______________________________________________________________________________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 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) 19,752,188 as of October 30, 1997
THORNBURG MORTGAGE ASSET CORPORATION
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets at September 30, 1997 and December 31, 1996 3
Statements of Operations for the three months and nine
months ended September 30, 1997 and September 30, 1996 4
Statement of Stockholders' Equity for the three months and
nine months ended September 30, 1997 5
Statements of Cash Flows for the three months and nine
months ended September 30, 1997 and September 30, 1996 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 3. Defaults Upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 29
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THORNBURG MORTGAGE ASSET CORPORATION
BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
1997 1997
------------------ -----------------
<S> <C> <C>
ASSETS
ARM assets (Notes 2 and 3) $ 4,463,002 $ 2,727,875
Cash and cash equivalents 20,427 3,693
Accrued interest receivable 37,274 23,563
Prepaid expenses and other 478 227
------------------ -----------------
$ 4,521,181 $ 2,755,358
================== =================
LIABILITIES
Reverse repurchase agreements (Note 3) $ 3,980,910 $ 2,459,132
Other borrowings (Note 3) 11,319 14,187
Payable for securities purchased 120,557 32,683
Accrued interest payable 24,571 18,747
Dividends payable (Note 6) 11,450 7,299
Accrued expenses and other 9,019 1,112
------------------ -----------------
4,157,826 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 65,805 -
Common stock: par value $.01 per share;
47,240,000 shares authorized, 19,560,892
and 16,219,241 shares issued and
outstanding, respectively 196 162
Additional paid-in-capital 301,911 233,177
Available-for-sale securities:
Unrealized gain (loss) (Note 2) (8,003) (15,807)
Realized deferred hedging gain 3,441 4,541
Retained earnings 5 125
------------------ -----------------
363,355 222,198
------------------ -----------------
$ 4,521,181 $ 2,755,358
================== =================
</TABLE>
See Notes to Financial Statements.
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Interest income from ARM assets
and cash $ 68,088 $ 40,173 $ 174,710 $ 108,556
Interest expense on borrowed funds (54,862) (32,221) (137,977) (87,188)
------------ ----------- ----------- -----------
Net interest income 13,226 7,952 36,733 21,368
------------ ----------- ----------- -----------
Gain (loss) on sale of ARM assets 335 520 360 533
Provision for credit losses (223) (200) (623) (200)
Management fee (Note 5) (974) (430) (2,661) (1,194)
Performance fee (Note 5) (931) (631) (2,569) (1,727)
Other operating expenses (251) (183) (689) (452)
------------ ----------- ----------- -----------
NET INCOME $ 11,182 $ 7,028 $ 30,551 $ 18,328
============ =========== =========== ===========
Net income $ 11,182 $ 7,028 $ 30,551 $ 18,328
Dividend on preferred stock (1,670) - (4,581) -
------------ ----------- ----------- -----------
Net income available to common
shareholders $ 9,512 $ 7,028 $ 25,970 $ 18,328
============ =========== =========== ===========
Net income per common share $ 0.50 $ 0.44 $ 1.49 $ 1.27
============ =========== =========== ===========
Average number of common shares
outstanding 19,152,374 16,080,363 17,437,270 14,425,873
============ =========== =========== ===========
</TABLE>
See Notes to Financial Statements.
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
Three Months and Nine Months Ended September 30, 1997
(In thousands, except share data)
<TABLE>
<CAPTION>
Available-for-Sale
Securities
-------------------------
Realized
Additional Unrealized Deferred
Preferred Common Paid-in Gain Gain From Retained
Stock Stock Capital (Loss) Hedging Earnings Total
----------- -------- ------------ ------------ ----------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31, 1996 $ - $ 162 $ 233,177 $ (15,807) $ 4,541 $ 125 $222,198
Series A preferred
stock issued, net
of issuance
cost (Note 5) 65,805 - - - - - 65,805
Issuance of common
stock (Note 5) - 11 20,407 - - - 20,418
Available-for-Sale
Securities: Fair
value adjustment,
net of amortization - - - 5,756 - - 5,756
Deferred gain on
sale of hedges,
net of
amortization - - - - (742) - (742)
Net income - - - - - 19,369 19,369
Dividends declared on
preferred stock -
$1.055 per share - - - - - (2,912) (2,912)
Dividends declared on
common stock -
$0.97 per share - - - - - (16,309) (16,309)
----------- -------- ------------ ------------ ----------- ---------- ---------
Balance,
June 30, 1997 65,805 173 253,584 (10,051) 3,799 273 313,583
Issuance of common
stock (Note 5) - 23 48,327 - - - 48,350
Available-for-Sale
Securities: Fair
value adjustment,
net of amortization - - - 2,048 - - 2,048
Deferred gain on
sale of hedges,
net of
amortization - - - - (358) - (358)
Net income - - - - - 11,182 11,182
Dividends declared on
preferred stock -
$0.605 per share - - - - - (1,670) (1,670)
Dividends declared on
common stock -
$0.50 per share - - - - - (9,780) (9,780)
----------- -------- ------------ ------------ ----------- ---------- ---------
Balance,
September 30, 1997 $ 65,805 $ 196 $ 301,911 $ (8,003) $ 3,441 $ 5 $363,355
=========== ======== ============ ============ =========== ========== =========
</TABLE>
See Notes to Financial Statements.
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Operating Activities:
Net Income $ 11,182 $ 7,028 $ 30,551 $ 18,328
Adjustments to reconcile net income to
net cash provided by operating
activities:
Amortization 6,962 3,432 16,134 10,210
Net (gain) loss from investing
activities (112) (320) 263 (333)
Change in assets and liabilities:
Accrued interest receivable 2,377) (2,026) (13,711) (2,783)
Prepaid expenses and other (91) (791) (249) (864)
Accrued interest payable 5,298 1,529 5,824 2,774
Accrued expenses and other 3,140 1,231 7,907 1,274
------------ ------------ ------------- ------------
Net cash provided by operating
activities 24,002 10,083 46,719 28,606
------------ ------------ ------------- ------------
Investing Activities:
Available-for-sale assets:
Purchase of ARM assets (786,268) (310,220) (2,256,576) (1,068,522)
Proceeds on sales of ARM assets 73,915 26,047 108,217 32,586
Principal payments on ARM assets 208,511 107,298 494,546 327,880
Held-to-maturity assets:
Principal payments on adjustable-rate
mortgage assets 14,207 27,191 44,732 94,697
ARM Loans:
Purchase of ARM loans (31,325) - (45,075) -
Principal payments on ARM loans 337 - 337 -
Purchase of interest rate cap agreements (1,234) - (3,128) (423)
------------ ------------ ------------- ------------
Net cash provided by (used in)
investing activities (521,857) (149,684) (1,656,947) (613,782)
------------ ------------ ------------- ------------
Financing Activities:
Net borrowings from reverse repurchase
agreements 469,338 137,677 1,521,778 546,919
Net borrowings from (repayments of)
other borrowings (825) (762) (2,869) (3,056)
Proceeds from preferred stock issued - - 65,805 -
Proceeds from common stock issued 48,350 2,456 68,768 55,560
Dividends paid (10,145) (6,375) (26,520) (15,979)
------------ ------------ ------------- ------------
Net cash provided by (used in)
financing activities 506,718 132,996 1,626,962 583,444
------------ ------------ ------------- ------------
Net increase (decrease) in cash and cash
equivalents 8,863 (6,605) 16,734 (1,732)
Cash and cash equivalents at beginning of
period 11,564 8,533 3,693 3,660
------------ ------------ ------------- ------------
Cash and cash equivalents at end of period $ 20,427 $ 1,928 $ 20,427 $ 1,928
============ ============ ============= ============
<FN>
Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.
