================================================================================
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
- ----- SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2000
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, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 85-0404134
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
119 E. MARCY STREET
SANTA FE, NEW MEXICO 87501
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (505) 989-1900
THORNBURG MORTGAGE ASSET CORPORATION
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1) Yes X No
--- ---
(2) Yes X No
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Common Stock ($.01 par value) 21,489,663 as of May 5, 2000
- --------------------------------------------------------------------------------
================================================================================
<PAGE>
THORNBURG MORTGAGE, INC.
FORM 10-Q
<TABLE>
<CAPTION>
INDEX
Page
----
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2000 and December 31, 1999 3
Consolidated Statements of Operations for the three months ended
March 31, 2000 and March 31, 1999 4
Consolidated Statement of Shareholders' Equity for the three months
ended March 31, 2000 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 2000 and March 31, 1999 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Changes in Securities 33
Item 3. Defaults Upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 34
EXHIBIT INDEX 35
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
March 31, 2000
(Unaudited) December 31, 1999
---------------- -------------------
<S> <C> <C>
ASSETS
Adjustable-rate mortgage ("ARM") assets: (Notes 2 and 4)
ARM securities $3,527,519 $3,391,467
Collateral for collateralized notes 856,907 903,529
ARM loans held for securitization 13,390 31,102
---------------- -------------------
4,397,816 4,326,098
---------------- -------------------
Cash and cash equivalents 33,288 10,234
Accrued interest receivable 34,059 31,928
Prepaid expenses and other 1,635 7,705
---------------- -------------------
$4,466,798 $4,375,965
================ ===================
LIABILITIES
Reverse repurchase agreements (Note 4) $3,303,809 $3,022,511
Collateralized notes (Note 4) 841,519 886,722
Other borrowings (Note 4) 8,522 21,289
Payable for assets purchased - 110,415
Accrued interest payable 14,502 18,864
Dividends payable (Note 6) 1,670 1,670
Accrued expenses and other 3,282 3,607
---------------- -------------------
4,173,304 4,065,078
---------------- -------------------
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 342,093 342,026
Accumulated other comprehensive income (loss) (100,849) (82,489)
Notes receivable from stock sales (4,632) (4,632)
Retained earnings (deficit) (4,477) (5,377)
Treasury stock: at cost, 500 and 500 shares, respectively (4,666) (4,666)
---------------- -------------------
293,494 310,887
---------------- -------------------
$4,466,798 $4,375,965
================ ===================
</TABLE>
See Notes to Consolidated Financial Statements.
3
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
Three Months Ended
March 31,
2000 1999
--------- ---------
<S> <C> <C>
Interest income from ARM assets and cash $ 72,654 $ 59,645
Interest expense on borrowed funds (63,337) (53,079)
--------- ---------
Net interest income 9,317 6,566
--------- ---------
Gain (loss) on sale of ARM assets - -
Provision for credit losses (331) (686)
Management fee (Note 8) (1,024) (1,018)
Performance fee (Note 8) - -
Other operating expenses (449) (263)
--------- ---------
NET INCOME $ 7,513 $ 4,599
========= =========
Net income $ 7,513 $ 4,599
Dividend on preferred stock (1,670) (1,670)
--------- ---------
Net income available to common shareholders $ 5,843 $ 2,929
========= =========
Basic earnings per share $ 0.27 $ 0.14
========= =========
Diluted earnings per share $ 0.27 $ 0.14
========= =========
Average number of common shares outstanding 21,490 21,490
========= =========
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
<TABLE>
<CAPTION>
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited)
Three Months Ended March 31, 2000
(In thousands, except share data)
Accum. Notes
Other Receivable
Additional Compre- From Retained Compre-
Preferred Common Paid-in hensive Stock Earnings/ Treasury hensive
Stock Stock Capital Income Sales (Deficit) Stock Income Total
---------- ------- -------- ---------- -------- ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1999 $ 65,805 $ 220 $342,026 $ (82,489) $(4,632) $ (5,377) $ (4,666) $310,887
Comprehensive income:
Net income 7,513 $ 7,513 7,513
Other comprehensive income:
Available-for-sale assets:
Fair value adjustment, net
of amortization - - - (18,144) - - - (18,144) (18,144)
Deferred gain on sale of
hedges, net of
amortization - - - (216) - - - (216) (216)
Other comprehensive ---------
income $(10,847)
Interest from notes =========
receivable from stock sales 67 67
Dividends declared on
preferred
stock - $0.605 per share - - - - - (1,670) - (1,670)
Dividends declared on
common
stock - $0.23 per share - - - - - (4,943) - (4,943)
---------- ------- -------- ---------- -------- ----------- ---------- ---------
Balance, March 31, 2000 $ 65,805 $ 220 $342,093 $(100,849) $(4,632) $ (4,477) $ (4,666) $293,494
========== ======= ======== ========== ======== =========== ========== =========
</TABLE>
See Notes to Consolidated Financial Statements.
5
<PAGE>
THORNBURG MORTGAGE, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Three Months Ended
March 31,
2000 1999
---------- ----------
<S> <C> <C>
Operating Activities:
Net Income $7,513 $4,599
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization 5,217 10,796
Net (gain) loss from investing activities 331 686
Change in assets and liabilities:
Accrued interest receivable (2,131) 8,071
Prepaid expenses and other 6,070 (3,520)
Accrued interest payable (4,362) (20,146)
Accrued expenses and other (325) (469)
---------- ----------
Net cash provided by operating activities 12,313 17
---------- ----------
Investing Activities:
Available-for-sale ARM securities:
Purchases (398,717) (99,707)
Principal payments 149,583 338,460
Collateral for collateralized notes:
Principal payments 45,641 73,258
ARM loans:
Purchases (2,729) -
Principal payments 629 5,092
Purchase of interest rate cap agreements (448) (1,469)
---------- ----------
Net cash provided by (used in) investing activities (206,041) 315,634
---------- ----------
Financing Activities:
Net borrowings from (repayments of) reverse
repurchase agreements 281,298 (223,358)
Repayments of collateralized notes (45,203) (74,752)
Repayments of other borrowings (12,767) (83)
Dividends paid (6,613) (6,613)
Interest from notes receivable from stock sales 67 66
---------- ----------
Net cash provided by (used in) financing activities 216,782 (304,740)
---------- ----------
Net increase (decrease) in cash and cash equivalents 23,054 10,911
Cash and cash equivalents at beginning of period 10,234 36,431
---------- ----------
Cash and cash equivalents at end of period $33,288 $47,342
========== ==========
Supplemental disclosure of cash flow information
and non-cash activities are included in Note 3.
</TABLE>
See Notes to Consolidated Financial Statements
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Therefore, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.
In the opinion of management, all material adjustments, consisting of
normal recurring adjustments, considered necessary for a fair presentation
have been included. The operating results for the quarter end March 31,
2000 are not necessarily indicative of the results that may be expected for
the calendar year ending December 31, 2000.
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
Thornburg Mortgage, Inc (the "Company") and its wholly-owned
bancruptcy remote special purpose finance subsidiaries, Thornburg
Mortgage Funding Corporation, Thornburg Mortgage Acceptance
Corporation and Thornburg Mortgage Acceptance Corporation II. The
Company formed these entities in connection with its securitization
and whole loan financing transactions 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 AAA notes payable, which
also consists of ARM securities and ARM loans. Included in the
Company's ARM assets are hybrid ARM securities and loans ("Hybrid
ARMs") that have a fixed interest rate for an initial period,
generally three to ten years, and then convert to an adjustable-rate
for their remaining term to maturity.
Management has made the determination that all of its ARM securities
should be designated as available-for-sale in order to be prepared to
respond to potential future opportunities in the market, to sell ARM
securities in order to optimize the portfolio's total return and to
retain its ability to respond to economic conditions that might
require the Company to sell assets in order to maintain an appropriate
level of liquidity. Since all ARM securities are designated as
available-for-sale, they are reported at fair value, with unrealized
gains and losses excluded from earnings and reported in accumulated
other comprehensive income as a separate component of shareholders'
equity.
Management has the intent and ability to hold the Company's ARM loans
for the foreseeable future and until maturity or payoff. Therefore,
they are carried at their unpaid principal balances, net of
unamortized premium or discount and allowance for loan losses.
The collateral for the AAA notes includes ARM securities and ARM
loans, which are accounted for in the same manner as the ARM
securities, and ARM loans that are not held as collateral.
Premiums and discounts associated with the purchase of the ARM assets
are amortized into interest income over the lives of the assets using
the effective yield method adjusted for the effects of estimated
prepayments.
