- -------------------------------------------------------------------------------
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, 1999
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) 21,489,663 as of April 28, 1999
- -------------------------------------------------------------------------------
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
FORM 10-Q
<TABLE>
<CAPTION>
INDEX
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1999 and December 31, 1998 3
Consolidated Statements of Operations for the three months ended
March 31, 1999 and March 31, 1998 4
Consolidated Statement of Shareholders' Equity for the three months
ended March 31, 1999 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and March 31, 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 2. Changes in Securities 31
Item 3. Defaults Upon Senior Securities 31
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURES 32
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
March 31, 1999 December 31, 1998
---------------- -------------------
<S> <C> <C>
ASSETS
Adjustable-rate mortgage ("ARM") assets: (Notes 2 and 3)
ARM securities $ 2,872,394 $ 3,094,657
Collateral for collateralized notes 1,072,773 1,147,350
ARM loans held for securitization 21,236 26,410
---------------- -------------------
3,966,403 4,268,417
---------------- -------------------
Cash and cash equivalents 47,342 36,431
Accrued interest receivable 29,868 37,939
Prepaid expenses and other 5,366 1,846
---------------- -------------------
$ 4,048,979 $ 4,344,633
================ ===================
LIABILITIES
Reverse repurchase agreements (Note 3) $ 2,643,849 $ 2,867,207
Collateralized notes (Note 3) 1,052,429 1,127,181
Other borrowings (Note 3) 1,946 2,029
Accrued interest payable 11,368 31,514
Dividends payable (Note 5) 1,670 1,670
Accrued expenses and other 2,740 3,209
---------------- -------------------
3,714,002 4,032,810
================ ===================
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, 21,990 and 21,990 shares
issued and 21,490 and 21,490 outstanding, respectively 220 220
Additional paid-in-capital 341,822 341,756
Accumulated other comprehensive income (loss) (57,046) (82,148)
Notes receivable from stock sales (4,632) (4,632)
Retained earnings (deficit) (6,526) (4,512)
Treasury stock: at cost, 500 and 500 shares, respectively (4,666) (4,666)
---------------- -------------------
334,977 311,823
---------------- -------------------
$ 4,048,979 $ 4,344,633
================ ===================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended
March 31,
1999 1998
--------- ---------
<S> <C> <C>
Interest income from ARM assets and cash $ 59,645 $ 76,315
Interest expense on borrowed funds (53,079) (64,889)
--------- ---------
Net interest income 6,566 11,426
--------- ---------
Gain (loss) on sale of ARM assets - 1,528
Provision for credit losses (686) (387)
Management fee (Note 7) (1,018) (1,028)
Performance fee (Note 7) - (759)
Other operating expenses (263) (284)
--------- ---------
NET INCOME $ 4,599 $ 10,496
========= =========
Net income $ 4,599 $ 10,496
Dividend on preferred stock (1,670) (1,670)
--------- ---------
Net income available to common shareholders $ 2,929 $ 8,826
========= =========
Basic earnings per share $ 0.14 $ 0.42
========= =========
Diluted earnings per share $ 0.14 $ 0.42
========= =========
Average number of common shares outstanding 21,490 20,797
========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Three Months Ended March 31, 1999
(In thousands, except share data)
Accum. Notes
Other Receiv-
Additional Compre- able From Retained Compre-
Preferred Common Paid-in hensive Stock Earnings/ Treasury hensive
Stock Stock Capital Income Sales (Deficit) Stock Income Total
----------- -------- ---------- ---------- --------- ---------- -------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 $ 65,805 $ 220 $ 341,756 $ (82,148) $ (4,632) $ (4,512) $(4,666) $ 311,823
Comprehensive income:
Net income 4,599 $ 4,599 4,599
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net
of amortization - - - 25,340 - - - 25,340 25,340
Deferred gain on sale of
hedges, net of amortization - - - (238) - - - (238) (238)
--------
Other comprehensive income $29,701
========
Interest from notes receivable
fromstock sales 66 66
Dividends declared on preferred
stock - $0.605 per share - - - - - (1,670) - (1,670)
Dividends declared on common
stock - $0.23 per share - - - - - (4,943) - (4,943)
----------- -------- ---------- ---------- --------- ---------- -------- -----------
Balance, March 31, 1999 $ 65,805 $ 220 $ 341,822 $ (57,046) $ (4,632) $ (6,526) $(4,666) $ 334,977
=========== ======== ========== ========== ========= ========== ======== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended
March 31,
1999 1998
---------- ----------
<S> <C> <C>
Operating Activities:
Net Income $ 4,599 $ 10,496
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 10,796 10,107
Net (gain) loss from investing activities 686 (1,141)
Change in assets and liabilities:
Accrued interest receivable 8,071 (898)
Prepaid expenses and other (3,520) (2,382)
Accrued interest payable (20,146) (21,622)
Accrued expenses and other (469) (3)
---------- ----------
Net cash provided by (used in) operating activities 17 (5,443)
---------- ----------
Investing Activities:
Available-for-sale ARM securities:
Purchases (99,707) (693,744)
Proceeds on sales - 191,825
Proceeds from calls - 54,879
Principal payments 338,460 330,536
Held-to-maturity ARM securities:
Principal payments - 16,152
Collateral for collateralized notes:
Principal payments 73,258 -
ARM loans:
Purchases - (120,025)
Principal payments 5,092 11,234
Purchase of interest rate cap agreements (1,469) (294)
---------- ----------
Net cash provided by (used in) investing activities 315,634 (209,437)
---------- ----------
Financing Activities:
Net borrowings from (repayments of) reverse
repurchase agreements (223,358) 199,929
Repayments of collateralized notes (74,752) -
Repayments of other borrowings (83) (857)
Proceeds from common stock issued - 16,290
Dividends paid (6,613) (11,756)
Interest from notes receivable from stock sales 66 -
---------- ----------
Net cash provided by (used in) financing activities (304,740) 203,606
---------- ----------
Net increase (decrease) in cash and cash equivalents 10,911 (11,274)
Cash and cash equivalents at beginning of period 36,431 13,780
---------- ----------
Cash and cash equivalents at end of period $ 47,342 $ 2,506
========== ==========
Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.
</TABLE>
See Notes to Consolidated Financial Statements
<PAGE>
NOTES TO CONSOLIDATED 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.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly owned special purpose finance subsidiaries, Thornburg Mortgage
Funding Corporation and Thornburg Mortgage Acceptance Corporation. The Company
formed these entities in connection with the issuance of the callable
collateralized notes discussed in Note 3. All material intercompany accounts
and transactions are eliminated in consolidation.
ADJUSTABLE-RATE MORTGAGE ASSETS
The Company's adjustable-rate mortgage ("ARM") assets are comprised of ARM
securities, ARM loans and collateral for AAA notes payable, which also consists
of ARM securities and ARM loans. Included in the Company's ARM assets are
hybrid ARM securities and loans ("Hybrid ARMs") that have a fixed interest rate
for an initial period, generally three to five years, and then convert to an
adjustable-rate for their remaining term to maturity.
Management has made the determination that all 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. Since all ARM securities are designated as
available-for-sale, they are reported at fair value, with unrealized gains and
losses excluded from earnings and reported in accumulated other comprehensive
income 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.
The collateral for the AAA notes includes ARM securities and ARM loans which are
accounted for in the same manner as the ARM securities and ARM loans that are
not held as collateral.
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
<PAGE>
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 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 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
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.