</FN>
</TABLE>
See Notes to Financial Statements.
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 fair value.
ADJUSTABLE-RATE MORTGAGE ASSETS
The Company's adjustable-rate mortgage ("ARM") assets are comprised of both
ARM securities and ARM loans. The Company's policy is to classify each of
its ARM securities as available-for-sale as they are purchased and then
monitor each ARM security for a period of time, generally six to twelve
months, prior to making a determination as to whether the ARM security will
be classified as held-to-maturity. Management has made the determination
that certain ARM securities should be designated as 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 as 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.
ARM loans that management has the intent and ability to hold for the
foreseeable future and until maturity or payoff are carried at their unpaid
principle balances, net of unamortized premium or discount and allowance
for loan losses.
Premiums and discounts associated with the purchase of the ARM assets are
amortized into interest income over the lives of the assets using the
effective yield method adjusted for the effects of estimated prepayments.
ARM asset transactions are recorded on the date the ARM assets are
purchased or sold. Purchases of new issue ARM securities and ARM loans are
recorded when all significant uncertainties regarding the characteristics
of the assets are removed, generally shortly before settlement date.
Realized gains and losses on ARM asset transactions are determined on the
specific identification basis.
CREDIT RISK
The Company limits its exposure to credit losses on its portfolio of ARM
assets by only purchasing ARM securities that have an investment grade
rating at the time of purchase and have some form of credit enhancement or
are guaranteed by an agency of the federal government. An investment grade
security generally has a security rating of BBB or Baa or better by at
least one of two nationally recognized rating agencies, Moody's or Standard
& Poor's (the "Rating Agencies"). Additionally, the Company may purchase
ARM loans and limit its exposure to credit losses by restricting its whole
loan purchases to ARM loans originated to "A" quality underwriting
standards. The Company further limits its exposure to credit losses by
limiting its investment in investment grade securities that are rated A, or
equivalent, BBB, or equivalent, or ARM loans originated to "A" quality
underwriting standards ("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
majority of the Company's portfolio is comprised of ARM assets that are
either guaranteed by an agency of the federal government or are rated
within one of the two highest rating categories by at least one of the
Rating Agencies.
The Company monitors the delinquencies and losses on the underlying
mortgages of its ARM securities. If the credit performance of the
underlying mortgage loans is not as good as expected, the Company 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. The Company also
makes a monthly provision for possible credit losses on its portfolio of
whole loans which is an increase to the reserve for possible loan losses.
The provision for possible credit losses on loans is based on loss
statistics of the real estate industry for similar loans, taking into
consideration factors including, but not limited to, underwriting
characteristics, seasoning, geographic location and current and projected
economic conditions. When a loan or a portion of a loan is deemed to be
uncollectible, the portion deemed to be uncollectible is charged against
the reserve and subsequent recoveries, if any, are credited to the reserve.
Provisions for credit losses do not reduce taxable income and thus 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.
DERIVATIVE FINANCIAL INSTRUMENTS
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 assets should interest rates rise above
specified levels. The Cap Agreements reduce the effect of the lifetime cap
feature so that the yield on the ARM assets 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 assets 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.,
convertible preferred stock and 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting No. 128, Earnings Per Share (SFAS No.
128). SFAS No. 128 supersedes APB Opinion No. 15, Earnings Per Share, and
specifies the computation, presentation and disclosure requirements for
earnings per share (EPS) for entities with publicly held common stock or
potential common stock. SFAS No. 128 will replace Primary EPS and Fully
Diluted EPS with Basic EPS and Diluted EPS, respectively. SFAS No. 128 will
require dual presentation of Basic EPS and Diluted EPS on the face of the
income statement for all entities with complex capital structures. SFAS No.
128 also will require a reconciliation of the numerator and denominator of
the Basic EPS to the numerator and denominator of the Diluted EPS
computation. SFAS No. 128 will be effective for financial statements for
periods ending after December 15, 1997.
In February 1997, the FASB issued SFAS No. 129, Disclosure of Information
about Capital Structure. This statement establishes standards for
disclosing information about an entity's capital structure.
On June 30, 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. This statement requires companies to classify items of other
comprehensive income 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 equity section of a
statement of financial position.
The Company intends to comply with the requirements of these statements
which are effective for periods ending after December 15, 1997. The Company
has determined that these statements will not result in material changes to
the Company's financial position and results of operations.
NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AGREEMENTS
Investments in ARM assets consists of ARM loans and ARM securities backed
by ARM loans, primarily on single-family residential housing.
The following tables present the Company's ARM assets as of September 30,
1997 and December 31, 1996. The ARM securities classified as
available-for-sale are carried at their fair value, the ARM securities
classified as held-to-maturity and the ARM loans are carried at their
amortized cost basis (dollars in thousands):
<TABLE>
<CAPTION>
September 30, 1997:
ARM Securities
-------------------------
Available- Held-to-
for-Sale Maturity ARM Loans Total
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Amortized cost basis $ 4,012,390 $ 414,576 $ 44,712 $ 4,471,678
Allowance for losses (1,521) - (13) (1,534)
------------ ------------ ----------- ------------
Amortized cost, net 4,010,869 414,576 44,699 4,470,144
------------ ------------ ----------- ------------
Gross unrealized gains 15,427 8,342 - 23,769
Gross unrealized losses (22,569) (3,118) - (25,687)
------------ ------------ ----------- ------------
Fair value $ 4,003,727 $ 419,800 $ 44,699 $ 4,468,226
============ ============ =========== ============
December 31, 1996:
ARM Securities
-------------------------
Available- Held-to-
for-Sale Maturity ARM Loans Total
------------ ------------ ----------- ------------
Amortized cost basis $ 2,282,991 $ 460,596 $ - $ 2,743,587
Allowance for losses (990) - - (990)
------------ ------------ ----------- ------------
Amortized cost, net 2,282,001 460,596 - 2,742,597
------------ ------------ ----------- ------------
Gross unrealized gains 7,686 4,169 - 11,855
Gross unrealized losses (22,408) (4,306) - (26,714)
------------ ------------ ----------- ------------
Fair value $ 2,267,279 $ 460,459 $ - $ 2,727,738
============ ============ =========== ============
</TABLE>
During the quarter ended September 30, 1997, the Company realized $446,000
in gains and $111,000 in losses on the sale of $73.6 million of ARM
securities which were classified as available-for-sale.
