UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 001-11914
THORNBURG MORTGAGE ASSET CORPORATION
(DBA THORNBURG MORTGAGE, INC.)
(Exact name of Registrant as specified in its Charter)
MARYLAND 85-0404134
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
119 E. MARCY STREET 87501
SANTA FE, NEW MEXICO (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code (505) 989-1900
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Exchange on Which Registered
---------------------- -----------------------------------------
Common Stock ($.01 par value) New York Stock Exchange
Series A 9.68% Cumulative Convertible Preferred Stock ($.01 par value) New
York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all 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.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At February 29, 2000, the aggregate market value of the voting stock held by
non-affiliates was $166,836,664, based on the closing price of the common stock
on the New York Stock Exchange.
Number of shares of Common Stock outstanding at February 29 , 2000: 21,489,663
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Registrant's definitive Proxy Statement dated March 27,
2000, issued in connection with the Annual Meeting of Shareholders of the
Registrant to be held on April 27, 2000, are incorporated by reference into
Parts I and III.
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THORNBURG MORTGAGE ASSET CORPORATION
(dba THORNBURG MORTGAGE, INC.)
1999 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Page
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ITEM 1. BUSINESS 4
ITEM 2. PROPERTIES 21
ITEM 3. LEGAL PROCEEDINGS 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED SHAREHOLDER MATTERS 22
ITEM 6. SELECTED FINANCIAL DATA 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 24
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISKS 44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 44
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 44
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 45
ITEM 11. EXECUTIVE COMPENSATION 45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT 45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 45
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K 45
FINANCIAL STATEMENTS F-1
SIGNATURES
EXHIBIT INDEX
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PART I
ITEM 1. BUSINESS
GENERAL
Thornburg Mortgage Asset Corporation, including 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. See "Federal Income Tax Considerations -- Requirements
for Qualification as a REIT". The Company has two REIT qualified subsidiaries
which are involved in financing its mortgage loan assets. The two financing
subsidiaries, Thornburg Mortgage Funding Corporation and Thornburg Mortgage
Acceptance Corporation, are consolidated in the Company's financial statements
and federal and state tax returns. In 1999, the Company formed a new REIT
qualified subsidiary, Thornburg Mortgage Home Loans, Inc., to originate loans
for the Company according to the Company's underwriting guidelines. This new
subsidiary did not commence any operations in 1999 but is expected to during the
first half of 2000.
Acquisition of FASLA Holding Company
On December 23, 1999, the Company and Thornburg Mortgage Advisory Corporation
(the "Manager") entered into an agreement to purchase FASLA Holding Company,
whose principal holding is First Arizona Savings, a privately held Phoenix-based
federally chartered thrift institution with six retail branch offices and, at
the time, approximately $138 million in assets. The cash purchase price is $15
million, subject to certain adjustments. The acquisition is subject to
regulatory approval which is expected to be received by mid-2000. Due to
ownership restrictions in the current Internal Revenue Code applicable to REITs,
the purchase has been structured such that the Company will pay 95% of the
purchase price for preferred stock of FASLA Holding Company which will represent
95% of the economic interests in FASLA Holding Company and the Manager will pay
5% of the purchase price for common shares with 100% of the voting rights of
FASLA Holding Company which will represent 5% of the economic value of FASLA
Holding Company. In this structure, FASLA Holding Company would be an
unconsolidated qualified taxable REIT subsidiary of the Company. During 1999,
legislation was enacted by the U.S. Congress, effective January 1, 2001, that
will permit REITs to have 100% ownership in qualified taxable subsidiaries,
subject to certain limitations, that would allow the Company and the Manager to
alter this structure such that FASLA Holding Company may become a wholly-owned
taxable subsidiary of the Company that would be consolidated for financial
statement purposes.
The primary purpose of this acquisition is to obtain nationwide lending
authority in order to expand the Company's acquisition channels for ARM loans.
As a federally chartered thrift institution, First Arizona Savings has the
authority to be a nationwide lender. The Company intends to initiate a mortgage
banking division within First Arizona Savings that would originate loans for
sale to the Company, based upon the Company's underwriting standards and ARM
product designs. It will also likely offer other standard loan products,
including fixed-rate loans, that would be originated and sold to third party
investors. The Company expects to avoid establishing an expensive
infrastructure involving substantial fixed costs generally associated with
operating a mortgage banking operation by utilizing private-label "fee based"
third-party vendors who (1) specialize in the underwriting, processing and
closing of mortgage loans and (2) a sub-servicer to provide the capability to
service the loans originated. The Company believes these third-party service
providers have developed both efficiencies and expertise through specialization
that afford the Company an opportunity to enter the mortgage origination and
loan servicing business in a cost effective manner with very little "up front"
investment.
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The Company also expects to continue operating First Arizona Savings as a full
service community bank within its current local market areas. First Arizona
Savings has traditionally been an originator of single-family residential loans,
both permanent and construction, based on underwriting standards that are
similar to the Company's. First Arizona Savings has generally retained ARM and
Hybrid ARM loans for its portfolio and have sold a significant percentage of
their fixed-rate loan production to FHLMC. First Arizona's primary source of
funds has been retail deposits and a limited amount of Federal Home Loan Bank
advances. The Company believes this business model is a consistent extension of
the Company's existing business model that emphasizes high credit quality
lending and prudent interest rate risk management. Further, the Company
believes that by utilizing third-party service provider specialists for the
mortgage banking division, the Company will be able to operate very cost
effectively with minimal capital at risk consistent with the Company's existing
business model.
Thornburg Brand Development
In 1999, the Company instituted a new marketing approach in conjunction with
affiliates aimed at developing brand recognition of the Thornburg name. In the
process, the Company has refined its marketing message and updated the Company's
logo and corporate literature. The Company began doing business as ("dba")
Thornburg Mortgage, Inc. as of October 14, 1999. In conjunction with these
efforts, the Board of Directors approved an amendment to the Company's Articles
of Incorporation to formally change the name of the Company to Thornburg
Mortgage, Inc. which will be voted on by the shareholders at the Shareholders
Meeting scheduled for April 27, 2000. This new name more accurately reflects
the expanded business of the Company from purely an asset manager to a
value-added operating enterprise that originates and services mortgage loans as
well as manages a portfolio of high quality mortgage assets on a low cost
basis.
OPERATING POLICIES AND STRATEGIES
Investment Strategies
Historically, the Company has relied solely on an investment strategy to
purchase ARM securities and ARM loans originated and serviced by other mortgage
lending institutions. Increasingly, mortgage lending is being conducted by
mortgage lenders who specialize in the origination and servicing of mortgage
loans and then sell these loans to other mortgage investment institutions, such
as the Company. In 1999, the Company expanded its acquisition strategy to
include acquiring assets that meet Thornburg underwriting guidelines through a
new correspondent lending program which currently includes approximately thirty
financial institutions approved by the Company. By increasing its sources for
mortgage loans, the Company expects to enhance its ability to acquire high
quality assets at attractive prices.
The Company purchases ARM assets from broker-dealers and financial institutions
that regularly make markets in these assets. The Company also purchases ARM
assets from other mortgage suppliers, including mortgage bankers, banks, savings
and loans, investment banking firms, home builders and other firms involved in
originating, packaging and selling mortgage loans. The Company believes it has a
competitive advantage in the acquisition and investment of these mortgage
securities and mortgage loans because of the low cost of its operations relative
to traditional mortgage investors like banks and savings and loans. Like
traditional financial institutions, the Company seeks to generate income for
distribution to its shareholders primarily from the difference between the
interest income on its ARM assets and the financing costs associated with
carrying its ARM assets.
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 are typically 30 year loans that 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. In keeping with
the Company's policy of minimizing interest rate risk in its portfolio, the
Hybrid ARMs are generally financed with fixed rate debt for the period in which
their interest rate is fixed. See "Hedging Strategies".
The Company's mortgage assets portfolio may consist of either agency or
privately issued securities (generally publicly registered) mortgage
pass-through securities, multiclass pass-through securities, collateralized
mortgage obligations ("CMOs"), collateralized bond obligations ("CBOs"),
generally backed by high quality mortgage backed securities, ARM loans, Hybrid
ARMs or short-term investments that either mature within one year or have an
interest rate that reprices within one year. The Company will not invest more
than 30% of its ARM assets in Hybrid ARMs and will limit its interest rate
repricing mismatch (the difference between the remaining fixed-rate period of a
Hybrid ARM and the maturity of the fixed-rate liability funding a Hybrid ARM) to
a duration of no more than one year. On June 15, 1999 the Company's Board of
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Directors expanded the Company's investment policy to include the acquisition of
Hybrid ARMs with fixed-rate periods of up to ten years from the previous limit
of five years. Hybrid ARMs with fixed-rate periods of greater than five years
are further limited to no more than 10% of the Company's ARM assets. As with
all its Hybrid ARMs, the Company will hedge the interest rate risk of financing
the longer Hybrid ARMs consistent with its hedging strategies. See "Hedging
Strategies".
The Company's investment policy requires the Company to invest at least 70% of
total assets in High Quality adjustable and variable rate mortgage securities
and short-term investments. High Quality means:
(1) securities that are unrated but are guaranteed by the U.S. Government
or issued or guaranteed by an agency of the U.S. Government;
(2) securities which are rated within one of the two highest rating
categories by at least one of either Standard & Poor's or Moody's
Investors Service, Inc. (the "Rating Agencies"); or
(3) securities that are unrated or whose ratings have not been updated but
are determined to be of comparable quality (by the rating standards of
at least one of the Rating Agencies) to a High Quality rated mortgage
security, as determined by the Manager (as defined below) and approved
by the Company's Board of Directors; or
(4) the portion of ARM or hybrid loans that have been deposited into a
trust and have received a credit rating of AA or better from at least
one Rating Agency.
The remainder of the Company's ARM portfolio, comprising not more than 30% of
total assets, may consist of Other Investment assets, which may include:
(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 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").
Acquisition of ARM and Hybrid ARM Loans
The Company acquires existing pools of ARM loans, acquires individual loans
directly from loan originators, and intends to begin offering mortgage loans on
a retail basis. All loans acquired are intended to be securitized and then held
in the ARM securities portfolio as high quality assets. Acquiring ARM loans for
securitization is expected to benefit the Company by providing: (i) greater
control over the quality and types of ARM assets acquired; (ii) the ability to
acquire ARM assets at lower prices so that the amount of the premium to be
amortized will be reduced in the event of prepayment; (iii) additional sources
of new whole-pool ARM assets; and (iv) potentially higher yielding investments
in its portfolio.
The Company acquires residential ARM and Hybrid ARM whole loans utilizing two
processes which the Company calls the Bulk Acquisition Method ("Bulk Method")
and the Flow Acquisition Method ("Flow Method"). The Bulk Method, which the
Company began utilizing in 1997, involves a number of the Company's established
relationships with mortgage originators, or mortgage aggregators, who sell the
Company pools of whole loans at market prices, with the servicing rights,
generally, remaining with the originator or seller. In cases where the Company
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buys the servicing rights along with the loans, the Company contracts with a
qualified loan servicer to perform the loan servicing function for a fee. In
the Bulk Method, the loans are originated using the seller's loan products,
programs and underwriting guidelines Additionally, the credit review of the
borrower, the appraisal of the property and the quality control procedures are
performed by the originator. The Company generally only considers the purchase
of loans when all of the borrowers have had their incomes and assets verified,
their credit checked and appraisals of the properties have been obtained. The
Company then obtains an independent underwriter's review, performed by a third
party for the benefit of the Company, which entails a review of the application
processing and loan closing methodologies used by the originators in qualifying
a borrower for a loan. In addition, the Company utilizes its own personnel to
re-review some of the individual loans in order to insure the highest possible
loan quality. The Company generally does not review all of the loans in a bulk
package of loans, but rather selects loans for underwriting review based upon
specific criteria such as property location, loan size, effective loan-to-value
ratios, borrowers' credit score and other criteria the Company believes to be
important indicators of credit risk. Additionally, prior to the purchase of
loans, the Company obtains representations and warranties from each seller
stating that each loan meets the seller's underwriting standards and other
requirements. The breach of such representations and warranties in regards to a
loan can result in the seller having an obligation to repurchase the loan.
In the Flow Method, which the Company began utilizing in the first half of 1999,
the Company acquires mortgage loans from correspondent lenders using the
Company's internally developed loan programs and underwriting criteria. This
means that the correspondent originates the individual loans using the Company's
established credit and program guidelines. All correspondents are pre-qualified
by the Company to determine their financial strength and the soundness of their
own established in-house mortgage procedures. Each borrower's credit and the
value of each property is underwritten by the correspondents to the Company's
specifications. This is the same process used by originators/sellers in the
Bulk Method except that in the Flow Method all of the application processing,
loan underwriting, credit approval and appraisal guidelines have been developed
by the Company to meet the Company's own credit criteria and portfolio
requirements.
Prior to closing, all of the loans acquired in the Flow Method are then
subjected to further credit review by mortgage insurance companies that also use
the Company's guidelines to review the loans to insure product quality and
compliance with the Company's guidelines. The three mortgage insurance
companies chosen by the Company to perform this function use a two-step loan
approval process. After the credit review and quality control review are
performed by the originator/seller, but prior to the purchase of the loans by
the Company, all of the higher risk/higher LTV loans are placed through an
automated underwriting system created by Fannie Mae ("FNMA") called "Desktop
Underwriter." This is the same system used by Fannie Mae in connection with
all of their own loan purchases. Secondly, all loans are then screened by the
mortgage insurance company personnel to verify their compliance to the Company's
guidelines. After closing, a select number of these loans are then subjected to
an additional quality control review performed by a third party which again
verifies that the loan was properly underwritten and to confirm that the loan
documents are complete and properly executed. All of the loans acquired through
the Flow Method are assigned a "Risk Evaluation Score" or "Mortgage Score" by
each of the mortgage insurance companies. The risk score evaluates not only the
borrower's credit but also the geographic location of the property, the economic
viability of the area, the general market conditions and the loan product chosen
by the borrower. The Company believes that obtaining risk scores will help in
reducing the Company's securitization costs by insuring that the Company
purchases the highest quality mortgage loans with the lowest risk possible.
Mortgage loans acquired through the Flow Method are acquired, generally, with
the servicing rights remaining with the originator/seller. In cases where the
Company buys the servicing rights along with the loans, the Company contracts
with a qualified loan servicer to perform the loan servicing function for a fee.
The Company obtains representations and warranties from each seller or program
participant stating that each loan meets the Company's underwriting standards
and other requirements. The breach of such representations and warranties in
regards to a loan can result in the seller having an obligation to repurchase
the loan.
In both methods the Company uses its in-house staff as well as third party
credit underwriters to verify the credit quality of the borrowers as well as the
soundness of the mortgage collateral securing the individual loans. As added
security, the Company uses the services of a third party document custodian to
insure the quality and accuracy of all individual mortgage loan documents, which
are then held in safekeeping with the third-party document custodian. As a
result, all of the original individual loan documents that are signed by the
borrower, other than the original credit verification documents, are examined,
verified and held by the custodian.
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The Company's retail lending strategy is to utilize technology to become the
mortgage lender of the future, which is a low cost, low overhead, efficient
lender that provides attractive and innovative mortgage products, competitive
mortgage rates, and a high level of customer service. By eliminating
intermediaries between the borrower and the Company, an investor in mortgage
assets, the Company expects to originate loans at attractive prices while still
offering borrowers attractive mortgage rates. In expanding into the retail
origination business, the Company intends to continue its strategy of acquiring
only "A" quality mortgages with the same emphasis on loan quality as in its
current loan acquisition activities.
In 2000, the Company expects to begin originating loans directly with borrowers
using two origination channels. One channel the Company expects to employ is to
originate loans using a telemarketing operation, where borrowers will be able to
call the Company, or its representatives, inquire about loan products and
interest rates, seek advice and counseling regarding qualifying for a loan and
the approval process. Prospective borrowers will be able to apply for a loan
over the telephone and receive pre-approval before the call is complete. A
completed mortgage loan application along with a request for additional
supporting documentation will be sent to the borrower for signature. Thornburg
Mortgage loan processors, or their third party agents, will be responsible for
working with the borrower to complete the processing of the loan application,
obtain a final loan approval and schedule the loan for closing.
The second channel the Company expects to employ is to originate loans through
the Company's website. In this instance, prospective borrowers will be able to
look up mortgage loan product and interest rate information through the
Company's website, seek an on-line pre-approval of their loan and submit a
mortgage loan application for processing, underwriting and closing. Once a
mortgage loan application has been submitted, a Thornburg Mortgage
representative will be assigned the responsibility for completing the loan
process on behalf of the borrower.
The Company expects to begin originating loans through one or both of these
channels during the first half of 2000. Initially, the Company intends to
originate mortgage loans through Thornburg Mortgage Home Loans, Inc., a newly
created subsidiary of Thornburg Mortgage, Inc. licensed to originate loans in
the state of New Mexico, and which is also able to originate loans in Colorado,
Utah and Texas. In the latter half of 2000, the Company intends to expand its
direct origination capability to a nationwide program upon approval and closing
of the Company's acquisition of First Arizona Savings. Once the First Arizona
Savings acquisition closes, the Company will then have a nationwide lending
license in order to pursue its objectives.
The mortgage origination process is a labor intensive, document intensive
business that requires significant back office systems and personnel. The
Company is in the process of contracting with a third party "back office"
mortgage service provider who would provide all of the loan processing,
underwriting, documentation and closing functions required to originate and
close mortgage loans. Additionally, this third party service provider will also
staff a mortgage loan call center for the benefit of Thornburg Mortgage. The
third party service provider will also build a "Thornburg Team" consisting of
loan counseling representatives, loan processors, underwriters and loan closers.
These services will be provided on a "private label" basis, meaning that all of
these representatives will identify themselves as being Thornburg Mortgage
representatives. The benefit to Thornburg Mortgage of this arrangement is that
the Company will pay for these services as it uses them, based on closed loans,
without a significant investment in personnel, systems, office space and
equipment.
For both of these origination channels, the Company expects that its prospective
borrowers will be able to track the progress of their mortgage loan application
as it makes its way through processing, underwriting and closing using the
Thornburg Mortgage website. In this way, prospective borrowers will be able to
stay fully informed regarding the status of their loan application.
The Company has also contracted with a third party to provide private label loan
servicing for loans which the Company originates. This third party sub-servicer
will collect mortgage loan payments, manage escrow accounts, provide coupon
payment books and notices to borrowers, offer on-line mortgage servicing
information and provide customer service, loan collection, loss mitigation,
foreclosure, bankruptcy and REO management services. The fees paid by the
Company for this service are based on a fixed rate schedule based on the number
of loans serviced. A third party service provider using the name Thornburg
Mortgage is providing all of these loan-servicing functions.
In addition, the Company is in discussions with providers of web-based mortgage
origination systems which are paid on a per closed loan basis. The Company
intends to offer mortgages online utilizing third party, private label web-based
origination systems that will offer the Company's mortgage products,
underwritten to the Company's guidelines, for sale to the Company.
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Securitization of ARM Loans
The Company acquires ARM loans for its portfolio with the intention of
securitizing them in such a way as to maximize the amount of high quality
securities that can be created from an accumulation of the ARM loans. In order
to facilitate the securitization of its loans, the Company generally retains a
subordinate interest in the loans which provides a limited amount of credit
enhancement, and often purchases an insurance policy from a third party
financial guarantor that "wraps" the remaining balance of the loans to a credit
rating of AA or better. Upon securitization, the Company then owns the high
quality ARM securities and the subordinate certificates in its portfolio and
finances the high quality securities in the repurchase agreement market, or
issues debt obligations in the capital markets as an alternative financing
source to the repurchase agreement market.
In 1999, the Company began securitizing its conforming balance loans through a
program provided by FNMA. See "FNMA Loan Programs". The Company exchanged a
pool of its loans with balances no greater than $242,000 for a FNMA
Mortgage-Backed Security or MBS. As described in the "FNMA Loan Programs"
below, the Company receives an MBS which pays the Company interest and principal
derived from the interest and principal payments on the underlying mortgages
less a fee paid to the servicer of the loans and less a guaranty fee paid to
FNMA. In this way, the Company no longer has any credit exposure to the pool of
mortgages and has exchanged the pool of mortgages for a High Quality asset.
Financing Strategies
The Company employs a leveraging strategy to increase its assets by borrowing
against its ARM assets and then using the proceeds to acquire additional ARM
assets. By leveraging its portfolio in this manner, the Company expects to
maintain an equity-to-assets ratio between 8% and 10%, when measured on a
historical cost basis. The Company believes that this level of capital is
sufficient to allow the Company to continue to operate in interest rate
environments in which the Company's borrowing rates might exceed its portfolio
yield. These conditions could occur when the interest rate adjustments on the
ARM assets lag the interest rate increases in the Company's variable rate
borrowings or when the interest rate of the Company's variable rate borrowings
are mismatched with the interest rate indices of the Company's ARM assets. The
Company also believes that this capital level is adequate to protect the Company
from having to sell assets during periods when the value of its ARM assets are
declining. If the ratio of the Company's equity-to-total assets, measured on a
historical cost basis, falls below 8%, the Company will take action to increase
its equity-to-assets ratio to 8% of total assets or greater, when measured on a
historical cost basis, through normal portfolio amortization, raising equity
capital, sale of assets or other steps as necessary.