ARM asset transactions are recorded on the date the ARM assets are
purchased or sold. Purchases of new issue ARM securities and all ARM
loans are recorded when all significant uncertainties regarding the
7
<PAGE>
characteristics of the assets are removed and, in the case of loans,
underwriting due diligence has been completed, generally shortly
before the settlement date. Realized gains and losses on ARM asset
transactions are determined on the specific identification basis.
CREDIT RISK
The Company limits its exposure to credit losses on its portfolio of
ARM securities by only purchasing ARM securities that have an
investment grade rating at the time of purchase and have some form of
credit enhancement or are 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
8
<PAGE>
Company's cost of borrowings also continue to rise. In similar
fashion, the Company has purchased Cap Agreements to limit the
financing rate of the Hybrid ARMs during their fixed rate term,
generally for three to ten years. In general, the cost of financing
Hybrid ARMs hedged with Cap Agreements is capped at a rate that is
0.75% to 1.00% below the fixed Hybrid ARM interest rate.
All Cap Agreements are classified as a hedge against
available-for-sale assets or ARM loans and are carried at their fair
value with unrealized gains and losses reported as a separate
component of equity. The carrying value of the Cap Agreements is
included in ARM securities on the balance sheet. The Company purchases
Cap Agreements by incurring a one-time fee or premium. The
amortization of the premium paid for the Cap Agreements is included in
interest income as a contra item (i.e., expense) and, as such, reduces
interest income over the lives of the Cap Agreements.
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.
Realized gains and losses resulting from the termination and
replacement of Swap Agreements, are recorded as basis adjustments to
the hedged liabilities and are thereafter amortized as a yield
adjustment over the remaining term of the Swap Agreements. The
terminated and replacement Swap Agreements generally have the same
terms and conditions other than the fixed rate. The amortization of
the realized gains and losses as a yield adjustment to the fixed rate
of the replacement Swap Agreement results in approximately the same
fixed cost between the terminated and replacement Swap Agreements. The
Company terminates and replaces Swap Agreements as an additional
source of liquidity when it is able to do so while maintaining
compliance to its hedging policies.
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
9
<PAGE>
of 1986, as amended (the "Code") with respect thereto. Accordingly,
the Company will not be subject to Federal income tax on that portion
of its income that is distributed to shareholders and as long as
certain asset, income and stock ownership tests are met.
NET EARNINGS PER SHARE
Basic EPS amounts are computed by dividing net income (adjusted for
dividends declared on preferred stock) by the weighted average number
of common shares outstanding. Diluted EPS amounts assume the
conversion, exercise or issuance of all potential common stock
instruments unless the effect is to reduce a loss or increase the
earnings per common share.
Following is information about the computation of the earnings per
share data for the three-month periods ended March 31, 2000 and 1999
(amounts in thousands except per share data):
<TABLE>
<CAPTION>
Earnings
Income Shares Per Share
---------- ------ ----------
Three Months Ended March 31, 2000
- ---------------------------------
<S> <C> <C> <C>
Net income $7,513
Less preferred stock dividends (1,670)
----------
Basic EPS, income available to
common shareholders 5,843 21,490 $0.27
=========
Effect of dilutive securities:
Stock options - -
---------- ------
Diluted EPS $5,843 21,490 $0.27
========== ======= =========
Three Months Ended March 31, 1999
- ---------------------------------
Net income $4,599
Less preferred stock dividends (1,670)
---------
Basic EPS, income available to
common stockholders 2,929 21,490 $ 0.14
=========
Effect of dilutive securities:
Stock options - -
---------- ------
Diluted EPS $ 2,929 21,490 $ 0.14
========== ======= =========
</TABLE>
The Company has granted options to directors and officers of the
Company and employees of the Manager to purchase 10,000 shares of
common stock at an average price of $8.44 per share during the quarter
ended March 31, 2000. The Company did not grant any options to
purchase shares of the Company's common stock to directors or officers
or to employees of the Manager during the quarter ended March 31,
1999. The conversion of preferred stock was not included in the
computation of diluted EPS 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 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.
10
<PAGE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
NOTE 2. ADJUSTABLE-RATE MORTGAGE ASSETS AND INTEREST RATE CAP AGREEMENTS
The following tables present the Company's ARM assets as of March 31, 2000
and December 31, 1999. The ARM securities classified as available-for-sale
are carried at their fair value, while the ARM loans are carried at their
amortized cost basis (dollar amounts in thousands):
<TABLE>
<CAPTION>
March 31, 2000:
Available-
for-Sale Collateral for
ARM Securities Notes Payable ARM Loans Total
-------------- ---------------- ----------- -----------
<S> <C> <C> <C> <C>
Principal balance outstanding $ 3,549,397 $ 845,428 $ 13,466 $4,408,291
Net unamortized premium 66,630 13,383 30 80,043
Deferred gain from hedging (263) - - (263)
Allowance for losses (1,842) (2,395) (106) (4,343)
Cap agreements 4,563 290 - 4,853
Principal payment receivable 10,532 201 - 10,733
---------------- ---------------- ----------- -----------
Amortized cost, net 3,629,017 856,907 13,390 4,499,314
---------------- ---------------- ----------- -----------
Gross unrealized gains 4,540 35 22 4,597
Gross unrealized losses (106,038) (14,194) (93) (120,325)
---------------- ---------------- ----------- -----------
Fair value $ 3,527,519 $ 842,748 $ 13,319 $4,383,586
================ ================ =========== ===========
Carrying value $ 3,527,519 $ 856,907 $ 13,390 $4,397,816
================ ================ =========== ===========
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
================ ================ =========== ===========
</TABLE>
During both the quarters ended March 31, 2000 and 1999, the Company
did not sell any ARM securities.
11
<PAGE>
As of March 31, 2000, 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 $1,842,000. The Company has
reduced the cost basis on two assets that have an aggregate carrying
value of $9.6 million, which represent approximately 0.2% of the
Company's total portfolio of ARM assets. The Company believes the
reduced cost basis of these assets is at the appropriate amount and
did not reduce the cost basis of these ARM assets during the quarter
ended March 31, 2000. During the first three months of 2000, in
accordance with its credit policies, the Company provided for
estimated credit losses on the subordinated classes of its securitized
loans in the amount of $38,000 and recorded a $293,000 provision for
potential credit losses on its loan portfolio, although no actual
losses have been realized in the loan portfolio to date.
The following tables summarize ARM loan delinquency information as of
March 31, 2000 and December 31, 1999 (dollar amounts in thousands):
<TABLE>
<CAPTION>
March 31, 2000
- --------------------
Percent
Loan Loan of ARM Percent of
Delinquency Status Count Balance Loans (1) Total Assets
-------- ---------- ----------- -------------
<S> <C> <C> <C> <C>
60 to 89 days 7 $ 1,509 0.13% 0.03%
90 days or more 2 5,049 0.43 0.11
In foreclosure 8 1,731 0.15 0.04
-------- ---------- ----------- -------------
17 $ 8,289 0.71% 0.18%
======== ========== =========== =============
December 31,1999
- --------------------
Percent
Loan Loan of ARM Percent of
Delinquency Status Count Balance Loans (1) Total Assets
-------- ---------- ----------- -------------
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%
======== ========== =========== =============
<FN>
(1) ARM loans includes loans that the Company has securitized and retained
first loss credit exposure for total amounts of $1.183 billion and
$1.108 billion at March 31, 2000 and December 31, 1999, respectively.
</TABLE>
The following table summarizes the activity for the allowance for losses on
ARM loans for the quarters ended March 31, 2000 and 1999 (dollar amounts in
thousands):
2000 1999
---- ----
Beginning balance $2,208 $804
Provision for losses 293 380
Charge-offs, net - -
------ ------
Ending balance $2,501 $1,184
====== ======
As of March 31, 2000, the Company had commitments to purchase $18.9 million
of ARM loans through its correspondent loan network.
As of March 31, 2000, the Company owned three real estate properties as a
result of foreclosing on delinquent loans in the aggregate amount of $1.7
million, which are included in collateral for collateralized notes on the
balance sheet. The Company believes that the above allowance is more than
adequate to cover estimated losses from these properties.
The average effective yield on the ARM assets owned was 6.58% as of March
31, 2000 and 6.38% as of December 31, 1999. 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.
