UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
- SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 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 August 4, 1999
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION
FORM 10-Q
INDEX
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 1999 and December 31, 1998 . . . 3
Consolidated Statements of Operations for the three and six months ended
June 30, 1999 and June 30, 1998 . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Shareholders' Equity for the six months
ended June 30, 1999 and 1998. . . . . . . . . . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows for the three and six months ended
June 30, 1999 and June 30, 1998 . . . . . . . . . . . . . . . . . . . . 6
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . . . . . . . . . . . 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 2. Changes in Securities . . . . . . . . . . . . . . . . . . . . . . 34
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . 34
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . 34
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . 34
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
EXHIBIT INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
June 30, 1999 December 31, 1998
--------------- -------------------
<S> <C> <C>
ASSETS
Adjustable-rate mortgage ("ARM") assets: (Notes 2 and 3)
ARM securities . . . . . . . . . . . . . . . . . . . . . $ 3,452,933 $ 3,094,657
Collateral for collateralized notes. . . . . . . . . . . 1,009,206 1,147,350
ARM loans held for securitization. . . . . . . . . . . . 12,187 26,410
--------------- -------------------
4,474,326 4,268,417
--------------- -------------------
Cash and cash equivalents. . . . . . . . . . . . . . . . . 39,746 36,431
Accrued interest receivable. . . . . . . . . . . . . . . . 32,850 37,939
Prepaid expenses and other . . . . . . . . . . . . . . . . 7,447 1,846
--------------- -------------------
$ 4,554,369 $ 4,344,633
=============== ===================
LIABILITIES
Reverse repurchase agreements (Note 3) . . . . . . . . . . $ 3,212,276 $ 2,867,207
Collateralized notes (Note 3). . . . . . . . . . . . . . . 989,848 1,127,181
Other borrowings (Note 3). . . . . . . . . . . . . . . . . 1,344 2,029
Accrued interest payable . . . . . . . . . . . . . . . . . 16,616 31,514
Dividends payable (Note 5) . . . . . . . . . . . . . . . . 1,670 1,670
Accrued expenses and other . . . . . . . . . . . . . . . . 3,545 3,209
--------------- -------------------
4,225,299 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 . . . . . . . . . . . . . . . . 341,890 341,756
Accumulated other comprehensive income (loss). . . . . . . (63,442) (82,148)
Notes receivable from stock sales. . . . . . . . . . . . . (4,632) (4,632)
Retained earnings (deficit). . . . . . . . . . . . . . . . (6,105) (4,512)
Treasury stock: at cost, 500 and 500 shares, respectively. (4,666) (4,666)
--------------- -------------------
329,070 311,823
--------------- -------------------
$. . . . . . . . . . . . . . . . . . . . . . . . . . 4,554,369 $ 4,344,633
=============== ===================
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Interest income from ARM assets and cash . . $ 63,087 $73,019 $ 122,732 $149,335
Interest expense on borrowed funds . . . . . (54,015) (65,243) (107,094) (130,132)
--------- -------- ---------- ---------
Net interest income. . . . . . . . . . . . 9,072 7,776 15,638 19,203
--------- -------- ---------- ---------
Gain on sale of ARM assets . . . . . . . . . 35 1,497 35 3,025
Provision for credit losses. . . . . . . . . (689) (453) (1,375) (841)
Management fee (Note 7). . . . . . . . . . . (1,020) (1,048) (2,038) (2,075)
Performance fee (Note 7) . . . . . . . . . . - - - (759)
Other operating expenses . . . . . . . . . . (364) (297) (627) (581)
--------- -------- ---------- ---------
NET INCOME . . . . . . . . . . . . . . . . $ 7,034 $ 7,475 $ 11,633 $ 17,972
========= ======== ========== =========
Net income . . . . . . . . . . . . . . . . . $ 7,034 $ 7,475 $ 11,633 $ 17,972
Dividend on preferred stock. . . . . . . . . (1,670) (1,670) (3,340) (3,340)
--------- -------- ---------- ---------
Net income available to common shareholders. $ 5,364 $ 5,805 $ 8,293 $ 14,632
========= ======== ========== =========
Basic earnings per share . . . . . . . . . . $ 0.25 $ 0.27 $ 0.39 $ 0.69
========= ======== ========== =========
Diluted earnings per share . . . . . . . . . $ 0.25 $ 0.27 $ 0.39 $ 0.69
========= ======== ========== =========
Average number of common shares outstanding. 21,490 21,796 21,490 21,299
========= ======== ========== =========
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Six Months Ended June 30, 1999 and 1998
(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, 1997 $ 65,805 $ 203 $ 315,240 $(19,445) $ 2,698) $ (951) $ - $ 358,154
Comprehensive income:
Net income 17,971 $ 17,971 17,971
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment,
of amortization - - - (10,875) - - - (10,875) (10,875)
Deferred gain on sale of
hedges, net of - - - (909) - - - (909) (909)
--------
Other comprehensive income $ 6,187
Issuance of common ========
stock (Note 5) 17 26,261 (1,934) 24,344
Dividends declared on preferred
stock - $1.21 per share - - - - - (3,340) - (3,340)
Dividends declared on common
stock - $0.675 per share - - - - - (14,513) - (14,513)
--------- -------- ---------- --------- --------- --------- -------- ----------
Balance, June 30, 1998 $ 65,805 $ 220 $ 341,501 $(31,229) $ (4,632) $ (833) $ - $ 370,832
========= ======== ========== ========= ========= ========= ======== ==========
Balance, December 31, 1998 $ 65,805 $ 220 $ 341,756 $(82,148) $ (4,632) $ (4,512) $(4,666) $ 311,823
Comprehensive income:
Net income 11,633 $ 11,633 11,633
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment,
of amortization - - - 19,131 - - - 19,131 19,131
Deferred gain on sale of
hedges, net of - - - (425) - - - (425) (425)
--------
Other comprehensive income $ 30,339
Interest from notes receivable ========
stock sales 134 134
Dividends declared on preferred
stock - $1.21 per share - - - - - (3,340) - (3,340)
Dividends declared on common
stock - $0.46 per share - - - - - (9,886) - (9,886)
--------- -------- ---------- --------- --------- --------- -------- ----------
Balance, June 30, 1999 $ 65,805 $ 220 $ 341,890 $(63,442) $ (4,632) $ (6,105) $(4,666) $ 329,070
========= ======== ========== ========= ========= ========= ======== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION
STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
---------- ---------- ---------- ------------
<S> <C> <C> <C> <C>
Operating Activities:
Net Income. . . . . . . . . . . . . . . . . . . . . $ 7,034 $ 7,475 $ 11,633 $ 17,972
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization. . . . . . . . . . . . . . . . . . . . 8,976 13,054 19,772 23,161
Net (gain) loss from investing activities . . . . . 654 (1,044) 1,340 (2,185)
Change in assets and liabilities:
Accrued interest receivable . . . . . . . . . . . . (2,982) (1,337) 5,089 (2,235)
Receivable for assets sold. . . . . . . . . . . . . - (39,991) - (39,991)
Prepaid expenses and other. . . . . . . . . . . . . (2,081) 225 (5,601) (2,157)
Accrued interest payable. . . . . . . . . . . . . . 5,248 10,677 (14,898) (10,945)
Accrued expenses and other. . . . . . . . . . . . . 805 115 336 111
---------- ---------- ---------- ------------
Net cash provided by (used in) operating activities 17,654 (10,826) 17,671 (16,269)
---------- ---------- ---------- ------------
Investing Activities:
Available-for-sale ARM securities:
Purchases . . . . . . . . . . . . . . . . . . . . . (839,360) (459,050) (939,067) (1,152,794)
Proceeds on sales . . . . . . . . . . . . . . . . . 6,574 141,687 6,574 333,512
Proceeds from calls . . . . . . . . . . . . . . . . 4,126 60,900 4,126 115,779
Principal payments. . . . . . . . . . . . . . . . . 241,161 451,193 579,621 781,729
Held-to-maturity ARM securities:
Principal payments. . . . . . . . . . . . . . . . . - - - 15,152
Collateral for collateralized notes:
Principal payments. . . . . . . . . . . . . . . . . 62,515 - 135,773 -
ARM Loans:
Purchases . . . . . . . . . . . . . . . . . . . . . - (373,947) - (493,972)
Principal payments. . . . . . . . . . . . . . . . . 1,476 21,429 6,568 32,663
Sales . . . . . . . . . . . . . . . . . . . . . . . - 2,043 - 2,043
Purchase of interest rate cap agreements. . . . . . (441) (248) (1,910) (542)
---------- ---------- ---------- ------------
Net cash provided by (used in) investing activities (523,949) (155,993) (208,315) (365,430)
---------- ---------- ---------- ------------
Financing Activities:
Net borrowings from reverse repurchase agreements . 568,427 171,609 345,069 371,538
Repayments of collateralized notes. . . . . . . . . (62,581) (1,353) (137,333) (2,210)
Repayments of other borrowings. . . . . . . . . . . (602) (1,353) (685) (2,210)
Proceeds from common stock issued . . . . . . . . . - 8,054 - 24,344
Dividends paid. . . . . . . . . . . . . . . . . . . (6,613) (9,641) (13,226) (21,397)
Interest from notes receivable from stock sales . . 68 - 134 -
---------- ---------- ---------- ------------
Net cash provided by (used in) financing activities 498,699 168,669 193,959 372,275
---------- ---------- ---------- ------------
Net increase (decrease) in cash and cash equivalents. (7,596) 1,850 3,315 (9,424)
Cash and cash equivalents at beginning of period. . . 47,342 2,506 36,431 13,780
---------- ---------- ---------- ------------
Cash and cash equivalents at end of period. . . . . . $ 39,746 $ 4,356 $ 39,746 $ 4,356
========== ========== ========== ============
<FN>
Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.
</TABLE>
See Notes to Financial Statements
6
<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 ten 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 securities and all ARM loans are recorded when
all significant uncertainties regarding the characteristics of the assets are
removed and, in the case of loans, underwriting due diligence has been
completed, generally shortly before the 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
7
<PAGE>
guaranteed by an agency of the federal government. An investment grade security
generally has a security rating of BBB or Baa or better by at least one of two
nationally recognized rating agencies, Moody's Investor Services, Inc. or
Standard & Poor's, Inc. (the "Rating Agencies"). Additionally, the Company has
also purchased ARM loans and limits its exposure to credit losses by restricting
its whole loan purchases to ARM loans generally originated to "A" quality
underwriting standards or loans that have at least five years of pay history
and/or low loan to property value ratios. The Company further limits its
exposure to credit losses by limiting its investment in investment grade
securities that are rated A, or equivalent, BBB, or equivalent, or ARM loans
originated to "A" quality underwriting standards ("Other Investments") to no
more than 30% of the portfolio, including the subordinate securities retained as
part of the Company's securitization of loans into AAA securities.
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 ten 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.
8
<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.
All Swap Agreements are classified as a liability hedge against the Company's
borrowings. As a result, the unrealized gains and losses on Swap Agreements are
off balance sheet and are reported in the Company's Notes to Financial
Statements.
OTHER HEDGING ACTIVITY
The Company also enters into hedging transactions in connection with the
purchase of Hybrid ARMs between the trade date and the settlement date. In
doing so, the Company hedges the cost of obtaining fixed rate financing, which
is obtained and priced at the time of the purchase of the Hybrid ARM, such that
the cost of the fixed rate financing closely approximates the cost available to
the Company at the time the Company committed to the purchase of the Hybrid ARM.
The Company generally does this by entering into a commitment to sell similar
duration fixed-rate FNMA mortgage-backed securities ("MBS") on the trade date
and settles the commitment by purchasing the same fixed-rate FNMA MBS on the
purchase date. Realized gains and losses are deferred and amortized as a yield
adjustment over the fixed rate period of the financing.
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.
9
<PAGE>
Following is information about the computation of the earnings per share data
for the three and six month periods ended June 30, 1999 and 1998 (amounts in
thousands except per share data):
<TABLE>
<CAPTION>
Earnings
Income Shares Per Share
---------- --------- ----------
<S> <C> <C> <C>
Three Months Ended June 30, 1999
- --------------------------------
Net income . . . . . . . . . . . $ 7,034
Less preferred stock dividends . (1,670)
----------
Basic EPS, income available to
common shareholders . . . . . . 5,364 21,490 $ 0.25
==========
Effect of dilutive securities:
Stock options . . . . . . . . . - 7
---------- ---------
Diluted EPS. . . . . . . . . . . $ 5,364 21,497 $ 0.25
========== ========= ==========
Three Months Ended June 30, 1998
- --------------------------------
Net income . . . . . . . . . . . $ 7,475
Less preferred stock dividends . (1,670)
----------
Basic EPS, income available to
common stockholders . . . . . . 5,805 21,796 $ 0.27
==========
Effect of dilutive securities:
Stock options . . . . . . . . . - -
---------- ---------
Diluted EPS. . . . . . . . . . . $ 5,805 21,796 $ 0.27
========== ========= ==========
</TABLE>
<TABLE>
<CAPTION>
Earnings
Income Shares Per Share
---------- --------- ----------
<S> <C> <C> <C>
Six Months Ended June 30, 1999
- --------------------------------
Net income . . . . . . . . . . . $ 11,633
Less preferred stock dividends . (3,340)
----------
Basic EPS, income available to
common shareholders . . . . . . 8,293 21,490 $ 0.39
==========
Effect of dilutive securities:
Stock options . . . . . . . . . - 2
---------- ---------
Diluted EPS. . . . . . . . . . . $ 8,293 21,492 $ 0.39
========== ========= ==========
Six Months Ended June 30, 1998
- --------------------------------
Net income . . . . . . . . . . . $ 17,972
Less preferred stock dividends . (3,340)
----------
Basic EPS, income available to
common stockholders . . . . . . 14,632 21,299 $ 0.69
==========
Effect of dilutive securities:
Stock options . . . . . . . . . - 3
---------- ---------
Diluted EPS. . . . . . . . . . . $ 14,632 21,302 $ 0.69
========== ========= ==========
</TABLE>
The Company has granted options to directors and officers of the Company and
employees of the Manager to purchase 141,779 and 42,784 shares of common stock
at average prices of $9.0625 and $15.99 per share during the six months ended
June 30, 1999 and 1998, respectively. The conversion of preferred stock was not
included in the computation of diluted EPS because such conversion would
increase the diluted EPS.
