10-Q 1 a4514649.txt ANNALY 10-Q 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, 2003 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: 1-13447 ANNALY MORTGAGE MANAGEMENT, INC. (Exact name of Registrant as specified in its Charter) MARYLAND 22-3479661 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1211 AVENUE OF THE AMERICAS, SUITE 2902 NEW YORK, NEW YORK (Address of principal executive offices) 10036 (Zip Code) (212) 696-0100 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No ----- ---- Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2) of the Exchange Act: Yes X No ----- ---- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of stock, as of the last practicable date: Class Outstanding at November 12, 2003 Common Stock, $.01 par value 96,013,214
Annaly Mortgage Management, Inc. FORM 10-Q INDEX Part I. FINANCIAL INFORMATION Item 1. Financial Statements: Statements of Financial Condition- September 30, 2003 (Unaudited) and December 31, 2002 1 Statements of Operations (Unaudited) for the quarters and nine months ended 2 September 30, 2003 and 2002 Statements of Stockholders' Equity (Unaudited) for the nine months ended September 30, 2003 3 Statements of Cash Flows (Unaudited) for the quarters and nine months ended 4 September 30, 2003 and 2002 Notes to Financial Statements (Unaudited) 5-13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15-25 Item 3. Quantitative and Qualitative Disclosures about Market Risk 26 Item 4. Controls and Procedures 27 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 28 SIGNATURES 29 CERTIFICATIONS 30-33
PART I. ITEM 1. FINANCIAL STATEMENTS ANNALY MORTGAGE MANAGEMENT, INC. STATEMENTS OF FINANCIAL CONDITION (dollars in thousands, except for share data) SEPTEMBER DECEMBER 31, 30, 2003 2002 (UNAUDITED) ------------ ------------ ASSETS Cash and cash equivalents $3,381 $726 Mortgage-Backed Securities, at fair value 11,628,271 11,551,857 Agency Debentures, at fair value 976,814 - Receivable for Mortgage-Backed Securities sold 177,304 55,954 Accrued interest receivable 53,955 49,707 Other assets 1,233 840 ------------ ------------ Total assets $12,840,958 $11,659,084 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Repurchase agreements $11,201,897 $10,163,174 Payable for Mortgage-Backed Securities purchased 445,148 338,691 Accrued interest payable 13,868 14,935 Dividends payable 26,876 57,499 Other liabilities 4,294 2,812 Accounts payable 3,147 1,907 ------------ ------------ Total liabilities 11,695,230 10,579,018 ------------ ------------ Stockholders' Equity: Common stock: par value $.01 per share; 500,000,000 Authorized 95,964,915 and 84,569,206 shares issued and outstanding, respectively 960 846 Additional paid-in capital 1,192,819 1,003,200 Accumulated other comprehensive gain (loss) (51,870) 75,511 Retained earnings 3,819 509 ------------ ------------ Total stockholders' equity 1,145,728 1,080,066 ------------ ------------ Total liabilities and stockholders' equity $12,840,958 $11,659,084 ============ ============ See notes to financial statements.
1
PART I. ITEM 1. FINANCIAL STATEMENTS ANNALY MORTGAGE MANAGEMENT, INC. STATEMENTS OF OPERATIONS (UNAUDITED) (dollars in thousands, except per share amounts) For the For the For the Nine For the Nine Quarter Ended Quarter Ended Months Ended Months Ended September 30, September 30, September 30, September 30, 2003 2002 2003 2002 ------------------------------- -------------- ----------------- INTEREST INCOME $66,855 $109,201 $248,247 $311,524 INTEREST EXPENSE 43,922 54,012 139,740 141,884 -------------- --------------- -------------- ----------------- NET INTEREST INCOME 22,933 55,189 108,507 169,640 GAIN ON SALE OF MORTGAGE- BACKED SECURITIES 9,656 4,747 40,907 9,500 GENERAL AND ADMINISTRATIVE EXPENSES 4,110 3,268 12,008 10,059 -------------- --------------- -------------- ----------------- NET INCOME 28,479 56,668 137,406 169,081 -------------- --------------- -------------- ----------------- OTHER COMPREHENSIVE INCOME (LOSS): Unrealized gain (loss) on available- for-sale securities (43,405) 11,846 (86,474) 45,713 Less: reclassification adjustment for net gains included in net income (9,656) (4,747) (40,907) (9,500) -------------- --------------- -------------- ----------------- Other comprehensive income (loss) (53,061) 7,099 (127,381) 36,213 -------------- --------------- -------------- ----------------- COMPREHENSIVE INCOME (LOSS) $(24,582) $63,767 $10,025 $205,294 ============== =============== ============== ================= NET INCOME PER SHARE: Basic $0.30 $0.68 $1.51 $2.08 ============== =============== ============== ================= Diluted $0.30 $0.68 $1.50 $2.07 ============== =============== ============== ================= WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING: Basic 94,685,685 83,668,422 90,929,196 81,206,156 ============== =============== ============== ================= Diluted 95,500,486 83,939,870 91,750,472 81,490,436 ============== =============== ============== ================= See notes to financial statements.
2 PART I ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC. STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 (UNAUDITED) (dollars in thousands, except per share amounts) Common Additional Other Stock Paid-In Comprehensive Retained Comprehensive Par Capital Income Earnings Income Total Value --------------------------------------------------------------- BALANCE, DECEMBER 31, 2002 $846 $1,003,200 $509 $75,511 $1,080,066 Net Income $50,775 50,775 Other comprehensive income: Unrealized net loss on securities, net of reclassification adjustment (4,511) (4,511) ------------- Comprehensive income $46,264 46,264 ============= Exercise of stock options - 215 215 Proceeds from direct purchase and dividend reinvestment - 955 955 Dividends declared for the quarter ended March 31, 2003, $0.60 per share (50,788) (50,788) ----------------- --------------------------------- BALANCE, MARCH 31, 2003 $846 $1,004,370 $496 $71,000 $1,076,712 Net Income $58,152 58,152 Other comprehensive income: Unrealized net loss on securities, net of reclassification adjustment (69,810) (69,810) ------------- Comprehensive loss $(11,658) (11,658) ============= Exercise of stock options - 154 154 Proceeds from direct purchase and dividend reinvestment 1 1,346 1,347 Proceeds from subsequent offering 93 151,222 151,315 Dividends declared for the quarter ended June 30, 2003, $0.60 per share (56,432) (56,432) ----------------- --------------------------------- BALANCE, JUNE 30, 2003 $940 $1,157,092 $2,216 $1,190 $1,161,438 Net Income $28,479 28,479 Other comprehensive income: Unrealized net loss on securities, net of reclassification adjustment (53,061) (53,060) ------------- Comprehensive loss $(24,582) (24,581) ============= Exercise of stock options - 17 17 Proceeds from direct purchase and dividend reinvestment 1 1,004 1,005 Proceeds from equity shelf program offering 19 34,706 34,725 Dividends declared for the quarter ended September 30, 2003, $0.28 per average share (26,876) (26,876) ----------------- --------------------------------- BALANCE, SEPTEMBER 30, 2003 $960 $1,192,819 $3,819 $(51,870)$1,145,728 ================= ================================= See notes to financial statements.
3 PART I ITEM 1. FINANCIAL STATEMENTS
ANNALY MORTGAGE MANAGEMENT, INC. STATEMENTS OF CASH FLOWS (UNAUDITED) (dollars in the thousands) For the For the For the NineFor the Nine Quarter Quarter Months Months Ended Ended Ended Ended September September September September 30, 30, 30, 2003 30, 2002 2003 2002 ------------------------------------------------ Cash flows from operating activities: Net income $28,479 $56,668 $137,406 $169,081 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of mortgage premiums and discounts, net 72,047 28,229 178,180 65,917 Gain on sale of Mortgage-Backed Securities (9,656) (4,747) (40,907) (9,500) Stock option expense - - 60 163 Market value adjustment on long-term repurchase agreement (313) 1,252 1,783 883 Decrease (increase) in accrued interest receivable 4,071 903 (4,248) (3,146) Increase in other assets (129) (15) (394) (1,061) (Decrease) increase in accrued interest payable (2,919) 7,325 (1,067) 11,992 Increase in accounts payable 945 233 1,240 1,084 ------------------------------------------------ Net cash provided by operating activities 92,525 89,848 272,053 235,413 ------------------------------------------------ Cash flows from investing activities: Purchase of Mortgage-Backed Securities (2,571,157) (2,021,616) (9,788,410) (8,011,359) Purchase of agency debentures (394,940) - (1,735,940) - Proceeds from sale of Mortgage-Backed Securities 596,487 321,237 2,708,880 1,129,673 Proceeds from callable agency debentures 575,000 - 746,000 - Principal payments of Mortgage-Backed Securities 2,686,374 1,014,235 6,736,696 2,972,127 ------------------------------------------------ Net cash provided by (used in) in investing activities 891,764 (686,144) (1,332,774) (3,909,559) ------------------------------------------------ Cash flows from financing activities: Proceeds from repurchase agreements 32,273,478 18,851,415 87,956,308 60,801,326 Principal payments on repurchase agreements (33,234,016)(18,226,432)(86,917,886)(57,359,369) Proceeds from exercise of stock options 17 123 327 608 Proceeds from direct purchase and dividend reinvestment 1,004 859 3,306 2,249 Net proceeds from offerings 34,725 28,102 186,040 375,439 Dividends paid (56,420) (56,415) (164,720) (144,534) ------------------------------------------------ Net cash provided by (used in) financing activities (981,212) 597,652 1,063,375 3,675,719 ------------------------------------------------ Net increase in cash and cash equivalents 3,077 1,356 2,655 1,573 Cash and cash equivalents, beginning of period 304 646 726 429 ------------------------------------------------ Cash and cash equivalents, end of period $3,381 $2,002 $3,381 $2,002 ================================================ Supplemental disclosure of cash flow information: Interest paid $46,842 $46,687 $140,807 $129,892 ================================================ Noncash financing activities: Net change in unrealized (loss) gain on available- for-sale securities net of reclassification adjustment $(53,061) $7,099 $(127,381) $36,213 ================================================ Dividends declared, not yet paid $26,876 $57,465 $26,876 $57,465 ================================================ See notes to financial statements.