Credit losses on pools of loans that are held as collateral for AAA notes
payable are also covered by third party insurance policies that protect the
Company from credit losses above a specified level, limiting the Company's
exposure to credit losses on such loans. The Company makes a monthly provision
for possible credit losses on these loans the same as it does for loans that are
not held as collateral for AAA notes payable, except, it takes into
consideration its maximum exposure.
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
manage interest rate risk. To date, most of the Cap Agreements purchased 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. In similar fashion, the
Company has purchased Cap Agreements to limit the financing rate of the Hybrid
ARMs during their fixed rate term, generally for three to five years. In
general, the cost of financing Hybrid ARMs hedged with Cap Agreements is capped
at a rate that is 0.75% to 1.00% below the fixed Hybrid ARM interest rate.
All Cap Agreements are classified as a hedge against available-for-sale assets
or ARM loans and are carried at their fair value with unrealized gains and
losses reported as a separate component of equity. The carrying value of the
Cap Agreements is included in ARM securities 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.
<PAGE>
Realized gains and losses resulting from the termination of the Cap Agreements
that were hedging assets classified as held-to-maturity were deferred as an
adjustment to the carrying value of the related assets and are being amortized
into interest income over the terms of the related assets. Realized gains and
losses resulting from the termination of such agreements that were hedging
assets classified as available-for-sale were 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. In general, swap
agreements have been utilized by the Company in two ways. One way has been to
use swap agreements as a cost effective way to lengthen the average repricing
period of its variable rate and short term borrowings. Additionally, as the
Company acquires Hybrid ARMs, it also enters into swap agreements in order to
manage the interest rate repricing mismatch (the difference between the
remaining fixed-rate period of a hybrid and the maturity of the borrowing
funding a Hybrid ARM) to approximately one year or less. 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 three month periods ended March 31, 1999 and 1998 (amounts in thousands
except per share data):
<TABLE>
<CAPTION>
Earnings
Income Shares Per Share
---------- ------ ----------
<S> <C> <C> <C>
Three Months Ended March 31, 1999
- ---------------------------------
Net income $ 4,599
Less preferred stock dividends (1,670)
----------
Basic EPS, income available to
common shareholders 2,929 21,490 $ 0.14
==========
Effect of dilutive securities:
Stock options - -
---------- ------
Diluted EPS $ 2,929 21,490 $ 0.14
========== ====== ==========
Three Months Ended March 31, 1998
- ---------------------------------
Net income $ 10,496
Less preferred stock dividends (1,670)
----------
Basic EPS, income available to
common stockholders 8,826 20,797 $ 0.42
==========
Effect of dilutive securities:
Stock options - 18
---------- ------
Diluted EPS $ 8,826 20,815 $ 0.42
========== ====== ==========
</TABLE>
<PAGE>
The Company did not grant any options to purchase shares of the Company's common
stock to directors or officers or to employees of the Manager during the quarter
ended March 31, 1999. The Company did grant options to directors and officers
of the Company and employees of the Manager to purchase 32,763 shares of common
stock at an average price of $16.52 per share during the quarter ended March 31,
1998. 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, 1999 and
December 31, 1998. The ARM securities classified as available-for-sale are
carried at their fair value, while the ARM loans are carried at their amortized
cost basis (dollar amounts in thousands):
<TABLE>
<CAPTION>
March 31, 1999:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- ---------------- ----------- -----------
<S> <C> <C> <C> <C>
Principal balance outstanding $ 2,837,503 $ 1,057,507 $ 21,068 $3,916,078
Net unamortized premium 78,723 16,367 251 95,341
Deferred gain from hedging (526) - - (526)
Allowance for losses (1,373) (1,101) (83) (2,557)
Cap agreements 8,447 410 - 8,857
Principal payment receivable 7,290 242 - 7,532
---------------- ---------------- ----------- -----------
Amortized cost, net 2,930,064 1,073,425 21,236 4,024,725
---------------- ---------------- ----------- -----------
Gross unrealized gains 2,448 1,182 29 3,659
Gross unrealized losses (60,770) (7,083) (63) (67,916)
---------------- ---------------- ----------- -----------
Fair value $ 2,871,742 $ 1,067,524 $ 21,202 $3,960,468
================ ================ =========== ===========
Carrying value $ 2,871,742 $ 1,073,425 $ 21,236 $3,966,403
================ ================ =========== ===========
December 31, 1998:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- ---------------- ----------- -----------
Principal balance outstanding $ 3,070,107 $ 1,131,007 $ 26,161 $4,227,275
Net unamortized premium 86,956 17,112 324 104,392
Deferred gain from hedging (613) - - (613)
Allowance for losses (1,242) (729) (75) (2,046)
Cap agreements 8,302 440 - 8,742
Principal payment receivable 14,330 - - 14,330
---------------- ---------------- ----------- -----------
Amortized cost, net 3,177,840 1,147,830 26,410 4,352,080
---------------- ---------------- ----------- -----------
Gross unrealized gains 1,070 38 53 1,161
Gross unrealized losses (84,253) (7,606) (87) (91,946)
---------------- ---------------- ----------- -----------
Fair value $ 3,094,657 $ 1,140,262 $ 26,376 $4,261,295
================ ================ =========== ===========
Carrying value $ 3,094,657 $ 1,147,350 $ 26,410 $4,268,417
================ ================ =========== ===========
</TABLE>
During the quarter ended March 31, 1999, the Company did not sell any ARM
securities. During the same period of 1998, the Company realized $1,786,000 in
gains and $258,000 in losses on the sale of $190.3 million of ARM securities.
All of the ARM securities sold were classified as available-for-sale.
<PAGE>
As of March 31, 1999, 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 $1,373,000. At March 31, 1999, the Company is
providing for potential future credit losses on two assets that have an
aggregate carrying value of $11.3 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 1999, the Company, in accordance with its credit policies, recorded a
$380,000 provision for potential credit losses on its loan portfolio, although
no actual losses have been realized in the loan portfolio to date.
The following tables summarize ARM loan delinquency information as of March 31,
1999 and December 31, 1998 (dollar amounts in thousands):
<TABLE>
<CAPTION>
March 31, 1999
- ------------------
Loan Loan Percent of Percent of
Delinquency Status Count Balance ARM Loans Total Assets
- ------------------ ----- ----------- ----------- -------------
<S> <C> <C> <C> <C>
30 to 59 days 3 $ 1,045 0.10% 0.03%
60 to 89 days 1 131 0.01 0.00
90 days or more 2 3,550 0.36 0.09
In foreclosure 4 817 0.08 0.02
Real estate owned 1 55 0.01 0.00
----- ----------- ----------- -------------
11 $ 5,598 0.56% 0.14%
===== =========== =========== =============
December 31, 1998
- ------------------
Loan Loan Percent of Percent of
Delinquency Status Count Balance ARM Loans Total Assets
- ------------------ ----- ----------- ----------- -------------
30 to 59 days 4 $ 1,138 0.11% 0.03%
60 to 89 days 2 423 0.04 0.01
90 days or more 1 3,450 0.32 0.08
In foreclosure 5 1,097 0.10 0.02
----- ----------- ----------- -------------
12 $ 6,108 0.57% 0.14%
===== =========== =========== =============
</TABLE>
The following table summarizes the activity for the allowance for
losses on ARM loans for the quarters ended
March 31, 1999 and 1998 (dollar amounts in thousands):
<TABLE>
<CAPTION>
1999 1998
------ -----
<S> <C> <C>
Beginning balance $ 804 $ 42
Provision for losses 380 59
Charge-offs, net - -
------ -----
Ending balance $1,184 $ 101
====== =====
</TABLE>
As of March 31, 1999, the Company had commitments to purchase $470.0 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 5.72% as
of March 31, 1999 and 5.86% as of December 31, 1998.
