During the same period
of 1996, the Company incurred operating expenses of $1,072,000 consisting of a
base management fee of $359,000, a performance based fee of $588,000 and other
operating expenses of $125,000. Total operating expenses decreased to 16.3% of
net interest income for the first quarter of 1997 as compared to 17.3% for the
same period of 1996, also contributing to the Company's improved net earnings.
Additionally, for the quarter ended March 31, 1997, the Company declared a
dividend of $1,242,000 or $0.45 per share to the shareholders of the Series A
9.68% Cumulative Convertible Preferred Stock for the partial period of January
24, 1997 (date of issuance) through March 31, 1997.
The Company's return on average common equity reached 13.4%, it's highest
quarterly level ever, for the quarter ended March 31, 1997. The table below
highlights the historical trend and the components of return on average common
equity (annualized):
<TABLE>
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
<CAPTION>
Net Gain (Loss)
Interest Provision on ARM G & A Performance Preferred Net
For The Income/ For Losses/ Sales/ Expense (2)/ Fee/ Dividend/ Income/
Quarter Ended Equity Equity Equity Equity Equity Equity Equity (ROE)
------------- -------- ----------- ----------- ------------ ----------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Mar 31, 1995 2.58% - -1.47% 1.02% - - 0.09%
Jun 30, 1995 5.51% - - 1.04% - - 4.47%
Sep 30, 1995 9.85% - 0.09% 1.07% 0.34% - 8.54%
Dec 31, 1995 11.94% - 0.11% 1.05% 0.97% - 10.03%
Mar 31, 1996 13.37% - 0.03% 1.04% 1.27% - 11.08%
Jun 30, 1996 13.14% - - 1.00% 0.92% - 11.22%
Sep 30, 1996 13.42% 0.34% 0.88% 1.03% 1.07% - 11.86%
Dec 31, 1996 14.99% 1.32% 1.38% 1.46% 1.23% - 12.37%
Mar 31, 1997 18.85% 0.32% 0.01% 1.65% 1.43% 2.07% 13.40%
<FN>
(1) Average common equity excludes unrealized gain(loss) on available-for-sale ARM securities.
(2) Excludes performance fees.
</FN>
</TABLE>
For the quarter ended March 31, 1997, the Company's taxable income was
$8,224,000 or $0.50 per weighted average share outstanding. Taxable income in
the first quarter of 1997 excludes the loss provisions of $190,000 but includes
actual credit losses of $18,000. For the quarter ended March 31, 1996, the
Company's taxable income was $5,118,000 or $0.41 per weighted average share
outstanding. As a REIT, the Company is required to declare dividends amounting
to 85% of each year's taxable income by the end of each calendar year and to
have declared dividends amounting to 95% of its taxable income for each year by
the time it files its applicable tax return and, therefore, generally passes
through substantially all of its earnings to shareholders without paying federal
income tax at the corporate level.
<PAGE>
The following table highlights the quarterly dividend history of the Company's
common shares:
<TABLE>
COMMON DIVIDEND SUMMARY
($ in thousands, except per common share amounts)
<CAPTION>
Common Common
Taxable Taxable Dividend Dividend Cumulative
For The Net Net Income Declared Pay-out Undistributed
Quarter Ended Income (1) Per Share (2) Per Share (2) Ratio (3) Taxable Net Income
--------------- ------------ -------------- ------------- -------- ------------------
<S> <C> <C> <C> <C> <C>
Mar 31, 1995 $ 701 $ 0.06 $ 0.15 252% (874)
Jun 30, 1995 1,993 0.17 0.15 89% (634)
Sep 30, 1995 3,791 0.32 0.25 79% 139
Dec 31, 1995 4,535 0.37 0.38 102% 41
Mar 31, 1996 5,118 0.41 0.40 97% 188
Jun 30, 1996 6,169 0.42 0.40 103% (18)
Sep 30, 1996 6,708 0.42 0.40 96% 250
Dec 31, 1996 8,164 0.50 0.45 89% 1,115
Mar 31, 1997 8,224 0.50 0.48 95% 1,505
<FN>
(1) Taxable net income after preferred dividends.
(2) Weighted average common shares outstanding.
(3) Common dividend declared divided into applicable quarter's taxable income available to common shareholders.