10
<PAGE>
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>
June 30, 1999:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- ---------------- ----------- -----------
<S> <C> <C> <C> <C>
Principal balance outstanding $ 3,405,554 $ 995,041 $ 12,173 $4,412,768
Net unamortized premium . . . 81,137 15,071 103 96,311
Deferred gain from hedging. . (450) - - (450)
Allowance for losses. . . . . (1,356) (1,479) (89) (2,924)
Cap agreements. . . . . . . . 7,516 380 - 7,896
Principal payment receivable. 25,063 193 - 25,256
---------------- ---------------- ----------- -----------
Amortized cost, net . . . . 3,517,464 1,009,206 12,187 4,538,857
---------------- ---------------- ----------- -----------
Gross unrealized gains. . . . 7,750 31 83 7,864
Gross unrealized losses . . . (72,281) (7,176) (1) (79,458)
---------------- ---------------- ----------- -----------
Fair value. . . . . . . . . $ 3,452,933 $ 1,002,061 $ 12,269 $4,467,263
================ ================ =========== ===========
Carrying value. . . . . . . $ 3,452,933 $ 1,009,206 $ 12,187 $4,474,326
================ ================ =========== ===========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- ---------------- ----------- -----------
<S> <C> <C> <C> <C>
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 June 30, 1999, the Company realized $35,000 in gains on
the sale of $6.5 million of ARM securities. During the same period of 1998, the
Company realized $1,712,000 in gains and $215,000 in losses on the sale of
$142.2 million of ARM securities. All of the ARM securities sold were
classified as available-for-sale.
Since the Company did not sell any ARM assets in the first quarter of 1999, the
gains realized during the six months ended June 30, 1998 are the same as for the
three month period. During the same six month period of 1998, the Company
realized $3,498,000 in gains and $473,000 in losses on the sale of $332.5
million of ARM securities. All of the ARM securities sold were classified as
available-for-sale.
11
<PAGE>
As of June 30, 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 $1,356,000. At June 30, 1999, the Company is
providing for potential future credit losses on two assets that have an
aggregate carrying value of $10.7 million, which represent less than 0.2% 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 six months of
1999, the Company, in accordance with its credit policies, recorded a $764,000
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 June 30,
1999 and December 31, 1998 (dollar amounts in thousands):
<TABLE>
<CAPTION>
June 30, 1999
- ------------------
Loan Loan Percent of Percent of
Delinquency Status Count Balance ARM Loans Total Assets
------ ------- ---------- ------------
<S> <C> <C> <C> <C>
30 to 59 days . . 2 $ 1,885 0.16% 0.04%
60 to 89 days . . 2 765 0.06 0.02
90 days or more . 3 4,802 0.40 0.10
In foreclosure. . 4 821 0.07 0.02
Real estate owned 1 55 0.00 0.00
------ ------- ---------- ------------
12 $ 8,328 0.69% 0.18%
====== ======= ========== ============
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998
- ------------------
Loan Loan Percent of Percent of
Delinquency Status Count Balance ARM Loans Total Assets
------ ------- ---------- ------------
<S> <C> <C> <C> <C>
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 June 30, 1999 and 1998 (dollar amounts in
thousands):
<TABLE>
<CAPTION>
1999 1998
------ -----
<S> <C> <C>
Beginning balance. . $ 804 $ 42
Provision for losses 764 195
Charge-offs, net . . - -
------ -----
Ending balance . . . $1,568 $ 237
====== =====
</TABLE>
As of June 30, 1999, the Company had commitments to purchase $176.3 million of
ARM securities, $103.8 million of which are ARM loans which are being
securitized as part of the purchase agreement. In addition the Company had
commitments to purchase $10.3 million of loans through its correspondent loan
program which commenced operations on May 15, 1999.
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 5.74% as
of June 30, 1999 and 5.86% as of December 31, 1998.
As of June 30, 1999 and December 31, 1998, the Company had purchased Cap
Agreements with a remaining notional amount of $3.425 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 5.75% to 13.00% and average approximately 9.74%. Of the Cap Agreements
owned by the Company as of June 30, 1999, $154 million are hedging the cost of
12
<PAGE>
financing Hybrid ARMs and $3.425 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 11.71%. The Cap Agreements had an average maturity of 2.2
years as of June 30, 1999. The initial aggregate notional amount of the Cap
Agreements declines to approximately $3.100 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 June 30, 1999, the Company had outstanding $3.212 billion of reverse
repurchase agreements with a weighted average borrowing rate of 5.15% and a
weighted average remaining maturity of 3.8 months. As of June 30, 1999, $1.757
billion of the Company's borrowings were variable-rate term reverse repurchase
agreements with original maturities that range from three months to fourteen
months. 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 June 30, 1999 were collateralized by ARM
assets with a carrying value of $3.375 billion, including accrued interest.
At June 30, 1999, the reverse repurchase agreements had the following remaining
maturities (dollar amounts in thousands):
<TABLE>
<CAPTION>
<S> <C>
Within 30 days . . $1,622,964
31 to 89 days. . . 230,381
90 days or greater 1,358,931
----------
$3,212,276
==========
</TABLE>
As of June 30, 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. This facility matures on January 8, 2000. During the
second quarter of 1999, the Company entered into two additional whole loan
financing facilities. One with an uncommitted amount of borrowing capacity of
$300 million and one with an unspecified amount of uncommitted borrowing
capacity. As of June 30, 1999, the Company has no balance borrowed against any
of these whole loan financing facilities.
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 June 30, 1999,
the Notes had a net balance of $989.8 million, an effective interest cost of
5.67% and were collateralized by ARM loans with a principal balance of $901.9
million and ARM securities with a balance of $125.5 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.
13
<PAGE>
As of June 30, 1999, the Company was a counterparty to seventeen interest rate
swap agreements ("Swaps") having an aggregate notional balance of $733.7
million. As of June 30, 1999, these Swaps had a weighted average remaining term
of 3.4 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
and the Cap Agreements that also hedge the fixed rate period of Hybrid ARMs, 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 22 days to 283 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 ten years. The Swaps at June 30, 1999
were collateralized by ARM assets with a carrying value of $0.9 million,
including accrued interest.
As of June 30, 1999, the Company had financed a portion of its portfolio of
interest rate cap agreements with $1.3 million of other borrowings which require
quarterly or semi-annual payments until the year 2000. These borrowings have a
weighted average fixed rate of interest of 7.87% and have a weighted average
remaining maturity of 10.8 months. The other borrowings financing cap
agreements at June 30, 1999 were collateralized by ARM securities with a
carrying value of $2.6 million, including accrued interest. The aggregate
maturities of these other borrowings are as follows (dollars in thousands):
1999 $ 712
2000 632
-------
$ 1,344
=======
The total cash paid for interest was $48.2 million during the quarter ended June
30, 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 June 30, 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>
June 30, 1999 December 31, 1998
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Assets:
ARM assets. . . . . . . . . . $4,468,436 $4,461,373 $4,266,497 $4,259,374
Cap Agreements. . . . . . . . 5,890 5,890 1,920 1,920
Liabilities:
Callable collateralized notes 989,848 989,848 1,127,181 1,127,181
Other borrowings. . . . . . . 1,344 1,369 2,029 2,077
Swap agreements . . . . . . . 1,454 (4,525) (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 aggregate characteristics of groups of
loans such as, but not limited to, collateral type, index, margin, life cap,
14
<PAGE>
periodic cap, underwriting standards, age and delinquency experience. The fair
value of the Company's long-term debt and interest rate swap agreements, which
are off-balance sheet financial instruments, are based on market values provided
by dealers who are familiar with the terms of the long-term debt and swap
agreements. The fair values reported reflect estimates and may not necessarily
be indicative of the amounts the Company could realize in a current market
exchange. Cash and cash equivalents, interest receivable, reverse repurchase
agreements, 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 three or six month periods ended June
30, 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 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 paid on April 12, 1999 to preferred shareholders of record as of
March 31, 1999.
On April 15, 1999, the Company declared a first quarter 1999 dividend of $0.23
per common share which was paid on May 18, 1999 to common shareholders of record
as of April 30, 1999.
On June 15, 1999, the Company declared a second quarter dividend of $0.605 per
share to the shareholders of the Series A 9.68% Cumulative Convertible Preferred
Stock which was paid on July 12, 1999 to preferred shareholders of record as of
June 30, 1999.
On July 15, 1999, the Company declared a second quarter 1999 dividend of $0.23
per common share which will be paid on August 18, 1999 to common shareholders of
record as of July 30, 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, non-qualified stock
options ("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.
15
<PAGE>
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 six month period ended June 30, 1999, there were 141,779 options
granted to buy common shares at an average exercise price of $9.0625 along with
63,803 DERs. As of June 30, 1999, the Company had 754,181 options outstanding
at exercise prices of $9.0625 to $22.625 per share, 496,482 of which were
exercisable. The weighted average exercise price of the options outstanding was
$15.95 per share. As of the June 30, 1999, there were 144,815 DERs granted, of
which 115,835 were vested, and 9,724 PSRs granted. In addition, the Company
recorded an expense associated with the DERs and the PSRs of $28,000 and $46,000
for the three and six month periods ended June 30, 1999, respectively.
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 June 30, 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 June 30, 1999 and 1998, the Company paid the Manager
$1,020,000 and $1,048,000, respectively, in base management fees in accordance
with the terms of the Agreement. For the six month periods ended June 30, 1999
and 1998, the Company paid the Manager base management fees of $2,038,000 and
$2,075,000, respectively.
The Manager is also entitled to earn performance based compensation in an amount
equal to 20% of the Company's annualized net income, before performance based
compensation, above an annualized Return on Equity equal to the ten year U.S.
Treasury Rate plus 1%. For purposes of the performance fee calculation, equity
is generally defined as proceeds from issuance of common stock before
underwriter's discount and other costs of issuance, plus retained earnings. For
the quarters ended June 30, 1999 and 1998 and for the six month period ended
June 30, 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 six month
period ended June 30, 1998, the Company paid the Manager an incentive fee of
$759,000.
16
<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. 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.
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
10 years, and then convert to an adjustable-rate for the balance of the term of
the Hybrid ARM. On July 15, 1999, the Company's Board of Directors expanded the
Company's investment policy to allow for the acquisition of Hybrid ARMs with an
initial fixed rate period of up to ten years. Previously, the Company's
investment policy limited the acquisition of Hybrid ARMs to Hybrid ARMs with
initial fixed rate periods of five years or less. To mitigate interest-rate
risk, it is the Company's policy to fund the Hybrid ARMs with long-term debt
obligations that mature within one year or less of the first interest rate reset
date of the Hybrid ARMs.
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's investment policy
limits its investment in Hybrid ARMs to no more than 30% of its total investment
portfolio, and limits 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 further limits its investment in Hybrid ARMs that
have a fixed rate period of seven years or greater to no more than 10% of its
portfolio.
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
17
<PAGE>
(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 ARM 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 asset portfolio, comprising not more than 30%
of total assets, may consist of Other Investment assets, which may include:
(1) adjustable or variable rate pass-through certificates, multi-class
pass-through certificates or CMOs backed by loans on single-family,
multi-family, commercial or other real estate-related properties so long as they
are rated at least Investment Grade at the time of purchase. "Investment
Grade" generally means a security rating of BBB or Baa or better by at least one
of the Rating Agencies;
(2) ARM loans secured by first liens on single-family residential
properties, generally underwritten to "A" quality standards, and acquired for
the purpose of future securitization (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 4%, 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 June 30, 1999, the Company held total assets of $4.554 billion, $4.474
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 June 30, 1999, 95.8% 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, 86.2% are in the form of adjustable-rate
pass-through certificates or ARM loans. The remainder are floating rate classes
of CMOs (9.9%) or investments in floating rate classes of CBOs (3.9%) backed
primarily by mortgaged-backed securities.