As of March 31, 1999 and December 31, 1998, the Company had purchased Cap
Agreements with a remaining notional amount of $3.795 billion and $4.026
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 7.10% to 13.00% and average approximately 9.89%. Of the Cap Agreements
owned by the Company as of March 31,1999, $95 million are hedging the cost of
financing Hybrid ARMs and $3.700 billion are hedging the lifetime interest rate
cap of ARM assets. The Company's ARM assets portfolio had an average lifetime
interest rate cap of 11.79%. The Cap Agreements had an average maturity of 2.4
years as of March 31, 1999. The initial aggregate notional amount of the Cap
<PAGE>
Agreements declines to approximately $3.336 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, COLLATERALIZED NOTES PAYABLE AND OTHER
BORROWINGS
The Company has entered into reverse repurchase agreements to finance most of
its ARM assets. The reverse repurchase agreements are short-term borrowings
that 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, 1999, the Company had outstanding $2.644 billion of reverse
repurchase agreements with a weighted average borrowing rate of 5.10% and a
weighted average remaining maturity of 1.6 months. As of March 31, 1999, $993.4
million 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- or three-month LIBOR rate and reprice accordingly. The reverse
repurchase agreements at March 31, 1999 were collateralized by ARM assets with a
carrying value of $2.801 billion, including accrued interest.
At March 31, 1999, the reverse repurchase agreements had the following remaining
maturities (dollar amounts in thousands):
<TABLE>
<CAPTION>
<S> <C>
Within 30 days $1,367,232
31 to 89 days 839,198
90 days or greater 437,419
----------
$2,643,849
==========
</TABLE>
As of March 31, 1999, the Company had one whole loan financing facility with a
committed borrowing capacity of $150 million, with an option to increase this
amount to $300 million. The Company had no balance borrowed against this
facility as of March 31, 1999. This facility matures on January 8, 2000.
During April 1999, the Company entered into an additional one-year whole loan
financing facility with an uncommitted capacity of $300 million.
On December 18, 1998, the Company, through a special purpose finance subsidiary,
issued $1.144 billion of callable AAA notes ("Notes") collateralized by ARM
loans and ARM securities. As part of this transaction, the Company retained
ownership of a subordinated certificate in the amount of $32.4 million, which
represents the Company's maximum exposure to credit losses on the loans
collateralizing the Notes. These Notes were issued with call features which
provided the Company with the ability to re-issue the debt at better financing
terms when and if the market for mortgage-backed debt improved. Effective March
25, 1999, the Company negotiated a modification of these Notes that reduced the
interest rate on the Notes from one-month LIBOR plus 0.70% to one-month LIBOR
plus 0.38%. The modification also eliminated the scheduled step-up in the
interest rate that was to take effect after November 1999. As of March 31,
1999, the Notes had a net balance of $1.052 billion, an effective interest cost
of 5.52% and were collateralized by ARM loans with a principal balance of $963.6
million and ARM securities with a balance of $126.5 million. The Notes mature
on January 25, 2029 and are callable by the Company at par once the balance of
the Notes is reduced to 25% of their original balance. In connection with the
issuance and modification of the Notes, the Company incurred costs of
approximately $6.0 million which is being amortized over the expected life of
the Notes. Since the Notes are paid down as the collateral pays down, the
amortization of the issuance cost will be adjusted periodically based on actual
payment experience. If the collateral pays down faster than currently
estimated, then the amortization of the issuance cost will increase and the
effective cost of the Notes will increase and, conversely, if the collateral
pays down slower than currently estimated, then the amortization of issuance
cost will be decreased and the effective cost of the Notes will also decrease.
<PAGE>
As of March 31, 1999, the Company was a counterparty to fourteen interest rate
swap agreements ("Swaps") having an aggregate notional balance of $499.8
million. As of March 31, 1999, these Swaps had a weighted average remaining
term of 2.9 years. In accordance with these Swaps, the Company will pay a fixed
rate of interest during the term of these Swaps and receive a payment that
varies monthly with the one-month LIBOR rate. As a result of entering into
these Swaps, the Company has reduced the interest rate variability of its cost
to finance its ARM assets by increasing the average period until the next
repricing of its borrowings from 26 days to 189 days. All of these Swaps were
entered into in connection with the Company's acquisition of Hybrid ARMs and
commitments to acquire Hybrid ARMs. The Swaps hedge the cost of financing
Hybrid ARMs during their fixed rate term, generally three to five years. The
Swaps at March 31, 1999 were collateralized by ARM assets with a carrying value
of $0.9 million, including accrued interest.
As of March 31, 1999, the Company had financed a portion of its portfolio of
interest rate cap agreements with $1.9 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 7.87% and have a weighted average
remaining maturity of 13.9 months. The other borrowings financing cap agreements
at March 31, 1999 were collateralized by ARM securities with a carrying value of
$2.9 million, including accrued interest. The aggregate maturities of these
other borrowings are as follows (dollars in thousands):
<TABLE>
<CAPTION>
<S> <C>
1999 $ 1,314
2000 632
-------
$ 1,946
=======
</TABLE>
The total cash paid for interest was $68.8 million during the quarter ended
March 31, 1999.
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, 1999 and December 31, 1998.
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, 1999 December 31, 1998
---------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ---------- ----------- ----------
Assets:
<S> <C> <C> <C> <C>
ARM assets $3,963,199 $3,957,264 $4,266,497 $4,259,374
Cap Agreements 3,204 3,204 1,920 1,920
Liabilities:
Callable collateralized notes 1,052,429 1,057,749 1,127,181 1,127,181
Other borrowings 1,946 1,979 2,029 2,077
Swap agreements 76 2,205 (87) 7,326
</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 for the foreseeable future 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 or third-party pricing services. The fair values for ARM loans are
determined by the Company by using the same pricing models employed by the
Company in the process of determining a price to bid for loans in the open
market, taking into consideration the aggregated characteristics of groups of
loans such as, but not limited to, collateral type, index, margin, life cap,
periodic cap, underwriting standards, age and delinquency experience. The fair
value of the Company's long-term debt and interest rate swap agreements, which
<PAGE>
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, callable collateralized notes 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
On July 13, 1998, the Board of Directors approved a common stock repurchase
program of up to 500,000 shares at prices below book value, subject to
availability of shares and other market conditions. On September 18, 1998, the
Board of Directors expanded this program by approving the repurchase of up to an
additional 500,000 shares. The Company did not repurchase any shares of its
common stock under this program during the quarter ended March 31,1999. To
date, the company has repurchased 500,016 at an average price of $9.28 per
share.
On January 21, 1999, the Company declared a dividend of $0.23 per common share
which was paid on February 18, 1999 to common shareholders of record as of
January 29, 1999.
On April 15, 1999, the Company declared a first quarter 1999 dividend of $0.23
per common share which will be paid on May 18, 1999 to common shareholders of
record as of April 30, 1999.
On March 17, 1999, 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 12, 1999 to preferred shareholders of record
as of March 31, 1999.
For federal income tax purposes, all dividends are expected to be ordinary
income to the Company's common and preferred shareholders, subject to year-end
allocations of the common dividend between ordinary income, capital gain income
and non-taxable income as return of capital, depending on the amount and
character of the Company's full year taxable 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 1999 the number of DERs issued is based on 45% of
the ISOs and NQSOs granted during 1999. 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, 1999, there were not any options to buy
common shares or DERs granted. As of March 31, 1999, the Company had 612,402
options outstanding at exercise prices of $9.375 to $22.625 per share, 496,482
of which were exercisable. The weighted average exercise price of the options
outstanding was $17.55 per share. As of the March 31, 1999, there were 86,012
DERs granted, of which 57,032 were vested, and 7,071 PSRs granted. In addition,
the Company recorded an expense associated with the DERs and the PSRs of $18,000
for the quarter ended March 31, 1999.