</FN>
</TABLE>
The primary reasons for the rise in the Company's net interest income for the
first quarter of 1997 as compared to the same period of 1996 was the combined
effect of the increased size of the Company as well as an increase in the yield
on the Company's portfolio of ARM securities and a decrease in the Company's
cost of funds. Net interest income increased by $5,142,000. Of this increase,
the increased average size of the Company during the first quarter of 1997 as
compared to 1996 contributed to higher net interest income in the amount of
$3,808,000. The average balance of the Company's interest earning assets was
$2.951 billion during the first quarter of 1997 as compared to $2.026 billion
during the same period of 1996, an increase of 46%. Additionally, $927,000 is
the result of the higher yield on the Company's ARM securities portfolio and
other interest earning assets and $406,000 is the result of the lower interest
rate on the Company's cost of funds for a combined favorable rate variance of
$1,333,000. The yield on the Company's interest earning assets during the
quarter ended March 31, 1997 was 6.64% as compared to 6.46% during the same
period of 1996. Also, during these same periods, the Company's cost of funds
decreased to 5.64% in 1997 from 5.73% in 1996. The Company's yield on net
interest earning assets, which includes the impact of shareholders' equity, rose
to 1.54% for the first quarter of 1997 from 1.22% for the same period of 1996.
<PAGE>
The following table highlights the components of net interest spread and the
annualized yield on net interest earning assets as of each applicable quarter
end (dollars in millions):
<TABLE>
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS (1)
<CAPTION>
ARM Securities
Average ----------------------------------- Yield on Yield on
Interest Wgt. Avg. Weighted Interest Net Net Interest
As of the Earning Fully Indexed Average Yield Earning Cost of Interest Earning
Quarter Ended Assets Coupon Coupon Adj.(2) Assets Funds Spread Assets
------------- ---------- ------------- --------- -------- --------- ------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mar 31, 1995 $ 1,748.7 8.46% 6.33% 0.26% 6.07% 6.33% -0.26% 0.49%
Jun 30, 1995 1,809.7 7.94% 6.77% 0.40% 6.37% 6.21% 0.16% 0.55%
Sep 30, 1995 1,864.3 7.93% 7.24% 0.58% 6.66% 6.04% 0.62% 1.04%
Dec 31, 1995 1,975.6 7.51% 7.42% 0.69% 6.73% 6.05% 0.68% 1.11%
Mar 31, 1996 2,025.8 7.56% 7.48% 0.99% 6.49% 5.60% 0.89% 1.32%
Jun 30, 1996 2,248.2 7.83% 7.28% 0.85% 6.43% 5.59% 0.84% 1.32%
Sep 30, 1996 2,506.0 7.80% 7.31% 0.80% 6.51% 5.71% 0.80% 1.32%
Dec 31, 1996 2,624.4 7.61% 7.57% 0.93% 6.64% 5.72% 0.92% 1.34%
Mar 31, 1997 2,950.6 7.93% 7.53% 0.89% 6.65% 5.67% 0.98% 1.54%
<FN>
(1)Yield on Net Interest Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest earning
assets.
(2)Yield adjustments include the impact of amortizing premiums and
discounts, the cost of hedging activities, the amortization of deferred
gains from hedging activities and the impact of principal payment
receivables. The following table presents these components of the yield
adjustments for the dates presented in the table above:
</FN>
</TABLE>
<TABLE>
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM SECURITIES
<CAPTION>
Impact of Amort. of
Premium/ Principal Deferred Gain Total
As of the Discount Payments Hedging from Hedging Yield
Quarter Ended Amort. Receivable Activity Activity Adjustment
------------- --------- ---------- -------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Mar 31, 1995 0.22% 0.02% 0.21% (0.19)% 0.26%
Jun 30, 1995 0.26% 0.03% 0.28% (0.17)% 0.40%
Sep 30, 1995 0.37% 0.06% 0.31% (0.16)% 0.58%
Dec 31, 1995 0.43% 0.10% 0.32% (0.16)% 0.69%
Mar 31, 1996 0.77% 0.11% 0.31% (0.20)% 0.99%
Jun 30, 1996 0.67% 0.07% 0.27% (0.16)% 0.85%
Sep 30, 1996 0.57% 0.08% 0.25% (0.10)% 0.80%
Dec 31, 1996 0.69% 0.09% 0.23% (0.08)% 0.93%
Mar 31, 1997 0.63% 0.13% 0.19% (0.07)% 0.89%
</TABLE>
As of the end of the quarter ended March 31, 1997, the Company's yield on its
ARM securities portfolio, including the impact of the amortization of premiums
and discounts, the cost of hedging, the amortization of deferred gains from
hedging activity and the impact of principal payment receivables, was 6.65% as
compared to 6.64% as of the end of 1996, an increase of 0.01%. The Company's
cost of funds as of March 31, 1997 was 5.67% as compared to 5.72% as of December
31, 1996, a decrease of 0.05%. As a result of these changes, the Company's net
interest spread as of March 31, 1997 was 0.98% as compared to 0.92% as of
December 31, 1996, an increase of 0.06%.