4 ANNALY MORTGAGE MANAGEMENT, INC. NOTES TO FINANCIAL STATEMENTS FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (UNAUDITED) -------------------------------------------------------------------------------- 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Annaly Mortgage Management, Inc. (the "Company") was incorporated in Maryland on November 25, 1996. The Company commenced its operations of purchasing and managing an investment portfolio of primarily Mortgage-Backed Securities and Agency Securities (as defined below) on February 18, 1997, upon receipt of the net proceeds from the private placement of equity capital. An initial public offering was completed on October 14, 1997. A summary of the Company's significant accounting policies follows: Basis of Presentation - The accompanying unaudited financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America ("GAAP"). The interim financial statements for the three month periods are unaudited; however, in the opinion of the Company's management, all adjustments, consisting only of normal recurring accruals, necessary for a fair statement of the results of operations have been included. These unaudited financials statements should be read in conjunction with the audited financial statements included in the Company's Annual Report on form 10-K for the year ended December 31, 2002. The nature of the Company's business is such that the results of any interim period are not necessarily indicative of results for a full year. Cash and Cash Equivalents - Cash and cash equivalents includes cash on hand and money market funds. The carrying amounts of cash equivalents approximates their value. Mortgage-Backed Securities and Agency Debentures - The Company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations and other mortgage-backed securities representing interests in or obligations backed by pools of mortgage loans (collectively, "Mortgage-Backed Securities"). The Company also invests in Federal Home Loan Bank ("FHLB"), Federal Home Loan Mortgage Corporation ("FHLMC"), and Federal National Mortgage Association ("FNMA") debentures. The Mortgage-Backed Securities and agency debentures are collectively referred to herein as "Investment Securities." Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires the Company to classify its investments as either trading investments, available-for-sale investments or held-to-maturity investments. Although the Company generally intends to hold most of its Investment Securities until maturity, it may, from time to time, sell any of its Investment Securities as part of its overall management of its statement of financial condition. Accordingly, this flexibility requires the Company to classify all of its Investment Securities as available-for-sale. All assets classified as available-for-sale are reported at fair value, based on market prices provided by certain dealers who make markets in these financial instruments, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Unrealized losses on Investment Securities that are considered other than temporary, as measured by the amount of decline in fair value attributable to factors other than temporary, are recognized in income and the cost basis of the Mortgage-Backed Securities is adjusted. There were no such adjustments for the nine months ended September 30, 2003 and 2002. Interest income is accrued based on the outstanding principal amount of the Investment Securities and their contractual terms. Premiums and discounts associated with the purchase of the Investment Securities are amortized into interest income over the lives of the securities using the interest method. 5 Investment Securities transactions are recorded on the trade date. Purchases of newly issued securities are recorded when all significant uncertainties regarding the characteristics of the securities are removed, generally shortly before settlement date. Realized gains and losses on such transactions are determined on the specific identification basis. Credit Risk - At September 30, 2003 and December 31, 2002, the Company has limited its exposure to credit losses on its portfolio of Investment Securities by only purchasing securities issued by Federal Home Loan Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA"), Government National Mortgage Association ("GNMA"), or Federal Home Loan Bank ("FHLB"). The payment of principal and interest on the FHLMC and FNMA and FHLB Investment Securities are guaranteed by those respective agencies and the payment of principal and interest on the GNMA Mortgage-Backed Securities are backed by the full-faith-and-credit of the U.S. government. At September 30, 2003 and December 31, 2002 all of the Company's Investment Securities have an actual or implied "AAA" rating. Repurchase Agreements -The Company finances the acquisition of its Investment Securities through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements. Accrued interest is recorded as a separate line item. Income Taxes - The Company has elected to be taxed as a Real Estate Investment Trust ("REIT") and intends to comply with the provisions of the Internal Revenue Code of 1986, as amended (the "Code") with respect thereto. Accordingly, the Company will not be subjected to Federal income tax to the extent of its distributions to shareholders and as long as certain asset, income and stock ownership tests are met. Use of Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 6 2. MORTGAGE-BACKED SECURITIES The following table pertains to the Company's Mortgage-Backed Securities classified as available-for-sale as of September 30, 2003, which are carried at their fair value:
Federal Home Loan Federal National Government National Total Mortgage-Backed Mortgage Corporation Mortgage Association Mortgage Association Securities ---------------------- --------------------- --------------------- --------------------- (dollars in thousands) Mortgage-Backed Securities, gross $3,886,310 $7,105,907 $381,044 $11,373,261 Unamortized discount (19) (1,070) - (1,089) Unamortized premium 84,525 203,973 6,345 294,843 ---------------------- --------------------- --------------------- --------------------- Amortized cost 3,970,816 7,308,810 387,389 11,667,015 Gross unrealized gains 12,075 14,891 473 27,439 Gross unrealized losses (20,406) (43,340) (2,437) (66,183) ---------------------- --------------------- --------------------- --------------------- Estimated fair value $3,962,485 $7,280,361 $385,425 $11,628,271 ====================== ===================== ===================== ===================== Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value ---------------------- --------------------- --------------------- --------------------- (dollars in thousands) Adjustable rate $ 7,740,589 $23,197 $(29,228) $ 7,734,558 Fixed rate 3,926,426 4,242 (36,955) 3,893,713 ---------------------- --------------------- --------------------- --------------------- Total $11,667,015 $27,439 $(66,183) $11,628,271 ====================== ===================== ===================== =====================
The following table pertains to the Company's Mortgage-Backed Securities classified as available-for-sale as of December 31, 2002, which are carried at their fair value:
Federal Home Loan Federal National Government National Total Mortgage-Backed Mortgage Corporation Mortgage Association Mortgage Association Securities ---------------------- --------------------- --------------------- --------------------- (dollars in thousands) Mortgage-Backed Securities, gross $5,120,929 $5,860,987 $ 220,468 $11,202,384 Unamortized discount (544) - (664) (120) Unamortized premium 105,872 164,071 4,684 274,627 ---------------------- --------------------- --------------------- --------------------- Amortized cost 5,226,257 6,024,938 225,152 11,476,347 Gross unrealized gains 31,731 58,239 90,507 537 Gross unrealized losses (9,554) (5,318) (125) (14,997) ---------------------- --------------------- --------------------- --------------------- Estimated fair value $5,248,434 $ 6,077,859 $ 225,564 $11,551,857 ====================== ===================== ===================== =====================
7
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value ---------------------- --------------------- --------------------- --------------------- Adjustable rate $ 7,144,741 $ 35,349 $ (12,424) $7,167,666 Fixed rate 4,331,606 55,158 (2,573) 4,384,191 ---------------------- --------------------- --------------------- --------------------- Total $ 11,476,347 $ 90,507 $ (14,997) $11,551,857 ====================== ===================== ===================== =====================
The adjustable rate Mortgage-Backed Securities are limited by periodic caps (generally interest rate adjustments are limited to no more than 1% every six months) and lifetime caps. The weighted average lifetime cap was 10.2% at September 30, 2003 and 8.8% at December 31, 2002. During the nine months ended September 30, 2003, the Company realized $40.9 million in gains from sales of Mortgage-Backed Securities. During the nine months ended September 30, 2002, the Company realized $9.5 million in gains from sales of Mortgage-Backed Securities. 3. AGENCY DEBENTURES At September 30, 2003, the Company owned callable agency debentures totaling $990.0 million par value. FHLMC, FNMA, and FHLB are the issuers of the debentures. All of the Company's agency debentures are classified as available-for-sale. The unrealized loss on the Company's agency debentures at September 30, 2003 was $13.1 million. The Company's agency debentures are adjustable rate and fixed rate with a weighted average lifetime cap of 5.80%. 4. REPURCHASE AGREEMENTS The Company had outstanding $11.2 billion and $10.2 billion of repurchase agreements with a weighted average borrowing rate of 1.46% and 1.72% and a weighted average remaining maturity of 74 days and 124 days as of September 30, 2003 and December 31, 2002, respectively. At September 30, 2003 and December 31, 2002, the repurchase agreements had the following remaining maturities:
September 30, 2003 December 31, 2002 ------------------------------- ---------------------------- (dollars in thousands) Within 30 days $ 9,484,851 $ 7,778,003 30 to 59 days 252,980 816,906 60 to 89 days - 104,500 90 to 119 days - - Over 120 days 1,464,066 1,463,765 ------------------------------- ---------------------------- Total $11,201,897 $10,163,174 =============================== ============================
