1
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: JUNE 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) 19,548,892 as of July 31, 1997
<PAGE>
26
THORNBURG MORTGAGE ASSET CORPORATION
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION ------
Item 1. Financial Statements
Balance Sheets at June 30, 1997 and December 31, 1996.... 3
Statements of Operations for the three months and six
months ended June 30, 1997 and June 30, 1996............. 4
Statement of Stockholders' Equity for the three months
and six months ended June 30, 1997....................... 5
Statements of Cash Flows for the three months and six
months ended June 30, 1997 and June 30, 1996............. 6
Notes to Financial Statements............................ 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 25
Item 2. Changes in Securities ...................................... 25
Item 3. Defaults Upon Senior Securities ............................ 25
Item 4. Submission of Matters to a Vote of Security Holders......... 25
Item 5. Other Information........................................... 25
Item 6. Exhibits and Reports on Form 8-K............................ 25
SIGNATURES ......................................................... 26
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
THORNBURG MORTGAGE ASSET CORPORATION
BALANCE SHEETS
(In thousands, except share data)
<CAPTION>
June 30, 1997 December 31, 1996
----------------- -----------------
<S> <C> <C>
ASSETS
ARM assets (Notes 2 and 3) $ 3,825,748 $ 2,727,875
Cash and cash equivalents 11,564 3,693
Accrued interest receivable 34,897 23,563
Prepaid expenses and other 387 227
------------- -------------
$ 3,872,596 $ 2,755,358
============= =============
LIABILITIES
Reverse repurchase agreements (Note 3) $ 3,511,572 $ 2,459,132
Other borrowings (Note 3) 12,144 14,187
Payable for securities purchased - 32,683
Accrued interest payable 19,273 18,747
Dividends payable (Note 6) 10,145 7,299
Accrued expenses and other 5,879 1,112
------------- -------------
3,559,013 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, 17,296,929
and 16,219,241 shares issued and outstanding,
respectively 173 162
Additional paid-in-capital 253,584 233,177
Available-for-sale securities:
Unrealized gain (loss) (Note 2) (10,051) (15,807)
Realized deferred hedging gain 3,799 4,541
Retained earnings 273 125
------------- -------------
313,583 222,198
------------- -------------
$ 3,872,596 $ 2,755,358
============= =============
</TABLE>
See Notes to Financial Statements.
<PAGE>
<TABLE>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except share data)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1997 1996 1997 1996
--------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Interest income from ARM assets and cash $ 57,623 $ 35,680 $ 106,622 $ 68,382
Interest expense on borrowed funds (45,448) (28,455) (83,115) (54,967
-------- --------- --------- ---------
Net interest income 12,175 7,225 23,507 13,415
-------- -------- --------- ---------
Gain (loss) on sale of ARM assets 21 - 25 13
Provision for credit losses (210) - (400) -
Management fee (Note 5) (876) (405) (1,687) (764)
Performance fee (Note 5) (781) (508) (1,638) (1,096)
Other operating expenses (254) (143) (437) (268)
-------- --------- --------- ---------
NET INCOME $ 10,075 $ 6,169 $ 19,370 $ 11,300
======= ======== ======== ========
Net income $ 10,075 $ 6,169 $ 19,370 $ 11,300
Dividend on preferred stock (1,670) - (2,912) -
-------- -------- --------- --------
Net income available to
common shareholders $ 8,405 $ 6,169 $ 16,458 $ 11,300
======= ======== ======== ========
Net income per common share $ 0.50 $ 0.42 $ 0.99 $ 0.83
======= ======== ======== ========
Average number of common shares
outstanding 16,816,873 14,844,227 16,565,505 13,589,537
========== ========== ========== ==========
</TABLE>
See Notes to Financial Statements.
<PAGE>
<TABLE>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
Three Months and Six Months Ended June 30, 1997 (In thousands, except share
data)
<CAPTION>
Available-for-Sale Securities
-----------------------------
Additional Realized
Preferred Common Paid-in Unrealized Deferred Gain Retained
Stock Stock Capital Gain (Loss) From Hedging Earnings Total
--------- ------- ---------- ------------ ------------- -------- ----------
<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) 65,809 - - - - - 65,809
Issuance of common
stock (Note 5) - 1 2,028 - - - 2,029
Available-for-Sale Sec.:
Fair value adj., net
of amortization - - - 2,243 - - 2,243
Deferred gain on
sale of hedges,
net of amortization - - - - (404) - (404)
Net income - - - - - 9,294 9,294
Dividends declared on
preferred stock -
$0.45 per share - - - - - (1,242) (1,242)
Dividends declared on
common stock -
$0.48 per share - - - - - (7,834) (7,834)
------- ----- -------- --------- ------- ------- ---------
Balance, March 31, 1997 65,809 163 235,205 (13,564) 4,137 343 292,093
Series A preferred stock,
adjustment to issuance
cost (Note 5) (4) - - - - - (4)
Issuance of common
stock (Note 5) - 10 18,379 - - - 18,389
Available-for-Sale Sec.:
Fair value adj., net
of amortization - - - 3,513 - - 3,513
Deferred gain on sale of
hedges, net of amort. - - - - (338) - (338)
Net income - - - - - 10,075 10,075
Dividends declared on
preferred stock -
$0.605 per share - - - - - (1,670) (1,670)
Dividends declared on
common stock -
$0.49 per share - - - - - (8,475) (8,475)
------- ----- -------- --------- ------- ------- ---------
Balance, June 30, 1997 $ 65,805 $ 173 $ 253,584 $ (10,051) $ 3,799 $ 273 $ 313,583
======= ===== ======== ========= ======= ======= =========
</TABLE>
See Notes to Financial Statements.