<PAGE>
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the quarters ended March 31, 1997 and 1996:
<TABLE>
AVERAGE BALANCE AND RATE TABLE
(Amounts in thousands)
<CAPTION>
For the Quarter Ended For the Quarter Ended
March 31, 1997 March 31, 1996
---------------------- ------------------------
Average Effective Average Effective
Balance Rate Balance Rate
------------ --------- ------------- ---------
<S> <C> <C> <C> <C>
Interest Earning Assets:
ARM securities $ 2,936,247 6.65% $ 2,012,676 6.46%
Cash and cash equivalents 14,348 5.27 13,086 5.61
---------- ------ ----------- ------
2,950,595 6.64 2,025,762 6.46
---------- ------ ----------- ------
Interest Bearing Liabilities:
Borrowings 2,670,033 5.64 1,850,508 5.73
---------- ------- ------------ ------
Net Interest Earning Assets and Spread $ 280,562 1.00% $ 175,254 0.73%
========== ======= ============ ======
Yield on Net Interest Earning Assets (1) 1.54% 1.22%
======= ======
<FN>
(1) Yield on Net Interest Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest earning assets.
</FN>
</TABLE>
During the first quarter of 1997, the Company realized a net gain from the sale
of ARM securities in the amount of $4,000 as compared to $13,000 during the
first quarter of 1996. Additionally, the Company recorded an expense for credit
losses in the amount of $190,000 during the quarter ended March 31, 1997.
Although the Company has only incurred actual credit losses of $18,000 to date,
the Company's review of the underlying ARM collateral indicates the potential of
some loss on three ARM securities that have an aggregate carrying value of $17.9
million, or 0.6% of the Company's ARM securities portfolio.
For the quarter ended March 31, 1997, the Company's ratio of operating expenses
to average assets was 0.25% as compared to 0.21% for the same quarter of 1996
and as compared to 0.24% for the previous quarter ended December 31, 1996. The
Company's expense ratios are among the lowest of any company investing in
mortgage assets, giving the Company what it believes to be a significant
competitive advantage over more traditional mortgage portfolio lending
institutions such as banks and savings and loans, enabling the Company to
operate with less risk, such as credit and interest rate risk, and still
generate an attractive return on equity when compared to these more traditional
mortgage portfolio lending institutions. The typical expense ratios of such
lending institutions range between 2.50% and 3.50%.
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
<TABLE>
ANNUALIZED OPERATING EXPENSE RATIOS
<CAPTION>
Management Fee & Total
For The Other Expenses/ Performance Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
------------- ---------------- ---------------- --------------
<S> <C> <C> <C>
Mar 31, 1995 0.10% 0.00% 0.10%
Jun 30, 1995 0.10% 0.00% 0.10%
Sep 30, 1995 0.10% 0.03% 0.13%
Dec 31, 1995 0.10% 0.09% 0.19%
Mar 31, 1996 0.09% 0.12% 0.21%
Jun 30, 1996 0.10% 0.09% 0.19%
Sep 30, 1996 0.10% 0.10% 0.20%
Dec 31, 1996 0.13% 0.11% 0.24%
Mar 31, 1997 0.14% 0.11% 0.25%
</TABLE>
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarters ended March 31, 1997 and
1996 consisted of reverse repurchase agreements, which totaled $2.936 billion
and $1.827 billion at the respective quarter ends. The Company's other
significant source of funds for the quarters ended March 31, 1997 and 1996
consisted of payments of principal and interest from its ARM securities
portfolio in the amounts of $194.2 million and $175.1 million, respectively. In
the future, the Company expects its primary sources of funds will continue to
consist of monthly payments of principal and interest on its ARM securities
portfolio and of borrowed funds under reverse repurchase agreement transactions
with one to twelve month maturities and possibly from asset sales as needed. The
Company's liquid assets generally consist of unpledged ARM securities, cash and
cash equivalents.