The Company's ARM assets are financed primarily at short-term borrowing rates
and can be financed utilizing reverse repurchase agreements, dollar-roll
agreements, borrowings under lines of credit and other secured or unsecured
financings which the Company may establish with approved institutional lenders.
Prior to 1998, reverse repurchase agreements had been the primary source of
financing utilized by the Company to finance its ARM assets. Since 1998,
however, the Company has diversified its financing sources by issuing debt in
the capital markets as described below. As of December 31, 1999, capital
markets debt represents 23% of the Company's total debt obligations. Generally,
upon repayment of each reverse repurchase agreement, the ARM assets used to
collateralize the financing will immediately be pledged to secure a new reverse
repurchase agreement. The Company has established lines of credit and
collateralized financing agreements with twenty-five different financial
institutions.
Reverse repurchase agreements take the form of a simultaneous sale of pledged
assets to a lender at an agreed upon price in return for the lender's agreement
to resell the same assets back to the borrower at a future date (the maturity of
the borrowing) at a higher price. The price difference is the cost of borrowing
under these agreements. In the event of the insolvency or bankruptcy of a
lender during the term of a reverse repurchase agreement, provisions of the
Federal Bankruptcy Code, if applicable, may permit the lender to consider the
agreement to resell the assets to be an executory contract that, at the lender's
option, may be either assumed or rejected by the lender. If a bankrupt lender
rejects its obligation to resell pledged assets to the Company, the Company's
claim against the lender for the damages resulting therefrom may be treated as
one of many unsecured claims against the lender's assets. These claims would be
subject to significant delay and, if and when payments are received, they may be
substantially less than the damages actually suffered by the Company. To
mitigate this risk the Company enters into collateralized borrowings with only
financially sound institutions approved by the Board of Directors, including a
majority of unaffiliated directors, and monitors the financial condition of such
institutions on a regular, periodic basis.
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The Company also utilizes capital market transactions by issuing debt
collateralized by specific pools of ARM assets that are placed in a trust. The
financing of ARM assets in this way eliminates the risk of margin calls on the
financing of those ARM assets and limits the Company's exposure to credit risk
on the ARM and Hybrid ARM loans collateralizing such debt. The Company receives
a credit rating on the debt based on the quality of the ARM assets, amount of
any credit enhancement obtained and subordination levels of the debt proscribed
by the rating agency(ies), all of which affects the interest rate at which the
debt can be issued. The principal and interest payments on the debt are paid by
the trust out of the cash flows received on the collateral. By utilizing such a
structure, the Company can issue either floating rate debt indexed to various
indices that more closely matches the characteristics of the collateralized ARM
assets, depending upon market constraints and conditions, or fixed rate debt
that corresponds to the characteristics of collateralized Hybrid ARM loans.
The Company also enters into financing facilities for whole loans. The Company
uses these credit lines to finance its acquisition of whole loans while it is
accumulating loans for securitization or until more permanent financing is
arranged in a capital markets collateralized debt transaction. In 1998, the
Company utilized two whole loan financing facilities that provided the Company
with uncommitted lines of credit based on the market value of its whole loans.
Uncommitted lines of credit are generally less expensive than a committed line
of credit, but during periods of market turmoil, uncommitted lines of credit can
be terminated by the counterparty with little notice to the Company and at a
time when the Company would have difficulty in replacing the line of credit.
Therefore, beginning in 1999, the Company has decided to negotiate and pay a fee
for committed facilities as well as continue to utilize uncommitted facilities.
During January 2000, the Company renewed one committed facility in the amount of
$150,000,000, which the Company can increase to $300,000,000 for an additional
fee, and has other uncommitted facilities in place.
The Company mitigates its interest-rate risk from borrowings by selecting
maturities that approximately match the interest-rate adjustment periods on its
ARM assets. Accordingly, borrowings bear variable or short-term fixed (one year
or less) interest rates. Generally, the borrowing agreements require the
Company to deposit additional collateral in the event the market value of
existing collateral declines, which, in dramatically rising interest rate
markets, could require the Company to sell assets to reduce the borrowings.
The Company's Bylaws limit borrowings, excluding the collateralized borrowings
in the form of reverse repurchase agreements, dollar-roll agreements and other
forms of collateralized borrowings discussed above, to no more than 300% of the
Company's net assets, on a consolidated basis, unless approved by a majority of
the unaffiliated directors. This limitation generally applies only to unsecured
borrowings of the Company. For this purpose, the term "net assets" means the
total assets (less intangibles) of the Company at cost, before deducting
depreciation or other non-cash reserves, less total liabilities, as calculated
at the end of each quarter in accordance with generally accepted accounting
principles. Accordingly, the 300% limitation on unsecured borrowings does not
affect the Company's ability to finance its total assets with collateralized
borrowings.
Hedging Strategies
The Company makes use of hedging transactions to mitigate the impact of certain
adverse changes in interest rates on its net interest income. In general, ARM
assets have a maximum lifetime interest rate cap, or ceiling, meaning that each
ARM asset contains a contractual maximum rate. The borrowings incurred by the
Company to finance its ARM assets portfolio are not subject to equivalent
interest rate caps. Accordingly, the Company purchases interest rate cap
agreements ("Cap Agreements") to prevent the Company's borrowing costs from
exceeding the lifetime maximum interest rate on its ARM assets. These Cap
Agreements have the effect of offsetting a portion of the Company's borrowing
costs if prevailing interest rates exceed the rate specified in the Cap
Agreement. A Cap Agreement is a contractual agreement for which the Company
pays a fee, which may at times be financed, typically to either a commercial
bank or investment banking firm. Pursuant to the terms of the Cap Agreements
owned as of December 31, 1999, the Company will receive cash payments if the
applicable index, generally the one-month, three-month, six-month LIBOR index or
Prime, increases above certain specified levels, which range from 7.10% to
13.00% and average approximately 9.96%. The fair value of these Cap Agreements
also tends to increase when general market interest rates increase and decrease
when market interest rates decrease, helping to partially offset changes in the
fair value of the Company's ARM assets.
In addition, ARM assets are generally subject to periodic caps. Periodic caps
generally limit the maximum interest rate coupon change on any interest rate
coupon adjustment date to either a maximum of 1% per semiannual adjustment or 2%
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per annual adjustment. The borrowings incurred by the Company do not have
similar periodic caps. The Company generally does not hedge against the risk of
its borrowing costs rising above the periodic interest rate cap level on the ARM
assets because the contractual future interest rate adjustments on the ARM
assets will cause their interest rates to increase over time and reestablish the
ARM assets' interest rate to a spread over the then current index rate. The
Company attempts to mitigate the effect of periodic caps in several ways.
First, the yield on the Company's ARM assets can change by more that the 1% or
2% per periodic interest rate adjustment limitation depending upon how
prepayment activity changes as interest rates change. Secondly, beginning in
1998, the Company began to acquire variable rate CMOs and CBOs ("Floaters"),
Hybrid ARMs and certain other ARM loans that do not have a periodic cap. As of
December 31, 1999, approximately $2.074 billion of the Company's ARM securities
and ARM loans did not have periodic caps or were Hybrid ARMs, representing
approximately 48% of total ARM assets.
The Hybrid ARMs have an initial fixed rate period, generally 3 to 5 years.
Since the Company's borrowings are generally short-term, the Company enters into
interest rate swap agreements that 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 a duration of no
more than one year. In accordance with the terms of these swap agreements, the
Company pays a fixed rate of interest during the term of the agreements, and
receives a payment that varies monthly with the one month LIBOR Index. The
Company generally enters into a swap that amortizes at an agreed upon prepayment
rate based on the Company's estimate of the expected rate of principal
amortization of the Hybrid ARMs being financed. In similar fashion, the Company
has purchased Cap Agreements to limit the interest rate of financing 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.
The Company may also enter into interest rate swap agreements to manage the
average interest rate reset period on its borrowings. In accordance with the
terms of the swap agreements, the Company pays a fixed rate of interest during
the term of the agreements and receives a payment that varies monthly with the
one month LIBOR Index. These agreements have the effect of fixing the Company's
borrowing costs on a similar amount of swaps owned by the Company and, as a
result, the Company reduces the interest rate variability of its borrowings.
The Company may also use interest rate swap agreements from time to time to
change from one interest rate index to another interest rate index and thus
decrease further the basis risk between the Company's interest yielding assets
and the financing of such assets.
The ARM assets held by the Company were generally purchased at prices greater
than par. The Company is amortizing the premiums paid for these assets over
their expected lives using the level yield method of accounting. To the extent
that the prepayment rate on the Company's ARM assets differs from expectations,
the Company's net interest income will be affected. Prepayments generally
increase when mortgage interest rates fall below the interest rates on ARM
loans. To the extent there is an increase in prepayment rates, resulting in a
shortening of the expected lives of the Company's ARM assets, the Company's net
income and, therefore, the amount available for dividends could be adversely
affected. To mitigate the adverse effect of an increase in prepayments on the
Company's ARM assets, the Company has purchased ARM assets at prices at or below
par, however the Company's portfolio of ARM assets is currently held at a net
premium. The Company may also purchase limited amounts of "principal only"
mortgage derivative assets backed by either fixed-rate mortgages or ARM assets
as a hedge against the adverse effect of increased prepayments. To date, the
Company has not purchased any "principal only" mortgage derivative assets.
The Company also enters into hedging transactions in connection with the
purchase of Hybrid ARMs to minimize the impact of changes in financing rates
between the trade date and the settlement date. Generally, the Company hedges
the cost of obtaining future fixed-rate financing by entering into a commitment
to sell similar duration fixed-rate mortgage-backed securities ("MBS") on the
trade date and settles the commitment by purchasing the same fixed-rate MBS on
the purchase date. Realized gains and losses are deferred and amortized as a
yield adjustment to the financing over the fixed-rate period of the Hybrid ARMs.
The Company may enter into other hedging-type transactions designed to protect
its borrowings costs or portfolio yields from interest rate changes. The
Company may also purchase "interest only" mortgage derivative assets or other
derivative products for purposes of mitigating risk from interest rate changes.
The Company has not, to date, entered into these types of transactions, but may
do so in the future. In 1999, the Board of Directors approved an expansion of
the financial instruments with which the Company currently implements its
hedging strategies. In addition to the instruments described above, the Company
will also utilize from time to time futures contracts and options on futures
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contracts on the Eurodollar, Fed Funds, Treasury bills and Treasury notes and
similar financial instruments. Utilization of these instruments is dependent
upon the Company being properly registered and receiving an exemption from being
classified as a "Commodity Pool Operator" by the Commodities and Futures Trade
Commission.
Hedging transactions currently utilized by the Company generally are designed to
protect the Company's net interest income during periods of changing market
interest rates. The Company does not intend to hedge for speculative purposes.
Further, no hedging strategy can completely insulate the Company from risk, and
certain of the federal income tax requirements that the Company must satisfy to
qualify as a REIT limit the Company's ability to hedge, particularly with
respect to hedging against periodic cap risk. The Company carefully monitors
and may have to limit its hedging strategies to ensure that it does not realize
excessive hedging income, or hold hedging assets having excess value in relation
to total assets. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT".
Operating Restrictions
The Board of Directors has established the Company's operating policies and any
revisions in the operating policies and strategies require the approval of the
Board of Directors, including a majority of the unaffiliated directors. Except
as otherwise restricted, the Board of Directors has the power to modify or alter
the operating policies without the consent of shareholders. Developments in the
market which affect the operating policies and strategies mentioned herein or
which change the Company's assessment of the market may cause the Board of
Directors (including a majority of the unaffiliated directors) to revise the
Company's operating policies and financing strategies.
In the event the rating of an ARM security held by the Company is reduced by the
Rating Agencies to below Investment Grade after acquisition by the Company, the
asset may be retained in the Company's investment portfolio if the Manager
recommends that it be retained and the recommendation is approved by the Board
of Directors (including a majority of the unaffiliated directors).
The Company has elected to qualify as a REIT for tax purposes. The Company has
adopted certain compliance guidelines which include restrictions on the
acquisition, holding and sale of assets. Prior to the acquisition of any asset,
the Company determines whether such asset will constitute a "Qualified REIT
Asset" as defined by the Internal Revenue Code of 1986, as amended (the "Code").
Substantially all the assets that the Company has acquired and will acquire for
investment are expected to be Qualified REIT Assets. This policy limits the
investment strategies that the Company may employ.
The Company closely monitors its purchases of ARM assets and the income from
such assets, including from its hedging strategies, so as to ensure at all times
that it maintains its qualification as a REIT. The Company developed certain
accounting systems and testing procedures with the help of qualified accountants
and tax experts to facilitate its ongoing compliance with the REIT provisions of
the Code. See "Federal Income Tax Considerations - Requirements for
Qualification as a REIT". No changes in the Company's investment policies and
operating policies and strategies, including credit criteria for mortgage asset
investments, may be made without the approval of the Company's Board of
Directors, including a majority of the unaffiliated directors.
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.
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 assets represent all the
certificates issued with respect to an underlying pool of mortgages, such
mortgage assets may be treated as assets separate from the underlying mortgage
loans and, thus, may not be considered Qualifying Interests for purposes of the
55% requirement. The Company closely monitors its compliance with this
requirement and intends to maintain its exempt status. Up to the present, the
Company has been able to maintain its exemption through the purchase of whole
pool government agency and privately issued ARM securities and loans that
qualify for the exemption. See "Portfolio of Mortgage Assets - Pass-Through
Certificates - Privately Issued ARM Pass-Through Certificates".
The Company does not purchase any assets from or enter into any servicing or
administrative agreements (other than the Management Agreement) with any
entities affiliated with the Manager. Any changes in this policy would be
subject to approval by the Board of Directors, including a majority of the
unaffiliated directors.
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PORTFOLIO OF MORTGAGE ASSETS
As of December 31, 1999, ARM assets comprised approximately 99% of the Company's
total assets. The Company has invested in the following types of mortgage
assets in accordance with the operating policies established by the Board of
Directors and described in "Business - Operating Policies and Strategies -
Operating Restrictions".
PASS-THROUGH CERTIFICATES
The Company's investments in mortgage assets are concentrated in High Quality
ARM pass-through certificates which account for approximately 77% of ARM assets
held. These High Quality ARM pass-through certificates consist of Agency
Certificates and privately issued ARM pass-through certificates that meet the
High Quality credit criteria. These High Quality ARM pass-through certificates
acquired by the Company represent interests in ARM loans which are secured
primarily by first liens on single-family (one-to-four units) residential
properties, although the Company may also acquire ARM pass-through certificates
secured by liens on other types of real estate-related properties. The Company
also includes in this category of assets a portion of the ARM and Hybrid ARM
loans that have been deposited in a trust and held as collateral for its notes
payable in the amount equivalent to the AAA portion of the debt issued by the
trust. The ARM pass-through certificates, including the ARM and Hybrid ARM
loans collateralizing notes payable, acquired by the Company are generally
subject to periodic interest rate adjustments, as well as periodic and lifetime
interest rate caps which limit the amount an ARM security's interest rate can
change during any given period.
The following is a discussion of each type of pass-through certificate held by
the Company as of December 31, 1999:
FHLMC ARM Programs
FHLMC is a shareholder-owned government sponsored enterprise created pursuant to
an Act of Congress on July 24, 1970. The principal activity of FHLMC consists
of the purchase of first lien, conventional residential mortgages, including
both whole loans and participation interests in such mortgages and the resale of
the loans and participations in the form of guaranteed mortgage assets. During
1999, FHLMC purchased $16.5 billion of ARM loans to securitize into ARM
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certificates and as of December 31, 1999, there was $35.1 billion of all types
of FHLMC ARM certificates outstanding, of which FHLMC held $17.1 billion in its
own portfolio.
Each FHLMC ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing an undivided interest in a pool of ARM
loans purchased by FHLMC. The ARM loans included in each pool are fully
amortizing, conventional mortgage loans with original terms to maturity of up to
40 years secured by first liens on one-to-four unit family residential
properties or multi-family properties. The interest rate paid on FHLMC ARM
Certificates adjust periodically on the first day of the month following the
month in which the interest rates on the underlying mortgage loans adjust.
FHLMC guarantees to each holder of its ARM Certificates the timely payment of
interest at the applicable pass-through rate and ultimate collection of all
principal on the holder's pro rata share of the unpaid principal balance of the
related ARM loans, but does not guarantee the timely payment of scheduled
principal of the underlying mortgage loans. The obligations of FHLMC under its
guarantees are solely those of FHLMC and are not backed by the full faith and
credit of the U.S. Government. If FHLMC were unable to satisfy such
obligations, distributions to holders of FHLMC ARM Certificates would consist
solely of payments and other recoveries on the underlying mortgage loans and,
accordingly, monthly distributions to holders of FHLMC ARM Certificates would be
affected by delinquent payments and defaults on such mortgage loans.
FNMA ARM Programs
FNMA is a federally chartered and privately owned corporation organized and
existing under the Federal National Mortgage Association Charter Act. FNMA
provides funds to the mortgage market primarily by purchasing home mortgage
loans from mortgage loan originators, thereby replenishing their funds for
additional lending. FNMA established its first ARM programs in 1982 and
currently has several ARM programs under which ARM certificates may be issued,
including programs for the issuance of assets through REMICs under the Code.
During 1999, FNMA issued $11.8 billion of FNMA ARM certificates and as of
December 31, 1999, FNMA held $13.4 billion in its own portfolio.
Each FNMA ARM Certificate issued to date has been issued in the form of a
pass-through certificate representing a fractional undivided interest in a pool
of ARM loans formed by FNMA. The ARM loans included in each pool are fully
amortizing conventional mortgage loans secured by a first lien on either
one-to-four family residential properties or multi-family properties. The
original term to maturity of the mortgage loans generally does not exceed 40
years. FNMA has issued several different series of ARM Certificates. Each
series bears an initial interest rate and margin tied to an index based on all
loans in the related pool, less a fixed percentage representing servicing
compensation and FNMA's guarantee fee.
FNMA guarantees to the registered holder of a FNMA ARM Certificate that it will
distribute amounts representing scheduled principal and interest (at the rate
provided by the FNMA ARM Certificate) on the mortgage loans in the pool
underlying the FNMA ARM Certificate, whether or not received, and the full
principal amount of any such mortgage loan foreclosed or otherwise finally
liquidated, whether or not the principal amount is actually received. The
obligations of FNMA under its guarantees are solely those of FNMA and are not
backed by the full faith and credit of the U.S. Government. If FNMA were unable
to satisfy such obligations, distributions to holders of FNMA ARM Certificates
would consist solely of payments and other recoveries on the underlying mortgage
loans and, accordingly, monthly distributions to holders of FNMA ARM
Certificates would be affected by delinquent payments and defaults on such
mortgage loans.
Privately Issued ARM Pass-Through Certificates
Privately issued ARM Pass-Through Certificates are structured similar to the
Agency Certificates discussed above but are issued by originators of, and
investors in, mortgage loans, including savings and loan associations, savings
banks, commercial banks, mortgage banks, investment banks and special purpose
subsidiaries of such institutions. Privately issued ARM pass-through
certificates are usually backed by a pool of non-conforming conventional
adjustable-rate mortgage loans and are generally structured with one or more
types of credit enhancement, including pool insurance, guarantees, or
subordination. Accordingly, the privately issued ARM pass-through certificates
typically are not guaranteed by an entity having the credit status of FHLMC or
FNMA.
Privately issued ARM pass-through certificates credit enhanced by mortgage pool
insurance provide the Company with an alternative source of ARM assets (other
than Agency ARM assets) that meet the Qualifying Interests test for purposes
maintaining the Company's exemption under the Investment Company Act of 1940.
Since the inception of the Company in 1993, most of the providers of mortgage
pool insurance have stopped providing such insurance. Although, in 1999, the
Company was successful in negotiating a new pool insurance policy for a one of
the privately-issued ARM Pass-Through Certificates it purchased. Since these
opportunities are rare, the Company has increased its investment in Agency ARM
securities and in whole loans as its primary sources of Qualifying Interests in
real estate.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"), MULTICLASS PASS-THROUGH ASSETS AND
COLLATERALIZED BOND OBLIGATIONS ("CBOS")
CMOs are debt obligations, ordinarily issued in series and most commonly backed
by a pool of fixed rate mortgage loans or pass-through certificates, each of
which consists of several serially maturing classes. Multiclass pass-through
securities are equity interests in a trust composed of similar underlying
mortgage assets. Generally, principal and interest payments received on the
underlying mortgage-related assets securing a series of CMOs or multiclass
pass-through securities are applied to principal and interest due on one or more
classes of the CMOs of such series or to pay scheduled distributions of
principal and interest on multiclass pass-throughs.
The CBOs acquired by the Company, like CMOs, are debt obligations, but, in the
case of CBOs, are secured by security interests in portfolios of high quality,
low duration, mortgage-backed, asset-backed and other fixed and floating rate
securities managed by third-parties. The Company only acquires CBO's that have
portfolios that consist primarily of either real estate qualifying assets or
high quality mortgage backed securities. In a CBO transaction, principal and
interest payments are used to pay current period interest and any excess is
reinvested into the portfolio. The amount of proceeds at maturity, on the CBO
classes owned by the Company, is generally dependent upon the total rate of
return performance of the underlying collateral and can result in a final
redemption value that is less than the face value of the investment. CBOs
typically don't amortize monthly, rather they mature on a specific maturity
date.
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Scheduled payments of principal and interest on the mortgage-related assets and
other collateral securing a series of CMOs, CBOs or multiclass pass-throughs are
intended to be sufficient to make timely payments of principal and interest on
such issues or securities and to retire each class of such obligations at their
stated maturity.