12
<PAGE>
As of March 31, 2000 and December 31, 1999, the Company had purchased Cap
Agreements with a remaining notional amount of $3.025 billion and $2.945
billion, respectively. The notional amount of the Cap Agreements purchased
decline at a rate that is expected to approximate the amortization of the
ARM assets. Under these Cap Agreements, the Company will receive cash
payments should the one-month, three-month or six-month London InterBank
Offer Rate ("LIBOR") increase above the contract rates of the Cap
Agreements that range from 5.75% to 12.50% and average approximately
10.02%. Of the Cap Agreements owned by the Company as of March 31, 2000,
$126.7 million are hedging the cost of financing Hybrid ARMs and $2.899
billion are hedging the lifetime interest rate cap of ARM assets. The
Company's ARM assets portfolio had an average lifetime interest rate cap of
11.68%. The Cap Agreements had an average maturity of 2.4 years as of March
31, 2000. The initial aggregate notional amount of the Cap Agreements
declines to approximately $2.758 billion over the period of the agreements,
which expire between 1999 and 2004. The Company has credit risk to the
extent that the counterparties to the cap agreements do not perform their
obligations under the Cap Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise
be entitled under the conditions of the Cap Agreement. In order to mitigate
this risk and to achieve competitive pricing, the Company has entered into
Cap Agreements with seven different counterparties, five of which are rated
AAA, and one is rated AA and one is rate A, but the Company has a two-way
collateral agreement protecting its credit exposure with this counterparty.
NOTE 3. AGREEMENT TO PURCHASE 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 that time, 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 the
third quarter of 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 assets
and bear interest rates that have historically moved in close relationship
to LIBOR.
As of March 31, 2000, the Company had outstanding $3.294 billion of reverse
repurchase agreements with a weighted average borrowing rate of 6.25% and a
weighted average remaining maturity of 2.5 months. As of March 31, 2000,
$1.613 billion of the Company's borrowings were variable-rate term reverse
repurchase agreements with original maturities that range from three months
to fourteen months. The interest rates of these term reverse repurchase
agreements are indexed to either the one- or three-month LIBOR rate and
reprice accordingly. The reverse repurchase agreements at March 31, 2000
were collateralized by ARM assets with a carrying value of $3.505 billion,
including accrued interest.
At March 31, 2000, the reverse repurchase agreements had the following
remaining maturities (dollar amounts in thousands):
Within 30 days $ 1,080,878
31 to 89 days 958,054
90 days or greater 1,264,877
-----------
$ 3,303,809
===========
13
<PAGE>
As of March 31, 2000, the Company had entered into four 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 matures in January 2001. During
the first quarter of 2000, the Company entered into a second committed
whole loan financing facility that also has a borrowing capacity of $150
million. This second committed facility matures in March of 2003, subject
to an annual review and extension by both parties. A third facility has an
uncommitted amount of borrowing capacity of $150 million and matures in
April 2000. The fourth facility is for an unspecified amount of uncommitted
borrowing capacity and does not have a specific maturity date. As of March
31, 2000, the Company had $8.5 million borrowed against these whole loan
financing facilities at an effective cost of 6.72%. The amount borrowed on
the whole loan financing agreements at March 31, 2000 was collateralized by
ARM loans with a carrying value of $8.8 million, including accrued
interest.
The whole loan financing facility entered into during the first quarter of
2000, discussed above, is a securitization transaction in which the Company
transfers groups of whole loans to a wholly-owned bankruptcy remote special
purpose subsidiary. The subsidiary in turn simultaneously transfers its
interest in the loans to a trust which issues beneficial interests in the
loans in the form of a note and a subordinated certificate, which are then
used to collateralize borrowings.
On December 18, 1998, the Company, through a wholly-owned bancrupcty remote
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
March 31, 2000, the Notes had a net balance of $841.5 million, an effective
interest cost of 6.83%, which changes each month at a spread to one-month
LIBOR. These Notes were collateralized by ARM loans with a principal
balance of $758.2 million and ARM securities with a balance of $119.5
million. The Notes mature on January 25, 2029 and are callable by the
Company at par once the balance of the Notes is reduced to 25% of their
original balance. In connection with the issuance and modification of the
Notes, the Company incurred costs of approximately $6.0 million, which is
being amortized over the expected life of the Notes. Since the Notes are
paid down as the collateral pays down, the amortization of the issuance
cost will be adjusted periodically based on actual payment experience. If
the collateral pays down faster than currently estimated, then the
amortization of the issuance cost will increase and the effective cost of
the Notes will increase and, conversely, if the collateral pays down slower
than currently estimated, then the amortization of issuance cost will be
decreased and the effective cost of the Notes will also decrease.
As of March 31, 2000, the Company was a counterparty to nineteen interest
rate swap agreements ("Swaps") having an aggregate notional balance of
$650.3 million. As of March 31, 2000, these Swaps had a weighted average
remaining term of 2.8 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 36 days to
229 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 March 31, 2000, they were not
collateralized by any ARM assets.
During the first quarter of 2000, the Company terminated and replaced six
Swaps and deferred the realized gain of $7.7 million. The replacement Swaps
have the identical terms as the terminated Swaps other than the fixed rate
to be paid by the Company. The amortization of the deferred gain as a yield
adjustment to the new fixed rate reduces the rate on the replacement Swaps
to approximately the same fixed rate as the terminated Swaps and, as an
additional benefit, the Company was able to increase liquid assets by $7.7
million which was used to reduce the Company's borrowings.
The total cash paid for interest was $66.9 million and $68.8 million during
the quarters ended March 31, 2000 and 1999, respectively.
14
<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 March 31, 2000 and December 31,
1999. FASB Statement No. 107, Disclosures About Fair Value of Financial
Instruments, defines the fair value of a financial instrument as the amount
at which the instrument could be exchanged in a current transaction between
willing parties, other than in a forced or liquidation sale (dollar amounts
in thousands):
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999
----------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Assets:
ARM assets $4,390,922 $4,376,692 $4,318,301 $4,305,060
Cap Agreements 6,894 6,894 7,797 7,797
Liabilities:
Callable collateralized notes 841,519 842,442 886,722 889,305
Other borrowings 8,522 8,522 21,289 21,289
Swap agreements 9,619 (6,479) 749 (11,527)
</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
On July 13, 1998, the Board of Directors approved a common stock repurchase
program of up to 500,000 shares at prices below book value, subject to
availability of shares and other market conditions. On September 18, 1998,
the Board of Directors expanded this program by approving the repurchase of
up to an additional 500,000 shares. The Company did not repurchase any
shares of its common stock under this program during the quarter ended
March 31, 2000. To date, the company has repurchased 500,016 at an average
price of $9.28 per share.
15
<PAGE>
On January 25, 2000, the Company declared the fourth quarter 1999 dividend
of $0.23 per common share, which was paid on February 17, 2000 to common
shareholders of record as of February 3, 2000.
On April 17, 2000, the Company declared the first quarter 2000 dividend of
$0.23 per common share, which will be paid on May 17, 2000 to common
shareholders of record as of May 4, 2000.
On March 15, 2000, the Company declared a first quarter dividend of $0.605
per share to the shareholders of the Series A 9.68% Cumulative Convertible
Preferred Stock which was also paid on April 10, 2000 to preferred
shareholders of record as of March 31, 2000.
For federal income tax purposes, all dividends are expected to be ordinary
income to the Company's common and preferred shareholders, subject to
year-end allocations of the common dividend between ordinary income,
capital gain income and non-taxable income as return of capital, depending
on the amount and character of the Company's full year taxable income.
NOTE 7. STOCK OPTION PLAN
The Company has a Stock Option and Incentive Plan (the "Plan") that
authorizes the granting of options to purchase an aggregate of up to
1,800,000 shares, but not more than 5% of the outstanding shares of the
Company's common stock. The Plan authorizes the Board of Directors, or a
committee of the Board of Directors, to grant Incentive Stock Options
("ISOs") as defined under section 422 of the Internal Revenue Code of 1986,
as amended, options not so qualified ("NQSOs"), Dividend Equivalent Rights
("DERs"), Stock Appreciation Rights ("SARs"), and Phantom Stock Rights
("PSRs").
The exercise price for any options granted under the Plan may not be less
than 100% of the fair market value of the shares of the common stock at the
time the option is granted. Options become exercisable six months after the
date granted and will expire ten years after the date granted, except
options granted in connection with an offering of convertible preferred
stock, in which case such options become exercisable if and when the
convertible preferred stock is converted into common stock.
The Company usually issues DERs at the same time ISOs and NQSOs are
granted. The number of PSRs issued is based on the level of the Company's
dividends and on the price of the Company's stock on the related dividend
payment date and is equivalent to the cash that otherwise would be paid on
the outstanding DERs and previously issued PSRs.