<PAGE>
<TABLE>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
1997 1996 1997 1995
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Operating Activities:
Net Income $ 10,075 $ 6,169 $ 19,370 $ 11,300
Adj to reconcile net income to
net cash provided by operating
activities:
Amortization 4,813 3,480 9,172 6,778
Net(gain)loss from investing
activities 189 - 375 (13)
Change in assets and liabilities:
Accrued interest receivable (5,182) (2,363) (11,334) (757)
Prepaid expenses and other 127 (6) (158) (73)
Accrued interest payable (2,258) 2,329 526 1,245
Accrued expenses and other 4,306 (248) 4,766 43
------- -------- -------- --------
Net cash provided by operating
activities 12,070 9,361 22,717 18,523
------- -------- -------- --------
Investing Activities:
Available-for-sale assets:
Purchase of ARM assets (813,493) (552,332) (1,484,058) (758,302)
Proceeds on sales of ARM assets 33,669 - 34,302 6,539
Principal payments on ARM assets 158,981 113,769 286,035 220,582
Held-to-maturity assets:
Principal payments on ARM assets 12,385 36,664 30,525 67,506
Purchase of int. rate cap agreements (1,496) (189) (1,894) (423)
-------- -------- -------- --------
Net cash provided by (used in)
investing activities (609,954) (402,088) (1,135,090) (464,098)
-------- -------- ---------- --------
Financing Activities:
Net borrowings from reverse
repurchase agreements 575,393 362,812 1,052,440 409,242
Net borrowings from (repayments of)
other borrowings (1,250) (10,098) (2,044) (2,294)
Proceeds from preferred stock issued (4) - 65,805 -
Proceeds from common stock issued 18,389 49,506 20,418 53,104
Dividends paid (9,076) (4,972) (16,375) (9,604)
--------- -------- --------- --------
Net cash provided by (used in)
financing activities 583,452 397,248 1,120,244 450,448
-------- -------- --------- --------
Net increase (decrease) in cash and
cash equivalents (14,432) 4,521 7,871 4,873
Cash and cash equivalents at beginning
of period 25,996 4,012 3,693 3,660
-------- -------- -------- --------
Cash and cash equivalents at end
of period $ 11,564 $ 8,533 $ 11,564 $ 8,533
======== ======== ======== ========
</TABLE>
Supplemental disclosure of cash flow information and non-cash activities are
included in Note 3.
See Notes to Financial Statements
<PAGE>
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their fair value.
ADJUSTABLE-RATE MORTGAGE ASSETS
The Company's adjustable-rate mortgage ("ARM") assets may be
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 are available-for-sale in
order to be prepared to respond to potential future opportunities in
the market, to sell ARM securities in order to optimize the
portfolio's total return and to retain its ability to respond to
economic conditions that require the Company to sell assets in order
to maintain an appropriate level of liquidity. Management
re-evaluates the classification of the ARM securities on a quarterly
basis. All ARM securities classified as held-to-maturity are carried
at the fair value of the security at the time the designation is
made and any fair value adjustment to the cost basis as of the date
of the classification is amortized into interest income as a yield
adjustment. All ARM securities designated available-for-sale are
reported at fair value, with unrealized gains and losses excluded
from earnings and reported as a separate component of shareholders'
equity.
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 has limited its exposure to credit losses on its
portfolio of ARM securities by only purchasing ARM securities that
have some form of credit enhancement and are either guaranteed by an
agency of the federal government or have an investment grade rating
at the time of purchase, or the equivalent, by at least one of two
nationally recognized rating agencies, Moody's or Standard & Poor's
(the "Rating Agencies"). The Company also limits its exposure to
credit losses by limiting its investment in investment grade
securities that are rated A, or equivalent, 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 Company
monitors the delinquencies and losses on the underlying mortgages of
its ARM securities and, if the credit performance of the underlying
mortgage loans is not as good as expected, makes a provision for
possible credit losses at a level deemed appropriate by management
to provide for known losses as well as unidentified potential future
losses in its ARM securities portfolio. The provision is based on
management's assessment of numerous factors affecting its portfolio
of ARM securities including, but not limited to, current and
projected economic conditions, delinquency status, credit losses to
date on underlying mortgages and remaining credit protection. The
provision is made by reducing the cost basis of the individual
security for the decline in fair value which is other than temporary
and the amount of such write-down is recorded as a realized loss,
thereby reducing earnings. Provisions for credit losses do not
reduce taxable income and therefore do not affect the dividends paid
by the Company to shareholders in the period the provisions are
taken. Actual losses realized by the Company do reduce taxable
income in the period the actual loss is realized and would affect
the dividends paid to shareholders for that tax year.
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, in
effect, 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., stock options), if dilutive, outstanding during
the period.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
<PAGE>
NOTE 2. ADJUSTABLE-RATE MORTGAGE 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 June 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>
June 30, 1997:
<CAPTION>
ARM Securities
------------------------
Available- Held-to-
for-Sale Maturity ARM Loans Total
------------ ---------- ----------- -----------
<S> <C> <C> <C> <C>
Amortized cost basis $ 3,393,255 $ 429,184 $ 13,749 $ 3,836,188
Allowance for losses (1,330) - - (1,330)
----------- --------- --------- ---------
Amortized cost, net 3,391,925 429,184 13,749 3,834,858
----------- --------- --------- ---------
Gross unrealized gains 12,619 6,934 - 19,553
Gross unrealized losses (21,729) (3,387) - (25,116)
----------- --------- --------- ---------
Fair value $ 3,382,815 $ 432,731 $ 13,749 $ 3,829,295
=========== ========= ========= =========
</TABLE>
<TABLE>
December 31, 1996:
<CAPTION>
ARM Securities
------------------------
Available- Held-to-
for-Sale Maturity ARM Loans Total
------------ ---------- ----------- -----------
<S> <C> <C> <C> <C>
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 June 30, 1997, the Company realized $21,000 in
gains on the sale of $33.6 million of ARM securities which were
classified as available-for-sale.