<PAGE>
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. As of March 31, 1999, there were
$4.6 million of notes receivable from stock sales outstanding.
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, 1999 and 1998, the Company paid the Manager
$1,018,000 and $1,028,000, 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 quarter ended March 31, 1999, the Company did not pay the Manager any
performance based compensation because the Company's net income, as measured by
Return on Equity, did not exceed the ten year U.S. Treasury Rate plus 1%. For
the quarter ended March 31, 1998, the Company paid the Manager $759,000 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" section of the Company's 1998 Annual Report on
Form 10-K on page 13 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 and subsidiaries (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. In 1998, the
Company began investing in hybrid ARM assets ("Hybrid ARMs") which are included
in the Company's references to ARM securities and ARM loans. Hybrid ARMs have a
fixed rate of interest for an initial period, generally 3 to 5 years, and then
convert to an adjustable-rate for the balance of the term of the Hybrid ARM. It
is the Company's policy to fund the Hybrid ARMs with long-term debt obligations
such that the debt obligations mature within one year or less of the first
interest rate reset date of the Hybrid ARMs. 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.
During 1998, in connection with the Company's issuance of $1.1 billion of
callable AAA notes, the Company formed two REIT qualified subsidiaries. These
subsidiaries are consolidated in the Company's financial statements and federal
and state tax returns.
The Company's mortgage assets portfolio may consist of either agency or
privately issued securities (generally publicly registered) mortgage
pass-through securities, multiclass pass-through securities, collateralized
mortgage obligations ("CMOs"), collateralized bond obligations ("CBOs"),
generally backed by high quality mortgage backed securities, ARM loans, Hybrid
ARMs or short-term investments that either mature within one year or have an
interest rate that reprices within one year. The Company will not invest more
than 30% 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
no more than 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 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; or
(4) the portion of ARM or hybrid loans that have been deposited into a trust
and have received a credit rating of AA or better from at least one
Rating Agency.
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:
<PAGE>
(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 (see description
of "A" quality in "Portfolio of Mortgage Assets - ARM and Hybrid
ARM Loans"); or
(3) a limited amount, currently $70 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%, currently
approximately 5%, of its total assets in Other Investment assets, excluding
loans held for securitization. Despite the generally higher yield, the Company
does not expect to significantly increase its investment in Other Investment
securities. This is primarily due to the difficulty of financing such assets at
reasonable financing terms and values through all economic cycles. The Company
has never had a large investment in Other Investment securities and believes it
has always been very selective and cautious regarding these investments.
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, 1999, the Company held total assets of $4.049 billion, $3.966
billion of which consisted of ARM assets, as compared to $4.345 billion and
$4.268 billion, respectively, at December 31, 1998. 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, 1999, 95.3% of the assets held by the Company,
including cash and cash equivalents, 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, 89.1% are in the form of
adjustable-rate pass-through certificates or ARM loans. The remainder are
floating rate classes of CMOs (6.3%) or investments in floating rate classes of
CBOs (4.6%) backed primarily by mortgaged-backed securities.
<PAGE>
The following table presents a schedule of ARM assets owned at March 31, 1999
and December 31, 1998 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.
<TABLE>
<CAPTION>
ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)
March 31, 1999 December 31, 1998
--------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
--------------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $ 1,872,394 47.2% $2,072,871 48.6%
Privately Issued:
AAA/Aaa Rating 1,316,780(1) 33.2 1,398,659(1) 32.8
AA/Aa Rating 570,034 14.4 597,493 14.0
--------------- ---------- ------------- ----------
Total Privately Issued 1,886,814 47.6 1,996,152 46.8
--------------- ---------- ------------- ----------
--------------- ---------- ------------- ----------
Total High Quality 3,759,208 94.8 4,069,023 95.4
--------------- ---------- ------------- ----------
OTHER INVESTMENT:
Privately Issued:
A Rating 54,833 1.4 40,591 1.0
BBB/Baa Rating 87,035 2.2 88,273 2.1
BB/Ba Rating and Other 44,091(1) 1.1 44,120(1) 0.9
Whole loans 21,236 0.5 26,410 0.6
--------------- ---------- ------------- ----------
Total Other Investment 207,195 5.2 199,394 4.6
--------------- ---------- ------------- ----------
Total ARM Portfolio $ 3,966,403 100.0% $4,268,417 100.0%
=============== ========== ============= ==========
<FN>
(1) AAA Rating category includes $946.5 million and $1.020 billion as of
March 31, 1999 and December 31, 1998, respectively, of whole loans that
Have been credit enhanced by an insurance policy purchased from a
third-party and credit support from an unrated subordinated certificate
for $32.4 million included in BB/Ba Rating and Other category and that
are held as collateral for callable AAA notes.
</TABLE>
As of March 31, 1999, the Company had reduced the cost basis of its ARM
securities by $1,373,000 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
$11.3 million, which represent less than 0.3% of the Company's total portfolio
of ARM assets. Although both of these assets continue to perform, there is only
minimal remaining credit support to mitigate the Company's exposure to potential
future credit losses.
Additionally, during the three months ended March 31, 1999, the Company recorded
a $380,000 provision for potential credit losses on its loan portfolio, although
no actual losses have been realized in the loan portfolio to date. As of March
31, 1999, the Company's ARM loan portfolio included seven loans that are
considered seriously delinquent (60 days or more delinquent) with an aggregate
balance of $4.5 million. The ARM loan portfolio also includes one property
("REO") that the Company acquired as the result of the foreclosure process in
connection with one loan in the amount of $55,000. The average original
effective loan-to-value ratio on these eight delinquent loans and REO is
approximately 60%. The Company estimates that the realizable value of each of
the single family homes backing these loans and the REO to be more than the
Company's investment in these individual loans and REO and, therefore, the
Company does not expect to realize a loss on any of these delinquent loans or
REO. 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.
<TABLE>
<CAPTION>
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
March 31, 1999 December 31, 1998
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ARM ASSETS:
INDEX:
One-month LIBOR $ 563,759 14.2% $ 556,574 13.0%
Three-month LIBOR 181,390 4.6 181,143 4.2
Six-month LIBOR 832,135 21.1 939,824 22.0
Six-month Certificate of Deposit 279,369 7.0 313,268 7.3
Six-month Constant Maturity Treasury 44,771 1.1 49,023 1.2
One-year Constant Maturity Treasury 1,380,349 34.8 1,479,054 34.7
Cost of Funds 247,285 6.2 268,486 6.3
---------- ---------- ---------- ----------
3,529,058 89.0 3,787,372 88.7
---------- ---------- ---------- ----------
HYBRID ARM ASSETS 437,345 11.0 481,045 11.3
---------- ---------- ---------- ----------
$3,966,403 100.0% $4,268,417 100.0%
========== ========== ========== ==========
</TABLE>
The portfolio had a current weighted average coupon of 7.03% at March 31, 1999.