5. OTHER LIABILITIES In July 2001, the Company entered into a repurchase agreement maturing in July 2004 which grants the buyer the right to extend the agreement, in whole or in part, in three-month increments up to July 2006. The repurchase agreement has a principal value of $100,000,000. The Company accounts for the extension option as a separate interest rate floor liability carried at fair value. The initial fair value of $1,205,000 allocated to the interest rate floor resulted in a similar discount on the repurchase agreement borrowings that is being amortized over the initial term of 3 years using the effective yield method. At September 30, 2003, the fair value of this interest rate floor was a $4,294,000 and was classified as other liabilities. 8 6. COMMON STOCK During the nine months ended September 30, 2003, the Company declared dividends to shareholders totaling $134,096,000 or $1.48 per share, which $26,876,000 was paid on October 29, 2003. On April 1, 2003 the Company entered into an underwriting agreement pursuant to which the Company raised net proceeds of approximately $151.3 million in equity in a subsequent offering of 9,300,700 shares of common stock. During the nine months ended September 30, 2003, 1,879,600 shares were issued through the Equity Shelf Program, totaling net proceeds of $34.7 million. During the nine months ended September 30, 2003, 37,622 options were exercised under the long-term compensation plan at $387,000. Also, 177,787 shares were purchased in the dividend reinvestment and direct purchase program at $3,305,000. During the Company's year ended December 31, 2002, the Company declared dividends to shareholders totaling $223,602,000, or $2.67 per share, of which $166,102,000 was paid during the year and $57,499,000 was paid on January 29, 2003. During the year ended December 31, 2002, the Company completed an offering of common stock in the first quarter issuing 23,000,000 shares, with aggregate net proceeds of approximately $347,337,000. Through the Equity Shelf Program, the Company raised $28,103,000 in net proceeds and issued 1,484,100 shares. During the year ended December 31, 2002, 97,095 options were exercised at $1,090,000. Total shares exchanged upon exercise of the stock options were 4,444 at a value of $76,000. Also, 165,480 shares were purchased in dividend reinvestment and share purchase plan, totaling $3,009,000. 7. EARNINGS PER SHARE (EPS) For the quarter ended September 30, 2003, the reconciliation is as follows:
For the Quarter Ended September 30, 2003 (dollars in thousands, except per share amounts) ------------------- --------------------- --------------------- Weighted Average Income Shares Per-Share (Numerator) (Denominator) Amount ------------------- --------------------- --------------------- Net income $28,479 ------------------- Basic earnings per share $28,479 94,686 $0.30 ===================== Effect of dilutive securities: Dilutive stock options 814 ------------------- --------------------- Diluted earnings per share $28,479 95,500 $0.30 =================== ===================== =====================
Options to purchase 12,500 shares of stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the quarter. 9 For the quarter ended September 30, 2002, the reconciliation is as follows:
For the Quarter Ended September 30, 2002 (dollars in thousands, except per share amounts) --------------------------------------------------------------- Weighted Average Income Shares Per-Share (Numerator) (Denominator) Amount ------------------- --------------------- --------------------- Net income $56,668 ------------------- Basic earnings per share $56,668 83,668 $0.68 ===================== Effect of dilutive securities: Dilutive stock options 271 ------------------- --------------------- Diluted earnings per share $56,668 83,939 $0.68 =================== ===================== =====================
Options to purchase 6,250 shares of stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the quarter. For the nine months ended September 30, 2003, the reconciliation is as follows:
For the Nine Months Ended September 30, 2003 (dollars in thousands, except per share amounts) --------------------------------------------------------------- Weighted Average Income Shares Per-Share (Numerator) (Denominator) Amount ------------------- --------------------- --------------------- Net income $137,406 ------------------- Basic earnings per share $137,406 90,929 $1.51 ===================== Effect of dilutive securities: Dilutive stock options 821 ------------------- --------------------- Diluted earnings per share $137,406 91,750 $1.50 =================== ===================== =====================
Options to purchase 12,500 shares of stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the nine months ended September 30, 2003. 10
For the nine months ended September 30, 2002, the reconciliation is as follows: For the Nine Months Ended September 30, 2002 (dollars in thousands, except per share amounts) --------------------------------------------------------------- Weighted Average Income Shares Per-Share (Numerator) (Denominator) Amount ------------------- --------------------- --------------------- Net income $169,081 ------------------- Basic earnings per share $169,081 81,206 $2.08 ===================== Effect of dilutive securities: Dilutive stock options 284 ------------------- --------------------- Diluted earnings per share $169,081 81,490 $2.07 =================== ===================== =====================
Options to purchase 6,250 shares of stock were outstanding and considered anti-dilutive as their exercise price exceeded the average stock price for the nine months ended September 30, 2002. 8. LONG-TERM STOCK INCENTIVE PLAN The Company has adopted a long term stock incentive plan for executive officers, key employees and nonemployee directors (the "Incentive Plan"). The Incentive Plan authorizes the Compensation Committee of the board of directors to grant awards, including incentive stock options as defined under Section 422 of the Code ("ISOs") and options not so qualified ("NQSOs"). The Incentive Plan authorizes the granting of options or other awards for an aggregate of the greater of 500,000 shares or 9.5% of the fully diluted outstanding shares of the Company's common stock. The following table sets forth activity relating to the Company's stock options awards
For the nine months ended September For the nine months ended September 30, 2003 30, 2002 Weighted Average Weighted Average Number of Shares Exercise Price Number of Shares Exercise Price Options outstanding at the beginning of period 512,706 $8.59 635,826 $8.48 Granted 643,450 18.00 6,250 20.35 Exercised (37,622) 8.69 (77,032) 8.87 Expired - - (32,275) 8.28 -------------------- ------------------ ------------------ ------------------- Options outstanding at the end of period 1,118,534 $14.00 532,769 $8.58 ==================== ================== ================== =================== Options exercisable at end of period 346,514 $8.90 319,198 $8.71
11 The following table summarizes information about stock options outstanding at September 30, 2003:
Range of Exercise Prices Options Outstanding Weighted Average Exercise Weighted Average Remaining Price Contractual Life (Years) $7.94-$19.99 1,106,034 $13.93 8.2 $20.00-$29.99 12,500 20.53 4.3 ---------------------------- ---------------------------- ---------------------------- 1,118,534 $14.00 8.1 ============================ ============================ ============================
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under SFAS No. 123, as amended by SFAS No. 148, requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. There were 643,450 stock options granted during the nine months ended September 30, 2003. There were 6,250 stock options granted during the nine months ended September 30, 2002. The weighted average fair value at date of grant for stock options granted during the nine months ended September 30, 2003 and 2002 was $1.52 and $0.83 per option, respectively. The fair value of stock options at date of grant was estimated using the Black-Scholes option pricing model utilizing the following weighted average assumptions:
For the Nine Months Ended September 30, 2003 2002 --------------------------------------------- Risk-free interest rate 4.28% 2.49% Expected option life in years 9.95 5 Expected stock price volatility 29% 22% Expected dividend yield 9.15% 11.28%
Because the Company's employee stock options have characteristics significantly different from those of traded options and changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are freely transferable. All available option pricing models require the input of highly subjective assumptions including the expected stock price volatility. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
For the Quarter Ended For the Nine Months Ended September 30, September 30, 2003 2002 2003 2002 ----------- ------------- ---------------- -------------- Net income, as reported $28,479 $56,668 $137,406 $169,081 Deduct: Total stock-based employee compensation expense determined under fair value based method (29) (5) (86) (14) ----------- ------------- ---------------- -------------- Pro-forma net income $28,450 $56,663 $137,320 $169,067 =========== ============= ================ ============== Net income per share, as reported Basic $0.30 $0.68 $1.51 $2.08 Diluted $0.30 $0.68 $1.50 $2.07 Pro-forma net income per share $0.30 $0.68 $1.51 $2.08 Basic $0.30 $0.68 $1.50 $2.07 Diluted
12 9. COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income. Statement No. 130 requires the reporting of comprehensive income in addition to net income from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. The Company at September 30, 2003 and December 31, 2002 held securities classified as available-for-sale. At September 30, 2003, the net unrealized loss totaled $51.9 million and at December 31, 2002, the net unrealized gain totaled $75.5 million. 10. LEASE COMMITMENTS The Company has a noncancelable lease for office space, which commenced in May 2002 and expires in December 2009. The Corporation's aggregate future minimum lease payments are as follows:
(dollars in thousands) ------------------------ 2003 500 2004 500 2005 500 2006 530 2007 532 Thereafter 1,064 ------------------------ Total remaining lease payments $3,626 ========================