As of September 30, 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 $1,521,000, including a provision
for credit losses of $210,000 during the quarter ended September 30, 1997.
At this time, the Company is providing for potential future credit losses
on two securities that have an aggregate carrying value of $14.5 million,
which represent less than 0.3% of the Company's total portfolio of ARM
assets. Both of these securities are performing and have varying degrees of
remaining credit support that mitigate the Company's exposure to potential
future credit losses. Additionally, during the third quarter, the Company,
in accordance with its credit policies, recorded a $13,000 provision for
potential credit losses on its loan portfolio, although no actual losses
have been realized in the loan portfolio to date.
As of September 30, 1997, the Company had $99.4 million of commitments to
purchase ARM securities.
The average effective yield on the ARM assets owned, including the
amortization of the net premium paid for the ARM assets and the Cap
Agreements, was 6.58% as of September 30, 1997 and 6.64% as of December 31,
1996.
As of September 30, 1997 and December 31, 1996, the Company had purchased
Cap Agreements with a remaining notional amount of $3.922 billion and
$2.266 billion, respectively. The notional amount of the Cap Agreements
purchased generally 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
specified in the Cap Agreements, which range from 7.50% to 13.00% and
average approximately 10.04%. The Company's ARM assets portfolio had an
average lifetime interest rate cap of 11.71% as of September 30, 1997. The
initial aggregate notional amount of the Cap Agreements will decline to
approximately $2.945 billion over the period of the agreements, which
expire between 1999 and 2004. 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 assets 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 six
different counterparties, five of which are rated AAA and one of which is
rated AA.
NOTE 3. REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS
The Company has entered into reverse repurchase agreements to finance most
of its ARM assets. The reverse repurchase agreements are secured by the
market value of the Company's ARM assets and bear interest rates that have
historically moved in close relationship to LIBOR.
As of September 30, 1997, the Company had outstanding $3.981 billion of
reverse repurchase agreements with a weighted average borrowing rate of
5.76% and a weighted average remaining maturity of 3.7 months. As of
September 30, 1997, $1.220 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-, two-, three-
or six-month LIBOR rate and reprice accordingly. The reverse repurchase
agreements at September 30, 1997 were collateralized by ARM securities with
a carrying value of $4.189 billion, including accrued interest.
At September 30, 1997, the reverse repurchase agreements had the following
remaining maturities (dollars in thousands):
<TABLE>
<S> <C>
Within 30 days $ 847,781
30 to 90 days 870,617
90 days to one year 2,262,512
-------------
$ 3,980,910
=============
</TABLE>
As of September 30, 1997, the Company had entered into two interest rate
swap agreements having an aggregate notional balance of $250 million and a
weighted average remaining term of 2.6 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 63 days to 68 days.
Additionally, during the quarter ended September 30, 1997, the Company
entered into three interest rate swap agreements that substantially offset
the terms of three other outstanding interest rate swap agreements. These
offsetting agreements have identical repricing dates and variable rates
that negate each other and partially offsetting fixed rates that, on
aggregate, generate an immaterial amount of net income to the Company over
their remaining terms. The three previously outstanding swap agreements
upon which the Company pays the fixed rate and receives the variable rate
are cancelable each month by the counterparty. The offsetting agreements
entered into during the third quarter are cancelable by the Company each
month beginning in February of 1998. All six of these swap agreements
mature during the first quarter of 1999.
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 September 30, 1997, there was no balance
outstanding under this agreement.
As of September 30, 1997, the Company had financed a portion of its
portfolio of interest rate cap agreements with $11.3 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 2.3 years. The
other borrowings financing cap agreements at September 30, 1997 were
collateralized by ARM securities with a carrying value of $15.2 million,
including accrued interest, and $500,000 of cash and cash equivalents. The
aggregate maturities of these other borrowings are as follows (dollars in
thousands):
<TABLE>
<S> <C>
1997 $ 1,301
1998 4,509
1999 4,877
2000 632
------------
$ 11,319
============
</TABLE>
During the quarter ended September 30, 1997, the total cash paid for
interest was $59.5 million.
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 September 30, 1997 and December
31, 1996. 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 (dollars in
thousands):
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
-------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Assets:
ARM assets $ 4,458,317 $ 4,465,956 $ 2,689,727 $ 2,692,521
Cap agreements 4,685 2,270 5,465 2,535
Liabilities:
Other borrowings 11,319 11,560 14,187 14,744
Swap agreements 32 428 (7) 440
</TABLE>
The above carrying amounts for assets are combined in the balance sheet
under the caption ARM assets. 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. The dividends
are cumulative commencing on the issue date and are payable quarterly, in
arrears. The dividends per share are equal to the greater of (i) $0.605 per
quarter, or (ii) the quarterly dividend declared on the Company's common
stock. Each share is convertible at the option of the holder at any time
into one share of common stock. The preferred shares are redeemable by the
Company on and after December 31, 1999, in whole or in part, as follows:
(i) for one share of common stock plus accumulated, accrued but unpaid
dividends, provided that for 20 trading days within any period of 30
consecutive trading days the closing price of the common stock equals or
exceeds the conversion price of $25, or (ii) for cash at the issue price of
$25, plus any accumulated, accrued but unpaid dividends through the
redemption date. In the event of liquidation, the holders of the preferred
shares will be entitled to receive out of the assets of the Company, prior
to any distribution to the common shareholders, the issue price of $25 per
share in cash, plus any accumulated, accrued and unpaid dividends.
In May 1997, the Company issued 861,850 shares of common stock at a price
of $19.50 per share pursuant to its Registration Statement on Form S-3
declared effective in December 1996. Net proceeds from this issuance
totaled $16.2 million.
In July 1997, the Company issued 2,100,000 shares of common stock at a
price of $22.625 per share pursuant to its Registration Statement on Form
S-3 declared effective in December 1996. Net proceeds from this issuance
totaled $45.0 million. Upon completion of this issuance of common stock,
the Company had $109 million of its securities registered for future sale
under this Registration Statement.
