UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
- ------ EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1998
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 (IRS 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) 21,523,723 as of April 22, 1998
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets at March 31, 1998 and December 31, 1997... 3
Statements of Operations for the three months ended
March 31, 1998 and March 31, 1997........................ 4
Statement of Shareholders' Equity for the three months
ended March 31, 1998..................................... 5
Statements of Cash Flows for the three months ended
March 31, 1998 and March 31, 1997........................ 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........................................... 27
Item 2. Changes in Securities ...................................... 27
Item 3. Defaults Upon Senior Securities ............................ 27
Item 4. Submission of Matters to a Vote of Security Holders......... 27
Item 5. Other Information........................................... 27
Item 6. Exhibits and Reports on Form 8-K............................ 27
SIGNATURES ......................................................... 28
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THORNBURG MORTGAGE ASSET CORPORATION
BALANCE SHEETS
(Amounts in thousands)
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
ASSETS
Adjustable-rate mortgage ("ARM") assets: (Notes 2 and 3)
ARM securities $ 4,598,677 $ 4,519,707
ARM loans held for securitization 227,702 118,987
------------- -------------
4,826,379 4,638,694
------------- -------------
Cash and cash equivalents 2,506 13,780
Accrued interest receivable 39,251 38,353
Prepaid expenses and other 2,671 289
------------- -------------
$ 4,870,807 $ 4,691,116
============= =============
LIABILITIES
Reverse repurchase agreements (Note 3) $ 4,470,099 $ 4,270,170
Other borrowings (Note 3) 9,161 10,018
Accrued interest payable 18,127 39,749
Dividends payable (Note 6) 9,708 11,810
Accrued expenses and other 1,212 1,215
------------- -------------
4,508,307 4,332,962
SHAREHOLDERS' EQUITY (Note 6)
Preferred stock: par value $.01 per share;
2,760 shares authorized; 9.68% Cumulative
Convertible Series A, 2,760 and 2,760 issued
and outstanding, respectively; aggregate
preference in liquidation $69,000 65,805 65,805
Common stock: par value $.01 per share;
47,240 shares authorized, 21,371 and 20,280
shares issued and outstanding, respectively 214 203
Additional paid-in-capital 333,453 315,240
Accumulated other comprehensive income (32,231) (19,445)
Notes receivable from stock sales (4,632) (2,698)
Retained earnings (deficit) (109) (951)
------------- -------------
362,500 358,154
------------- -------------
$ 4,870,807 $ 4,691,116
============= =============
</TABLE>
See Notes to Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
----------- ----------
<S> <C> <C>
Interest income from ARM assets and cash $ 76,315 $ 48,999
Interest expense on borrowed funds (64,889) (37,667)
--------- ---------
Net interest income 11,426 11,332
--------- ---------
Realized gain (loss) on:
Sale of ARM securities (Note 2) 1,528 4
Provision for credit losses on ARM assets (Note 2) (387) (190)
Management fee (Note 7) (1,028) (811)
Performance fee (Note 7) (759) (857)
Other operating expenses (284) (183)
--------- ---------
NET INCOME $ 10,496 $ 9,295
========= =========
Net income $ 10,496 $ 9,295
Dividend on preferred stock (1,670) (1,241)
--------- ----------
Net income available to common shareholders $ 8,826 $ 8,054
========= =========
Basic earnings per share $ 0.42 $ 0.49
========= =========
Primary earnings per share $ 0.42 $ 0.49
========= =========
Average number of common shares outstanding 20,797 16,311
========= =========
</TABLE>
See Notes to Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
Three Months Ended March 31, 1998
(In thousands, except share data)
<TABLE>
<CAPTION>
Notes
Accumulated Receivable
Additional Other From Retained
Preferred Common Paid-in Comprehensive Stock Earnings/ Comprehensive
Stock Stock Capital Income Sales (Deficit) Income Total
--------- -------- ---------- ------------- ---------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 65,805 $ 203 $ 315,240 $ (19,445) $ (2,698) $ (951) $ 358,154
Comprehensive income:
Net income 10,496 $ 10,496 10,496
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net
of amortization - - - (12,448) - - (12,448) (12,448)
Deferred gain on sale of
hedges, net of amortization - - - (338) - - (338) (338)
----------
Other comprehensive income (loss) $ (2,290)
==========
Issuance of common stock (Note 5) - 11 18,213 - (1,934) - 16,290
Dividends declared on preferred
stock - $0.605 per share - - - - - (1,670) (1,670)
Dividends declared on common
stock - $0.375 per share - - - - - (7,984) (7,984)
======= ====== ======== ========== ======== ======== =======
Balance, December 31, 1998 $ 65,805 $ 214 $ 333,453 $ (32,231) $ (4,632) $ (109) $ 362,500
======= ====== ======== ========== ======== ======== =======
</TABLE>
See Notes to Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
----------- ----------
<S> <C> <C>
Operating Activities:
Net Income $ 10,496 $ 9,295
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 10,107 4,359
Net (gain) loss from investing activities (1,141) 186
Change in assets and liabilities:
Accrued interest receivable (898) (6,152)
Prepaid expenses and other (2,382) (285)
Accrued interest payable (21,622) 2,784
Accrued expenses and other (3) 459
---------- ---------
Net cash provided by (used in) operating activities (5,443) 10,646
---------- ---------
Investing Activities:
Available-for-sale ARM securities:
Purchases (693,744) (670,565)
Proceeds on sales 191,825 633
Proceeds from calls 54,879 -
Principal payments 330,536 127,054
Held-to-maturity ARM securities:
Principal payments 16,152 18,140
ARM loans:
Purchases (120,025) -
Principal payments 11,234 -
Purchase of interest rate cap agreements (294) (398)
---------- --------
Net cash provided by (used in) investing activities (209,437) (525,136)
---------- --------
Financing Activities:
Net borrowings from reverse repurchase agreements 199,929 477,047
Net repayments of other borrowings (857) (793)
Proceeds from preferred stock issued - 65,809
Proceeds from common stock issued 16,290 2,029
Dividends paid (11,756) (7,299)
---------- ----------
Net cash provided by (used in) financing activities 203,606 536,793
---------- ----------
Net increase (decrease) in cash and cash equivalents (11,274) 22,303
Cash and cash equivalents at beginning of period 13,780 3,693
---------- ----------
Cash and cash equivalents at end of period $ 2,506 $ 25,996
========= =========
</TABLE>
Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.