During the quarter ended March 31, 2000, there were 10,000 options to buy
common shares and 5,500 DERs granted. As of March 31, 2000, the Company had
799,473 options outstanding at exercise prices of $8.375 to $22.625 per
share, 631,828 of which were exercisable. The weighted average exercise
price of the options outstanding was $15.41 per share. As of the March 31,
2000, there were 167,675 DERs outstanding, of which 139,514 were vested,
and 20,344 PSRs outstanding. In addition, the Company recorded an expense
associated with the DERs and the PSRs of $18,000 for each of the quarters
ended March 31, 2000 and 1999.
Notes receivable from stock sales result from the Company selling shares of
common stock through the exercise of stock options partially for
consideration for notes receivable. The notes have remaining maturity terms
ranging from 1 year to 7 years and accrue interest at rates that range from
5.40% to 6.00% per annum. In addition, the notes are full recourse
promissory notes and are secured by a pledge of the shares of the Common
Stock acquired. Interest, which is credited to paid-in-capital, is payable
quarterly, with the balance due at the maturity of the notes. The payment
of the notes will be accelerated only upon the sale of the shares of Common
Stock pledged for the notes. The notes may be prepaid at any time at the
option of each borrower. As of March 31, 2000, there were $4.6 million of
notes receivable from stock sales outstanding.
16
<PAGE>
NOTE 8. TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement (the "Agreement") with 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 quarters ended March 31, 2000 and 1999, the Company paid the
Manager $1,024,000 and $1,018,000, respectively, in base management fees in
accordance with the terms of the Agreement.
The Manager is also entitled to earn performance based compensation in an
amount equal to 20% of the Company's annualized net income, before
performance based compensation, above an annualized Return on Equity equal
to the ten year U.S. Treasury Rate plus 1%. For purposes of the performance
fee calculation, equity is generally defined as proceeds from issuance of
common stock before underwriter's discount and other costs of issuance,
plus retained earnings. For the quarters ended March 31, 2000 and 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%.
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 the quarter ended March 31, 2000, the
combined amount of rent paid to the Manager was $6,000.
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain information contained in this Quarterly Report on Form 10-Q constitute
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Exchange Act, which can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," or "continue" or the negatives thereof or
other variations thereon or comparable terminology. Investors are cautioned
that all forward-looking statements involve risks and uncertainties including,
but not limited to, risks related to the future level and relationship of
various interest rates, prepayment rates and the timing of new programs. The
statements in the "Risk Factors" section of the Company's 1999 Annual Report on
Form 10-K on page 17 constitute cautionary statements identifying important
factors, including certain risks and uncertainties, with respect to such
forward-looking statements that could cause the actual results, performance or
achievements of the Company to differ materially from those reflected in such
forward-looking statements.
GENERAL
- -------
Thornburg Mortgage, Inc., 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. The Company has three REIT qualified subsidiaries that are
involved in financing its mortgage loan assets. The three financing
subsidiaries, Thornburg Mortgage Funding Corporation, Thornburg Mortgage
Acceptance Corporation and Thornburg Mortgage Acceptance Corporation II, 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 subsidiary is expected to commence
operations during the second quarter of 2000.
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. Hybrid ARM assets ("Hybrid ARMs")
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. 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. Hybrid ARMs with
fixed-rate periods greater than five years are further limited to no more than
10% of the Company's ARM assets.
The Company's investment policy is to invest at least 70% of total assets in
High Quality adjustable and variable rate mortgage securities and short-term
investments. High Quality means:
(1) securities that are unrated but are guaranteed by the U.S. Government
or issued or guaranteed by an agency of the U.S. Government;
(2) securities which are rated within one of the two highest rating
categories by at least one of either Standard & Poor's or Moody's
Investors Service, Inc. (the "Rating Agencies"); or
(3) securities that are unrated or whose ratings have not been updated but
are determined to be of comparable quality (by the rating standards of
at least one of the Rating Agencies) to a High Quality rated mortgage
security, as determined by the Manager (as defined below) and approved
by the Company's Board of Directors; or
(4) the portion of ARM or hybrid loans that have been deposited into a
trust and have received a credit rating of AA or better from at least
one Rating Agency.
18
<PAGE>
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");
(3) real estate properties acquired as a result of foreclosing on the
Company's ARM loans; or
(4) 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 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 the third quarter of 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 starting up and operating a mortgage banking operation by utilizing "fee
based" third-party vendors who specialize in private label loan underwriting,
application processing and loan closing, 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 has sold a significant percentage of its 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.
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.
19
<PAGE>
Thornburg Brand Development
In 1999, the Company instituted a new marketing approach in conjunction with the
other affiliated Thornburg Companies 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's
shareholders approved an amendment to the Company's Articles of Incorporation to
formally change the name of the Company to Thornburg Mortgage, Inc. at the
Annual Shareholders Meeting held on 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.
FINANCIAL CONDITION
- --------------------
At March 31, 2000, the Company held total assets of $4.467 billion, $4.398
billion of which consisted of ARM assets, as compared to $4.375 billion and
$4.326 billion, respectively, at December 31, 1999. Since commencing
operations, the Company has purchased either ARM securities (backed by agencies
of the U.S. government or privately-issued, generally publicly registered,
mortgage assets, most of which are rated AA or higher by at least one of the
Rating Agencies) or ARM loans generally originated to "A" quality underwriting
standards. At March 31, 2000, 96.0% of the assets held by the Company,
including cash and cash equivalents, were High Quality assets, far exceeding the
Company's investment policy minimum requirement of investing at least 70% of its
total assets in High Quality ARM assets and cash and cash equivalents. Of the
ARM assets currently owned by the Company, 86.1% are in the form of
adjustable-rate pass-through certificates or ARM loans. The remainder are
floating rate classes of CMOs (10.3%) or investments in floating rate classes of
CBOs (3.6%) backed primarily by ARM mortgaged-backed securities.
The following table presents a schedule of ARM assets owned at March 31, 1999
and December 31, 1998 classified by High Quality and Other Investment assets and
further classified by type of issuer and by ratings categories.
<TABLE>
<CAPTION>
ARM ASSETS BY ISSUER AND CREDIT RATING
(Dollar amounts in thousands)
March 31, 2000 December 31, 1999
------------------------ -----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
HIGH QUALITY:
FHLMC/FNMA $2,129,913 48.4% $2,068,152 47.8%
Privately Issued:
AAA/Aaa Rating 1,630,970(1) 37.1 1,585,099(1) 36.6
AA/Aa Rating 439,844 10.0 459,858 10.6
------------- ---------- ------------- -------
Total Privately Issued 2,070,814 47.1 2,044,957 47.2
------------- ---------- ------------- -------
------------- ---------- ------------- -------
Total High Quality 4,200,727 95.5 4,113,109 95.0
------------- ---------- ------------- -------
OTHER INVESTMENT:
Privately Issued:
A Rating 50,793 1.2 49,995 1.2
BBB/Baa Rating 85,557 2.0 84,929 2.0
BB/Ba Rating or below 47,349(1) 1.1 46,963(1) 1.1
Whole loans 13,390 0.2 31,102 0.7
------------- ---------- ------------- -------
Total Other Investment 197,089 4.5 212,989 5.0
------------- ---------- ------------- -------
Total ARM Portfolio $4,397,816 100.0% $4,326,098 100.0%
============= ========== ============= =======
<FN>
- -----------------
(1) AAA Rating category includes $737.2 million and $781.8 million as of March
31, 2000 and December 31, 1999, 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 million as of March 31, 2000 and December 31, 1999.
The subordinated certificate is included in the BB/Ba Rating and Other
category.
</TABLE>
20
<PAGE>
As of March 31, 2000, the Company had reduced the cost basis of its ARM
securities by $1,842,000 due to estimated credit losses (other than temporary
declines in fair value). The Company has provided for estimated credit losses
on two securities that have an aggregate carrying value of $9.6 million, which
represent approximately 0.2% of the Company's total portfolio of ARM assets.
The Company believes the reduced cost basis of these two ARM securities is at
the appropriate amount and did not reduce the cost basis of these ARM securities
during the quarter ended March 31, 2000.
Additionally, during the first three months of 2000, in accordance with its
credit policies, the Company provided for estimated credit losses on the
subordinated classes of its securitized loans in the amount of $38,000 and
recorded a $293,000 provision for estimated credit losses on its loan portfolio,
although no actual losses have been realized in the loan portfolio to date. As
of March 31, 2000, the Company's ARM loan portfolio included 17 loans that are
considered seriously delinquent (60 days or more delinquent) with an aggregate
balance of $8.3 million. The ARM loan portfolio also includes three properties
("REO") that the Company acquired as the result of foreclosure processes in the
amount of $1.7 million. The average original effective loan-to-value ratio on
these 17 delinquent loans and REO is approximately 68%. The Company believes
that its current level of reserves is more than adequate to cover estimated
losses from these loans and REO properties. 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.