During the quarter ended September 30, 1997, the Company issued 151,963
shares of common stock under its Dividend Reinvestment and Stock Purchase
Plan and received net proceeds of $3.2 million. For the nine month period
ended September 30, 1997, the Company issued 367,801 shares of common stock
under this plan and received net proceeds of $7.4 million.
On September 17, 1997, the Company declared a third quarter dividend of
$0.50 per common share which was paid on October 10, 1997 to common
shareholders of record as of September 30, 1997. Additionally, the Company
declared a dividend of $0.605 per share to the shareholders of the Series A
9.68% Cumulative Convertible Preferred Stock for the third quarter which
was also paid on October 10, 1997 to preferred shareholders of record as of
September 30, 1997. For federal income tax purposes such dividends are
ordinary income to the Company's common and preferred shareholders.
NOTE 6. STOCK OPTION PLAN
The Company has a Stock Option 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 September 30, 1997, there were 88,200 options
granted to buy common shares at an exercise price of $22.625 along with
22,050 DERs. As of September 30, 1997, the Company had 855,066 options
outstanding at exercise prices of $9.375 to $22.625 per share, 614,746 of
which were exercisable. The weighted average exercise price of the options
outstanding is $17.03 per share. There were 12,000 options exercised during
the quarter ended September 30, 1997 by Mr. Stuart Sherman, a member of the
Company's Board of Directors, at an exercise price of $15 for which the
Company received proceeds of $180,000. As of the quarter ended September
30, 1997, there were 60,081 DERs granted, of which 31,101 were vested, and
199 PSRs granted. In addition, the Company recorded an expense associated
with the DERs and the PSRs of $20,000 for both the three- and nine-month
periods ending September 30, 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 September 30, 1997 and 1996, the Company paid the
Manager $974,000 and $430,000, respectively, in base management fees in
accordance with the terms of the Agreement. For the nine month periods
ended September 30, 1997 and 1996, the Company paid the Manager base
management fees of $2,661,000 and $1,194,000, respectively.
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 September 30, 1997 and 1996,
the Company paid the Manager $931,000 and $631,000, respectively, in
performance based compensation in accordance with the terms of the
Agreement. For the nine month periods ended September 30, 1997 and 1996,
the Company paid the Manager performance based compensation in the amounts
of $2,569,000 and $1,727,000, respectively.
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 July 14, 1997.
GENERAL
Thornburg Mortgage Asset Corporation (the "Company") is a mortgage portfolio
lending institution that primarily invests in adjustable-rate mortgage ("ARM")
assets comprised of ARM securities and ARM loans, 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 assets and seeks to generate income based on the difference
between the yield on its ARM assets 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 ARM assets portfolio may consist of either agency or privately
issued (generally publicly registered) mortgage pass-through securities,
multiclass pass-through securities, collateralized mortgage obligations
("CMOs"), ARM loans 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
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 ARM portfolio's overall high credit quality. The Company's ARM
portfolio is currently comprised of approximately 4% of Other Investment assets.
The Company may increase its investment in Other Investment assets, specifically
classes of multi-class pass-through certificates, 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 has also acquired 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 characteristics of the ARM securities originated and
held in its investment portfolio. The Company plans on securitizing the loans
that it acquires in order to continue its current strategy of owning high
quality, liquid ARM securities and financing them in the reverse repurchase
market because the Company believes this strategy will increase the portfolio's
total return and result in a higher net spread when considering the cost of
financing and credit provisions. In pursuing this strategy the Company will
likely have a higher degree of credit risk than when acquiring securities
directly from the market. However, any additional credit risk will be consistent
with the Company's objectives of maintaining a portfolio with a high level of
credit quality that provides 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 September 30, 1997, the Company held total assets of $4.521 billion, $4.463
billion of which consisted of ARM assets, as compared to $2.755 billion and
$2.728 billion, respectively, at December 31, 1996. Since commencing operations,
the Company has purchased either ARM securities which have been either backed by
agencies of the U.S. government, privately-issued (generally publicly
registered) mortgage securities, most of which are rated AA or higher by at
least one of the Rating Agencies or ARM loans originated to "A" quality
underwriting standards. At September 30, 1997, 95.7% of the Company's assets
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 ARM pass-through certificates.
The following table presents a schedule of ARM assets owned at September 30,
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>
<CAPTION>
ARM PORTFOLIO BY ISSUER AND CREDIT RATING
(amounts in thousands)
September 30, 1997 December 31, 1996
------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $ 3,089,614 69.2% $ 1,474,842 54.1%
Privately Issued Securities:
AAA/Aaa Rating 344,046 7.7 260,031 9.5
AA/Aa Rating 843,858 18.9 862,727 31.6
------------ ----------- ------------ -----------
Total Privately Issued 1,187,904 26.6 1,122,758 41.1
------------ ----------- ------------ -----------
------------ ----------- ------------ -----------
Total High Quality 4,277,518 95.8 2,597,600 95.2
------------ ----------- ------------ -----------
OTHER INVESTMENT:
Privately Issued Securities:
A Rating 113,014 2.6 106,531 3.9
BBB/Baa Rating 18,012 0.4 14,017 0.5
BB/Ba rating 9,721 0.2 9,727 0.4
Whole loans 44,737 1.0 - -
------------ ----------- ------------ -----------
Total Other Investment 185,484 4.2 130,275 4.8
------------ ----------- ------------ -----------
Total ARM Portfolio $ 4,463,002 100.0% $ 2,727,875 100.0%
============ =========== ============ ===========
</TABLE>
As of September 30, 1997, the Company had reduced the cost basis of its ARM
assets due to potential future credit losses (other than temporary declines in
fair value) in the amount of $1,521,000, including provisions for credit losses
of $210,000 for ARM securities and $13,000 for ARM loans recorded during the
quarter ended September 30, 1997. During the third 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. At this time, the Company is providing for potential future losses
on two securities, the aforementioned senior class of a multi-class pass-through
security and one other, that have an aggregate carrying value of $14.5 million,
which is less than 0.3% of the Company's total portfolio of ARM securities. Both
of these securities are performing and have varying degrees of remaining credit
support that mitigate the Company's exposure to potential future credit losses.
The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.
<TABLE>
<CAPTION>
ARM PORTFOLIO BY INDEX
(amounts in thousands)
September 30, 1997 December 31, 1996
-------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
INDEX:
One-month LIBOR $ - - % $ 10,646 0.4%
Six-month LIBOR 1,538,130 34.5 1,252,884 45.9
Six-month Certificate of Deposit 232,643 5.2 69,348 2.6
Six-month Constant Maturity Treasury 67,881 1.5 8,841 0.3
One-year Constant Maturity Treasury 2,263,010 50.7 1,238,892 45.4
Cost of Funds 361,338 8.1 147,264 5.4
------------ ----------- ------------ -----------
$ 4,463,002 100.0% $ 2,727,875 100.0%
============ =========== ============ ===========
</TABLE>
The ARM portfolio had a current weighted average coupon of 7.65% at September
30, 1997. If the ARM portfolio were "fully indexed," the weighted average coupon
would be 7.63%, based upon the current composition of the ARM portfolio and the
applicable indices at September 30, 1997.
