-----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, PIwXoW0/Zl5OakcHnRrD71i553t4uXeoYrTv/b3bEAcuD9CoARDjgPGywN+qnJie Q1/42veKFwuRXrTNhiBH+w== 0000944209-99-001216.txt : 19990730 0000944209-99-001216.hdr.sgml : 19990730 ACCESSION NUMBER: 0000944209-99-001216 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990729 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ANWORTH MORTGAGE ASSET CORP CENTRAL INDEX KEY: 0001047884 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 522059785 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13709 FILM NUMBER: 99672841 BUSINESS ADDRESS: STREET 1: 1299 OCEAN AVENUE STREET 2: SUITE 210 CITY: SANTA MONICA STATE: CA ZIP: 90401 BUSINESS PHONE: 3103931428 MAIL ADDRESS: STREET 1: 1299 OCEAN AVENUE STREET 2: SUITE 210 CITY: SANTA MONICA STATE: CA ZIP: 90401 10-Q 1 FORM 10-Q FOR PERIOD ENDED 06/30/1999 ================================================================================ U. S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q ______________________ (Mark One) [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ______________ Commission File No. 001-13709 ______________________ ANWORTH MORTGAGE ASSET CORPORATION (Exact name of Registrant as specified in its charter) MARYLAND 52-2059785 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1299 Ocean Avenue, #200 Santa Monica, CA 90401 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (310) 394-0115 ______________________ Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ___ --- As of June 30, 1999, 2,328,000 and 2,278,000 shares of Common Stock, $0.01 par value per share, were issued and outstanding, respectively. ______________________ ================================================================================ INDEX -----
Part I. Financial Information Page - ------ --------------------- ---- Item 1. Financial Statements Balance Sheets at June 30, 1999 and December 31, 1998............... 3 Statements of Operations for the three months and six months ended June 30, 1999 and for the three months ended June 30, 1998 and for the period March 17, 1998 (Commencement of Operations) to June 30, 1998................................................................ 4 Statement of Stockholders' Equity for the three months ended March 31, 1999 and for the six months ended June 30, 1999................. 5 Statements of Cash Flows for the three months and six months ended June 30, 1999 and for the three months ended June 30, 1998 and for the period March 17, 1998 (Commencement of Operations) to June 30, 1998................................................................ 6 Notes to the Financial Statements................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 10 Part II. Other Information - -------- ----------------- Item 1. Legal Proceedings................................................... 17 Item 2. Changes in Securities............................................... 18 Item 3. Defaults upon Senior Securities..................................... 18 Item 4. Submission of Matters to a Vote of Security Holders................. 18 Item 5. Other Information................................................... 18 Item 6. Exhibits and Reports on Form 8-K.................................... 25 Signatures...................................................................... 25
Page 2 Part I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
ANWORTH MORTGAGE ASSET CORPORATION Balance Sheets (Amounts in thousands) June 30, 1999 December 31,1998 ---------------- ---------------- (unaudited) Assets Mortgage backed securities $ 171,854 $ 184,245 Other marketable securities 532 488 Cash and cash equivalents 3,441 13,299 Accrued interest receivable 1,175 1,411 Prepaid expenses and other 43 15 ----------- ------------ $ 177,045 $ 199,458 =========== ============ Liabilities and Stockholders Equity Liabilities Reverse repurchase agreements $ 147,834 $ 170,033 Payable for purchase of mortgage-backed securities 9,588 10,047 Accrued interest payable 1,919 1,799 Dividends payable 296 279 Accrued expenses and other 58 58 ----------- ------------ 159,695 182,216 ----------- ------------ STOCKHOLDERS' EQUITY Preferred stock, par value $.01 per share; authorized 20,000,000 shares; no shares issued and outstanding - - Common stock; par value $.01 per share; authorized 100,000,000 shares; 2,328,000 issued and 2,278,000 and 2,328,000 outstanding respectively 23 23 Additional paid in capital, net 18,971 18,971 Other comprehensive income, unrealized gain (loss) on available for sale securities (1,446) (1,775) Retained earnings 31 23 Treasury stock at cost (50,000 shares) (229) - ----------- ------------ 17,350 17,242 ----------- ------------ $ 177,045 $ 199,458 =========== ============