The following table classifies the Company's portfolio of ARM assets by type of
interest rate index.
<TABLE>
<CAPTION>
ARM ASSETS BY INDEX
(Dollar amounts in thousands)
March 31, 2000 December 31, 1999
---------------------- ----------------------
Carrying Portfolio Carrying Portfolio
Value Mix Value Mix
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ARM ASSETS:
INDEX:
One-month LIBOR $ 710,333 16.2% $ 680,449 15.7%
Three-month LIBOR 155,968 3.5 170,384 3.9
Six-month LIBOR 584,469 13.3 626,616 14.5
Six-month Certificate of Deposit 289,190 6.6 304,621 7.0
Six-month Constant Maturity Treasury 35,903 0.8 37,781 0.9
One-year Constant Maturity Treasury 1,393,024 31.7 1,359,229 31.4
Cost of Funds 203,065 4.6 213,800 5.0
---------- ---------- ---------- ----------
3,371,952 76.7 3,392,880 78.4
---------- ---------- ---------- ----------
HYBRID ARM ASSETS 1,025,864 23.3 933,218 21.6
---------- ---------- ---------- ----------
$4,397,816 100.0% $4,326,098 100.0%
========== ========== ========== ==========
</TABLE>
The ARM portfolio had a current weighted average coupon of 7.26% at March 31,
2000. This consisted of an average coupon of 6.63% on the hybrid portion of the
portfolio and an average coupon of 7.45% 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 8.12%, based upon the current
composition of the portfolio and the applicable indices. As of December 31,
1999, the ARM portfolio had a weighted average coupon of 7.08%. 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 composition of the portfolio and
the applicable indices at the time. The higher average interest coupon on the
ARM portfolio as of March 31, 2000 compared to the end of 1999 is reflective of
Federal Reserve Board interest rate increases that have been occurring since
June of 1999. The average interest rate on the ARM portion of the portfolio is
expected to continue to rise during 2000 to the "fully indexed" rate.
21
<PAGE>
At March 31, 2000, the current yield of the ARM assets portfolio was 6.58%,
compared to 6.38% as of December 31, 1999, with an average term to the next
repricing date of 354 days as of March 31, 2000, compared to 344 days as of
December 31, 1999. 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
the first quarter of 2000, which, in general, do not reprice for five years from
their origination date. As of March 31, 2000, hybrid ARMs comprised 23.3% of
the total ARM portfolio, up from 21.6% as of the end of 1999. 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 0.20% as of March 31, 2000, compared to December
31, 1999, is primarily due to the increased weighted average interest rate
coupon discussed above, which increased by 0.18%. The yield also improved as a
result of lower hedging cost, which decreased by 0.06%, as higher cost hedges
matured and were replaced with lower cost hedges. The impact of non-interest
earning principal payments receivables also decreased during the first quarter
of 2000, increasing the portfolio yield by 0.02%, as the rate of ARM portfolio
prepayments slowed to 15% from the 16% rate during the fourth quarter of 1999.
These favorable factors that increased the ARM portfolio yield were partially
offset by a higher level of net premium amortization, which had the effect of
lowering the yield by 0.06%.
The following table presents various characteristics of the Company's ARM and
Hybrid ARM loan portfolio as of March 31, 2000. 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 $270,871 $3,450,000 $169
Coupon rate on loans 7.40% 9.63% 5.00%
Pass-through rate 7.03% 9.23% 4.61%
Pass-through margin 1.89% 5.06% 0.48%
Lifetime cap 12.96% 16.75% 9.75%
Original Term (months) 342 480 72
Remaining Term (months) 318 359 55
Geographic Distribution (Top 5 States): Property type:
California 20.17% Single-family 64.50%
Florida 11.41 DeMinimus PUD 20.40
Georgia 7.37 Condominium 9.87
New York 6.98 Other 5.23
New Jersey 4.79
Occupancy status: Loan purpose:
Owner occupied 84.56% Purchase 58.01%
Second home 10.75 Cash out refinance 24.47
Investor 4.69 Rate & term refinance 17.52
Documentation type: Periodic Cap:
Full/Alternative 93.33% None 60.97%
Other 6.67 2.00% 37.44
1.00% 0.47
Average effective original 0.50% 1.11
loan-to-value: 67.94%
</TABLE>
22
<PAGE>
During the quarter ended March 31, 2000, the Company settled the purchase of
$401.4 million of ARM assets, 98.4% of which were High Quality assets. Of the
ARM assets acquired during the first three months of 2000, approximately 48%
were indexed to U.S. Treasury bill rates, 36% were Hybrid ARMs and 16% were
indexed to LIBOR. Additionally, as of March 31, 2000, the Company has
commitments to purchase approximately $18.9 million of loans through its
correspondent network. The Company did not sell any assets during the quarter
ended March 31, 2000.
The Company's ARM asset purchases during the first quarter of 2000 included
$129.2 million of ARM securities that were formed from whole loans that the
Company securitized in the process of acquiring them. The Company combined the
loans being purchased in the first quarter with $19.8 million of other loans
acquired in previous periods to create total securities in the amount of $149.1
million. The Company structured the securitization as a senior subordinated
structure, which, when rated by the Rating Agencies, resulted in approximately
99.5% of the securities receiving an investment grade rating and 97.6% receiving
a high enough rating (AA or better) to qualify for the Company's High Quality
asset portfolio.
For the quarter ended March 31, 2000, the Company's mortgage assets paid down at
an approximate average annualized constant prepayment rate of 15% compared to
29% for the quarter ended March 31, 1999 and 16% for the quarter ended December
31, 1999. When prepayment experience increases, 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
decreases, 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 decreased by 0.31% from a negative adjustment of 2.40% of the
portfolio as of December 31, 1999, to a negative adjustment of 2.71% as of March
31, 2000. This price decrease was primarily due to the effect of rising
interest rates. The amount of the negative adjustment to fair value on the ARM
assets classified as available-for-sale increased from $83.4 million as of
December 31, 1999, to $101.5 million as of March 31, 2000. The fair value of
the Company's portfolio of ARM assets 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 March 31, 2000, the unrecorded positive
fair value adjustment for Swap Agreements was $16.1 million. As of March 31,
2000, 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. These Cap Agreements purchased by the Company will allow the yield
on the ARM assets to continue to rise in a high interest rate environment just
as the Company's cost of borrowings would continue to rise, since the borrowings
do not have any interest rate cap limitation. At March 31, 2000, 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
$2.899 billion with an average final maturity of 2.4 years, compared to a
remaining notional balance of $2.810 billion with an average final maturity of
2.2 years at December 31, 1999. 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 12.50% and average approximately 10.02%. The Company has also entered
into Cap Agreements with a notional balance of $126.7 as of March 31, 2000 in
connection with hedging the fixed rate period 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 that generally
corresponds to within one year of the initial fixed rate term of Hybrid ARM
assets. The Cap Agreements hedging Hybrid ARM assets as of March 31, 2000 would
receive cash payments if the one-month LIBOR Index increases above certain
specified levels, which range from 5.75% to 6.00% and average approximately
5.93% and have a remaining term of 3.2 years. The fair value of Cap Agreements
also tends to increase when general market interest rates increase and decrease
when market interest rates decrease, helping to partially offset changes in the
fair value of the Company's ARM assets. At March 31, 2000, the fair value of
the Company's Cap Agreements was $6.9 million, $2.0 million more than the
amortized cost of the Cap Agreements.
23
<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 March 31, 2000:
<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>
26,936 8.01% $26,000 7.10% 3.0 Years
178,625 8.33 178,590 7.50 0.3
511,511 9.69 511,503 8.00 2.1
62,129 10.73 61,685 8.50 0.1
37,784 10.94 37,059 9.00 1.7
65,100 11.07 65,148 9.50 2.5
392,291 11.39 391,487 10.00 2.4
226,466 11.73 225,566 10.50 2.0
457,677 12.34 458,178 11.00 3.4
472,137 12.82 472,763 11.50 2.6
385,901 13.61 385,850 12.00 3.3
87,111 16.03 84,853 12.50 0.8
- ------------ ---------- -------------- ------------ --------------
2,903,668 11.68% $2,898,682 10.19% 2.4 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 March 31, 2000, the Company was a counterparty to nineteen interest rate
swap agreements ("Swaps") having an aggregate notional balance of $650.3
million. As of March 31, 2000, these Swaps had a weighted average remaining
term of 2.8 years. In accordance with these Swaps, the Company will pay a fixed
rate of interest during the term of these Swaps and receive a payment that
varies monthly with the one-month LIBOR rate. All of these Swaps were entered
into in connection with the Company's acquisition of Hybrid ARMs and commitments
to acquire Hybrid ARMs. 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 36
days to 229 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 to within a one year duration of their fixed rate term, generally
three to ten years. The average remaining fixed rate term of the Company's
Hybrid ARM assets as of March 31, 2000 was 3.5 years. The Company has also
entered into one delayed Swap Agreement that becomes effective for a one-year
term, beginning in April of 2002. This delayed Swap Agreement has a notional
balance of $100 million and is designated to hedge the interest rate exposure of
Hybrid ARM assets upon the termination of the other Swap Agreements.