See Notes to Financial Statements
<PAGE>
NOTES TO FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their value.
ADJUSTABLE-RATE MORTGAGE ASSETS
The Company's adjustable-rate mortgage ("ARM") assets are comprised
of both ARM securities and ARM loans, primarily secured by
single-family residential housing.
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 most of its 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 might 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.
Management has the intent and ability to hold the Company's ARM
loans for the foreseeable future and until maturity or payoff.
Therefore, they are carried at their unpaid principal 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 assets 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 securities 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 Investor Services, Inc. or
Standard & Poor's, Inc. (the "Rating Agencies"). Additionally, the
Company has also purchased ARM loans and limits its exposure to
credit losses by restricting its whole loan purchases to ARM loans
generally originated to "A" quality underwriting standards or loans
that have at least five years of pay history and/or low loan to
property value ratios. 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.
The Company monitors the delinquencies and losses on the underlying
mortgage loans backing its ARM assets. If the credit performance of
the underlying mortgage loans is not 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 assets portfolio. The provision
is based on management's assessment of numerous factors affecting
its portfolio of ARM assets 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 for ARM securities 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 ARM
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
assets are initially carried at their fair value as of the time the
Cap Agreements and the related assets 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 assets are carried at fair value
with unrealized gains and losses reported as a separate component of
equity, consistent with the reporting of such assets. The carrying
value of the Cap Agreements are included in ARM assets on the
balance sheet. The Company purchases Cap Agreements by incurring a
one-time fee or premium. The amortization of the premium paid for
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 complies 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
on that portion of its income that is distributed to shareholders
and as long as certain asset, income and stock ownership tests are
met.
NET EARNINGS PER SHARE
Basic EPS amounts are computed by dividing net income (adjusted for
dividends declared on preferred stock) by the weighted average
number of common shares outstanding. Diluted EPS amounts assume the
conversion, exercise or issuance of all potential common stock
instruments unless the effect is to reduce a loss or increase the
earnings per common share.
Following is information about the computation of the earnings per
share data for the 3 month periods ended March 31, 1998 and 1997
(Amounts in thousands except per share data):
<TABLE>
<CAPTION>
Earnings
Income Shares Per Share
------------- ------------- -------------
<S> <C> <C> <C>
Three Months Ended March 31, 1998
---------------------------------
Net income $ 10,496
Less preferred stock dividends (1,670)
------------
Basic EPS, income available to
common shareholders 8,826 20,797 $ 0.42
===========
Effect of dilutive securities:
Stock options 18
------------ -------------
Diluted EPS $ 8,826 20,815 $ 0.42
============ ============= ===========
Three Months Ended March 31, 1997
---------------------------------
Net income $ 9,294
Less preferred stock dividends (1,242)
------------
Basic EPS, income available to
common stockholders 8,052 16,311 $ 0.49
===========
Effect of dilutive securities:
Stock options 153
------------ -------------
Diluted EPS $ 8,052 16,464 $ 0.49
============ ============= ===========
</TABLE>
The Company has granted options to directors and officers of the
Company and employees of the Manager to purchase 32,763 and 115,920
shares of common stock at average prices of $16.52 and $20.00 per
share during the quarters ended March 31, 1998 and 1997,
respectively. The conversion of preferred stock was not included in
the computation of diluted EPS because such conversion would
increase the diluted EPS.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AGREEMENTS
The following tables present the Company's ARM assets as of March 31,
1998 and December 31, 1997. The ARM securities classified as
available-for-sale are carried at their fair value, while the
held-to-maturity ARM securities and ARM loans are carried at their
amortized cost basis (dollar amounts in thousands):
March 31, 1998:
<TABLE>
<CAPTION>
ARM Securities
---------------------------------------
Available- Held-to-
for-Sale Maturity Total ARM Loans
------------ ----------- ------------- ------------
<S> <C> <C> <C> <C>
Amortized cost basis $ 4,245,122 $ 377,120 $ 4,622,242 $ 227,803
Allowance for losses (1,502) - (1,502) (101)
----------- ----------- ----------- -----------
Amortized cost, net 4,243,620 377,120 4,620,740 227,702
----------- ----------- ----------- -----------
Gross unrealized gains 7,079 3,808 10,887 -
Gross unrealized losses (32,184) (728) (32,912) -
=========== =========== =========== ===========
Fair value $ 4,218,515 $ 380,200 $ 4,598,715 $ 227,702
=========== =========== =========== ===========
Carrying value $ 4,218,515 $ 377,120 $ 4,595,635 $ 227,702
=========== =========== =========== ===========
December 31, 1997:
ARM Securities
---------------------------------------
Available- Held-to-
for-Sale Maturity Total ARM Loans
------------ ----------- ------------- ------------
Amortized cost basis $ 4,147,384 $ 395,803 $ 4,543,187 $ 119,029
Allowance for losses (1,739) - (1,739) (42)
----------- ----------- ----------- -----------
Amortized cost, net 4,145,645 395,803 4,541,448 118,987
----------- ----------- ----------- -----------
Gross unrealized gains 11,075 5,609 16,684 -
Gross unrealized losses (32,816) (2,859) (35,675) -
=========== =========== =========== ===========
Fair value $ 4,123,904 $ 398,553 $ 4,522,457 $ 118,987
=========== =========== =========== ===========
Carrying value $ 4,123,904 $ 395,803 $ 4,519,707 $ 118,987
=========== =========== =========== ===========
</TABLE>
During the quarter ended March 31, 1998, the Company realized
$1,786,000 in gains and $258,000 in losses on the sale of $190.3
million of ARM securities. During the same period of 1997, the Company
realized $4,000 in gains on the sale of $629,000 of ARM securities. All
of the ARM securities sold were classified as available-for-sale.
As of March 31, 1998, 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 $1,502,000. At March 31, 1998,
the Company is providing for potential future credit losses on two
assets that have an aggregate carrying value of $12.6 million, which
represent less than 0.3% of the Company's total portfolio of ARM
assets. Both of these assets are performing and one has some remaining
credit support that mitigates the Company's exposure to potential
future credit losses. Additionally, during the first three months of
1998, the Company, in accordance with its credit policies, recorded a
$59,000 provision for potential credit losses on its loan portfolio,
although no actual losses have been realized in the loan portfolio to
date. The following table summarizes the activity for the allowance for
losses on ARM loans for the quarter ended March 31, 1998 (dollar
amounts in thousands):
Beginning balance $ 42
Provision for losses 59
Charge-offs, net 0
--------
Ending balance $ 101
========
As of March 31, 1998, the Company had commitments to purchase $134.2
million of ARM assets.