Multiclass pass-through securities backed by ARM assets or ARM loans owned by
the Company are typically structured into classes designated as senior classes,
mezzanine classes and subordinated classes. The Company also owns variable rate
classes of CMOs and CBOs that are backed by both fixed- and adjustable-rate
mortgages that are issued by FHLMC, FNMA and other private issuers.
The senior classes in a multiclass pass-through security generally have first
priority over all cash flows and consequently have the least amount of credit
risk since principal losses are generally covered by mortgage pool insurance
policies or are charged against the subordinated classes in order of
subordination. As a result of these features, the senior classes receive the
highest credit rating from Rating Agencies of the series of classes for each
multiclass pass-through security.
The mezzanine classes of a multiclass pass-through security generally have a
slightly greater risk of principal loss than the senior classes since they
provide some credit enhancement to the senior classes. In most, but not all,
instances, mezzanine classes participate on a pro-rata basis with senior classes
in their right to receive cash flow and have expected lives similar to the
senior classes. In other instances, mezzanine classes are subordinate in their
right to receive cash flow and have average lives that are longer than the
senior classes. However, in all cases, a mezzanine class has a similar or
slightly lower credit rating than the senior class from the Rating Agencies.
Generally, the mezzanine classes that the Company has acquired are rated High
Quality.
Subordinated classes are junior in the right to receive payment from the
underlying mortgages to other classes of a multiclass pass-through security.
The subordination provides credit enhancement to the senior and mezzanine
classes. Subordinated classes may be at risk for some payment failures on the
mortgage loans securing or underlying such assets and generally represent a
greater level of credit risk as they are responsible for bearing the risk of
credit loss on all of the outstanding loans underlying a CMO, CBO or multi-class
pass-through. As a result of being subject to more credit risk, subordinated
classes generally have lower credit ratings relative to the senior and mezzanine
classes.
The Subordinated classes which the Company has acquired were all rated at least
Investment Grade at the time of purchase by one of the Rating Agencies, and in
certain cases are High Quality, or were created as part of the Company's process
of securitizing whole loans. The Subordinated classes acquired by the Company
in the open market are limited in amount and bear yields which the Company
believes are commensurate with the increased risks involved. In general, the
Company acquires subordinated classes when they are seasoned and when the more
senior classes of the multi-class security have been paid down to levels that
mitigate the risk of non-payment on the subordinate classes.
The market for Subordinated classes is not extensive and at times may be
illiquid. In addition, the Company's ability to sell Subordinated classes is
limited by the REIT Provisions of the Code. The Company has not purchased any
Subordinated classes that are not Qualified REIT Assets. The Subordinated
classes acquired by the Company, which are not High Quality, together with the
Company's other investments in Other Investment assets, may not, in the
aggregate, comprise more than 30% of the Company's total assets, in accordance
with the Company's investment policy.
The variable rate classes of CMOs and CBOs, or Floaters, owned by the Company
generally float at a spread to the one-month LIBOR index and are backed by
mortgages that are either fixed-rate or are adjustable-rate mortgages indexed to
the one-year U. S. Treasury yield or a Cost of Funds index.
ARM AND HYBRID ARM LOANS
The ARM and Hybrid ARM loans the Company has acquired are all first mortgages on
single-family residential properties. Some have additional collateral in the
form of pledged financial assets. The Company acquires loans that are generally
underwritten to "A" quality standards. The Company considers loans to be "A"
quality when they are underwritten in such a way as to assure that the borrower
has adequate verified income to make the required loan payment, adequate
verified equity in the underlying property, and by the borrower's willingness
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and ability to repay the mortgage as demonstrated by a good credit history. As
a result, the loans acquired by the Company are generally fully documented loans
to borrowers with good credit histories, adequate income to support the monthly
mortgage payment, adequate assets to close the loan, with 80% or lower effective
loan-to-value ratios based on independently appraised property values or are
seasoned loans with over five years or more of good payment history.
When acquiring ARM and Hybrid ARM loans, either originated specifically for the
Company or when the Company acquires pools of loans in bulk, the Company focuses
its attention on key aspects of a borrower's profile and the characteristics of
a mortgage loan product that the Company believes are most important in insuring
excellent loan performance and minimal credit exposure. The Company's loan
programs focus on larger down payments, excellent borrower credit history (as
measured by a credit report and a credit score) and a conservative appraisal
process. If an ARM or Hybrid ARM loan acquired has a loan-to-property-value
that is above 80%, then the borrower is required to pay for private mortgage
insurance providing additional protection to the Company against credit risk.
The loans acquired have original maturities of forty years or less. The ARM and
Hybrid ARM loans are either fully amortizing or are interest only for up to ten
years and fully amortizing thereafter. All ARM loans acquired bear an interest
rate that is tied to an interest rate index and some have periodic and lifetime
constraints on how much the loan interest rate can change on any predetermined
interest rate reset date. In general, the interest rate on each ARM loan resets
at a frequency that is either monthly, semi-annually or annually. The ARM loans
generally adjust based upon the following indices: a U.S. Treasury Bill index, a
LIBOR index, a Certificate of Deposit index, a Cost of Funds index or Prime.
The Hybrid ARM loans have an initial fixed rate period, generally 3 to 10 years,
and then they convert to an ARM loan with the features of an ARM loan described
above.
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RISK FACTORS
FORWARD-LOOKING STATEMENTS
In accordance with the Private Securities Litigation Reform Act of 1995
(the "1995 Act"), the Company can obtain a "Safe Harbor" for forward-looking
statements by identifying those statements and by accompanying those statements
with cautionary statements which identify factors that could cause actual
results to differ from those in the forward-looking statements. Accordingly,
the following information contains or may contain forward-looking statements:
(1) information included in this Annual Report on Form 10-K, including, without
limitation, statements made regarding investments in ARM securities and ARM
loans, and Hybrid ARM loans, hedging, leverage, interest rates and statements in
Item 7, Management's Discussion and Analysis of Financial Condition and Results
of Operations, (2) information included in future filings by the Company with
the Securities and Exchange Commission including, without limitation, statements
with respect to growth, projected revenues, earnings, returns and yields on its
portfolio of mortgage assets, the impact of interest rates, costs, and business
strategies and plans, and (3) information contained in the Company's Annual
Report or other written material, releases and oral statements issued by or on
behalf of, the Company, including, without limitation, statements with respect
to growth, projected revenues, net income, returns and yields on its portfolio
of mortgage assets, the impact of interest rates, costs and business strategies
and plans.
The following is a summary of the factors the Company believes important
and that could cause actual results to differ from the Company's expectations.
The Company is publishing these factors pursuant to the 1995 Act. Such factors
should not be construed as exhaustive or as an admission regarding the adequacy
of disclosure made by the Company prior to the effective date of the 1995 Act.
Readers should understand that many factors govern whether any forward-looking
statement will be or can be achieved. Any one of those factors could cause
actual results to differ materially from those projected. No assurance is or
can be given that any important factor set forth below will be realized in a
manner so as to allow the Company to achieve the desired or projected results.
The words "believe," "except," "anticipate," "intend," "aim," "expect," "will,"
and similar words identify forward-looking statements. The Company cautions
readers that the following important factors, among others, could affect the
Company's actual results and could cause the Company's actual consolidated
results to differ materially from those expressed in any forward-looking
statements made by or on behalf of the Company.
- - A Dramatic Increase in Short-term Interest Rates
- - The Effectiveness of Using Various Interest Rate Derivative Instruments
for Hedging ARM Assets or Borrowing Costs
- - The Ability to Acquire Attractively Priced and Underwritten ARM and Hybrid
ARM Loans and Securities
- - Interest Rate Repricing Mismatch Between Asset Yields and Borrowing Rates
- - A Decline in the Market Value of ARM Securities, Which Would Result in
Margin Calls
- - Unanticipated Levels of Prepayment Rates
- - A Flattening or Inversion of the Yield Curve Between Short and Long-Term
Interest Rates
- - The Use of Substantial Borrowed Funds to Enhance Returns
- - Risk of Credit Loss Associated with Acquiring, Accumulating and
Securitizing ARM Loans
- - Interest Rate Risks Associated with any Future Unhedged Portion of the
Fixed Term of Hybrid ARMs
- - The Loss of Key Personnel
- - Fundamental Changes in Investment Policies and Strategies
- - Fluctuations or Variability of Dividend Distributions
- - Capital Stock Price Volatility
- - Uncertainty Associated With New Business Lines
- - Additional Investment in New Business Lines
17
<PAGE>
COMPETITION
In acquiring ARM assets, the Company competes with other mortgage REITs,
investment banking firms, savings and loan associations, banks, mortgage
bankers, insurance companies, mutual funds, other lenders, FNMA, FHLMC and other
entities purchasing ARM assets, many of which have greater financial resources
than the Company. The existence of these competitive entities, as well as the
possibility of additional entities forming in the future, may increase the
competition for the acquisition of ARM assets resulting in higher prices and
lower yields on such mortgage assets.
EMPLOYEES
As of December 31, 1999, the Company had no employees. Thornburg Mortgage
Advisory Corporation (the "Manager") carries out the day to day operations of
the Company, subject to the supervision of the Board of Directors and under the
terms of a management agreement discussed below.
THE MANAGEMENT AGREEMENT
On June 15, 1999, the Company renewed its management agreement with Thornburg
Mortgage Advisory Corporation (the "Management Agreement"), the Manager, for a
term of ten years, with an annual review required each year. In addition to
extending the term, the Management Agreement was amended to include a minimum
fee to be paid to the Manager upon termination. The Management Agreement also
provides that in the event a person or entity obtains more than 20% of the
Company's common stock, if the Company is combined with another entity, or if
the Company terminates the Agreement other than for cause, the Company is
obligated to acquire substantially all of the assets of the Manager through an
exchange of shares with a value based on a formula tied to the Manager's net
profits. The Company has the right to terminate the Management Agreement upon
the occurrence of certain specific events, including a material breach by the
Manager of any provision contained in the Management Agreement.
The Manager at all times is subject to the supervision of the Company's Board of
Directors and has only such functions and authority as the Company may delegate
to it. The Manager is responsible for the day-to-day operations of the Company
and performs such services and activities relating to the assets and operations
of the Company as may be appropriate.
The Manager receives a per annum base management fee on a declining scale 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. The Manager
is also entitled to receive, as incentive compensation for each fiscal quarter,
an amount equal to 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 1% over the Ten Year U.S. Treasury Rate. In addition, during
1999, the two wholly-owned REIT qualified subsidiaries of the Company entered
into separate Management Agreements with the Manager for additional management
services for a combined amount of $1,250 per calendar quarter, paid in arrears.
For further information regarding the base management fee, incentive
compensation and applicable definitions, see the Company's Proxy Statement dated
March 27, 2000 under the caption "Certain Relationships and Related
Transactions".
Subject to the limitations set forth below, the Company pays all operating
expenses except those specifically required to be paid by the Manager under the
Management Agreement. The operating expenses required to be paid by the Manager
include the compensation of the Company's officers and the cost of office space,
equipment and other personnel required for the Company's day-to-day operations.
The expenses that will be paid by the Company will include issuance and
transaction costs incident to the acquisition, disposition and financing of
investments, regular legal and auditing fees and expenses, the fees and expenses
of the Company's directors, the costs of printing and mailing proxies and
reports to shareholders, the fees and expenses of the Company's custodian and
transfer agent, if any, and reimbursement of any obligation of the Manager for
any New Mexico Gross Receipts Tax liability. The expenses required to be paid
by the Company which are attributable to the operations of the Company shall be
limited to an amount per year equal to the greater of 2% of the Average Net
Invested Assets of the Company or 25% of the Company's Net Income for that year.
The determination of Net Income for purposes of calculating the expense
limitation will be the same as for calculating the Manager's incentive
compensation except that it will include any incentive compensation payable for
such period. Expenses in excess of such amount will be paid by the Manager,
unless the unaffiliated directors determine that, based upon unusual or
18
<PAGE>
non-recurring factors, a higher level of expenses is justified for such fiscal
year. In that event, such expenses may be recovered by the Manager in
succeeding years to the extent that expenses in succeeding quarters are below
the limitation of expenses. The Company, rather than the Manager, will also be
required to pay expenses associated with litigation and other extraordinary or
non-recurring expenses. Expense reimbursement will be made monthly, subject to
adjustment at the end of each year.
The transaction costs incident to the acquisition and disposition of
investments, the incentive compensation and the New Mexico Gross Receipts Tax
liability will not be subject to the 2% limitation on operating expenses.
Expenses excluded from the expense limitation are those incurred in connection
with the servicing of mortgage loans, the raising of capital, the acquisition of
assets, interest expenses, taxes and license fees, non-cash costs and the
incentive management fee.
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The Company has elected to be treated as a REIT for federal income tax purposes.
In brief, if certain detailed conditions imposed by the REIT provisions of the
Code are met, electing entities that invest primarily in real estate and
mortgage loans, and that otherwise would be taxed as corporations are, with
certain limited exceptions, not taxed at the corporate level on their taxable
income that is currently distributed to their shareholders. This treatment
eliminates most of the "double taxation" (at the corporate level and then again
at the shareholder level when the income is distributed) that typically results
from the use of corporate investment vehicles.
In the event that the Company does not qualify as a REIT in any year, it would
be subject to federal income tax as a domestic corporation and the amount of the
Company's after-tax cash available for distribution to its shareholders would be
reduced. The Company believes it has satisfied the requirements for
qualification as a REIT since commencement of its operations in June 1993. The
Company intends at all times to continue to comply with the requirements for
qualification as a REIT under the Code, as described below.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must meet
certain tests which are described briefly below.
Ownership of Common Stock
For all taxable years after the first taxable year for which a REIT election is
made, the Company's shares of capital stock must be held by a minimum of 100
persons for at least 335 days of a 12 month year (or a proportionate part of a
short tax year). In addition, at all times during the second half of each
taxable year, no more than 50% in value of the capital stock of the Company may
be owned directly or indirectly by five or fewer individuals. The Company is
required to maintain records regarding the actual and constructive ownership of
its shares, and other information, and to demand statements from persons owning
above a specified level of the REIT's shares (as long as the Company has over
200 but fewer than 2,000 shareholders of record, only persons holding 1% or more
of the Company's outstanding shares of capital stock) regarding their ownership
of shares. The Company must keep a list of those shareholders who fail to reply
to such a demand.
The Company is required to use the calendar year as its taxable year for income
purposes.
Nature of Assets
On the last day of each calendar quarter at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government assets, cash
and cash items. The Company expects that substantially all of its assets will
continue to be Qualified REIT Assets. On the last day of each calendar quarter,
of the investments in assets not included in the foregoing 75% assets test, the
value of securities issued by any one issuer may not exceed 5% in value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities. Pursuant to its compliance guidelines,
the Company intends to monitor closely the purchase and holding of its assets in
order to comply with the above assets tests.
19
<PAGE>
At present, REITs are generally limited to holding non-voting preferred stock in
taxable affiliates. The recently enacted REIT Modernization Act, effective for
2001 and thereafter, includes provisions that will allow REITs to own some or
all of the stock of taxable subsidiaries. In general, it limits the aggregate
value of businesses undertaken by a REIT through taxable subsidiaries to 20% or
less of the REIT's total assets. Existing taxable subsidiaries will have to be
converted to qualified taxable REIT subsidiaries after December 31, 2000, unless
the existing taxable subsidiary has been in place since July 12, 1999 and there
has been no material change in the taxable subsidiary's assets or business since
that time. As a result the Company will likely have to make an election on its
2001 tax return to treat FASLA Holding Company, Inc. as a qualified taxable
subsidiary. The Company may from time to time hold, through one or more taxable
subsidiaries, assets that, if held directly by the Company, could otherwise
generate income that would have an adverse effect on the Company's qualification
as a REIT or on certain classes of the Company's shareholders. The Company does
not reasonably expect that the value of such taxable subsidiaries, in the
aggregate, ever to exceed 20% of the Company's assets and therefore the Company
does not anticipate that the proposal, if enacted, would have a material effect
on the Company's operations.
Sources of Income
The Company must meet the following separate income-based tests each year:
1. THE 75% TEST. At least 75% of the Company's gross income for the
taxable year must be derived from Qualified REIT Assets including interest
(other than interest based in whole or in part on the income or profits of any
person) on obligations secured by mortgages on real property or interests in
real property. The investments that the Company has made and will continue to
make will give rise primarily to mortgage interest qualifying under the 75%
income test.
2. THE 95% TEST. In addition to deriving 75% of its gross income
from the sources listed above, at least an additional 20% of the Company's gross
income for the taxable year must be derived from those sources, or from
dividends, interest or gains from the sale or disposition of stock or other
assets that are not dealer property. The Company intends to limit substantially
all of the assets that it acquires (other than stock in certain affiliate
corporations as discussed below) to Qualified REIT Assets. The policy of the
Company to maintain REIT status may limit the type of assets, including hedging
contracts and other assets, that the Company otherwise might acquire.
Distributions
The Company must distribute to its shareholders on a pro rata basis each year an
amount equal to at least (i) 95% of its taxable income before deduction of
dividends paid and excluding net capital gain, plus (ii) 95% of the excess of
the net income from foreclosure property over the tax imposed on such income by
the Code, less (iii) any "excess noncash income". The Company intends to make
distributions to its shareholders in sufficient amounts to meet the distribution
requirement. As a result of legislation enacted in 1999 and effective for 2001
and thereafter, the Company will have to distribute an amount calculated by
substituting 90% for 95% in the foregoing formula.
The Service has ruled that if a REIT's dividend reinvestment plan (the "DRP")
allows shareholders of the REIT to elect to have cash distributions reinvested
in shares of the REIT at a purchase price equal to at least 95% of fair market
value on the distribution date, then such cash distributions qualify under the
95% distribution test. The Company believes that its DRP complies with this
ruling.
TAXATION OF THE COMPANY'S SHAREHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its shareholders out of
current or accumulated earnings and profits will be includable by the
shareholders as ordinary income for federal income tax purposes unless properly
designated by the Company as capital gain dividends. Distributions of the
Company will not be eligible for the dividends received deduction for
corporations. Shareholders may not deduct any net operating losses or capital
losses of the Company.
If the Company makes distributions to its shareholders in excess of its current
and accumulated earnings and profits, those distributions will be considered
first a tax-free return of capital, reducing the tax basis of a shareholder's
shares until the tax basis is zero. Such distributions in excess of the tax
basis will be taxable as gain realized from the sale of the Company's shares.
20
<PAGE>
The Company will withhold 30% of dividend distributions to shareholders that the
Company knows to be foreign persons unless the shareholder provides the Company
with a properly completed IRS form for claiming the reduced withholding rate
under an applicable income tax treaty.
The provisions of the Code are highly technical and complex. This summary is
not intended to be a detailed discussion of all applicable provisions of the
Code, the rules and regulations promulgated thereunder, or the administrative
and judicial interpretations thereof. The Company has not obtained a ruling
from the Internal Revenue Service with respect to tax considerations relevant to
its organization or operation, or to an acquisition of its common stock. This
summary is not intended to be a substitute for prudent tax planning, and each
shareholder of the Company is urged to consult its own tax advisor with respect
to these and other federal, state and local tax consequences of the acquisition,
ownership and disposition of shares of stock of the Company and any potential
changes in applicable law.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in Santa Fe, New
Mexico and are provided by the Manager in accordance with the
Management Agreement. The Company's two wholly-owned qualified REIT
subsidiaries have their principal offices in Santa Fe, New Mexico and
are leased from the Manager.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 1999, there were no pending legal proceedings to which
the Company was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders
during the fourth quarter of 1999.
21
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
The Company's common stock is traded on the New York Stock Exchange under the
trading symbol "TMA". As of February 3, 2000, the Company had 21,489,663 shares
of common stock outstanding which were held by 1,030 holders of record and
approximately 15,449 beneficial owners.
The following table sets forth, for the periods indicated, the high, low and
closing sales prices per share of common stock as reported on the New York Stock
Exchange composite tape and the cash dividends declared per share of common
stock.
<TABLE>
<CAPTION>
Cash
Stock Prices Dividends
-------------------------------- Declared
1999 High Low Close Per Share
- ---- -------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Fourth Quarter ended December 31, 1999 9 3/16 7 15/16 8 1/4 $ 0.23 (1)
Third Quarter ended September 30, 1999 10 7/8 8 1/4 8 13/16 $ 0.23
Second Quarter ended June 30, 1999 11 3/8 7 9/16 10 $ 0.23
First Quarter ended March 31, 1999 10 7 7/16 8 5/8 $ 0.23
1998
- ----
Fourth Quarter ended December 31, 1998 9 1/2 5 5/8 7 5/8 $ 0.23
Third Quarter ended September 30, 1998 13 5/8 7 3/16 9 - (2)
Second Quarter ended June 30, 1998 16 1/8 10 1/2 11 7/8 $ 0.30
First Quarter ended March 31, 1998 18 1/2 14 3/4 15 7/8 $ 0.375
1997
- ----
Fourth Quarter ended December 31, 1997 22 1/4 15 7/8 16 1/2 $ 0.50
Third Quarter ended September 30, 1997 24 9/16 20 21 $ 0.50
Second Quarter ended June 30, 1997 22 1/8 17 3/4 21 1/2 $ 0.49
First Quarter ended March 31, 1997 22 7/8 18 3/4 19 $ 0.48
<FN>
(1) The fourth quarter of 1999 dividend was declared in January 2000 and paid
in February 2000.