As of June 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 $1,330,000, including a
provision for credit losses of $210,000 during the quarter ended June
30, 1997. At this time, the Company is providing for potential future
credit losses on two securities that have an aggregate carrying value
of $14.7 million, which represent less than 0.4% of the Company's total
portfolio of ARM assets. Both of these securities are performing and
have varying degrees of remaining credit support that mitigates the
Company's exposure to potential future credit losses.
As of June 30, 1997, the Company had $76.0 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 6.67% as of June 30, 1997 and 6.64% as of December 31,
1996.
As of June 30, 1997 and December 31, 1996, the Company had purchased
Cap Agreements with a remaining notional amount of $3.447 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 of the Cap Agreements which range from 7.50% to 13.00%
and average approximately 10.44%. The Company's ARM assets portfolio
had an average lifetime interest rate cap of 11.68% as of June 30,
1997. The initial aggregate notional amount of the Cap Agreements will
decline to approximately $2.552 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, four of which are rated AAA and two of which are rated
AA.
NOTE 3. REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS
The Company has entered into reverse repurchase agreements to finance
most of its ARM 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 June 30, 1997, the Company had outstanding $3.512 billion of
reverse repurchase agreements with a weighted average borrowing rate of
5.76% and a weighted average remaining maturity of 3.1 months. As of
June 30, 1997, $1.244 billion of the Company's borrowings were
variable-rate term reverse repurchase agreements with original
maturities that range from three months to two years. The interest
rates of these term reverse repurchase agreements are indexed to either
the one, three or six-month LIBOR rate and reprice accordingly. The
reverse repurchase agreements at June 30, 1997 were collateralized by
ARM securities with a carrying value of $3.705 billion, including
accrued interest.
At June 30, 1997, the reverse repurchase agreements had the following
remaining maturities (dollars in thousands):
Within 30 days $ 1,149,124
30 to 90 days 1,527,868
90 days to one year 834,580
-----------
$ 3,511,572
===========
As of June 30, 1997, the Company had entered into nine interest rate
swap agreements having an aggregate notional balance of $1.090 billion
and a weighted average remaining term of 3.1 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 37 days to 61 days.
The Company has a line of credit agreement which provides for
short-term borrowings of up to $25 million collateralized by the
Company's principal and interest receivables. As of June 30, 1997,
there was no balance outstanding under this agreement.
As of June 30, 1997, the Company had financed a portion of its
portfolio of interest rate cap agreements with $12.1 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 2.5
years. The other borrowings financing cap agreements at June 30, 1997
were collateralized by ARM securities with a carrying value of $15.9
million, including accrued interest. The aggregate maturities of these
other borrowings are as follows (dollars in thousands):
1997 $ 2,126
1998 4,509
1999 4,877
2000 632
----------
$ 12,144
During the quarter ended June 30, 1997, the total cash paid for
interest was $47.3 million.
<PAGE>
NOTE 4. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at June 30, 1997 and
December 31, 1996. FASB Statement No. 107, Disclosures About Fair Value
of Financial Instruments, defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties, other than in a forced
or liquidation sale (dollars in thousands):
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1996
------------------------ ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Assets:
ARM assets $ 3,820,702 $ 3,826,870 $ 2,689,727 $ 2,692,521
Cap agreements 5,046 2,425 5,465 2,535
Liabilities:
Other borrowings 12,144 12,403 14,187 14,744
Swap agreements (33) 93 (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 June 30, 1997, the Company issued 113,501
shares of common stock under its dividend reinvestment and stock
purchase plan and received net proceeds of $2.2 million. For the six
month period ended June 30, 1997, the Company issued 215,838 shares of
common stock under this plan and received net proceeds of $4.2 million.
On June 18, 1997, the Company declared a second quarter dividend of
$0.49 per common share which was paid on July 10, 1997 to common
shareholders of record as of June 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 second
quarter which was also paid on July 10, 1997 to preferred shareholders
of record as of June 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 June 30, 1997, there were 36,200 options
granted to buy common shares at an exercise price of $19.50 along with
9,051 DERs. As of June 30, 1997, the Company had 778,866 options
outstanding at exercise prices of $9.375 to $20 per share, 626,746 of
which were exercisable. The weighted average exercise price of the
options outstanding is $16.36 per share. There have been no options
exercised during 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 June 30, 1997 and 1996, the Company paid the
Manager $876,000 and $405,000, respectively, in base management fees in
accordance with the terms of the Agreement. For the six month periods
ended June 30, 1997 and 1996, the Company paid the Manager base
management fees of $1,687,000 and $764,000, 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 June
30, 1997 and 1996, the Company paid the Manager $781,000 and $508,000,
respectively, in performance based compensation in accordance with the
terms of the Agreement. For the six month periods ended June 30, 1997
and 1996, the Company paid the Manager performance based compensation
in the amounts of $1,638,000 and $1,096,000, respectively.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Report on Form 10-Q contains forward-looking statements which are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Investors are cautioned that all forward-looking statements
involve risks and uncertainties including, without limitation, risks related to
future interest rates, prepayment rates and the timing of new programs. For
additional information regarding these and other risks, reference is made to the
Company's Prospectus Supplement dated July 14, 1997.