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 6.24% as of March 31, 1998 and 6.38% as of December 31,
1997.
As of March 31, 1998 and December 31, 1997, the Company had purchased
Cap Agreements with a remaining notional amount of $4.181 billion and
$4.156 billion, respectively. The notional amount of the Cap Agreements
purchased decline at a rate that is expected to approximate the
amortization of the ARM assets. Under these Cap Agreements, the Company
will receive cash payments should the one-month, 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 10.15%. The Company's ARM assets portfolio
had an average lifetime interest rate cap of 11.37%. The Cap Agreements
had an average maturity of 2.9 years as of March 31, 1998. The initial
aggregate notional amount of the Cap Agreements declines to
approximately $3.360 billion over the period of the agreements, which
expire between 1999 and 2004. 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 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 March 31, 1998, the Company had outstanding $4.470 billion of
reverse repurchase agreements with a weighted average borrowing rate of
5.75% and a weighted average remaining maturity of 2.6 months. As of
March 31, 1998, $1.868 billion of the Company's reverse repurchase
agreements 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. In addition, as of March 31, 1998, $174.4 million of the
Company's reverse repurchase agreements were collateralized by whole
loans under one year financing agreements that are indexed to the
one-month LIBOR rate and reprice either daily or once a month. The
reverse repurchase agreements at March 31, 1998 were collateralized by
ARM assets with a carrying value of $4.723 billion, including accrued
interest.
At March 31, 1998, the reverse repurchase agreements had the following
remaining maturities (dollars in thousands):
Within 30 days $ 1,508,509
30 to 90 days 1,626,327
91 days to one year 1,335,263
-----------
$ 4,470,099
===========
As of March 31, 1998, the Company was a counterparty to two interest
rate swap agreements having an aggregate notional balance of $260
million and a weighted average remaining term of 11.5 months, although
they are cancelable monthly. 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. Since these agreements are cancelable monthly, they have no
effect on the average period to the next repricing of the Company's
borrowings. The average period to the next repricing of the Company's
borrowings was 36 days as of March 31, 1998.
The Company has a line of credit agreement which provides for
short-term borrowings of up to $25 million collateralized by the
Company's principal and interest receivables. As of March 31, 1998,
there was no balance outstanding under this agreement.
As of March 31, 1998, the Company had financed a portion of its
portfolio of interest rate cap agreements with $9.2 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 7.90% and have a weighted average remaining maturity of 1.8
years. The other borrowings financing cap agreements at March 31, 1998
were collateralized by ARM securities with a carrying value of $14.1
million, including accrued interest and $500 thousand of cash. The
aggregate maturities of these other borrowings are as follows (dollars
in thousands):
1998 $ 3,652
1999 4,877
2000 632
----------
$ 9,161
==========
During the quarter ended March 31, 1998, the total cash paid for
interest was $85.7 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 March 31, 1998 and
December 31, 1997. Financial Accounting Standard Board ("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 (dollar amounts in thousands):
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
------------------------- ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Assets:
ARM assets $ 4,823,337 $ 4,826,417 $ 4,634,612 $ 4,639,513
Cap agreements 3,042 1,161 4,082 1,931
Liabilities:
Other borrowings 9,161 8,990 10,018 10,321
Swap agreements (44) 210 (50) 184
</TABLE>
The above carrying amounts for assets are combined in the balance sheet
under the caption adjustable-rate mortgage 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 values for ARM loans are based on
market prices for similar securitized loans, adjusted for differences
in loan characteristics. 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.
<PAGE>
NOTE 5. COMMON AND PREFERRED STOCK
During the quarter ended March 31, 1998, the Company issued 1,027,000
shares of common stock under its dividend reinvestment and stock
purchase plan and received net proceeds of $16.3 million.
During the quarter ended March 31, 1998, stock options for 128,377
shares of common stock were exercised at an average price of $15.80 for
cash and notes receivable. The Company received net cash proceeds of
$21,000 and $1.9 million of notes receivable were executed in
connection with the exercise of these options.
On March 24, 1998, the Company declared a first quarter dividend of
$0.375 per common share which was paid on April 10, 1998 to common
shareholders of record as of March 31, 1998. Additionally, the Company
declared a first quarter dividend of $0.605 per share to the
shareholders of the Series A 9.68% Cumulative Convertible Preferred
Stock which was also paid on April 10, 1997 to preferred shareholders
of record as of March 31, 1997. For federal income tax purposes such
dividends are ordinary income to the Company's common and preferred
shareholders, subject to year-end allocations of the common dividend
between ordinary income and capital gain income, depending on the
character of the Company's full year income.
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.
The Company issued DERs at the same time as ISOs and NQSOs based upon a
formula defined in the Plan. During 1998 the number of DERs issued is
based on 35% of the ISOs and NQSOs granted during 1998. The number of
PSRs issued are based on the level of the Company's dividends and on
the price of the Company's stock on the related dividend payment date
and is equivalent to the cash that otherwise would be paid on the
outstanding DERs and previously issued PSRs.
During the quarter ended March 31, 1998, there were 32,763 options
granted to buy common shares at an average exercise price of $16.52
along with 11,473 DERs. As of March 31, 1998, the Company had 585,381
options outstanding at exercise prices of $9.375 to $22.625 per share,
436,698 of which were exercisable. The weighted average exercise price
of the options outstanding was $17.77 per share. As of the March 31,
1998, there were 71,554 DERs granted, of which 42,574 were vested, and
2,012 PSRs granted. In addition, the Company recorded an expense
associated with the DERs and the PSRs of $17,000 for the quarter ended
March 31, 1998.
Notes receivable from stock sales result from the Company selling
shares of common stock through the exercise of stock options partially
for consideration for notes receivable. The notes have maturity terms
ranging from 3 years to 9 years and accrue interest at rates that range
from 5.40% to 6.00% per annum. In addition, the notes are full recourse
promissory notes and are secured by a pledge of the shares of the
Common Stock acquired. Interest, which is credited to paid-in-capital,
is payable quarterly, with the balance due at the maturity of the
notes. The payment of the notes will be accelerated only upon the sale
of the shares of Common Stock pledged for the notes. The notes may be
prepaid at any time at the option of each borrower.
