-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OIWpl3AMgbyHp/iF3kdgSB79DknHLNepECKSoCJVWrKm5+ik+aZh6Ni6D6gd9ZdS If6/GD/+zBzxGQ0mXVTjew== 0000936392-98-001474.txt : 19981113 0000936392-98-001474.hdr.sgml : 19981113 ACCESSION NUMBER: 0000936392-98-001474 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AMERICAN RESIDENTIAL INVESTMENT TRUST INC CENTRAL INDEX KEY: 0001035744 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 330741174 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13485 FILM NUMBER: 98744329 BUSINESS ADDRESS: STREET 1: 445 MARINE VIEW AVE SUITE 230 STREET 2: STE 260 CITY: DEL MAR STATE: CA ZIP: 92014 BUSINESS PHONE: 6193505000 MAIL ADDRESS: STREET 1: 445 MARINE VIEW AVE SUITE 230 CITY: DEL MAR STATE: CA ZIP: 92014 10-Q 1 FORM 10-Q 1 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: September 30, 1998 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ________________ to ________________ Commission File Number: 1-13485 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. (Exact name of Registrant as specified in its Charter) Maryland 33-0741174 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification Number) 445 Marine View Avenue, Suite 230 Del Mar, California 92014 (Address of principal executive offices) Zip Code Registrant's telephone number, including area code (619) 350-5000 (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 files such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock ($.01 par value) 8,055,500 as of November 1, 1998 2 INDEX
Page ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets at September 30, 1998 and December 31, 1997 1 Consolidated Statements of Operations for the three months ended September 30, 1998 and 1997, for the nine months ended September 30, 1998, and for the period from February 11, 1997 (commencement of operations) through September 30, 1997 2 Consolidated Statements of Cash Flows for the nine months ended September 30, 1998 and for the period from February 11, 1997 (commencement of operations) through September 30, 1997 3 Notes to Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosures about Market Risk 25 PART II. OTHER INFORMATION Item 1. Legal Proceedings 25 Item 2. Changes in Securities and Use of Proceeds 25 Item 3. Defaults Upon Senior Securities 25 Item 4. Submission of Matters to a Vote of Security Holders 25 Item 5. Other Information 25 Item 6. Exhibits and Reports on Form 8-K 25
3 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
September 30, December 31, 1998 1997 --------- --------- Cash and cash equivalents $ 12,608 $ 5,893 Retained interest in securitization 6,700 -- Mortgage securities available-for-sale, net 258,536 387,099 Mortgage loans held-for-investment, net, pledged 637,823 162,762 Interest rate cap agreements 1,132 411 Accrued interest receivable 9,698 5,169 Due from affiliate 989 269 Investment in American Residential Holdings 715 -- Other assets 224 231 -------------------------- $ 928,425 $ 561,834 ========================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Short-term debt $ 400,988 $ 451,288 Long-term debt, net 418,412 -- Accrued interest payable 2,099 1,839 Due to affiliate 543 -- Accrued expenses and other liabilities 1,128 632 Management fees payable 697 208 Accrued dividends -- 1,298 -------------------------- Total liabilities 823,867 455,265 Stockholders' Equity: Preferred stock, par value $.01 per share; 1,000 shares authorized; no shares issued and outstanding -- -- Common stock, par value $.01 per share; 25,000,000 shares authorized; 8,055,500 shares issued and outstanding 81 81 Additional paid-in-capital 109,271 109,786 Accumulated other comprehensive loss (5,800) (3,300) Cumulative dividends declared (6,945) (2,401) Retained earnings 7,951 2,403 -------------------------- Total stockholders' equity 104,558 106,569 -------------------------- $ 928,425 $ 561,834 ==========================
See accompanying notes to consolidated financial statements. 1 4 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA)
For the Period from February 11, 1997 For the Three For the Three For the Nine (commencement of Months Ended Months Ended Months Ended operations) through Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997 -------------- -------------- -------------- ------------------- Interest income: Mortgage assets $18,447 $ 4,222 $51,704 $ 8,390 Cash and investments 195 -- 402 -- ---------------------------------------------------------- Total interest income 18,642 4,222 52,106 8,390 Interest expense 16,974 3,532 44,611 6,977 ---------------------------------------------------------- Net interest income 1,668 690 7,495 1,413 Provision for loan losses 296 -- 714 -- ---------------------------------------------------------- Net interest income after provision for loan losses 1,372 690 6,781 1,413 Other operating income: Management fee income 214 -- 317 -- Equity in income of Holdings 240 -- 1,125 -- Prepayment penalty 311 -- 494 -- ---------------------------------------------------------- Total other operating income 765 -- 1,936 -- ---------------------------------------------------------- Net operating income 2,137 690 8,717 1,413 Other expenses: Management fees 697 104 1,866 173 Loan expenses 103 -- 359 -- General and administrative expenses 336 67 944 137 ---------------------------------------------------------- Total other expenses 1,136 171 3,169 310 ---------------------------------------------------------- Net income $ 1,001 $ 519 $ 5,548 $ 1,103 ========================================================== Net income per share of Common Stock -- Basic $ 0.12 $ 0.32 $ 0.69 $ 0.68 Net income per share of Common Stock -- Diluted $ 0.12 $ 0.31 $ 0.69 $ 0.66 Dividends per share of Common Stock for related period $ 0.12 $ 0.32 $ 0.68 $ 0.68
See accompanying notes to consolidated financial statements. 2 5 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS, EXCEPT SHARE DATA)
For the period For the February 11, 1997 Nine Months (commencement of Ended operations) through September 30, September 30, 1998 1997 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 5,548 $ 1,103 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of mortgage assets premiums 9,558 1,000 Amortization of interest rate cap agreements 321 86 Amortization of closing costs 2 1 Provision for loan loss 714 -- Increase in accrued interest receivable (4,529) (2,232) Decrease/(increase) in other assets 5 (14) Increase in due from affiliate (720) -- Increase in accrued interest payable 260 1,605 Increase in accrued expenses and management fees payable 985 309 Increase in due to affiliate 543 82 ----------------------------- Net cash provided by operating activities 12,687 1,940 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of mortgage securities available-for-sale -- (256,947) Purchases of mortgage loans held for investment (650,685) -- Principal payments on mortgage securities available-for-sale 121,140 28,150 Principal payments on mortgage loans held for investment 61,207 -- Sale of mortgage loans held for investment 109,068 -- Investment in Holdings (715) -- Purchase of retained interest in securitization (6,700) -- Purchase of interest rate cap agreements (1,042) (542) ----------------------------- Net cash used in investing activities (367,727) (229,339) CASH FLOWS FROM FINANCING ACTIVITIES: Increase/(decrease) in net borrowings from reverse repurchase agreements (50,300) 209,706 Net proceeds from stock issuance -- 20,026 Purchase of treasury stock (492) -- Dividends paid (5,842) (584) Issuance of CMO/FASIT bonds 456,536 -- Payments on CMO/FASIT bonds (38,124) -- Other (23) -- ----------------------------- Net cash provided by financing activities 361,755 229,148 Net increase in cash and cash equivalents 6,715 1,749 Cash and cash equivalents at beginning of period 5,893 -- ----------------------------- Cash and cash equivalents at end of period $ 12,608 $ 1,749 ============================= Supplemental information - interest paid $ 34,567 $ 4,371 ============================= Non-cash transactions: Increase in accumulated other comprehensive income/(loss) $ (2,500) $ 804 ============================= Equity in income of Holdings $ 1,125 $ -- =============================