GENERAL
Thornburg Mortgage Asset Corporation (the "Company") is a specialized financial
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 mortgage 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
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 less than 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 also expects to acquire additional 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 June 30, 1997, the Company held total assets of $3.873 billion, $3.826
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 only 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 June 30, 1997, 96.1% 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 adjustable-rate pass-through certificates.
The following table presents a schedule of ARM assets owned at June 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>
ARM PORTFOLIO BY ISSUER AND CREDIT RATING
(amounts in thousands)
<CAPTION>
June 30, 1997 December 31, 1996
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $2,481,097 64.9% $1,474,842 54.1%
Privately Issued Sec.:
AAA/Aaa Rating 332,658 8.7 260,031 9.5
AA/Aa Rating 866,650 22.6 862,727 31.6
--------- -------- --------- --------
Total Privately Issued 1,199,308 31.3 1,122,758 41.1
--------- -------- --------- --------
Total High Quality 3,680,405 96.2 2,597,600 95.2
--------- -------- --------- --------
OTHER INVESTMENT:
Privately Issued Sec.:
A Rating 115,197 3.0 106,531 3.9
BBB/Baa Rating 6,664 0.2 14,017 0.5
BB/Ba rating 9,723 0.2 9,727 0.4
Whole loans 13,759 0.4 - -
--------- -------- --------- --------
Total Other Investment 145,343 3.8 130,275 4.8
--------- -------- --------- --------
Total ARM Portfolio $3,825,748 100.0% $2,727,875 100.0%
========= ======== ========= ========
</TABLE>
As of June 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 $1,330,000, including a provision for credit
losses of $210,000 recorded during the quarter ended June 30, 1997. During the
second quarter of 1997, the Company realized actual credit losses of $42,000 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 that have an aggregate
carrying value of $14.7 million, which is less than 0.4% of the Company's total
portfolio of ARM securities. Both of these securities are performing and have
varying degrees of remaining credit support that mitigates the Company's
exposure to potential future credit losses.
The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.
<TABLE>
ARM PORTFOLIO BY INDEX
(amounts in thousands)
<CAPTION>
June 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 1,301,198 34.0 1,252,884 45.9
Six-month Certificate of Deposit 205,991 5.4 69,348 2.6
Six-month Constant Maturity Treasury 42,956 1.1 8,841 0.3
One-year Constant Maturity Treasury 2,000,043 52.3 1,238,892 45.4
11th District Cost of Funds 275,560 7.2 147,264 5.4
---------- --------- ---------- --------
$3,825,748 100.0% $2,727,875 100.0%
========= ========= ========= ========
</TABLE>
The ARM portfolio had a current weighted average coupon of 7.57% at June 30,
1997. If the ARM portfolio were "fully indexed," the weighted average coupon
would be 7.75%, based upon the current composition of the ARM portfolio and the
applicable indices at June 30, 1997.
At June 30, 1997, the current yield of the ARM portfolio was 6.67%. The current
yield includes the impact of the amortization of applicable premiums and
discounts, the cost of hedging, the amortization of the deferred gains from
hedging activity and the impact of principal payment receivables.
As presented in the table below, the interest rate coupon on each of the
Company's ARM assets is scheduled to reprice at least once a year. As of June
30, 1997, the weighted average repricing frequency of the ARM portfolio was 8.5
months as compared to 8.0 months as of December 31, 1996. The lengthening of the
repricing frequency reflects the fact that the predominant ARM loan product
currently being originated for sale by mortgage loan originators is tied to the
one-year Constant Maturity Treasury Index and reprices once a year.
<TABLE>
ARM PORTFOLIO BY REPRICING FREQUENCY
(amounts in thousands)
<CAPTION>
June 30, 1997 December 31, 1996
--------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
FREQUENCY:
Every month $ 216,095 5.7% $ 157,910 5.8%
Every six months 1,866,995 48.8 1,528,042 56.0
Every twelve months 1,742,658 45.6 1,041,923 38.2
--------- --------- --------- ---------
$3,825,748 100.0% $2,727,875 100.0%
========= ========= ========= =========
</TABLE>
During the quarter ended June 30, 1997, the Company purchased $799.8 million of
ARM securities, 100% of which were High Quality assets and $13.7 million of ARM
loans originated to "A" quality underwriting standards. The Company also sold
$33.6 million of ARM securities, $16.2 million of High Quality ARM securities
and $17.4 million of Other Investments, all of which were classified as
available-for-sale for a net gain of $21,000 during the quarter ended June 30,
1997.
During the six month period ended June 30, 1997, the Company purchased $1,470.4
million of ARM securities, 98.5% of which were High Quality assets and $13.7
million of ARM loans originated to "A" quality underwriting standards. The
Company also sold $34.3 million of ARM securities, $16.2 million of High Quality
ARM securities and $18.1 million of Other Investments, all of which were
classified as available-for-sale for a net gain of $25,000 during the six month
period ended June 30, 1997.
For the quarter and six month period ended June 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 portfolio of ARM securities increased during the
quarter ended June 30, 1997. As of June 30, 1997, the Company's portfolio of ARM
securities available-for-sale, including the applicable Cap Agreements, had a
net unrealized loss of $9.1 million, or 0.27% of the securities
available-for-sale, as compared to a net unrealized loss of $14.7 million or
0.65% of the securities available-for-sale, as of December 31, 1996.