<PAGE>
NOTE 7. TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement (the "Agreement") with Thornburg
Mortgage Advisory Corporation ("the Manager"). Under the terms of this
Agreement, the Manager, subject to the supervision of the Company's
Board of Directors, is responsible for the management of the day-to-day
operations of the Company and provides all personnel and office space.
The Agreement provides for an annual review by the unaffiliated
directors of the Board of Directors of the Manager's performance under
the Agreement.
The Company pays the Manager an annual base management fee based on
average shareholders' equity, adjusted for liabilities that are not
incurred to finance assets ("Average Shareholders' Equity" or "Average
Net Invested Assets" as defined in the Agreement) payable monthly in
arrears as follows: 1.1% of the first $300 million of Average
Shareholders' Equity, plus 0.8% of Average Shareholders' Equity above
$300 million.
For the quarters ended March 31, 1998 and 1997, the Company paid the
Manager $1,028,000 and $811,000, respectively, in base management fees
in accordance with the terms of the Agreement.
The Manager is also entitled to earn performance based compensation in
an amount equal to 20% of the Company's annualized net income, before
performance based compensation, above an annualized Return on Equity
equal to the ten year U.S. Treasury Rate plus 1%. For purposes of the
performance fee calculation, equity is generally defined as proceeds
from issuance of common stock before underwriter's discount and other
costs of issuance, plus retained earnings. For the quarters ended March
31, 1998 and 1997, the Company paid the Manager $759,000 and $857,000,
respectively, in performance based compensation in accordance with the
terms of the Agreement.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain information contained in this Quarterly Report on Form 10-Q constitute
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Exchange Act, which can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negatives thereof or
other variations thereon or comparable terminology. Investors are cautioned that
all forward-looking statements involve risks and uncertainties including, but
not limited to, risks related to the future level and relationship of various
interest rates, prepayment rates and the timing of new programs. The statements
in the "Risk Factors" of the Company's Prospectus Supplement dated July 14, 1997
constitute cautionary statements identifying important factors, including
certain risks and uncertainties, with respect to such forward-looking statements
that could cause the actual results, performance or achievements of the Company
to differ materially from those reflected in such forward-looking statements.
GENERAL
Thornburg Mortgage Asset Corporation (the "Company") is a mortgage acquisition
company 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
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 assets 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.
On March 23, 1998, the Board of Directors approved an expansion of the Company's
investment strategies to include portfolio investments in "Hybrid ARMs", which
are loans or securities backed by Hybrid ARM loans. Hybrid ARM loans have an
interest rate that is fixed for an initial period of time, generally 3 to 5
years, and then convert to an adjustable-rate for the balance of the term of the
loan. The Company will not invest more than 20% of its ARM assets in Hybrid ARMs
and will limit its interest rate repricing mismatch (the difference between the
remaining fixed-rate period of a Hybrid ARM and the maturity of the fixed-rate
liability funding a Hybrid ARM) to approximately one year.
The Company does not invest in REMIC residuals or other CMO residuals and,
therefore does not create excess inclusion income or unrelated business taxable
income for tax exempt investors. Therefore, the Company is a mortgage REIT
eligible for purchase by tax exempt investors, such as pension plans, profit
sharing plans, 401(k) plans, Keogh plans and Individual Retirement Accounts
("IRAs").
FINANCIAL CONDITION
At March 31, 1998, the Company held total assets of $4.871 billion, $4.826
billion of which consisted of ARM assets, as compared to $4.691 billion and
$4.639 billion, respectively, at December 31, 1997. Since commencing operations,
the Company has purchased either ARM securities (backed by agencies of the U.S.
government or privately-issued, generally publicly registered, mortgage assets,
most of which are rated AA or higher by at least one of the Rating Agencies) or
ARM loans generally originated to "A" quality underwriting standards. At March
31, 1998, 92.3% of the assets held by the Company were High Quality assets, far
exceeding the Company's investment policy minimum requirement of investing at
least 70% of its total assets in High Quality ARM assets and cash and cash
equivalents. Of the ARM assets currently owned by the Company, 85.9% are in the
form of adjustable-rate pass-through certificates. The remainder are floating
rate classes of CMOs, investments in floating rate classes of trusts backed by
mortgaged-backed assets or ARM loans.
<PAGE>
The following table presents a schedule of ARM assets owned at March 31, 1998
and December 31, 1997 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.
ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $ 3,141,567 65.1% $ 3,117,937 67.2%
Privately Issued:
AAA/Aaa Rating 576,392 12.0 476,615 10.3
AA/Aa Rating 735,452 15.2 782,206 16.8
----------- ----------- ---------- -----------
Total Privately Issued 1,311,844 27.2 1,258,821 27.1
----------- ----------- ---------- -----------
----------- ----------- ---------- -----------
Total High Quality 4,453,411 92.3 4,376,758 94.3
----------- ----------- ---------- -----------
OTHER INVESTMENT:
Privately Issued:
A Rating 95,951 2.0 115,055 2.5
BBB/Baa Rating 38,076 0.8 17,625 0.4
BB/Ba Rating and Other 11,239 0.2 10,269 0.2
Whole loans 227,702 4.7 118,987 2.6
----------- ----------- ----------- -----------
Total Other Investment 372,968 7.7 261,936 5.7
----------- ----------- ----------- -----------
Total ARM Portfolio $ 4,826,379 100.0% $ 4,638,694 100.0%
=========== =========== =========== ===========
</TABLE>
As of March 31, 1998, the Company had reduced the cost basis of its ARM
securities by $1,502,000 due to potential future credit losses (other than
temporary declines in fair value). The Company is providing for potential future
credit losses on two securities that have an aggregate carrying value of $12.6
million, which represent less than 0.3% of the Company's total portfolio of ARM
assets. Both of these assets continue to perform and one has some minimal
remaining credit support to mitigate the Company's exposure to potential future
credit losses.
Additionally, during the three months ended March 31, 1998, the Company recorded
a $59,000 provision for potential credit losses on its loan portfolio, although
no actual losses have been realized in the loan portfolio to date. The Company's
credit reserve policy regarding ARM loans is to record a monthly provision of
0.15% (annualized rate) on the outstanding principal balance of loans (including
loans securitized by the Company for which the Company has retained first loss
exposure), subject to adjustment on certain loans or pools of loans based upon
factors such as, but not limited to, age of the loans, borrower payment history,
low loan-to-value ratios and quality of underwriting standards applied by the
originator.