(2) On August 17, 1998, the Company's Board of Directors announced that
dividends on common stock, in the future, would be declared after each
quarter-end rather than during the applicable quarter.
</TABLE>
The Company intends to pay quarterly dividends and to make such distributions to
its shareholders in such amounts that all or substantially all of its taxable
income each year (subject to certain adjustments) is distributed, so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the earnings and financial condition of the
Company, maintenance of REIT status and such other factors as the Board of
Directors may deem relevant from time to time.
DIVIDEND REINVESTMENT PLAN
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP") that
allows both common and preferred shareholders to have their dividends reinvested
in additional shares of common stock and to purchase additional shares. The
common stock to be acquired for distribution under the DRP may be purchased at
the Company's discretion from the Company at a discount from the then prevailing
market price or in the open market. Shareholders and non-shareholders also can
make additional purchases of stock monthly, subject to a minimum of $100 ($500
for non-shareholders) and a maximum of $5,000 for each optional cash purchase.
Continental Stock Transfer & Trust Company (the "Agent"), the Company's transfer
agent, is the Trustee and administrator of the DRP. Additional information
about the details of the DRP and a prospectus are available from the Agent or
the Company. Shareholders who own stock that is registered in their own name
and want to participate must deliver a completed enrollment form to the Agent.
Forms are available from the Agent or the Company. Shareholders who own stock
that is registered in a name other than their own (e.g., broker or bank nominee)
and want to participate must either request the broker or nominee to participate
on their behalf or request that the broker or nominee re-register the stock in
the shareholder's name and deliver a completed enrollment form to the Agent.
22
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from audited financial
statements of the Company for the years ended December 31, 1999, 1998, 1997,
1996 and 1995. The selected financial data should be read in conjunction with
the more detailed information contained in the Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Conditions and
Results of Operations" included elsewhere in this Form 10-K (Amounts in
thousands, except per share data).
<TABLE>
<CAPTION>
OPERATIONS STATEMENT HIGHLIGHTS
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net interest income $ 34,015 $ 31,040 $ 49,064 $ 30,345 $ 13,496
Net income $ 25,584 $ 22,695 $ 41,402 $ 25,737 $ 10,452
Basic earnings per share $ 0.88 $ 0.75 $ 1.95 $ 1.73 $ 0.88
Diluted earnings per share $ 0.88 $ 0.75 $ 1.94 $ 1.73 $ 0.88
Average common shares 21,490 21,488 18,048 14,874 11,927
Distributable income per common share $ 0.99 $ 0.84 $ 1.98 $ 1.76 $ 0.92
Dividends declared per common share $ 0.92 $ 0.905 $ 1.97 $ 1.65 $ 0.93
Yield on net int.-earning assets (Portfolio Margin) 0.77% 0.64% 1.30% 1.29% 0.73%
Return on average common equity 5.81% 4.80% 12.72% 11.68% 5.81%
Noninterest expense to average assets 0.12% 0.13% 0.21% 0.21% 0.13%
BALANCE SHEET HIGHLIGHTS
As of December 31
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
Adjustable-rate mortgage assets $4,326,098 $4,268,417 $4,638,694 $2,727,875 $1,995,287
Total assets $4,375,965 $4,344,633 $4,691,115 $2,755,358 $2,017,985
Shareholders' equity (1) $ 394,241 $ 395,484 $ 380,658 $ 238,005 $ 182,312
Historical book value per share (2) $ 15.28 $ 15.34 $ 15.53 $ 14.67 $ 14.96
Market value adjusted book value per share (3) $ 11.40 $ 11.45 $ 14.42 $ 13.70 $ 13.16
Number of common shares outstanding 21,490 21,490 20,280 16,219 12,191
Yield on ARM assets 6.38% 5.86% 6.38% 6.64% 6.73%
<FN>
(1) Shareholders' equity before unrealized market value adjustments.
(2) Shareholders' equity before unrealized market value adjustments, excluding
preferred stock, divided by common shares outstanding.
(3) Shareholders' equity, excluding preferred stock, divided by common shares
outstanding.
</TABLE>
23
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ACQUISITION OF FASLA HOLDING COMPANY
On December 23, 1999, the Company and the Manager entered into an agreement to
purchase FASLA Holding Company, whose principal holding is First Arizona
Savings, a privately held Phoenix-based federally chartered thrift institution
with six retail branch offices and, at that time, $138 million in assets. The
cash purchase price is $15 million, subject to certain adjustments. The
acquisition is subject to regulatory approval which is expected to be received
by mid-2000.
The primary purpose of this acquisition is to obtain nationwide lending
authority in order to expand the Company's acquisition channels for ARM loans.
The Company intends to initiate a mortgage banking division within First Arizona
Savings that would originate loans for sale to the Company, based upon the
Company's underwriting standards and ARM product design. It is also likely that
other standard loan products, including fixed-rate loans, would be originated
and sold to third party investors. The Company expects to avoid establishing an
expensive infrastructure involving substantial fixed costs generally associated
with operating a mortgage banking operation by utilizing a "fee based"
third-party vendor who specializes in private label loan underwriting,
application processing and the loan closing process and by utilizing a
sub-servicer to service the loans originated. The Company believes these
third-party service providers have developed both efficiencies and expertise
through specialization that afford the Company an opportunity to enter this
business in a cost effective manner with very little initial capital investment.
The Company also expects to continue operating First Arizona Savings as a full
service community bank within its current local market areas. First Arizona
Savings has traditionally been an originator of single-family residential loans,
both permanent and construction, based on underwriting standards that are
similar to the Company's and has generally retained ARM and Hybrid ARM loans for
its portfolio and have sold a significant percentage of their fixed-rate loan
production to FHLMC. First Arizona's primary source of funds has been retail
deposits and a limited amount of Federal Home Loan Bank advances. The Company
believes this business model is a consistent extension of the Company's existing
business model that emphasizes high credit quality lending and prudent interest
rate risk management. Further, the Company believes that by utilizing
third-party service provider specialists for the mortgage banking division, the
Company will be able to operate very cost effectively with minimal capital at
risk consistent with the Company's existing business model.
Due to the uncertainty of receiving regulatory approval and the timing of the
regulatory decision, the Company does not believe this acquisition will have a
material effect on the Company's operations during 2000. Further, the Company
believes that the combination of the existing community-bank style of operations
and the effect of the projected mortgage banking operations will have a positive
effect on the Company's overall operations beginning in 2001.
FINANCIAL CONDITION
At December 31, 1999, the Company held total assets of $4.376 billion, $4.326
billion of which consisted of ARM assets. That compares to $4.345 billion in
total assets and $4.268 billion of ARM assets 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 December 31, 1999, 95.4% 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, 80.6% are in the
form of adjustable-rate pass-through certificates or ARM loans. The remainder
are floating rate classes of CMOs (15.5%) or investments in floating rate
classes of CBOs (3.9%) backed primarily by mortgaged-backed securities.
24
<PAGE>
The following table presents a schedule of ARM assets owned at December 31, 1999
and December 31, 1998 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.
<TABLE>
<CAPTION>
ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)
December 31, 1999 December 31, 1998
------------------------- -------------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
------------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $ 2,068,152 47.8% $ 2,072,871 48.6%
Privately Issued:
AAA/Aaa Rating 1,585,099(1) 36.6 1,398,659(1) 32.8
AA/Aa Rating 459,858 10.6 597,493 14.0
------------- ---------- ------------- ----------
Total Privately Issued 2,044,957 47.2 1,996,152 46.8
------------- ---------- ------------- ----------
------------- ---------- ------------- ----------
Total High Quality 4,113,109 95.0 4,069,023 95.4
------------- ---------- ------------- ----------
OTHER INVESTMENT:
Privately Issued:
A Rating 49,995 1.2 40,591 1.0
BBB/Baa Rating 84,929 2.0 88,273 2.1
BB/Ba Rating and Other 46,963(1) 1.1 44,120(1) 0.9
Whole loans 31,102 0.7 26,410 0.6
------------- ---------- ------------- ----------
Total Other Investment 212,989 5.0 199,394 4.6
------------- ---------- ------------- ----------
Total ARM Portfolio $ 4,326,098 100.0% $ 4,268,417 100.0%
============= ========== ============= ==========
<FN>
(1) The AAA Rating category includes $781.8 million and $1.020 billion
of whole loans as of December 31, 1999 and 1998, respectively, that have been
credit enhanced to AAA by a combination of an insurance policy purchased from a
third-party and an unrated subordinated certificate retained by the Company in
the amount of $32.3 and $32.4 million as of December 31, 1999 and 1998,
respectively. The subordinated certificate is included in the BB/Ba Rating and
Other category.
</TABLE>
As of December 31, 1999, the Company had reduced the cost basis of its ARM
securities by a total of $1,930,000 due to estimated credit losses (other than
temporary declines in fair value). The Company is providing for estimated
credit losses on two securities that have an aggregate carrying value of $9.9
million, which represent less than 0.3% of the Company's total portfolio of ARM
assets. Although both of these assets continue to perform, there is only
minimal remaining credit support to mitigate the Company's exposure to credit
losses.
Additionally, during 1999, the Company recorded a $1,404,000 provision for
estimated credit losses on its loan portfolio, although no actual losses have
been realized in the loan portfolio to date. As of December 31, 1999, the
Company's ARM loan portfolio included 11 loans that are considered seriously
delinquent (60 days or more delinquent) with an aggregate balance of $5.6
million. The ARM loan portfolio also includes two real estate properties
("REO") that the Company owns as the result of the foreclosure process in
connection with two loans that total $1.0 million. The average original
effective loan-to-value ratio of the 11 delinquent loans and two REO properties
is approximately 65% and the Company believes that its current reserves for
credit losses are more than adequate to cover probable credit losses from these
assets. The Company's credit reserve policy regarding ARM loans is to record a
provision based 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, historical loss experience, current economic
conditions and quality of underwriting standards applied by the originator.
25
<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)
December 31, 1999 December 31, 1998
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ARM ASSETS:
INDEX:
One-month LIBOR $ 680,449 15.7% $ 556,574 13.0%
Three-month LIBOR 170,384 3.9 181,143 4.2
Six-month LIBOR 626,616 14.5 939,824 22.0
Six-month Certificate of Deposit 304,621 7.0 313,268 7.3
Six-month Constant Maturity Treasury 37,781 0.9 49,023 1.2
One-year Constant Maturity Treasury 1,359,229 31.4 1,479,054 34.7
Cost of Funds 213,800 5.0 268,486 6.3
---------- ---------- ---------- ----------
3,392,880 78.4 3,787,372 88.7
---------- ---------- ---------- ----------
HYBRID ARM ASSETS 933,218 21.6 481,045 11.3
---------- ---------- ---------- ----------
$4,326,098 100.0% $4,268,417 100.0%
========== ========== ========== ==========
</TABLE>
The ARM portfolio had a current weighted average coupon of 7.08% at December 31,
1999. This consisted of an average coupon of 6.54% on the hybrid portion of the
portfolio and an average coupon of 7.22% on the rest of the portfolio. If the
non-hybrid portion of the portfolio had been "fully indexed," the weighted
average coupon would have been approximately 7.79%, 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%. This consisted
of an average coupon of 6.96% on the hybrid portion of the portfolio and an
average coupon of 7.32% on the rest of the portfolio. If the non-hybrid portion
of the portfolio had been "fully indexed," the weighted average coupon would
have been approximately 6.79%, based upon the composition of the portfolio and
the applicable indices at the time. The lower average coupon on the ARM
portfolio as of the end of 1999 compared to 1998 is reflective of the overall
lower interest rates in the U.S. economy during these respective periods,
although by the end of 1999, interest rates in the U.S. had risen above the
rates prevailing during most of 1998 and 1999 and the average interest rate on
the ARM portion of the portfolio is expected to rise during 2000 to the "fully
indexed" rate.
At December 31, 1999, the current yield of the ARM assets portfolio was 6.38%,
compared to 5.86% as of December 31, 1998, with an average term to the next
repricing date of 344 days as of December 31, 1999, compared to 253 days as of
December 31, 1998. The increase in the number of days until the next repricing
of the ARMs is primarily due to the hybrid ARMs acquired by the Company during
1999, which, in general, do not reprice for three to five years from their
origination date and have an average remaining fixed rate period of 3.9 years.
As of the end of 1999, hybrid ARMs comprised 21.6% of the total ARM portfolio,
up from 11.3% as of the end of 1998. The Company finances its hybrid ARM
portfolio with longer term borrowings such that the duration mismatch of the
hybrid ARMs and the corresponding borrowings is one year or less. 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 increase in the yield of 0.52% as of December 31, 1999, compared to December
31, 1998, is primarily due to the decreased rate of ARM portfolio prepayments as
of the end of 1999 compared to the end of 1998, the effect of owning the ARM
portfolio at a lower price as of the end of 1999 compared to the end of 1998,
and the higher level of overall U.S. interest rates as of the end of 1999 which
is used in the computation of the current yield to determine the appropriate
amount of net premium amortization. These favorable factors were partially
offset by the 0.20% decrease in the weighted average coupon discussed above.
During the fourth quarter of 1999 the rate of prepayments had slowed to 16%,
compared to the 29% CPR experienced during the fourth quarter of 1998. As of
the end of 1999, the net premium on the total ARM portfolio amounted to 1.95% of
the principal balance outstanding, compared to 2.47% as of the end of 1998. As
of the end of 1999, the Company's non-hybrid portion of its ARM portfolio was
less than "fully indexed" by 0.57%, compared to being more than "fully indexed"
at the end of 1998 by 0.53%. This resulted in less premium amortization as of
the end of 1999 in order to achieve the appropriate portfolio long-term yield,
which is a calculation based on current interest rates and the expected
26
<PAGE>
remaining life of the portfolio. The lower level of prepayments decreased the
amount of premium amortization expense and decreased the impact of non-interest
earning assets in the form of principal payment receivables. These factors
increased the ARM portfolio yield by 0.72% as of the end of 1999 compared to the
end of 1998.
The following table presents various characteristics of the Company's ARM and
Hybrid ARM loan portfolio as of December 31, 1999. This information pertains to
loans held for securitization, loans held as collateral for the notes payable
and loans TMA has securitized for its own portfolio for which the Company
retained credit loss exposure.
<TABLE>
<CAPTION>
ARM AND HYBRID ARM LOAN PORTFOLIO CHARACTERISTICS
Average High Low
--------- ----------- -------
<S> <C> <C> <C>
Unpaid principal balance $273,989 $3,450,000 $7,587
Coupon rate on loans 7.22% 9.63% 5.00%
Pass-through rate 6.84% 9.23% 4.63%
Pass-through margin 1.90% 5.06% 0.48%
Lifetime cap 12.88% 16.75% 9.75%
Original Term (months) 339 480 72
Remaining Term (months) 316 359 33
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Geographic Distribution (Top 5 States): Property type:
California 21.07% Single-family 65.26%
Florida 11.88 DeMinimus PUD 20.19
New York 7.01 Condominium 9.41
Georgia 6.70 Other 5.14
New Jersey 4.97
Occupancy status: Loan purpose:
Owner occupied 84.09% Purchase 56.06%
Second home 11.27 Cash out refinance 25.36
Investor 4.64 Rate & term refinance 18.58
Documentation type: Periodic Cap:
Full/Alternative 95.01% None 57.31%
Other 4.99 2.00% 40.91
1.00% 0.53
Average effective original 0.50% 1.25
loan-to-value: 67.94%
</TABLE>
During the year ended December 31, 1999, the Company purchased $1.244 billion of
ARM securities, 98.0% of which were High Quality assets, and $35.4 million of
ARM loans generally originated to "A" quality underwriting standards. Of the
ARM assets acquired during 1999, approximately 51% were Hybrid ARMs, 22% were
indexed to LIBOR, 17% were indexed to U.S. Treasury bill rates, 8% were indexed
to a Certificate of Deposit Index and 2% were indexed to a Cost of Funds Index.
The Company emphasized purchasing assets during 1999 and 1998 at substantially
lower prices relative to par in order to reduce the potential impact of future
prepayments. As a result, the Company emphasized the acquisition of ARM and
Hybrid ARM assets and high quality floating rate collateralized mortgage and
bond obligations during this two year period. In doing so, the average premium
paid for ARM assets acquired in 1999 and 1998 was 0.45% and 1.09% of par,
respectively, as compared to 3.29% of par in 1997 when the Company emphasized
the purchase of seasoned ARM assets.
The Company sold ARM assets in the amount of $18.6 million during 1999. These
sales consisted of a mixture of securities and loans, that generally did not fit
the Company's current portfolio parameters, as well as one REO property. During
1998, the Company sold $932.3 million of ARM assets. The Company monitors the
performance of its individual ARM assets and generally sells an asset when there
is an opportunity to replace it with an ARM asset that has an expected higher
long-term yield or more attractive interest rate characteristics. The Company
is presented with investment opportunities in the ARM assets market on a daily
basis and management evaluates such opportunities against the performance of its
27
<PAGE>
existing portfolio. At times, the Company is able to identify opportunities
that it believes will improve the total return of its portfolio by replacing
selected assets. In managing the portfolio, the Company may realize either
gains or losses in the process of replacing selected assets.
For the quarter ended December 31, 1999, the Company's mortgage assets paid down
at an approximate average annualized constant prepayment rate of 16% compared to
29% during the same period of 1998. The annualized constant prepayment rate
averaged approximately 24% during the full year of 1999 compared to 31% during
1998. When prepayment experience exceeds expectations due to sustained
increased prepayment activity, 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 of the Company's portfolio of ARM assets classified as
available-for-sale improved by 0.22% from a negative adjustment of 2.62% of the
portfolio as of December 31, 1998, to a negative adjustment of 2.40% as of
December 31, 1999. This price improvement was primarily due to an improvement
in the value of interest rate cap agreement values, which generally increase in
value as interest rates and volatility rise. The amount of the negative
adjustment to fair value on the ARM assets classified as available-for-sale
increased from $83.2 million as of December 31, 1998, to $83.4 million as of
December 31, 1999. The size of the available-for-sale portfolio increased by
almost 10%, which is why the negative adjustment as a percent of the portfolio
declined when the amount of the adjustment increased. The fair value of the
Company's portfolio of ARM assets also excludes an adjustment for fair value
changes in Swap Agreements, since the Swap Agreements hedge liabilities, i.e.
the financing of Hybrid ARMs. As of December 31, 1999, the unrecorded positive
fair value adjustment for Swap Agreements was $12.3 million. As of December 31,
1999, all of the Company's ARM securities are classified as available-for-sale
and are carried at their fair value.
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. The Cap Agreements purchased by the Company will allow the yield on
the ARM assets to continue to rise in a high interest rate environment just as
the Company's cost of borrowings would continue to rise, since the borrowings do
not have any interest rate cap limitation. At December 31, 1999, the Cap
Agreements owned by the Company that are designated as a hedge against the
lifetime interest rate cap on ARM assets had a remaining notional balance of
$2.810 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 9.96%. The Company has also entered
into $134.6 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 December 31, 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 3.5 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 December 31, 1999, the fair value of the
Company's Cap Agreements was $7.8 million, $2.6 million more than the amortized
cost of the Cap Agreements.
28
<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 December 31, 1999:
<TABLE>
<CAPTION>
CAP AGREEMENTS STRATIFIED BY STRIKE PRICE
(Dollar amounts in thousands)
Hedged Weighted Cap Agreement Weighted
ARM Assets Average Notional Average
Balance (1) Life Cap Balance Strike Price Remaining Term
- ------------ --------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
$ 27,080 8.01% $ 26,000 7.10% 3.3 Years
232,952 8.38 233,517 7.50 0.5
515,776 9.92 516,963 8.00 2.3
156,694 10.98 155,889 8.50 0.2
120,078 11.30 120,324 9.00 0.7
94,966 11.46 93,712 9.50 2.0
302,184 11.58 301,978 10.00 2.4
230,114 12.22 230,805 10.50 2.2
260,879 12.46 260,104 11.00 4.0
518,851 12.96 519,293 11.50 2.6
186,529 13.67 187,475 12.00 3.8
86,260 14.53 86,768 12.50 1.1
72,344 16.06 77,106 13.00 0.1
- ------------ --------- -------------- ------------- --------------
$ 2,804,707 11.65% $ 2,809,934 9.96% 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 December 31, 1999, the Company was a counterparty to nineteen interest
rate swap agreements ("Swaps") having an aggregate notional balance of $694.2
million. These Swaps had a weighted average remaining term of 3.0 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 23
days to 258 days. All of these Swaps were entered into in connection with the
Company's acquisition of Hybrid ARMs. The Swaps hedge the cost of financing
Hybrid ARMs during their fixed rate term, generally three to ten years.
RESULTS OF OPERATIONS - 1999 COMPARED TO 1998
For the year ended December 31, 1999, the Company's net income was $25,584,000,
or $0.88 per share (Basic EPS), based on a weighted average of 21,490,000 shares
outstanding. That compares to $22,695,000, or $0.75 per share (Basic EPS),
based on a weighted average of 21,488,000 shares outstanding for the year ended
December 31, 1998. Net interest income for the year totaled $34,015,000,
compared to $31,040,000 for the same period in 1998. Net interest income is
comprised of the interest income earned on portfolio assets less interest
expense from borrowings. During 1999, the Company recorded a net gain on the
sale of ARM assets of $47,000 as compared to a net loss of $278,000 during 1998.