See accompanying notes to consolidated financial statements. 3 6 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF FINANCIAL PRESENTATION AND ORGANIZATION Basis of Financial Statement Presentation The consolidated financial statements include the accounts of American Residential Investment Trust, Inc. ("AmRES") and American Residential Eagle, Inc. ("Eagle"), its wholly owned subsidiary (collectively "AmRIT"). Substantially all of the assets of Eagle are pledged or subordinated to support long-term debt in the form of collateralized mortgage bonds ("Long-Term Debt") and are not available for the satisfaction of general claims of AmRIT and American Residential Holdings, Inc. ("Holdings"), (collectively the "Company"). The Company's exposure to loss on the assets pledged as collateral is limited to its net investment, as the Long-Term Debt is non-recourse to the Company. All significant intercompany balances and transactions with Eagle have been eliminated in the consolidation of AmRIT. During the first half of 1998, the Company formed Holdings, through which a portion of the Company's Mortgage Loan acquisition and finance activities will be conducted. AmRIT owns all of the preferred stock and has a non-voting 95% economic interest in Holdings. Because AmRIT does not control Holdings, its investment in Holdings is accounted for under the equity method. Under this method, original equity investments in Holdings are recorded at cost and adjusted by AmRIT's share of earnings or losses and decreased by dividends received. For financial reporting purposes, references to AmRIT mean AmRES and Eagle; while references to the "Company" mean AmRES, Eagle, and Holdings. Certain amounts for prior periods have been reclassified to conform with the 1998 presentation. The accompanying consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP") and with the instructions to Form 10-Q promulgated under the Securities and Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of the management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of AmRIT and its consolidated financial condition and results of operations have been included. Operating results for the three and nine months ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ended December 31, 1998. Organization American Residential Investment Trust, Inc., a Maryland corporation, commenced operations on February 11, 1997. AmRES was financed through a private equity funding from its manager, Home Asset Management Corporation (the "Manager"). AmRES 4 7 operates as a mortgage real estate investment trust ("REIT") which has elected to be taxed as a real estate investment trust for Federal income tax purposes, which generally will allow AmRES to pass through its income to its stockholders without payment of corporate level Federal income tax, provided that the Company distributes at least 95% of its taxable income to stockholders. During 1998, the Company formed Eagle, a special-purpose finance subsidiary. Holdings, a non-REIT, taxable affiliate of the Company, was established during the first half of 1998. The Company acquires residential mortgage-backed securities and mortgage loans (collectively, "Mortgage Assets"). These Mortgage Assets are typically secured by single-family real estate properties throughout the United States. The Company utilizes both debt and equity to finance its acquisitions. The Company may also use securitization techniques to enhance the value and liquidity of the Company's Mortgage Assets and may sell Mortgage Assets from time to time. The Company diversified its residential mortgage loan sales activities in the second quarter of 1998 to include the securitization of such loans through a Real Estate Mortgage Investment Conduit ("REMIC"). The REMIC, which consisted of pooled adjustable-rate first-lien mortgages, was issued by Holdings to the public through the registration statement of the related underwriter. Earnings Per Share Effective December 31, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128"). This statement replaces the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effect of options. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts have been restated to conform to the SFAS No. 128 requirements. The following table illustrates the computation of basic and diluted earnings per share:
For the period For the February 11, 1997 For the Three Months Ended Nine Months (commencement of September 30, Ended operations) through 1998 1997 Sept. 30, 1998 Sept. 30, 1997 ---------- ---------- -------------- -------------- (dollars in thousands, except per share data) Numerator: Numerator for basic income per share - net income $ 1,001 $ 519 $ 5,548 $ 1,103 Denominator: Denominator for basic income per share - weighted average number of common shares outstanding during the period 8,080,345 1,614,000 8,102,658 1,614,000 Incremental common shares attributable to exercise of outstanding options -- 61,989 -- 61,989 -------------------------------------------------------------- Denominator for diluted income per share 8,080,345 1,675,989 8,102,658 1,675,989 Basic income per share $ 0.12 $ 0.32 $ 0.69 $ 0.68 Diluted income per share 0.12 0.31 0.69 0.66
5 8 Comprehensive Income Effective with the quarter ending March 31, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 requires all items that are required to be recognized under accounting standards as components of comprehensive income to be reported in a financial statement that is displayed in equal prominence with the other financial statements and to disclose as a part of shareholders' equity accumulated comprehensive income. The Company has chosen, for purposes of its interim financial reporting, to present a statement of comprehensive income in the notes to the financial statements. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income generally includes net income, foreign currency items, minimum pension liability adjustments, and unrealized gains and losses on investments in certain debt and equity securities (i.e., securities available for sale). The Company's statement of comprehensive income for the periods presented is as follows (in thousands):
For the period from For the February 11, 1997 For the Nine Months (commencement of Three Months Ended Ended operations) through September 30, Sept. 30, Sept. 30, 1998 1997 1998 1998 ------- ------- ------------ -------------------- (dollars in thousands) Net income $ 1,001 $ 519 $ 5,548 $ 1,103 Other comprehensive gain/(loss), net of related income taxes: Unrealized gains/(losses) on securities: Unrealized holding gains/(losses) arising during the period (1,170) 804 (2,500) 804 Less reclassification of realized gains/( losses) included in income -- -- -- -- ------------------------------------------------------- (1,170) 804 (2,500) 804 ------------------------------------------------------- Comprehensive income/(loss) $ (169) $ 1,323 $ 3,048 $ 1,907 =======================================================
Recent Accounting Developments Disclosure about Segments of an Enterprise and Related Information In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that selected information about these operating segments be reported in interim financial statements. This statement supersedes SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise." SFAS No. 131 requires that all public enterprises report financial and 6 9 descriptive information about its reportable operating segments. Operating segments are defined as components evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. This statement is effective for fiscal years beginning after December 15, 1997. In the initial year of application, comparative information for earlier years should be restated. Accounting for Derivative Instruments and Hedging Activities In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. Under SFAS No. 133, an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk. SFAS No. 133 amends SFAS No. 32, "Foreign Currency Translation," to permit special accounting for a hedge of a foreign currency forecasted transaction with a derivative. It supersedes SFAS No. 80, "Accounting for Futures Contracts," SFAS No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk," and SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments." It amends SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," to include in SFAS No. 107 the disclosure provisions about concentrations of credit risk from SFAS No. 105. This Statement also nullifies or modifies the consensuses reached in a number of issues addressed by the Emerging Issues Task Force. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. 7 10 NOTE 2. MORTGAGE SECURITIES AVAILABLE FOR SALE, NET At September 30, 1998, the Company's Mortgage Securities consisted of the following mortgage participation certificates issued or guaranteed by Federal government sponsored agencies:
Federal Home Federal National Loan Mortgage Mortgage Corporation Association Total ------------- ---------------- --------- (dollars in thousands) Mortgage Securities available-for-sale, principal $ 171,835 $ 82,480 $ 254,315 Unamortized premium 6,537 3,484 10,021 --------- --------- --------- Amortized cost 178,372 85,964 264,336 Unrealized loss (3,855) (1,945) (5,800) --------- --------- --------- Fair value $ 174,517 $ 84,019 $ 258,536 ========= ========= =========
At September 30, 1998 all investments in Mortgage Securities consisted of interests in adjustable rate mortgage loans on residential properties. The securitized interest in pools of adjustable rate mortgages from the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association are guaranteed as to principal and interest. The original maturity is subject to change based on the prepayments of the underlying mortgage loans. At September 30, 1998, the weighted average net coupon on the Mortgage Securities was 7.70% per annum based on the amortized cost of the Mortgage Securities. All Mortgage Securities have a repricing frequency of one year or less. NOTE 3. MORTGAGE LOANS HELD FOR INVESTMENT, NET, PLEDGED The Company purchases certain non-conforming Mortgage Loans to be held as long-term investments. At September 30, 1998, Mortgage Loans held for investment consists of the following (dollars in thousands): Mortgage Loans held for investment, principal $ 597,751 Unamortized premium 43,224 Allowance for loan losses (3,152) --------- $ 637,823 =========
At September 30, 1998, the weighted average net coupon on the Mortgage Loans was 9.29% per annum. All Mortgage Loans have a repricing frequency of five years or less. At September 30, 1998, approximately 40% of the collateral was located in California with no other state representing more than approximately 6%. 8 11 NOTE 4. SHORT-TERM DEBT The Company has entered into uncommitted reverse repurchase agreements (collectively "short-term" debt), which may be withdrawn at any time, to finance the acquisition of a portion of its Mortgage Assets. The maximum aggregate amount available under the uncommitted reverse repurchase agreements at September 30, 1998 is over $3.2 billion. These reverse repurchase agreements are collateralized by a portion of the Company's Mortgage Assets. Mortgage Securities The maximum outstanding reverse repurchase agreements with any one lender during the nine months ended September 30, 1998 was approximately $168.3 million, or approximately 70% of the total repurchase liability for the month ending August 31, 1998. At September 30, 1998, Mortgage Securities pledged had an estimated fair value of approximately $233.5 million. At September 30, 1998, the Company had approximately $231.1 million of Mortgage Securities reverse repurchase agreements outstanding with a weighted average borrowing rate of 5.57% per annum and a weighted average remaining maturity of 37 days. The maximum month end balance and the average balance outstanding for the nine months ended September 30, 1998 were approximately $304.4 million and $269.3 million, respectively. At September 30, 1998, the Mortgage Securities reverse repurchase agreements had the following characteristics:
Weighted Average Repurchase Underlying Interest Rate Weighted Average Mortgage Securities Liability Collateral (per annum) Maturity Date -------- ---------- ------------- ---------------- (dollars in thousands) ----------------------------------------------------------------------- Mortgage Securities FHLMC $ 31,196 $ 30,656 5.62% Oct. 21, 1998 FNMA 77,356 76,139 5.62 Oct. 31, 1998 Paine Webber 122,549 126,659 5.53 Nov. 13, 1998 ----------------------------------------------------------------------- $231,101 $233,454 5.57% Nov. 6, 1998 =======================================================================
Mortgage Loans Reverse repurchase agreements for Mortgage Loans are currently placed with two investment banking firms. The maximum amount outstanding with Lehman Brothers during the nine months ended September 30, 1998 was approximately $668.7 million. At September 30, 1998, Mortgage Loans pledged had an estimated fair value of approximately $161.5 million. 9 12 At September 30, 1998, the Company had approximately $169.9 million of Mortgage Loans reverse repurchase agreements outstanding with a weighted average borrowing rate of 6.39% per annum and a weighted average remaining maturity of one day. The maximum month end balance and the average balance outstanding for the nine months ended September 30, 1998 were approximately $668.7 million and $333.2 million, respectively. At September 30, 1998, the Mortgage Loans reverse repurchase agreements had the following characteristic:
Repurchase Underlying Interest Rate Weighted Average Mortgage Loans Liability Collateral (per annum) Maturity Date ---------- ---------- ------------- --------------- (dollars in thousands) ---------------------------------------------------------------------- Lehman Brothers $ 98,603 $104,619 6.40% Oct. 1, 1998 Bear Stearns 71,284 56,874 6.38 Sept. 30, 1998 ---------------------------------------------------------------------- $169,887 $161,493 6.39% Oct. 1, 1998 ======================================================================
NOTE 5. LONG-TERM DEBT, NET During the second quarter of 1998, AmRIT, through its wholly owned subsidiary, Eagle, issued approximately $456.5 million of collateralized mortgage bonds (Long-Term Debt) through a Financial Asset Securitization Investment Trust (FASIT). The bonds were assigned to a FASIT trust and trust certificates evidencing the assets of the trust were sold to investors. The trust certificates were issued in classes representing senior, mezzanine, and subordinate payment priorities. Payments received on single-family mortgage loans ("Bond Collateral") are used to make payments on the Long-Term Debt. The obligations under the Long Term Debt are payable solely from the Bond Collateral and are otherwise non-recourse to AmRIT. The maturity of each class of trust certificates is directly affected by the rate of principal repayments on the related Bond Collateral. The Long-Term Debt is also subject to redemption according to the specific terms of the indenture pursuant to which the bonds were issued and the FASIT trust. As a result, the actual maturity of the Long-Term Debt is likely to occur earlier than its stated maturity. The components of the Long-Term Debt at September 30, 1998 along with selected other information are summarized below (dollars in thousands): Long-Term Debt $ 418,757 Capitalized Costs on Long-Term Debt (345) --------- Total Long-Term Debt $ 418,412 ========= Range of Certificate pass-through rates 5.74% - 7.05% Stated maturities 2008 - 2028