<PAGE>
The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
INDEX:
One-month LIBOR $ 404,008 8.4% $ 115,198 2.5%
Three-month LIBOR 89,438 1.9 31,215 0.7
Six-month LIBOR 1,369,898 28.4 1,489,802 32.1
Six-month Certificate of Deposit 256,874 5.3 278,386 6.0
Six-month Constant Maturity Treasury 64,266 1.3 66,669 1.4
One-year Constant Maturity Treasury 2,139,444 44.3 2,271,914 49.0
Cost of Funds 502,451 10.4 385,510 8.3
=========== =========== =========== ===========
$ 4,826,379 100.0% $ 4,638,694 100.0%
=========== =========== =========== ===========
</TABLE>
The portfolio had a current weighted average coupon of 7.47% at March 31, 1998.
The portfolio, on a weighted average basis, was "fully indexed," as of March 31,
1998, based upon the current composition of the portfolio and the applicable
indices. As of December 31, 1997, the portfolio had a weighted average coupon of
7.56%. If the portfolio had been "fully indexed," the weighted average coupon
would have been approximately 7.64%, based upon the composition of the portfolio
and the applicable indices at that time.
At December 31, 1997, the current yield of the ARM assets portfolio was 6.24%,
compared to 6.38% as of December 31, 1997, with an average term to the next
repricing date of 101 days as of December 31, 1997, compared to 110 days as of
December 31, 1997. 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.
The reduction in the yield as of March 31, 1998, compared to December 31, 1997,
is primarily because of the higher rate of ARM portfolio prepayments which have
occurred during the first quarter of 1998. The higher level of prepayments
increased the amount of premium amortization expense and increased the impact of
non-interest earning assets in the form of principal payment receivables. The
constant prepayment rate ("CPR") of the Company's ARM portfolio was 27% during
the first quarter of 1998 compared to 24% during the fourth quarter of 1997.
Higher premium amortization and a higher balance of principal payment
receivables decreased the ARM portfolio yield by 0.05% as of March 31, 1998
compared to the end of 1997, which was partially offset by a 0.01% decrease in
the net cost of hedging.
During the quarter ended March 31, 1998, the Company purchased $693.7 million of
ARM securities, 96.8% of which were High Quality assets, and $120.0 million of
ARM loans generally originated to "A" quality underwriting standards or seasoned
loans with over five years of good payment history and/or low loan-to-value
ratios. Of the ARM assets acquired during the first three months of 1998,
approximately 49% were indexed to LIBOR, 31% were indexed to a Cost of Funds
Index, 18% were indexed to U.S. Treasury bill rates and the remaining 2% to
other indices. Although a larger proportion of fixed-rate loans compared to ARM
loans are being originated in the current market, the Company has continued to
find sufficient attractive ARM asset acquisition opportunities to reinvest its
cash flows and to continue its asset growth while maintaining the high quality
credit profile of the ARM portfolio.
The Company sold ARM assets in the amount of $190.3 million at a net gain of
$1,528,000 during the first quarter of 1998. These sales reflect the Company's
desire to manage the portfolio with a view to enhancing the total return of the
portfolio. The Company monitors the performance of its individual ARM assets and
selectively sells an asset when there is an opportunity to replace it with an
ARM asset that has an expected higher long-term yield or more attractive
interest rate characteristics. Most of the ARM assets sold in the first quarter
of 1998 were prepaying faster than expected and, as a group, 86% or $163.5
million of the ARMs sold had yields at the time of sale approximately 0.37%
below the portfolio average yield at the time. The Company is presented with
investment opportunities in the ARM assets market on a daily basis and
management evaluates such opportunities against the performance of its existing
ARM assets. At times, the Company is able to identify opportunities that it
believes will improve the total return of its ARM assets portfolio by replacing
selected assets. In managing the portfolio, the Company may at times realize
either gains or losses in the process of replacing selected assets when it
believes it has identified better investment opportunities in order to improve
long-term total return.
For the quarter ended March 31, 1998, the Company's mortgage assets paid down at
an approximate average annualized constant prepayment rate of 27% compared to
22% for the quarter ended March 31, 1997 and 24% for the quarter ended December
31, 1997. When prepayment experience exceeds expectations, the Company has 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 price of the Company's portfolio of ARM assets classified as
available-for-sale declined by 0.07% from a negative adjustment of 0.52% of the
portfolio as of December 31, 1997, to a negative adjustment of 0.59% as of March
31, 1998. This price decline was primarily because of increased future
prepayment expectations which have the effect of shortening the average life of
the Company's ARM assets and decreasing their market value. The amount of the
negative adjustment to fair value on the ARM assets classified as
available-for-sale increased from $21.7 million as of December 31, 1997, to
$25.1 million as of March 31, 1998.
The Company has purchased Cap Agreements in order to limit its exposure to risks
associated with the lifetime interest rate caps of its ARM assets 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 assets to
continue to rise in a high interest rate environment just as the Company's cost
of borrowings would continue to rise, since the borrowings do not have any
interest rate cap limitation. At March 31, 1998, the Cap Agreements owned by the
Company had a remaining notional balance of $4.181 billion with an average final
maturity of 2.9 years, compared to a remaining notional balance of $4.156
billion with an average final maturity of 3.1 years at December 31, 1997.
Pursuant to the terms of the Cap Agreements, the Company will receive cash
payments if the one-month, three-month or six-month LIBOR index increases above
certain specified levels, which range from 7.50% to 13.00% and average
approximately 10.15%. The fair value of these Cap Agreements also tends to
increase when general market interest rates increase and decrease when market
interest rates decrease, helping to partially offset changes in the fair value
of the Company's ARM assets. At March 31, 1998, the fair value of the Cap
Agreements was $1.2 million, $11.1 million less than the amortized cost of the
Cap Agreements.
<PAGE>
The following table presents information about the Company's Cap Agreement
portfolio as of March 31, 1998:
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Cap Weighted
Hedged Weighted Agreement Average
ARM Assets Average Notional Strike Remaining
Balance (1) Life Cap Balance Price Term
------------- ----------- ------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 654,612 9.00% $ 477,310 7.50% 2.1 Years
500,891 10.05 442,754 8.00 3.8
145,898 10.53 195,912 8.50 2.0
197,110 10.11 311,777 9.00 1.7
151,509 10.82 153,870 9.50 2.5
322,863 11.02 324,745 10.00 4.1
453,445 11.43 458,369 10.50 2.6
443,852 12.03 385,404 11.00 3.6
356,626 12.53 571,616 11.50 4.2
555,755 12.96 579,064 12.00 2.8
227,401 13.54 183,885 12.50 2.2
226,839 14.43 95,902 13.00 1.9
98,930 None N/A N/A N/A
----------- ----------- ----------- ----------- --------------
$ 4,335,732 11.37% $ 4,180,608 10.15% 2.9 Years
=========== =========== =========== =========== ==============
<FN>
-------------
(1) 90% of the ARM Assets' balance, which approximates the financed
portion.