The Company has purchased Cap Agreements in order to limit its exposure to risks
associated with the lifetime interest rate caps of its ARM 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 June 30, 1997, the Cap Agreements owned by the
Company had a remaining notional balance of $3.447 billion with an average final
maturity of 3.2 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
10.44%. The expense of the Company's hedging activity amounted to $836,000 and
decreased the yield on the ARM portfolio by 0.10% during the quarter ended June
30, 1997. In general, the fair value of Cap Agreements increase when market
interest rates increase and decrease when market interest rates decrease,
helping to partially offset changes in the fair value of the Company's ARM
portfolio. At June 30, 1997 the fair value of the Cap Agreements was $2.4
million, $11.5 million less than the amortized cost of the Cap Agreements. The
following table presents information about the Company's Cap Agreement portfolio
as of June 30, 1997:
<TABLE>
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
<CAPTION>
Hedged Weighted Cap Agreement Weighted
ARM Securities Average Notional Average
Balance (1) Life Cap Balance Strike Price Remaining Term
---------------- -------- --------------- ------------ --------------
<S><C> <C> <C> <C> <C>
$ 375,169,000 9.57% $ 380,798,000 7.50% 2.7 Years
219,661,000 10.31 219,312,000 8.50 2.1
261,490,000 10.13 350,190,000 9.00 2.5
148,186,000 10.83 112,118,000 9.50 2.4
297,947,000 11.03 254,172,000 10.00 4.8
464,530,000 11.50 482,498,000 10.50 3.3
349,578,000 11.96 342,725,000 11.00 3.7
406,267,000 12.57 399,763,000 11.50 3.9
525,510,000 12.94 610,063,000 12.00 3.5
194,813,000 13.53 195,379,000 12.50 3.0
176,012,000 14.15 99,527,000 13.00 2.6
------------- ------- ------------ -------- ------
$ 3,419,163,000 11.68% $ 3,446,545,000 10.44% 3.2 Years
============= ======= ============== ======== ======
<FN>
(1) 90% of the ARM securities' balance which approximates the
financed portion.
</FN>
</TABLE>
As of June 30, 1997, the Company had entered into nine interest rate swap
agreements having an aggregate notional balance of $1.090 billion and a weighted
average remaining term of three 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
June 30, 1997, the average cost of the Company's borrowings was 5.77%, 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 37 days to 61 days.
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share pursuant to
an effective Registration Statement. Net proceeds from this issuance totaled
$65.4 million. In May 1997, the Company issued 861,850 shares of common stock at
a price of $19.50 per shares, also pursuant to an effective Registration
Statement. Net proceeds from this issuance totaled $16.2 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 $323.6 million as of June 30, 1997 from $238.0
million as of December 31, 1996. As of June 30, 1997, the Company's ratio of
shareholders' equity to assets, excluding the fair value adjustment for assets
held as available-for sale, was 8.34% as compared to 8.59% as of December 31,
1996. The ratio of shareholders' equity to assets as of June 30, 1997 reflects
the high level of asset acquisition opportunities that the Company was able to
take advantage of during the second quarter of 1997 and is at the low end of the
range of 8% to 10% that the Company plans to operate at, in accordance with its
investment policies. In July 1997, the Company issued 2,100,000 new shares of
common stock at a price of $22.625 per share and received net proceeds of $45.0
million, which was fully invested and leveraged at the time of receipt as a
result of the second quarter acquisitions and was applied to the outstanding
commitments to purchase ARM securities as of June 30, 1997. In general, the
Company expects to continue to acquire additional ARM assets in advance of
raising new capital in order to maximize shareholder value and return by
minimizing the length of the investment period normally associated with raising
new capital, without exceeding any of its investment policies.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1997
For the quarter ended June 30, 1997, the Company's net income was $10,075,000 as
compared to $6,169,000 for the quarter ended June 30, 1996. Net income available
to common shareholders, after the $0.65 per share dividend to preferred
shareholders, increased to $8,405,000 or $0.50 per common share based on
weighted average common shares of 16,816,873 from $6,169,000 or $0.42 per common
share based on weighted average common shares of 14,844,227 for the quarter
ended June 30, 1996. This is an increase in net income per common share
available to common shareholders of 19%. Net interest income for the quarter
totaled $12,175,000 as compared to $7,225,000 for the same period in 1996, an
increase of 69%. Net interest income is comprised of the interest income earned
on mortgage investments and cash less interest expense from borrowings. During
the second quarter of 1997, the Company recorded a gain on the sale of ARM
securities of $21,000 as compared to no gain or loss during the second quarter
of 1996. Additionally, during the second quarter of 1997, the Company reduced
earnings and the carrying value of its ARM securities by $210,000 for projected
credit losses. For the quarter ended June 30, 1997, the Company incurred
operating expenses of $1,911,000 consisting of a base management fee of
$876,000, a performance based fee of $781,000 and other operating expenses of
$254,000. During the same period of 1996, the Company incurred operating
expenses of $1,056,000 consisting of a base management fee of $405,000, a
performance based fee of $508,000 and other operating expenses of $143,000.