11. RELATED PARTY TRANSACTION Michael A.J. Farrell, our Chairman of the Board, Chief Executive Officer and President, Wellington J. Denahan, our Vice Chairman and Chief Investment Officer, Kathryn F. Fagan, our Chief Financial Officer and Treasurer, Jennifer A. Stephens, our Executive Vice President and Secretary, and other of the Company's officers and employees are the shareholders of Fixed Income Discount Advisory Company (or FIDAC). Mr. Farrell, Ms. Denahan and other officers and employees are actively involved in managing mortgage-backed securities and other fixed income assets on behalf of FIDAC. Mr. Farrell, on behalf of FIDAC, approached the Company about the possibility of acquiring FIDAC. The Company's board of directors formed a special committee of independent directors to consider this matter and the special committee retained independent counsel and an independent financial adviser to assist it. The special committee has determined that the Company should explore the possible acquisition of FIDAC. The Company is currently engaged in discussions with FIDAC regarding the Company's potential acquisition of FIDAC, the outcome of which is uncertain. The price and terms of the proposed acquisition of FIDAC have not yet been determined. The Company's management believes, however, that if a transaction were to go forward the purchase price will be payable in shares of the Company's common stock. No assurances can be made as to whether or when the Company will acquire FIDAC. The Company cannot predict the terms and conditions of the proposed acquisition. Either party may at any time determine not to proceed with this proposed acquisition without any further obligation. In addition, the Company cannot be sure of the potential consequences of acquiring or not acquiring FIDAC. If the Company is able to reach an agreeement to acquire FIDAC, the proposed acquisition will be submitted to a vote of our stockholders. 13 If we are able to reach an agreement to acquire FIDAC, we expect that the proposed acquisition will be submitted to a vote of our stockholders. Our management currently allocates rent and other general and administrative expenses in the amounts of 90% and 10% to the Company and FIDAC, respectively. 12. INTEREST RATE RISK The primary market risk to the Company is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond the Company's control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with the interest-bearing liabilities, by affecting the spread between the interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of the Investment Securities and the Company's ability to realize gains from the sale of these assets. The Company seeks to manage the extent to which net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. In addition, although the Company has not done so to date, the Company may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in the portfolio of Mortgage-Backed Securities by entering into interest rate agreements such as interest rate caps and interest rate swaps. Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on Mortgage-Backed Securities. The Company will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets purchased at a premium with assets purchased at a discount. To date, the aggregate premium exceeds the aggregate discount on the Mortgage-Backed Securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce net income compared to what net income would be absent such prepayments. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Special Note Regarding Forward-Looking Statements Certain statements contained in this quarterly report, and certain statements contained in our future filings with the Securities and Exchange Commission (the "SEC" or the "Commission"), in our press releases or in our other public or shareholder communications may not be, based on historical facts and are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements which are based on various assumptions, (some of which are beyond our control) may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "anticipate," "continue," or similar terms or variations on those terms, or the negative of those terms. Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, changes in interest rates, changes in yield curve, changes in prepayment rates, the availability of mortgage backed securities for purchase, the availability of financing and, if available, the terms of any financing. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see our 2002 Form 10-K. We do not undertake, and specifically disclaim any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Overview Annaly Mortgage Management, Inc. ("we" or "us") is a real estate investment trust that owns and manages a portfolio of Investment Securities which consist of Mortgage-Backed Securities and agency debentures. Our principal business objective is to generate net income for distribution to our stockholders from the spread between the interest income on our Investment Securities and the costs of borrowing to finance our acquisition of Investment Securities. Critical Accounting Policies Management's discussion and analysis of financial condition and results of operations is based on the amounts reported in our financial statements. These financial statements are prepared in conformity with GAAP. In preparing the financial statements, management is required to make various judgments, estimates and assumptions that affect the reported amounts. Changes in these estimates and assumptions could have a material effect our financial statements. The following is a summary our policies that is most affected by management's judgments, estimates and assumptions. Market Valuation of Securities: All assets classified as available-for-sale are reported at fair value, based on market prices. Our policy is to obtain market values from three independent sources and record the market value of the securities based on the average of the three. Amortization of premiums and accretion of discounts: Premiums and discounts associated with the purchase of the Investment Securities are amortized into interest income over the lives of the securities using the interest method. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds, and current market conditions. Results of Operations: For the Quarters and Nine months ended September 30, 2003 and 2002 Net Income Summary For the quarter ended September 30, 2003, our net income was $28.5 million, or $0.30 basic earnings per average share, as compared to $56.7 million, or $0.68 basic earnings per average share, for the quarter ended September 30, 2002. We attribute the decrease in net income for the quarter 15 ended September 30, 2003, over the quarter ended September 30, 2002, to the decline in the interest rate spread between the rate on interest-earning assets and the cost of funds for interest-bearing liabilities. We believe the decline in net income is due to the extremely high levels of mortgage refinancings which resulted in very high levels of premium amortization on our Investment Securities. We compute our net income per share by dividing net income by the weighted average number of shares of outstanding common stock during the period, which was 94,685,685 for the quarter ended September 30, 2003 and 83,668,422 for the quarter ended September 30, 2002. Dividends per share outstanding for the quarter ended September 30, 2003 was $0.28 per share, or $26.9 million in total. Dividends per actual share outstanding for the quarter ended September 30, 2002 was $0.68 per share, or $57.5 million in total. Our return on average equity was 9.88 % for the quarter ended September 30, 2003 and 21.24% for the quarter ended September 30, 2002. The decline in the return on average equity resulted from the declining interest rate spread. For the nine months ended September 30, 2003, our net income was $137.4 million, or $1.51 basic earnings per average share, as compared to $169.1 million, or $2.08 basic earnings per average share, for the nine months ended September 30, 2002. We attribute the decrease in net income for the nine month period ended September 30, 2003, over the nine month period ended September 30, 2002, to the decline in the interest rate spread between the rate on interest-earning assets and the cost of funds for interest-bearing liabilities. As noted above, the extremely high levels of premium amortization on our Investment Securities has reduced our net income, primarily in the third quarter of 2003. We compute our net income per share by dividing net income by the weighted average number of shares of outstanding common stock during the period, which was 90,929,196 for the nine months ended September 30, 2003 and 81,206,156 for the nine months ended September 30, 2002. Dividends per actual share outstanding for the nine months ended September 30, 2003 was $1.48 per share, or $134.1 million in total. Dividends per actual share outstanding for the nine months ended September 30, 2002 was $1.99 per share, or $166.1 million in total. Our annualized return on average equity was 16.42% for the nine months ended September 30, 2003 and 23.67% for the nine months ended September 30, 2002.
Net Income Summary (dollars in the thousands, except for per-share amounts) Quarter Ended Quarter Ended Nine Months Nine Months September Ended Ended September 30, 30, 2002 September 30, September 30, 2003 2003 2002 ---------------- --------------- --------------- ---------------- Interest Income $66,855 $109,201 $248,247 $311,524 Interest Expense 43,922 54,012 139,740 141,884 ---------------- --------------- --------------- ---------------- Net Interest Income 22,933 55,189 108,507 169,640 Gain on Sale of Investment Securities 9,656 4,747 40,907 9,500 General and Administrative Expenses 4,110 3,268 12,008 10,059 ---------------- --------------- --------------- ---------------- Net Income $28,479 $56,668 $137,406 $169,081 ================ =============== =============== ================ Weighted Average Number of Basic Shares Outstanding 94,685,685 83,668,422 90,929,196 81,206,156 Weighted Average Number of Diluted Shares Outstanding 95,500,486 83,939,870 91,750,472 81,490,436 Basic Net Income Per Share 0.30 0.68 $1.51 $2.08 Diluted Net Income Per Share 0.30 0.68 $1.50 $2.07 Average Total Assets $13,775,543 $11,398,653 $12,971,228 $10,193,258 Average Equity $1,153,583 $1,067,212 $1,115,986 $952,617 Annualized Return on Average Assets 0.83% 1.99% 1.41% 2.21% Annualized Return on Average Equity 9.88% 21.24% 16.42% 23.67%
16 Interest Income and Average Earning Asset Yield We had average earning assets of $12.6 billion and $10.7 billion for the quarters ended September 30, 2003 and 2002, respectively. Our primary source of income for the quarters ended September 30, 2003 and 2002 was interest income. A portion of our income was generated by gains on the sales of our Investment Securities. Our interest income was $66.9 million for the quarter ended September 30, 2003 and $109.2 million for the quarter ended September 30, 2002. Our yield on average earning assets was 2.13% and 4.10% for the same respective periods. Our average earning asset balance increased by $1.9 billion and interest income decreased by $42.3 million for the quarter ended September 30, 2003 as compared to the quarter ended September 30, 2002, due to the substantial decline in the yield on interest-earning assets because of increased premium amortization. The decline in the yield was the result of increased prepayment speeds and reduced coupons. We had average earning assets of $12.1 billion and $9.3 billion for the nine months ended September 30, 2003 and 2002, respectively. Our interest income was $248.2 million for the nine months ended September 30, 2003 and $311.5 million for the nine months ended September 30, 2002. Our yield on average earning assets was 2.74 % and 4.47 % for the same respective periods. Our average earning asset balance increased by $2.8 billion and interest income decreased by $63.3 million for the nine months ended September 30, 2003 as compared to the nine months ended September 30, 2002. The average earning assets increased as a result of the equity offering in the second quarter of 2003 and the equity shelf program in the third quarter of 2002. The table below shows our average balance of cash equivalents and investment securities, the yields we earned on each type of earning asset, our yield on average earning assets and our interest income for the quarter ended September 30, 2003, June 30, 2003 March 31, 2003, the year ended December 31, 2002 and the four quarters in 2002.