This consisted of an average coupon of 6.94% on the hybrid portion of the
portfolio and an average coupon of 7.04% on the rest of the portfolio. If the
non-hybrid portion of the portfolio had been "fully indexed" on March 31, 1999,
the weighted average coupon of the non-hybrid portion of the portfolio would
have been approximately 6.84%, based upon the current composition of the
portfolio and the applicable indices. As of December 31, 1998, the ARM
portfolio had a weighted average coupon of 7.28%, consisting of an average
coupon of 6.96% on the ARM Hybrids and 7.32% on the remainder of the ARM
portfolio. The lower average coupon on the ARM portfolio as of March 31, 1999
compared to December 31, 1998 is primarily the result of the ARM portfolio
adjusting to the current lower interest rate market as individual ARM loans and
securities reach their scheduled interest rate reset dates.
At March 31, 1999, the current yield of the ARM assets portfolio was 5.72%,
compared to 5.86% as of December 31, 1998, with an average term to the next
repricing date of 243 days as of March 31, 1999, compared to 253 days as of
December 31, 1998. The average term to the next repricing date includes the
effect of Hybrid ARMs which have an average remaining fixed-rate term of 4.1
years as of March 31, 1999. The non-hybrid portion of the ARM portfolio has an
average next repricing term of 89 days as of March 31, 1999. 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 of 0.14% as of March 31, 1999, compared to December
31, 1998, is due to a number of factors including a 0.25% decrease in the
weighted average coupon and an increase in the cost of hedging by 0.02%. These
two factors were partially offset by less amortization of purchase premiums
which improved by 0.09% and the impact of non-interest earning principal payment
receivable improved by 0.04%.
<PAGE>
The following table presents various characteristics of the Company's ARM and
Hybrid ARM loan portfolio as of March 31, 1999. This information pertains to
both the loans held for securitization and the loans held as collateral for the
callable AAA notes payable.
<TABLE>
<CAPTION>
ARM AND HYBRID ARM LOAN PORTFOLIO CHARACTERISTICS
Average High Low
--------- ----------- -------
<S> <C> <C> <C>
Unpaid principal balance $258,707 $3,450,000 $1,000
Coupon rate on loans 7.52% 9.63% 5.13%
Pass-through rate 7.16% 9.23% 4.73%
Pass-through margin 2.19% 5.06% 0.48%
Lifetime cap 13.02% 16.75% 9.75%
Original Term (months) 327 476 117
Remaining Term (months) 311 347 89
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C>
Geographic Distribution (Top 5 States): Property type:
California 21.33% Single-family 64.71%
Florida 13.08 DeMinimus PUD 20.63
Georgia 7.13 Condominium 9.88
New York 6.98 Other 4.78
Colorado 4.58
Occupancy status: Loan purpose:
Owner occupied 83.81% Purchase 57.67%
Second home 11.58 Cash out refinance 23.66
Investor 4.61 Rate & term refinance 18.67
Documentation type: Periodic Cap:
Full/Alternative 95.32% None 48.58%
Other 4.68 3.00% 0.19
2.00% 49.57
Average effective original 0.50% 1.66
loan-to-value: 79%
</TABLE>
During the quarter ended March 31, 1999, the Company purchased $99.7 million of
ARM securities, 84.9% of which were High Quality assets. Of the ARM assets
acquired during the first three months of 1999, approximately 69% were indexed
to LIBOR and 31% were indexed to U.S. Treasury bill rates. Additionally, as of
March 31, 1999, the Company has commitments to purchase approximately $470.0
million of Hybrid ARM loans. The Company did not sell any assets during the
quarter ended March 31, 1999.
For the quarter ended March 31, 1999, the Company's mortgage assets paid down at
an approximate average annualized constant prepayment rate of 29% compared to
27% for the quarter ended March 31, 1998 and 29% for the quarter ended December
31, 1998. 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 securities improved by
0.63% from a negative adjustment of 2.62% of the portfolio as of December 31,
1998, to a negative adjustment of 1.99% as of March 31, 1999. This price
improvement was primarily the result of an improved market for mortgage product
in general as buying and selling activity picked up during the most recent three
month period as the outlook regarding prepayments and the financing of mortgage
assets improved. The amount of the negative adjustment to fair value on the ARM
securities decreased from $83.2 million as of December 31, 1998, to $58.3
million as of March 31, 1999.
<PAGE>
The Company has purchased Cap Agreements in order to hedge exposure to changing
interest rates. The majority of the Cap Agreements have been purchased to limit
the Company's exposure to risks associated with the lifetime interest rate caps
of its ARM assets should interest rates rise above specified levels. These Cap
Agreements act to reduce the effect of the lifetime or maximum interest rate cap
limitation. These 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, 1999, the Cap
Agreements owned by the Company that are designated as a hedge against the
lifetime interest rate cap on ARM assets had a remaining notional balance of
$3.700 billion with an average final maturity of 2.3 years, compared to a
remaining notional balance of $4.026 billion with an average final maturity of
2.3 years at December 31, 1998. 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
7.10% to 13.00% and average approximately 9.99%. The Company has also entered
into $95 million of Cap Agreements in connection with hedging the fixed rate
period of certain of its Hybrid ARM assets. In doing so, the Company
establishes a maximum cost of financing the Hybrid ARM assets during the term of
the designated Cap Agreements which generally corresponds to the initial fixed
rate term of Hybrid ARM assets. The Cap Agreements hedging Hybrid ARM assets as
of March 31, 1999 would receive cash payments if one-month LIBOR exceeded 6.00%
and have a remaining term of 4.1 years. The fair value of 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, 1999, the fair value of the
Company's Cap Agreements was $2.4 million, $5.7 million less than the amortized
cost of the Cap Agreements.
The following table presents information about the Company's Cap Agreement
portfolio that is designated as a hedge against the lifetime interest rate cap
on ARM assets as of March 31, 1999:
<TABLE>
<CAPTION>
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
(Dollar amounts in thousands)
Hedged Weighted Cap Agreement Weighted
ARM Assets Average Notional Average
Balance (1) Life Cap Balance (2) Strike Price Remaining Term
- ------------ --------- --------------- ------------- --------------
<S> <C> <C> <C> <C>
$ 25,899 8.00% $ 26,000 7.10% 4.0 Years
424,906 9.25 424,545 7.50 1.1
527,560 10.37 531,040 8.00 3.0
168,873 10.97 171,148 8.50 1.0
266,892 11.37 264,404 9.00 0.7
145,494 11.73 141,675 9.50 1.5
305,879 12.23 307,256 10.00 3.2
384,052 12.30 384,889 10.50 1.8
242,675 12.70 241,757 11.00 4.0
545,516 13.15 546,464 11.50 3.3
251,526 14.40 413,064 12.00 2.5
48,466 16.40 160,914 12.50 1.2
- - 86,513 13.00 0.9
- ------------ --------- --------------- ------------- --------------
$ 3,337,738 11.78% $ 3,699,669 9.99% 2.3 Years
============ ========= =============== ============= ==============
<FN>
(1) Excludes ARM assets that do not have life caps or are hybrids that are
match funded during a fixed rate period, in accordance with the Company's
investment policy.
(2) As of March 31, 1999, the Company was $361.9 million over hedged, primarily
because of the ARM asset sales that occurred during the fourth quarter of 1998.
The Company has retained these Cap Agreements to hedge its future acquisitions
which it expects to make during 1999. The retained Cap Agreements have no
carrying value.