See notes to financial statements. Page 3
ANWORTH MORTGAGE ASSET CORPORATION Statements of Operations (unaudited) (Amounts in thousands, except per share data) Period from March 17, 1998 (Commencement of Three months ended June 30, Six months ended Operations) to 1999 1998 June 30, 1999 June 30, 1998 Interest and dividend income net of amortization of premium $ 2,211 $ 2,799 $ 4,615 $ 2,872 Interest expense 1,816 2,318 3,852 2,360 ---------- --------- ---------- ---------- Net interest income $ 395 $ 481 $ 763 $ 512 Expenses: Management fee 45 46 89 53 Incentive fee - 2 - 2 Other expense 49 76 95 84 ---------- --------- ---------- ---------- Net Income $ 301 $ 357 $ 579 $ 373 ========== ========= ========== ========== Basic and diluted earnings per share $ 0.13 $ 0.15 $ 0.25 $ 0.15 ========== ========= ========== ========== Dividends declared per share $ 0.13 $ 0.15 $ 0.25 $ 0.15 ========== ========= ========== ========== Average number of shares outstanding 2,279 2,310 2,299 2,294 ========== ========= ========== ========== Statement of Comprehensive Income Net Income $ 301 $ 357 $ 579 $ 373 Available for sale securities, fair value adjustment (607) (757) 360 (757) ---------- --------- ---------- ---------- Comprehensive Income $ (306) $ (400) $ 939 $ (384) ========== ========= ========== ==========
See notes to financial statements. Page4 ANWORTH MORTGAGE ASSET CORPORATION Statement of Stockholders' Equity Three Months Ended March 31, 1999 and June 30, 1999
Accum. Other Other Common Common Additional Compre- Treasury Compre- Stock Stock Paid-in hensive Retained Stock hensive Shares Par Value Capital Income Earnings at Cost Income ----------------------------------------------------------------------------------------- Balance, December 31, 1998 2,328,000 $23,000 $18,971,000 $(1,775,000) $ 23,000 $ - Issuance of common stock - - Available-for-sale securities, Fair value adjustment 936,500 936,500 Net income 278,500 278,500 ---------- $1,215,000 ========== Repurchase of common stock (36,700) (170,000) Dividends declared- $0.12 per share (275,000) -------------------------------------------------------------------------- Balance, March 31, 1999 2,291,300 $23,000 $18,971,000 $ (838,500) $ 26,500 $(170,000) ========================================================================== Issuance of common stock - - Available-for-sale securities, Fair value adjustment (606,500) (606,500) Net income 300,500 300,500 ---------- $ (306,000) ========== Repurchase of common stock (13,300) (59,000) Dividends declared- $0.13 per share (296,000) -------------------------------------------------------------------------- Balance, June 30, 1999 2,278,000 $23,000 $18,971,000 $(1,445,000) $ 31,000 $(229,000) ========================================================================== Total ----------- Balance, December 31, 1998 $17,242,000 Issuance of common stock - Available-for-sale securities, Fair value adjustment 936,500 Net income 278,500 Repurchase of common stock (170,000) Dividends declared- $0.12 per share (275,000) ----------- Balance, March 31, 1999 $18,012,000 =========== Issuance of common stock - Available-for-sale securities, Fair value adjustment (606,500) Net income 300,500 Repurchase of common stock (59,000) Dividends declared- $0.13 per share (296,000) ----------- Balance, June 30, 1999 $17,351,000 ===========
See notes to the financial statements Page 5 ANWORTH MORTGAGE ASSET CORPORATION Statements of Cash Flows (unaudited) (Amounts in thousands)
Period from March 17, 1998 (Commencement of Three months ended June 30, Six months ended Operations) to 1999 1998 June 30, 1999 June 30, 1998 Net income $ 301 $ 357 $ 579 $ 373 Adjustments to reconcile net income to net cash provided by operating activites: Amortization 421 337 939 342 Decrease (increase) in accrued interest receivable 37 (794) 231 (1,490) Decrease (increase) in deferred organization expense - (52) - (64) Increase (decrease) in accrued interest payable 349 1,746 120 1,788 Increase (decrease) in accrued expenses and other (77) 81 (26) 108 --------- -------- --------- ----------- Net cash provided by operating activities 1,031 1,675 1,843 1,057 Investing Activities: Available-for-sale securities: Purchases (21,080) (28,135) (21,126) (216,815) Principal payments 14,423 18,847 32,404 18,848 --------- -------- --------- ----------- Net cash (used in) investing activities (6,657) (109,288) 11,278 (197,967) Financing Activities: Net borrowings from reverse repurchase agreements 6,514 103,936 (22,199) 187,443 Proceeds from common stock issued, net - 622 - 19,003 Repurchase of common stock (60) (230) Dividends paid (275) - (550) - --------- -------- --------- ----------- Net cash provided by financing activities 6,179 104,558 (22,979) 206,446 --------- -------- --------- ----------- Net increase (decrease) in cash and cash equivalents 553 (3,055) (9,858) 9,536 Cash and cash equivalents at beginning of period 2,888 12,592 13,299 1 --------- -------- --------- ----------- Cash and cash equivalents at end of period $ 3,441 $ 9,537 $ 3,441 $ 9,537 ========= ======== ========= ===========