Average Earning Asset Yield (dollars in thousands) (ratios for the quarters have been annualized ) Yield on Yield on Yield on Average Average Average Average Average Average Interest Cash Investment Earning Cash Investment Earning Interest EquivalentsSecurities Assets Equivalents Securities Assets Income For the Quarter Ended September 30,2003 - $12,577,165 $12,577,165 - 2.13% 2.13% $66,855 For the Quarter Ended June 30, 2003 - $12,815,290 $12,815,290 - 2.93% 2.93% $93,892 For the Quarter Ended March 31, 2003 - $10,837,147 $10,837,147 - 3.23% 3.23% $87,500 -------------------------------------------------------------------------------------------------------------------------- For the Year Ended December 31, 2002 $2 $9,575,365 $9,575,367 1.14% 4.22% 4.22% $404,165 For the Quarter Ended December 31, 2002 $2 $10,400,894 $10,400,896 0.88% 3.56% 3.56% $92,641 For the Quarter Ended September 30, $2 $10,661,228 $10,661,230 1.14% 4.10% 4.10% $109,201 2002 For the Quarter Ended June 30, 2002 $2 $9,629,332 $9,629,334 1.23% 4.55% 4.55% $109,423 For the Quarter Ended March 31, 2002 $2 $7,610,006 $7,610,008 1.29% 4.88% 4.88% $92,900
The constant prepayment rate ("CPR") on our Mortgage-Backed Securities for the quarters ended September 30, 2003 and 2002 48% and 34% respectively. CPR is an assumed rate of prepayment for our Mortgage-Backed Securities, expressed as an annual rate of prepayment relative to the outstanding principal balance of our Mortgage-Backed Securities. CPR does not purport to be either a historical description of the prepayment experience of our Mortgage-Backed Securities or a prediction of the anticipated rate of prepayment of our Mortgage-Backed Securities. Principal prepayments had a negative effect on our earning asset yield for the quarters ended September 30, 2003 and 2002 because we adjust our rates of premium amortization and discount accretion monthly based upon the effective yield method, which takes into consideration changes in prepayment speeds. Interest Expense and the Cost of Funds We had average borrowed funds of $12.2 billion and total interest expense of $43.9 million for the quarter ended September 30, 2003. We had average borrowed funds of $10.1 billion and total interest expense of $54.0 million for the quarter ended September 30, 2002. Our average cost of funds was 1.44 % for the quarter ended September 30, 2003 and 2.13% for the quarter ended September 30, 2002. The cost of funds rate decreased 69 basis points and the average borrowed funds increased by $2.1 billion for the quarter ended September 30, 2003 when compared to the quarter ended September 30, 2002. Interest expense for the quarter decreased 19% due to the large decline in the average cost of funds. 17 We had average borrowed funds of $11.7 billion and total interest expense of $139.7 million for the nine months ended September 30, 2003. We had average borrowed funds of $8.8 billion and total interest expense of $141.9 million for the nine months ended September 30, 2002. Our average cost of funds was 1.60 % for the nine months ended September 30, 2003 and 2.15 % for the nine months ended September 30, 2002. The cost of funds rate decreased 55 basis points and the average borrowed funds increased by $2.9 billion for the nine months ended September 30, 2003 when compared to the nine months ended September 30, 2002. The table below shows our average borrowed funds, interest expense and average cost of funds as compared to average one-month and average six-month LIBOR for the quarters ended September 30, 2003, June 30, 2003, March 31, 2003, the year ended December 31, 2002 and the four quarters in 2002.
Average Cost of Funds (dollars in thousands) (ratios for the quarters have been annualized) Average One-Month Average Cost Average Cost LIBOR Less of Funds of Funds Less Average Average Average Average Average Less Average to Average Borrowed InterestCost of One-MonthSix-Month Six-Month One-Month Six-Month Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR For the Quarter Ended September 30, 2003 $12,186,985 $43,922 1.44% 1.11% 1.17% (0.06%) 0.33% 0.27% For the Quarter Ended June 30, 2003 $12,311,329 $51,770 1.68% 1.26% 1.20% 0.06% 0.42% 0.48% For the Quarter Ended March 31, 2003 $10,463,252 $44,048 1.68% 1.34% 1.33% 0.01% 0.34% 0.35% ---------------------------------------------------------------------------------------------------------------------- For the Year Ended December 31, 2002 $9,128,933 $191,758 2.10% 1.77% 1.88% (0.11%) 0.33% 0.22% For the Quarter Ended December 31, 2002 $10,097,676 $49,874 1.98% 1.57% 1.55% 0.02% 0.41% 0.43% For the Quarter Ended September 30, 2002 $10,122,840 $54,012 2.13% 1.82% 1.82% - 0.31% 0.31% For the Quarter Ended June 30, 2002 $9,102,992 $47,860 2.10% 1.85% 2.11% (0.26%) 0.25% (0.01%) For the Quarter Ended March 31, 2002 $7,192,222 $40,012 2.23% 1.85% 2.06% (0.21%) 0.38% 0.17%
Our net interest income, which equals interest income less interest expense, totaled $22.9 million for the quarter ended September 30, 2003 and $55.2 million for the quarter ended September 30, 2002. Our net interest income decreased because of the decline in net interest spread. This decline in spread is the direct result of the low interest rate environment and the high prepayment speeds. Our net interest spread, which equals the yield on our average assets for the period less the average cost of funds for the period, was 0.69% for the quarter ended September 30, 2003 as compared to 1.97% for the quarter ended September 30, 2002. This 128 basis point decrease in spread income is reflected in the decrease in net interest income. Our net interest income, which equals interest income less interest expense, totaled $108.5 million for the nine months ended September 30, 2003 and $169.6 million for the nine months ended September 30, 2002. Our net interest income declined for the nine month period due to the large amount of prepayments and the lower interest rate environment. Our net interest spread, which equals the yield on our average assets for the period less the average cost of funds for the period, was 1.14% for the nine months ended September 30, 2003 as compared to 2.32% for the nine months ended September 30, 2002. This 118 basis point increase in spread income is reflected in the increase in net interest income. The table below shows our average investment securities and cash equivalents, total interest income, yield on assets interest expense, average repurchase agreements, average cost of funds, and net interest income for the quarters ended September 30, 2003, June 30, 2003, March 31, 2003, the year ended December 31, 2002, and each of the four quarters in 2002. 18
Net Interest Income (dollars in thousands) (ratios for the quarters have been annualized) Yield on Average Interest Average Average Average Investment Income on Total Interest Balance of Cost Net Securities Investment Average Cash Interest Earning Repurchase Interest of Interest Held Securities Equivalents Income Assets Agreements Expense Funds Income ------------ ---------- ------------- -------- -------- ------------ --------- -------- ------- For the Quarter Ended September 30, 2003 $12,577,165 $66,855 - $66,855 2.13% $12,186,985 $43,922 1.44% $22,933 For the Quarter Ended $12,815,290 $93,892 - $93,892 2.93% $12,311,329 $51,770 1.68% $42,122 June 30, 2003 For the Quarter Ended $10,837,147 $87,500 - $87,500 3.23% $10,463,251 $44,048 1.68% $43,452 March 31, 2003 -------------------------------------------------------------------------------------------------------------------- For the Year Ended December 31, 2002 $9,575,365 $404,165 $2 $404,165 4.22% $9,128,933 $191,758 2.10% $212,407 For the Quarter Ended December 31, 2002 $10,400,894 $92,641 $2 $92,641 3.56% $10,097,676 $49,874 1.98% $42,767 For the Quarter Ended $10,661,228 $109,201 $2 $109,201 4.10% $10,122,840 $54,012 2.13% $55,189 September 30, 2002 For the Quarter Ended $9,629,332 $109,423 $2 $109,423 4.55% $9,102,992 $47,860 2.10% $61,563 June 30, 2002 For the Quarter Ended $7,610,006 $92,900 $2 $92,900 4.88% $7,192,222 $40,012 2.23% $52,888 March 31, 2002
