-----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, LHRFHFrtwOj7conbX1NOW1tiTJxBzIAT38qq8UCdpnGh9nnOezEz0Af0PceyJC1l sbaIa7PqKiiOuM2SsJF65A== 0000936392-98-000806.txt : 19980515 0000936392-98-000806.hdr.sgml : 19980515 ACCESSION NUMBER: 0000936392-98-000806 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980514 SROS: NYSE 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: 98620042 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 DATED 3-31-98 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: March 31, 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 430-69111 (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) 8,114,000 as of May 1, 1998 2 INDEX
Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Balance Sheets at March 31, 1998 and December 31, 1997 1 Statements of Operations for the three months ended March 31, 1998, for the three months ended December 31, 1997 and for the period from February 11, 1997 (commencement of operations) through March 31, 1997 2 Statements of Cash Flows for the three months ended March 31, 1998, for the three months ended December 31, 1997 and for the period from February 11, 1997 (commencement of operations) through March 31, 1997 3 Notes to Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings 16 Item 2. Changes in Securities and Use of Proceeds 16 Item 3. Defaults Upon Senior Securities 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Item 5. Other Information 16 Item 6. Exhibits and Reports on Form 8-K 16
3 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. BALANCE SHEETS (dollars in thousands, except share data)
March 31, 1998 December 31 1997 -------------- ---------------- ASSETS Cash and cash equivalents $ 1,061 $ 5,893 Mortgage securities available-for-sale 350,760 387,099 Mortgage loans held-for-investment 536,457 162,762 Interest rate cap agreements 365 411 Accrued interest receivable 8,557 5,169 Due from affiliate 636 269 Other assets 358 231 --------- --------- $ 898,194 $ 561,834 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Reverse repurchase agreements $ 785,936 $ 451,288 Accrued interest payable 3,006 1,839 Accrued expenses and other liabilities 660 632 Management fees payable 469 208 Accrued dividends -- 1,298 --------- --------- Total liabilities 790,071 455,265 --------- --------- Stockholders' Equity: Preferred stock, par value $.01 per share; 1,000,000 shares authorized; no shares issued and outstanding -- -- Common stock, par value $.01 per share; 25,000,000 shares authorized; 8,114,000 shares issued and outstanding 81 81 Additional paid-in capital 109,763 109,786 Accumulated other comprehensive loss (4,000) (3,300) Cumulative dividends declared (2,401) (2,401) Retained earnings 4,680 2,403 --------- --------- Total stockholders' equity 108,123 106,569 --------- --------- $ 898,194 $ 561,834 ========= =========
See accompanying notes to financial statements 1 4 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. STATEMENTS OF OPERATIONS (dollars in thousands, except share data)
For the period from For the For the February 11, 1997 Three Months Three Months (commencement of Ended Ended operations) through March 31, 1998 December 31, 1997 March 31, 1997 -------------- ----------------- ------------------ Interest income: Mortgage assets $14,381 $ 5,767 $ 217 Cash and investments 72 91 109 ------- ------- ------- Total interest income 14,453 5,858 326 Interest expense 11,049 4,357 170 ------- ------- ------- Net interest income 3,404 1,501 156 Provision for loan losses 136 -- -- ------- ------- ------- Net interest income after provision for loan losses 3,268 1,501 156 Other operating income: Prepayment penalty 22 -- -- Other expenses: Management fee 469 109 3 General and administrative expenses 544 92 7 ------- ------- ------- Total other expenses 1,013 201 10 ------- ------- ------- Net income $ 2,277 $ 1,300 $ 146 ======= ======= ======= Net income per share of Common Stock -- Basic $ 0.28 $ 0.22 $ 0.09 Net income per share of Common Stock -- Diluted $ 0.28 $ 0.21 $ 0.09 Dividends per share of Common Stock for related period $ 0.28 $ 0.16 $ 0.09
See accompanying notes to financial statements. 2 5 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. STATEMENTS OF CASH FLOWS (dollars in thousands, except share data)
For the period from For the For the February 11, 1997 Three Months Three Months (commencement of Ended Ended operations) through March 31, 1998 December 31, 1998 March 31, 1997 ------------- ------------- ------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,277 $ 1,300 $ 146 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of premium on mortgage assets 1,915 797 20 Amortization of interest rate cap agreements 46 46 -- Provision for loan loss 136 -- -- Increase in accrued interest receivable (3,388) (2,937) (999) Increase in other assets (127) (80) (4) Increase in due from affiliate (367) (269) -- Increase in accrued interest payable 1,167 233 155 Increase in accrued expenses, other liabilities & management fees 289 450 169 ------------- ------------- ------------- Net cash provided by (used in) operating activities 1,948 (460) (553) CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of mortgage securities available-for-sale -- (183,933) (153,120) Purchases of mortgage loans held for investment (378,341) (162,762 -- Principal payments on mortgage securities available-for-sale 34,106 20,534 -- Principal payments on mortgage loans held for investment 4,128 -- ------------- ------------- ------------- Net cash used in investing activities (340,106) (326,161) (153,120) CASH FLOWS FROM FINANCING ACTIVITIES: Increase in net borrowings from reverse repurchase agreements 334,648 241,582 141,068 Increase/(decrease) in net proceeds from stock issuances -- 89,702 20,165 Dividends paid (1,298) (519) (145) Other (23) -- -- ------------- ------------- ------------- Net cash provided by financing activities 333,328 330,765 161,088 Net increase/(decrease) in cash and cash equivalents (4,832) 4,144 7,415 Cash and cash equivalents at beginning of period 5,893 1,749 -- ------------- ------------- ------------- Cash and cash equivalents at end of period $ 1,061 $ 5,893 $ 7,415 ============= ============= ============= Supplemental information - interest paid $ 7,968 $ 3,837 $ 34 ============= ============= ============= Non-cash transactions: Increase in accumulated other comprehensive loss $ (700) $ (4,104) $ (217) ============= ============= =============