The borrowings incurred at March 31, 1997 had a weighted average interest cost
of 5.67%, which includes the cost of interest rate swaps, a weighted average
original term to maturity of 7.9 months and a weighted average remaining term to
maturity of 3.8 months. As of March 31, 1997, $1.261 billion of the Company's
borrowings were variable-rate term reverse repurchase agreements with original
maturities that range from three months to two years. The interest rates of
these term reverse repurchase agreements are indexed to either the one, three or
six-month LIBOR rate and reprice accordingly.
The Company has borrowing arrangements with twenty-two different investment
banking firms and commercial banks and at March 31, 1997 had borrowed funds
under reverse repurchase agreements with fourteen of these firms. Because the
Company borrows funds based on the fair value of its ARM securities, the
Company's borrowing ability could be adversely affected as a result of either a
significant increase in short-term interest rates or a credit downgrade of a
mortgage pool or a mortgage pool insurer, either of which would reduce the fair
value of the Company's ARM securities. If such a decrease in fair value was
significant enough, it could require the Company to sell assets in order to
maintain liquidity. For the quarter ended March 31, 1997, the Company had
adequate cash flow, liquid assets and unpledged collateral with which to meet
its margin requirements. Further, the Company has always maintained sufficient
liquidity to meet its cash requirements from its primary sources of funds and
believes it will be able to do so in the future.
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share pursuant to
its effective Registration Statement. Net proceeds from this issuance totaled
$65.8 million. Upon completion of this issuance of preferred stock, the Company
had $173 million of its securities registered for future sale under this
registration statement.
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "Plan")
designed to provide a convenient and economical way for existing common and
preferred shareholders to automatically invest their dividends into shares of
common stock and to purchase common shares at a 3% discount from the current
market price, as defined in the Plan. As a result of first quarter 1997
participation in the Plan, the Company issued 102,337 new shares of common stock
and received $2.0 million of new equity capital.
In October 1995, the Company entered into a Sales Agency Agreement with
PaineWebber Incorporated. In accordance with the Sales Agency Agreement,
PaineWebber agreed to sell, at the direction and discretion of the Company, up
to 1,174,969 additional shares of the Company's common stock. During 1997, the
Company has not sold any shares under this Sales Agency Agreement.
EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates impact the Company's earnings in various ways. While
the Company only invests in ARM securities, rising short-term interest rates may
temporarily negatively affect the Company's earnings and conversely falling
short-term interest rates may temporarily increase the Company's earnings. This
impact can occur for several reasons and may be mitigated by portfolio
prepayment activity as discussed below. First, the Company's borrowings will
react to changes in interest rates sooner than the Company's ARM securities
because the weighted average next re-pricing date of the borrowings is usually a
shorter time period. Second, interest rates on ARM loans are generally limited
to an increase of either 1% or 2% per adjustment period (commonly referred to as
the periodic cap) and the Company's borrowings do not have similar limitations.
Third, the Company's ARM securities lag behind changes in the indices due to the
notice period provided to ARM borrowers when the interest rate on their loans
are scheduled to change. The periodic cap only affects the Company's earnings
when interest rates move by more than 1% per six-month period or 2% per year.
The rate of prepayment on the Company's mortgage securities may decrease if
interest rates rise, or if the difference between long-term and short-term
interest rates increases. Decreased prepayments would cause the Company to
amortize the premiums paid for its ARM securities over a longer time period than
otherwise, resulting in an increased yield on its mortgage securities.
Therefore, in rising short-term interest rate environments where prepayments are
declining, the interest rate on the ARM securities portfolio will likely
increase to re-establish a spread over the higher interest rates and the yield
would also rise due to slower prepayments. This combined effect could
significantly mitigate the negative effects that rising short-term interest
rates might have on earnings.