</TABLE>
On December 18, 1998, the Company issued $1.1 billion of Notes to finance
certain ARM assets, primarily ARM loans. Under this financing structure, the
financing of the ARM assets that collateralize the Notes is not subject to
margin calls as is the case when financing such assets in the reverse repurchase
agreement market and, in general, such financing structures do not require as
much capital as other financing alternatives such as whole loan financing lines
of credit or reverse repurchase agreements. In December, when the Company was
issuing the Notes, the cost of such financing was unusually high. As a result,
<PAGE>
the Company negotiated a Note structure that provided the Company the right to
call the Notes, at par, on a monthly basis. Early in 1999, as expected, the
market for re-issuing the Notes improved and the Company began increasing its
liquidity by temporarily ceasing its asset acquisition strategies. During the
first quarter, it became apparent to management that the Company had an
opportunity to negotiate a modification of the Notes with the holders of the
Notes, thereby avoiding the need for increased liquidity to call the Notes.
Effective March 25, 1999, the Company negotiated a modification of these Notes
that reduced the interest rate on the Notes from one-month LIBOR plus 0.70% to
one-month LIBOR plus 0.38% and eliminated the Company's right to call the Notes
until the underlying ARM assets are paid down to 25% of their original amount
collateralizing the Notes. The modification also eliminated the scheduled
step-up in the interest rate that was to take effect after November 1999.
As of March 31, 1999, the Company was a counterparty to fourteen interest rate
swap agreements ("Swaps") having an aggregate notional balance of $499.8
million. As of March 31, 1999, these Swaps had a weighted average remaining
term of 2.9 years. In accordance with these Swaps, the Company will pay a fixed
rate of interest during the term of these Swaps and receive a payment that
varies monthly with the one-month LIBOR rate. All of these Swaps were entered
into in connection with the Company's acquisition of Hybrid ARMs and commitments
to acquire Hybrid ARMs. The Swaps hedge the cost of financing Hybrid ARMs
during their fixed rate term, generally three to five years. The average
remaining fixed rate term of the Company's Hybrid ARM assets as of March 31,
1999 was 4.1 years. The Company has also entered into one delayed Swap
Agreement that becomes effective for a one year term, beginning in April of
2002. This delayed Swap Agreement has a notional balance of $100 million and is
designated to hedge the interest rate exposure of Hybrid ARM assets upon the
termination of the other Swap Agreements. These other swap agreements terminate
on average in 2.9 years during the remaining fixed term of the Hybrid ARMs,
which is approximately one additional year beyond the average termination date
of the Swap Agreements that were in effect as of March 31, 1999.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999
For the quarter ended March 31, 1999, the Company's net income was $4,599,000,
or $0.14 per share (Basic and Diluted EPS), based on a weighted average of
21,490,000 shares outstanding. That compares to $10,496,000, or $0.42 per share
(Basic and Diluted EPS), based on a weighted average of 20,797,000 shares
outstanding for the quarter ended March 31, 1998. Net interest income for the
quarter totaled $6,566,000, compared to $11,426,000 for the same period in 1998.
Net interest income is comprised of the interest income earned on mortgage
investments less interest expense from borrowings. During the first three
months of 1999, the Company did not record any gain or loss from the sale of ARM
securities compared to a gain of $1,528,000 during the same period of 1998.
Additionally, during the first quarter of 1999, the Company reduced its earnings
and the carrying value of its ARM assets by reserving $686,000 for potential
credit losses, compared to $387,000 during the first quarter of 1998. During
the first quarter of 1999, the Company incurred operating expenses of
$1,281,000, consisting of a base management fee of $1,018,000 and other
operating expenses of $263,000. During the same period 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. Total operating expenses decreased as a percentage of average
assets to 0.12% for the three months ended March 31, 1999, compared to 0.16% for
the same period of 1998.
The Company's return on average common equity was 3.60% for the quarter ended
March 31, 1999 compared to 10.9% for the quarter ended March 31, 1998 and
compared to -1.95% for the prior quarter ended December 31, 1998. The Company's
return on equity began to improve in this past quarter compared to the prior
quarter primarily because the Company's net interest spread has begun to improve
and because the Company did not experience any losses from asset sales in the
first quarter of 1999 as it had in the prior quarter ended December 31, 1998.
<PAGE>
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:
<TABLE>
<CAPTION>
COMPONENTS OF RETURN ON AVERAGE COMMON EQUITY (1)
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, 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%
Jun 30, 1998 9.15% 0.53% 1.76% 1.58% - 1.96% 6.83% 5.60% 1.23%
Sep 30, 1998 6.82% 0.66% 0.89% 1.54% - 1.97% 3.54% 5.24% -1.70%
Dec 31, 1998 7.27% 0.76% -4.88% 1.57% - 2.01% -1.95% 4.66% -6.61%
Mar 31, 1999 8.07% 0.84% - 1.58% - 2.05% 3.60% 4.98% -1.38%
<FN>
(1) Average common equity excludes unrealized gain (loss) on available-for-sale ARM securities.
(2) Excludes performance fees.
</TABLE>
The decline in the Company's return on common equity in the first quarter of
1999, compared 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, an increase in the Company's provision for losses,
and the lack of any gains from the sale of ARM assets in the first quarter of
1999. These negative impacts on the Company's return on equity were partially
offset by the elimination of any performance fee to the Manager and a slight
reduction in other expenses.
The following table presents the components of the Company's net interest income
for the quarters ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)
1999 1998
-------- --------
<S> <C> <C>
Coupon interest income on ARM assets $69,991 $86,284
Amortization of net premium (9,768) (9,207)
Amortization of Cap Agreements (1,345) (1,364)
Amort. of deferred gain from hedging 325 463
Cash and cash equivalents 442 139
-------- --------
Interest income 59,645 76,315
-------- --------
Reverse repurchase agreements 35,366 64,676
AAA notes payable 16,351 -
Other borrowings 39 188
Interest rate swaps 1,323 25
-------- --------
Interest expense 53,079 64,889
-------- --------
Net interest income $ 6,566 $11,426
======== ========
</TABLE>
As presented in the table above, the Company's net interest income decreased by
$4.9 million in the first quarter of 1999 compared to the first three months of
1998. The most significant causes are: (1) the Company's average interest
coupon on its ARM portfolio was 7.12% during the first three months of 1999
<PAGE>
compared to 7.51% during the same period in 1998; and (2) the Company's ARM
portfolio paid off at an annualized CPR of 29% during the first quarter of 1999
compared to 27% during the same quarter of 1998, increasing the amortization of
the net premium. These items were partially offset by a lower cost of funds on
the Company's borrowings which was 5.56% during the first quarter of 1999
compared to 5.79% during the first quarter of 1998.
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, 1999 and 1998:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
March 31, 1999 March 31, 1998
---------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $4,166,311 5.68% $4,847,193 6.29%
Cash and cash equivalents 30,044 5.88 12,546 4.42
---------- ---------- ---------- ----------
4,196,355 5.69 4,859,739 6.28
---------- ---------- ---------- ----------
Interest Bearing Liabilities:
Borrowings 3,815,961 5.56 4,479,208 5.79
---------- ---------- ---------- ----------
Net Interest Earning Assets and Spread $ 380,394 0.13% $ 380,531 0.49%
========== ========== ========== ==========
Yield on Net Interest Earning Assets (1) 0.63% 0.94%
========== ==========
<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.