18
<PAGE>
The following table presents a schedule of ARM assets owned at June 30, 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)
June 30, 1999 December 31, 1998
-------------------------- --------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
-------------- ---------- -------------- ----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA . . . . . . . . $ 2,016,453 45.1% $ 2,072,871 48.6%
Privately Issued:
AAA/Aaa Rating . . . . . 1,719,434 (1) 38.4 1,398,659 (1) 32.8
AA/Aa Rating . . . . . . 541,001 12.1 597,493 14.0
-------------- ---------- -------------- ----------
Total Privately Issued 2,260,435 50.5 1,996,152 46.8
-------------- ---------- -------------- ----------
-------------- ---------- -------------- ----------
Total High Quality . . 4,276,888 95.6 4,069,023 95.4
-------------- ---------- -------------- ----------
OTHER INVESTMENT:
Privately Issued:
A Rating . . . . . . . . 54,275 1.2 40,591 1.0
BBB/Baa Rating . . . . . 83,617 1.8 88,273 2.1
BB/Ba Rating and Other . 47,359 (1) 1.1 44,120 (1) 0.9
Whole loans. . . . . . . . 12,187 0.3 26,410 0.6
-------------- ---------- -------------- ----------
Total Other Investment 197,438 4.4 199,394 4.6
-------------- ---------- -------------- ----------
Total ARM Portfolio. . $ 4,474,326 100.0% $ 4,268,417 100.0%
============== ========== ============== ==========
<FN>
(1) AAA Rating category includes $883.5 million and $1.020 billion as of June
30, 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 June 30, 1999, the Company had reduced the cost basis of its ARM
securities by $1.4 million 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
$10.7 million, which represent less than 0.2% 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 June 30, 1999, the Company recorded
a $384,000 provision for potential credit losses on its loan portfolio,
although no actual losses have been realized in the loan portfolio to date. As
of June 30, 1999, the Company's ARM loan portfolio included nine loans that are
considered seriously delinquent (60 days or more delinquent) with an aggregate
balance of $6.4 million. The ARM loan portfolio also includes one real estate
property ("REO") that the Company owns 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 of these nine delinquent loans and REO is
approximately 66%. 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 assets and, therefore, the Company does not
currently 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.
19
<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)
June 30, 1999 December 31, 1998
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ARM ASSETS:
INDEX:
One-month LIBOR. . . . . . . . . . . $ 709,409 15.9% $ 556,574 13.0%
Three-month LIBOR. . . . . . . . . . 175,653 3.9 181,143 4.2
Six-month LIBOR. . . . . . . . . . . 768,134 17.2 939,824 22.0
Six-month Certificate of Deposit . . 250,688 5.6 313,268 7.3
Six-month Constant Maturity Treasury 41,078 0.9 49,023 1.2
One-year Constant Maturity Treasury. 1,452,636 32.5 1,479,054 34.7
Cost of Funds. . . . . . . . . . . . 244,865 5.5 268,486 6.3
---------- ---------- ---------- ----------
3,642,463 81.5 3,787,372 88.7
---------- ---------- ---------- ----------
HYBRID ARM ASSETS . . . . . . . . . . . . 831,863 18.5 481,045 11.3
---------- ---------- ---------- ----------
$4,474,326 100.0% $4,268,417 100.0%
========== ========== ========== ==========
</TABLE>
The portfolio had a current weighted average coupon of 6.85% at June 30, 1999.
This consisted of an average coupon of 6.73% on the Hybrid ARM portion of the
portfolio and an average coupon of 6.86% on the rest of the portfolio. If the
non-hybrid portion of the portfolio had been "fully indexed" on June 30, 1999,
the weighted average coupon of the non-hybrid portion of the portfolio would
have been approximately 7.19%, 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 Hybrid ARMs and 7.32% on the remainder of the ARM
portfolio. The lower average coupon on the ARM portfolio as of June 30, 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 June 30, 1999, the current yield of the ARM assets portfolio was 5.74%,
compared to 5.86% as of December 31, 1998, with an average term to the next
repricing date of 320 days as of June 30, 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 3.9
years as of June 30, 1999. The non-hybrid portion of the ARM portfolio has an
average next repricing term of 86 days as of June 30, 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 0.12% as of June 30, 1999, compared to December
31, 1998, is due to a number of factors including a 0.43% decrease in the
weighted average coupon and an increase in the cost of hedging by 0.01%. These
two factors were partially offset by reduced amortization of purchase premiums,
which improved by 0.31%, and a 0.01% improvement in the impact of the
non-interest earning principal payment receivables.
20
<PAGE>
The following table presents various characteristics of the Company's ARM and
Hybrid ARM loan portfolio as of June 30, 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 . . . . . . . . $ 273,440 $ 3,450,000 $ 309
Coupon rate on loans . . . . . . . . . . 7.23% 9.63% 5.00%
Pass-through rate. . . . . . . . . . . . 6.92% 9.23% 4.61%
Pass-through margin. . . . . . . . . . . 2.28% 5.45% 0.75%
Lifetime cap . . . . . . . . . . . . . . 12.90% 16.00% 9.50%
Original Term (months) . . . . . . . . . 339 480 72
Remaining Term (months). . . . . . . . . 309 349 32
Geographic Distribution (Top 5 States):. Property type:
California . . . . . . . . . . . . . . 21.04% Single-family 64.13%
Florida. . . . . . . . . . . . . . . . 11.98 DeMinimus PUD 20.59
Georgia. . . . . . . . . . . . . . . . 7.02 Condominium 9.45
New York . . . . . . . . . . . . . . . 6.56 Other 5.83
New Jersey . . . . . . . . . . . . . . 4.66
Occupancy status:. . . . . . . . . . . . Loan purpose:
Owner occupied . . . . . . . . . . . . 83.77% Purchase 56.25%
Second home. . . . . . . . . . . . . . 11.30 Cash out refinance 25.76
Investor . . . . . . . . . . . . . . . 4.93 Rate & term refinance 17.99
Documentation type:. . . . . . . . . . . Periodic Cap:
Full/Alternative . . . . . . . . . . . 95.46% None 57.99%
Other. . . . . . . . . . . . . . . . . 4.54 3.00% 0.13
2.00% 40.15
Average effective original . . . . . . . 1.00% 0.51
loan-to-value: . . . . . . . . . . . . . 67.77% 0.50% 1.22
</TABLE>
On May 15, 1999, the Company commenced the operations of its correspondent
lending program under which the Company acquires ARM and Hybrid ARM loans that
have been originated in conformance with the Company's criteria by a network of
correspondent mortgage lenders approved by the Company. The Company has
selectively approved ten correspondents and is currently either in discussion or
considering the application of sixteen others. The Company reviews the
financial strength, the past ability to originate ARM and Hybrid ARM products as
well as the credit performance and prepayment characteristics of past
originations of a prospective correspondent in making its decision to approve a
correspondent. The Company's underwriting guidelines specify that borrowers
must be "A" quality only and are generally more restrictive than current FNMA
guidelines, other than the size of the loan. Over time, the Company expects
that most of the loans acquired through the correspondent lending program will
be non-conforming or "Jumbo" loans based on the size of the loan. (Currently,
any loan over $240,000 is non-conforming or a "Jumbo" loan). However, most of
the loans acquired to date through this program have been conforming. The
Company believes that one of the benefits of the correspondent lending program
will be the acquisition of loans at prices close to par. In fact, the average
price of the loans acquired to date has been at a discount price. Acquiring
loans at or below par eliminates the risk of having to write-off the remaining
premium balance if a loan prepays sooner than expected and should help to
stabilize the Company's net income during periods of rapid prepayment of ARM
assets.
During the quarter ended June 30, 1999, the Company purchased $839.4 million of
ARM assets, 99.4% of which were High Quality assets. Of these ARM assets
acquired, $273.5 million of them were Hybrid ARM loans that were securitized
into AAA securities as part of the purchase transaction and $2.0 million were
Hybrid ARM loans acquired through the Company's correspondent lending program
that commenced operations during the quarter. Of the ARM assets acquired during
the three months ended June 30, 1999, approximately 55% were Hybrids ARMs, 24%
were indexed to LIBOR, 19% were indexed to U.S. Treasury bill rates and 2% were
indexed to a Cost of Funds index.
21
<PAGE>
During the six months ended June 30, 1999, the Company purchased $939.1 million
of ARM assets, 97.9% of which were High Quality assets. Of the ARM assets
acquired during the first six months of 1999, approximately 49% were Hybrid
ARMs, 29% were indexed to LIBOR, 20% were indexed to U.S. Treasury bill rates
and the remaining 2% were indexed to a Cost of Funds index.
As of June 30, 1999, the Company had commitments to purchase $176.3 million of
ARM securities, $103.8 million of which are ARM loans which are being
securitized as part of the purchase agreement. In addition, the Company had
commitments to purchase $10.3 million of loans through its correspondent loan
program.
During both the three and six month periods ended June 30, 1999, the Company
sold only one asset in the amount of $6.5 million for a gain of $35,000. The
Company acquires ARM assets for investment purposes only and therefore generally
does not realize significant gains and losses from the sale of assets in the
normal course of its business. The Company does sell selected assets at times
for the purpose of improving long-term portfolio characteristics or to improve
liquidity, as part of its ARM portfolio management.
For the quarter ended June 30, 1999, the Company's ARM assets paid down at an
approximate average annualized constant prepayment rate of 26% compared to 34%
for the quarter ended June 30, 1998 and 29% for the prior quarter ended March
31, 1999. 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
0.79% from a negative adjustment of 2.62% of the portfolio as of December 31,
1998, to a negative adjustment of 1.83% as of June 30, 1999. The negative
adjustment also improved from March 31, 1999 when the price adjustment was 1.99%
of the portfolio of ARM securities, although the fair value adjustment on
certain assets, particularly Hybrid ARM assets, decreased during the quarter due
to concern over rising interest rates. This price improvement from year-end is
primarily the result of an improved market for mortgage products in general, as
buying and selling activity has picked up during 1999 with the improvement in
the outlook regarding prepayments and the financing of mortgage assets, compared
to the end of 1998. The amount of the negative adjustment to the fair value of
the ARM securities decreased from $83.2 million as of December 31, 1998, to
$64.5 million as of June 30, 1999.
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 June 30, 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
$3.425 billion with an average final maturity of 2.2 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 these 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 9.91%. The Company has also entered
into $154.3 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 June 30, 1999 would receive cash payments if one-month LIBOR increases above
certain specified levels, which range from 5.75% to 6.00%, and have a remaining
average term of 3.9 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 June 30, 1999, the fair value of the Company's
Cap Agreements was $5.1 million, $2.0 million less than the amortized cost of
the Cap Agreements.
22
<PAGE>
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 June 30, 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 Strike Price Remaining Term
- ------------ --------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
$ 25,909 8.00% $ 26,000 7.10% 3.8 Years
411,837 8.79 409,218 7.50 0.8
523,431 10.12 526,781 8.00 2.8
169,195 11.00 168,932 8.50 0.7
252,722 11.34 252,738 9.00 0.5
139,325 11.39 138,471 9.50 1.3
296,578 11.89 297,776 10.00 2.9
319,867 12.27 319,352 10.50 1.9
178,917 12.45 178,570 11.00 5.0
537,902 12.89 538,035 11.50 3.0
392,262 13.53 391,647 12.00 2.3
93,535 14.19 93,896 12.50 1.6
104,958 16.07 83,508 13.00 0.6
- ------------ --------- -------------- ------------- --------------
$ 3,446,438 11.71% $ 3,424,924 9.91% 2.2 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.
</TABLE>
As of June 30, 1999, the Company was a counterparty to seventeen interest rate
swap agreements ("Swaps") having an aggregate notional balance of $733.7
million. As of June 30, 1999, these Swaps had a weighted average remaining term
of 3.4 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. Generally, as the Company enters into a commitment to
purchase a Hybrid ARM asset, the Company will simultaneously enter into a
transaction to hedge the financing of the Hybrid ARM to achieve a fixed rate
during a substantial period of the Hybrid ARMs fixed rate period. At times,
since there is a period of time between the commitment date and the actual cash
purchase date of the Hybrid ARM, the Company will enter into a short-term hedge
transaction on the commitment date in order to achieve a cost of financing on
the cash settlement date that approximates the Company's expected cost of
financing at the time it entered into the commitment. The Company generally
does this by entering into a commitment to sell similar duration fixed-rate FNMA
MBS on the trade date and settles the commitment by purchasing the same
fixed-rate FNMA MBS on the purchase date. Realized gains and losses are
deferred and amortized as a yield adjustment over the fixed rate period of the
financing. The Swaps hedge the cost of financing Hybrid ARMs during a
substantial period of their fixed rate term, generally three to ten years. The
average remaining fixed rate term of the Company's Hybrid ARM assets as of June
30, 1999 was 3.7 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 certain other Swap Agreements. As of June 30, 1999, the Swaps
had a fair value of $4.5 million which was $6.0 million higher than their
carrying value. Since the Swaps are designated a liability hedge, the
unrealized gain of $6.0 million is off balance sheet and is not recorded by the
Company as Other Comprehensive Income as part of the Company's shareholders'
equity. As of March 31, 1999, the Swaps had a fair value of negative $2.2
million which was $2.1 million less than their carrying value. This improvement
in the fair value of the Company's Swaps is a result of rising interest rates
and is comparable to the decline in the fair value of the Company's portfolio of
Hybrid ARMs.