<PAGE>
The Company's return on average common equity reached 13.45%, it's highest
quarterly level ever, for the quarter ended June 30, 1997 as compared to 11.22%
for the same period in 1996. The table below highlights the historical trend and
the components of return on average common equity (annualized):
<TABLE>
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
<CAPTION>
Net Gain (Loss)
Interest Provision on ARM G & A Performance Preferred Net
For The Income/ For Losses/ Sales/ Expense (2)/ Fee/ Dividend/ Income/
Quarter Ended Equity Equity Equity Equity Equity Equity Equity (ROE)
------------- --------- ----------- ---------- ------------ ----------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Mar 31, 1995 2.58% - -1.47% 1.02% - - 0.09%
Jun 30, 1995 5.51% - - 1.04% - - 4.47%
Sep 30, 1995 9.85% - 0.09% 1.07% 0.34% - 8.54%
Dec 31, 1995 11.94% - 0.11% 1.05% 0.97% - 10.03%
Mar 31, 1996 13.37% - 0.03% 1.04% 1.27% - 11.08%
Jun 30, 1996 13.14% - - 1.00% 0.92% - 11.22%
Sep 30, 1996 13.42% 0.34% 0.88% 1.03% 1.07% - 11.86%
Dec 31, 1996 14.99% 1.32% 1.38% 1.46% 1.23% - 12.37%
Mar 31, 1997 18.85% 0.32% 0.01% 1.65% 1.43% 2.07% 13.40%
Jun 30, 1997 19.48% 0.34% 0.03% 1.81% 1.25% 2.67% 13.45%
<FN>
(1) Average common equity excludes unrealized gain (loss)on
available-for-sale ARM securities.
(2) Excludes performance fees.
</FN>
</TABLE>
For the quarter ended June 30, 1997, the Company's taxable income was $8,573,000
or $0.51 per weighted average share outstanding. Taxable income in the second
quarter of 1997 excludes the loss provisions of $210,000 but includes actual
credit losses of $42,000. For the quarter ended June 30, 1996, the Company's
taxable income was $6,169,000 or $0.42 per weighted average share outstanding.
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level.
The following table highlights the quarterly dividend history of the Company's
common shares:
<TABLE>
COMMON DIVIDEND SUMMARY
($ in thousands, except per common share amounts)
<CAPTION>
Common Common Cumulative
Taxable Taxable Dividend Dividend Undistributed
For The Net Net Income Declared Pay-out Taxable
Quarter Ended Income (1) Per 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
<FN>
(1) Taxable net income after preferred dividends.
(2) Weighted average common shares outstanding.
(3) Common dividend declared divided into applicable quarter's taxable income
available to common shareholders.
</FN>
</TABLE>
The primary reasons for the rise in the Company's net interest income for the
second 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
$4,950,000. Of this increase, the increased average size of the Company during
the second quarter of 1997 as compared to 1996 contributed to higher net
interest income in the amount of $4,079,000. The average balance of the
Company's interest earning assets was $3.464 billion during the second quarter
of 1997 as compared to $2.248 billion during the same period of 1996, an
increase of 54%. Additionally, $1,711,000 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 $841,000 for a combined favorable rate variance of $870,000. The yield
on the Company's interest earning assets during the quarter ended June 30, 1997
was 6.65% as compared to 6.35% during the same period of 1996. Also, during
these same periods, the Company's cost of funds increased to 5.76% in 1997 from
5.60% in 1996. The Company's yield on net interest earning assets, which
includes the impact of shareholders' equity, rose to 1.41% for the second
quarter of 1997 from 1.29% 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>
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS (1)
<CAPTION>
ARM Assets
Average ---------------------------------- Yield on Yield on
Interest Wgt. Avg. Weighted Interest Net Net Interest
As of the Earning Fully Indexed Average Yield Earning Cost of Interest Earning
Quarter Ended Assets Coupon Coupon Adj. (2) Assets Funds Spread Assets
------------- ---------- ------------- -------- -------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mar 31, 1995 $ 1,748.7 8.46% 6.33% 0.26% 6.07% 6.33% -0.26% 0.49%
Jun 30, 1995 1,809.7 7.94% 6.77% 0.40% 6.37% 6.21% 0.16% 0.55%
Sep 30, 1995 1,864.3 7.93% 7.24% 0.58% 6.66% 6.04% 0.62% 1.04%
Dec 31, 1995 1,975.6 7.51% 7.42% 0.69% 6.73% 6.05% 0.68% 1.11%
Mar 31, 1996 2,025.8 7.56% 7.48% 0.99% 6.49% 5.60% 0.89% 1.32%
Jun 30, 1996 2,248.2 7.83% 7.28% 0.85% 6.43% 5.59% 0.84% 1.32%
Sep 30, 1996 2,506.0 7.80% 7.31% 0.80% 6.51% 5.71% 0.80% 1.32%
Dec 31, 1996 2,624.4 7.61% 7.57% 0.93% 6.64% 5.72% 0.92% 1.34%
Mar 31, 1997 2,950.6 7.93% 7.53% 0.89% 6.65% 5.67% 0.98% 1.54%
Jun 30, 1997 3,464.1 7.75% 7.57% 0.90% 6.67% 5.77% 0.90% 1.39%
<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>
<PAGE>
<TABLE>
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS
<CAPTION>
Impact of Amort. of
Premium/ Principal Deferred Gain Total
As of the Discount Payments Hedging from Hedging Yield
Quarter Ended Amort. Receivable Activity Activity Adjustment
------------- --------- ---------- -------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Mar 31, 1995 0.22% 0.02% 0.21% (0.19)% 0.26%
Jun 30, 1995 0.26% 0.03% 0.28% (0.17)% 0.40%
Sep 30, 1995 0.37% 0.06% 0.31% (0.16)% 0.58%
Dec 31, 1995 0.43% 0.10% 0.32% (0.16)% 0.69%
Mar 31, 1996 0.77% 0.11% 0.31% (0.20)% 0.99%
Jun 30, 1996 0.67% 0.07% 0.27% (0.16)% 0.85%
Sep 30, 1996 0.57% 0.08% 0.25% (0.10)% 0.80%
Dec 31, 1996 0.69% 0.09% 0.23% (0.08)% 0.93%
Mar 31, 1997 0.63% 0.13% 0.19% (0.07)% 0.89%
Jun 30, 1997 0.66% 0.13% 0.16% (0.05)% 0.90%
</TABLE>
As of the end of the quarter ended June 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 6.67% as compared
to 6.65% as of March 31, 1997, an increase of 0.02%. The Company's cost of funds
as of June 30, 1997 was 5.77% as compared to 5.67% as of March 31, 1997, an
increase of 0.10%. As a result of these changes, the Company's net interest
spread as of June 30, 1997 was 0.90% as compared to 0.98% as of March 31, 1997,
a decrease of 0.08%. This decrease in the net interest spread was offset by the
continued growth of the Company and more efficient use of capital enabling the
Company to actually increase its return on equity despite an increase in short
term interest rates by the Federal Reserve Bank of 0.25% in March of 1997.