NOTE 6. COLLATERAL FOR LONG-TERM DEBT AmRIT has pledged collateral in order to secure the Long-Term Debt issued in the form of Bond Collateral. This Bond Collateral consists primarily of adjustable-rate, conventional, 30-year mortgage loans secured by first liens on one- to four-family residential properties. All Bond Collateral is pledged to secure repayment of the related 10 13 Long-Term Debt obligation. All principal and interest (less servicing and related fees) on the Bond Collateral is remitted to a trustee and is available for payment on the Long-Term Debt obligation. AmRIT's exposure to loss on the Bond Collateral is limited to its net investment, as the Long-Term Debt is non-recourse to AmRIT. The components of the Bond Collateral at September 30, 1998 are summarized as follows (dollars in thousands): Mortgage loans $ 425,008 Unamoritized premium 34,343 Allowance for loan losses (3,027) Accrued interest receivable 3,594 --------- $ 459,918 ========= Weighted average gross coupon 9.95% Weighted average net coupon 9.30% Weighted average pass-through rate 9.28%
NOTE 7. RETAINED INTEREST IN SECURITIZATION Retained interests in securitization consist of assets generated by the Company's loan securitization. These assets at September 30, 1998 were as follows (dollars in thousands): REMIC subordinate certificates $6,700 ======
The Company classifies REMIC securities as trading securities in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and carries them as current assets at market value. The fair value of the retained interest is determined by computing the present value of the excess of the weighted-average coupon of the residential mortgages sold (9.32%) over the sum of: (1) the coupon on the senior interest (5.95%), and (2) a basic servicing fee paid to servicer of the residential mortgages (0.50%) and other fees, and taking into account expected estimated losses to be incurred on the portfolio of residential mortgages sold over the estimated lives of the residential mortgages and using an estimated future average prepayment assumption (25%) per year. The prepayment assumptions used in estimating the cash flows is based on recent evaluations of the actual prepayments of the related portfolio and on market prepayment rates on new portfolios of similar residential mortgages, taking into consideration the current interest rate environment and its expected impact on the estimated future prepayment rate. The estimated cash flows expected to be received by the Company are discounted at an interest rate that the 11 14 Company believes is commensurate with the risk of holding such a financial instrument. The rate used to discount the cash flows coming out of the trust was approximately 12%. To the extent that actual future excess cash flows are different from estimated excess cash flows, the fair value of the Company's retained interest could decline. Under the terms of the securitization, the retained interest is required to build overcollateralization to specified levels using the excess cash flows described above until set percentages of the securitized portfolio are attained. Future cash flows to the retained interest holder are all held by the REMIC trust until a specific percentage of either the original or current certificate balance is attained which percentage can be raised if certain charge-offs and delinquency ratios are exceeded. The certificate holders' recourse for credit losses is limited to the amount of overcollateralization held in the REMIC trust. Upon maturity of the certificates or upon exercise of an option ("clean up call") to repurchase all the remaining residential mortgages once the balance of the residential mortgages in the trust are reduced to 10% of the original balance of the residential mortgages in the trust, any remaining amounts in the trust are distributed. The current amount of any overcollateralization balance held by the trust is recorded as part of the retained interest. NOTE 8. DIVIDENDS On October 15, 1998, the Company declared a dividend of $967 thousand or $0.12 per share. This dividend was paid on November 2, 1998 to holders of record of Common Stock as of October 26, 1998. On July 13, 1998, the Company declared a dividend of $2.3 million or $0.28 per share. This dividend was paid on July 31, 1998 to holders of record of Common Stock as of July 24, 1998. On April 24, 1998, the Company declared a dividend of $2.3 million or $0.28 per share. This dividend was paid on April 30, 1998 to holders of record of Common Stock as of April 24, 1998. On December 19, 1997, the Company declared a dividend of $1.3 million or $0.16 per share. The dividend was paid on January 21, 1998 to holders of record of Common Stock as of December 31, 1997. 12 15 NOTE 9. INVESTMENT IN AMERICAN RESIDENTIAL HOLDINGS, INC. The following condensed financial information summarizes the financial position and results of operations of American Residential Holdings, Inc. (dollars in thousands, except per share data): AMERICAN RESIDENTIAL HOLDINGS, INC. CONDENSED BALANCE SHEET
September 30, 1998 ------------------ ASSETS Cash and cash equivalents $ 8 Due from affiliate 533 Class "X" Certificate - CMO/FASIT 475 Other assets 25 ------- $ 1,041 ======= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Other liabilities $ 241 ------- Total liabilities 241 Stockholders' Equity: Preferred stock, par value $1,000 per share; 10,000 shares authorized; 475 shares issued and outstanding 475 Common stock, par value $.01 per share; 100 shares authorized; 50 shares issued and outstanding -- Additional paid-in-capital 25 Cumulative dividends declared (885) Retained earnings 1,185 ------- Total stockholders' equity 800 ------- $ 1,041 =======
AMERICAN RESIDENTIAL HOLDINGS, INC. CONDENSED STATEMENT OF OPERATIONS
For the period January 28, 1998 (commencement of operations) through September 30, 1998 ------------------- Income: Gain on sale of loans $1,589 Interest income 266 Other income 2 ------ Total income 1,857 Expenses: Other expenses 19 ------ Income before taxes 1,838 Taxes 653 ------ Net income $1,185 ======
13 16 AMERICAN RESIDENTIAL HOLDINGS, INC. CONDENSED STATEMENT OF CASH FLOWS
For the period January 28, 1998 (commencement of operations) through September 30, 1998 ------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,185 Adjustments to reconcile net income to net cash provided by operating activities: Increase in other assets (558) Increase in accrued expenses 241 ------- Net cash provided by operating activities 868 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of Class "X" certificates - CMO/FASIT (475) ------- Net cash used in investing activities (475) CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from stock issuance 500 Dividends paid (885) ------- Net cash used in financing activities (385) Net increase in cash and cash equivalents at end of period 8 Cash and cash equivalents at beginning of period -- ------- Cash and cash equivalents at end of period $ 8 =======
NOTE 10. SUBSEQUENT EVENT On October 29, 1998, management of the Company announced its intention to sell, during the fourth quarter, $264.3 million of FNMA and FHLMC securities which are classified as available-for-sale. As of September 30, 1998, the Mortgage Securities had an unrealized loss allowance of $5.8 million. The Company has estimated the loss on sale of these Mortgage Securities to be approximately $8 million to $10 million, which will negatively impact earnings upon the completion of the sale. On October 30, 1998, the Company sold approximately $65.4 million of Mortgage Securities at a loss of $1.9 million. On November 4, 1998, approximately $130.1 million of Mortgage Securities were traded to be settled November 23, 1998, for a loss on the sale of approximately $3.3 million. The Company is reasonably assured the remaining $68.8 million will be sold in December 1998. 