Gains and Losses on Sales of Mortgage-Backed Securities For the quarter ended September 30, 2003, we sold Mortgage-Backed Securities with an aggregate historical amortized cost of $377.0 million for an aggregate gain of $9.7 million. For the quarter ended September 30, 2002, we sold Mortgage-Backed Securities with an aggregate historical amortized cost of $393.7 million for an aggregate gain of $4.7 million. The difference between the sale price and the historical amortized cost of our Mortgage-Backed Securities is a realized gain and increases income accordingly. We do not expect to sell assets on a frequent basis, but may from time to time sell existing assets to move into new assets, which our management believes might have higher risk-adjusted returns, or to manage our statement of financial condition as part of our asset/liability management strategy. During the quarter ended September 30, 2003, we had $575.0 million of callable agency debentures called at par. There was no gain or loss associated with the call on the securities. For the nine months ended September 30, 2003, we sold Mortgage-Backed Securities with an aggregate historical amortized cost of $2.7 billion for an aggregate gain of $40.9 million. For the nine months ended September 30, 2002, we sold Mortgage-Backed Securities with an aggregate historical amortized cost of $1.1 billion for an aggregate gain of $9.5 million. The difference between the sale price and the historical amortized cost of our Mortgage-Backed Securities is a realized gain and increases income accordingly. During the nine months ended September 30, 2003, we had $746 million of callable agency debentures called at par. There was no gain or loss associated with the call on the securities. General and Administrative Expense General and administrative ("G&A") expenses were $4.1 million for the quarter ended September 30, 2003 and $3.3 million for the quarter ended September 30, 2002. G&A expenses as a percentage of average assets was 0.12% for the quarter ended September 30, 2003 and 0.12% for the quarter ended September 30, 2002, on an annualized basis. G&A expenses as a percentage of average equity was 1.42% and 1.22% on an annualized basis for the quarters ended September 30, 2003 and 2002, respectively. The Company is internally managed and continues to be a low-cost provider. Even though G&A expenses increased by $800,000 for the quarter ended September 30, 2003, when compared to the quarter ended September 30, 2002, G&A as a percentage of average assets remained unchanged. 19
G&A Expenses and Operating Expense Ratios (dollars in thousands) Total G&A Total G&A Expenses/Average Expenses/Average Total G&A Assets Equity Expenses (annualized) (annualized) - - For the Quarter Ended September 30, 2003 $4,110 0.12% 1.42% For the Quarter Ended June 30, 2003 $4,201 0.12% 1.50% For the Quarter Ended March 31, 2003 $3,697 0.12% 1.37% ----------------------------------------- ------------------ --------------- ------------------ For the Year Ended December 31, 2002 $13,963 0.13% 1.43% For the Quarter Ended December 31, 2002 $3,904 0.13% 1.44% For the Quarter Ended September 30, 2002 $3,268 0.12% 1.22% For the Quarter Ended June 30, 2002 $3,536 0.13% 1.37% For the Quarter Ended March 31, 2002 $3,255 0.14% 1.55% --------------------------------------------------------------------------------------------------
Net Income and Return on Average Equity Our net income was $28.5 million for the quarter ended September 30, 2003 and $56.7 million for the quarter ended September 30, 2002. Our return on average equity was 9.88% for the quarter ended September 30, 2003 and 21.24% for the quarter ended September 30, 2002. Our net income was $137.4 million for the nine months ended September 30, 2003 and $169.1 million for the nine months ended September 30, 2002. The decline in net interest income was only partially offset by the increase in gain on sale of securities and decrease in interest expense. The table below shows our net interest income, gain on sale of Mortgage-Backed Securities and G&A expenses each as a percentage of average equity, and the return on average equity for the quarters ended September 30, 2003, June 30, 2003, March 31, 2003, the year ended December 31, 2002, and for each of the four quarters in 2002.
Components of Return on Average Equity (Ratios for all Quarters are annualized) Gain on Sale of Net Interest Mortgage-Backed G&A Return on Income/Average Securities/Averag Expenses/Average Average Equity Equity Equity Equity --------------------------------------------------------------- For the Quarter Ended September 30, 2003 7.95% 3.35% 1.42% 9.88% For the Quarter Ended June 30, 2003 15.06% 7.23% 1.50% 20.79% For the Quarter Ended March 31, 2003 16.11% 4.09% 1.37% 18.83% ------------------------------------------------------------------------------------------------------------ For the Year Ended December 31, 2002 21.72% 2.15% 1.43% 22.44% For the Quarter Ended December 31, 2002 15.80% 4.27% 1.44% 18.63% For the Quarter Ended September 30, 2002 20.68% 1.78% 1.22% 21.24% For the Quarter Ended June 30, 2002 23.93% 0.52% 1.37% 23.08% For the Quarter Ended March 31, 2002 25.24% 1.63% 1.55% 25.32%
Financial Condition Investment Securities All of our Mortgage-Backed Securities at September 30, 2003 were adjustable-rate or fixed-rate Mortgage-Backed Securities backed by single-family mortgage loans. All of the mortgage assets underlying these Mortgage-Backed Securities were secured with a first lien position on the underlying single-family properties. All our Mortgage-Backed Securities were FHLMC, FNMA or GNMA mortgage pass-through certificates or collateralized mortgage obligations ("CMOs"), which carry an actual or implied "AAA" rating. We mark-to-market all of our earning assets at fair value. 20 All of our Agency Debentures are callable and carry an implied "AAA" rating. We mark-to-market all of our Agency Debentures at fair value. We accrete discount balances as an increase in interest income over the life of discount Investment Securities and we amortize premium balances as a decrease in interest income over the life of premium Investment Securities. At September 30, 2003 and December 31, 2002, we had on our Statement of Financial Condition a total of $1.2 million and $664,000 million respectively, of unamortized discount (which is the difference between the remaining principal value and current historical amortized cost of our Investment Securities acquired at a price below principal value) and a total of $294.8 million and $274.6 million, respectively, of unamortized premium (which is the difference between the remaining principal value and the current historical amortized cost of our Investment Securities acquired at a price above principal value). We received mortgage principal repayments of $2.7 billion for the quarter ended September 30, 2003 and $1.0 billion for the quarter ended September 30, 2002. Given our current portfolio composition, if mortgage principal prepayment rates were to increase over the life of our Mortgage-Backed Securities, all other factors being equal, our net interest income would decrease during the life of these Mortgage-Backed Securities as we would be required to amortize our net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of our Mortgage-Backed Securities, all other factors being equal, our net interest income would increase during the life of these Mortgage-Backed Securities, as we would amortize our net premium balance over a longer time period. The table below summarizes our Investment Securities at September 30, 2003, June 30, 2003, March 31, 2003, December 31, 2002, September 30, 2002, June 30, 2002, and March 31, 2002.
Investment Securities (dollars in thousands) Estimated Amortized Fair Weighted Net Amortized Cost/Principal Estimated Value/Principal Average Principal Value Premium Cost Value Fair Value Value l Yield At September 30, 2003 $12,363,260 $293,694 $12,656,954 102.38% $12,605,085 101.96% 2.35% At June 30, 2003 $13,939,447 $322,838 $14,262,285 102.32% $14,263,475 102.32% 2.87% At March 31, 2003 $11,957,710 $289,360 $12,247,070 102.42% $12,318,070 103.01% 2.83% ---------------------------------------------------------------------------------------------------------------------- At December 31, 2002 $11,202,384 $273,963 $11,476,347 102.45% $11,551,857 103.12% 3.25% At September 30, 2002 $11,170,379 $244,777 $11,415,156 102.19% $11,489,538 102.86% 3.67% At June 30, 2002 $10,833,374 $224,114 $11,057,488 102.07% $11,124,771 102.69% 3.90% At March 31, 2002 $9,982,678 $193,048 $10,175,726 101.93% $10,206,228 102.24% 4.31% ----------------------------------------------------------------------------------------------------------------------
The tables below set forth certain characteristics of our Investment Securities. The index level for adjustable-rate Investment Securities is the weighted average rate of the various short-term interest rate indices, which determine the coupon rate.