During the first quarter of 2000, the Company terminated and replaced six Swaps
and deferred the realized gain of $7.7 million. The replacement Swaps have the
identical terms as the terminated Swaps other than the fixed rate to be paid by
the Company. The amortization of the deferred gain as a yield adjustment to the
new fixed rate reduces the rate on the replacement Swaps to approximately the
same fixed rate as the terminated Swaps and, as an additional benefit, the
Company was able to increase liquid assets by $7.7 million which was used to
reduce the Company's borrowings.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2000
For the quarter ended March 31, 2000, the Company's net income was $5,843,000,
or $0.27 per share (Basic and Diluted EPS) compared to $2,929,000, or $0.14 per
share (Basic and Diluted EPS) for the quarter ended March 31, 1999. There were
21,490,000 weighted average common shares outstanding during both periods. Net
interest income for the quarter totaled $9,317,000, compared to $6,566,000 for
the same period in 1999. Net interest income is comprised of the interest
income earned on mortgage investments less interest expense from borrowings.
During the first three months of both 2000 and 1999, the Company did not record
any gain or loss from the sale of ARM assets. Additionally, during the first
quarter of 2000, the Company reduced its earnings and the carrying value of its
ARM assets by reserving $331,000 for estimated credit losses, compared to
$686,000 during the first quarter of 1999. During the first quarter of 2000,
the Company incurred operating expenses of $1,473,000, consisting of a base
management fee of $1,024,000 and other operating expenses of $449,000. During
the same period of 1999, the Company incurred operating expenses of $1,281,000,
consisting of a base management fee of $1,018,000 and other operating expenses
of $263,000. Total operating expenses increased as a percentage of average
assets to 0.13% for the three months ended March 31, 2000, compared to 0.12% for
the same period of 1999.
24
<PAGE>
The Company's return on average common equity was 7.20% for the quarter ended
March 31, 2000 compared to 3.60% for the quarter ended March 31, 1999 and
compared to 6.29% for the prior quarter ended December 31, 1999. The Company's
return on equity improved in this past quarter compared to the prior quarter
primarily because the Company's provision for credit losses declined and net
interest income improved due to more efficient use of capital during the quarter
ended March 31, 2000 compared to the fourth quarter of 1999 when the Company was
preserving capital due to concerns related to Y2K and year-end financing of the
ARM portfolio.
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 that 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, 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% - 1.86% - 2.05% 6.29% 6.14% 0.15%
Mar 31, 2000 11.49% 0.41% - 1.82% - 2.06% 7.20% 6.47% 0.73%
<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 in the first quarter of
2000, compared to the first 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 a decrease in the Company's provision for
losses. These positive impacts on the Company's return on equity were partially
offset by an increase in other expenses.
25
<PAGE>
The following table presents the components of the Company's net interest income
for the quarters ended March 31, 2000 and 1999:
<TABLE>
<CAPTION>
COMPARATIVE NET INTEREST INCOME COMPONENTS
(Dollar amounts in thousands)
2000 1999
-------- -------
<S> <C> <C>
Coupon interest income on ARM assets $77,615 $69,991
Amortization of net premium (4,683) (9,768)
Amortization of Cap Agreements (838) (1,345)
Amort. of deferred gain from hedging 304 325
Cash and cash equivalents 256 442
-------- --------
Interest income 72,654 59,645
-------- --------
Reverse repurchase agreements 48,883 35,366
AAA notes payable 14,660 16,351
Other borrowings 285 39
Interest rate swaps (491) 1,323
-------- --------
Interest expense 63,337 53,079
-------- --------
Net interest income $9,317 $6,566
======== =======
</TABLE>
As presented in the table above, the Company's net interest income increased by
$2.8 million in the first quarter of 2000 compared to the first three months of
1999. The most significant causes are: (1) the Company's average interest
coupon on its ARM portfolio was 7.24% during the first three months of 2000
compared to 7.12% during the same period in 1999; and (2) the Company's ARM
portfolio paid off at an annualized CPR of 15% during the first quarter of 2000
compared to 29% during the same quarter of 1999, decreasing the amortization of
the net premium. These items were partially offset by a higher cost of funds on
the Company's borrowings, which was 6.20% during the first quarter of 2000
compared to 5.56% during the first quarter of 1999.
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the quarters ended March 31, 2000 and 1999:
<TABLE>
<CAPTION>
AVERAGE BALANCE AND RATE TABLE
(Dollar amounts in thousands)
For the Quarter Ended For the Quarter Ended
March 31, 2000 March 31, 1999
----------------------- ----------------------
Average Effective Average Effective
Balance Rate Balance Rate
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Adjustable-rate mortgage assets $4,455,295 6.50% $4,166,311 5.68%
Cash and cash equivalents 15,699 6.52 30,044 5.88
----------- ---------- ---------- ----------
4,470,994 6.50 4,196,355 5.69
----------- ---------- ---------- ----------
Interest Bearing Liabilities:
Borrowings 4,088,287 6.20 3,815,961 5.56
----------- ---------- ---------- ----------
Net Interest Earning Assets and Spread $ 382,707 0.30% $ 380,394 0.13%
=========== ========== ========== ==========
Yield on Net Interest Earning Assets (1) 0.83% 0.63%
========== ==========
<FN>
(1) Yield on Net Interest Earning Assets is computed by dividing annualized net
interest income by the average daily balance of interest earning assets.
</TABLE>
26
<PAGE>
As a result of the yield on the Company's interest-earning assets increasing to
6.50% during the first three months of 2000 from 5.69% during the same period of
1999 and the Company's cost of funds increasing to 6.20% from 5.56% during the
same time periods, net interest income increased by $2,751,000. This increase
in net interest income is primarily a rate variance and to a lesser extent a
volume variance. There was a net favorable rate variance of $2,508,000,
primarily due to a favorable rate variance of $8,548,000 on the Company's ARM
assets portfolio and other interest-earning assets, which was partially offset
by an unfavorable rate variance on borrowings that decreased net interest income
by $6,039,000. The increased average size of the Company's portfolio during the
first quarter of 2000 compared to the same period in 1999 increased net interest
income in the amount of $243,000. The average balance of the Company's
interest-earning assets was $4.471 billion during the first three months of
2000, compared to $4.196 billion during the first three months of 1999 -- an
increase of 7%.
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, 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%
Mar 31, 2000 $4,471.0 7.77% 7.26% 0.68% 6.58% 6.32% 0.26% 0.83%
<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, 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%
Mar 31, 2000 0.57% 0.07% 0.07% (0.03)% 0.68%
</TABLE>
27
<PAGE>
As of March 31, 2000, 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 6.58%, compared to 6.38% as of December 31,
1999-- an increase of 0.20%. The Company's cost of funds as of March 31, 2000,
was 6.32%, compared to 6.47% as of December 31, 1999 -- a decrease of 0.15%. As
a result of these changes, the Company's net interest spread as of March 31,
2000 was 0.26%, compared to negative 0.09% as of December 31, 1999. The
improvement in the net interest spread is largely attributable to the increase
in the average interest rate coupon on the ARM portfolio and lower hedging cost
discussed earlier and the lower cost of funds on borrowings. The cost of funds
on borrowings declined principally as a result of getting beyond the impact of
Y2K concerns and year-end financing concerns which typically increase the
Company's cost of funds temporarily during the fourth quarter of each year.
Until the last couple of quarters, 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 31.7% at March 31, 2000
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
U.S. Treasury Month LIBOR Month LIBOR to 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%
Mar 31, 2000 6.19% 6.02% 0.17% 31.7%
</TABLE>
The Company's provision for estimated credit losses decreased in the first
quarter of 2000 because the Company discontinued reducing the cost basis of two
securities that the Company now believes have been reduced to a cost basis that
fully reflects its estimate of credit losses for these two securities. The
outlook for estimated loss on these two securities has improved as the
underlying loans have been paying off and real estate values have improved,
primarily in the California market. The Company's 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
28
<PAGE>
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 March 31, 2000, 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 26.8% of the
Company's portfolio of ARM assets or $1.183 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.