23
<PAGE>
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1999
For the quarter ended June 30, 1999, the Company's net income was $7,034,000, or
$0.25 per share (Basic and Diluted EPS), based on a weighted average of
21,490,000 shares outstanding. That compares to $7,475,000, or $0.27 per share
(Basic and Diluted EPS), based on a weighted average of 21,796,000 shares
outstanding for the quarter ended June 30, 1998. Net interest income for the
quarter totaled $9,072,000, compared to $7,776,000 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 three months
ended June 30, 1999, the Company recorded $35,000 of gains from the sale of one
ARM security compared to a net gain of $1,497,000 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 $689,000 for
potential credit losses, compared to $453,000 during the second quarter of 1998.
During the second quarter of 1999, the Company incurred operating expenses of
$1,384,000, consisting of a base management fee of $1,020,000 and other
operating expenses of $364,000. During the same period of 1998, the Company
incurred operating expenses of $1,345,000, consisting of a base management fee
of $1,048,000 and other operating expenses of $297,000.
The Company's return on average common equity was 6.60% for the quarter ended
June 30, 1999 compared to 6.83% for the quarter ended June 30, 1998 and compared
to 3.60% for the prior quarter ended March 31, 1999. The Company's return on
equity improved in this past quarter compared to the prior quarter primarily
because the Company's net interest income, the Company's core source of income,
improved.
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%
Jun 30, 1999. 11.17% 0.85% 0.04% 1.70% - 2.05% 6.60% 5.54% 1.06%
<FN>
- -------------------
(1) Average common equity excludes unrealized gain (loss) on available-for-sale ARM securities.
(2) Excludes performance fees.
</TABLE>
The Company's return on common equity in the second quarter of 1999, although,
as a whole, was comparable to the second quarter of 1998, reflects significant
improvement in core earnings. A significant component of the Company's return
on common equity in the second quarter of 1998 was the result of gains in the
amount of $1,479,000 realized on the sale of ARM securities compared to $35,000
in the second quarter of 1999. As presented in the table below, the most
significant improvement in core earnings resulted from the lower cost of funds
which improved net interest income by $11.2 million. Coupon interest income
also decreased with lower market interest rates by $14.4 million, but this was
partially offset by the decrease in the amortization of net premium which
declined by $4.4 million resulting in a net decrease in interest income on ARM
assets of $10.0 million. The decline in the amortization of the net premium is
primarily the result of the following three items: (1) a slow down in the rate
of ARM asset prepayments (26% rate of prepayments in the second quarter of 1999
versus 34% in the second quarter of 1998); (2) the decline in the average
interest coupon of the ARM portfolio (6.85% versus 7.44%) resulting in less
24
<PAGE>
gross interest income to adjust to an appropriate yield; and (3) the cumulative
effect of recent purchases at lower prices such that there is less premium to be
amortized over the remaining expected life of the portfolio. During 1999, the
average purchase price of newly acquired ARM assets has been approximately 1%
above par as compared to the portfolio average remaining purchase price as of
December 31, 1998 of 2.47%. As of June 30, 1999, the average remaining purchase
price of the ARM portfolio is 2.18% and is expected to decline further as the
Company realizes the benefits of its newly created correspondent lending
business, the continued purchase of bulk loans and continues to selectively
purchase other ARM and Hybrid ARM assets at prices below the current portfolio
average.
The following table presents the components of the Company's net interest income
for the quarters ended June 30, 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 $71,586 $86,034
Amortization of net premium. . . . . (7,837) (12,228)
Amortization of Cap Agreements . . . (1,377) (1,375)
Amort. of deferred gain from hedging 263 549
Cash and cash equivalents. . . . . . 452 39
-------- --------
Interest income. . . . . . . . . . 63,087 73,019
-------- --------
Reverse repurchase agreements. . . . 38,470 65,096
AAA notes payable. . . . . . . . . . 14,292 -
Other borrowings . . . . . . . . . . 35 170
Interest rate swaps. . . . . . . . . 1,218 (23)
-------- --------
Interest expense . . . . . . . . . 54,015 65,243
-------- --------
Net interest income. . . . . . . . . $ 9,072 $ 7,776
======== ========
</TABLE>
The following table presents the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the quarters ended June 30, 1999 and 1998:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Quarter Ended For the Quarter Ended
June 30, 1999 June 30, 1998
----------------------- ------------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets. . . . $4,374,336 5.73% $4,913,708 5.94%
Cash and cash equivalents. . . . . . . 30,940 5.85 4,581 3.40
----------- ---------- ----------- -----------
4,405,276 5.73 4,918,289 5.94
----------- ---------- ----------- -----------
Interest Bearing Liabilities:
Borrowings . . . . . . . . . . . . . . 4,034,856 5.35 4,528,635 5.76
----------- ---------- ----------- -----------
Net Interest Earning Assets and Spread . $ 370,420 0.38% $ 389,654 0.18%
========== =========== =========== ===========
Yield on Net Interest Earning Assets (1) 0.82% 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.
</TABLE>
As a result of the yield on the Company's interest-earning assets declining to
5.73% during the second quarter of 1999 from 5.94% during the same period of
1998 and the Company's cost of funds decreasing to 5.35% from 5.76% during the
same time periods, net interest income increased by $1,345,000. This increase
in net interest income is primarily a favorable rate variance, partially offset
25
<PAGE>
by an unfavorable volume variance. There was a net favorable rate variance of
$2,078,000, composed of a favorable rate variance on borrowings that increased
net interest income by $4,673,000 and an unfavorable rate variance of $2,594,000
on the Company's ARM assets portfolio and other interest-earning assets. The
decreased average size of the Company's portfolio during the second quarter of
1999 compared to the same period in 1998 decreased net interest income in the
amount of $733,000. The average balance of the Company's interest-earning
assets was $4.405 billion during the second quarter of 1999, compared to $4.918
billion during the second quarter of 1998 -- a decrease of 10%. 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. The
Company completed the negotiation of the modification of the Notes in the first
quarter of 1999 and commenced acquiring assets at a pace comparable to the first
half of 1998. During the second quarter of 1999, the Company acquired $839.4
million of ARM assets and ended the quarter with total assets of $4.6 billion
compared to $4.0 billion as of March 31, 1999.
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)
ARM Assets
Average ------------------------------------ Yield on Yield on
Interest Wgt. Avg. Weighted Interest 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%
Jun 30, 1999. 4,405.3 7.10% 6.85% 1.11% 5.74% 5.40% 0.34% 0.82%
<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%
Jun 30, 1999. 0.87% 0.13% 0.13% (0.02)% 1.11%
</TABLE>
26
<PAGE>
As of June 30, 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, and its cash and cash equivalents was 5.74%,
compared to 5.71% as of March 31, 1999-an increase of 0.03%. The Company's cost
of funds as of June 30, 1999, was 5.40%, compared to 5.36% as of March 31, 1999
- - an increase of 0.04%. As a result of these changes, the Company's net
interest spread as of June 30, 1999 was 0.34%, compared to 0.35% as of March 31,
1999. The slight decrease in the net interest spread is largely attributable to
the impact of rising interest rates as of the end of the quarter as a result of
Federal Reserve Board action.
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 spread relationship 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
32.5% at June 30, 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 1 Year U.S.
For the Year Ended Rates During Rates During Rates During Treasury Rates at
December 31, Period Period Period End of 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
Jun 30, 1999. . . . . 4.88 5.02 -0.14 32.5
</TABLE>
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 June 30, 1999, the Company's
whole loans, including those held as collateral for the AAA notes payable and
those that have been securitized by the Company for which the Company has
retained credit loss exposure, accounted for 27.3% of the Company's portfolio of
ARM assets compared to 12.3% as of June 30, 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 reserved 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
27
<PAGE>
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:
<TABLE>
<CAPTION>
RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)
Quarters Ending June 30,
------------------------
1999 1998
-------- --------
<S> <C> <C>
Net income. . . . . . . . . . . . . . . . . . $ 7,034 $ 7,475
Additions:
Provision for credit losses. . . . . . . . . 689 453
Net compensation related items . . . . . . . 96 (98)
Deductions:
Dividend on Series A Preferred Shares (1,670) (1,670)
Capital loss carryover from 1998. . . (35) -
Actual credit losses on ARM securities (323) (411)
-------- --------
Taxable net income. . . . . . . . . . . . . . $ 5,791 $ 5,749
======== ========
</TABLE>
For the quarter ended June 30, 1999, the Company's ratio of operating expenses
to average assets was 0.12% compared to 0.10% 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 second quarter of 1999 and
1998, 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.
28
<PAGE>
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%
Jun 30, 1999. 0.12% - 0.12%
</TABLE>
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1999
For the six months ended June 30, 1999, the Company's net income was
$11,633,000, or $0.39 per share (Basic and Diluted EPS), based on a weighted
average of 21,490,000 shares outstanding. That compares to $17,972,000, or
$0.69 per share (Basic and Diluted EPS), based on a weighted average of
21,299,000 shares outstanding for the six months ended June 30, 1998. Net
interest income for the quarter totaled $15,638,000, compared to $19,203,000 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 six months of 1999, the Company recorded a gain on the sale of
ARM securities of $35,000 as compared to a gain of $3,025,000 during the same
period of 1998. Additionally, during the first half of 1999, the Company
reduced its earnings and the carrying value of its ARM assets by reserving
$1,357,000 for potential credit losses, compared to $841,000 during the first
half of 1998. During the six months ended June 30, 1999, the Company incurred
operating expenses of $2,665,000, consisting of a base management fee of
$2,038,000 and other operating expenses of $627,000. During the same period of
1998, the Company incurred operating expenses of $3,415,000, consisting of a
base management fee of $2,075,000, a performance-based fee of $759,000 and other
operating expenses of $581,000.
The Company's return on average common equity was 5.1% for the six months ended
June 30, 1999 compared to 8.8% for the six months ended June 30, 1998. The
primary reasons for the lower return on average common equity is a slightly
lower interest rate spread, as discussed below, the lower level of gains
recorded during this six month period on the sale of ARM assets as compared to
the same period during 1998 and the higher level of provisions for credit losses
commensurate with the increased size of the Company's whole loan portfolio.
One primary reason for the decline in the ARM portfolio yield is that the
average interest rate of the ARM portfolio at June 30, 1999 was 6.85% as
compared to 7.44% a year earlier. Based on market interest rates on June 30,
1998, the ARM portfolio average rate of 7.44% was within 0.06% of being the
fully indexed rate whereas the ARM portfolio average rate of 6.85% as of June
30, 1999 is 0.25% from the fully indexed rate of 7.10%. The Company expects the
ARM portfolio average interest rate to increase over the next several months as
the portfolio assets have an opportunity to reset to current interest rates.
This lower average interest rate of the ARM portfolio was partially offset by
lower cost of funds which has also declined since June 30, 1998. The Company's
cost of funds as of June 30, 1998 was 5.81% and has declined to 5.40%, a 0.41%
decrease compared to the 0.59% decrease in the ARM portfolio average interest
rate. One of the reasons why the Company's cost of funds has not decreased as
much as the yield on the Company's ARM assets is that the Company has shortened
the average mismatch between the interest rate repricing of its ARM assets and
its borrowings. As of June 30, 1998, the mismatch was 53 days and as of June
30, 1999, the mismatch was 37 days.
29
<PAGE>
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the six month periods ended June 30, 1999 and 1998:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Six Month For the Six Month
Period Ended Period Ended
June 30, 1999 June 30, 1998
----------------------- ------------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets. . . . $4,270,323 5.71% $4,880,450 6.11%
Cash and cash equivalents. . . . . . . 30,492 5.87 8,564 4.15
----------- ---------- ----------- -----------
4,300,815 5.71 4,889,014 6.11
----------- ---------- ----------- -----------
Interest Bearing Liabilities:
Borrowings . . . . . . . . . . . . . . 3,925,409 5.46 4,503,922 5.78
----------- ---------- ----------- -----------
Net Interest Earning Assets and Spread . $ 375,407 0.25% $ 385,092 0.33%
========== =========== =========== ===========
Yield on Net Interest Earning Assets (1) 0.73% 0.79%
=========== ===========
<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 net result of the yield on the Company's interest-earning assets declining
to 5.71% during the first half of 1999 from 6.11% during the first half of 1998
and the Company's cost of funds decreasing to 5.46% from 5.78% for the same
respective time periods, its net interest income decreased by $3,564,000. This
decrease in net interest income is primarily the result of a rate variance as
well as a less significant volume variance. There was a net unfavorable rate
variance of $2,583,000, which consisted of an unfavorable variance of $9,838,000
resulting from the lower yield on the Company's ARM assets portfolio and other
interest-earning assets and a favorable variance of $7,255,000 resulting from a
decrease in the Company's cost of funds. The decreased average size of the
Company's portfolio during the first half of 1999 compared to the same period of
1998 also contributed to lower net interest income in the amount of $981,000.