Additionally, during 1999, the Company reduced its earnings and the carrying
value of its ARM assets by reserving $2,867,000 for estimated credit losses,
compared to $2,032,000 during 1998. During 1999, the Company incurred operating
expenses of $5,611,000, consisting of a base management fee of $4,088,000 and
other operating expenses of $1,523,000. During 1998, the Company incurred
operating expenses of $6,035,000, consisting of a base management fee of
$4,142,000, a performance-based fee of $759,000 and other operating expenses of
$1,134,000. Total operating expenses decreased as a percentage of average
assets to 0.12% for 1999, compared to 0.13% for 1998.
29
<PAGE>
The Company's return on average common equity was 5.81% for the year ended
December 31, 1999 compared to 4.80% for the year ended December 31, 1998. 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%
Sep 30, 1999 11.48% 0.94% 0.02% 1.76% - 2.05% 6.75% 5.88% 0.87%
Dec 31, 1999 11.09% 0.89% 0.00% 1.86% - 2.05% 6.29% 6.14% 0.15%
<FN>
(1) Average common equity excludes unrealized gain (loss) on available-for-sale
ARM securities.
(2) Excludes performance fees.
</TABLE>
The increase in the Company's return on common equity from the fourth quarter of
1998 to the fourth quarter of 1999 is primarily due to the improvement in the
net interest spread between the Company's interest-earning assets and
interest-bearing liabilities and the impact of not having any significant gain
or loss on ARM sales as compared to a net loss on ARM sales in the fourth
quarter of 1998. The modest decline in the Company's return on common equity
from the third quarter of 1999 to the fourth quarter of 1999 is primarily due to
a decrease in the Company's net interest income resulting from year-end and Y2K
financing issues, which increased the Company's cost of funds during the fourth
quarter of 1999.
30
<PAGE>
The following table presents the components of the Company's net interest income
for the years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)
1999 1998
--------- ---------
<S> <C> <C>
Coupon interest income on ARM assets $289,991 $335,983
Amortization of net premium (26,634) (46,101)
Amortization of Cap Agreements (5,352) (5,444)
Amort. of deferred gain from hedging 906 1,889
Cash and cash equivalents 1,454 705
--------- ---------
Interest income 260,365 287,032
--------- ---------
Reverse repurchase agreements 163,807 251,462
Notes payable 58,893 2,811
Other borrowings 105 632
Interest rate swaps 3,545 1,087
--------- ---------
Interest expense 226,350 255,992
--------- ---------
Net interest income $ 34,015 $ 31,040
========= =========
</TABLE>
As presented in the table above, the Company's net interest income increased by
$3.0 million in 1999 compared to 1998. Amortization of net premium decreased by
$19.5 million. In 1999 the amortization of net premium was 9.2% of coupon
interest income on ARM assets as compared to 13.7% in 1998, reflecting, in part,
the decreased rate of ARM prepayments in 1999 as compared to 1998.
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
December 31, 1999 December 31, 1998
-------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
---------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $4,378,998 5.92% $4,800,772 5.96%
Cash and cash equivalents 21,679 4.71 16,214 4.35
---------- -------- ---------- ----------
4,400,677 5.92 4,816,986 5.96
---------- -------- ---------- ----------
Interest Bearing Liabilities:
Borrowings 4,026,970 5.62 4,430,167 5.78
---------- -------- ---------- ----------
Net Interest Earning Assets and Spread $ 373,707 0.30% $ 386,819 0.18%
========== ======== ========== ==========
Yield on Net Interest Earning Assets (1) 0.77% 0.64%
======== ==========
<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 Company's cost of funds declining to 5.62% during 1999 from
5.78% during 1998, which was partially offset by a decline in the yield on the
Company's interest-earning assets to 5.92% during 1999 from 5.96% during 1998,
net interest income increased by $2,975,000. This increase in net interest
income is a combination of rate and volume variances. There was a net favorable
rate variance of $4,883,000, which was the result of the lower cost of funds,
partially offset by the lower yield on the Company's ARM assets portfolio and
other interest-earning assets. The decreased average size of the Company's
31
<PAGE>
portfolio during 1999 compared to 1998 contributed to less net interest income
in the amount of $1,908,000. The average balance of the Company's
interest-earning assets was $4.401 billion during 1999 compared to $4.817
billion during 1998 -- a decrease of 8.6%.
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 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% (3) 0.47% (3) 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% (3) -0.08% (3) 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%
Sep 30, 1999 4,552.1 7.20% 6.85% 0.76% 6.09% 5.74% 0.35% 0.82%
Dec 31, 1999 4,449.0 7.51% 7.08% 0.70% 6.38% 6.47% (3) -0.09% (3) 0.81%
<FN>
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest income for the applicable quarter by the average daily balance of
interest earning assets during the quarter.
(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.
(3) The year-end cost of funds and net interest spread are commonly effected by
significant, but generally temporary, year-end pressures that raise the
Company's cost of financing mortgage assets over year-end. The effect
generally begins during the latter part of November and continues through
January.
</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%
Sep 30, 1999 0.51% 0.13% 0.13% (0.01)% 0.76%
Dec 31, 1999 0.51% 0.09 0.11% (0.01)% 0.70%
</TABLE>
32
<PAGE>
As of December 31, 1999, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 6.38%, compared to 5.86% as of December
31, 1998-- an increase of 0.52%. The Company's cost of funds as of December 31,
1999, was 6.47%, compared to 5.94% as of December 31, 1998 -- an increase of
0.53%. As a result of these changes, the Company's net interest spread as of
December 31, 1999 was -0.09%, compared to -0.08% as of December 31, 1998.
The increase in the Company's cost of funds as of year end is generally the
impact of year end pressures on short-term interest rates that were magnified by
concerns regarding Y2K that combined to cause a temporary rise in the interest
rate on the Company's borrowings. The Company's cost of funds reflects, in
part, the increase in one-month LIBOR that occurred at the end of November which
increased by approximately 0.87% on November 24, 1999. During the month of
December, the Company's cost of funds increased by 0.46%. By the end of January
2000, the Company's cost of funds had decreased by 0.44%, in part reflecting a
decrease in one-month LIBOR at the end of December of approximately 0.65%. The
Company's portfolio yield is not as sensitive to changes in one-month LIBOR.
The Company's portfolio yield increased by 0.10% in December and an additional
0.06% by the end of January 2000.
Until recently, the Company's spreads and net interest income had been
negatively impacted since early 1998 by the spread relationship between U.S.
Treasury rates and LIBOR. This spread relationship had 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 much of this period of time, U.S. Treasury
rates decreased significantly whereas LIBOR had not decreased 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 and much of 1999.
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 31.4% at December 31,
1999 from 49.0% as of the end of 1997. The data is as follows:
<TABLE>
<CAPTION>
ONE-YEAR U.S. TREASURY RATES COMPARED TO ONE- AND THREE-MONTH LIBOR RATES
Average Spread
Between 1 Year
U.S. Treasury Percent of ARM
Average 1 Year Average 1 and 3 Rates and 1 & 3 Portfolio Indexed 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%
1999 5.08% 5.33% -0.25% 31.4%
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%
Sep 30, 1999 5.16% 5.36% -0.20% 30.5%
Dec 31, 1999 5.62% 5.96% -0.34% 31.4%
</TABLE>
33
<PAGE>
The Company's provision for losses has increased with its acquisition and
securitization of whole loans. The provision for estimated loan losses is based
on a number of factors including, but not limited to, the outstanding principal
balance of loans, historical loss experience, current economic conditions,
borrower payment history, age of loans, loan-to-value ratios and underwriter
standards applied by the originator. The Company includes the outstanding
balance of loans which it has securitized and retained an exposure to credit
losses, although the credit losses in certain securitization structures may be
limited by third party credit enhancement agreements. As of December 31, 1999,
the Company's whole loans, including those held as collateral for the notes
payable and those that the Company has securitized but retained credit loss
exposure, accounted for 25.7% of the Company's portfolio of ARM assets or $1.108
billion. To date, the Company has not experienced any actual losses in its
whole loan portfolio, although losses are expected and are being estimated as
the portfolio ages.
During 1999, the Company realized a net gain from the sale of ARM assets in the
amount of $47,000 compared to a net loss of $278,000 during 1998. The sales
during 1999 were a combination of securities and loans that did not meet the
current investment criteria for the Company's ARM portfolio and one sale of a
real estate property that the Company acquired through foreclosure, which was
sold for a $10,000 gain. The 1998 sales generally fall into two categories.
During the first nine months of 1998, the Company realized a net gain on the
sale of ARM assets in the amount $3,780,000 as part of the Company's ongoing
portfolio management. These sales reflect the Company's desire to manage the
portfolio with a view to enhancing the total return of the portfolio over the
long-term while generating current earnings during this period of fast
prepayments and narrow interest spreads. The Company monitors the performance
of its individual ARM assets and selectively sells an asset when there is an
opportunity to replace it with an ARM asset that has an expected higher
long-term yield or more attractive interest rate characteristics. The Company
sold $511.8 million of ARM assets during the first nine months of 1998, most of
which were either indexed to a Cost of Funds index, the one-year U. S. Treasury
index or were prepaying faster than expected. During the first nine months of
1998 when the Company sold selected assets, it was able to reinvest the proceeds
in ARM assets that were indexed to indices preferred by the Company and at
prices that reflected current market assumptions regarding prepayments speeds
and interest rates and thus far, as a whole, they have been performing better
than the portfolio acquired before 1998. During the fourth quarter of 1998,
the Company sold assets for the primary purpose of maintaining adequate levels
of liquidity at a time when the mortgage finance market experienced a sudden
liquidity crises and, thus, was able to avoid the forced liquidation of any of
its assets by its mortgage finance counterparties. However, the Company
realized a net loss of $4,059,000 on these sales.
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. As of December 31, 1999, the Company had met all of
the dividend distribution requirements of a REIT. 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)
Years Ending
December 31,
------------------
1999 1998
-------- --------
<S> <C> <C>
Net income $25,584 $22,695
Additions:
Provision for credit losses 2,867 2,032
Net compensation related items 362 (209)
Non-deductible capital losses (47) 278
Deductions:
Dividend on Series A Preferred Shares 6,679) (5,009)
Actual credit losses on ARM securities (776) (1,766)
-------- --------
Taxable net income available to common $21,311 $18,021
======== ========
</TABLE>
34
<PAGE>
For the year ended December 31, 1999, the Company's ratio of operating expenses
to average assets was 0.12% compared to 0.13% for 1998. The primary reason for
the decline in this ratio is that the Manager did not receive any performance
fee in 1999 compared to earning a performance fee of $759,000 in 1998. The
Company's other expenses did increase by approximately $389,000, primarily due
to increased usage of legal services in connection with the Company's financing
and securitization of loans and other general corporate matters. 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, not
assets, as defined in the Management Agreement, payable monthly in arrears as
follows: 1.1% of the first $300 million of Average Shareholders' Equity, plus
0.8% of Average Shareholders' Equity above $300 million. Since this management
fee is based on shareholders' equity and not assets, this fee increases as the
Company successfully accesses capital markets and raises additional equity
capital and is, therefore, managing a larger amount of invested capital on
behalf of its shareholders. In order for the Manager to earn a performance fee,
the rate of return on the shareholders' investment, as defined in the Management
Agreement, must exceed the average ten-year U.S. Treasury rate during the
quarter plus 1%. As presented in the following table, the performance fee is a
variable expense that fluctuates with the Company's return on shareholders'
equity relative to the average 10-year U.S. Treasury rate.
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
<TABLE>
<CAPTION>
ANNUALIZED OPERATING EXPENSE RATIOS
Management Fee & Total
For The Other Expenses/ Performance Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
- ------------- ----------------- ----------------- ---------------
<S> <C> <C> <C>
Mar 31, 1997 0.14% 0.11% 0.25%
Jun 30, 1997 0.13% 0.09% 0.22%
Sep 30, 1997 0.12% 0.09% 0.21%
Dec 31, 1997 0.12% 0.05% 0.17%
Mar 31, 1998 0.10% 0.06% 0.16%
Jun 30, 1998 0.10% - 0.10%
Sep 30, 1998 0.10% - 0.10%
Dec 31, 1998 0.11% - 0.11%
Mar 31, 1999 0.12% - 0.12%
Jun 30, 1999 0.12% - 0.12%
Sep 30, 1999 0.13% - 0.13%
Dec 31, 1999 0.13% - 0.13%
</TABLE>
RESULTS OF OPERATIONS - 1998 COMPARED TO 1997
For the year ended December 31, 1998, the Company's net income was $22,695,000,
or $0.75 per share (Basic EPS), based on a weighted average of 21,488,000 shares
outstanding. That compares to $41,402,000, or $1.95 per share (Basic EPS),
based on a weighted average of 18,048,000 shares outstanding for the year ended
December 31, 1997. Net interest income for the year totaled $31,040,000,
compared to $49,064,000 for the same period in 1997. Net interest income is
comprised of the interest income earned on portfolio assets less interest
expense from borrowings. During 1998, the Company recorded a net loss on the
sale of ARM securities of $278,000 as compared to a gain of $1,189,000 during
1997. Additionally, during 1998, the Company reduced its earnings and the
carrying value of its ARM assets by reserving $2,032,000 for estimated credit
losses, compared to $886,000 during 1997. During 1998, the Company incurred
operating expenses of $6,035,000, consisting of a base management fee of
$4,142,000, a performance-based fee of $759,000 and other operating expenses of
$1,134,000. During 1997, the Company incurred operating expenses of $7,965,000,
consisting of a base management fee of $3,664,000, a performance-based fee of
$3,363,000 and other operating expenses of $938,000. Total operating expenses
decreased as a percentage of average assets to 0.13% for 1998, compared to 0.21%
for 1997, primarily due to the elimination of the performance-based fee during
the last three quarters of 1998.
35
<PAGE>
The Company's return on average common equity was 4.80% for the year ended
December 31, 1998 compared to 12.72% for the year ended December 31, 1997. The
primary reasons for the lower return on average common equity are the Company's
lower interest rate spread, discussed further below and the net loss recorded in
1998 on the sale of ARM securities, which were partially offset by lower
operating expenses.
The following table presents the components of the Company's net interest income
for the years ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)
1998 1997
--------- ---------
<S> <C> <C>
Coupon interest income on ARM assets $335,983 $271,170
Amortization of net premium (46,101) (21,343)
Amortization of Cap Agreements (5,444) (5,313)
Amort. of deferred gain from hedging 1,889 1,992
Cash and cash equivalents 705 1,215
--------- ---------
Interest income 287,032 247,721
--------- ---------
Reverse repurchase agreements 251,462 197,006
Notes payable 2,811 -
Other borrowings 632 969
Interest rate swaps 1,087 682
--------- ---------
Interest expense 255,992 198,657
--------- ---------
Net interest income $ 31,040 $ 49,064
========= =========
</TABLE>
As presented in the table above, the Company's net interest income decreased by
$18.0 million in 1998 compared to 1997, primarily because the amortization of
net premium increased by $24.8 million. In 1998 the amortization of net premium
was 13.7% of coupon interest income on ARM assets as compared to 7.9% in 1997,
reflecting, in part, the increased rate of ARM prepayments in 1998 as compared
to 1997.
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the years ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Year Ended For the Year Ended
December 31, 1998 December 31, 1997
----------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $4,800,772 5.96% $3,755,064 6.56%
Cash and cash equivalents 16,214 4.35 21,774 5.57
----------- ---------- ---------- ----------
4,816,986 5.96 3,776,838 6.56
----------- ---------- ---------- ----------
Interest Bearing Liabilities:
Borrowings 4,430,167 5.78 3,446,913 5.76
----------- ---------- ---------- ----------
Net Interest Earning Assets and Spread $ 386,819 0.18% $ 329,925 0.80%
=========== ========== ========== ==========
Yield on Net Interest Earning Assets (1) 0.64% 1.30%
========== ==========
<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>
36
<PAGE>
As a result of the yield on the Company's interest-earning assets declining to
5.96% during 1998 from 6.56% during 1997 and the Company's cost of funds
increasing to 5.78% during 1998 from 5.76% during 1997, net interest income
decreased by $18,024,000. This decrease in net interest income is a combination
of rate and volume variances. There was a combined unfavorable rate variance of
$23,332,000, which was almost entirely the result of a lower yield on the
Company's ARM assets portfolio and other interest-earning assets. The increased
average size of the Company's portfolio during 1998 compared to 1997 contributed
to higher net interest income in the amount of $5,310,000. The average balance
of the Company's interest-earning assets was $4.817 billion during 1998 compared
to $3.777 billion during 1997 -- an increase of 28%.
As of December 31, 1998, the Company's yield on its ARM assets portfolio,
including the impact of the amortization of premiums and discounts, the cost of
hedging, the amortization of deferred gains from hedging activity and the impact
of principal payment receivables, was 5.86%, compared to 6.38% as of December
31, 1997-- a decrease of 0.52%. The Company's cost of funds as of December 31,
1998, was 5.94%, compared to 5.91% as of December 31, 1997 -- an increase of
0.03%. As a result of these changes, the Company's net interest spread as of
December 31, 1998 was -0.08%, compared to 0.47% as of December 31, 1997.
The primary reasons for this decline in the net interest spread were the
relationship between the one-year U. S. Treasury yield and LIBOR and the impact
of the increased rate of ARM prepayments as well as the impact of issuing the
notes payable close to year-end. From December 31, 1997 to December 31, 1998,
the one-year U.S. Treasury yield declined by approximately 0.98%, from 5.51% to
4.53%, while LIBOR rates applicable to the Company's borrowings decreased by
only 0.70%, from 5.77% to 5.07%, creating a negative index spread as of December
31, 1998 of -0.54% compared to a negative index spread as of December 31, 1997
of -0.26%. As of December 31, 1998, approximately 35% of the Company's ARM
assets were indexed to the one-year U. S. Treasury bill yield, down from
approximately 49% as of December 31, 1997, and, therefore, the yield on such
assets declined with the index. To put this in historical perspective, the
one-year U.S. Treasury bill yield had a spread of -0.26% to the average of the
one- and three-month LIBOR rate as of December 31, 1997, compared to having a
spread of -0.02% at December 31, 1996, -.06% on average during 1997, 0.04% on
average during 1996 and -0.07% on average during 1995. For the five-year period
from 1993 to 1997, the average spread was 0.15%. The average spread during the
three month period ended December 31, 1998 was -0.93%, which was substantially
worse than the average spread during the previous quarter of -0.53% or in the
second quarter of 1998 when the average spread was -0.27%. The Company does not
know when or if the relationship between the one-year U. S. Treasury bill yield
and LIBOR will return to historical norms, but the Company's spreads are
expected to improve if that occurs. As of the middle of March 1999, the
one-year U.S. Treasury bill yield and LIBOR spread had improved back to
approximately -.25%. The Company is also continuing to decrease its exposure to
the one-year U. S. Treasury/LIBOR relationship by reducing the portion of the
portfolio indexed to the one-year U. S. Treasury rate and financed with LIBOR.
The Company's ARM portfolio yield also was lower as of December 31, 1998
compared to December 31, 1997 because of an increase in the amortization of the
net premium on ARM assets which reflects an increase in the average rate of
prepayments on the ARM portfolio. During the fourth quarter of 1998, the
average prepayment rate was 29%, compared to 24% during the comparable period in
1997. The impact of this was to increase the average amount of
non-interest-earning assets in the form of principal payments receivable as well
as to increase the amortization expense related to writing off the Company's
premiums and discounts. The Company generally amortizes its premiums and
discounts on a monthly basis based on the most recent three-month average of the
prepayment rate of its ARM assets, thereby adjusting its amortization to current
market conditions, which is reflected in the yield of the ARM portfolio. As of
December 31, 1998, the yield adjustment related to premium amortization amounted
to 1.18% compared to 0.94% as of December 31, 1997. As discussed above, the
Company's net spread of -.08% also reflects the cost of the notes payable which
were issued on December 18, 1998 and had an interest rate of 6.32% as of
year-end, which has subsequently declined to a rate of 5.64% in January and
which will continue to float with one-month LIBOR.
The Company's provision for losses has increased with the acquisition of whole
loans. The provision for loan losses is based on a number of pertinent factors
as discussed above. As of December 31, 1998, the Company's whole loans,
including those held as collateral for the notes payable, accounted for 24.5% of
the Company's portfolio of ARM assets compared to 2.6% as of December 31, 1997.
To date, the Company has not experienced any actual losses in its whole loan
portfolio, although losses are expected and are being estimated as the portfolio
ages.
During 1998, the Company realized a net loss from the sale of ARM securities in
the amount of $278,000 compared to a gain of $1,189,000 during 1997. The 1998
sales generally fall into two categories. During the first nine months of 1998,
the Company realized a net gain on the sale of ARM assets in the amount
$3,780,000 as part of the Company's ongoing portfolio management. These sales
37
<PAGE>
reflect the Company's desire to manage the portfolio with a view to enhancing
the total return of the portfolio over the long-term while generating current
earnings during this period of fast prepayments and narrow interest spreads.
The Company monitors the performance of its individual ARM assets and
selectively sells an asset when there is an opportunity to replace it with an
ARM asset that has an expected higher long-term yield or more attractive
interest rate characteristics. The Company sold $511.8 million of ARM assets
during the first nine months of 1998, most which were either indexed to a Cost
of Funds index, the one-year U. S. Treasury index or were prepaying faster than
expected. During the first nine months of 1998 when the Company sold selected
assets, it was able to reinvest the proceeds in ARM assets that were indexed to
indices preferred by the Company and at prices that reflected current market
assumptions regarding prepayments speeds and interest rates and thus far, as a
whole, they have been performing better than the portfolio acquired before 1998.