During the second quarter of 1997 the Company's average equity to average total
assets ratio was 9.03% as compared to 9.72% during the first quarter of 1997.
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 June 30, 1997 and 1996:
<TABLE>
AVERAGE BALANCE AND RATE TABLE
(Amounts in thousands)
<CAPTION>
For the Quarter Ended For the Quarter Ended
June 30, 1997 June 30, 1996
---------------------- ---------------------
Average Effective Average Effective
Balance Rate Balance Rate
------------ --------- ----------- ---------
<S> <C> <C> <C> <C>
Interest Earning Assets:
ARM assets $ 3,444,058 6.66% $ 2,232,603 6.36%
Cash and cash equivalents 20,059 5.78 15,612 4.83
---------- ------ ---------- ------
3,464,117 6.65 2,248,215 6.35
---------- ------ ---------- ------
Interest Bearing Liabilities:
Borrowings 3,155,664 5.76 2,034,159 5.60
---------- ------ ---------- ------
Net Interest Earning Assets
and Spread $ 308,453 0.89% $ 214,056 0.75%
========== ====== ========== ======
Yield on Net Interest
Earning Assets (1) 1.41% 1.29%
====== ======
<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 second quarter of 1997, the Company realized a net gain from the sale
of ARM securities in the amount of $21,000 as compared to no gain or loss during
the second quarter of 1996. Additionally, the Company recorded an expense for
credit losses in the amount of $210,000 during the quarter ended June 30, 1997,
although the Company only incurred actual credit losses of $42,000 during the
quarter. 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 $14.7
million, or 0.4% of the Company's ARM portfolio.
For the quarter ended June 30, 1997, the Company's ratio of operating expenses
to average assets was 0.22% as compared to 0.19% for the same quarter of 1996
and as compared to 0.25% for the previous quarter ended March 31, 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>
ANNUALIZED OPERATING EXPENSE RATIOS
<CAPTION>
Management Fee & Total
For The Other Expenses/ Performance Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
------------- ---------------- ---------------- --------------
<S> <C> <C> <C>
Mar 31, 1995 0.10% 0.00% 0.10%
Jun 30, 1995 0.10% 0.00% 0.10%
Sep 30, 1995 0.10% 0.03% 0.13%
Dec 31, 1995 0.10% 0.09% 0.19%
Mar 31, 1996 0.09% 0.12% 0.21%
Jun 30, 1996 0.10% 0.09% 0.19%
Sep 30, 1996 0.10% 0.10% 0.20%
Dec 31, 1996 0.13% 0.11% 0.24%
Mar 31, 1997 0.14% 0.11% 0.25%
Jun 30, 1997 0.13% 0.09% 0.22%
</TABLE>
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1997
For the six month period ended June 30, 1997, the Company's net income was
$19,370,000 as compared to $11,300,000 for the first half of 1996. Net income
available to common shareholders, after the $1.05 per share dividend to
preferred shareholders for the period from January 24, 1997 (date of issuance)
through June 30, 1997, increased to $16,458,000 or $0.99 per common share based
on weighted average common shares of 16,565,505 from $11,300,000 or $0.83 per
common share based on weighted average common shares of 13,589,537 for the six
month period ended June 30, 1996. This is an increase in net income available to
common shareholders per common share of 19%. Net interest income for the first
half of 1997 totaled $23,507,000 as compared to $13,415,000 for the same period
in 1996, an increase of 75%. Net interest income is comprised of the interest
income earned on mortgage investments and cash less interest expense from
borrowings. During the first half of 1997, the Company recorded a gain on the
sale of ARM securities of $25,000 as compared to a net gain of $13,000 during
the first half of 1996. Additionally, during the first half of 1997, the Company
reduced earnings and the carrying value of its ARM securities by $400,000 for
projected credit losses. The Company incurred operating expenses of $3,762,000
for the six month period, consisting principally of the base management fee of
$1,687,000, a performance fee of $1,638,000 and other miscellaneous expenses of
$437,000 as compared to operating expenses of $2,128,000 for the same period in
1996, consisting principally of the base management fees of $764,000, a
performance fee of $1,096,000 and other miscellaneous expenses of $268,000.
As discussed above, the primary reasons for the rise in the Company's net
interest income for the six month period ended June 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 $10,092,000. Of this increase, the increased average size of
the Company during the second quarter of 1997 as compared to 1996 contributed to
higher net interest income in the amount of $7,905,000. The average balance of
the Company's interest earning assets was $3.207 billion during the first half
of 1997 as compared to $2.137 billion during the same period of 1996, an
increase of 50%. Additionally, $2,643,000 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 $456,000 for a combined favorable rate variance of $2,186,000. The
yield on the Company's interest earning assets during the six month period ended
June 30, 1997 was 6.65% as compared to 6.40% during the same period of 1996.