The average balance of the Company's interest-earning assets was $4.301 billion
during the first half of 1999 compared to $4.889 billion during the first half
of 1998 -- a decrease of 12%.
During the first half of 1999, the Company realized a net gain from the sale of
one ARM security in the amount of $35,000 as compared to $3,025,000 during the
first half of 1998. The Company considers selling assets as a portfolio and
liquidity management tool and not a core source of earnings. During 1998 the
Company was focused on repositioning its portfolio into less prepayment
sensitive ARM assets and selling assets that were prepaying faster than expected
for which the Company could get a good value from a sale. As a result, the
Company was more active in selling a few selected assets in 1998 than it has
been year to date in 1999. In 1999, especially during the second quarter, the
Company has been focused on fully utilizing its capital capacity after allowing
the Company's assets to decrease during the latter part of 1998 and early 1999
and has, therefore, not been seeking opportunities to sell assets. The Company
recorded an expense for credit losses in the amount of $1,375,000 during the six
months ended June 30, 1999, compared to $841,000 during the same period of 1998.
The increase in the provision reflects the increased size of the Company's ARM
loan portfolio which includes loans held for securitization, loans held as
collateral for AAA notes and securitized loans for which the Company retained
all of the classes of securities created upon securitization, including the
first loss classes, although the Company has acquired third-party credit
insurance that has reduced or capped the Company's exposure to credit losses on
securitized loans. To date, the Company has not experienced any losses from its
loan portfolio and the loans that are currently delinquent appear to be
adequately secured by the collateral value so that the Company does not believe
it will experience any loss from the loans currently delinquent. The one REO
property that the Company owned at June 30, 1999 has subsequently been sold for
an amount above the Company's carrying value.
30
<PAGE>
For the six months ended June 30, 1999, the Company's ratio of operating
expenses to average assets was 0.12% as compared to 0.13% for the same period of
1998. The primary reason for the decline in operating expenses is the variable
nature of the performance based fee paid to the Manager, which is based on the
performance of the Company relative to the average 10-year U.S. Treasury rate
during the applicable period. During the first half of 1999, the Manager did
not earn a performance fee as compared to earning a performance fee of $759,000
during the same period of 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarter ended June 30, 1999
consisted of reverse repurchase agreements, which totaled $3.212 billion, and
callable AAA notes, which had a balance of $989.8 million. The Company's other
significant source of funds for the quarter ended June 30, 1999 consisted of
payments of principal and interest from its ARM assets in the amount of $374.2
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.
Total borrowings outstanding at June 30, 1999, had a weighted average effective
cost of 5.27%. The reverse repurchase agreements had a weighted average
remaining term to maturity of 3.8 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 June 30, 1999, $1.757
billion 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 fourteen months. 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 June 30, 1999, had borrowed funds with
13 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. The Company had
adequate liquidity throughout the quarter ended June 30, 1999. Further, the
Company believes it will continue to have sufficient liquidity to meet its
future cash requirements from its primary sources of funds for the foreseeable
future without needing to sell assets.
As of June 30, 1999, the Company had $989.8 million 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 June 30, 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. This facility matures on January 8, 2000. During the
second quarter of 1999, the Company entered into two additional whole loan
financing facilities. One with an uncommitted amount of borrowing capacity of
$300 million and one with an unspecified amount of uncommitted borrowing
capacity.
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 June 30, 1999, the Company had $109
million of its securities registered for future sale under this Registration
Statement.
31
<PAGE>
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 six 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 six months 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.
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 factors 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.
32
<PAGE>
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
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 primary software used by the Company has been internally developed using
products that are Year 2000 compliant. Other software that has been purchased
has also been certified to be Year 2000 compliant. The Manager has 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, conducted a
survey, which was 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.
All surveyed parties have either certified that they are Year 2000 compliant or
that they are in the testing stage and expect to be Year 2000 compliant. All
third parties that indicated they are in the testing stage will be re-surveyed
by early in the fourth quarter. The Company cannot be certain that the survey
fully identified all Year 2000 issues 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 developed a contingency plan for what it believes to be likely
worst case scenarios. The Company believes that the most likely worst case
scenarios all impact the availability and cost of financing ARM assets over
year-end. For this reason, the Company has already entered into financing
arrangements that finances over 60% of the Company's ARM portfolio over
year-end. In addition, the Company has decided to increase its liquidity as
year-end approaches by de-emphasizing the acquisition of ARM assets over the
balance of the year. As an additional precaution, the Company is reviewing the
appropriateness of selling a few selected assets that may prove to be difficult
to finance over year-end, if acceptable financing arrangements for such assets
can not or are not expected to be consummated by the end of the year. The
Company is also discussing the financing of its agency payment receivables with
other financial institutions as another possible source of liquidity. The
Company believes that these steps, as part of its contingency plan, are prudent
measures in light of the uncertainty related to Year 2000 issues. Further, the
Company believes that these steps will be sufficient to address the most likely
worst case scenarios, but the Company can provide no certainty that such will
prove to be the case.
OTHER MATTERS
As of June 30, 1999, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.0% 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 six months 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 June 30, 1999, the Company believes that it will
continue to qualify as a REIT under the provisions of the Code.
33
<PAGE>
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" ("Qualifying Interests"). Under current interpretation of the
staff of the SEC, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. In
addition, unless certain mortgage securities represent all the certificates
issued with respect to an underlying pool of mortgages, such mortgage securities
may be treated as securities separate from the underlying mortgage loans and,
thus, may not be considered Qualifying Interests for purposes of the 55%
requirement. The Company calculates that it is in compliance with this
requirement.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 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
(a) The Annual Meeting of Shareholders of the Company was held
on April 29, 1999.
(c) The following matters were voted on at the Annual Meeting:
(1) Election of Directors
Votes
--------------------
Nominee For Withheld
---------------- ---------- --------
Owen M. Lopez 18,872,510 267,253
James H. Lorie 18,868,379 271,384
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
See "Exhibit Index"
(b) Reports on Form 8-K
None
34
<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: August 4, 1999 By: /s/ Larry A. Goldstone
--------------------------
Larry A. Goldstone
President and Chief Operating Officer
(authorized officer of registrant)
Dated: August 4, 1999 By: /s/ Richard P. Story
-----------------------
Richard P. Story,
Chief Financial Officer and Treasurer
(principal accounting officer)
35
<PAGE>
<TABLE>
<CAPTION>
Exhibit Index
Sequentially
Numbered
Exhibit Number Exhibit Description Page
- -------------- ---------------------------------------------------------- --------------
<S> <C> <C>
10.1 Management Agreement between the Registrant and Thornburg
Mortgage Advisory Corporation dated July 15, 1999 37
10.3.2 Amendment dated April 15, 1999 to the amended and restated
1992 Stock Option and Incentive Plan 52
27 Financial Data Schedule
</TABLE>
36
<PAGE>
EXHIBIT 10.1
MANAGEMENT AGREEMENT
THIS MANAGEMENT AGREEMENT, is entered into as of July 15, 1999, by and
between THORNBURG MORTGAGE ASSET CORPORATION, a Maryland corporation
(hereinafter referred to as the "Company"), and THORNBURG MORTGAGE ADVISORY
CORPORATION, a Delaware corporation (hereinafter referred to as the "Manager"),
with respect to the following:
WITNESSETH:
WHEREAS, the Company is engaged in the business of investing in mortgage
securities ("Mortgage Securities") and mortgage loans ("Mortgage Loans")
(collectively, "Mortgage Assets") and has qualified for the tax benefits
accorded to a real estate investment trust ("REIT") by Sections 856 through 860
of the Internal Revenue Code of 1986 ("Code"), as amended; and
WHEREAS, the Company desires to continue to retain the Manager to manage
the assets of the Company and to perform administrative services for the Company
in the manner and on the terms set forth herein, and wishes to enter into this
Agreement for a ten (10) year term and thereafter until the Company's board of
directors (the "Board of Directors") shall have met to take action on the
renewal or termination of this Agreement; and
WHEREAS, the Manager shall not engage in any activity which would cause it
to be required to register as an investment advisor under the Investment
Advisers Act of 1940; and
WHEREAS, the Manager shall comply with all laws applicable to it and
arising in connection with this Agreement.
NOW THEREFORE, in consideration of the mutual agreements herein set forth,
the parties hereto agree as follows:
SECTION 1. Definitions. Capitalized terms used but not defined herein
-----------
shall have the meanings assigned them in the currently effective Prospectus and
Form 10-K of the Company as filed with the Securities and Exchange Commission as
of the date of this Agreement. In addition, the following terms shall have the
meanings assigned to them:
(a) "Agreement" means this Management Agreement, as amended from time
to time.
(b) "Agreement Date" means the date reflected on page one as of which
this Agreement is signed and dated.
(c) "Average Net Invested Assets" means for any period the difference
between (i) the aggregate book value of the consolidated assets of the Company
and it subsidiaries, before reserves for depreciation or bad debts or other
similar noncash market value adjustments and reserves, and (ii) the book value
of average debt associated with the Company's ownership of Mortgage Assets,
computed by taking the average of such net values at the end of each month
during such period.
(d) "Average Net Worth" means for any period the arithmetic average of
the sum of the gross proceeds from any offering of its equity securities by the
Company, before deducting any underwriting discounts and commissions and other
expenses and costs relating to the offering, plus the Company's retained
earnings (without taking into account any losses incurred in prior periods)
computed by taking the average of such values at the end of each month during
such period, and shall be reduced by any amount that the Company pays for the
repurchases of Common Stock.
37
<PAGE>
(e) "Governing Instruments" means the articles of incorporation and
bylaws in the case of a corporation.
(f) "Return on Equity" means for any quarter the product of the
Company's Net Income for the quarter divided by the Company's Average Net Worth
for the quarter.
SECTION 2. General Duties of the Manager. Subject to the supervision
------------------------------
of the Company's board of directors (the "Board of Directors"), the Manager
shall provide services to the Company, and to the extent directed by the Board
of Directors, shall provide similar services to any subsidiary of the Company as
follows:
(a) serve as the Company's consultant with respect to formulation and
updating of investment criteria and policy guidelines for consideration by the
Board of Directors ("Guidelines");
(b) represent the Company in connection with (i) its commitments to
purchase and (ii) the purchase of Mortgage Assets, including the accumulation of
Mortgage Loans for securitization;
(c) furnish reports and statistical and economic research to the
Company regarding the Company's investments and activities and the services
performed for the Company by the Manager;
(d) monitor and provide to the Board of Directors on an on-going basis
price information and other data obtained from certain nationally recognized
dealers that maintain markets in Mortgage Assets identified by the Board of
Directors from time to time, and provide data and advice to the Board of
Directors in connection with the identification of such dealers;
(e) administer the day-to-day operations of the Company and perform or
supervise the performance of such other administrative functions necessary or
advisable for the management of the Company as may be agreed upon by the Manager
and the Board of Directors including, without limitation, collection of the
Company's revenues and payment of the Company's expenses, debts and obligations
and maintenance of appropriate computer services to provide such administrative
functions;
(f) communicate on behalf of the Company with the holders of the equity
and debt securities of the Company as required to satisfy the continuous
reporting and other requirements of any governmental bodies or agencies to
holders of such securities and third parties and to maintain effective relations
with such holders of the Company's securities;
(g) designate a servicer for those Mortgage Loans sold to the Company
by originators or sellers that have elected not to service such loans and
arrange for the monitoring and administering of such servicers;
(h) counsel the Company in connection with policy decisions to be made
by the Board of Directors;
(i) upon request by and in accordance with the directions of the Board
of Directors, invest or reinvest any money of the Company;
(j) engage in hedging activities on behalf of the Company consistent
with the Company's qualification as a REIT and with the Guidelines;
(k) arrange for the issuance of Mortgage Securities from pools of
Mortgage Loans acquired by the Company, and provide to the Company itself or
through another appropriate party all services in connection with the creation
of Mortgage Securities, including:
(1) serving as consultant with respect to the structuring of each class
or series of Mortgage Securities;
38
<PAGE>
(2) negotiating the rating requirements with rating agencies with
respect to the rating of each class or series of Mortgage Securities;
(3) accumulating and reviewing all Mortgage Loans which may secure or
constitute the mortgage pool for each class or series of Mortgage Securities;
(4) negotiating all agreements and credit enhancements with respect to
each class or series of Mortgage Securities;
(5) issuing commitments on behalf of the Company to purchase Mortgage
Loans to be used to secure or constitute the mortgage pool for each class or
series of Mortgage Securities;
(6) organizing and administering all activities in connection with the
closing of each class or series of Mortgage Securities, including all
negotiations and agreements with underwriters, trustees, servicers, master
servicers and other parties; and
(7) performing such other services as may be required from time to time
for completing the creation of each class or series of Mortgage Securities.
(l) provide to the Company itself or through another appropriate party
all services in connection with the administration of each class or series of
Mortgage Securities created by the Company;
(m) provide the executive and administrative personnel, office space
and services required in rendering the foregoing services to the Company;
(n) perform such other services as may be required from time to time
for management and other activities relating to the assets of the Company as the
Manager shall deem necessary, advisable or appropriate under the particular
circumstances;
(o) cause the Company to qualify to do business in all applicable
jurisdictions as may be required from time to time under applicable state and
federal laws; and
(p) comply with all laws applicable to the Manager and use its best
efforts to cause the Company to comply with all laws applicable to the Company.