During the fourth quarter of 1998, the Company sold assets for the primary
purpose of maintaining adequate levels of liquidity at a time when the mortgage
finance market experienced a sudden liquidity crises and, thus, was able to
avoid the forced liquidation of any of its assets by mortgage finance
counterparties. However, the Company realized a net loss of $4,059,000 on these
sales. Although the Company is never pleased when it has to sell assets at a
loss, the Company was very pleased with the response of its mortgage finance
counterparties to the high credit quality and highly liquid characteristics of
the Company's ARM portfolio in that all of the Company's counterparties, upon
review of the company's ARM portfolio and investment policies, continued to
provide financing at reasonable collateral values and reasonable requirements
for over collateralization.
For the year ended December 31, 1998, the Company's ratio of operating expenses
to average assets was 0.13% compared to 0.21% for 1997. The Company's expense
ratios are among the lowest of any company investing in mortgage assets, giving
the Company what it believes to be a significant competitive advantage over more
traditional mortgage portfolio lending institutions such as banks and savings
and loans. 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, not assets, as
defined in the Management Agreement, payable monthly in arrears as follows:
1.1% of the first $300 million of Average Shareholders' Equity, plus 0.8% of
Average Shareholders' Equity above $300 million. Since this management fee is
based on shareholders' equity and not assets, this fee increases as the Company
successfully accesses capital markets and raises additional equity capital and
is, therefore, managing a larger amount of invested capital on behalf of its
shareholders. In order for the Manager to earn a performance fee, the rate of
return on the shareholders' investment, as defined in the Management Agreement,
must exceed the average ten-year U.S. Treasury rate during the quarter plus 1%.
During 1998, as the Company's return on shareholders' equity declined, compared
to 1997, the performance fee also declined, to an annualized 0.02% of average
assets compared to 0.09% during 1997.
MARKET RISKS
The market risk management discussion and the amounts estimated from the
analysis that follows are forward-looking statements regarding market risk that
assume that certain market conditions occur. Actual results may differ
materially from these projected results due to changes in the Company's ARM
portfolio and borrowings mix and due to developments in the domestic and global
financial and real estate markets. Developments in the financial markets
include the likelihood of changing interest rates and the relationship of
various interest rates and their impact on the Company's ARM portfolio yield,
cost of funds and cashflows. The analytical methods utilized by the Company to
assess and mitigate these market risks should not be considered projections of
future events or operating performance.
As a financial institution that has only invested in U.S. dollar denominated
instruments, primarily residential mortgage instruments, and has only borrowed
money in the domestic market, the Company is not subject to foreign currency
exchange or commodity price risk, but rather the Company's market risk exposure
is limited solely to interest rate risk. Interest rate risk is defined as the
sensitivity of the Company's current and future earnings to interest rate
volatility, variability of spread relationships, the difference in repricing
intervals between the Company's assets and liabilities and the effect interest
rates may have on the Company's cashflows, especially ARM portfolio prepayments.
Interest rate risk impacts the Company's interest income, interest expense and
the market value on a large portion of the Company's assets and liabilities.
The management of interest rate risk attempts to maximize earnings and to
preserve capital by minimizing the negative impacts of changing market rates,
asset and liability mix and prepayment activity.
The table below presents the Company's consolidated interest rate risk using the
static gap methodology. This method reports the difference between interest
rate sensitive assets and liabilities at specific points in time as of December
31, 1999, based on the earlier of term to repricing or the term to repayment of
38
<PAGE>
the of the asset or liability. The table does not include assets and
liabilities that are not interest rate sensitive such as payment receivables,
prepaid expenses, payables and accrued expenses. The table provides a projected
repricing or maturity based on scheduled rate adjustments, scheduled payments,
and estimated prepayments. For many of the Company's assets and certain of the
Company's liabilities, the maturity date is not determinable with certainty. In
general, the Company's ARM assets can be prepaid before contractual amortization
and/or maturity. Likewise, the Company's AAA rated notes payable are paid down
as the related ARM asset collateral pays down. The static gap report reflects
the Company's investment policy that allows for only the acquisition of ARM
assets that reprice within one year or Hybrids ARMs that are match funded to
within a duration mismatch of one-year.
The difference between assets and liabilities repricing or maturing in a given
period is one approximate measure of interest rate sensitivity. More assets
than liabilities repricing in a period (a positive gap) implies earnings will
rise as interest rates rise and decline as interest rates decline. More
liabilities repricing than assets (a negative gap) implies declining income as
rates rise and increasing income as rates decline. The static gap analysis does
not take into consideration constraints on the repricing of the interest rate of
ARM assets in a given period resulting from periodic and lifetime cap features
nor the behavior of various indexes applicable to the Company's assets and
liabilities. Different interest rate indexes exhibit different degrees of
volatility in the same interest rate environment due to other market factors
such as, but not limited to, government fiscal policies, market concern
regarding potential credit losses, changes in spread relationships among
different indexes and global market disruptions.
The use of interest rate instruments such as Swaps and Cap Agreements are
integrated into the Company's interest rate risk management. The notional
amounts of these instruments are not reflected in the Company's balance sheet.
The Swaps and Caps that hedge the Company's Hybrid ARMs are included in the
static gap report for purposes of analyzing interest rate risk because they have
the affect of adjusting the repricing characteristics of the Company's
liabilities. The Cap Agreements that hedge the lifetime cap on the Company's
ARM assets are not considered in a static gap report because they do not effect
the timing of the repricing of the instruments they hedge, but rather they, in
effect, remove the limit on the amount of interest rate change that can occur
relative to the applicable hedged asset.
39
<PAGE>
<TABLE>
<CAPTION>
INTEREST RATE SENSITIVITY GAP ANALYSIS
(Dollar amounts in millions)
December 31, 1999
Over 3 Over 6
3 Months Months to Months to Over
or less 6 Months 1 Year 1 Year Total
------------ ----------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
ARM securities $ 1,576,474 $ 715,014 $587,926 $ - $2,879,414
ARM loans 355,502 67,663 22,365 - 445,530
Hybrid ARM loans 44,469 55,214 114,353 741,908 955,944
Cash and cash equivalents 10,234 - - - 10,234
------------ ----------- --------- --------- ----------
Total interest-earning assets 1,986,679 837,891 724,644 741,908 4,291,122
------------ ----------- --------- --------- ----------
Interest-bearing liabilities:
Reverse repurchase agreements 3,022,511 - - - 3,022,511
Notes payable 886,722 - - - 886,722
Whole Loan Financing 21,290 - - - 21,290
Swaps (819,840) 40,122 93,787 685,930 -
------------ ----------- --------- --------- ----------
Total interest-bearing
liabilities 3,110,683 40,122 93,787 685,930 3,930,523
------------ ----------- --------- --------- ----------
Interest rate sensitivity gap $(1,124,004) $ 797,769 $630,857 $ 55,978 $ 360,599
============ =========== ========= ========= ==========
Cumulative interest rate
sensitivity gap $(1,124,004) $ (326,236) $304,621 $360,599
============ =========== ========= =========
Cumulative interest rate sensitivity
gap as a percentage of total assets
before market value adjustments (25.21)% (7.32)% 6.83% 8.09%
============ =========== ========= =========
</TABLE>
The Company generally ends each year with a significant sensitivity to liability
repricing due to year-end aberrations in the cost of financing mortgage assets.
Although the Company begins the process of financing many of its mortgage assets
over year-end as early as the third quarter, the Company has a significant
amount of assets that are in term reverse repurchase agreements that re-price
monthly as does the Company's notes payable, as well as other assets that are
not financed over year-end until close to the end of the year. As a result, the
Company typically re-finances assets during the latter part of the year with
short maturity borrowings in order to avoid locking in year-end rates for a
longer maturity. In this way, assets that are financed close to year-end at
unusually high rates have an opportunity to be re-financed at lower rates soon
after year-end, which has been a common seasonal fluctuation applicable to
financing mortgage assets.
Although the static gap methodology is widely accepted in identifying interest
rate risk, it does not take into consideration changes that may occur such as,
but not limited to, changes in investment and financing strategies, changes in
market spreads and relationships among different indexes, changes in hedging
strategy, changes in prepayment speeds and changes in business volumes.
Accordingly, the Company makes extensive usage of an earnings simulation model
to analyze its level of interest rate risk. This analytical technique used to
measure and manage interest rate risk includes the impact of all
on-balance-sheet and off-balance-sheet financial instruments.
There are a number of key assumptions made in using the Company's earnings
simulation model. These key assumptions include changes in market conditions
that effect interest rates, the pricing of ARM products, the availability of ARM
products, the availability and the cost of financing for ARM products. Other
key assumptions made in using the simulation model include prepayment speeds,
management's investment, financing and hedging strategies and the issuance of
new equity. The Company typically runs the simulation model under a variety of
hypothetical business scenarios that may include different interest rate
scenarios, different investment strategies, different prepayment possibilities
and other scenarios that provide the Company with a range of possible earnings
outcomes in order to assess potential interest rate risk. The assumptions used
represent the Company's estimate of the likely effect of changes in interest
40
<PAGE>
rates and do not necessarily reflect actual results. The earnings simulation
model takes into account periodic and lifetime caps embedded in the Company's
ARM assets in determining the earnings at risk.
At December 31, 1999, based on the earnings simulation model, the Company's
potential earnings at risk to a gradual, parallel 100 basis point rise in market
interest rates over the next twelve months was approximately 6.3% of projected
1999 net income. The assumptions used in the earnings simulation model are
inherently uncertain and as a result, the analysis cannot precisely predict the
impact of higher interest rates on net income. Actual results would differ from
simulated results due to timing, magnitude and frequency of interest rate
changes, changes in prepayment speed other than what was assumed in the model,
changes in other market conditions and management strategies to offset its
potential exposure, among other factors. This measure of risk represents the
Company's exposure to higher interest rates at a particular point in time. The
Company's actual risk is always changing. The Company continuously monitors the
Company's risk profile as it changes and alters its strategies as appropriate in
its view of the likely course of interest rates and other developments in the
Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the year ended December 31, 1999
consisted of reverse repurchase agreements, which totaled $3.023 billion, and
notes payable, which had a balance of $886.7 million. The Company's other
significant sources of funds for the year ended December 31, 1999 consisted
primarily of payments of principal and interest from its ARM assets in the
amount of $1.275 billion. 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 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 incurred at December 31, 1999, had a weighted average interest
rate of 6.50%. The reverse repurchase agreements had a weighted average
remaining term to maturity of 1.6 months and the 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 December 31, 1999, $1.429
billion of the Company's borrowings were variable-rate term reverse repurchase
agreements. The Company's term reverse repurchase agreements are committed
financings with original maturities that range from four 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 notes payable adjusts monthly based on changes in
one-month LIBOR.
The Company has entered into reverse repurchase agreements with 24 different
financial institutions and on December 31, 1999, had borrowed funds with ten 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 4.3%) 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 year ended December 31, 1999. 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 December 31, 1999, the Company had $886.7 million of collateralized notes
payable outstanding, which are not subject to margin calls. Due to the
structure of the collateralized notes payable, 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 December 31, 1999, the Company had entered into three whole loan financing
facilities. One of the whole loan financing facilities has a committed
borrowing capacity of $150 million, with an option to increase this amount to
$300 million. This facility matured in January 2000, but was re-newed for an
additional one-year term during January 2000. The second has an uncommitted
amount of borrowing capacity of $150 million and matures in April 2000. The
third facility is for an unspecified amount of uncommitted borrowing capacity
and does not have a specific maturity date. As of December 31, 1999, the
Company had $21.3 million borrowed against these whole loan financing
facilities.
41
<PAGE>
On December 23, 1999, the Company and the Manager entered into an agreement to
purchase FASLA Holding Company for $15 million, subject to certain adjustments,
in a cash transaction. The Company expects to complete this acquisition by
mid-2000 or during the third quarter of 2000, depending upon the timing of
receiving regulatory approval. The Company expects to generate sufficient
working capital in advance of the purchase acquisition date in order to complete
the acquisition with cash-on-hand.
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 December 31, 1999, the Company had $109
million of its securities registered for future sale under this Registration
Statement.
During 1998, the Board of Directors approved a common stock repurchase program
of up to 1,000,000 shares at prices below book value, subject to availability of
shares and other market conditions. The Company did not repurchase any shares
during 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 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 homeowners in the U.S. As a result, the Company has acquired ARM
assets indexed to a mix of indices in order to diversify its exposure to changes
in LIBOR in contrast to changes in other indices. During times of global
economic instability, U.S. Treasury rates generally decline because foreign and
domestic investors generally consider U.S. Treasury instruments to be a safe
haven for investments. The Company's ARM assets indexed to U.S. Treasury rates
then decline in yield as U.S. Treasury rates decline, whereas the Company's
borrowings and other ARM assets may not be affected by the same pressures or to
the same degree. As a result, the Company's income can improve or decrease
depending on the relationship between the various indices that the Company's ARM
assets are indexed to 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.
42
<PAGE>
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.
OTHER MATTERS
The Company calculates its Qualified REIT Assets, as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), to be 99.6% of its total assets,
compared to the Code requirement that at least 75% of its total assets must be
Qualified REIT Assets. The Company also calculates that 99.5% of its 1999
revenue qualifies for the 75% source of income test and 100% of its 1999 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 December 31, 1999, the
Company believes that it will continue to qualify as a REIT under the provisions
of the Code.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, 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 assets represent all the certificates issued with respect to an
underlying pool of mortgages, such mortgage assets may be treated as assets
separate from the underlying mortgage loans and, thus, may not be considered
Qualifying Interests for purposes of the 55% requirement. As of December 31,
1999, the Company calculates that it is in compliance with this requirement.
43
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by Item 7A is incorporated by reference
from the information in Item 7 under the caption "Market Risk" set
forth on pages 38 through 41 in this Form 10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company, the related notes and
schedules to the financial statements, together with the Reports of
Independent Accountants thereon are set forth on pages F-3 through
F-24 in this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On August 30, 1999, McGladrey & Pullen, LLP ("McGladrey") voluntarily
resigned as independent auditors of the Company as a result of their
pending merger with H & R Block.
None of the reports of McGladrey on the financial statements of the
Company for either of the past two fiscal years contained an adverse
opinion or a disclaimer of opinion, or was qualified or modified as to
uncertainty, audit scope or accounting principles.
During the Company's two most recent fiscal years and subsequent
interim period preceding the termination of McGladrey, there were no
disagreements with McGladrey on any matter of accounting principle or
practices, financial statement disclosure, or auditing scope or
procedure, which disagreements, if not resolved to the satisfaction of
McGladrey would have caused it to make reference to the subject matter
of disagreement in connection with its report.
None of the reportable events listed in Item 304 (a) (1) (v) of
Regulation S-K occurred with respect to the Company during the
Company's two most recent fiscal years and the subsequent interim
period preceding the termination of McGladrey.
On August 30, 1999, the Company , with the approval of its Board of
Directors, engaged PricewaterhouseCoopers LLP (PwC) as its independent
auditors.
During the Company's two most recent fiscal years and the subsequent
interim period preceding the engagement of PwC, neither the Company
nor anyone on its behalf consulted PwC regarding the application of
accounting principles to a specified completed or contemplated
transaction or the type of audit opinion that might be rendered on the
Company's financial statements, and no written or oral advice
concerning same was provided to the Company that was an important
factor considered by the Company in reaching a decision as to any
accounting, auditing or financial reporting issue.
44
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by
reference to the definitive Proxy Statement dated March 27, 2000
pursuant to General Instruction G(3).
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by
reference to the definitive Proxy Statement dated March 27, 2000
pursuant to General Instruction G(3).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by
reference to the definitive Proxy Statement dated March 27, 2000
pursuant to General Instruction G(3).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by
reference to the definitive Proxy Statement dated March 27, 2000
pursuant to General Instruction G(3).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following Financial Statements of the Company are
included in Part II, Item 8 of this Annual Report on Form-K:
Reports of Independent Accountants;
Consolidated Balance Sheets as of December 31, 1999 and
1998;
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997;
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1999, 1998 and 1997;
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997 and
Notes to Consolidated Financial Statements.
2. Schedules to Consolidated Financial Statements:
All consolidated financial statement schedules are included
in Part II, Item 8 of this Annual Report on Form-K.
3. Exhibits:
See "Exhibit Index".
(b) Reports on Form 8-K:
None
45
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES
(DBA THORNBURG MORTGAGE, INC.)
CONSOLIDATED FINANCIAL STATEMENTS
AND
REPORTS OF INDEPENDENT ACCOUNTANTS
For Inclusion in Form 10-K
Filed with
Securities and Exchange Commission
December 31, 1999
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION
AND SUBSIDIARIES
(DBA THORNBURG MORTGAGE, INC.)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINANCIAL STATEMENTS:
Reports of Independent Accountants F-3
Consolidated Balance Sheets F-5
Consolidated Statements of Operations F-6
Consolidated Statement of Shareholders' Equity F-7
Consolidated Statements of Cash Flows F-8
Notes to Consolidated Financial Statements F-9
FINANCIAL STATEMENT SCHEDULE:
Schedule IV - Mortgage Loans on Real Estate F-23
</TABLE>
F-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Thornburg Mortgage Asset Corporation
In our opinion, the accompanying consolidated balance sheet as of December 31,
1999 and the related consolidated statement of operations, shareholders' equity
and cash flows present fairly, in all material respects, the financial position
of Thornburg Mortgage Asset Corporation (dba Thornburg Mortgage, Inc.) and its
subsidiaries at December 31, 1999, and the results of their operations and their
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States. In addition, in our opinion, the
accompanying financial statement schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and the
financial statement schedule are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements and
the financial statement schedule based on our audit. We conducted our audit of
these statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
New York, New York
January 21, 2000
F-3
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Thornburg Mortgage Asset Corporation
We have audited the accompanying consolidated balance sheet of Thornburg
Mortgage Asset Corporation and its subsidiaries as of December 31, 1998, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the two years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Thornburg Mortgage
Asset Corporation and its subsidiaries at December 31, 1998 and the results of
their operations and their cash flows for each of the two years in the period
ended December 31 1998 in conformity with generally accepted accounting
principles.
/s/ McGladrey & Pullen, LLP
New York, New York
January 20, 1999
F-4
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
(DBA THORNBURG MORTGAGE, INC.)
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
December 31
------------------------
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Adjustable-rate mortgage ("ARM") assets (Notes 2 and 4)
ARM securities $3,391,467 $3,094,657
Collateral for collateralized notes 903,529 1,147,350
ARM loans held for securitization 31,102 26,410
----------- -----------
4,326,098 4,268,417
Cash and cash equivalents (Note 4) 10,234 36,431
Accrued interest receivable 31,928 37,939
Prepaid expenses and other 7,705 1,846
----------- -----------
$4,375,965 $4,344,633
=========== ===========
LIABILITIES
Reverse repurchase agreements (Note 4) $3,022,511 $2,867,207
Collateralized notes payable (Note 4) 886,722 1,127,181
Other borrowings (Note 4) 21,289 2,029
Payable for assets purchased 110,415 -
Accrued interest payable 18,864 31,514
Dividends payable (Note 6) 1,670 1,670
Accrued expenses and other 3,607 3,209
----------- -----------
4,065,078 4,032,810
----------- -----------
COMMITMENTS (Note 2)
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 342,026 341,756
Accumulated other comprehensive income (loss) (82,489) (82,148)
Notes receivable from stock sales (4,632) (4,632)
Retained earnings (deficit) (5,377) (4,512)
Treasury stock: at cost, 500 and 500 shares respectively (4,666) (4,666)
----------- -----------
310,887 311,823
----------- -----------
$4,375,965 $4,344,633
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
(DBA THORNBURG MORTGAGE, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
Year ended December 31
----------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Interest income from ARM assets and cash $ 260,365 $ 287,032 $ 247,721
Interest expense on borrowed funds (226,350) (255,992) (198,657)
---------- ---------- ----------
Net interest income 34,015 31,040 49,064
---------- ---------- ----------
Gain (loss) on sale of ARM assets 47 (278) 1,189
Provision for credit losses (2,867) (2,032) (886)
Management fee (Note 8) (4,088) (4,142) (3,664)
Performance fee (Note 8) - (759) (3,363)
Other operating expenses (1,523) (1,134) (938)
---------- ---------- ----------
NET INCOME $ 25,584 $ 22,695 $ 41,402
========== ========== ==========
Net income $ 25,584 $ 22,695 $ 41,402
Dividend on preferred stock (6,679) (6,679) (6,251)
---------- ---------- ----------
Net income available to common shareholders $ 18,905 $ 16,016 $ 35,151
========== ========== ==========
Basic earnings per share $ 0.88 $ 0.75 $ 1.95
========== ========== ==========
Diluted earnings per share $ 0.88 $ 0.75 $ 1.94
========== ========== ==========
Average number of common shares outstanding 21,490 21,488 18,048
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements.