</TABLE>
As a result of the yield on the Company's interest-earning assets declining to
5.69% during the first three months of 1999 from 6.28% during the same period of
1998 and the Company's cost of funds decreasing to 5.56% from 5.79% during the
same time periods, net interest income decreased by $4,860,000. This decrease
in net interest income is primarily a rate variance and to a lesser extent a
volume variance. There was a net unfavorable rate variance of $4,668,000,
primarily due to an unfavorable rate variance of $7,252,000 on the Company's ARM
assets portfolio and other interest-earning assets, which was partially offset
by a favorable rate variance on borrowings that increased net interest income by
$2,584,000. The decreased average size of the Company's portfolio during the
first quarter of 1999 compared to the same period in 1998 decreased net interest
income in the amount of $192,000. The average balance of the Company's
interest-earning assets was $4.196 billion during the first three months of
1999, compared to $4.860 billion during the first three months of 1998 -- a
decrease of 14%. The Company allowed its portfolio to decrease during the first
quarter of 1999 in order to increase liquidity in anticipation of calling its
collateralized AAA notes. Now that the Company has negotiated a modification of
the Notes, the Company has begun to acquire assets in order to utilize its
unused leverage capacity.
<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:
<TABLE>
<CAPTION>
COMPONENTS OF NET INTEREST SPREAD AND YIELD ON NET INTEREST EARNING ASSETS (1)
(Dollar amounts in millions)
Average ARM Assets 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, 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%
Jun 30, 1998 4,918.3 7.51% 7.44% 1.50% 5.94% 5.81% 0.13% 0.56%
Sep 30, 1998 4,963.7 6.97% 7.40% 1.52% 5.88% 5.78% 0.09% 0.46%
Dec 31, 1998 4,526.2 6.79% 7.28% 1.42% 5.86% 5.94% -0.08% 0.61%
Mar 31, 1999 4,196.4 6.85% 7.03% 1.31% 5.71% 5.36% 0.35% 0.63%
<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:
</TABLE>
<TABLE>
<CAPTION>
COMPONENTS OF THE YIELD ADJUSTMENTS ON ARM ASSETS
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, 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%
Jun 30, 1998 1.24% 0.17% 0.13% (0.04)% 1.50%
Sep 30, 1998 1.25% 0.18% 0.13% (0.04)% 1.52%
Dec 31, 1998 1.18% 0.14% 0.14% (0.04)% 1.42%
Mar 31, 1999 1.09% 0.10% 0.15% (0.03)% 1.31%
</TABLE>
As of March 31, 1999, 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 5.72%, compared to 5.86% as of December 31,
1998-- a decrease of 0.14%. The Company's cost of funds as of March 31, 1999,
was 5.36%, compared to 5.94% as of December 31, 1998 -- a decrease of 0.58%. As
a result of these changes, the Company's net interest spread as of March 31,
1999 was 0.35%, compared to negative 0.08% as of December 31, 1998. The
improvement in the net interest spread is largely attributable to the decline in
the cost of the Company's borrowings which is primarily the result of both
negotiating a modification of the Notes that reduced their cost to a spread over
one-month LIBOR of 0.38% from 0.70% and a reduction of the cost of the Company's
reverse repurchase agreements to a weighted average rate of 5.10% as of
quarter-end from a weighted average borrowing rate of 5.62% as of 1998 year-end.
This decrease in the borrowing rate on reverse repurchase agreements reflects
the reduction of LIBOR rates since year-end. The modification of the Notes
occurred close to quarter-end, so the modification of the Notes had little
effect on the Company's cost of funds during the first quarter of 1999, but the
entire second quarter of 1999 will benefit from the modification. Net of the
amortization of the cost of the modification, the Company expects to realize a
benefit of approximately $0.03 per common share during the second quarter of
1999.
<PAGE>
The Company's spreads and net interest income have been negatively impacted
since early 1998 by the spread relationship between U.S. Treasury rates and
LIBOR. This has negatively impacted the Company because a portion of the
Company's ARM portfolio is indexed to U.S. Treasury rates and the interest rates
on all of the Company's borrowings tend to change with changes in LIBOR. During
this period of time, U.S. Treasury rates decreased significantly whereas LIBOR
did not decrease to the same degree. As a result, the Company had been reducing
its exposure to ARM assets that are indexed to U.S. Treasury rates through the
product mix of its sales and acquisitions in order to reduce the negative impact
of this situation. Over recent months, the relationship between U.S. Treasury
rates and LIBOR has improved, although the Company does not know if this
improvement will continue or revert back to the relationship that existed during
1998. The following table presents historical data since the year the Company
commenced operations regarding this relationship as well as data regarding the
percent of the Company's ARM portfolio that is indexed to U.S. Treasury rates.
As presented in the table below, the Company has reduced the proportion of its
ARM portfolio that is indexed to U.S. Treasury rates to 34.8% at March 31, 1999
from 49.0% as of the end of 1997. The data is as follows:
<TABLE>
<CAPTION>
ONE-YEAR U.S. TREASURY RATES COMPARED TO ONE- AND THREE-MONTH LIBOR RATES
Average Spread
Between 1 Year
U.S. Treasury Percent of ARM
Average 1 Year Average 1 and 3 Rates and 1 & 3 Portfolio Index to
U.S. Treasury Month LIBOR Month LIBOR U.S. Treasury
For the Year Ended Rates During Rates During Rates During Rates at End of
December 31, Period Period Period Period
- --------------------- --------------- ---------------- ---------------- ------------------
<S> <C> <C> <C> <C>
1993 3.43% 3.25% 0.18% 20.9
1994 5.32 4.61 0.71 15.5
1995 5.94 6.01 -0.07 19.3
1996 5.52 5.48 0.04 45.4
1997 5.63 5.69 -0.06 49.0
1998 5.05 5.57 -0.52 34.7
For the Quarter Ended
- ---------------------
Mar 31, 1998 5.32 5.66 -0.34 44.3
Jun 30, 1998 5.41 5.68 -0.27 38.8
Sep 30, 1998 5.10 5.62 -0.52 37.5
Dec 31, 1998 4.39 5.32 -0.93 34.7
Mar 31, 1999 4.67 4.98 -0.31 34.8
</TABLE>
During the first three months of 1999, the Company did not sell any ARM assets
and therefore did not record any gain or loss from the sale of ARM assets.
During the same period of 1998, the Company realized a net gain from the sale of
ARM assets in the amount of $1,528,000.
The Company's provision for losses has increased with the acquisition of whole
loans. The provision for loan losses is based on an annualized rate of 0.15% on
the outstanding principal balance of loans as of each month-end, subject to
certain adjustments as discussed above. As of March 31, 1999, the Company's
whole loans, including those held as collateral for the AAA notes payable,
accounted for 29.0% of the Company's portfolio of ARM assets compared to 4.7% as
of March 31, 1998. To date, the Company has not experienced any actual losses
in its whole loan portfolio, but based on industry standards, losses are
expected and are being provided for as the portfolio ages.
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. The following table provides a reconciliation between the
Company's earnings as reported based on generally accepted accounting principles
and the Company's taxable income before its' common dividend deduction:
<PAGE>
<TABLE>
<CAPTION>
RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)
Quarters Ending March 31,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Net income $ 4,599 $10,496
Additions:
Provision for credit losses 686 387
Net compensation related items 85 (280)
Deductions:
Dividend on Series A Preferred Shares (1,670) (1,670)
Actual credit losses on ARM securities (175) (565)
-------- --------
Taxable net income $ 3,525 $ 8,368
======== ========
</TABLE>
For the quarter ended March 31, 1999, the Company's ratio of operating expenses
to average assets was 0.12% compared to 0.16% for the same quarter in 1998. 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. This competitive advantage
enables the Company to operate with less risk, such as credit and interest rate
risk, and still generate an attractive long-term 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 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 1999, the
Company did not pay the Manager a performance fee in accordance with the terms
of the Management Agreement. 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.