As a REIT, the Company is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of its taxable income for each year by the time it
files its applicable tax return and, therefore, generally passes through
substantially all of its earnings to shareholders without paying federal income
tax at the corporate level. Since the Company, as a REIT, pays its dividends
based on taxable earnings, the dividends may at times be more or less than
reported earnings. The following table provides a reconciliation between the
Company's earnings as reported based on generally accepted accounting principles
and the Company's taxable income before its' common dividend deduction:
<TABLE>
<CAPTION>
RECONCILIATION OF REPORTED NET INCOME TO TAXABLE NET INCOME
(Dollar amounts in thousands)
Quarters Ending March 31,
----------------------------
2000 1999
<S> <C> <C>
-------- --------
Net income $7,513 $4,599
Additions:
Provision for credit losses 331 686
Net compensation related items 86 85
Deductions:
Dividend on Series A Preferred Shares (1,670) (1,670)
Actual credit losses on ARM securities (126) (175)
-------- --------
Taxable net income $6,134 $3,525
-------- --------
-------- --------
Taxable income per share $0.29 $0.16
======== ========
</TABLE>
For the quarter ended March 31, 2000, the Company's ratio of operating expenses
to average assets was 0.13% compared to 0.12% for the same period in 1999 and
0.13% for the prior quarter ended December 31, 1999. The Company's other
expenses increased by approximately $186,000 for the quarter ended March 31,
2000 compared to the same three-month period in 1999. The other expenses
increased primarily due to increased usage of legal services in connection with
the Company's financing and securitization of loans, increased usage of investor
and public relations services in order to increase the visibility and awareness
of the Company to potential new investors and due to 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%. The Company has not
paid the Manager a performance fee since the first quarter of 1998. 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.
29
<PAGE>
The following table highlights the quarterly trend of operating expenses as a
percent of average assets:
<TABLE>
<CAPTION>
ANNUALIZED OPERATING EXPENSE RATIOS
Management Fee & Total
For The Other Expenses/ Performance Fee/ G & A Expense/
Quarter Ended Average Assets Average Assets Average Assets
- ----------------- ---------------- ----------------- --------------
<S> <C> <C> <C>
Mar 31, 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%
Mar 31, 2000 0.13% - 0.13%
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary source of funds for the quarter ended March 31, 2000
consisted of reverse repurchase agreements, which totaled $3.304 billion, and
callable AAA notes, which had a balance of $841.5 million. The Company's other
significant source of funds for the quarter ended March 31, 2000 consisted of
payments of principal and interest from its ARM assets in the amount of $271.2
million. In the future, the Company expects its primary sources of funds will
consist of borrowed funds under reverse repurchase agreement transactions with
one- to twelve-month maturities, capital market financing transactions
collateralized by ARM and Hybrid ARM loans, proceeds from monthly payments of
principal and interest on its ARM assets portfolio and occasional asset sales.
The Company's liquid assets generally consist of unpledged ARM assets, cash and
cash equivalents.
Total borrowings outstanding at March 31, 2000, had a weighted average effective
cost of 6.32%. The reverse repurchase agreements had a weighted average
remaining term to maturity of 2.5 months and the collateralized AAA notes
payable had a final maturity of January 25, 2029, but will be paid down as the
ARM assets collateralizing the notes are paid down. As of March 31, 2000,
$1.613 billion of the Company's borrowings were variable-rate term reverse
repurchase agreements. Term reverse repurchase agreements are committed
financings with original maturities that range from three months to fourteen
months. The interest rates on these term reverse repurchase agreements are
indexed to either the one- or three-month LIBOR rate and reprice accordingly.
The interest rate on the collateralized AAA notes adjusts monthly based on
changes in one-month LIBOR.
The Company has arrangements to enter into reverse repurchase agreements with 25
different financial institutions and on March 31, 2000, had borrowed funds with
13 of these firms. Because the Company borrows money under these agreements
based on the fair value of its ARM assets and because changes in interest rates
can negatively impact the valuation of ARM assets, the Company's borrowing
ability under these agreements could be limited and lenders may initiate margin
calls in the event interest rates change or the value of the Company's ARM
assets decline for other reasons. Additionally, certain of the Company's ARM
assets are rated less than AA by the Rating Agencies (approximately 4.0%) and
have less liquidity than assets that are rated AA or higher. Other mortgage
assets which are rated AA or higher by the Rating Agencies derive their credit
rating based on a mortgage pool insurer's rating. As a result of either changes
in interest rates, credit performance of a mortgage pool or a downgrade of a
mortgage pool issuer, the Company may find it difficult to borrow against such
assets and, therefore, may be required to sell certain mortgage assets in order
to maintain liquidity. If required, these sales could be at prices lower than
the carrying value of the assets, which would result in losses. During the
first quarter of 2000, the Company increased its level of liquidity and the
Company believes it will continue to have sufficient liquidity to meet its
future cash requirements from its primary sources of funds for the foreseeable
future without needing to sell assets.
As of March 31, 2000, the Company had $841.5 million of AAA collateralized
notes outstanding, which are not subject to margin calls. Due to the structure
of the collateralized notes, their financing is not based on market value or
subject to subsequent changes in mortgage credit markets, as is the case of the
reverse repurchase agreement arrangements.
30
<PAGE>
As of March 31, 2000, the Company had entered into four 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 matures in January 2001. During the first quarter
of 2000, the Company entered into a second committed whole loan financing
facility that also has a borrowing capacity of $150 million. This second
committed facility matures in March of 2003, subject to an annual review and
extension by both parties. A third facility has an uncommitted amount of
borrowing capacity of $150 million and matures in April 2000. The fourth
facility is for an unspecified amount of uncommitted borrowing capacity and does
not have a specific maturity date. As of March 31, 2000, the Company had $8.5
million borrowed against these whole loan financing facilities at an effective
cost of 6.72%.
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 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 March 31, 2000, the Company had $109
million of its securities registered for future sale under this Registration
Statement.
During 1998, the Board of Directors approved a common stock repurchase program
of up to 1,000,000 shares at prices below book value, subject to availability of
shares and other market conditions. The Company did not repurchase any shares
during the first three months of 2000. To date, the Company has repurchased
500,016 shares at an average price of $9.28 per share.
The Company has a Dividend Reinvestment and Stock Purchase Plan (the "DRP")
designed to provide a convenient and economical way for existing shareholders to
automatically reinvest their dividends in additional shares of common stock and
for new and existing shareholders to purchase shares, as defined in the DRP.
During the first quarter of 2000, 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 rates can also affect the Company's net return on its Hybrid ARMs (net
of the cost of financing Hybrid ARMs). The Company has estimated the duration
of the fixed rate period of its Hybrid ARM and operates under a policy to hedge
a minimum of the duration of the fixed rate period less one year. The
financing of the unhedged fixed rate remaining period of one year or less is
subject to prevailing interest rates on the remaining balance of the Hybrid ARMs
at the expiration of the hedged period. As a result, if the cost of funds on
borrowings is higher at the expiration of the hedged period, the Company's net
interest spread on the remaining balance of a Hybrid ARM asset will be affected
unfavorably and conversely, if the cost of funds on borrowings is lower, the net
interest spread will be affected favorably.
31
<PAGE>
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.
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
As of March 31, 2000, the Company calculates its Qualified REIT Assets, as
defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be
99.1% of its total assets, as compared to the Code requirement that at least 75%
of its total assets must be Qualified REIT Assets. The Company also calculates
that 99.0% of its 2000 revenue for the first quarter qualifies for the 75%
source of income test and 100% of its revenue qualifies for the 95% source of
income test under the REIT rules. The Company also met all REIT requirements
regarding the ownership of its common stock and the distributions of its net
income. Therefore, as of March 31, 2000, the Company believes that it will
continue to qualify as a REIT under the provisions of the Code.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment
Company Act exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interests in
real estate" ("Qualifying Interests"). Under current interpretation of the
staff of the SEC, in order to qualify for this exemption, the Company must
maintain at least 55% of its assets directly in Qualifying Interests. In
addition, unless certain mortgage securities represent all the certificates
issued with respect to an underlying pool of mortgages, such mortgage securities
may be treated as securities separate from the underlying mortgage loans and,
thus, may not be considered Qualifying Interests for purposes of the 55%
requirement. The Company calculates that it is in compliance with this
requirement.
32
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
At March 31, 2000, there were no pending legal proceedings to which
the Company was a party or of which any of its property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
On April 27, 2000, the shareholders of the Registrant approved an
amendment to the Registrant's Articles of Incorporation to change the
name of the Registrant to Thornburg Mortgage, Inc.