At September 30, 1997, the current yield of the ARM portfolio was 6.58%. 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.
During the quarter ended September 30, 1997, the Company purchased $786.3
million of ARM securities, 98.5% of which were High Quality assets, and $31.3
million of ARM loans originated to "A" quality underwriting standards. Of the
ARM assets acquired during the third quarter, approximately 50% are indexed to
US Treasury rates, 33% are indexed to LIBOR, 12% are indexed to a Cost of Funds
Index and the remaining 5% to other miscellaneous indices. Although a larger
proportion of fixed rate loans as compared to ARM loans are being originated in
the current market, the Company has continued to find sufficient attractive ARM
asset acquisition opportunities to continue its asset and earnings growth while
maintaining the high credit quality profile of the ARM portfolio. The Company
has placed particular emphasis on acquiring seasoned ARM assets, which are loans
that were originated over five years ago. These ARM assets are expected to
prepay at a slower rate than newly originated ARM assets. The Company believes,
partially as a result of this strategy, that it has been experiencing lower
prepayment activity in its ARM portfolio than it otherwise would have, which
contributes to a higher and more stable ARM portfolio yield.
The Company also sold $73.6 million of ARM securities during the third quarter,
all of which were High Quality ARM securities and were classified as
available-for-sale, for a net gain of $335,000. The Company tracks the total
return performance of each ARM asset on a monthly basis and regularly selects
assets to be sold based on the overall performance of individual assets. In
general, the assets selected for sale during the third quarter were primarily
selected based on their prepayment characteristics.
During the nine month period ended September 30, 1997, the Company purchased
$2,256.6 million of ARM securities, 98.5% of which were High Quality assets, and
$45.1 million of ARM loans originated to "A" quality underwriting standards. The
Company also sold $107.9 million of ARM securities during the nine month period
ended September 30, 1997, $89.8 million of High Quality ARM securities and $18.1
million of Other Investments, all of which were classified as
available-for-sale, at a net gain of $360,000.
For both the three month and nine month periods ended September 30, 1997, the
Company's mortgage assets continued to pay down at an approximate average
annualized constant prepayment rate of 22%, which approximates 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 assets. 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 ARM securities portfolio increased by $7.6
million during the quarter ended September 30, 1997. As of September 30, 1997,
the Company's ARM securities portfolio available-for-sale, including the
applicable Cap Agreements, had a net unrealized market value loss of $7.1
million, or 0.18% of the securities available-for-sale, as compared to a net
unrealized market value 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 portfolio 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 portfolio 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 September 30, 1997, the Cap Agreements owned by
the Company had a remaining notional balance of $3.922 billion with an average
final maturity of 3.3 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
10.04%. The expense of the Company's hedging activity amounted to $885,000 and
decreased the yield on the ARM portfolio by 0.09% during the quarter ended
September 30, 1997. In general, the fair value of Cap Agreements increases when
market interest rates increase and decreases when market interest rates
decrease, helping to partially offset changes in the fair value of the Company's
ARM portfolio. At September 30, 1997 the fair value of the Cap Agreements was
$2.3 million, $11.2 million less than the amortized cost of the Cap Agreements.
The following table presents information about the Company's Cap Agreement
portfolio as of September 30, 1997:
<TABLE>
<CAPTION>
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
Weighted
Hedged Weighted Cap Agreement Average
ARM Securities Average Notional Strike Remaining
Balance (1) Life Cap Balance Price Term
- ---------------- ----------- --------------- ----------- ---------------
<C> <C> <C> <C> <C>
$ 367,445,000 9.56% $ 366,786,000 7.50% 2.5 Years
357,915,000 10.09 170,000,000 8.00 3.8
103,173,000 10.54 207,821,000 8.50 1.9
247,461,000 10.13 337,651,000 9.00 2.2
155,353,000 10.84 159,482,000 9.50 3.0
321,281,000 11.03 332,309,000 10.00 4.6
463,351,000 11.48 478,318,000 10.50 3.1
435,698,000 11.99 397,884,000 11.00 4.0
437,863,000 12.54 578,154,000 11.50 4.7
594,190,000 12.95 600,965,000 12.00 3.3
242,283,000 13.53 193,575,000 12.50 2.7
257,847,000 14.40 98,679,000 13.00 2.4
- ---------------- ----------- --------------- ----------- ---------------
$ 3,983,860,000 11.71% $3,921,624,000 10.04% 3.3 Years
================ =========== =============== =========== ===============
<FN>
- ----------------
(1) 90% of the ARM securities' balance which approximates the financed
portion.
</FN>
</TABLE>
As of September 30, 1997, the Company had entered into two interest rate swap
agreements having an aggregate notional balance of $250 million and a weighted
average remaining term of 2.6 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
September 30, 1997, the average cost of the Company's borrowings was 5.79%,
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 63 days to 68 days.
Additionally, during the quarter ended September 30, 1997, the Company entered
into three interest rate swap agreements that substantially offset the terms of
three other outstanding interest rate swap agreements. These offsetting
agreements have identical repricing dates and variable rates that negate each
other and partially offsetting fixed rates that, on aggregate, generate an
immaterial amount of net income to the Company over their remaining terms. The
three previously outstanding swap agreements upon which the Company pays the
fixed rate and receives the variable rate are cancelable each month by the
counterparty. The offsetting agreements entered into during the third quarter
are cancelable by the Company each month beginning in February of 1998. All six
of these swap agreements mature during the first quarter of 1999.
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. Net proceeds
from this issuance totaled $65.4 million. In May 1997, the Company issued
861,850 shares of common stock at a price of $19.50 per share. Net proceeds from
this issuance totaled $16.2 million. In July 1997, the Company issued 2,100,000
shares of common stock at a price of $22.625 per share and received net proceeds
of $45.0 million. Primarily as a result of these issuances of common and
preferred stock, the Company's shareholders' equity, excluding the fair value
adjustment for assets held as available-for sale, has grown to $371.4 million as
of September 30, 1997 from $238.0 million as of December 31, 1996. As of
September 30, 1997, the Company's ratio of shareholders' equity to assets,
excluding the fair value adjustment for assets held as available-for sale, was
8.20% as compared to 8.59% as of December 31, 1996. The ratio of shareholders'
equity to assets as of September 30, 1997 reflects the high level of asset
acquisition opportunities that the Company has been able to take advantage of
during 1997.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
For the quarter ended September 30, 1997, the Company's net income was
$11,182,000 as compared to $7,028,000 for the quarter ended September 30, 1996.