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
<TABLE>
<CAPTION>
ANNUALIZED OPERATING EXPENSE RATIOS
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, 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%
Jun 30, 1998 0.10% - 0.10%
Sep 30, 1998 0.10% - 0.10%
Dec 31, 1998 0.11% - 0.11%
Mar 31, 1999 0.12% - 0.12%
</TABLE>
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarter ended March 31, 1999
consisted of reverse repurchase agreements, which totaled $2.644 billion, and
callable AAA notes, which had a balance of $1.052 billion. The Company's other
significant source of funds for the quarter ended March 31, 1999 consisted of
payments of principal and interest from its ARM assets in the amount of $490.6
million. 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, capital market financing transactions
collateralized by ARM and Hybrid ARM loans, proceeds from monthly payments of
principal and interest on its ARM assets portfolio and occasional asset sales.
The Company's liquid assets generally consist of unpledged ARM assets, cash and
cash equivalents.
<PAGE>
Total borrowings outstanding at March 31, 1999, had a weighted average effective
cost of 5.22%. The reverse repurchase agreements had a weighted average
remaining term to maturity of 1.6 months and the collateralized AAA notes
payable had a final maturity of January 25, 2029, but will be paid down as the
ARM assets collateralizing the notes are paid down. As of March 31, 1999,
$993.4 million of the Company's borrowings were variable-rate term reverse
repurchase agreements. Term reverse repurchase agreements are committed
financings with original maturities that range from three months to two years.
The interest rates on these term reverse repurchase agreements are indexed to
either the one- or three-month LIBOR rate and reprice accordingly. The interest
rate on the collateralized AAA notes adjusts monthly based on changes in
one-month LIBOR.
The Company has arrangements to enter into reverse repurchase agreements with 25
different financial institutions and on March 31, 1999, had borrowed funds with
12 of these firms. Because the Company borrows money under these agreements
based on the fair value of its ARM assets and because changes in interest rates
can negatively impact the valuation of ARM assets, the Company's borrowing
ability under these agreements could be limited and lenders may initiate margin
calls in the event interest rates change or the value of the Company's ARM
assets decline for other reasons. Additionally, certain of the Company's ARM
assets are rated less than AA by the Rating Agencies (approximately 4.0%) 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. During the
first quarter of 1999, the Company increased its level of liquidity and 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.
As of March 31, 1999, the Company had $1.1 billion of AAA collateralized notes
outstanding, which are not subject to margin calls. Due to the structure of the
collateralized notes, their financing is not based on market value or subject to
subsequent changes in mortgage credit markets, as is the case of the reverse
repurchase agreement arrangements.
As of March 31, 1999, the Company had one whole loan financing facility with a
committed borrowing capacity of $150 million, with an option to increase this
amount to $300 million. The Company had no balance borrowed against this
facility as of March 31, 1999. This facility matures on January 8, 2000.
During April 1999, the Company entered into an additional one-year whole loan
financing facility with an uncommitted capacity of $300 million.
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, 1999, the Company had $109
million of its securities registered for future sale under this Registration
Statement.
During 1998, the Board of Directors approved a common stock repurchase program
of up to 1,000,000 shares at prices below book value, subject to availability of
shares and other market conditions. The Company did not repurchase any shares
during the first three months of 1999. To date, the Company has repurchased
500,016 shares at an average price of $9.28 per share.
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP")
designed to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of common stock and
for new and existing shareholders to purchase shares, as defined in the DRP.
During the first quarter of 1999, the Company purchased shares in the open
market on behalf of the participants in its DRP instead of issuing new shares
below book value. In accordance with the terms and conditions of the DRP, the
Company pays the brokerage commission in connection with these purchases.
<PAGE>
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 rates 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.
Interest rate changes may also impact the Company's ARM assets and borrowings
differently because the Company's ARM assets are indexed to various indices
whereas the interest rate on the Company's borrowings generally move with
changes in LIBOR. Although the Company has always favored acquiring LIBOR based
ARM assets in order to reduce this risk, LIBOR based ARMs are not generally well
accepted by home owners in the U.S. As a result, the Company has acquired ARM
assets indexed to a mix of indices in order to diversify its exposure to changes
in LIBOR in contrast to changes in other indices. During times of global
economic instability, U.S. Treasury rates generally decline because foreign and
domestic investors generally consider U.S. Treasury instruments to be a safe
haven for investments. The Company's ARM assets indexed to U.S. Treasury rates
then decline in yield as U.S. Treasury rates decline, whereas the Company's
borrowings and other ARM assets may not be affected by the same pressures or to
the same degree. As a result, the Company's income can increase or decrease
depending on the relationship between the various indices to which the Company's
ARM assets are indexed, compared to changes in the Company's cost of funds.
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.
Conversely, 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.
Lastly, because the Company only invests in ARM assets and approximately 8% to
10% 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.
YEAR 2000 ISSUES
The Year 2000 issues involve both hardware design flaws in which many computer
systems, and machines that use computer chips, will not correctly recognize the
date beginning in the Year 2000 and, additionally, software applications and
compilers that do not use a four-digit reference to years which might not behave
<PAGE>
as intended once the Year 2000 is reached. Three general areas of concern are:
1) clocks built into computers and computer chips that will rollover to 1900 or
1980 instead of 2000, 2) purchased software that does not recognize the Year
2000 as a leap year or that does not use a four-digit reference to years, and 3)
internally developed applications that do not store the year as a four-digit
year. The Company invests in assets and enters into agreements that employ the
use of dates and is, therefore, concerned about the ability of equipment and
computer programs to interpret dates or recognize dates accurately.
In consideration of the Year 2000 issues, the Manager has reviewed the ability
of its own computers and computer programs to properly recognize and handle
dates in the Year 2000. Through the normal upgrading of computer equipment, the
Manager has already replaced all computers that were not Year 2000 compliant.
The software used by the Company has been internally developed using products
that are Year 2000 compliant. The Manager has also reviewed all the date fields
embedded in its internally developed spreadsheets, databases and other programs
and has determined that all such programs are using four-digit years in
references to dates. Therefore, the Company believes that all of its equipment
and internal systems are ready for the Year 2000. To date, the Manager has
incurred all costs in order for the Company to be Year 2000 compliant.
The Company believes that most of its exposure to Year 2000 issues involves the
readiness of third parties such as, but not limited to, loan servicers, security
master servicers, security paying agents and trustees, its stock transfer agent,
its securities custodian, the counterparties on its various financing agreements
and hedging contracts and vendors. The Manager, at its expense, is conducting a
survey, which is expected to be completed during the first half of 1999, of all
such third parties to try to determine the readiness of such third parties to
handle Year 2000 dates and to try to determine the potential impact of Year 2000
issues. The Company cannot be certain that such a survey will fully identify
all Year 2000 issues or to fully access the potential problems or loss
associated with Year 2000 issues or that any failure by these other third
parties to resolve Year 2000 issues would not have an adverse effect on the
Company's operations and financial condition. The Company and the Manager
believe that they are spending the appropriate and necessary resources to try to
identify Year 2000 issues and to resolve them or to mitigate the impact of them
to the best of their ability as they are identified. The Company has not
developed likely worst case scenarios nor contingency plans for such scenarios.
OTHER MATTERS
As of March 31, 1999, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
98.7% 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 99.3% of its 1999 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, 1999, 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.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At March 31, 1999, 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 28, 1999 By: /s/ Larry A. Goldstone
-------------------------
Larry A. Goldstone
President and Chief Operating Officer
(authorized officer of registrant)
Dated: April 28, 1999 By: /s/ Richard P. Story
-----------------------
Richard P. Story,
Chief Financial Officer and Treasurer
(principal accounting officer)
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the March
31, 1999 Form 10-Q and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1000
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
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