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
See "Exhibit Index"
(b) Reports on Form 8-K
None
33
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized,
THORNBURG MORTGAGE, INC.
Dated: May 5, 2000 By: /s/ Larry A. Goldstone
-------------------------------------
Larry A. Goldstone
President and Chief Operating Officer
(authorized officer of registrant)
Dated: May 5, 2000 By: /s/ Richard P. Story
-------------------------------------
Richard P. Story,
Chief Financial Officer and Treasurer
(principal accounting officer)
34
<PAGE>
Exhibit Index
Sequentially
Numbered
Exhibit Number Exhibit Description Page
- --------------- -------------------- ------------
3.1.3 Amendment to Articles of Incorporation dated April 27, 2000 36
3.3 Audit Committee Charter, adopted April 17, 2000 37
27 Financial Data Schedule 40
35
<PAGE>
EXHIBIT 3.1.3
THORNBURG MORTGAGE ASSET CORPORATION
------------------------------------
ARTICLES OF AMENDMENT
---------------------
THORNBURG MORTGAGE ASSET CORPORATION, a Maryland corporation, hereby
certifies to the State Department of Assessments and Taxation of Maryland that:
The Articles of Incorporation are hereby amended as follows:
ARTICLE SECOND: Is hereby amended to read as follows:
---------------
"The name of the corporation (which is hereinafter called the
"Corporation") is:
THORNBURG MORTGAGE, INC."
This amendment of the Articles of Incorporation has been approved by the
directors and shareholders of the corporation.
We, the undersigned President and Secretary, swear under penalties of
perjury that the foregoing is a corporate act.
/S/ Michael B. Jeffers, Secretary /S/ Larry A. Goldstone, President
- ---------------------------------- ---------------------------------
By: Michael B. Jeffers, Secretary By: Larry A. Goldstone, President
Thornburg Mortgage, Inc.
119 E. Marcy Street
Santa Fe, NM 87501
<PAGE>
EXHIBIT 3.3
AUDIT COMMITTEE CHARTER
Thornburg Mortgage, Inc.
Revised April 26, 2000
The Audit Committee (the "Committee") is appointed by the Thornburg
Mortgage, Inc (the "Company") Board of Directors (the "Board") to assist the
Board in fulfilling its oversight responsibilities. The Audit Committee and the
Board of Directors have the responsibility to select, evaluate and, where
appropriate, replace the external auditors (the "Auditors"), who are responsible
to the Board and the Audit Committee. The Audit Committee, with the assistance
of Management and the Auditors, will review i) the financial reporting process,
ii) the system of internal controls, iii) the audit process, and iv) the
Company's process for monitoring compliance with laws and regulations. In
performing its duties, the Committee will maintain effective working
relationships with the Board of Directors, Management, and the Auditors. To
effectively perform its role, each Committee member will obtain an understanding
of the responsibilities of Committee membership as outlined in this charter as
well as the Company's business, operations, and risks. The Board has adopted
and approved this charter which will govern the activities of the Audit
Committee.
The Audit Committee shall meet the independence and experience requirements
of the New York Stock Exchange ("NYSE") rules on audit committees. The Audit
Committee shall have at least three members, all of whom are directors and have
no business relationship with the Company (or an affiliate) that may interfere
with the exercise of their independent judgment. If any business relationship
does exist, it will be disclosed to the Board and the Board will determine if
that business relationship might interfere with the director's exercise of
independent judgment. In order to serve on the Audit Committee each member
shall be financially literate. At least one member shall have accounting or
related financial expertise. The Board, based upon the recommendation of the
Nominating Committee, shall appoint the members of the Audit Committee.
The Audit Committee shall have the authority to request any officer or
employee of the Company or the Company's outside counsel or Auditors to attend a
meeting of the Committee or to meet with any members of, or consultants to, the
Committee. Under special circumstances that may arise, the Committee may
request authority from the Board of Directors to retain special legal counsel,
auditors or other consultants to advise the Committee.
As a matter of Company policy and as part of the Auditor's annual
engagement agreement, the Company's Auditors will review the interim financial
statements prior to filing its Form 10-Q with the Securities and Exchange
Commission (the "SEC"). The Auditors will be instructed to communicate any
significant unresolved matters arising out of such review to the Audit Committee
or its Chairman, when possible, prior to the filing of the Form 10-Q.
The Audit Committee shall meet separately at least twice annually
(generally as part of the annual audit process as described below) and shall
report on such meetings to the Board at the next earliest opportunity.
<PAGE>
The Audit Committee shall have the following responsibilities:
1. Annually evaluate the performance of the Auditors, recommend to the Board
the appointment of the Auditors and approve the fees to be paid to such
Auditors.
2. Meet with the Auditors prior to the audit of the annual financial
statements to review the planning, scope and staffing of the audit.
3. Meet with the Auditors to review the annual audited financial statements
and to discuss the results of the audit, including:
a. major issues regarding accounting and auditing principles and
practices,
b. judgments about the quality of the Company's accounting principles and
underlying estimates,
c. the adequacy of internal controls that could significantly affect the
Company's financial statements, and
d. any other matters required to be discussed by Statement on Auditing
Standards No. 61, Communications With Audit Committees, relating to
the conduct of the audit.
4. Recommend to the Board the inclusion of the annual audited financial
statements in the Annual Report on Form 10-K to be filed with the SEC.
5. The Auditors are free to contact the Chairman of the Audit Committee at any
time to discuss any matter that the Auditors feel needs to be brought to
the attention of the Audit Committee.
6. Annually receive reports and/or letters from the Auditors regarding their
independence as required by Independence Standards Board Standard No. 1.
Discuss with the Auditors any disclosed relationships or services that may
affect the Auditors' independence and, if so determined by the Audit
Committee, recommend that the Board take appropriate action to satisfy
itself of the independence of the Auditors.
7. Review the quarterly financial statements with Management at each quarterly
Board meeting and review major risk exposures and steps Management has
taken to monitor and control such exposures.
8. Prior to the Company's filing and after the Auditors review, the Company
will distribute the Annual Report on Form 10-K and Quarterly Reports on
Form 10-Q that are required to be filed with the SEC.
9. Obtain quarterly reports from Management and, when applicable, annual
confirmation from the Auditors regarding the compliance of the Company and
its subsidiaries with applicable REIT requirements, SEC requirements and
its investment policies.
10. Annually, review and reassess the adequacy of the Audit Committee Charter
and recommend any proposed changes to the Board for approval.
11. Require that the Company's legal counsel disclose at each Board meeting the
existence of any legal matter that might have a significant impact on the
Company's financial statements, and notify the members of the Audit
Committee of any significant legal matter that might arise between Board
meetings.
<PAGE>
12. Require that the Company make disclosures as required by the SEC and NYSE
in its annual proxy statement regarding the following:
a. audit committee independence,
b. that the Company has adopted an Audit Committee Charter, with a copy
attached every three years, and
c. the annual Audit Committee report that the Committee has:
1. reviewed and discussed the annual financial statements with
Management and recommended their inclusion in the Form 10-K,
2. met with the Auditors and discussed the matters related to the
conduct of the audit as required under SAS 61, and
3. received written disclosures and a letter from the Auditors and
confirmed the Auditors independence.
13. Require Management to provide written confirmation to the NYSE on audit
committee member qualifications and related board determinations, as well
as the review and re-evaluation of the Audit Committee Charter.
Safe Harbor Statement
- -----------------------
While the Audit Committee has the responsibilities and powers set forth in
this Charter, it is not the duty of the Audit Committee to plan or conduct
audits or to determine that the Company's financial statements are complete,
accurate and in accordance with generally accepted accounting principles. That
is the responsibility of Management and the Auditors. Nor is it the duty of the
Audit Committee to conduct investigations, to resolve disagreements, if any,
between Management and the Auditors or to assure compliance with applicable laws
and regulations.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the March
31, 2000 Form 10-Q and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 33288
<SECURITIES> 4388663
<RECEIVABLES> 47555
<ALLOWANCES> 4343
<INVENTORY> 0
<CURRENT-ASSETS> 1635
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 4466798
<CURRENT-LIABILITIES> 4173304
<BONDS> 0
0
65805
<COMMON> 220
<OTHER-SE> 227469
<TOTAL-LIABILITY-AND-EQUITY> 4466798
<SALES> 0
<TOTAL-REVENUES> 72654
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1473
<LOSS-PROVISION> 331
<INTEREST-EXPENSE> 63337
<INCOME-PRETAX> 7513
<INCOME-TAX> 0
<INCOME-CONTINUING> 7513
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7513
<EPS-BASIC> .27
<EPS-DILUTED> .27
</TABLE>