Also, during these same periods, the Company's cost of funds increased to 5.71%
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 1.47% for the first
half of 1997 from 1.26% for the same period of 1996.
As of the end of the quarter ended June 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 6.67% as compared to 6.64%
as of December 31, 1996, an increase of 0.03%. The Company's cost of funds as of
June 30, 1997 was 5.77% as compared to 5.72% as of December 31, 1996, an
increase of 0.05%. As a result of these changes, the Company's net interest
spread as of June 30, 1997 was 0.90% as compared to 0.92% as of December 31,
1996, a decrease of 0.02%.
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 six month periods ended June 30, 1997 and June 30, 1996:
<TABLE>
AVERAGE BALANCE AND RATE TABLE
(Amounts in thousands)
<CAPTION>
For the Six Month For the Six Month
Period Ended Period Ended
June 30, 1997 June 30, 1996
--------------------- ---------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Interest Earning Assets:
ARM assets $ 3,190,153 6.65% $ 2,122,639 6.41%
Cash and cash equivalents 17,203 5.57 14,349 5.19
3,207,356 6.65 2,136,988 6.40
--------- ------ --------- ------
Interest Bearing Liabilities:
Borrowings 2,912,848 5.71 1,942,333 5.66
Net Interest Earning Assets
and Spread $ 294,508 0.94% $ 194,655 0.74%
========= ====== ========= ======
Yield on Net Interest
Earning Assets (1) 1.47% 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 US Treasury rate during the quarter
plus 1%. During the first half of 1997, the Manager earned a performance fee of
$1,638,000 as compared to $1,096,000 during the same period of 1996. During the
six month period ended June 30, 1997, after paying this performance fee, the
Company's return on average common equity reached 13.42% as compared to 11.16%
during the same period of 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarters ended June 30, 1997 and
1996 consisted of reverse repurchase agreements, which totaled $3.512 billion
and $2.190 billion at the respective quarter ends. The Company's other
significant source of funds for the quarters ended June 30, 1997 and 1996
consisted of payments of principal and interest from its ARM portfolio in the
amounts of $228.2 million and $186.4 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 June 30, 1997 had a weighted average interest cost of
5.77%, which includes the cost of interest rate swaps, a weighted average
original term to maturity of 6.2 months and a weighted average remaining term to
maturity of 3.3 months. As of June 30, 1997, $1.244 billion of the Company's
borrowings were variable-rate term reverse repurchase agreements with original
maturities that range from three months to two years. The interest rates of
these term reverse repurchase agreements are indexed to either the one, three or
six-month LIBOR rate and reprice accordingly.
The Company has borrowing arrangements with twenty-three different investment
banking firms and commercial banks and at June 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 June 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 second quarter 1997
participation in the Plan, the Company issued 113,501 new shares of common stock
and received $2.2 million of new equity capital. During the six month period
ended June 30, 1997, the Company issued 215,838 new shares of common stock and
received $4.2 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 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 June 30, 1997, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.8% of its total assets, as compared to the Code requirement that at least 75%
of its total assets must be Qualified REIT Assets. The Company also calculates
that 99.6% of its 1997 revenue for the first quarter qualifies for the 75%
source of income test and 100% of its revenue qualifies for the 95% source of
income test under the REIT rules. Furthermore, the Company's revenues during the
six month period ended June 30, 1997 subject to the 30% income limitation under
the REIT rules amounted to 0.78% 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 June 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 June
30, 1997, the Company calculates that it is in compliance with this requirement.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At June 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
(a) The Annual Meeting of Shareholders of the Company was held on
May 2, 1996.
(c) The following matters were voted on at the Annual Meeting:
(1) Election of Directors
Votes
-----------------------
Nominee For Withheld
------------------------- ---------- --------
H. Garrett Thornburg, Jr. 14,415,980 85,620
Joseph H. Badal 14,414,680 86,920
Owen M. Lopez 14,409,574 92,026
Stuart C. Sherman 14,412,649 88,951
(2) Amendments to the registrant's amended and restated 1992
Stock Option Plan
Votes
----------------------------------------
For Against Abstain
---------- -------- --------
13,176,394 818,206 158,168
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
None
(b) Reports on Form 8-K
None
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized,
THORNBURG MORTGAGE ASSET CORPORATION
Dated: July 31, 1997 By: /s/ Larry A. Goldstone
-----------------------
Larry A. Goldstone,
President and Chief Operating Officer
(authorized officer of registrant)
Dated: July 31, 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 June 30,
1997 Quarterly Report on form 10-Q and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 11,564
<SECURITIES> 3,825,748
<RECEIVABLES> 34,897
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 387
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,872,596
<CURRENT-LIABILITIES> 3,559,013
<BONDS> 0
0
65,805
<COMMON> 173
<OTHER-SE> 247,605
<TOTAL-LIABILITY-AND-EQUITY> 3,872,596
<SALES> 0
<TOTAL-REVENUES> 106,647
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 3,762
<LOSS-PROVISION> 400
<INTEREST-EXPENSE> 83,115
<INCOME-PRETAX> 19,370
<INCOME-TAX> 0
<INCOME-CONTINUING> 19,370
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,370
<EPS-PRIMARY> .99
<EPS-DILUTED> .99
</TABLE>