Net income available to common shareholders, after the $0.605 per share dividend
to preferred shareholders, increased to $9,512,000 or $0.50 per common share
based on weighted average common shares of 19,152,374 from $7,028,000 or $0.44
per common share based on weighted average common shares of 16,080,363 for the
quarter ended September 30, 1996. This is an increase in net income per common
share available to common shareholders of 14%. Net interest income for the
quarter totaled $13,226,000 as compared to $7,952,000 for the same period in
1996, an increase of 66%. Net interest income is comprised of the interest
income earned on mortgage investments and cash less interest expense from
borrowings. During the third quarter of 1997, the Company recorded a gain on the
sale of ARM securities of $335,000 as compared to a gain of $520,000 during the
third quarter of 1996. Additionally, during the third quarter of 1997, the
Company reduced its earnings and the carrying value of its ARM securities by
reserving $223,000 for potential credit losses as compared to $200,000 for this
same time period in 1996. For the quarter ended September 30, 1997, the Company
incurred operating expenses of $2,156,000 consisting of a base management fee of
$974,000, a performance based fee of $931,000 and other operating expenses of
$251,000. During the same period of 1996, the Company incurred operating
expenses of $1,244,000 consisting of a base management fee of $430,000, a
performance based fee of $631,000 and other operating expenses of $183,000.
The Company's return on average common equity was 12.70% for the quarter ended
September 30, 1997 as compared to 11.86% for the same period in 1996. The
Company's return on average common equity for the nine month period ended
September 30, 1997 was 13.15% as compared to 11.42% for the same period in 1996.
The table below highlights the historical trend and the components of return on
average common equity (annualized):
<TABLE>
<CAPTION>
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
Net Provision Gain Net
Interest For (Loss) G & A Permformance Preferred Income/
For The Income/ Losses/ on ARM Expense (2)/ Fee/ Dividend/ Equity
Quarter Ended Equity Equity Sales/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%
Jun 30, 1997 19.48% 0.34% 0.03% 1.81% 1.25% 2.67% 13.45%
Sep 30, 1997 17.66% 0.30% 0.45% 1.64% 1.24% 2.23% 12.70%
<FN>
- -------------
(1) Average common equity excludes unrealized gain (loss) on available-for-sale
ARM securities.
(2) Excludes performance fees.
</FN>
</TABLE>
The decline in the Company's return on common equity from the second quarter of
1997 to the third quarter of 1997 is due to the decline in the net interest
spread between the Company's interest earning assets and interest bearing
liabilities from 0.90% as of June 30, 1997 to 0.79% as of September 30, 1997.
The primary reason for this decline in the net interest spread has to do with
the current relationship between the one-year U. S. Treasury rate and LIBOR.
During the third quarter, the one-year U. S. Treasury rate declined by
approximately 0.20% whereas LIBOR rates remained substantially the same
throughout the quarter. Approximately 50% of the Company's ARM assets are
indexed to the one-year U. S. Treasury rate and, therefore, the yield on such
assets declined with the index. Conversely, the interest rate on the Company's
borrowings is generally LIBOR based and, thus, did not change significantly
during the third quarter. To put this in perspective, the one-year U. S.
Treasury rate had a spread of -0.24% to the average of the one- and three-month
LIBOR rate as of September 30, 1997 as compared to having a spread of -0.06% at
June 30, 1997, -0.02% at December 31, 1996, 0.04% on average during 1996 and
- -0.07% on average during 1995. For the five-year period from 1992 to 1996, the
average spread was 0.20%. The Company does not know when or if the current
relationship between the one-year U. S. Treasury rate and LIBOR will revert back
to these historical norms, but the Company's spreads are expected to rebound
when and if the relationship does revert.
For the quarter ended September 30, 1997, the Company's taxable income was
$9,737,000 or $0.51 per weighted average share outstanding. Taxable income in
the third quarter of 1997 excludes the loss provisions of $223,000 and an
expense of $20,000 for DERs and PSRs but includes actual credit losses of
$18,000. For the quarter ended September 30, 1996, the Company's taxable income
was $6,708,000 or $0.42 per weighted average share outstanding. Taxable income
in the third quarter of 1996 included the effect of $520,000 of capital loss
carry forwards from 1995 and excluded the loss provisions of $200,000 recorded
during the third quarter of 1996. The Company generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level, and as a REIT, is required to declare dividends
amounting to 85% of each year's taxable income by the end of each calendar year
and to have declared dividends amounting to 95% of its taxable income for each
year by the time it files its applicable tax return.
The following table highlights the quarterly dividend history of the Company's
common shares:
<TABLE>
<CAPTION>
COMMON DIVIDEND SUMMARY
($ in thousands, except per common share amounts)
Common Common Cumulative
Taxable Taxable Net Dividend Dividend Undistributed
For The Net Income Per Declared Pay-out Taxable
Quarter Ended Income (1) Share (2) Per Share (2) Ratio (3) 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
Jun 30, 1997 8,573 0.51 0.49 99% 1,603
Sep 30, 1997 9,737 0.51 0.50 100% 1,560
<FN>
- -------------
(1) Taxable net income after preferred dividends.
(2) Weighted average common shares outstanding.
(3) Common dividend declared divided by 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
third quarter of 1997 as compared to the same period of 1996 was the combined
effect of the increased size of the Company's balance sheet as well as an
increase in the yield on the Company's portfolio of ARM assets, partially offset
by an increase in the Company's cost of funds. Net interest income increased by
$5,274,000. Of this increase, the increased average size of the Company during
the third quarter of 1997 as compared to 1996 contributed to higher net interest
income in the amount of $5,006,000. The average balance of the Company's
interest earning assets was $4.144 billion during the third quarter of 1997 as
compared to $2.506 billion during the same period of 1996, an increase of 65%.
Additionally, $1,006,000 is the result of the higher yield on the Company's ARM
assets portfolio and other interest earning assets. This was partially offset by
an increase to the Company's cost of funds which had an impact of $738,000 for a
combined favorable rate variance of $268,000. The yield on the Company's
interest earning assets during the quarter ended September 30, 1997 was 6.57% as
compared to 6.41% during the same period of 1996. During these same periods, the
Company's cost of funds increased to 5.79% in 1997 from 5.66% in 1996. The
Company's yield on net interest earning assets, which includes the impact of
shareholders' equity, was 1.28% for the third quarter of 1997 as compared to
1.27% for the same period of 1996.