See notes to financial statements. NOTES TO FINANCIAL STATEMENTS June 30, 1999 NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Anworth Mortgage Asset Corporation (the "Company") was incorporated in Maryland on October 20, 1997. The Company commenced its operations of purchasing and managing an investment portfolio of mortgage-backed ("MBS") securities on March 17, 1998, upon completion of its initial public offering of the Company's common stock. A summary of the company's significant accounting policies follows: BASIS OF PRESENTATION The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule Page 6 10-01 of Regulation S-X. Therefore, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. The operating results for the quarter ended June 30, 1999 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 1999. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of twelve months or less. The carrying amount of cash equivalents approximates their fair value. MORTGAGE BACKED SECURITIES The Company has invested primarily in adjustable-rate mortgage pass-through certificates ("ARMs") and hybrid ARMs. Hybrid ARM securities have an initial interest rate that is fixed for a certain period, usually three to five years, and then adjusts annually for the remainder of the term of the loan. Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to classify its investments as either trading investments, available-for-sale investments or held-to-maturity investments. It is the Company's policy to classify each of its MBS as available-for-sale and then to monitor the security's performance over time before making a final determination as to the permanent classification. At this time all of the Company's MBS are classified as available-for-sale. All assets that are classified as available-for-sale are carried at fair value. Interest income is accrued based on the outstanding principal amount of the MBS and their contractual terms. Premiums and discounts associated with the purchase of MBS are amortized into interest income over the estimated lives of the asset using the effective yield method. MBS transactions are recorded on the date the securities are purchased or sold. CREDIT RISK At June 30, 1999 the Company has limited its exposure to credit losses on its portfolio of mortgage backed securities by purchasing primarily securities from Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA"). The payment of principal and interest on the FHLMC and FNMA ARM securities are guaranteed by those respective agencies. At June 30, 1999, all of the Company's ARM securities have an implied "AAA" rating. INCOME TAXES The Company intends to elect to be taxed as a Real Estate Investment Trust and to comply with the provisions of the Internal Revenue Code with respect thereto. Accordingly, the Company will not be subject to Federal income tax to the extent that its distributions to stockholders satisfy the REIT requirements. EARNINGS PER SHARE Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce a loss or increase the income per share. Stock options that could potentially dilute basic EPS in the future were not included in the computation of diluted EPS because to do so would have been antidilutive. Page 7 USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 2. MORTGAGE BACKED SECURITIES The following table pertains to the Company's mortgage backed securities classified as available-for-sale as of June 30, 1999, which are carried at their fair value:
Federal Federal Home Loan National Total Mortgage Mortgage MBS Corporation Association Assets - -------------------------------------------------------------------------------------------------------- Amortized Cost ($000's) $ 34,634 $ 137,442 $ 172,076 Unrealized gains (losses) (288) (1,183) (1,470) ------------------------------------------------------------- Fair value $ 34,346 $ 136,259 $ 170,605 =============================================================
In addition, at June 30, 1999 the Company held a position in a preferred stock issued by Thornburg Mortgage Asset Corporation which had a fair value of $532,000. The remaining portion of the mortgage backed securities consisted of a principal payments receivable of $1,249,000. The following table summarizes the Company's securities as of June 30, 1999 at their fair value:
Fixed REIT Rate Preferred ARMS MBS Stock Total - --------------------------------------------------------------------------------------------------- Amortized Cost ($000's) $ 156,003 $ 16,072 $ 507 $ 172,582 Unrealized gains 166 25 191 Unrealized losses (1,146) (490) (1,636) -------------------------------------------------------------- Estimated fair value $ 155,023 $ 15,582 $ 532 $ 171,137 ==============================================================
NOTE 3. REVERSE REPURCHASE AGREEMENTS The Company has entered into reverse repurchase agreements to finance most of its MBS. The reverse repurchase agreements are short-term borrowings that are secured by the market value of the Company's MBS and bear interest rates that have historically moved in close relationship to LIBOR. At June 30, 1999, the repurchase agreements had the following remaining - ----------------------------------------------------------------------- maturities: - ---------- Within 59 days $ 63,829,000 60 to 89 days 0 90 to 119 days 55,480,000 Over 120 28,525,153 ------------ $147,834,153 ============
Page 8 NOTE 4. INITIAL PUBLIC OFFERING On March 12, 1998 the Company completed its initial public offering of common stock, $0.01 par value. The Company issued 2,200,000 shares of common stock at a price of $9 per share and received net proceeds of $18,414,000, net of underwriting discount of $0.63 per share. Offering costs in connection with the public offering, including the underwriting discount and other expenses, which total $491,182, have been charged against the proceeds of the offering. Prior to March 17, 1998, the Company had no operations other than activities relating to its organization, registration under the Securities Act of 1933 and the issuance of 100 shares of its common stock to its initial stockholder. The Company granted the underwriters of the initial public offering of the Company's common stock a 30-day option to purchase additional shares of common stock solely to cover over-allotments, if any, at the public offering price of $9 per share. On April 14, 1998, the underwriters purchased an additional 127,900 shares under the terms of this option. As a result, the Company received additional net proceeds of $1,070,523, net of the underwriting discount of $0.63 per share, on April 14, 1998. NOTE 5. TRANSACTIONS WITH AFFILIATES The Company entered into a Management Agreement (the "Agreement") with Anworth Mortgage Advisory Corporation (the "Manager"), effective March 12, 1998. Under the terms of the Agreement, the Manager, subject to the supervision of the Company's Board of Directors, is responsible for the management of the day-to- day operations of the Company and provides all personnel and office space. The Company pays the Manager an annual base management fee equal to 1% of the first $300 million of Average Net Invested Assets (as defined in the Agreement), plus 0.8% of the portion above $300 million (the "Base Management Compensation"). In addition to the Base Management Compensation, the Manager shall receive as incentive compensation for each fiscal quarter an amount equal to 20% of the Net Income of the Company, before incentive compensation, for such fiscal quarter in excess of the amount that would produce an annualized Return on Equity (calculated by multiplying the Return on Equity for such fiscal quarter by four) equal to the Ten-Year U.S. Treasury Rate for such fiscal quarter plus 1% (the "Incentive Management Compensation"). For the quarters ended June 30, 1999 and June 30, 1998, the Company paid the Manager $45,000 and $46,000, respectively, in base management fee. The Company has adopted the Anworth Mortgage Asset Corporation 1997 Stock Option and Awards Plan (the "Stock Option Plan") which authorizes the grant of options to purchase an aggregate of up to 300,000 of the outstanding shares of the company's Common Stock. The plan authorizes the Board of Directors, or a committee of the Board of Directors, to grant incentive stock options ("ISOs") as defined under section 422 of the Internal Revenue Code of 1986, as amended, options not so qualified ("NQSOs"), dividend equivalent rights ("DERs") and stock appreciation rights ("SARs"). The exercise price for any option granted under the Stock Option Plan may not be less than 100% of the fair market value of the shares of Common Stock at the time the option is granted. As of June 30, 1999, the Company had granted a total of 198,000 options, with strike prices of either $9 per share or $4.60 per share, and 148,500 DER's. Options granted to officers either become exercisable at a rate of 33.3% each year following their date of grant or become exercisable three years after their date of grant. Options granted to directors either became exercisable six months after their date of grant or become exercisable