F-6
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three Years Ended December 31, 1999
(Dollar amounts in thousands, except per share data)
Notes
Accum. Receiv-
Addit- Other able
Pref- ional Compre- From Retained Compre-
erred 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, 1996 . . . . . $ - $ 162 $233,177 $(11,266) $ - $ 125 $ - $222,198
Comprehensive income:
Net income. . . . . . . . . . . . 41,402 $ 41,402 41,402
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net. . - - - (6,697) - - - (6,697) (6,697)
Deferred gain on sale of
hedges, net of amortization . - - - (1,482) - - - (1,482) (1,482)
---------
Other comprehensive loss. . . . . $(33,223)
=========
Series A preferred stock issued,
Net of issuance cost (Note 6) . . 65,805 - - - - - - 65,805
Issuance of common
Issuance of common stk. (Note 6) . . - 41 82,063 - (2,698) - - 79,406
Dividends declared on preferred
stock - $2.265 per share. . . . . . - - - - - (6,251) - (6,251)
Dividends declared on common
stock - $1.97 per share . . . . . . - - - - - (36,227) - (36,227)
------- -------- -------- --------- -------- ---------- ---------- ---------
Balance, December 31, 1997 . . . . . 65,805 203 315,240 (19,445) (2,698) (951) - 358,154
Comprehensive income:
Net income. . . . . . . . . . . . 22,695 $22,695 22,695
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net. . - - - (61,157) - - - (61,157) (61,157)
Deferred gain on sale of
hedges, net of amortization . - - - (1,546) - - - (1,546) (1,546)
---------
Other comprehensive loss. . . . . $(40,008)
=========
Issuance of common stk. (Note 6) . - 17 26,259 - (1,934) - - 24,342
Purchase of Treasury stk. (Note 6) . - - - - - - (4,666) (4,666)
Interest from notes receivable
from stock sales . . . . . . . . . 257 257
Dividends declared on preferred
stock - $2.42 per share . . . . . . - - - - - (6,679) - (6,679)
Dividends declared on common
stock - $0.905 per share. . . . . . - - - - - (19,577) - (19,577)
------- -------- -------- --------- -------- ---------- ---------- ---------
Balance, December 31, 1998 . . . . . 65,805 220 341,756 (82,148) (4,632) (4,512) (4,666) 311,823
Comprehensive income:
Net income. . . . . . . . . . . . 25,584 $ 25,584 25,584
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net. . - - - 307 - - - 307 307
Deferred gain on sale of
hedges, net of amortization . - - - (648) - - - (648) (648)
---------
Other comprehensive income. . . . $ 25,243)
=========
Interest from notes receivable from
stock sales . . . . . . . . . . . . 270 270
Dividends declared on preferred
stock - $2.42 per share . . . . . . - - - - - (6,679) - (6,679)
Dividends declared on common
stock - $0.92 per share. . . . . . - - - - - (19,770) - (19,770)
------- -------- -------- --------- -------- ---------- ---------- ---------
Balance, December 31, 1998 . . . . . $65,805 $ 220 $342,026 $(82,489) $(4,632) $ (5,377) $ (4,666) $310,887
======= ======== ======== ========= ======== ========== ========== =========
</TABLE>
See Notes to Consolidated Financial Statements.
F-7
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
(DBA THORNBURG MORTGAGE, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Year ended December 31
----------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Operating Activities:
Net income $ 25,584 $ 22,695 $ 41,402
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 31,080 49,657 24,665
Net realized (gain) loss from investing activities 2,819 2,310 (303)
Decrease (increase) in accrued interest receivable 6,011 414 (14,789)
Decrease (increase) in prepaid expenses and other (5,859) (1,557) (62)
Increase (decrease) in accrued interest payable (12,650) (8,235) 21,002
Increase (decrease) in accrued expenses and other 398 1,994 101
------------ ------------ ------------
Net cash provided by operating activities 47,383 67,278 72,016
------------ ------------ ------------
Investing Activities:
Available-for-sale securities:
Purchases (1,244,341) (1,501,961) (2,929,746)
Proceeds on sales 9,922 929,999 190,196
Proceeds from calls 6,234 138,926 67,202
Principal payments 1,026,098 1,635,298 756,379
Held-to-maturity securities:
Principal payments - 16,152 63,120
Collateral for collateralized notes payable:
Principal payments 239,737 13,416 -
ARM Loans:
Purchases (35,417) (1,092,238) (123,211)
Principal payments 9,339 115,081 4,092
Proceeds on sales 8,775 2,043 -
Purchase of interest rate cap and floor agreements (1,853) (1,081) (4,074)
------------ ------------ ------------
Net cash provided by (used in) investing activities 18,494 255,635 (1,976,042)
------------ ------------ ------------
Financing Activities:
Net borr. from (repayments of) reverse repurchase agreements
155,304 (1,402,963) 1,811,038
Net borr. from (repayments of) collateralized notes (240,459) 1,127,181 -
Net borr. from (repayments of) oth. borrowings 19,260 (7,989) (4,169)
Proceeds from preferred stock issued - - 65,805
Proceeds from common stock issued - 24,342 79,406
Purchase of treasury stock - (4,666) -
Dividends paid (26,449) (36,396) (37,967)
Interest from notes receivable from stock sales 270 229 -
------------ ------------ ------------
Net cash provided by (used in) financing activities (92,074) (300,262) 1,914,113
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (26,197) 22,651 10,087
Cash and cash equivalents at beginning of period 36,431 13,780 3,693
------------ ------------ ------------
Cash and cash equivalents at end of period $ 10,234 $ 36,431 $ 13,780
============ ============ ============
Supplemental disclosure of cash flow information and non-cash
investing and financing activities are included in Notes 2 and 4.
</TABLE>
See Notes to Consolidated Financial Statements.
F-8
<PAGE>
THORNBURG MORTGAGE ASSET CORPORATION AND SUBSIDIARIES
(DBA THORNBURG MORTGAGE, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Thornburg Mortgage Asset Corporation (the "Company") was incorporated in
Maryland on July 28, 1992. The Company commenced its operations of
purchasing and managing for investment a portfolio of adjustable-rate
mortgage assets on June 25, 1993, upon receipt of the net proceeds from the
initial public offering of the Company's common stock.
A summary of the Company's significant accounting policies follows:
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
Thornburg Mortgage Asset Corporation (dba Thornburg Mortgage, Inc.)
(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 collateralized notes payable
discussed in Note 4. 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 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 notes payable 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.
F-9
<PAGE>
CREDIT RISK
The Company limits its exposure to credit losses on its portfolio of
ARM securities by only purchasing ARM securities that have an
investment grade rating at the time of purchase and have some form of
credit enhancement or are guaranteed by an agency of the federal
government. An investment grade security generally has a security
rating of BBB or Baa or better by at least one of two nationally
recognized rating agencies, Standard & Poor's, Inc. or Moody's
Investor Services, 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 probable credit losses at a level deemed appropriate by
management to provide for known losses as well as estimated losses
inherent 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 estimated credit losses
on its portfolio of ARM loans which is an increase to the reserve for
possible loan losses. The provision for estimated 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 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 estimated credit losses on these
loans the same as it does for loans that are not held as collateral
for 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.
F-10
<PAGE>
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.
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 Cap 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
duration of a hybrid and the maturity of the borrowing funding a
Hybrid ARM) to a mismatched duration of 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 Note 5.
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. Generally, the Company hedges the cost of obtaining future fixed
rate financing by entering into a commitment to sell similar duration
fixed-rate mortgage-backed securities ("MBS") on the trade date and
settles the commitment by purchasing the same fixed-rate 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.
F-11
<PAGE>
Following is information about the computation of the earnings per
share data for the years ended December 31, 1999, 1998 and 1997
(Amounts in thousands except per share data):
<TABLE>
<CAPTION>
Earnings
Income Shares Per Share
---------- ------ ----------
1999
<S> <C> <C> <C>
Net income $ 25,584
Less preferred stock dividends (6,679)
----------
Basic EPS, income available to
common shareholders 18,905 21,490 $ 0.88
==========
Effect of dilutive securities:
Stock options - -
---------- ------
Diluted EPS $ 18,905 21,490 $ 0.88
========== ====== ==========
1998
Net income $ 22,695
Less preferred stock dividends (6,679)
----------
Basic EPS, income available to
common shareholders 16,016 21,488 $ 0.75
==========
Effect of dilutive securities:
Stock options - -
---------- ------
Diluted EPS $ 16,016 21,488 $ 0.75
========== ====== ==========
1997
Net income $ 41,402
Less preferred stock dividends (6,251)
----------
Basic EPS, income available to
common stockholders 35,151 18,048 $ 1.95
==========
Effect of dilutive securities:
Stock options - 110
---------- ------
Diluted EPS $ 35,151 18,158 $ 1.94
========== ====== ==========
</TABLE>
The Company has granted options to directors and officers of the
Company and employees of the Manager to purchase 186,779, 59,784 and
240,320 shares of common stock at average prices of $8.90, $14.82 and
$20.89 per share during the years ended December 31, 1999, 1998 and
1997, respectively. The conversion of preferred stock was not included
in the computation of diluted EPS for any year because such conversion
would increase the diluted EPS.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 established a
framework of accounting rules that standardize accounting and
reporting for all derivative instruments and is effective for
financial statements issued for fiscal years beginning after June 15,
2000. The Statement requires that all derivative financial instruments
be carried on the balance sheet at fair value. Currently the only
derivative instruments that are not on the Company's balance sheet at
fair value are interest rate swap agreements. The fair value of
interest rate swap agreements is disclosed in Note 5, Fair Value of
Financial Instruments. The Company believes that its use of interest
rate swap agreements qualify as cash-flow hedges as defined in the
statement. Therefore, the effective hedge
F-12
<PAGE>
portion of the derivative instrument's change in fair value will be
recorded in other comprehensive income and the ineffective portion
will be included in earnings when the Company adopts the statement in
the first quarter of its fiscal 2001 year.
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 AND FLOOR
AGREEMENTS
The following tables present the Company's ARM assets as of December
31, 1999 and 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>
December 31, 1999:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- ---------------- ----------- -----------
<S> <C> <C> <C> <C>
Principal balance outstanding $ 3,388,160 $ 890,701 $ 31,649 $4,310,510
Net unamortized premium 70,409 14,045 (445) 84,009
Deferred gain from hedging (351) - - (351)
Allowance for losses (1,930) (2,106) (102) (4,138)
Cap agreements 4,923 320 - 5,243
Principal payment receivable 13,610 569 - 14,179
---------------- ---------------- ----------- -----------
Amortized cost, net 3,474,821 903,529 31,102 4,409,452
---------------- ---------------- ----------- -----------
Gross unrealized gains 5,462 29 65 5,556
Gross unrealized losses (88,816) (13,165) (170) (102,151)
---------------- ---------------- ----------- -----------
Fair value $ 3,391,467 $ 890,393 $ 30,997 $4,312,857
================ ================ =========== ===========
Carrying value $ 3,391,467 $ 903,529 $ 31,102 $4,326,098
================ ================ =========== ===========
December 31, 1998:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
---------------- ---------------- ----------- -----------
Principal balance outstanding $ 3,070,107 $ 1,131,007 $ 26,161 $4,227,275
Net unamortized premium 86,956 17,112 324 104,392
Deferred gain from hedging (613) - - (613)
Allowance for losses (1,242) (729) (75) (2,046)
Cap agreements 8,302 440 - 8,742
Principal payment receivable 14,330 - - 14,330
---------------- ---------------- ----------- -----------
Amortized cost, net 3,177,840 1,147,830 26,410 4,352,080
---------------- ---------------- ----------- -----------
Gross unrealized gains 1,070 38 53 1,161
Gross unrealized losses (84,253) (7,606) (87) (91,946)
---------------- ---------------- ----------- -----------
Fair value $ 3,094,657 $ 1,140,262 $ 26,376 $4,261,295
================ ================ =========== ===========
Carrying value $ 3,094,657 $ 1,147,350 $ 26,410 $4,268,417
================ ================ =========== ===========
</TABLE>
During 1999, the Company realized $52,000 in gains and $5,000 in
losses on the sale of $18.6 million of ARM assets. During 1998, the
Company realized $4,634,000 in gains and $4,912,000 in losses on the
sale of $932.3 million of ARM securities and ARM loans, and during
1997, the Company realized $2,179,000 in gains and $990,000 in losses
on the sale of $189.0 million of ARM securities.
F-13
<PAGE>
All of the ARM securities sold were classified as available-for-sale.
During 1998, approximately $379 million of securities previously
classified as held-to-maturity were reclassified as
available-for-sale.
As of December 31, 1999, the Company had reduced the cost basis of its
ARM securities due to estimated credit losses (other than temporary
declines in fair value) in the amount of $1,930,000. At December 31,
1999, the Company is providing for estimated credit losses on two
assets that have an aggregate carrying value of $9.9 million, which
represent less than 0.3% of the Company's total portfolio of ARM
assets. Both of these assets are performing and one has some remaining
credit support that mitigates the Company's exposure to credit losses.
Additionally, during 1999, the Company, in accordance with its credit
policies, recorded a $1,404,000 provision for estimated 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
December 31, 1999 and 1998 (dollar amounts in thousands):
<TABLE>
<CAPTION>
1999
- ----
Percent
Loan Loan of ARM Percent of
Delinquency Status Count Balance Loans (1) Total Assets
- ------------------ ------- -------- ----------- -------------
<S> <C> <C> <C> <C>
60 to 89 days 1 $ 110 0.01% 0.00%
90 days or more - - - -
In foreclosure 10 5,450 0.49 0.12
------- -------- ----------- -------------
11 $ 5,560 0.50% 0.12%
======= ======== =========== =============
1998
- -------
Percent
Loan Loan of ARM Percent of
Delinquency Status Count Balance Loans (1) Total Assets
- ------------------ ------- -------- ----------- -------------
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
------- -------- ----------- -------------
8 $ 4,970 0.46% 0.11%
======= ======== =========== =============
<FN>
(1) ARM loans includes loans that the Company has securitized and retained
first loss credit exposure for total amounts of $1.108 billion and $1.085
billion at December 31, 1999 and 1998, respectively.
</TABLE>
The following table summarizes the activity for the allowance for
losses on ARM loans for the year ended December 31, 1999 and 1998
(dollar amounts in thousands):
<TABLE>
<CAPTION>
1999 1998
------ -----
<S> <C> <C>
Beginning balance $ 804 $ 42
Provision for losses 1,404 762
Charge-offs, net 0 0
------ -----
Ending balance $2,208 $ 804
====== =====
</TABLE>
As of December 31, 1999, the Company owned two real estate properties
as a result of foreclosing on delinquent loans in the aggregate amount
of $1.0 million, which are included in collateral for collateralized
notes on the balance sheet. The Company believes that its current
level of reserves are more than adequate to cover potential losses
from these properties.
As of December 31, 1999, the Company had commitments to purchase
$169.3 million of ARM securities, the terms of which were not final as
of December 31, 1999, and $136.4 million of ARM loans.
The average effective yield on the ARM assets owned was 6.38% as of
December 31, 1999 and 5.86% as of December 31, 1998. The average
effective yield is based on historical cost and includes the
amortization of the net premium paid for the ARM assets and the Cap
Agreements, the impact of ARM principal payment receivables and the
amortization of deferred gains from hedging activity.
F-14
<PAGE>
As of December 31, 1999 and 1998, the Company had purchased Cap
Agreements with a remaining notional amount of $2.945 billion and
$4.026 billion, respectively. The notional amount of the Cap
Agreements purchased declines 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 9.78%. Of
the Cap Agreements owned by the Company as of December 31, 1999, $135
million are hedging the cost of financing Hybrid ARMs and $2.810
billion are hedging the lifetime interest rate cap of ARM assets. The
Company's ARM assets portfolio, excluding ARM assets that don't have a
lifetime interest rate cap and Hybrid ARMs, had an average lifetime
interest rate cap of 11.65%. The Cap Agreements had an average
maturity of 2.2 years as of December 31, 1999. The initial aggregate
notional amount of the Cap Agreements declines to approximately $2.629
billion over the period of the agreements, which expire between 2000
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. AGREEMENT TO PURCHASE FASLA HOLDING COMPANY
On December 23, 1999, the Company and the Manager entered into an
agreement to purchase FASLA Holding Company, whose principal holding
is First Arizona Savings, a privately held Phoenix-based federally
chartered thrift institution with six retail branch offices and
approximately $138 million in assets for $15 million, subject to
certain adjustments. The acquisition is subject to regulatory approval
which is expected to be received by mid-2000. Due to ownership
restrictions in the current IRS tax code applicable to REITs, the
purchase has been structured such that the Company will pay 95% of the
purchase price for preferred stock of FASLA Holding Company which will
represent 95% of the economic interests in FASLA Holding Company and
the Manager will pay 5% of the purchase price for common shares of
FASLA Holding Company which will be voting shares that will represent
5% of the economic value of FASLA Holding Company. In this structure,
FASLA Holding Company would be an unconsolidated qualified taxable
REIT subsidiary of the Company. During 1999, legislation was enacted
by the U.S. Congress, effective January 1, 2001, that will permit
REITs to have 100% ownership in qualified taxable subsidiaries,
subject to certain limitations, that would permit the Company and the
Manager to alter this structure such that FASLA Holding Company may
become a wholly-owned consolidated taxable subsidiary of the Company.
NOTE 4. 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 securities and bear interest rates that have
historically moved in close relationship to LIBOR.
As of December 31, 1999, the Company had outstanding $3.023 billion of
reverse repurchase agreements with a weighted average effective
borrowing cost of 6.30% and a weighted average remaining maturity of
1.6 months. As of December 31, 1999, $1.429 billion of the Company's
borrowings were variable-rate term reverse repurchase agreements with
original maturities that range from four 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 December 31, 1999
were collateralized by ARM assets with a carrying value of $3.225
billion, including accrued interest.
At December 31, 1999, the reverse repurchase agreements had the
following remaining maturities (dollar amounts in thousands):
<TABLE>
<CAPTION>
<S> <C>
Within 30 days $1,404,255
31 to 89 days 1,037,952
90 days or greater 580,304
----------
$3,022,511
==========
</TABLE>
F-15
<PAGE>
As of December 31, 1999, the Company had entered into three whole loan
financing facilities. One of the whole loan financing facilities has a
committed borrowing capacity of $150 million, with an option to
increase this amount to $300 million. This facility matured in January
2000, but was renewed for an additional one-year term during January
2000. One has an uncommitted amount of borrowing capacity of $150
million and matures in April 2000. The third facility is for an
unspecified amount of uncommitted borrowing capacity and does not have
a specific maturity date. As of December 31, 1999, the Company had
$21.3 million borrowed against these whole loan financing facilities
at an effective cost of 6.77%. The amount borrowed on the whole loan
financing agreements at December 31, 1999 were collateralized by ARM
loans with a carrying value of $22.5 million, including accrued
interest.
On December 18, 1998, the Company, through a special purpose finance
subsidiary, issued $1.144 billion of notes payable ("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. As of December 31, 1999, the Notes had a
net balance of $886.7 million, an effective interest cost of 7.17%,
which changes each month at a spread to one-month LIBOR. These Notes
were collateralized by ARM loans with a principal balance of $801.8
million and ARM securities with a balance of $121.1 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.
As of December 31, 1999, the Company was a counterparty to nineteen
interest rate swap agreements ("Swaps") having an aggregate notional
balance of $694.2 million. As of December 31, 1999, these Swaps had a
weighted average remaining term of 3.0 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 23 days to 258 days. All of these
Swaps were entered into in connection with the Company's acquisition
of Hybrid ARMs. The Swaps hedge the cost of financing Hybrid ARMs
during their fixed rate term, generally three to ten years. Due to the
favorable market value of the Swaps at December 31, 1999, they were
not collateralized by any ARM assets.
The total cash paid for interest was $233.3 million, $267.9 million
and $177.9 million for 1999, 1998 and 1997 respectively.
F-16
<PAGE>
NOTE 5. FAIR VALUE OF FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET CREDIT RISK
The following table presents the carrying amounts and estimated fair
values of the Company's financial instruments at December 31, 1999 and
December 31, 1998. FASB Statement No. 107, Disclosures About Fair
Value of Financial Instruments, defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in
a current transaction between willing parties, other than in a forced
or liquidation sale (dollar amounts in thousands):
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Assets:
ARM assets $4,318,301 $4,305,060 $4,266,497 $4,259,374
Cap Agreements 7,797 7,797 1,920 1,920
Liabilities:
Collateralized notes payable 886,722 889,305 1,127,181 1,127,181
Other borrowings 21,289 21,289 2,029 2,077
Swap agreements 749 (11,527) (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 securities, which are categorized as available-for-sale, is
their fair value whereas the carrying amount for loans, which are
categorized as held for the foreseeable future, is their amortized
cost.
The fair values of the Company's ARM securities and cap agreements are
generally based on market prices provided by certain dealers who make
markets in these financial instruments or third-party pricing
services. If the fair value of an ARM security is not reasonably
available from a dealer or a third-party pricing service, management
estimates the fair value based on characteristics of the security it
receives from the issuer and available market information. The fair
values for ARM loans is estimated by the Company by using the same
pricing models employed by the Company in the process of determining a
price to bid for loans in the open market, taking into consideration
the aggregated characteristics of groups of loans such as, but not
limited to, collateral type, index, margin, life cap, periodic cap,
underwriting standards, age and delinquency experience. The fair value
of the Company's collateralized notes payable 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, other borrowings 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.