Adjustable-Rate Investment Security Characteristics (dollars in thousands) Weighted Principal Value Weighted Weighted Weighted Average Weighted at Period End as Average Average Average Term to Weighted Average % of Total Principal Coupon Index Net Next Average Asset Mortgage-Backed Value Rate Level Margin Adjustment Lifetime Cap Yield Securities At September 30, 2003 $8,498,116 3.76% 2.17% 1.59% 22 months 9.75% 1.77% 68.74% At June 30, 2003 $8,889,012 3.69% 2.18% 1.51% 18 months 9.70% 2.47% 63.77% At March 31, 2003 $7,716,248 3.93% 2.31% 1.62% 13 months 10.04% 2.20% 64.53% ------------------------------------------------------------------------------------------------------------------------- At December 31, 2002 $7,007,062 4.10% 2.51% 1.59% 11 months 10.37% 2.33% 62.55% At September 30, 2002 $7,583,147 4.37% 2.80% 1.57% 10 months 10.36% 2.90% 67.89% At June 30, 2002 $7,939,126 4.57% 2.96% 1.61% 12 months 10.46% 3.17% 73.28% At March 31, 2002 $7,248,832 4.94% 3.25% 1.69% 16 months 10.73% 3.52% 72.61% -------------------------------------------------------------------------------------------------------------------------
21
Fixed-Rate Investment Security Characteristics (dollars in thousands) Principal Value at Weighted Period End as % of Weighted Average Average Asset Total Investment Principal Value Coupon Rate Yield Securities At September 30, 2003 $3,865,171 5.86% 3.63% 31.26% At June 30, 2003 $5,050,434 5.97% 3.58% 36.23% At March 31, 2003 $4,241,462 6.53% 3.98% 35.47% ------------------------- ----------------- ------------------ ---------------- ------------------------ At December 31, 2002 $4,195,322 6.76% 4.78% 37.45% At September 30, 2002 $3,587,232 6.95% 5.29% 32.11% At June 30, 2002 $2,894,248 7.09% 5.91% 26.72% At March 31, 2002 $2,733,846 7.01% 6.40% 27.39% ----------------------------------------------------------------------------------------------------------
Adjustable-Rate Investment Securities by Index September 30, 2003 12-Month 11th Twelve Moving District Six-Month Month Six-Month Average Cost of Interest Six-Month 1-Year 2-Year 3-Year 5-Year One-Month Libor Libor Auction Funds Rate CD Rate Treasury TreasuryTreasury Treasury Libor Average Step Up Index Index Index Index Weighted Average Term to 1mo. 27 mo. 30 mo. 5 mo. 1 mo. 1 mo. 179 mo. 2 mo. 22 mo. 10 mo. 17 mo. 25 mo. Next Adjustment Weighted Average Annual Period Cap None 2.22% 2.00% 1.00% 0.15% None 2.00% 1.00% 1.88% 2.00% 2.00% 2.00% Weighted Average Lifetime 8.86% 9.77% 10.22% 13.01% 10.72% 12.30% 6.76% 11.63% 10.14% 11.96% 12.88% 12.62% Cap at September 30, 2003 Investment Principal Value as Percentage of Investment Securities at September 30, 2003 19.15% 1.14% 8.81% 0.02% 0.62% 1.03% 2.26% 0.10% 34.85% 0.02% 0.53% 0.21%
Adjustable-Rate Investment Securities by Index December 31, 2002 Six-Month 12-Month 2-Year Auction Moving 1-Year Treasury 3-Year 5-Year One-Month Six-Month Average Average Six-Month Treasury Index Treasury Treasury LIBOR LIBOR CD Rate Index Index Index Weighted Average Term to Next Adjustment 1 mo. 41 mo. 2 mo. 1 mo. 2 mo. 22 mo. 10 mo. 20 mo. 31 mo. Weighted Average Annual Period Cap None 2.00% 2.00% None 1.00% 1.93% 2.00% 2.00% 2.00% Weighted Average Lifetime Cap at December 31, 2002 9.01% 11.31% 13.00% 10.37% 11.60% 11.83% 11.93% 12.83% 12.57% Investment Principal Value as Percentage of Investment- Securities at December 31, 2002 32.43% 0.33% 0.03% 0.58% 0.14% 27.67% 0.03% 0.92% 0.42%
22 Borrowings To date, our debt has consisted entirely of borrowings collateralized by a pledge of our Investment Securities. These borrowings appear on our statement of financial condition as repurchase agreements. At September 30, 2003, we had established uncommitted borrowing facilities in this market with twenty-six lenders in amounts, which we believe, are in excess of our needs. All of our Investment Securities are currently accepted as collateral for these borrowings. However, we limit our borrowings, and thus our potential asset growth, in order to maintain unused borrowing capacity and thus increase the liquidity and strength of our statement of financial condition. For the quarter ended September 30, 2003 the term to maturity of our borrowings ranged from one day to three years, with a weighted average original term to maturity of 171 days. For the quarter ended September 30, 2002, the term to maturity of our borrowings ranged from one day to three years, with a weighted average original term to maturity of 218 days. At September 30, 2003, the weighted average cost of funds for all of our borrowings was 1.46% and the weighted average term to next rate adjustment was 74 days. At September 30, 2002, the weighted average cost of funds for all of our borrowings was 2.09% and the weighted average term to next rate adjustment was 139 days. Liquidity Liquidity, which is our ability to turn non-cash assets into cash, allows us to purchase additional Investment Securities and to pledge additional assets to secure existing borrowings should the value of our pledged assets decline. Potential immediate sources of liquidity for us include cash balances and unused borrowing capacity. Unused borrowing capacity will vary over time as the market value of our Investment Securities varies. Our Statement of Financial Condition also generates liquidity on an on-going basis through mortgage principal repayments and net earnings held prior to payment as dividends. Should our needs ever exceed these on-going sources of liquidity plus the immediate sources of liquidity discussed above, we believe that our Investment Securities could in most circumstances be sold to raise cash. The maintenance of liquidity is one of the goals of our capital investment policy. Under this policy, we limit asset growth in order to preserve unused borrowing capacity for liquidity management purposes. Stockholders' Equity We use "available-for-sale" treatment for our Investment Securities; we carry these assets on our Statement of Financial Condition at estimated fair value rather than historical amortized cost. Based upon this "available-for-sale" treatment, our equity base at September 30, 2003 was $1.1 billion, or $11.94 per share. If we had used historical amortized cost accounting, our equity base at September 30, 2003 would have been $1.2 billion, or $12.48 per share. Our equity base at September 30, 2002 was $1.1 billion, or $12.84 per share. If we had used historical amortized cost accounting, our equity base at September 30, 2002 would have been $1.0 billion, or $11.96 per share. With our "available-for-sale" accounting treatment, unrealized fluctuations in market values of assets do not impact our taxable income but rather are reflected on our Statement of Financial Condition by changing the carrying value of the asset and stockholders' equity under "Accumulated Other Comprehensive Income (Loss)." By accounting for our assets in this manner, we hope to provide useful information to stockholders and creditors and to preserve flexibility to sell assets in the future without having to change accounting methods. As a result of this mark-to-market accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used historical amortized cost accounting. As a result, comparisons with companies that use historical cost accounting for some or all of their balance sheet may not be meaningful. The table below shows unrealized gains and losses on the Investment Securities in our portfolio. 23
Unrealized Gains and Losses (dollars in thousands) At At At At At At At Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, March 31, 2003 2003 2003 2002 2002 2002 2002 ----------------------------------------------------------------------------------- Unrealized Gain $ 27,439 $51,208 $ 98,768 $90,507 $93,254 $75,832 $46,894 Unrealized Loss (79,309) (50,018) (27,768) (14,997) (18,872) (8,549) (16,392) ----------------------------------------------------------------------------------- Net Unrealized Gain (loss) $(51,870) $ 1,190 $71,000 $75,510 $74,382 $67,283 $30,502 =================================================================================== Net Unrealized Gain (loss) as % of Investment Securities Principal Value (0.41)% 0.01% 0.59% 0.67% 0.67% 0.62% 0.31% Net Unrealized Gain (loss) as % of Investment Securities Amortized Cost (0.41)% 0.01% 0.59% 0.67% 0.65% 0.61% 0.30%
Unrealized changes in the estimated net market value of Investment Securities have one direct effect on our potential earnings and dividends: positive mark-to-market changes increase our equity base and allow us to increase our borrowing capacity while negative changes decrease our equity base and tend to limit borrowing capacity under our capital investment policy. A very large negative change in the net market value of our Investment Securities might impair our liquidity position, requiring us to sell assets with the likely result of realized losses upon sale. "Unrealized Net Loss on Available for Sale Securities" was $51.8 million, or (0.41)% of the amortized cost of our Investment Securities at September 30, 2003. "Unrealized Net Gain on Available for Sale Securities" was $75.5 million or 0.67% of the amortized cost of our Investment Securities at December 31, 2002. The table below shows our equity capital base as reported and on a historical amortized cost basis at September 30, 2003, June 30, 2003, March 31, 2003, December 31, 2002, September 30, 2002, June 30, 2002 and March 31, 2002. Issuances of common stock, the level of earnings as compared to dividends declared, and other factors influence our historical cost equity capital base. The reported equity capital base is influenced by these factors plus changes in the "Unrealized Net Gains (Losses) on Assets Available for Sale" account.