three years after their date of grant. All options will expire ten years after their date of grant. The DER's are payable only when their associated stock options are exercised, thereby reducing the effective strike price of such options. The Company will recognize compensation expense at the time the average market price of the stock exceeds the effective strike price. For the quarter ended June 30, 1999, the Company recorded $2,000 in operating expense associated with this plan. Page 9 NOTE 6. SHARE REPURCHASE In December of 1998, the Board of Directors authorized the repurchase of 50,000 shares of the Company's common stock. As of June 30, 1999, the entire 50,000 shares had been repurchased at an average cost of $4.58 per share. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain information contained in this Quarterly Report on Form 10-Q constitutes "Forward-Looking Statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, which can be identified by the use of forward-looking terminology such as "may," "will," "expect," "anticipate," "estimate," or "continue" or the negatives thereof or other variations thereon or comparable terminology. Investors are cautioned that all forward-looking statements involve risks and uncertainties including, but not limited to, risks related to the future level and relationship of various interest rates, prepayment rates and the timing of new programs. The statements in the "Risk Factors" of the Company's Prospectus dated March 12, 1998 constitute cautionary statements identifying important factors, including certain risks and uncertainties, with respect to such forward-looking statements that could cause the actual results, performance or achievements of the Company to differ materially from those reflected in such forward-looking statements. GENERAL Anworth Mortgage Asset Corporation (the "Company") was formed in October 1997 to invest in mortgage assets, including mortgage pass-through certificates, collateralized mortgage obligations, mortgage loans and other securities representing interests in, or obligations backed by, pools of mortgage loans which can be readily financed and short-term investments (collectively, Mortgage-Backed Securities). The Company's principal business objective is to generate net income for distribution to stockholders from the spread between the interest income on its Mortgage-Backed Securities and the costs of borrowing to finance its acquisition of Mortgage-Backed Securities. The Company commenced operations on March 17, 1998 upon the closing of its initial public offering. Since that date the Company has deployed its capital and built its balance sheet through the acquisition of mortgage assets and the financing of those assets in the credit markets. The Company seeks to generate income through its use of leverage and active management of the asset/liability yield spread. The Company will seek to generate growth in earnings and dividends per share in a variety of ways, including through (i) issuing new Common Stock and increasing the size of the balance sheet when opportunities in the market for Mortgage- Backed Securities are likely to allow growth in earnings per share, (ii) seeking to improve productivity by increasing the size of the balance sheet at a rate faster than the rate of increase in operating expenses, (iii) continually reviewing the mix of Mortgage-Backed Security types on the balance sheet in an effort to improve risk-adjusted returns, and (iv) attempting to improve the efficiency of the Company's balance sheet structure through the issuance of uncollateralized subordinated debt, preferred stock and other forms of capital, to the extent management deems such issuances appropriate. The Company is organized for tax purposes as a real estate investment trust ("REIT") and therefore generally passes through substantially all of its earnings to stockholders without paying federal or state income tax at the corporate level. At its June 17, 1999 meeting the Board of Directors approved new operating policies for the Company which are included in Item 5 of this report. Effective upon the filing of this quarterly report, the Company will begin to modify its policy of investing primarily in adjustable rate mortgage assets. The new policy allows the Company to invest substantially more of its assets in fixed rate mortgage securities. Depending on mortgage market conditions, these purchases may Page 10 or may not be accompanied by the purchase of hedging instruments intended to mitigate the attendant interest rate risk. The Company will target an overall one year duration for the portfolio, taking all assets and hedging instruments into account. See "Statement of Operating Policies" below. The