14 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The statements contained in this Report that are not purely historical are forward looking statements, including statements regarding the Company's expectations, hopes, beliefs, intentions or strategies regarding the future. Statements which use the words "intends", "expects", "will", "may", "anticipates" and "seeks" are forward looking statements. These forward looking statements, including statements regarding changes in the Company's future income and intent to acquire fixed rate Mortgage Loans, are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward looking statement. It is important to note that the Company's actual results could differ materially from those in such forward looking statements. Among the factors that could cause actual results to differ materially are the factors set forth below under the heading "Business Risks". In particular, the Company's future income could be affected by changes in levels of repayments, changes in interest rates, lack of available Mortgage Assets which meet the Company's acquisition criteria, the type of Mortgage Assets acquired by the Company and the credit characteristics of the borrowers under Mortgage Loans acquired by the Company. OVERVIEW The Company's income to date consists primarily of interest income generated from its Mortgage Assets and its cash balances (collectively, "earning assets"). The Company funds its acquisitions of earning assets with both its equity capital and with borrowings. For that portion of the Company's earning assets funded with equity capital ("equity-funded lending"), net interest income is derived from the average yield on earning assets. Due to the adjustable-rate nature of its earning assets, the Company expects that income from this source will tend to increase and decrease as interest rates rise and fall, respectively. For that portion of the Company's earning assets funded with borrowings ("spread lending"), the resulting net interest income is a function of the volume of spread lending and the difference between the Company's average yield on earning assets and the cost of borrowed funds and interest rate hedging agreements. Net income from spread lending may initially decrease following an increase in interest rates and then, after a lag period, be restored to its former level as earning assets yields adjust to market conditions. Net income from spread lending may likewise increase following a fall in interest rates, but then decrease as earning assets yields adjust to the new market conditions after a lag period. RESULTS OF OPERATIONS For the three months ended September 30, 1998, the Company generated net income of approximately $1.0 million and diluted net income per share of Common Stock of $0.12. At September 30, 1998 the Company held Mortgage Securities that had a carrying value 15 18 of approximately $258.5 million, including a $5.8 million net unrealized loss, and Mortgage Loans with a carrying value of approximately $637.8 million. Net income for the Company increased 92.9% from approximately $519 thousand for the three months ended September 30, 1997, to approximately $1.0 million for the three months ended September 30, 1998. The growth in net income was directly attributable to an increase in net interest income and other operating income. Net interest income grew approximately 142% from the three months ended September 30, 1997 to the three months ended September 30, 1998, from approximately $690 thousand to approximately $1.7 million, respectively. Other operating income was zero for the three months ended September 30, 1997 and was approximately $765 thousand for the three months ended September 30, 1998. This increase in income was partially offset by an increase in other expenses consisting of management fees, loan expenses and general and administrative expenses. From the three months ended September 31, 1997 to the three months ended September 30, 1998, other expenses increased from approximately $171 thousand to approximately $1.1 million, or approximately 564%. The growth in net interest income from the three months ended September 30, 1997 to the three months ended September 30, 1998 was due to an increase in the Company's Mortgage Loans held-for-investment during the third quarter of 1998. An increase in other operating income includes the increase in management fee income, prepayment penalty income and equity in income of Holdings. Management fee income increased due to the increase in the Company's Mortgage Loans during the third quarter of 1998 and prepayment penalty income increased due to the high levels of prepayments in the Mortgage Securities portfolio during the three months ended September 30, 1998. Holdings income increased due to an increase in interest income from the sale of loans structured in a Real Estate Mortgage Investment Conduit ("REMIC"). For the nine months ended September 30, 1998, the Company generated net income of approximately $5.5 million and diluted net income per share of Common Stock of $0.69. Net income for the Company increased 403% from approximately $1.1 million for the period from February 11, 1997 (commencement of operations) through September 30, 1997, to approximately $5.5 million for the nine months ended September 30, 1998. The growth in net income was directly attributable to an increase in net interest income and other operating income. Net interest income grew approximately 430% from the period from February 11, 1997 (commencement of operations) through September 30, 1997 to the nine months ended September 30, 1998, from approximately $1.4 million to approximately $7.5 million respectively. Other operating income was zero for the period from February 11, 1997 (commencement of operations) through September 30, 1997 and was approximately $1.9 million for the nine months ended September 30, 1998. This increase in income was offset by an increase in other expenses consisting of management fees, loan expenses and general and administrative expenses. From the period from February 11, 1997 (commencement of operations) through September 30, 1997 to the nine months ended September 30, 1998, other expenses increased from approximately $310 thousand to approximately $3.2 million, or 922%. 16 19 The growth in net interest income from the period from February 11, 1997 (commencement of operations) through September 30, 1997 to the nine months ended September 30, 1998 was due to an increase in the Company's Mortgage Loans held-for-investment during the first nine months of 1998. An increase in other operating income includes the increase in management fee income, prepayment penalty income and equity in income from Holdings. Management fee income increased due to the increase in the Company's Mortgage Loans during the first nine months of 1998 and prepayment penalty income increased due to the high levels of prepayments in the Mortgage Securities portfolio during the nine months ended September 30, 1998. While prepayment income increases cash flow, higher than expected prepayments have a long-term negative effect on operating income due to write-offs of capitalized mortgage premiums which would otherwise have been amortized over a longer period of time. Equity in income of Holdings increased due to interest income from the sale of loans structured in a Real Estate Mortgage Investment Conduit ("REMIC"). The Company does not anticipate that it will receive other operating income from REMIC transactions in the future on a regular basis, or at all. Similarly, the increase in other expenses from the period from February 11, 1997 (commencement of operations) through September 30, 1997 to the nine months ended September 30, 1998 is primarily the result of (i) the Company's increased management fees caused from the increase in the Company's Mortgage Loans and (ii) the result of the Company's inital public offering which increased professional fees, printing and reproduction expenses caused from the 10-K and annual report. The Company experienced very high levels of prepayments in the Mortgage Security portfolio in the nine months ended September 30, 1998. The annualized Mortgage Security principal prepayment rate for the Company was approximately 53% in the nine months ending September 30, 1998 compared to the annualized mortgage principal prepayment rate of approximately 28% for the period from February 11, 1997 (commencement of operations) through September 30, 1997. The Company anticipates that prepayment rates may continue at very high levels for an indefinite period. The sale of these securities may reduce this prepayment risk. The Company's financial condition and results of operations will continue to be materially adversely affected if prepayments continue at high levels. See "Business Risks - High Levels of Mortgage Loan Prepayments May Reduce Operating Income". The 95% economic interest in the taxable affiliate, Holdings, was $1.1 million for the nine months ended September 30, 1998 compared to zero for the period from February 11, 1997 (commencement of operations) through September 30, 1997. Holdings' future earnings will be recognized using the equity method of accounting and will be disclosed as a separate line-item on the Company's income statement. See "Note 9. Investment in American Residential Holdings, Inc." in the notes to Consolidated Financial Statements section above for additional information on Holdings. 