SECTION 3. Additional Activities of Manager.
-----------------------------------
(a) Nothing herein shall prevent the Manager or any of its Affiliates
from engaging in other businesses or from rendering services of any kind to any
other person or entity, including investment in, or advisory service to others
investing in, any type of real estate investment, including investments which
meet the principal investment objectives of the Company. Notwithstanding
anything elsewhere in this Agreement to the contrary, the Manager shall not
engage in any activity which would cause it to be required to register as an
investment advisor under the Investment Advisers Act of 1940. In furtherance
thereof, during any twelve (12) month period, the Manager shall not (i) render
investment advice to more than fifteen (15) clients, (ii) hold itself out
generally to the public as an investment advisor, or (iii) act as an investment
advisor to any investment Company that is registered under the Investment
Company Act.
(b) Directors, officers, employees and agents of the Manager or
Affiliates of the Manager may serve as directors, officers, employees, agents,
nominees or signatories for the Company or any subsidiary of the Company, to the
extent permitted by their Governing Instruments, as from time to time amended,
or by any resolutions duly adopted by the Board of Directors pursuant to the
Company's Governing Instruments. When executing documents or otherwise acting
in such capacities for the Company, such persons shall use their respective
title in the Company.
39
<PAGE>
SECTION 4. Bank Accounts. At the direction of the Board of Directors,
-------------
the Manager may establish and maintain one or more bank accounts in the name of
the Company or any subsidiary of the Company, and may collect and deposit into
any such account or accounts, and disburse funds from any such account or
accounts, under such terms and conditions as the Board of Directors may approve;
and the Manager shall from time to time render appropriate accountings of such
collections and payments to the Board of Directors and, upon request by the
Company, to the auditors of the Company or any subsidiary of the Company.
SECTION 5. Records; Confidentiality. The Manager shall maintain
-------------------------
appropriate books of account and records relating to services performed
hereunder, and such books of account and records shall be accessible for
inspection by representatives of the Company or any subsidiary of the Company at
any time during normal business hours. The Manager shall keep confidential any
and all information it obtains from time to time in connection with the services
it renders under this Agreement and shall not disclose any portion thereof to
non-affiliated third parties except with the prior written consent of the
Company, or except as may be required by applicable law or judicial process.
SECTION 6. Obligations of Manager.
------------------------
(a) The Manager shall require each seller or transferor of Mortgage
Assets to the Company to make such representations and warranties regarding such
Mortgage Assets as may be, in the judgment of the Manager, necessary, advisable
and appropriate. In addition, the Manager shall take such other action as it
deems necessary, advisable or appropriate with regard to the protection of the
Company's investments.
(b) The Manager shall refrain from any action which would adversely
affect the status of the Company or, if applicable, any subsidiary of the
Company as a REIT or which would violate any law, rule or regulation of any
governmental body or agency having jurisdiction over the Company or any such
subsidiary or which would otherwise not be permitted by the Company's or such
subsidiary's Governing Instruments. If the Manager is ordered to take any such
action by the Board of Directors, the Manager shall promptly notify the Board of
Directors of the Manager's judgment that such action would adversely affect such
status or violate any such law, rule or regulation or the Governing Instruments.
The Manager, its directors, officers, stockholders and employees shall not be
liable to the Company, any subsidiary of the Company, or the Board of Directors,
including the "Independent Directors" (as defined in the Company's Bylaws), for
any act or omission by the Manager, its directors, officers, stockholders or
employees except as provided in Section 11 of this Agreement.
SECTION 7. Compensation.
------------
(a) Annual Base Management Fee. For services rendered under this
-----------------------------
Agreement, the Company shall pay to the Manager, commencing with the month in
which the Agreement Date occurs, an annual base management fee based on the
Average Net Invested Assets of the Company and its subsidiaries for each year,
payable monthly in arrears, as follows:
1.1% of the first $300 million of Average Net Invested Assets,
plus .8% of the portion of Average Net Invested Assets above
$300 million.
The annual base management fee shall be calculated by the Manager within fifteen
(15) days after the end of the each month, and such calculation shall be
promptly delivered to the Company. The Company shall pay to the Manager the
applicable portion of the annual base management fee payable pursuant to this
Section 7 (a) for each month within thirty (30) days after the end of each such
month. Payments of the applicable portion of the annual base management fee
shall be pro rated based on the number of days elapsed during any partial month.
40
<PAGE>
(b) Incentive Compensation. In addition to the annual base management
-----------------------
fee, the Manager shall receive as incentive compensation for each fiscal quarter
an amount equal to twenty percent (20%) of the Net Income of the Company, before
Incentive Compensation, in excess of the amount that would produce an annualized
Return on Equity equal to the Ten Year U.S. Treasury Rate (average of weekly
average yield to maturity for U.S. Treasury securities (adjusted to a constant
maturity of ten (10) years) as published weekly by the Federal Reserve Board in
publication H.15 during a quarter) plus one percent (1%). The incentive
compensation calculation and payment shall be made quarterly in arrears. The
Manager shall compute the incentive compensation payable under this Section 7(b)
within forty-five (45) days after the end of each fiscal quarter. The Company
shall pay the incentive compensation with respect to each fiscal quarter within
15 days following the delivery to the Company of Manager's written statement
setting forth the computation of the incentive compensation for such quarter.
(c) If loans are made to the Company by an "Affiliate" (as such term is
defined as the Company's by-laws) of the Manager, the maximum amount of interest
that may be charged by such Affiliate shall be the prime rate publicly announced
by Citibank, N.A. from time to time plus 1% per year.
(d) Net Income of the Company, solely for purposes of calculating the
Manager's Incentive Compensation under Section 7(b), shall be determined by
calculating net income available to shareholders of Common Stock, in accordance
with generally accepted accounting principles ("GAAP"), as determined by the
Company's independent certified public accountants.
(e) The proceeds from any issue of preferred stock which may from time
to time be created and authorized for issuance by the Board of Directors (the
"Preferred Stock") shall be included in Average Net Invested Assets in
calculating the Manager's annual base management fee under Section 7(a). For
calculating the Manager's Incentive Compensation, Preferred Stock shall be
excluded from Average Net Worth and the minimum or fixed rate portion of any
Preferred Stock dividend shall be deducted from taxable income before incentive
compensation.
SECTION 8. Expenses of the Company. The Company or any subsidiary of
------------------------
the Company shall pay all of its expenses as set forth on Annex A attached, and
shall reimburse the Manager for documented expenses of the Manager reasonably
incurred on its behalf in furtherance of the Manager's responsibilities under
this Agreement. The reimbursable expenses of the Manager shall include, without
limitation, the amount of any New Mexico Gross Receipts Tax which the Manager
becomes obligated to pay based on the annual base management fees, incentive
compensation and any other receipts which the Manager derives in connection with
its service to the Company. The Manager shall be responsible for its own costs
of operation set forth under Section II on Annex A.
SECTION 9. Annual Operating Expenses Limitation Requiring Reimbursement by
---------------------------------------------------------------
the Manager.
- ------------
(a) Subject to the adjustment as provided in paragraph (b), expenses
incurred by the Manager on behalf of the Company shall be reimbursed monthly to
the Manager within 30 days after the end of each month. The Manager shall
prepare a statement documenting the expenses of the Company and those incurred
by the Manager on behalf of the Company during each month, and shall deliver
such statement to the Company within 15 days after the end of each month.
(b) Within 120 days after the end of each of the Company's fiscal
years, the Manager shall reimburse the Company for any expense reimbursement
received by the Manager from the Company hereunder with respect to such fiscal
year to the extent that the Operating Expenses (as defined in Annex A attached
hereto) of the Company for such fiscal year exceed the greater of 2% of its
Average Net Invested Assets or 25% of its Net Income for such fiscal year;
unless a majority of the Independent Directors determines that, based upon such
unusual or nonrecurring factors which they deem sufficient, a higher level of
expenses is justified for such fiscal year, in which case, such expenses shall
be payable to the Manager in succeeding fiscal years to the extent that the
expenses of the Company are less than the greater of 2% of its Average Net
Invested Assets or 25% of its Net Income for such fiscal year. The
determination of Net Income for any period for purposes of calculating the
expense limitation will be the same as for calculating the Manager's incentive
compensation, except that the determination of Net Income for purposes of
calculating the expense limitation will include any incentive compensation
payable for such period. The amount of any Gross Receipts Tax reimbursed by the
Company to the Manager pursuant to Section 8 above, as well as the other costs
and expenses enumerated on Annex A attached hereto, are not Operating Expenses
and are not subject to the operating expense limitation set forth above.
41
<PAGE>
SECTION 10. Monitoring Servicing. The Manager will monitor and administer
--------------------
the servicing of the Company's Mortgage Loans, other than loans pooled to back
Mortgage Securities. Such monitoring and administrative services will include,
but not be limited to, the following activities: serving as the Company's
consultant with respect to the servicing of loans; collection of information and
submission of reports pertaining to the Mortgage Loans and to moneys remitted to
the Manager or the Company by Servicers; periodic review and evaluation of the
performance of each servicer to determine its compliance with the terms and
conditions of the applicable servicing agreement and, if deemed appropriate,
recommending to the Company the termination of such servicing agreement; acting
as a liaison between Servicers and the Company and working with servicers to the
extent necessary to improve their servicing performance; review of and
recommendations as to fire losses, easement problems and condemnation,
delinquency, foreclosing and other reports on Mortgage Loans; supervising claims
filed under any mortgage insurance policies; and enforcing the obligation of any
servicer to repurchase Mortgage Loans from the Company. The Manager may enter
into subcontracts with other parties, including its Affiliates, to provide any
such services for the Manager; provided however, all such subcontractors shall
----------------
then be subject to the terms of this Agreement and the Manager shall provide
written notice of such subcontracts to the Company; and, provided further, in no
-------- -------
event shall any such subcontracts or subcontractors contravene the Manager's
obligations and limitations set forth in Section 3 (a) of this Agreement.
SECTION 11. Limits of Manager Responsibility.
-----------------------------------
(a) The Manager assumes no responsibility under this Agreement other
than to render the services called for hereunder in good faith and shall not be
responsible for any action of the Board of Directors in following or declining
to follow any advice or recommendations of the Manager. The Manager, its
directors, officers, stockholders and employees will not be liable to the
Company, any subsidiary of the Company, the independent Directors or the
Company's or its subsidiary's stockholders for any acts or omissions by the
Manager, its directors, officers, stockholders or employees under or in
connection with this Agreement, except by reason of acts constituting bad faith,
willful misconduct, gross negligence or reckless disregard of their duties. The
Company shall reimburse, indemnify and hold harmless the Manager, its
stockholders, directors, officers and employees of and from any and all
expenses, losses, damages, liabilities, demands, charges and claims of any
nature whatsoever (including, without limitation, attorneys' fees) in respect of
or arising from any acts or omissions of the Manager, its stockholders,
directors, officers and employees made in good faith in the performance of the
Manager's duties under this Agreement and not constituting bad faith, willful
misconduct, gross negligence or reckless disregard of its duties.
(b) The Manager shall reimburse, indemnify and hold harmless the
Company, any subsidiary, or any of their stockholders, directors, officers and
employees from any and all expenses, losses, damages, liabilities, demands,
charges and claims (including, without limitation, attorneys' fees) arising out
of any intentional misstatements of fact made by the Manager in connection with
the issuance of commitments to purchase Mortgage Assets on behalf of the Company
and the purchase of Mortgage Assets by the Company resulting from such
commitments.
SECTION 12. No Joint Venture. The Company and the Manager are not
------------------
partners or joint venturers with each other and nothing herein shall be
construed to make them such partners or joint venturers or impose any liability
as such on either of them.
SECTION 13. Term; Termination.
------------------
(a) This Agreement shall commence on the Agreement Date and shall
continue in force until the next regularly scheduled Board of Directors meeting
of the Company following the tenth anniversary of the Agreement Date, and
thereafter, it may be extended only with the consent of the Manager and by the
affirmative vote of a majority of the Board of Directors, including a majority
of the Independent Directors. Each extension shall be executed in writing by
the parties hereto before the expiration of this Agreement or any extension
thereof. Each such extension shall not exceed a term of ten years.
Notwithstanding any other provision to the contrary, this Agreement, or any
extension hereof, may be terminated by the Company, upon 60 days written notice,
by majority vote of the Independent Directors or by majority vote of the
Stockholders. If this Agreement is terminated pursuant to this Section 13, such
termination shall be subject to the provisions of Section 16 of this Agreement.
42
<PAGE>
(b) Name Change Upon Termination of Management Agreement. The Company
-----------------------------------------------------
agrees that, if at any time the Manager or any Affiliate of the Manager shall
cease to serve generally as Manager of the Company or any Subsidiary, upon
receipt of a written request of the Manager, the Company and such Subsidiary
will cause their governing instruments, including articles of incorporation and
by-laws, to be amended so as to change the name of the Company or such
Subsidiary to a name that does not include "Thornburg" or any approximation
thereof.