Company has established the policies included in Item 5 in response to the current interest rate environment. The Company believes that, given the current shape of the yield curve and current conditions in the mortgage markets, it may be able to increase earnings by implementing these new policies. These policies may be modified or waived by the Board of Directors at any time without consent of the Company's stockholders. The ultimate effect of any such changes is uncertain. Prior to the adoption of the operating policies attached at Item 5 of this report, the Company's investment policy was to invest at least 70% of total assets in "Primary" adjustable-rate Mortgage Securities and Short-Term Investments (investments with an average life of one year or less). "Primary" as used herein means either (i) securities that are rated within one of the two highest rating categories by at least one of either Standard & Poor's or Moody's, or (ii) securities that are unrated but are either obligations of the United States or obligations guaranteed by the United States government or an agency or instrumentality of the United States government. The remainder of the Company's investment portfolio, comprising not more than 30% of its total assets, may have consisted of mortgage assets which are unrated, or, if rated, are less than Primary. See Item 5 below for a description of the new operating policies. The Company will generally not acquire inverse floaters, Remic residuals or first loss subordinated bonds. The Company may acquire mortgage derivative securities, including, but not limited to, interest only, principal only or other mortgage securities that receive a disproportionate share of interest income or principal, either as an independent stand-alone investment opportunity or to assist in the management of prepayment and other risks, but only on a limited basis due to the greater risk of loss associated with mortgage derivative securities. FINANCIAL CONDITION At June 30, 1999, the Company held total assets of $177 million, consisting primarily of $156 million of ARM, $16 million of fixed-rate mortgage backed securities and $0.5 million of REIT preferred stock. At June 30, 1999, 91% of the qualified real estate assets held by the Company were Primary assets. Of the ARM securities owned by the Company, 84% were adjustable-rate pass-through certificates which reset at least once a year. The remaining 16% were 3/1 and 5/1 hybrid ARMS with an average reset of 3.5 years. Hybrid ARM securities have an initial interest rate that is fixed for a certain period, usually three to five years, and then adjust annually for the remainder of the term of the loan. The following table presents a schedule of mortgage backed securities owned at June 30, 1999 classified by type of issuer. ARM SECURITIES BY ISSUER (Dollar amounts in thousands)
- --------------------------------------------------------------------------------------- Agency Carrying Portfolio Value Percentage - --------------------------------------------------------------------------------------- FNMA $ 34,346 20 - --------------------------------------------------------------------------------------- FHLMC 136,259 80 - --------------------------------------------------------------------------------------- Total Portfolio $ 170,605 100 =======================================================================================
Page 11 The following table classifies the Company's portfolio of mortgage backed securities by type of interest rate index. ARM ASSETS BY INDEX (Dollar amounts in thousands)
- --------------------------------------------------------------- Index Carrying Portfolio Value Percentage - --------------------------------------------------------------- Six-month LIBOR $ 11,101 6.5% - --------------------------------------------------------------- Six-month Certificate of Deposit 6,279 3.7% - --------------------------------------------------------------- One-year Constant Maturity Treasury 131,698 77.2% - --------------------------------------------------------------- Cost of Funds Index 5,945 3.5% - --------------------------------------------------------------- Fixed rate 15,582 9.1% - --------------------------------------------------------------- $170,605 100.0% ===============================================================