17 20 LIQUIDITY AND CAPITAL RESOURCES During the nine months ended September 30, 1998, net cash provided by operating activities was approximately $12.7 million. Net cash provided by operating activities was negatively impacted by an increase in accrued interest receivable. Mortgage Loans increased from $162.8 million on December 31, 1997 to $637.8 million at September 30, 1998 and, therefore, accrued interest receivable at September 30, 1998 has increased proportionally to loans, thereby negatively affecting cash. The net increase in "Due from affiliate", also adversely affects cash flow. Net cash for the period was positively affected by an increase in accrued interest payable and management fees payable and due to affiliate. Net cash used in investing activities for the nine months ended September 30, 1998 was approximately $367.7 million. Net cash used for the period was negatively affected by the purchase of Mortgage Loans in the amount of approximately $650.7 million and positively affected by principal prepayments of mortgage securities of approximately $121.1 million and mortgage loans of approximately $61.2 million, and sale of mortgage loans held for investment of approximately $109.1 million. For the nine months ended September 30, 1998, net cash provided by financing activities was approximately $361.8 million. Net cash used was positively affected by the issuance of long-term debt in the form of CMO/FASIT bonds issued for approximately $456.5 million. Net cash used was negatively affected by a decrease in borrowings under reverse repurchase agreements of $50.3 million and payments on CMO/FASIT bonds of approximately $38.1 million. SALE OF ASSETS The Company anticipates selling its entire Mortgage Securities portfolio (approximately $264.3 million) in the fourth quarter of 1998. These assets are categorized as "available for sale". The Company expects to realize a capital loss of between $8 million and $10 million including writing off unamortized cap hedge protections. On October 30, 1998, approximately $65.4 million of Mortgage Securities were sold. On November 4, 1998, approximately $130.1 million of Mortgage Securities were traded to be settled November 23, 1998. The Company is reasonably assured the remaining $68.8 million will be sold in December 1998. FINANCING At September 30, 1998 the Company had committed reverse repurchase agreement facilities in place to provide $150 million to finance investments in Mortgage loans. In addition, the Company had uncommitted reverse repurchase agreement facilities in place to provide over $ 3 billion to finance investments in Mortgage Assets. 18 21 If the Company's cash resources are insufficient to satisfy the Company's liquidity requirements, the Company may be required to sell additional equity or debt securities. There is no assurance that such financing will be available to the Company on favorable terms, or at all. BUSINESS RISKS Failure to Implement Company's Leverage Strategy May Adversely Affect Results of Operations The Company relies on short term borrowings to fund acquisitions of Mortgage Assets. Accordingly, the ability of the Company to achieve its investment objectives depends on its ability (i) to borrow money in sufficient amounts and on favorable terms, (ii) to renew or replace on a continuous basis its maturing short term borrowings and (iii) to successfully leverage its Mortgage Assets. In addition, the Company is dependent upon a few lenders to provide the primary credit facilities for its purchases of Mortgage Assets. Any failure to obtain or renew adequate funding under these facilities or other financing on favorable terms, could reduce the Company's net interest income and have a material adverse effect on the Company's operations. In the event the Company is not able to renew or replace maturing borrowings, the Company could be required to sell Mortgage Assets under adverse market conditions and could incur losses as a result. In addition, in such event, the Company may be required to terminate hedge positions, which could result in further costs to the Company. Any event or development, such as a sharp rise in interest rates or increasing market concern about the value or liquidity of a type or types of Mortgage Assets in which the Company's Mortgage Asset portfolio is concentrated, will reduce the market value of the Mortgage Assets, which would likely cause lenders to require additional collateral. A number of such factors in combination may cause difficulties for the Company, including a possible liquidation of a major portion of the Company's Mortgage Assets at disadvantageous prices with consequent losses, which could have a material adverse effect on the Company and could render it insolvent. Lenders will have claims on the Company's assets superior to the claims of the holders of the Shares and may require that the Company agree to covenants that could restrict its flexibility in the future and limit the Company's ability to pay dividends. In the event of the insolvency or bankruptcy of the Company, any creditor under a reverse repurchase agreement may be allowed to avoid the automatic stay provisions of the Bankruptcy Code and to foreclose on the collateral agreements without delay. In the event of the insolvency or bankruptcy of a lender during the term of a reverse repurchase agreement, the lender may be permitted to repudiate the contract, and the Company's claim against the lender for damages therefrom may be treated simply as one of the unsecured creditors. Should this occur, the Company's claims would be subject to significant delay 19 22 and, if received, may be substantially less than the damages actually suffered by the Company. Due to the underlying loan to collateral values established by the Company's lenders, the Company may be subject to calls for additional capital in the event of adverse market conditions. Such conditions include (i) higher than expected levels of prepayments on Mortgage Loans and (ii) sudden increases in interest rates. To the extent that the Company is highly leveraged, it may not be able to meet its loan to collateral value requirements, which may result in losses to the Company. There can be no assurance that the Company will not face additional margin calls. High Levels of Mortgage Loan Prepayments May Reduce Operating Income Prepayments of Mortgage Assets adversely affect the Company's results of operations in several ways. A portion of the adjustable-rate Mortgage Assets acquired by the Company bear initial "teaser" interest rates which are lower than their "fully-indexed" rates (the applicable index plus a margin. In the event that such an adjustable-rate Mortgage Asset is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, the Company will have held the Mortgage Asset during its least profitable period and lost the opportunity to receive interest at the fully-indexed rate over the expected life of the adjustable-rate Mortgage Asset. In addition, the prepayment of any Mortgage Asset that has been purchased with a premium by the Company would result in the immediate write-off of any remaining capitalized premium amount and the consequent reduction of the Company's net interest income by such amount. Finally, in the event that the Company is unable to acquire new Mortgage Assets to replace the prepaid Mortgage Assets, the Company's financial condition and results of operations could be materially adversely affected. Mortgage