See accompanying notes to financial statements. 3 6 AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1. BASIS OF FINANCIAL PRESENTATION AND ORGANIZATION Basis of Financial Statement Presentation The accompanying 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 American Residential Investment Trust, Inc. (the "Company") and its financial condition and results of operations have been included. Operating results for the quarter ended March 31, 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. The Company was financed through a private equity funding from its manager, Home Asset Management Corporation (the "Manager"). The Company operates as a mortgage real estate investment trust which has elected to be taxed as a real estate investment trust ("REIT") for Federal income tax purposes, which generally will allow the Company to pass through its income to its stockholders without payment of corporate level Federal income tax. The Company was formed for the purpose of investing in residential adjustable-rate mortgage-backed securities and mortgage loans (collectively, "Mortgage Assets"). The Company finances its acquisitions of Mortgage Assets with equity and short-term secured borrowings. Income 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 income per share with basic and diluted income per share. Unlike primary income per share, basic income per share excludes any dilutive effect of options. Diluted income per share is very similar to the previously reported fully diluted income per share. All income per share amounts have been restated to conform to the SFAS No. 128 requirements. 4 7 The following table illustrates the computation of basic and diluted earnings per share:
For the period from For the For the February 11, 1997 Three Months Three Months (commencement of Ended Ended operations) through March 31, 1998 December 31, 1997 March 31, 1997 -------------- ----------------- -------------- (dollars in thousands, except per share data) Numerator: Net income $ 2,277 $ 1,300 $ 146 Denominator: Denominator for basic earnings per share - weighted average number of common shares outstanding during the period 8,114,000 6,082,750 1,600,000 Incremental common shares attributable to dilutive outstanding options 7,700 41,399 -- ---------- ---------- ---------- Denominator for diluted earnings per share 8,121,700 6,124,149 1,600,000 Basic earnings per share $ 0.28 $ 0.21 $ 0.09 Diluted earnings per share $ 0.28 $ 0.21 $ 0.09
Comprehensive Income In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement 130). Statement 130 establishes standards for reporting and display of comprehensive income and its components in the financial statements. The FASB defines comprehensive income as "the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." The following table illustrates comprehensive income:
For the period from For the For the February 11, 1997 Three Months Three Months (commencement of Ended Ended operations) through March 31, 1998 December 31, 1997 March 31, 1997 -------------- ----------------- -------------- (dollars in thousands) Net income $ 2,277 $ 1,300 $ 146 Other comprehensive loss (700) (4,100) (217) ------- ------- ------- Comprehensive income (loss) $ 1,577 $(2,800) $ (71) ======= ======= =======
5 8 NOTE 2. MORTGAGE SECURITIES AVAILABLE FOR SALE At March 31, 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 $ 230,316 $ 111,034 $ 341,350 Unamortized premium 8,746 4,664 13,410 --------- --------- --------- Amortized cost 239,062 115,698 354,760 Unrealized loss (2,603) (1,397) (4,000) --------- --------- --------- Fair value $ 236,459 $ 114,301 $ 350,760 ========= ========= =========
At March 31, 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 March 31, 1998, the weighted average interest rate on the Mortgage Securities was 7.87% 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 The Company purchases certain non-conforming Mortgage Loans to be held as long-term investments. At March 31, 1998, Mortgage Loans held for investment consists of the following (dollars in thousands): Mortgage Loans held for investment, principal $ 499,113 Unamortized premium 39,997 Allowance for loan losses (2,653) --------- $ 536,457 =========
6 9 At March 31, 1998, the weighted average interest rate on the Mortgage Loans was 9.18% per annum. All Mortgage Loans have a repricing frequency of two years or less. At March 31, 1998, 33.90% of the collateral was located in California with no other state representing more than 7.67%. NOTE 4. REVERSE REPURCHASE AGREEMENTS The Company has entered into uncommitted reverse repurchase agreements, which may be withdrawn at any time, to finance the acquisition of its Mortgage Assets. The maximum aggregate amount available under the uncommitted reverse repurchase agreements at March 31, 1998 is over $2.5 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 quarter was 31.02%. At March 31, 1998, Mortgage Securities pledged had an estimated fair value of approximately $288.7 million. At March 31, 1998, the Company had approximately $282.7 million of Mortgage Securities reverse repurchase agreements outstanding with a weighted average borrowing rate of 5.49% per annum and a weighted average remaining maturity of 40 days. The maximum month end balance and the average balance outstanding for the quarter ended March 31, 1998 were $282.7 million and $293.1 million, respectively. At March 31, 1998, the Mortgage Securities reverse repurchase agreements were comprised of the following:
Repurchase Underlying Interest Rate Weighted Average Mortgage Securities Liability Collateral (per annum) Maturity Date - ---------------------------------------- ------------- -------------- ----------------- ---------------- (dollars in thousands) -------------------------------------------------------------------- ABN-AMRO $ 40,036 $ 40,648 5.55% May 2, 1998 Prudential 87,698 88,655 5.54 April 29, 1998 Federal Home Loan Mortgage Corporation 9,318 9,332 5.50 April 1, 1998 Morgan Stanley 22,900 23,400 5.58 May 26, 1998 First Boston 76,029 79,676 5.34 June 7, 1998 First Union 46,714 46,947 5.55 April 24, 1998 --------- --------- ---- -------------- $ 282,695 $ 288,658 5.49% May 10, 1998 ========= ========= ==== ==============
Mortgage Loans Reverse repurchase agreements for Mortgage Loans are currently placed with one investment banking firm. At March 31, 1998, Mortgage Loans pledged had an estimated fair value of approximately $539.5 million. 7 10 At March 31, 1998, the Company had approximately $503.2 million of Mortgage Loans reverse repurchase agreements outstanding with a weighted average borrowing rate of 6.11% per annum and a weighted average remaining maturity of one day. The maximum month end balance and the average balance outstanding for the quarter ended March 31, 1998 were $503.2 million and $393.1 million, respectively. At March 31, 1998, the Mortgage Loans reverse repurchase agreements were comprised of the following:
Repurchase Underlying Interest Rate Weighted Average Mortgage Loans Liability Collateral (per annum) Maturity Date - ---------------------- --------------- --------------- ------------------ ---------------- (dollars in thousands) --------------------------------------------------------------------------- Lehman Brothers $ 503,241 $ 539,110 6.11% April 1, 1998 ============== ============== ============ ==============
NOTE 5. STOCKHOLDERS' EQUITY On April 14, 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. 8 11 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 "expects", "will", "may", "anticipates" and "seeks" are forward looking statements. These forward looking statements, including statements regarding changes in the Company's future income, 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 interest rates, changes in levels of prepayments, 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. 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. 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. The Company may seek to generate growth in net income in a variety of ways, including methods such as (i) issuing new Common Stock and increasing the balance/amount of the earning assets when opportunities in the mortgage market are likely to allow growth in net income per share of Common Stock, (ii) improving productivity by increasing the size of the earning assets at a rate faster than operating expenses increase, (iii) changing the mix of Mortgage Asset types among the earning assets in an effort to improve returns, 9 12 and (iv) increasing the efficiency with which the Company uses its equity capital over time by increasing the Company's use of debt when prudent and by issuing subordinated debt, preferred stock or other forms of debt and equity. There can be no assurance, however, that the Company's efforts will be successful or that the Company will increase or maintain its income level. RESULTS OF OPERATIONS The Company does not believe that a comparison of the quarters ended March 31, 1997 and March 31, 1998 is meaningful because of the Company's significantly greater level of operations in 1998. For the quarter ended March 31, 1998, the Company generated net income of approximately $2.3 million and diluted net income per share of Common Stock of $0.28. At March 31, 1998 the Company held Mortgage Securities that had a carrying value of approximately $350.8 million, including a $4.0 million net unrealized loss, and Mortgage Loans with a carrying value of approximately $536.5 million. Net income for the Company increased 75.15% from approximately $1.3 million for the quarter ended December 31, 1997, to approximately $2.3 million for the quarter ended March 31, 1998. The growth in net income was directly attributable to an increase in net interest income. Net interest income grew 126.78% between the quarter ended December 31, 1997 and the quarter ended March 31, 1998, from approximately $1.5 million to approximately $3.4 million respectively. This increase in net interest income was partially offset by an increase in general and administrative expenses. From the quarter ended December 31, 1997 to the quarter ended March 31, 1998, general and administrative expenses increased from approximately $201,000 to approximately $1.0 million. The growth in net interest income between the quarters ended December 31, 1997 and March 31, 1998 was due to an increase in the Company's Mortgage Loans held-for-investment during the first quarter of 1998. Similarly, the increase in general and administrative expenses between the quarters ended December 31, 1997 and March 31, 1998 is primarily the result of the Company's increased management fees which resulted from the increase in the Company's Mortgage Loans and the increased professional fees and printing and reproduction expenses related to the Form 10-K and annual report. The Company experienced high levels of prepayments in the Mortgage Securities portfolio during the quarter ended March 31, 1998. The annualized Mortgage Securities principal prepayment rate for the Company was approximately 37.39% in the quarter ending March 31, 1998 compared to the annualized Mortgage Securities principal prepayment rate of approximately 31.43% for the quarter ended December 31, 1997. The Company anticipates that prepayment rates in the Mortgage Securities portfolio will continue at high levels for an indefinite period and may increase above current levels. As such, the Company has also increased the amortization of the premiums on these Mortgage Securities. 