(c) The Independent Directors shall determine at least annually that
the compensation paid to the Manager is reasonable in relation to the nature and
quality of services performed and also shall supervise performance of the
Manager and the compensation paid to it to determine that the provisions of this
Agreement are being carried out. The Independent Directors shall also determine
at least annually that the total fees and expenses of the Company are reasonable
in light of all relevant factors. Each such determination shall be based upon
the following factors and all other factors the Independent Directors may deem
relevant and the findings of the Independent Directors on each of such factors
shall be recorded in the minutes of the Board of Directors:
(1) the size of the management fee in relation to the size,
compensation and profitability of the investment portfolio of the Company;
(2) the success of the Manager in generating opportunities that meet
the investment objectives of the Company;
(3) the rates charged to other real estate investment trusts and to
other investors by advisors performing similar services;
(4) additional revenues realized by the Manager and its affiliates
through their relationship with the Company whether paid by the Company or by
others with whom the Company does business;
(5) the quality and extent of service and advice furnished to the
Company;
(6) the performance of the investment portfolio of the Company,
including income, conservation or appreciation of capital, frequency of problem
investments and competence in dealing with distress situations; and
(7) the quality of the investment portfolio of the Company.
SECTION 14. Assignments.
-----------
(a) Except as set forth in Section 13(b) of this Agreement, this
Agreement shall terminate automatically in the event of its assignment, in whole
or in part, by the Manager, unless the Company (with the approval of a majority
of the Independent Directors) consents to such assignment in advance. Any such
assignment shall bind the assignee hereunder in the same manner as the Manager
is bound. In addition, the assignee shall execute and deliver to the Company a
counterpart of this Agreement naming such assignee as Manager. This Agreement
shall not be assigned by the Company without the prior written consent of the
Manager, except in the case of assignment by the Company to a REIT or other
organization which is a successor (by merger, consolidation or purchase of
assets) to the Company, in which case such successor organization shall be bound
hereunder and by the terms of such assignment in the same manner as the Company
is bound hereunder.
(b) Notwithstanding any provision of this Agreement to the contrary,
subject to Section 3(a), the Manager may subcontract and assign any or all of
its responsibilities under Sections 2(k), 2(l) and 10 of this Agreement to any
of its Affiliates, and the Company hereby consents to any such assignment and
subcontracting.
43
<PAGE>
SECTION 15. Termination by Company for Cause. At the option of the
------------------------------------
Company, this Agreement shall be and become terminated upon 60 days written
notice of termination from the Board of Directors to the Manager if any of the
following events shall occur:
(a) if the Manager shall violate any provision of this Agreement and,
after notice of such violation, shall not cure such violation within 30 days;
(b) there is entered an order for relief or similar decree or order
with respect to the Manager by a court having competent jurisdiction in an
involuntary case under the federal bankruptcy laws as now or hereafter
constituted or under any applicable federal or state bankruptcy, insolvency or
other similar laws; or the Manager (i) ceases, or admits in writing its
inability to pay its debts as they become due and payable, or makes a general
assignment for the benefit of, or enters into any composition or arrangement
with, creditors; (ii) applies for, or consents (by admission of material
allegations of a petition or otherwise) to the appointment of a receiver,
trustee, assignee, custodian, liquidator or sequestrator (or other similar
official) of the Manager or of any substantial part of its properties or assets,
or authorizes such an application or consent, or proceedings seeking such
appointment are commenced without such authorization, consent or application
against the Manager and continue undismissed for 30 days; (iii) authorizes or
files a voluntary petition in bankruptcy, or applies for or consents (by
admission of material allegations of a petition or otherwise) to the application
of any bankruptcy, reorganization, arrangement, readjustment of debt,
insolvency, dissolution, liquidation or other similar law of any jurisdiction,
or authorizes such application or consent, or proceedings to such end are
instituted against the Manager without such authorization, application or
consent and are approved as properly instituted and remain undismissed for 30
days or result in adjudication of bankruptcy or insolvency; or (iv) permits or
suffers all or any substantial part of its properties or assets to be
sequestered or attached by court order and the order remains undismissed for 30
days; or
(c) If any of the events specified in Section 15(b) of this Agreement
shall occur, the Manager shall give prompt written notice thereof to the Board
of Directors upon the occurrence of such event.
SECTION 16. Action Upon Termination.
-------------------------
(a) From and after the effective date of termination of this Agreement,
pursuant to Sections 13, 14 or 15 of this Agreement, the Manager shall not be
entitled to compensation for further services hereunder, except pursuant to any
------
separate written management termination agreement that may hereafter be
negotiated by the parties, but shall be paid all compensation accruing to the
date of termination, including deferred incentive compensation which is
recoverable in accordance with Section 7(e) of this Agreement. Upon such
termination, the Manager shall forthwith:
(1) after deducting any accrued compensation and reimbursement for its
expenses to which it is then entitled, pay over to the Company or any subsidiary
of the Company all money collected and held for the account of the Company or
any subsidiary of the Company pursuant to this Agreement;
(2) deliver to the Board of Directors a full accounting, including a
statement showing all payments collected by it and a statement of all money held
by it, covering the period following the date of the last accounting furnished
to the Board of Directors with respect to the Company or any subsidiary of the
Company;
(3) pay to the Company all sums set forth on the accounting referenced
in (b) above; and
(4) deliver to the Board of Directors all property and documents of the
Company or any subsidiary of the Company then in the custody of the Manager.
44
<PAGE>
(b) Upon the occurrence of (i) an "Acquisition Event" or (ii) the
termination of this Agreement by the Company (in either case, a "Termination
Event"), other than a termination for cause on the grounds set forth in Section
15 of this Agreement, the Company agrees to, and shall be obligated to, acquire
and pay for substantially all of the assets of the Manager in a transaction
intended to qualify, in the opinion of counsel reasonably acceptable to the
Manager, as a tax free reorganization pursuant to Section 368(a)(1)(A) or
368(a)(1)(C) of the Internal Revenue Code, as amended, (the "Reorganization").
The Reorganization shall be effected in a transaction intended to qualify, in
the opinion of the Company's certified public accountants, as a pooling of
interests for financial accounting purposes if such treatment is then available
and, in the determination of the Company, advisable. In consideration for the
Reorganization, the Company shall issue to the Manager an amount of publicly
registered shares of Common Stock of the Company, calculated as follows:
(1) The Manager will retain an independent certified public accountant
mutually acceptable to the Company and the Manager to prepare in accordance with
generally accepted accounting principals on the cash receipts and disbursements
method of accounting audited financial statements for the three 12 month periods
(the "Statements") over the thirty-six month period ending with the most
recently completed calendar quarter (the "Measuring Period"). The Statements
will show gross revenues received by the Manager less all expenses (excluding
bonus payments to the Manager's employees and affiliates) paid by the Manager
during the Measuring Period.
(2) The Company will issue to the Manager as payment for the
Reorganization that number of shares of Common Stock of the Company equal to
120% of the quotient of the Manager's net profit (excluding bonus payments to
the Manager's employees and affiliates) on the Statement for the 12 month period
showing the highest net profit during the Measuring Period, divided by the
dividend per share declared by the Company during the most recent fiscal quarter
in which a dividend was declared, on an annualized basis; provided, however,
that such Reorganization payment shall not be less than the sum of $5 million
for each $100 million of equity capital attributable to the Company's Common
Stock and preferred stock.
(3) "Acquisition Event" means -- (A) the acquisition by any person or
entity who or which, together with all affiliates and associates of such person
or entity shall become the beneficial owner of 20% or more of the common stock
of the Company then outstanding, but shall not include the Company, any
subsidiary or employee benefit plan thereof (collectively, "Excluded Entities"),
through an unsolicited tender offer or exchange offer or other acquisition of
such number of shares by such person, or -- (B) a change in the majority of the
Board of Directors of the Company, whether by resignation or removal, which
change occurs as a result of the acquisition of a controlling interest in the
outstanding voting stock of the Company by any person or entity, other than
Excluded Entities, or -- (C) a merger, consolidation, or reorganization between
the Company and another entity with the Company being either the surviving
entity or the acquired entity, or the transfer of assets into the Company for
stock or other equity securities of the Company, or securities exercisable or
convertible into equity securities by any person or entity, other than Excluded
Entities.
(4) The Company shall at all times keep and maintain an adequate
reserve of authorized but unissued shares available to fulfill the obligation to
issue shares pursuant to the Reorganization.
(5) Upon the occurrence of an Acquisition Event, the Company shall
promptly file a registration statement and use its best efforts to cause such
registration statement to become effective under the Securities Act of 1933, as
amended, with respect to the public offering and distribution of such shares
reserved for issuance pursuant to the Reorganization.
(6) The Company and the Manager will, as soon as possible after the
occurrence of an Acquisition Event, but in no event later than 60 days after the
Acquisition Event, take all necessary corporate action to consummate and close
the Reorganization, including the Company's issuance of the shares of common
stock to the Manager as determined in paragraph (2) above.
45
<PAGE>
SECTION 17. Release of Money or Other Property Upon Written Request. The
-------------------------------------------------------
Manager agrees that any money or other property of the Company or any subsidiary
of the Company held by the Manager under this Agreement shall be held by the
Manager as custodian for the Company or such subsidiary, and the Manager's
records shall be appropriately marked clearly to reflect the ownership of such
money or other property by the Company or such subsidiary. Upon the receipt by
the Manager of a written request signed by a duly authorized officer of the
Company requesting the Manager to release to the Company or any subsidiary of
the Company any money or other property then held by the Manager for the account
of the Company or any subsidiary of the Company under this Agreement, the
Manager shall release such money or other property to the Company or any
subsidiary of the Company within a reasonable period of time, but in no event
later than 30 days following such request. The Manager shall not be liable to
the Company, any subsidiary of the Company, the Independent Directors, or the
Company's stockholders for any acts performed or omissions to act by the Company
or any subsidiary of the Company in connection with the money or other property
released to the Company or any subsidiary of the Company in accordance with this
Section. Subject to the foregoing, the Company shall indemnify the Manager, its
directors, officers, stockholders and employees against any and all expenses,
losses, damages, liabilities, demands, charges and claims of any nature
whatsoever, which arise in connection with the Manager's release of such money
or other property to the Company or any subsidiary of the Company in accordance
with the terms of this Section 17. Indemnification pursuant to this provision
shall be in addition to any right of the Manager to indemnification under
Section 11 of this Agreement.
SECTION 18. Representations and Warranties.
--------------------------------
(a) The Company hereby represents and warrants to the Manager as
follows:
(1) The Company is duly organized, validly existing and in good
standing under the laws of the jurisdiction of its incorporation, has the
corporate power to own its assets and to transact the business in which it is
now engaged and is duly qualified as a foreign corporation and in good standing
under the laws of each jurisdiction where its ownership or lease of property or
the conduct of its business requires such qualification, except for failures to
be so qualified, authorized or licensed that could not in the aggregate have a
material adverse effect on the business, operations, assets or financial
condition of the Company and its subsidiaries, taken as a whole. The Company
does not do business under any fictitious business name.
(2) The Company has the corporate power and authority to execute,
deliver and perform this Agreement and all obligations required hereunder and
has taken all necessary corporate action to authorize this Agreement on the
terms and conditions hereof and the execution, delivery and performance of this
Agreement and all obligations required hereunder. No consent of any other person
including, without limitation, stockholders and creditors of the Company, and no
license, permit, approval or authorization of, exemption by, notice or report
to, or registration, filing or declaration with, any governmental authority is
required by the Company in connection with this Agreement or the execution,
delivery, performance, validity or enforceability of this Agreement and all
obligations required hereunder. This Agreement has been, and each instrument or
document required hereunder will be, executed and delivered by a duly authorized
officer of the Company, and this Agreement constitutes, and each instrument or
document required hereunder when executed and delivered hereunder will
constitute, the legally valid and binding obligation of the Company enforceable
against the Company in accordance with its terms.
(3) The execution, delivery and performance of this Agreement and the
documents or instruments required hereunder, will not violate any provision of
any existing law or regulation binding on the Company, or any order, judgment,
award or decree of any court, arbitrator or governmental authority binding on
the Company, or the Governing Instruments of, or any securities issued by the
Company or of any mortgage, indenture, lease, contract or other agreement,
instrument or undertaking to which the Company is a party or by which the
Company or any of its assets may be bound, the violation of which would have a
material adverse effect on the business operations, assets or financial
condition of the Company and its subsidiaries, taken as a whole, and will not
result in, or require, the creation or imposition of any lien on any of its
property, assets or revenues pursuant to the provisions of any such mortgage,
indenture, lease, contract or other agreement, instrument or undertaking.
(4) Nothing in this Agreement shall or is intended to contravene any
fact or representation set forth in any prospectus, registration statement,
annual report or quarterly report as filed by the Company with the Securities
and Exchange Commission.
(b) The Manager hereby represents and warrants to the Company as
follows:
46
<PAGE>
(1) The Manager is duly organized, validly existing and in good
standing under the laws of the jurisdiction of its formation, has the corporate
power to own its assets and to transact the business in which it is now engaged
and is duly qualified to do business and is in good standing under the laws of
each jurisdiction where its ownership or lease of property or the conduct of its
business require such qualification, except for failures to be so qualified,
authorized or licensed that could not in the aggregate have a material adverse
effect on the business operations, assets or financial condition of the Manager
and its subsidiaries, taken as a whole. The Manager does not do business under
any fictitious business name.