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>
<CAPTION>
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS (1)
ARM Assets
-------------------------- Yield on
Average Wgt. Avg. Yield on Net
Interest Fully Weighted Yield Interest Cost Net Interest
As of the Earning Indexed Average Adj. Earning of Interest Earning
Quarter Ended Assets Coupon Coupon (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%
Jun 30, 1997 3,464.1 7.75% 7.57% 0.90% 6.67% 5.77% 0.90% 1.39%
Sep 30, 1997 4,143.7 7.63% 7.65% 1.07% 6.58% 5.79% 0.79% 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.
(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>
<CAPTION>
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS
Amort. of
Impact of Deferred
Premium/ Principal Gain from Total
As of the Discount Payments Hedging 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%
Jun 30, 1997 0.66% 0.13% 0.16% -0.05% 0.90%
Sep 30, 1997 0.85% 0.12% 0.15% -0.05% 1.07%
</TABLE>
As of September 30, 1997, the Company's yield on its ARM assets 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 6.58% as compared to 6.67% as of June 30,
1997, a decrease of 0.09%. The Company's cost of funds as of September 30, 1997
was 5.79% as compared to 5.77% as of June 30, 1997, an increase of 0.02%. As a
result of these changes, the Company's net interest spread as of September 30,
1997 was 0.79% as compared to 0.90% as of June 30, 1997, a decrease of 0.11%.
This reduction in the net interest spread is primarily due to the relationship
between the one-year U. S. Treasury rate and LIBOR as discussed above.
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 September 30, 1997 and 1996:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Amounts in thousands)
For the Quarter For the Quarter
Ended September Ended September
30, 1997 30, 1996
--------------------- ---------------------
Average Effective Average Effective
Balance Rate Balance Rate
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $4,116,223 6.58% $2,489,894 6.42%
Cash and cash equivalents 27,524 5.66 16,106 5.42
---------- --------- ---------- ---------
4,143,747 6.57 2,506,000 6.41
---------- --------- ---------- ---------
Interest Bearing Liabilities:
Borrowings 3,788,879 5.79 2,276,228 5.66
---------- --------- ---------- ---------
Net Interest Earning Assets and Spread $ 354,868 0.78% $ 229,772 0.75%
========== ========= ========== =========
Yield on Net Interest Earning Assets (1) 1.28% 1.27%
========= =========
<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 third quarter of 1997, the Company realized a net gain from the sale
of ARM securities in the amount of $335,000 as compared to a gain of $520,000
during the third quarter of 1996. Additionally, the Company recorded an expense
for credit losses in the amount of $223,000 during the quarter ended September
30, 1997, although the Company only incurred actual credit losses of $18,000
during the quarter, as compared to an expense for credit losses in the amount of
$200,000 during the same period in 1996. The Company provided for additional
credit losses because its review of underlying ARM collateral indicates
potential for some loss on two ARM securities, which are being carried at their
current market value of $14.5 million, or 0.3% of the Company's ARM portfolio.
The Company also has a policy to regularly record a provision for possible
credit losses on its portfolio of ARM loans.
For the quarter ended September 30, 1997, the Company's ratio of operating
expenses to average assets was 0.21% as compared to 0.20% for the same quarter
of 1996 and as compared to 0.22% for the previous quarter ended June 30, 1997.
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 following table highlights the quarterly trend of operating expenses as a
percent of average assets:
<TABLE>
<CAPTION>
ANNUALIZED OPERATING EXPENSE RATIOS
Management Fee
& Other Performance Total
For The Expenses/ 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%
Jun 30, 1997 0.13% 0.09% 0.22%
Sep 30, 1997 0.12% 0.09% 0.21%
</TABLE>
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
For the nine month period ended September 30, 1997, the Company's net income was
$30,551,000 as compared to $18,328,000 for the same period of 1996. Net income
available to common shareholders, after the $1.66 per share dividend to
preferred shareholders for the period from January 24, 1997 (date of issuance)
through September 30, 1997, increased to $25,970,000 or $1.49 per common share
based on weighted average common shares of 17,437,270 from $18,328,000 or $1.27
per common share based on weighted average common shares of 14,425,873 for the
nine month period ended September 30, 1996. This is an increase in net income
available to common shareholders per common share of 17%. Net interest income
for the first nine months of 1997 totaled $36,733,000 as compared to $21,368,000
for the same period in 1996, an increase of 72%. Net interest income is
comprised of the interest income earned on mortgage investments and cash, less
interest expense from borrowings. During the first nine months of 1997, the
Company recorded a gain on the sale of ARM securities of $360,000 as compared to
a net gain of $533,000 during the same period of 1996. Additionally, during the
first nine months of 1997, the Company reduced earnings and the carrying value
of its ARM assets by $623,000 for projected credit losses as compared to
$200,000 during the same period of 1996. The Company incurred operating expenses
of $5,919,000 for the nine month period, consisting principally of the base
management fee of $2,661,000, a performance fee of $2,569,000 and other
miscellaneous expenses of $689,000 as compared to operating expenses of
$3,373,000 for the same period in 1996, consisting principally of the base
management fees of $1,194,000, a performance fee of $1,727,000 and other
miscellaneous expenses of $452,000.
As discussed above, the primary reasons for the rise in the Company's net
interest income for the nine month period ended September 30, 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
assets, partially offset by an increase in the Company's cost of funds. Net
interest income increased by $15,365,000. Of this increase, the increased
average size of the Company's investment portfolio during the first nine months
of 1997 as compared to 1996 contributed to higher net interest income in the
amount of $12,972,000. The average balance of the Company's interest earning
assets was $3.519 billion during the first nine months of 1997 as compared to
$2.260 billion during the same period of 1996, an increase of 56%. Additionally,
$3,620,000 is the result of the higher yield on the Company's ARM assets
portfolio and other interest earning assets. This was partially offset by an
increase to the Company's cost of funds which had an impact of $1,227,000 for a
combined favorable rate variance of $2,393,000. The yield on the Company's
interest earning assets during the nine month period ended September 30, 1997
was 6.62% as compared to 6.40% during the same period of 1996. Also, during
these same periods, the Company's cost of funds increased to 5.74% in 1997 from
5.66% in 1996. The Company's yield on net interest earning assets, which
includes the impact of shareholders' equity, rose to 1.39% for the first nine
months of 1997 from 1.26% for the same period of 1996.
As of the end of the quarter ended September 30, 1997, the Company's yield on
its ARM 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 6.58% as compared
to 6.64% as of December 31, 1996, a decrease of 0.06%. The Company's cost of
funds as of September 30, 1997 was 5.79% as compared to 5.72% as of December 31,
1996, an increase of 0.07%. As a result of these changes, the Company's net
interest spread as of September 30, 1997 was 0.79% as compared to 0.92% as of
December 31, 1996, a decrease of 0.13%.