Stockholders' Equity (dollars in thousands, except per share amounts) Net Unrealized Historical Historical Gains (Losses) on GAAP Reported Amortized Cost GAAP Reported Amortized Cost Assets Available Equity Base Equity Per Equity (Book Equity Base for Sale (Book Value) Share Value) Per Share At September 30, 2003 $1,197,598 $(51,870) $1,145,728 $12.48 $11.94 At June 30, 2003 $1,160,248 $ 1,190 $1,161,438 $12.34 $12.35 At March 31, 2003 $1,005,712 $ 71,000 $1,076,712 $11.88 $12.72 ------------------------------------------------------------------------------------------------------------- At December 31, 2002 $1,004,555 $ 75,511 $1,080,066 $11.88 $12.77 At September 30, 2002 $1,010,623 $74,382 $1,085,005 $11.96 $12.84 At June 30, 2002 $ 982,348 $ 67,283 $1,049,631 $11.84 $12.65 At March 31, 2002 $ 978,186 $ 30,502 $1,008,688 $11.80 $12.17 ---------------------------------------------------------------------------------------------------------------
Leverage Our debt-to- equity ratio at September 30, 2003 and September 30, 2002 was 9.8:1 and 9.0:1 respectively. We generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this range from time to time based upon various factors, including our management's opinion of the level of risk of our assets and liabilities, our liquidity position, our level of unused borrowing capacity and over-collateralization levels required by lenders when we pledge assets to secure borrowings. 24 Our target debt-to-equity ratio is determined under our capital investment policy. Should our actual debt-to-equity ratio increase above the target level due to asset acquisition or market value fluctuations in assets, we will cease to acquire new assets. Our management will, at that time, present a plan to our Board of Directors to bring us back to our target debt-to-equity ratio; in many circumstances, this would be accomplished in time by the monthly reduction of the balance of our Investment Securities through principal repayments. Asset/Liability Management and Effect of Changes in Interest Rates We continually review our asset/liability management strategy with respect to interest rate risk, mortgage prepayment risk, credit risk and the related issues of capital adequacy and liquidity. We seek attractive risk-adjusted stockholder returns while maintaining a strong statement of financial condition. We seek to manage the extent to which our net income changes as a function of changes in interest rates by matching adjustable-rate assets with variable-rate borrowings. In addition, although we have not done so to date, we may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in our portfolio of Investment Securities by entering into interest rate agreements such as interest rate caps and interest rate swaps. Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on Mortgage-Backed Securities. We will seek to mitigate the effect of changes in the mortgage principal repayment rate by balancing assets we purchase at a premium with assets we purchase at a discount. To date, the aggregate premium exceeds the aggregate discount on our Mortgage-Backed Securities. As a result, prepayments, which result in the expensing of unamortized premium, will reduce our net income compared to what net income would be absent such prepayments. Inflation Virtually all of our assets and liabilities are financial in nature. As a result, interest rates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our dividends based upon our net income as calculated for tax purposes; in each case, our activities and statement of financial condition are measured with reference to historical cost or fair market value without considering inflation. Other Matters We calculate that our qualified REIT assets, as defined in the Internal Revenue Code, are 100% and 100% of our total assets at September 30, 2003 and 2002, as compared to the Internal Revenue Code requirement that at least 75% of our total assets be qualified REIT assets. We also calculate that 100% of our revenue qualifies for the 75% source of income test, and 100% of our revenue qualifies for the 95% source of income test, under the REIT rules for the quarters ended September 30, 2003 and 2002. We also met all REIT requirements regarding the ownership of our common stock and the distribution of our net income. Therefore, as of September 30, 2003 and 2002, we believe that we qualified as a REIT under the Internal Revenue Code. We at all times intend to conduct our business so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended. If we were to become regulated as an investment company, then our use of leverage would be substantially reduced. The Investment Company Act of 1940, as amended, exempts entities that are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate" (qualifying interests). Under current interpretation of the staff of the SEC, in order to qualify for this exemption, we must maintain at least 55% of our assets directly in qualifying interests. In addition, unless certain mortgage securitites represent all the certificates issued with respect to an underlying pool of mortgages, the Mortgage-Backed Securities may be treated as securities separate from the underlying mortgage loans and, thus, may not be considered qualifying interests for purposes of the 55% requirement. We calculate that as of September 30, 2003 and 2002 we were in compliance with this requirement. 25 ITEM. 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which we are exposed is interest rate risk, which is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities, by affecting the spread between our interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of our Investment Securities and our ability to realize gains from the sale of these assets. We may utilize a variety of financial instruments, including interest rate swaps, caps, floors and other interest rate exchange contracts, in order to limit the effects of interest rates on our operations. If we use these types of derivatives to hedge the risk of interest-earning assets or interest-bearing liabilities, we may be subject to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of securities and that the losses may exceed the amount we invested in the instruments. To date, we have not purchased any hedging instruments. Our profitability and the value of our portfolio may be adversely affected during any period as a result of changing interest rates. The following table quantifies the potential changes in net interest income and portfolio value should interest rates go up or down 25, 50, and 75 basis points, assuming the yield curves of the rate shocks will be parallel to each other and the current yield curve. All changes in income and value are measured as percentage changes from the projected net interest income and portfolio value at the base interest rate scenario. The base interest rate scenario assumes interest rates at September 30, 2003 and various estimates regarding prepayment and all activities are made at each level of rate shock. Actual results could differ significantly from these estimates.
Projected Percentage Change in Projected Percentage Change in Change in Interest Rate Net Interest Income Portfolio Value ---------------------------------------- -------------------------------------- -------------------------------------- -75 Basis Points (3.06%) 0.62% -50 Basis Points (2.03%) 0.43% -25 Basis Points (1.01%) 0.22% Base Interest Rate +25 Basis Points 4.35% (0.24%) +50 Basis Points 7.15% (0.50%) +75 Basis Points 14.53% (0.77%)
ASSET AND LIABILITY MANAGEMENT ------------------------------ Asset and liability management is concerned with the timing and magnitude of the repricing of assets and liabilities. We attempt to control risks associated with interest rate movements. Methods for evaluating interest rate risk include an analysis of our interest rate sensitivity "gap", which is the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities. A gap is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category. 26 The following table sets forth the estimated maturity or repricing of our interest-earning assets and interest-bearing liabilities at September 30, 2003. The amounts of assets and liabilities shown within a particular period were determined in accordance with the contractual terms of the assets and liabilities, except adjustable-rate loans, and securities are included in the period in which their interest rates are first scheduled to adjust and not in the period in which they mature. Mortgage-Backed Securities reflect estimated prepayments that were estimated based on analyses of broker estimates, the results of a prepayment model that we utilized and empirical data. Our management believes that these assumptions approximate actual experience and considers them reasonable; however, the interest rate sensitivity of our assets and liabilities in the table could vary substantially if different assumptions were used or actual experience differs from the historical experience on which the assumptions are based.
More than 1 Within 3 Months Year to 3 Years 3 Years and 4-12 Months Over Total ==================================== ---------------- ----------------- ---------------- ---------------- -------------- (dollars in thousands) Rate Sensitive Assets: Investment Securities $2,895,717 $1,033,838 $3,547,517 $4,886,188 $12,363,260 Rate Sensitive Liabilities: Repurchase Agreements 9,737,831 324,066 1,140,000 11,201,897 ---------------- ----------------- ---------------- ---------------- -------------- Interest rate sensitivity gap ($6,842,114) $709,772 $2,407,517 $4,886,188 $1,161,363 ================ ================= ================ ================ ============== Cumulative rate sensitivity gap ($6,842,114) ($6,132,342) ($3,724,825) $1,161,363 ================ ================= ================ ================ ============== Cumulative interest rate sensitivity gap as a percentage of total rate-sensitive assets (55%) (50%) (30%) 9%
Our analysis of risks is based on management's experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in the above tables and in this report. These analyses contain certain forward-looking statements and are subject to the safe harbor statement set forth under the heading, "Special Note Regarding Forward-Looking Statements." ITEM 4. CONTROLS AND PROCEDURES As of September 30, 2003, an evaluation was performed under the supervision and with the participation of our management, including the Chairman of the board of directors, Chief Executive Officer and President and our Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including the Chairman of the board of directors, Chief Executive Officer and President and our Chief Financial Officer and Treasurer, concluded that our disclosure controls and procedures were effective as of September 30, 2003. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to September 30, 2003. There were no significant material weaknesses identified in the course of such review and evaluation and, therefore, we have taken no corrective measures. 27 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit Index Exhibit Number Exhibit Description 31.1 Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer, 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer, 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports of Form 8-K We filed a current report on Form 8-K on July 28, 2003, reporting under Item 12 and attaching our press release dated July 28, 2003, which announced our earnings for the quarter ended June 30, 2003. We filed a current report on Form 8-K on August 12, 2003 reporting under Items 5 and 7 and which announced that we had entered into an amended and restated sales agency agreement, dated August 12, 2003, with UBS Securities LLC and attaching a copy of the amended and restated sales agency agreement. We filed a current report on Form 8-K on September 9, 2003 reporting under Items 7, 9 and 12 and attaching our press release dated September 9, 2003, which provided earnings guidance for the third quarter of 2003. The following current report on Form 8-K was filed by the Company subsequent to the third quarter of 2003: We filed a current report on Form 8-K on October 21, 2003 reporting under Item 12 and attaching our press release dated October 21, 2003, which announced our financial results for the third quarter of 2003. 28 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. ANNALY MORTGAGE MANAGEMENT, INC. Dated: November 12, 2003 By:/s/ Michael A.J. Farrell ------------------------- Michael A.J. Farrell (Chairman of the Board and Chief Executive Officer (authorized officer of registrant) Dated: November 12, 2003 By:/s/ Kathryn F. Fagan --------------------- Kathryn F. Fagan Chief Financial Officer and Treasurer (principal financial and chief accounting officer) 29