Conversely, the rate of prepayment on the Company's mortgage securities may
increase if interest rates decline, or if the difference between long-term and
short-term interest rates diminishes. Increased prepayments would cause the
Company to amortize the premiums paid for its mortgage securities faster,
resulting in a reduced yield on its mortgage securities. Additionally, to the
extent proceeds of prepayments cannot be reinvested at a rate of interest at
least equal to the rate previously earned on such mortgage securities, the
Company's earnings may be adversely affected.
Lastly, because the Company only invests in ARM assets and approximately 9% of
such mortgage assets are purchased with shareholders' equity, the Company's
earnings over time will tend to increase following periods when short-term
interest rates have risen and decrease following periods when short-term
interest rates have declined. This results because the financed portion of the
Company's portfolio of ARM securities will, over time, re-price to a spread over
the Company's cost of funds while the portion of the Company's portfolio of ARM
securities that are purchased with shareholders' equity will generally have a
higher yield in a higher interest rate environment and a lower yield in a lower
interest rate environment.
Changes in interest rates also affect the fair value of the Company's ARM
securities and certain liabilities. In general, when interest rates rise the
Company's ARM securities will likely decrease in value initially, and then
recover a portion of their value as their interest rate coupons adjust to market
interest rates, but may not recover all of the decline in value because the
adjusted interest rate coupons will be closer to the life time caps on the ARM
securities. Because the Company borrows funds based on the fair value of its ARM
securities, the Company's borrowing ability could be adversely affected as a
result of a significant increase in short-term interest rates. A substantial
decrease in the fair value of the Company's ARM securities could require the
Company to sell assets in order to maintain liquidity. Additionally, when
interest rates rise, the Company's hedging instruments and other borrowings will
likely increase in value. The converse impact on the fair value of the Company's
ARM securities and certain liabilities will likely occur when interest rates
decline. Changes in interest rates have little if any effect on the fair value
of the Company's cash, cash equivalents or reverse repurchase agreements due to
the short term nature of these financial instruments.
OTHER MATTERS
As of March 31, 1997, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.3% 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 99.6% of its 1997 revenue for the first quarter qualifies for the 75%
source of income test and 100% of its revenue qualifies for the 95% source of
income test under the REIT rules. Furthermore, the Company's revenues during the
quarter ended March 31, 1997 subject to the 30% income limitation under the REIT
rules amount to 0.01% of total revenue. The Company also met all REIT
requirements regarding the ownership of its common stock and the distributions
of its net income. Therefore, as of March 31, 1997, 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. 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 the certificates issued with respect
to an underlying pool of mortgages, such mortgage securities may be treated as
securities separate from the underlying mortgage loans and, thus, may not be
considered Qualifying Interests for purposes of the 55% requirement. As of March
31, 1997, the Company calculates that it is in compliance with this requirement.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At March 31, 1997, 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
None
(b) Reports on Form 8-K
The Registrant has filed the following Current Report on Form 8-K
during the period covered by this Form: 10-Q:
(i)Current Report on Form 8-K, dated January 22, 1997 regarding the
Underwriting Agreement entered into by the Registrant on January 20,
1997. The Underwriting Agreement, Articles Supplementary and an
Amendment to the 1992 Stock Option Plan dated December 19, 1996 were
included as Exhibits to this Current Report on Form 8-K.
<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,
THORNBURG MORTGAGE ASSET CORPORATION
Dated: May 5, 1997 By:/s/ Larry A. Goldstone
-----------------------
Larry A. Goldstone
President and Chief Operating Officer
(authorized officer of registrant)
Dated: May 5, 1997 By:/s/ Richard P. Story
--------------------
Richard P. Story,
Chief Financial Officer and Treasurer
(principal accounting officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the March
31, 1997 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-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 25,996
<SECURITIES> 3,217,621
<RECEIVABLES> 29,716
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 512
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,273,845
<CURRENT-LIABILITIES> 2,981,752
<BONDS> 0
0
65,809
<COMMON> 163
<OTHER-SE> 226,121
<TOTAL-LIABILITY-AND-EQUITY> 3,273,845
<SALES> 0
<TOTAL-REVENUES> 49,004
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,852
<LOSS-PROVISION> 190
<INTEREST-EXPENSE> 37,668
<INCOME-PRETAX> 9,294
<INCOME-TAX> 0
<INCOME-CONTINUING> 9,294
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,294
<EPS-PRIMARY> .49
<EPS-DILUTED> .49
</TABLE>