</FN>
</TABLE>
As of March 31, 1998, the Company was a counterparty to two interest rate swap
agreements having an aggregate notional balance of $260 million and a weighted
average remaining term of 11.5 months, although they are cancelable monthly.
Under 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. Since these agreements are cancelable monthly, they have
no effect on the average period to the next repricing of the Company's
borrowings. The average period to the next repricing of the Company's borrowings
was 36 days as of March 31, 1998.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1998
For the quarter ended March 31, 1998, the Company's net income was $10,496,000,
or $0.42 per share (Basic EPS), based on a weighted average of 20,797,000 shares
outstanding. That compares to $9,295,000, or $0.49 per share (Basic EPS), based
on a weighted average of 16,311,000 shares outstanding for the quarter ended
March 31, 1997. Net interest income for the quarter totaled $11,426,000,
compared to $11,332,000 for the same period in 1997. Net interest income is
comprised of the interest income earned on mortgage investments less interest
expense from borrowings. During the first three months of 1998, the Company
recorded a gain on the sale of ARM securities of $1,528,000 as compared to a
gain of $4,000 during the same period of 1997. Additionally, during the first
quarter of 1998, the Company reduced its earnings and the carrying value of its
ARM assets by reserving $387,000 for potential credit losses, compared to
$190,000 during the first quarter of 1997. During the first quarter of 1998, the
Company incurred operating expenses of $2,071,000, consisting of a base
management fee of $1,028,000, a performance-based fee of $759,000 and other
operating expenses of $284,000. During the same period of 1997, the Company
incurred operating expenses of $1,851,000, consisting of a base management fee
of $811,000, a performance-based fee of $857,000 and other operating expenses of
$183,000. Total operating expenses decreased as a percentage of average assets
to 0.16% for the three months ended March 31, 1998, compared to 0.25% for the
same period of 1997.
The Company's return on average common equity was 10.9% for the quarter ended
March 31, 1998 compared to 13.40% for the quarter ended March 31, 1997 and
compared to 11.63% for the prior quarter ended December 31, 1997. The primary
reason for the lower return on average common equity is the Company's lower
interest rate spread, discussed further below, partially offset by the higher
level of gains recorded this quarter on the sale of ARM securities and the lower
performance fee earned by the Manager. The table below highlights the historical
trend and the components of return on average common equity (annualized) and the
10-year U S Treasury average yield during each respective quarter which is
applicable to the computation of the performance fee:
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
<TABLE>
<CAPTION>
ROE in
Excess of
Net Gain (Loss) Net 10-Year 10-Year
Interest Provision on ARM G & A Performance Preferred Income/ US Treas. US Treas.
For The Income/ For Losses/ Sales/ Expense (2)/ Fee/ Dividend/ Equity Average Average
Quarter Ended Equity Equity Equity Equity Equity Equity (ROE) Yield Yield
------------- -------- ----------- ----------- ------------ ----------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mar 31, 1996 13.37% - 0.03% 1.04% 1.27% - 11.08% 5.90% 5.18%
Jun 30, 1996 13.14% - - 1.00% 0.92% - 11.22% 6.72% 4.50%
Sep 30, 1996 13.42% 0.34% 0.88% 1.03% 1.07% - 11.86% 6.78% 5.08%
Dec 31, 1996 14.99% 1.32% 1.38% 1.46% 1.23% - 12.37% 6.35% 6.02%
Mar 31, 1997 18.85% 0.32% 0.01% 1.65% 1.43% 2.07% 13.40% 6.55% 6.85%
Jun 30, 1997 19.48% 0.34% 0.03% 1.81% 1.25% 2.67% 13.45% 6.71% 6.74%
Sep 30, 1997 17.66% 0.30% 0.45% 1.64% 1.24% 2.23% 12.70% 6.26% 6.44%
Dec 31, 1997 15.62% 0.33% 1.06% 1.59% 1.01% 2.12% 11.63% 5.92% 5.71%
Mar 31, 1998 14.13% 0.48% 1.89% 1.62% 0.94% 2.06% 10.91% 5.60% 5.31%
<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 first quarter of
1997 to the first quarter of 1998 is primarily due to the decline in the net
interest spread between the Company's interest-earning assets and
interest-bearing liabilities from 0.98% as of March 31, 1997, to 0.50% as of
March 31, 1998. The primary reasons for this decline continue to be the change
in the relationship between the one-year U. S. Treasury yield and LIBOR and the
impact of increased ARM prepayment speeds. From March 31, 1997 to March 31,
1998, the one-year U.S. Treasury yield declined by approximately 0.41% while
LIBOR rates applicable to the Company's borrowings decreased by only 0.03%,
creating a negative spread as of March 31, 1998 of -0.31. Approximately 45% of
the Company's ARM assets are indexed to the one-year U. S. Treasury bill yield
and, therefore, the yield on such assets declined with the index. To put this in
historical perspective, the one-year U.S. Treasury bill yield had a spread of
- -0.26% to the average of the one-and three-month LIBOR rate as of December 31,
1997, compared to having a spread of -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 1993 to 1997, the average spread was 0.15%. The Company does not know when
or if the relationship between the one-year U. S. Treasury bill yield and LIBOR
will return to these historical norms, but the Company's spreads would be
expected to improve if that occurs. The Company's ARM portfolio yield also was
lower during the first quarter of 1998 compared to the first quarter of 1997
because of an increase in the prepayment rate of ARM assets. During the first
quarter of 1998, the average prepayment rate was 27%, compared to 22% during the
comparable period in 1997. The impact of this was to increase the average amount
of non-interest-earning assets in the form of principal payments receivable as
well as to increase the amortization expense related to writing off the
Company's premiums and discounts. The Company generally amortizes its premiums
and discounts on a monthly basis based on the most recent three-month average of
the prepayment rate of its ARM assets, thereby adjusting its amortization to
current market conditions, which is reflected in the yield of the ARM portfolio.