Asset prepayment rates generally increase when new Mortgage Loan interest rates fall below the interest rates on the adjustable-rate Mortgage Assets, Prepayment experience also may be affected by the geographic location of the property securing the adjustable-rate Mortgage Loans, the assumability of an adjustable-rate Mortgage Loan, the ability of the borrower to obtain or convert to a fixed-rate Mortgage Loan, conditions in the housing and financial markets and general economic conditions. The level of prepayments is also subject to the same seasonal influences as the residential real estate industry with prepayment rates generally being highest in the summer months and lowest in the winter months. The Company experienced very high levels of prepayments during the nine months ended September 30, 1998 and the Company anticipates that prepayment rates will continue at very high levels for an indefinite period. Certain Mortgage Loans acquired by the Company may contain provisions restricting prepayments of such Mortgage Loans and require a charge in connection with the prepayment thereof. Such prepayment restrictions can, but do not necessarily, provide a deterrent of prepayments. Prepayment charges may be in an amount which is less than the figure which would fully compensate the Company for a lower yield upon reinvestment of the prepayment proceeds. 20 23 Borrower Credit May Decrease Value of Mortgage Loans A substantial portion of the Company's Mortgage Assets consist of Mortgage Loans. Accordingly, the Company is subject to increased credit risks, including risks of borrower defaults and bankruptcies and special hazard losses that are not covered by standard hazard insurance (such as those occurring from earthquakes or floods.) In the event of a default on any Mortgage Loan held by the Company, the Company will bear the risk of loss of principal to the extent of any deficiency between the value of the secured property, and the amount owing on the Mortgage Loan, less any payments from an insurer or guarantor. Defaulted Mortgage Loans will also cease to be eligible collateral for borrowings, and will have to be financed by the Company out of other funds until ultimately liquidated. Although the Company established an allowance for Mortgage Loan losses in an amount that it believes is adequate to cover these risks, in view of its limited operating history and lack of experience with the Company's current Mortgage Loans and Mortgage Loans that may be acquired, there can be no assurance that any allowance for Mortgage Loan losses which are established will be sufficient to offset losses on Mortgage Loans in the future. The Company's Mortgage Loans remain relatively young from a delinquency perspective, and there have not yet been any losses incurred on these loans. Because of the age of the Company's loans, current delinquency and loss information is not yet expected to be representative of future delinquencies and losses. At September 30, 1998, approximately 7.74% of the Company's Mortgage Loans were delinquent 30 days or more. In addition, at September 30, 1998, 37 Mortgage Loans were in bankruptcy with a total loan value of approximately $4.5 million and 87 Mortgage Loans in foreclosure with a total loan value of approximately $12.8 million. Credit risks associated with non-conforming Mortgage Loans, especially sub-prime Mortgage Loans, may be greater than those associated with Mortgage Loans that conform to FNMA and FHLMC guidelines. The principal difference between non-conforming sub-prime Mortgage Loans and conforming Mortgage Loans include the applicable loan-to-value ratios, the credit and income histories of the mortgagors, the documentation required for approval of the mortgagors, the types of properties securing the Mortgage Loans, loan sizes and the mortgagors' occupancy status with respect to the mortgaged property. As a result of these and other factors, the interest rates charged on non-conforming Mortgage Loans are often higher than those charged for conforming Mortgage Loans. The combination of different underwriting criteria and higher rates of interest may lead to higher delinquency rates and/or credit losses for non-conforming as compared to conforming Mortgage Loans and could have an adverse effect on the Company to the extent that the Company has invested in such Mortgage Loans or securities secured by such Mortgage Loans. 21 24 At September 30, 1998, the Mortgage Loans held for Investment had the following credit grade characterizations:
Credit Grade Percent Non-Conforming Loans ------------ ------- -------------------- A 65% $388,538 B 22 131,505 C 11 65,753 D 2 11,955 -------- -------- 100% $597,751 ======== ========
Even assuming that properties secured by the Mortgage Loans held by the Company provide adequate security for such Mortgage Loans, substantial delays could be encountered in connection with the foreclosure of defaulted Mortgage Loans, with corresponding delays in the receipt of related proceeds by the Company. State and local statutes and rules may delay or prevent the Company's foreclosure on or sale of the mortgaged property and may prevent the Company from receiving net proceeds sufficient to repay all amounts due on the related Mortgage Loan. In addition, the Company's servicing agent may be entitled to receive all expenses reasonably incurred in attempting to recover amounts due and not yet repaid on liquidated Mortgage Loans, thereby reducing amounts available to the Company. Some properties which will collateralize the Company's Mortgage Loans may have unique characteristics or may be subject to seasonal factors which would materially prolong the time period required to resell such properties. The Company Has Significant Conflicts with, and Is Dependent on, an Affiliate of the Executive Officers of the Company The Company is subject to conflicts of interest with the Manager and its executive officers. The executive officers of the Company generally will also be executive officers, employees and stockholders of the Manager, and will therefore be affiliated with the Manager. The Manager will manage the day-to-day operations of the Company. Accordingly, the Company's success will depend in significant part on the Manager. Under the Management Agreement, the Manager will receive an annual base management fee payable monthly in arrears and the Manager will have the opportunity to earn incentive compensation under the Management Agreement based on the Company's annualized net income. The ability of the Company to achieve the performance level required for the Manager to earn the incentive compensation is dependent upon the level and volatility of interest rates, the Company's ability to react to changes in interest rates and to implement the operating strategies described herein, and other factors, many of which are not within the Company's control. In evaluating Mortgage Assets for investment and other strategies, an undue emphasis on maximizing income at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation for the Manager, could result in increased risk to the value of the Company's Mortgage Asset portfolio. 