(2) The Manager has the corporate power and authority to execute,
deliver and perform this Agreement and all obligations required hereunder and
has taken all necessary partnership action to authorize this Agreement on the
terms and conditions hereof and the execution, delivery and performance of this
Agreement and all obligations required hereunder. No consent of any other
person including, without limitation, partners and creditors of the Manager, and
no license, permit, approval or authorization of, exemption by, notice or report
to, or registration, filing or declaration with, any governmental authority is
required by the Manager in connection with this Agreement or the execution,
delivery, performance, validity or enforceability of this Agreement and all
obligations required hereunder. This Agreement has been, and each instrument or
document required hereunder will be executed and delivered by a duly authorized
agent of the Manager, and this Agreement constitutes, and each instrument or
document required hereunder when executed and delivered hereunder will
constitute, the legally valid and binding obligation of the Manager enforceable
against the Manager in accordance with its terms.
(3) The execution, delivery and performance of this Agreement and the
documents or instruments required hereunder, will not violate any provision of
any existing law or regulation binding on the Manager, or any order, judgment,
award or decree of any court, arbitrator or governmental authority binding on
the Manager, or any securities issued by the Manager or of any mortgage,
indenture, lease, contract or other agreement, instrument or undertaking to
which the Manager is a party or by which the Manager or any of its assets may be
bound, the violation of which would have a material adverse effect on the
business operations, assets or financial condition of the Manager and its
subsidiaries, taken as a whole, and will not result in, or require, the creation
or imposition of any lien on any of its property assets or revenues pursuant to
the provisions of any such mortgage indenture, lease, contract or other
agreement, instrument or undertaking.
(4) Nothing in this Agreement shall or is tended to contravene any fact
or representation set forth in the Prospectus.
SECTION 19. Notice. Unless expressly provided otherwise herein, all
------
notices, request, demands and other communications required or permitted under
this Agreement shall be in writing and shall be deemed to have been duly given,
made and received when delivered against receipt or upon actual receipt of
registered or certified mail, postage prepaid, return receipt requested. The
parties may deliver to each other notice by electronically transmitted facsimile
copies ("Fax") provided that such Fax notice is followed within twenty-four (24)
hours by any type of notice otherwise provided for in this paragraph. Any
notice shall be duly addressed to the parties as follows:
47
<PAGE>
If to the Company: 119 East Marcy
Santa Fe, NM 87501
Attention: Larry A. Goldstone
Copy to: Michael B. Jeffers, Esq.
Jeffers, Wilson, Shaff & Falk, LLP
18881 Von Karman Avenue, Suite 1400
Irvine, CA 92612
If to the Manager: 119 East Marcy
Santa Fe, NM 87501
Attention: Garrett Thornburg
Copy to: Michael B. Jeffers, Esq.
Jeffers, Wilson, Shaff & Falk, LLP
18881 Von Karman Avenue, Suite 1400
Irvine, CA 92612
Either party may alter the address to which communications or copies are to be
sent by giving notice of such change of address in conformity with the
provisions of this Section 19 for the giving of notice.
SECTION 20. Binding Nature of Agreement; Successors and Assigns. This
------------------------------------------------------
Agreement shall be binding upon and inure to the benefit of the parties hereto
and their respective heirs, personal representatives, successors and assigns as
provided herein.
SECTION 21. Entire Agreement. This Agreement contains the entire
-----------------
agreement and understanding among the parties hereto with respect to the subject
matter hereof, and supersedes all prior and contemporaneous agreements,
understandings, inducements and conditions, express or implied, oral or written,
of any nature whatsoever with respect to the subject matter hereof. The express
terms hereof control and supersede any course of performance and/or usage of the
trade inconsistent with any of the terms hereof. This Agreement may not be
modified or amended other than by an agreement in writing approved by the
Company (including a majority of the Independent Directors) and the Manager.
SECTION 22. Controlling Law. This Agreement and all questions relating to
---------------
its validity, interpretation, performance and enforcement shall be governed by
and construed, interpreted and enforced in accordance with the laws of the State
of New Mexico, notwithstanding any New Mexico or other conflict of law
provisions to the contrary.
SECTION 23. Schedules and Exhibits. All Schedules and Exhibits referred
-----------------------
to herein or attached hereto are hereby incorporated by reference into, and made
a part of, this Agreement.
SECTION 24. Indulgences, Not Waivers. Neither the failure nor any delay
-------------------------
on the part of a party to exercise any right, remedy, power or privilege under
this Agreement shall operate as a waiver thereof, nor shall any single or
partial exercise of any right, remedy, power or privilege, nor shall any waiver
of any right, remedy, power or privilege with respect to any occurrence be
construed as a waiver of such right, remedy, power or privilege with respect to
any other occurrence. No waiver shall be effective unless it is in writing and
is signed by the party asserted to have granted such waiver.
SECTION 25. Titles Not to Affect Interpretation. The titles of paragraphs
-----------------------------------
and subparagraphs contained in this Agreement are for convenience only, and they
neither form a part of this Agreement nor are they to be used in the
construction or interpretation hereof.
48
<PAGE>
SECTION 26. Execution in Counterparts. This Agreement may be executed in
-------------------------
any number of counterparts, including electronically transmitted counterparts,
each of which shall be deemed to be an original as against any party whose
signature appears thereon, and all of which shall together constitute one and
the same instrument. this Agreement shall become binding when one or more
counterparts hereof, individually or taken together, shall bear the signatures
of all of the parties reflected hereon as the signatories.
SECTION 27. Provisions Separable. The provisions of this Agreement are
---------------------
independent of and separable from each other, and no provision shall be affected
or rendered invalid or unenforceable by virtue of the fact that for any reason
any other or others of them may be invalid or unenforceable in whole or in part.
SECTION 28. Gender. Words used herein regardless of the number and gender
------
specifically used, shall be deemed and construed to include any other number,
singular or plural, and any other gender, masculine, feminine or neuter, as the
context requires.
SECTION 29. Computation of Interest. Interest will be computed on the
-------------------------
basis of a 360-day year consisting of twelve months of thirty days each.
[SIGNATURE PAGE FOLLOWS]
49
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Management
Agreement as of the date first written above.
"Company"
THORNBURG MORTGAGE ASSET CORPORATION
a Maryland corporation
By: /s/ Larry A. Goldstone
-------------------------
Larry A. Goldstone, President
"Manager"
THORNBURG MORTGAGE ADVISORY CORPORATION,
a Delaware corporation
By: /s/ Garrett Thornburg
-----------------------
Garrett Thornburg, Chairman
50
<PAGE>
ANNEX A
Definition of "Operating Expenses"
I. The term "Operating Expenses" means all of the Company's ordinary and
necessary operating expenses of every type including, but not limited to, costs
of operating, owning, acquiring, carrying, monitoring the servicing of and
disposing of the Company's assets, including software and costs of equipment
related thereto, and costs of organizing any subsidiary of the Company, costs of
issuing, servicing, paying dividends or interest on, selling or reacquiring any
instrument or security or mortgage asset (whether or not a security), costs
preparatory to entering into a business or activity, costs of winding up or
disposing of a business or activity, interest, points, fees, finance costs,
costs of maintaining compliance with governmental requirements of any type,
taxes, losses, bad debts of any type, in each case incurred by or on behalf of
the Company regardless whether such expenses and costs would be treated as
current costs or expenses for tax purposes or under generally accepted
accounting principles.
II. The term "Operating Expenses" of the Company shall not include the
following:
(A) employment expenses of the Manager's personnel (including
Directors, officers, and employees of the Company who are directors, officers,
or employees of the Manager or its Affiliates), other than the expenses of those
employee services listed in Section I above; and
(B) rent, telephone, utilities, and office furnishings and other office
expenses of the Manager (except those relating to a separate office, if any,
maintained by the Company).
51
<PAGE>
EXHIBIT 10.3.2
THORNBURG MORTGAGE ASSET CORPORATION
1992 STOCK OPTION AND INCENTIVE PLAN,
AMENDMENT DATED AS OF APRIL 15, 1999
52
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
1992 STOCK OPTION AND INCENTIVE PLAN
AMENDMENT DATED AS OF APRIL 15, 1999
Pursuant to Section 12 of the 1992 Stock Option and Incentive Plan, amended
and restated as of March 14, 1997, as previously amended as of December 19, 1997
(the "Plan"), the Board of Directors of Thornburg Mortgage Asset Corporation
(the "Company") hereby revises and amends the terms of the Plan as follows:
1. The fourth article of the Plan is amended by adding as Section 4(d)
thereof, the following:
d. Interested Committee Member. Grants pursuant to Section 7(c) to be
----------------------------
made to a Non-Employee Director who is a member of the Committee are subject to
approval by the Committee without the participation or vote of the proposed
recipient Non-Employee Director.
2. Section 7(b) of the Plan is amended and restated in its entirety to
read as follows:
b. Written Agreements.
-------------------
i. Agreements. Grants to Eligible Persons shall be evidenced by
----------
written Agreements in such form as the Committee shall from time to time
determine. Such Agreements shall comply with and be subject to the terms and
conditions set forth below.
ii. Number of Shares. The Agreement affecting each Option or other
------------------
Grant made to an Eligible Person shall state the number of Shares to which it
pertains and shall provide for the adjustment thereof in accordance with the
provisions of Section 10 hereof.
3. Section 7(c) (iv) of the Plan is amended and restated in its
entirety to read as follows:
i. Generally, to exercise such powers and to perform such acts as are
deemed necessary or expedient to promote the best interests of the Company with
respect to the Plan. Each Option shall state the Exercise Price. The Exercise
Price for any Option shall not be less than the Fair Market Value on the date of
Grant.
4. The first sentence of Section 7(d) of the Plan is amended and
restated in its entirety to read as follows:
d. The Purchase Price for each Option granted to an Optionee shall be
payable in full in United States dollars upon the exercise of the Option.
5. Section 7(f) of the Plan in amended and restated in its entirety to
read as follows:
f. Termination of Employment, Except by Death or Disability. Upon any
---------------------------------------------------------
Termination of Employment for any reason other than his or her death or
Disability, a recipient of a Grant shall have the right, subject to the
restrictions of (c) above, to exercise or redeem his or her Grant at any time
within three (3) months after Termination of Employment, but only to the extent
that, at the date of Termination of Employment, the recipient's right to
exercise or redeem such Grant had accrued pursuant to the terms of the
applicable Agreement and had not previously been exercised; provided, however,
-----------------
that if the recipient was terminated as an Employee or removed as a member of
the Board for cause (as defined in the applicable Agreement or as determined by
the Committee) any Grant not exercised or redeemed in full prior to such
termination shall be canceled; and further provided, however, no DERs, SARs or
-------------------------
PSRs shall accrue for such recipient after the effect date of his or her
Termination of Employment. For this purpose, the employment relationship shall
be treated as continuing intact while the recipient is on military leave, sick
leave or other bona fide leave of absence (to be determined in the sole
discretion of the Committee). The foregoing notwithstanding, in the case of an
Incentive Stock Option, employment shall not be deemed to continue beyond the
ninetieth (90th) day after the Optionee's reemployment rights are guaranteed by
statute or by contract.
6. Section 7(j) of the Plan is amended and restated in its entirety to
read as follows:
53
<PAGE>
j. Modification, Extension and Renewal of Option. Within the
--------------------------------------------------
limitations of the Plan, including Section 4(d) hereof, with respect to Options,
the Committee may modify, extend or renew outstanding Options or accept the
cancellation of outstanding Options (to the extent not previously exercised) for
the granting of new Options in substitution therefor. The Committee may not
modify, extend or renew any Option unless such modification, extension or
renewal shall satisfy the requirements of Rule 16b-3. The foregoing
notwithstanding, no modification of an Option shall, without the consent of the
Optionee, alter or impair any rights or obligations under any Option previously
granted.
The Company has caused this amendment of the Plan to be executed in the
name and on behalf of the Company by an officer of the Company thereunto duly
authorized as of April 15, 1999.
THORNBURG MORTGAGE ASSET CORPORATION
a Maryland corporation
By: /s/ Garrett Thornburg
-------------------------
Garrett Thornburg,
Chairman
54
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the June 30,
1999 Form 10-Q and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 39746
<SECURITIES> 4464974
<RECEIVABLES> 45126
<ALLOWANCES> 2924
<INVENTORY> 0
<CURRENT-ASSETS> 7447
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4554369
<CURRENT-LIABILITIES> 4225299
<BONDS> 0
<COMMON> 220
0
65805
<OTHER-SE> 263045
<TOTAL-LIABILITY-AND-EQUITY> 4554369
<SALES> 0
<TOTAL-REVENUES> 122767
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2665
<LOSS-PROVISION> 1375
<INTEREST-EXPENSE> 107094
<INCOME-PRETAX> 11633
<INCOME-TAX> 0
<INCOME-CONTINUING> 11633
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11633
<EPS-BASIC> .39
<EPS-DILUTED> .39
</TABLE>