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. Since the Company, as a REIT, pays its dividends
based on taxable earnings, the dividends may at times be more or less than
reported earnings. As of March 31, 1998, the Company had a retained deficit of
$109,000 because its dividends, which consisted entirely of taxable income, were
higher than its reported earnings, principally because of loss provisions
recorded that are not deductible for tax purposes until actually realized. The
following table provides a reconciliation between the Company's earnings as
reported based on generally accepted accounting principals and the Company's
taxable income before it's common dividend deduction:
RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Month Period Ending March 31,
-----------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
Net income $ 10,496 $ 9,295
Additions:
Provision for credit losses 387 190
Deductions:
Dividend on Series A Preferred Shares (1,670) (1,241)
Actual credit losses on ARM securities (565) (18)
Net compensation related items (3) -
---------------- --------------
Taxable net income $ 8,645 $ 8,226
================ ==============
</TABLE>
The following table highlights the quarterly dividend history of the Company's
common shares:
COMMON DIVIDEND SUMMARY
(Dollar amounts in thousands, except per share data)
<TABLE>
<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, 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 8,226 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
Dec 31, 1997 9,207 0.46 0.50 110% 629
Mar 31, 1998 8,645 0.42 0.375 93% 1,290
<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>
As of March 31, 1998, 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 6.24%, compared to 6.65% as of March 31,
1997-- a decrease of 0.41%, and compared to 6.38% as of December 31, 1997 -- a
decrease of 0.14%. The Company's cost of funds as of March 31, 1998, was 5.74%,
compared to 5.67% as of March 31, 1997 -- an increase of 0.07%, and compared to
5.91% as of December 31, 1997 -- a decrease of 0.17%. The higher cost of funds
as of year-end was primarily the result of financing a portion of the ARM
portfolio over 1997 year-end at a time when LIBOR interest rates increased
suddenly late in November due to year-end market pressures. Fortunately the
Company, expecting this to occur, had already financed most of its portfolio
over year-end before the LIBOR increase and, thus, was able to avoid the full
potential impact of the higher market interest rates. Subsequent to year-end,
LIBOR interest rates have generally returned to their previous level, which is
reflected in a decrease in the Company's cost of funds as of March 31, 1998. As
a result of these changes, the Company's net interest spread as of March 31,
1998 was 0.50%, compared to 0.98% as of March 31, 1997 and compared to 0.47% as
of the end of 1997.
<PAGE>
The following table highlights the components of net interest spread and the
annualized yield on net interest-earning assets as of each applicable quarter
end:
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS (1)
(Dollar amounts in millions)
<TABLE>
<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, 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%
Dec 31, 1997 4,548.9 7.64% 7.56% 1.18% 6.38% 5.91% 0.47% 0.96%
Mar 31, 1998 4,859.7 7.47% 7.47% 1.23% 6.24% 5.74% 0.50% 0.92%
<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>
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS
<TABLE>
<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, 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%
Dec 31, 1997 0.94% 0.14% 0.14% (0.04)% 1.18%
Mar 31, 1998 0.98% 0.16% 0.13% (0.04)% 1.23%
</TABLE>
<PAGE>
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the quarters ended March 31, 1998 and 1997:
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
For the Quarter Ended For the Quarter Ended
March 31, 1998 March 31, 1997
--------------------- ---------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $ 4,847,192 6.29% $ 2,936,247 6.65%
Cash and cash equivalents 12,546 4.42 14,348 5.27
---------- ----- --------- -----
4,859,739 6.28 2,950,595 6.64
---------- ----- --------- -----
Interest Bearing Liabilities:
Borrowings 4,479,208 5.79 2,670,033 5.64
---------- ----- ---------- -----
Net Interest Earning Assets and Spread $ 380,531 0.49% $ 280,562 1.00%
========== ===== ========== =====
Yield on Net Interest Earning Assets (1) 0.94% 1.54%
===== =====
<FN>
(1) Yield on Net Interest Earning Assets is computed by dividing annualized
net interest income by the average daily balance of interest earning
assets.
</FN>
</TABLE>
Although the yield on the Company's interest-earning assets declined to 6.28%
during the first quarter of 1998 from 6.64% during the first quarter of 1997 and
the Company's cost of funds increased to 5.79% from 5.64% during the same time
periods, its net interest income increased, primarily due to the increased size
of the Company's portfolio. Net interest income increased by $94,000, which is a
combination of rate and volume variances. There was a combined unfavorable rate
variance of $3,708,000, which consisted of an unfavorable variance of $2,696,000
resulting from the lower yield on the Company's ARM assets portfolio and other
interest-earning assets and an unfavorable variance of $1,012,000 resulting from
an increase in the Company's cost of funds. The increased average size of the
Company's portfolio during the first three months of 1998 compared to the same
period of 1997 contributed to higher net interest income in the amount of
$3,803,000. The average balance of the Company's interest-earning assets was
$4.860 billion during the first quarter of 1998 compared to $2.951 billion
during the first quarter of 1997 -- an increase of 66%.
During the first quarter of 1998, the Company realized a net gain from the sale
of ARM securities in the amount of $1,528,000 as compared to $4,000 during the
first quarter of 1997. Most of the ARMs sold were sold for portfolio management
reasons because the average yield on 86% of the ARMs sold was 0.37% below the
average portfolio yield at the time of sale. Most of the gain, $1.4 million, is
from selling the other 14% of the ARMs sold, which increased the Company's
retained earnings from a deficit at year end of $951,000 to a deficit of
$109,000 as of March 31, 1998. Additionally, the Company recorded an expense for
credit losses in the amount of $387,000 during the quarter ended March 31, 1998,
compared to $190,000 during the same period of 1997. The Company increased its
provision on the two ARM securities for which it has been providing for credit
losses to $300,000 and, in accordance with its credit reserve policy for loans,
also recorded a provision of $59,000 on its ARM loan portfolio and $28,000 on
its portfolio of loans securitized by the Company on which the Company retained
the first credit loss exposure.