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 nine month periods ended September 30, 1997 and September 30, 1996:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Amounts in thousands)
For the Nine Month For the Nine Month
Period Ended Period Ended
September 30, 1997 September 30, 1996
--------------------- --------------------
Average Effective Average Effective
Balance Rate Balance Rate
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $3,498,843 6.62% $2,245,058 6.41%
Cash and cash equivalents 20,643 5.61 14,935 5.27
---------- --------- ---------- ---------
3,519,486 6.62 2,259,993 6.40
---------- --------- ---------- ---------
Interest Bearing Liabilities:
Borrowings 3,204,859 5.74 2,053,632 5.66
---------- --------- ---------- ---------
Net Interest Earning Assets and Spread $ 314,627 0.88% $ 206,361 0.74%
========== ========= ========== =========
Yield on Net Interest Earning Assets (1) 1.39% 1.26%
========= =========
<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>
The increase in the Company's operating expenses is primarily the result of
increased management and performance fees paid to the Manager which are
commensurate with the increased equity base of the Company and the increase in
the Company's return on equity. In order for the Manager to earn a performance
fee, the rate of return to the shareholders, as defined in the Management
Agreement, must exceed the average ten-year U.S. Treasury rate during the
quarter plus 1%. During the first nine months of 1997, the Manager earned a
performance fee of $2,569,000 as compared to $1,727,000 during the same period
of 1996. During the nine month period ended September 30, 1997, after paying
this performance fee, the Company's return on average common equity reached
13.15% as compared to 11.42% during the same period of 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarters ended September 30, 1997
and 1996 consisted of reverse repurchase agreements, which totaled $3.981
billion and $2.328 billion at the respective quarter ends. The Company's other
significant source of funds for the quarters ended September 30, 1997 and 1996
consisted of payments of principal and interest from its ARM portfolio in the
amounts of $294.9 million and $176.4 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 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 assets, cash and cash equivalents.
The borrowings incurred at September 30, 1997 had a weighted average interest
cost of 5.79%, which includes the cost of interest rate swaps, a weighted
average original term to maturity of 6.8 months and a weighted average remaining
term to maturity of 3.7 months. As of September 30, 1997, $1.220 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-, two-, three- or six-month LIBOR rate and reprice accordingly.
The Company has borrowing arrangements with twenty-four different investment
banking firms and commercial banks and at September 30, 1997 had borrowed funds
under reverse repurchase agreements with fifteen of these firms. Because the
Company borrows funds based on the fair value of its ARM assets, 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 September 30, 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 Registration Statement on Form S-3 declared effective in December 1996. Net
proceeds from this issuance totaled $65.8 million.
In May 1997, the Company issued 861,850 shares of common stock at a price of
$19.50 per share pursuant to its Registration Statement on Form S-3 declared
effective in December 1996. Net proceeds from this issuance totaled $16.2
million.
In July 1997, the Company issued 2,100,000 shares of common stock at a price of
$22.625 per share pursuant to its Registration Statement on Form S-3 declared
effective in December 1996. Net proceeds from this issuance totaled $45.0
million. Upon completion of this issuance of common stock, the Company had $109
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 third quarter 1997
participation in the Plan, the Company issued 151,963 new shares of common stock
and received $3.2 million of new equity capital. During the nine month period
ended September 30, 1997, the Company issued 367,801 new shares of common stock
and received $7.4 million of new equity capital.
EFFECTS OF INTEREST RATE CHANGES
Changes in interest rates impact the Company's earnings in various ways. While
the Company only invests in ARM assets, 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 assets 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 assets 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 Company's earnings can also be affected by variations in the amount and
direction of change among the various indices upon which the interest income
from the Company's ARM asset portfolio is generated and the similar, but not
identical, effect on the Company's cost of borrowing. In general, the Company
has chosen to invest in diverse assets that are affected by a variety of indices
whereas the cost of the Company's borrowings most closely corresponds to LIBOR.
This contributes to fluctuations in the spread between the Company's asset yield
and its cost of borrowed money which can cause both favorable and unfavorable
fluctuations in the Company's earnings depending upon the current relationship
between the indices.
The rate of prepayment on the Company's mortgage assets 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 assets over a longer time period than otherwise,
resulting in an increased yield on its mortgage assets. Therefore, in rising
short-term interest rate environments where prepayments are declining, the
interest rate on the ARM 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 assets 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 assets. 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 assets, 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 assets 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
assets 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 assets
and certain liabilities. In general, when interest rates rise the Company's ARM
assets 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 assets. Because the
Company borrows funds based on the fair value of its ARM assets, 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 assets 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 assets 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 September 30, 1997, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.6% 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 99.5% of its 1997 revenue for the first nine months of 1997 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 nine month period ended September 30, 1997 subject to the 30% income
limitation under the REIT rules amounted to 0.72% 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 September 30, 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
September 30, 1997, the Company calculates that it is in compliance with this
requirement.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 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 three Current Reports on Form
8-K during the period covered by the Form 10-Q:
(i) Current Report on Form 8-K, dated July 3, 1997 regarding the
Registrant's press release dated July 3, 1997 announcing the
filing of a prospectus supplement with the Securities and
Exchange Commission for the public offering of 2,000,000
shares of common stock. The press release was included as an
Exhibit to the Current Report on Form 8-K.
(ii) Current Report on Form 8-K, dated July 10, 1997 regarding the
Registrant's press release dated July 10, 1997 announcing
the Registrant's earnings for the quarter ending June 30, 1997.
The press release was included as an Exhibit to the Current
Report on Form 8-K.
(iii) Current Report on Form 8-K, dated July 14, 1997 regarding the
Underwriting Agreement entered into by the Registrant on July
14, 1997. The Underwriting Agreement was included as an
Exhibit to the Current Report on Form 8-K.
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: October 30, 1997 By: /s/ Larry A. Goldstone
-------------------------------
Larry A. Goldstone,
President and Chief Operating Officer
(authorized officer of registrant)
Dated: October 30, 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
September 30, 1997 Form 10-Q and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 20,427
<SECURITIES> 4,464,536
<RECEIVABLES> 37,274
<ALLOWANCES> 1,534
<INVENTORY> 0
<CURRENT-ASSETS> 478
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4,521,181
<CURRENT-LIABILITIES> 4,157,826
<BONDS> 0
0
65,805
<COMMON> 196
<OTHER-SE> 297,354
<TOTAL-LIABILITY-AND-EQUITY> 4,521,181
<SALES> 0
<TOTAL-REVENUES> 175,070
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 5,919
<LOSS-PROVISION> 623
<INTEREST-EXPENSE> 137,977
<INCOME-PRETAX> 30,551
<INCOME-TAX> 0
<INCOME-CONTINUING> 30,551
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 30,551
<EPS-PRIMARY> 1.49
<EPS-DILUTED> 1.49
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