The Company's transactions in interest rate swap agreements and
hedging activity using commitments to sell securities create
off-balance -sheet risk. These instruments involve market and credit
risk that is not recognized on the balance sheet. The principal risk
related to the swap agreements is the possibility that a counterparty
to the agreement may be unable or unwilling to meet the terms of the
agreement. With respect to commitments to sell securities, there is a
risk that the change in the value of the hedged item may not
substantially offset the change in the value of the commitment. The
Company reduces counterparty risk by dealing only with several
experienced counterparties with AA or better credit ratings or a
two-way collateral agreement is required.
NOTE 6. COMMON AND PREFERRED STOCK
In January 1997, the Company issued 2,760,000 shares of Series A 9.68%
Cumulative Convertible Preferred Stock at a price of $25 per share
pursuant to its Registration Statement on Form S-3 declared effective
in December 1996. Net proceeds from this issuance totaled $65.8
million. The dividends are cumulative commencing on the issue date and
are payable quarterly, in arrears. The
F-17
<PAGE>
dividends per share are equal to the greater of (i) $0.605 per
quarter, or (ii) the quarterly dividend declared on the Company's
common stock. Each share is convertible at the option of the holder at
any time into one share of common stock. The preferred shares are
redeemable by the Company on and after December 31, 1999, in whole or
in part, as follows: (i) for one share of common stock plus
accumulated, accrued but unpaid dividends, provided that for 20
trading days within any period of 30 consecutive trading days the
closing price of the common stock equals or exceeds the conversion
price of $25, or (ii) for cash at the issue price of $25, plus any
accumulated, accrued but unpaid dividends through the redemption date.
In the event of liquidation, the holders of the preferred shares will
be entitled to receive out of the assets of the Company, prior to any
distribution to the common shareholders, the issue price of $25 per
share in cash, plus any accumulated, accrued and unpaid dividends. The
Company has not, nor does it have any currents plans to exercise its
redemption rights at this time.
During 1999, the Company did not issue any shares of common stock
under its Dividend Reinvestment and Stock Purchase Plan. During 1998,
the Company issued 1,581,550 shares of common stock under this plan
and received net proceeds of $24.4 million, and during 1997, the
Company issued 912,590 shares of common stock under this plan and
received net proceeds of $18.0 million.
During 1999, there were no exercises of stock options. During 1998,
stock options for 128,377 shares of common stock were exercised at an
average price of $15.23 and $2.0 million of notes receivable were
executed in connection with the exercise of these options. During
1997, stock options for 186,071 shares of common stock were exercised
at an average price of $15.71. The Company received net proceeds of
$0.2 million, and $2.7 million of notes receivable were executed in
connection with the exercise of certain options.
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 common stock during 1999. To
date, the Company has repurchased 500,016 shares of common stock under
this program at an average price of $9.28 per share.
The following table presents information regarding the Company's
common and preferred dividends declared for the 1999, 1998 and 1997
fiscal years:
<TABLE>
<CAPTION>
28% (1) 20% (1) Return
Ordinary Capital Capital of
Income Gains Gains Capital Total
--------- -------- -------- ------- ----------
<S> <C> <C> <C> <C> <C>
Common Dividends:
1999 $ 0.9200 $ - $ - $ - $0.920 (2)
1998 0.8412 - - 0.0638 0.905 (2)
1997 1.9100 0.01 0.05 - 1.970 (2)
Preferred Dividends:
1999 $ 2.420 $ - $ - $ - $2.420 (3)
1998 2.420 - - - 2.420 (3)
1997 2.265 - - - 2.265 (3)
<FN>
(1) Maximum federal tax rate applicable to capital gains
(2) $0.23 and $0.50 of dividends was paid in the following fiscal years for
1999 and 1998, respectively.
(3) $0.605, $0.605 and $0.605 was paid in the following fiscal year for 1999,
1998, and 1997, respectively.
</TABLE>
In addition, the $0.605 preferred dividend paid on January 10, 2000
will be taken as a dividend deduction on the Company's 2000 income tax
return and is therefore not taxable income for preferred shareholders
until 2000.
NOTE 7. STOCK OPTION PLAN
The Company has a Stock Option and Incentive Plan (the "Plan") which
authorizes the granting of options to purchase an aggregate of up to
1,800,000 shares, but not more than 5% of the outstanding shares of
the Company's common stock. The Plan authorizes the Board of
Directors, or a committee of the Board of Directors, to grant
Incentive Stock Options ("ISOs") as defined under section 422 of the
Internal Revenue Code of 1986, as amended, options not so qualified
("NQSOs"), Dividend Equivalent Rights ("DERs"), Stock Appreciation
Rights ("SARs"), and Phantom Stock Rights ("PSRs").
F-18
<PAGE>
The exercise price for any options granted under the Plan may not be
less than 100% of the fair market value of the shares of the common
stock at the time the option is granted. Options become exercisable
six months after the date granted and will expire ten years after the
date granted, except options granted in connection with an offering of
convertible preferred stock, in which case such options become
exercisable if and when the convertible preferred stock is converted
into common stock.
The Company issued DERs at the same time as ISOs and NQSOs. 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. The Company recorded an
expense associated with the DERs and the PSRs of $92,000, $11,000 and
$32,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.
Notes receivable from stock sales has resulted from the Company
selling shares of common stock through the exercise of stock options.
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 December 31, 1999, there were $4.6
million of notes receivable from stock sales outstanding.
The Company adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized
for the Company's stock option plan. Had compensation cost for the
Company's stock option plan been determined based on the fair value at
the grant date for awards in 1999, 1998 and 1997 consistent with the
provisions of SFAS No. 123, the Company's net earnings and earnings
per share would have been reduced to the pro forma amounts indicated
in the table below. The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing model
(dollar amounts in thousands, except per share data).
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net income - as reported $ 25,584 $ 22,695 $ 41,402
Net income - pro forma 25,428 22,629 41,093
Basic EPS - as reported 0.88 0.75 1.95
Basic EPS - pro forma 0.87 0.74 1.93
Diluted EPS - as reported 0.88 0.75 1.94
Diluted EPS - pro forma 0.87 0.74 1.92
Assumptions:
Dividend yield 10.00% 10.00% 10.00%
Expected volatility 30.1% 25.60% 21.50%
Risk-free interest rate 5.48% 5.68% 6.40%
Expected lives 7 years 7 years 7 years
</TABLE>
F-19
<PAGE>
Information regarding options is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------------- ------------------- ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- ---------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 612,402 $ 17.549 680,995 $17.353 626,746 $15.510
Granted 186,779 8.897 59,784 14.817 240,320 20.888
Exercised - - (128,377) 15.234 (186,071) 15.711
Expired 9,708 18.227 - - - -
--------- --------- ---------- ------- --------- -------
Outstanding, end of year 789,473 $ 15.494 612,402 $17.549 680,995 $17.353
========= ========= ========== ======= ========= =======
Weighted average fair value of
options granted during the year $ 0.93 $ 1.22 $ 1.29
Options exercisable at year end 631,828 479,482 476,875
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Options Contractual Exercise Exercisable Exercise
Range of Exercise Prices Outstanding Life (Yrs) Price At 12/31/99 Price
- ------------------------- ----------- ------------ --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$8.375 - $12.4375 205,086 9.4 $ 9.194 160,086 $ 9.425
$14.375 - $16.125 320,428 4.6 15.343 320,428 15.343
$17.500 - $20.000 178,279 7.2 19.586 65,634 18.876
$22.625 85,680 7.5 22.625 85,680 22.625
- ------------------------- ----------- ------------ --------- ----------- ---------
$9.375 - $22.625 789,473 6.8 15.494 631,828 15.198
========================= =========== ============ ========= =========== =========
</TABLE>
NOTE 8. 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. In addition, during 1999, the two wholly-owned REIT
qualified subsidiaries of the Company entered into separate Management
Agreements with the Manager for additional management services for a
combined amount of $1,250 per calendar quarter, paid in arrears.
For the years ended December 31, 1999, 1998 and 1997, the Company paid
the Manager $4,088,000, $4,142,000 and $3,664,000, respectively, in
base management fees in accordance with the terms of the Agreement.
The Manager is also entitled to earn performance based compensation in
an amount equal to 20% of the Company's annualized net income, before
performance based compensation, above an annualized Return on Equity
equal to the ten year U.S. Treasury Rate plus 1%. For purposes of the
performance fee calculation, equity
F-20
<PAGE>
is generally defined as proceeds from issuance of common stock before
underwriter's discount and other costs of issuance, plus retained
earnings. For the year 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 years ended December 31, 1998 and 1997,
the Company paid the Manager $759,000 and $3,363,000, respectively, in
performance based compensation in accordance with the terms of the
Agreement.
Beginning in August 1999, the Company's two wholly-owned REIT
qualified subsidiaries entered into separate lease agreements with the
Manager for office space in Santa Fe. During 1999, the combined amount
of rent paid to the Manager was $10,000.
NOTE 9. NET INTEREST INCOME ANALYSIS
The following table summarizes the amount of interest income and
interest expense and the average effective interest rate for the
periods ended December 31, 1999, 1998 and 1997 (dollar amounts in
thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------- ---------------- ---------------
Average Average Average
Amount Rate Amount Rate Amount Rate
--------- -------- --------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Interest Earning Assets:
ARM assets $258,911 5.92% $286,327 5.96% $246,507 6.56%
Cash and cash equivalents 1,454 4.71 705 4.35 1,214 5.57
--------- -------- --------- ----- -------- -----
260,365 5.92 287,032 5.96 247,721 6.56
--------- -------- --------- ----- -------- -----
Interest Bearing Liabilities:
Borrowings 226,350 5.62 255,992 5.78 198,657 5.76
--------- -------- --------- ----- -------- -----
Net Interest Earning Assets and Spread $ 34,015 0.30% $ 31,040 0.18% $ 49,064 0.80%
========= ======== ========= ===== ======== =====
Yield on Net Interest Earning Assets (1) 0.77% 0.64% 1.30%
======== ===== =====
<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>
The following table presents the total amount of change in interest
income/expense from the table above and presents the amount of change
due to changes in interest rates versus the amount of change due to
changes in volume (dollar amounts in thousands):
<TABLE>
<CAPTION>
1999 versus 1998 1998 versus 1997
------------------------------ ------------------------------
Rate Volume Total Rate Volume Total
-------- --------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Interest Income:
ARM assets $(2,477) $(24,938) $(27,415) $(22,549) $62,368 $ 39,819
Cash and cash equivalents 382 366 748 (266) (242) (508)
-------- --------- --------- --------- -------- ---------
(2,095) (24,572) (26,667) (22,815) 62,126 39,311
-------- --------- --------- --------- -------- ---------
Interest Expense:
Borrowings (6,979) (22,663) (29,642) 518 56,817 57,335
-------- --------- --------- --------- -------- ---------
Net interest income $ 4,884 $ (1,909) $ 2,975 $(23,333) $ 5,309 $(18,024)
======== ========= ========= ========= ======== =========
</TABLE>
F-21
<PAGE>
NOTE 10. SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of the quarterly results of operations
(amounts in thousands, except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31, 1999
------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest income from ARM assets and cash $ 69,678 $ 67,955 $ 63,087 $ 59,645
Interest expense on borrowed funds (60,633) (58,623) (54,015 (53,079)
--------- --------- --------- ---------
Net interest income 9,045 9,332 9,072 6,566
--------- --------- --------- ---------
Gain (loss) on ARM assets (731) (749) (654) (686)
General and administrative expenses (1,518) (1,428) (1,384) (1,281)
Dividend on preferred stock (1,669) (1,670) (1,670) (1,670)
--------- --------- --------- ---------
Net income available to common shareholders $ 5,127 $ 5,485 $ 5,364 $ 2,929
========= ========= ========= =========
Basic EPS $ 0.24 $ 0.26 $ 0.25 $ 0.14
========= ========= ========= =========
Diluted EPS $ 0.24 $ 0.26 $ 0.25 $ 0.14
========= ========= ========= =========
Average number of common shares outstanding 21,490 21,490 21,490 21,490
========= ========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31, 1998
------------------------------------------
Fourth Third Second First
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest income from ARM assets and cash $ 65,446 $ 72,252 $ 73,019 $ 76,315
Interest expense on borrowed funds (59,402) (66,458) (65,243) (64,889)
--------- --------- --------- ---------
Net interest income 6,044 5,794 7,776 11,426
--------- --------- --------- ---------
Gain (loss) on ARM assets (4,689) 194 1,044 1,141
General and administrative expenses (1,309) (1,310) (1,345) (2,071)
Dividend on preferred stock (1,669) (1,670) (1,670) (1,670)
--------- --------- --------- ---------
Net income available to common shareholders $ (1,623) $ 3,008 $ 5,805 $ 8,826
========= ========= ========= =========
Basic EPS $ (0.08) $ 0.14 $ 0.27 $ 0.42
========= ========= ========= =========
Diluted EPS $ (0.08) $ 0.14 $ 0.27 $ 0.42
========= ========= ========= =========
Average number of common shares outstanding 21,490 21,858 21,796 20,797
========= ========= ========= =========
</TABLE>
F-22
<PAGE>
SCHEDULE IV - Mortgage Loans on Real Estate
Column A, Description: The Company's whole loan portfolio at December
31, 1999, which consists of only first mortgages on single-family
residential housing, is stratified as follows (dollar amounts in
thousands):
<TABLE>
<CAPTION>
Column A (continued) Column B Column C Column G Column H
- -------------------------------------- ----------- -------- -------------- ----------------------
Description (4)
Range of Number Final Carrying Principal Amount of
Carrying Amounts of Interest Maturity Amount of Loans Subject to
of Mortgages Loans Rate Date Mortgages (3) Delinquent
Principal or Interest
- ------------------------------ ------ ----------- -------- -------------- ----------------------
<S> <C> <C> <C> <C> <C>
ARM Loans:
$ 0 - 250 647 5.25 - 8.61 Various $ 85,921 $ 996
251 - 500 357 4.61 - 8.11 Various 125,010 489
501 - 750 119 6.08 - 8.23 Various 72,936 625
751 - 1,000 64 5.61 - 7.86 Various 57,985 -
over 1,000 63 5.48 - 8.98 Various 93,648 3,450
------ -------------- ----------------------
1,250 435,500 5,560
------ -------------- ----------------------
Hybrid Loans:
0 - 250 1,172 5.38 - 9.23 Various 147,709 -
251 - 500 432 5.25 - 8.13 Various 150,983 -
501 - 750 73 5.38 - 7.88 Various 43,935 -
751 - 1,000 31 5.63 - 7.78 Various 28,625 -
over 1,000 16 5.98 - 7.48 Various 25,691 -
------ -------------- ----------------------
1,724 396,943 -
------ -------------- ----------------------
Premium 13,599
Allowance for losses (2) (2,208)
------ -------------- ----------------------
2,974 $ 843,834 $ 5,560
====== ============== ======================
<FN>
Notes:
(1) Reconciliation of carrying amounts of mortgage loans:
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Balance at December 31, 1998 $1,078,325
Additions during 1999:
Loan purchases 35,417
Deductions during 1999:
Collections of principal 243,029
Cost of mortgage loans sold 8,767
Cost of mortgage loans securitized 12,693
Cost of mortgage loans transferred to REO 1,048
Provision for losses 1,404
Amortization of premium 2,967
----------
269,908
Balance at December 31, 1999 $ 843,834
==========
<FN>
(2) The provision for losses is based on management's assessment of various
factors.
(3) Cost for Federal income taxes is the same.
(4) The geographic distribution of the Company's whole loan portfolio at
December 31, 1999 is as follows:
</TABLE>
F-23
<PAGE>
<TABLE>
<CAPTION>
Number of
State or Territory Loans Carrying Amount
- ----------------------- ---------- -----------------
<S> <C> <C>
Arizona 75 $ 21,068
California 401 173,458
Colorado 76 38,839
Connecticut 54 21,385
Florida 450 108,217
Georgia 190 57,923
Illinois 71 18,872
Massachusetts 67 20,583
Michigan 171 33,269
Missouri 159 30,561
New Jersey 140 40,323
New York 255 62,713
Pennsylvania 58 15,261
Texas 103 25,140
Washington 53 15,447
Other states, less than 651 149,384
50 loans each
Premium 13,599
Allowance for losses (2,208)
---------- -----------------
TOTAL 2,974 $ 843,834
========== =================
</TABLE>
F-24
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities 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
(dba THORNBURG MORTGAGE, INC.)
(Registrant)
Dated: March 3, 2000 /s/ Garrett Thornburg
-----------------------
Garrett Thornburg
Chairman of the Board of Directors and
Chief Executive Officer
(Principal Executive Officer)
Dated: March 3, 2000 /s/ Richard P. Story
-----------------------
Richard P. Story
Chief Financial Officer and Treasurer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
- ---------------------- ----------------------- -------------
<S> <C> <C>
/s/ Garrett Thornburg Chairman of the Board, March 3, 2000
- ----------------------
Garrett Thornburg Director and Chief
Executive Officer
/s/ Larry A. Goldstone President, Director and March 3, 2000
- ----------------------
Larry A. Goldstone Chief Operating Officer
/s/ David A. Ater Director March 3, 2000
- ----------------------
David A. Ater
/s/ Joseph H. Badal Director March 3, 2000
- ----------------------
Joseph H. Badal
/s/ Owen M. Lopez Director March 3, 2000
- ----------------------
Owen M. Lopez
/s/ James H. Lorie Director March 3, 2000
- ----------------------
James H. Lorie
/s/ Stuart C. Sherman Director March 3, 2000
- ----------------------
Stuart C. Sherman
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Index
Sequentially
Numbered
Exhibit Number Exhibit Description Page
- -------------- ---------------------------------------------------------------------------- ----
<C> <S> <C>
1.1 Sales Agency Agreement (a)
3.1 Articles of Incorporation of the Registrant (b)
3.1.1 Articles of Amendment to Articles of Incorporation dated June 29, 1995 (c)
3.1.2 Articles Supplementary dated January 21, 1997 (d)
3.2 Amended and Restated Bylaws of the Registrant (e)
3.2.1.1 Amendment to the Restated Bylaws of the Registrant (f)
4.1 Specimen Common Stock Certificates (b)
4.2 Specimen Preferred Stock Certificates (d)
10.1 Management Agreement between the Registrant and Thornburg Mortgage
Advisory Corporation dated July 15, 1999 (g)
10.2 Form of Servicing Agreement (b)
10.3 Form of 1992 Stock Option and Incentive Plan as amended and
restated March 14, 1997 (h)
10.3.1 Amendment dated December 16, 1997 to the amended and restated
1992 Stock Option and Incentive Plan (i)
10.3.2 Amendment dated April 15, 1999 to the amended and restated
1992 Stock Option and Incentive Plan (g)
10.4 Form of Dividend Reinvestment and Stock Purchase Plan (j)
10.5 Trust Agreement dated as of December 1, 1998 (k)
10.6 Indenture Agreement dated as of December 1, 1998 (k)
10.7 Sales and Service Agreement dated as of December 1, 1998 (k)
22. Notice and Proxy Statement for the Annual Meeting of Shareholders to be
held on April 27, 2000 (l)
27 Financial Data Schedule * 73
<FN>
* Being filed herewith.
(a) Previously filed with Registrant's Form 8-K dated October 10, 1995 and incorporated herein
by reference pursuant to Rule 12b-32.
(b) Previously filed as part of Form S-11 which went effective on June 18, 1993 and
incorporated herein by reference pursuant to Rule 12b-32.
(c) Previously filed with Registrant's Form 10-Q dated June 30, 1995 and incorporated herein
by reference pursuant to Rule 12b-32.
(d) Previously filed as part of Form 8-A dated January 17, 1997 and incorporated herein by
reference pursuant to Rule 12b-32.
(e) Previously filed as part of Form S-8 dated July 1, 1994 and incorporated herein by
reference pursuant to Rule 12b-32.
(f) Previously filed with Registrant's Form 10-Q dated September 30, 1999 and incorporated
herein by reference pursuant to Rule 12b-32.
(g) Previously filed with Registrant's Form 10-Q dated June 30, 1999 and incorporated herein
by reference pursuant to Rule 12b-32.
(h) Previously filed with Registrant's Form 10-K dated December 31, 1996 and incorporated
herein by reference pursuant to Rule 12b-32.
(i) Previously filed with Registrant's Form 10-K dated December 31, 1997 and incorporated
herein by reference pursuant to Rule 12b-32.
(j) Previously filed as Exhibit 4 to Registrant's registration statement on Form S-3D dated
September 24, 1997 and incorporated herein by reference pursuant to Rule 12b-32.
(k) Previously filed with Registrant's Form 10-K dated December 31, 1998 and incorporated
herein by reference pursuant to Rule 12b-32.
(l) Previously filed on March 27, 2000 and incorporated by reference pursuant to Rule 12-b32.
</TABLE>
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the December
31, 1999 Form 10-K and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 10234
<SECURITIES> 4299032
<RECEIVABLES> 63132
<ALLOWANCES> 4138
<INVENTORY> 0
<CURRENT-ASSETS> 7705
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4375965
<CURRENT-LIABILITIES> 4065078
<BONDS> 0
0
65805
<COMMON> 220
<OTHER-SE> 244862
<TOTAL-LIABILITY-AND-EQUITY> 4375965
<SALES> 0
<TOTAL-REVENUES> 260412
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 5611
<LOSS-PROVISION> 2867
<INTEREST-EXPENSE> 226350
<INCOME-PRETAX> 25584
<INCOME-TAX> 0
<INCOME-CONTINUING> 25584
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 25584
<EPS-BASIC> .88
<EPS-DILUTED> .88
</TABLE>