22 25 The Management Agreement does not limit or restrict the right of the Manager or any of its officers, directors, employees or affiliates to engage in any business or to render services of any kind to any other person, including purchasing, or rendering advice to others purchasing, Mortgage Assets which meet the Company's policies and criteria, except that the Manager and its officers, directors, or employees will not be permitted to provide any such services to any REIT which invests primarily in residential Mortgage Assets, other than the Company. Sudden Interest Rate Fluctuations May Reduce Income From Operations Substantially all of the Company's Mortgage Assets have a repricing frequency of two years or less, and substantially all of the Company's borrowings have maturities of three months or less. The interest rates on the Company's borrowings may be based on interest rate indices which are different from, and adjust more rapidly than, the interest rate indices of its related Mortgage Assets. Consequently, changes in interest rates may significantly influence the Company's net interest income. While increases in interest rates will generally increase the yields on the Company's adjustable-rate Mortgage Assets, rising rates will also increase the cost of borrowings by the Company. To the extent such costs rise more rapidly than the yields on such Mortgage Assets, the Company's net interest income will be reduced or a net interest loss may result. Adjustable-rate Mortgage Assets are typically subject to periodic and lifetime interest rate caps which limit the amount an adjustable-rate Mortgage Asset interest rate can change during any given period. The Company's borrowings will not be subject to similar restrictions. Hence, in a period of increasing interest rates, the cost of the Company's borrowings could increase without limitation by caps while the yields on the Company's Mortgage Assets could be limited. Further, some adjustable-rate Mortgage Assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in receipt by the company of a lesser amount of cash income on its adjustable-rate Mortgage Assets than is required to pay interest on the related borrowings, which will not have such payment caps. These factors could lower the Company's net income or cause a net interest loss during periods of rising interest rates, which would negatively impact the Company's financial condition and results of operations. The Company's results of operations may also be adversely affected to the extent the Company acquires fixed-rate Mortgage Loans and is not able to fully hedge the interest rate risk associated with such loans through hedging activities or the financing of such loans through long-term securitizations. Failure To Successfully Manage Interest Rates Risks May Adversely Affect Results of Operations The Company will follow a program intended to protect against interest rate changes. However, developing an effective interest rate risk management strategy is complex and 23 26 no management strategy can completely insulate the Company from risks associated with interest rate changes. In addition, hedging involves transaction costs. In the event the Company hedges against interest rate risks, the Company may substantially reduce its net income. Further, the Federal tax laws applicable to REITs may limit the Company's ability to fully hedge its interest rate risks. Such Federal tax laws may prevent the Company from effectively implementing hedging strategies that, absent such restrictions, would best insulate the Company from the risks associated with changing interest rates. In the event that the Company purchases interest rate caps or other interest rate derivatives to hedge against lifetime, periodic rate or payment caps, and the provider of such caps on interest rate derivatives becomes financially unsound or insolvent, the Company may be forced to unwind such caps on its interest rate derivatives with such provider and may take a loss thereon. Further, the Company could suffer the adverse consequences that the hedging transaction was intended to protect against. Although the Company intends to purchase interest rate caps and derivatives only from financially sound institutions and to monitor the financial strength of such institutions on a periodic basis, no assurance can be given that the Company can avoid such third party risks. Currently, the Company has entered into hedging transactions which seek to protect only against the Mortgage Securities lifetime rate caps and not against periodic rate caps or unexpected prepayments. In addition, the Company's lifetime cap hedges are for a two year period which began in the second quarter of 1998. Accordingly, the Company may not be adequately protected against risks associated with interest rate changes and such changes could aversely affect the Company's financial condition and results of operations. Future Offerings of Securities May Affect Market Price of Common Stock The Company may in the future increase its capital resources by making additional offerings of equity and debt securities, including classes of preferred stock, Common Stock, commercial paper, medium-term notes, CMOs and senior or subordinated notes. All debt securities and classes of preferred stock will be senior to the Common Stock in a liquidation of the Company. The effect of additional equity offerings may be the dilution of the equity of stockholders of the Company or the reduction of the price of the Company's Common Stock, or both. The Company is unable to estimate the amount, timing, or nature of additional offerings as they will depend upon market conditions and other factors. There can be no assurance that the Company will be able to raise the capital it will require through such offerings on favorable terms or at all. The inability of the Company to obtain needed resources of capital on favorable terms could have a materially adverse affect on the Company. Year 2000 Issues The Company may face problems in the year 2000 if any relied-on computer system, either internally or externally, utilizes only two digits to identify a year. If not addressed and corrected, a company's computer applications may fail or give incorrect results. 24 27 The Company is currently in the process of reviewing its internal and external exposure and contingency plans regarding Year 2000 issues. All internal computer systems and programs that the Company relies on have been developed or upgraded within the last five years. Additionally, the Company is in the process of contacting all software and computer vendors to assess the potential for problems from the change to the Year 2000. The Company does not anticipate any interruption or problems arising from its internal systems that would be detrimental to operations. The Company likewise does not expect to incur any material expense associated with addressing Year 2000 compliance. There can be no assurance, however, that the Company's counterparties will be Year 2000 compliant. Item 3. Quantitative and Qualitative Disclosures about Market Risk Not required. PART II. OTHER INFORMATION Item. 1. Legal Proceedings At September 30, 1998, there were no pending legal proceedings to which the Company was a party or of which any of its property was subject. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information Proposals of stockholders intended to be presented at the next Annual Meeting of the Stockholders of the Company (other than proposals made under Rule 14a-8 of the Securities Exchange Act of 1934, as amended) must be received by the Company at its offices at 445 Marine View Avenue, Suite 230, Del Mar California 92014, between February 21 and March 23, 1999. Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits *3.1 Articles of Amendment and Restatement of the Registrant *3.2 Amended and Restated Bylaws of the Registrant *4.1 Registration Rights Agreement dated February 11, 1997 25 28 **4.2 Indenture dated as of June 1, 1998 between American Residential Eagle Board Trust 1998-1, a California wholly-owned consolidated subsidiary of AmREIT, and First Union National Bank, as Trustee. 27. Financial Data Schedule * Incorporated by reference to Registration Statement on Form S-11 (File No. 333-33679) ** Incorporated by reference to registration Statement on Form 8-K dated June 17, 1998, filed with the Commission on July 2, 1998. (b) Reports on Form 8-K None 26 29 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 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. Dated: November 12, 1998 By: /s/ Mark A. Conger ------------------------------------ Mark A. Conger, Executive Vice President Chief Financial Officer 27 EX-27 2 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the September 30, 1998 Form 10-Q and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1998 SEP-30-1998 12,608 906,211 12,758 3,152 0 928,425 0 0 928,425 405,455 418,412 0 0 81 104,477 928,425 0 54,042 0 0 3,169 714 44,611 5,548 0 5,548 0 0 0 5,548 0.69 0.69
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