10 13 Liquidity and Capital Resources During the quarter ended March 31, 1998, net cash provided by operating activities was $1.9 million. Net cash provided by operating activities was negatively impacted by an increase in accrued interest receivable. Mortgage Loans at December 31, 1997 were approximately $162.8 million compared to $536.5 million at March 31, 1998 and, therefore, accrued interest receivable at March 31, 1998 has increased proportionally to loans, thereby negatively affecting cash. Net cash for the period was positively affected by an increase in accrued interest payable. Net cash used in investing activities for the quarter ended March 31, 1998 was approximately $340.0 million. Net cash used for the period was negatively affected by the purchase of Mortgage Loans in the amount of approximately $378.3 million and positively affected by principal prepayments of approximately $38.2 million. For the quarter ended March 31, 1998, net cash provided by financing activities was approximately $333.3 million. Net cash provided was primarily affected by borrowings under reverse repurchase agreements. At March 31, 1998 the Company had uncommitted reverse repurchase agreement facilities, which may be withdrawn at any time, in place to provide over $2.5 billion to finance investments in Mortgage Assets. In addition, the Company has a line of credit with one counter party to a reverse repurchase agreement. Pursuant to the line of credit, the Company may borrow the lesser of $25 million and the outstanding principal and interest receivable balance with the counter party, for a period of up to 36 days at an interest rate equal to LIBOR plus 0.6%. The line of credit has no set expiration date. 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 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 had been purchased with a premium by the Company would result in the immediate 11 14 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 high levels of prepayments during the three months ended March 31, 1998 and the Company anticipates that prepayment rates will continue at high levels for an indefinite period and may increase above current levels. 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 to 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. Borrower Credit May Decrease Value of Mortgage Loans A substantial portion of the Company's Mortgage Assets consist of Mortgage Loans. Accordingly, during the time it holds Mortgage Loans, 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 amounts 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 pursuant to the Freedom Program, 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. 12 15 The Company's loans remain relatively young from a delinquency perspective, and there has 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 March 31, 1998, there were approximately 1.25% of Mortgage Loans that were greater than 60 days delinquent. In addition, at March 31, 1998, there were no Mortgage Loans in bankruptcy. 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 invests in such Mortgage Loans or securities secured by such Mortgage Loans. 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 could materially prolong the time period required to resell such properties 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 six 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 13 16 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 interest 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. Failure To Successfully Manage Interest Rate 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 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 payments. In addition, the Company's lifetime cap hedges are for a two year period which does not begin until the second quarter of 1998. Accordingly, the Company may not be adequately protected against risks associated with interest rate changes and 14 17 such changes could adversely affect the Company's financial condition and results of operations. 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. 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. 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 sources of capital on favorable terms could have a material adverse affect on the Company 15 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk Not required PART II. OTHER INFORMATION Item. 1. Legal Proceedings At March 31, 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 Not applicable Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits None (b) Reports on Form 8-K None 16 19 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: May 11, 1998 By: /s/ MARK A. CONGER ---------------------------------------- Mark A. Conger, Executive Vice President Chief Financial Officer (authorized signatory and principal financial officer) 17 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE MARCH 31, 1998 FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1998 MAR-31-1998 1,061 887,217 9,916 0 0 898,194 0 0 898,194 790,071 0 0 0 81 105,763 898,194 0 14,475 0 0 1,149 0 11,049 2,277 0 2,277 0 0 0 2,277 0.28 0.28
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