For the quarter ended March 31, 1998, the Company's ratio of operating expenses
to average assets was 0.16% as compared to 0.25% for the same quarter of 1997
and as compared to 0.17% for the previous quarter ended December 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 Company pays the Manager an annual
base management fee, generally based on average shareholders' equity, not
assets, as defined in the Management 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. Since this management
fee is based on shareholders' equity and not assets, this fee increases as the
Company successfully accesses capital markets and raises additional equity
capital and is, therefore, managing a larger amount of invested capital on
behalf of its shareholders. In order for the Manager to earn a performance fee,
the rate of return on the shareholders' investment, as defined in the Management
Agreement, must exceed the average ten-year U.S. Treasury rate during the
quarter plus 1%. During the first quarter of 1998, the Manager earned a
performance fee of $759,000. During the first quarter of 1998, after paying this
performance fee, the Company's return on common equity was 10.91%. As presented
in the following table, the performance fee is a variable expense that
fluctuates with the Company's return on shareholders' equity relative to the
average 10-year U.S. Treasury rate. As the Company's return on shareholders'
equity declined during the first quarter of 1998, compared to the first quarter
of 1997, the performance fee also declined, to an annualized 0.06% of average
assets compared to 0.11% during the same period in 1997.
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
ANNUALIZED OPERATING EXPENSE RATIOS
<TABLE>
<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, 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%
Dec 31, 1997 0.12% 0.05% 0.17%
Mar 31, 1998 0.10% 0.06% 0.16%
</TABLE>
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarters ended March 31, 1998 and
1997 consisted of reverse repurchase agreements, which totaled $4.470 billion
and $2.936 billion at the respective quarter ends. The Company's other
significant source of funds for the quarters ended March 31, 1998 and 1997
consisted of payments of principal and interest from its ARM assets portfolio in
the amounts of $442.0 million and $194.2 million, respectively. In the future,
the Company expects its primary sources of funds will consist of borrowed funds
under reverse repurchase agreement transactions with one- to twelve-month
maturities, of monthly payments of principal and interest on its ARM assets
portfolio and possibly asset sales as needed. The Company's liquid assets
generally consist of unpledged ARM assets, cash and cash equivalents.
The borrowings incurred at March 31, 1998 had a weighted average interest cost
of 5.75%, which includes the cost of interest rate swaps, a weighted average
original term to maturity of 5.5 months and a weighted average remaining term to
maturity of 2.6 months. As of March 31, 1998, $1.868 billion of the Company's
reverse repurchase agreements 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. In
addition, as of March 31, 1998, $174.4 million of the Company's reverse
repurchase agreements were collateralized by whole loans under one year
financing agreements that are indexed to the one-month LIBOR rate and reprice
either daily or once a month.
The Company has borrowing arrangements with 24 different financial institutions
and on March 31, 1998, had borrowed funds under reverse repurchase agreements
with 18 of these firms. Because the Company borrows money based on the fair
value of its ARM assets and because increases in short-term interest rates can
negatively impact the valuation of ARM assets, the Company's borrowing ability
could be limited and lenders may initiate margin calls in the event short-term
interest rates increase or the value of the Company's ARM assets declines for
other reasons. Additionally, certain of the Company's ARM assets are rated less
than AA by the Rating Agencies and have less liquidity than assets that are
rated AA or higher. Other mortgage assets which are rated AA or higher by the
Rating Agencies derive their credit rating based on a mortgage pool insurer's
rating. As a result of either changes in interest rates, credit performance of a
mortgage pool or a downgrade of a mortgage pool issuer, the Company may find it
difficult to borrow against such assets and, therefore, may be required to sell
certain mortgage assets in order to maintain liquidity. If required, these sales
could be at prices lower than the carrying value of the assets, which would
result in losses. For the quarter ended March 31, 1998, the Company had adequate
cash flow, liquid assets and unpledged collateral with which to meet its margin
requirements during such periods. Further, the Company believes it will continue
to have sufficient liquidity to meet its future cash requirements from its
primary sources of funds for the foreseeable future without needing to sell
assets.
In December 1996, the Company's Registration Statement on Form S-3, registering
the sale of up to $200 million of additional equity securities, was declared
effective by the Securities and Exchange Commission. This registration statement
includes the possible issuances of common stock, preferred stock, warrants or
shareholder rights. As of March 31, 1998, 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 "DRP")
designed to provide a convenient and economical way for existing common and
preferred shareholders to automatically reinvest their dividends in additional
shares of common stock and for new and existing shareholders to purchase shares
at a discount to the current market price of the common stock, as defined in the
DRP. As a result of participation during the first three months of 1998 in the
DRP, the Company issued 1,027,000 new shares of common stock and received $16.3
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 repricing 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 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, resulting in an
increased yield on its mortgage assets. Therefore, in rising interest rate
environments where prepayments are declining, not only would the interest rate
on the ARM assets portfolio increase to re-establish a spread over the higher
interest rates, but the yield also would rise due to slower prepayments. The
combined effect could significantly mitigate other 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 assets 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 8% to
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 is because the financed portion of
the Company's portfolio of ARM assets will, over time, reprice 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.
OTHER MATTERS
As of March 31, 1998, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.9% 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 99.8% of its 1998 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. The Company also met all REIT requirements
regarding the ownership of its common stock and the distributions of its net
income. Therefore, as of March 31, 1998, the Company believes that it will
continue to qualify as a REIT under the provisions of the Code.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. 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. The Company
calculates that it is in compliance with this requirement.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At March 31, 1998, there were no pending legal proceedings to which
the Company was a party or of which any of its property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
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: April 22, 1998 By: /s/ Larry A. Goldstone
-----------------------
Larry A. Goldstone
President and Chief Operating Officer
(authorized officer of registrant)
Dated: April 22, 1998 By: /s/ Richard P. Story
--------------------
Richard P. Story,
Chief Financial Officer and Treasurer
(principal accounting officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the March
31, 1998 Form 10-Q and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> MAR-31-1998 SEP-30-1997
<CASH> 2,506 20,427
<SECURITIES> 4,600,179 4,464,536
<RECEIVABLES> 267,054 37,274
<ALLOWANCES> 1,603 1,534
<INVENTORY> 0 0
<CURRENT-ASSETS> 2,671 478
<PP&E> 0 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 4,870,807 4,521,181
<CURRENT-LIABILITIES> 4,508,307 4,157,826
<BONDS> 0 0
0 0
65,805 65,805
<COMMON> 214 196
<OTHER-SE> 296,481 297,354
<TOTAL-LIABILITY-AND-EQUITY> 4,870,807 4,521,181
<SALES> 0 0
<TOTAL-REVENUES> 77,843 175,070
<CGS> 0 0
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 2,071 5,919
<LOSS-PROVISION> 387 623
<INTEREST-EXPENSE> 64,889 137,977
<INCOME-PRETAX> 10,496 30,551
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 10,496 30,551
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 10,496 30,551
<EPS-PRIMARY> .42 1.49
<EPS-DILUTED> .42 1.48
</TABLE>