The ARM portfolio had a weighted average coupon of 6.86% at June 30, 1999. The weighted average one-month constant prepayment rates ("CPR") of the Company's MBS portfolio were 39%, 28% and 27%, respectively, for the months of April, May and June, 1999. At June 30, 1999 the unamortized net premium paid for the mortgage-backed securities was $3.9 million. The Company analyzes its mortgage-backed securities and the extent to which prepayments impact the yield of the securities. When actual prepayments exceed expectations, the Company amortizes the premiums paid on mortgage assets over a shorter time period, resulting in a reduced yield to maturity on the Company's mortgage assets. Conversely, if actual prepayments are less than the assumed constant prepayment rate, the premium would be amortized over a longer time period, resulting in a higher yield to maturity. The Company monitors its yield expectations versus its actual prepayment experience on a monthly basis in order to adjust the amortization of the net premium. The fair value of the Company's portfolio of mortgage-backed securities classified as available-for-sale was $1.47 million less than the amortized cost of the securities, resulting in a negative adjustment of 0.85% of the amortized cost of the portfolio as of June 30, 1999. This price decline reflects the possibility of faster future prepayments which would have the effect of shortening the average life of the Company's MBS and decreasing their yield. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1999 For the quarter ended June 30, 1999, the Company's net income was $301,000, or $0.13 per share (basic and diluted EPS), based on an average of 2,278,697 average shares outstanding. Net interest income for the quarter totaled $395,000. Net interest income is comprised of the interest income earned on mortgage investments, net of premium amortization, less interest expense from borrowings. During the second quarters of 1999 and 1998, the Company incurred operating expenses of $94,000 and $124,000 respectively, consisting in 1999 of a base management fee of $45,000 and other operating expenses of $49,000 and in 1998 of a base management fee of $46,000 and other operating expenses of $78,000. The significant reduction in other operating expenses in the second quarter of 1999 versus the second quarter of 1998 was caused by the Company's discontinuing to accrue compensation expense related to DER's that were issued in March of 1998; the options associated with these DER's have a strike price that currently is significantly above the current market price and the Company believes that the possibility of near-term exercise of these options and DER's is unlikely. The Company commenced operations on March 17, 1998; therefore the quarter ended June 30, 1999 is the first quarter in which comparing results of operations to the corresponding period in 1998 is meaningful. The Company's return on average equity was 1.7% or, on an annualized basis, 7.0%, for the quarter ended June 30, 1999. The table below shows the components of return on average equity. Page 12 COMPONENTS OF RETURN ON AVERAGE EQUITY/(1)/
For the Quarter Ended Net Interest Income/ G&A Expense/(2)/ Net Income/ Equity Equity Equity - ----------------------------------------------------------------------------------------------------------------------- Jun 30, 1998 2.52% 0.65% 1.87% - ----------------------------------------------------------------------------------------------------------------------- Sep 30, 1998 1.92% 0.64% 1.28% - ----------------------------------------------------------------------------------------------------------------------- Dec 31, 1998 1.62% 0.23% 1.40% - ----------------------------------------------------------------------------------------------------------------------- Mar 31, 1999 1.94% 0.47% 1.46% - ----------------------------------------------------------------------------------------------------------------------- Jun 30, 1999 2.20% 0.49% 1.70% - -----------------------------------------------------------------------------------------------------------------------
/(1)/ Average equity excludes unrealized gain (loss) on available-for-sale MBS. /(2)/ Excludes performance fees. The following table shows the Company's average daily balances of cash equivalents and mortgage assets, the yields earned on each type of earning assets, the yield on average daily earning assets and interest income.
Average Yield on Daily Yield on Average Yield on Average Amortized Average Average Daily Average Dividend Daily Cost of Daily Daily Amortized Daily and Cash Mortgage Earning Cash Cost of Earning Interest In thousands Equivalents Assets Assets Equivalents Mortgage Assets Income Assets - --------------------------------------------------------------------------------------------------------------------------- For the quarter ended June 30, 1998 $6,878 $175,340 $182,218 5.59 6.17 6.14 $2,799 - --------------------------------------------------------------------------------------------------------------------------- For the quarter ended September 30, 1998 $5,476 $196,014 $201,490 5.56 5.92 5.91 $2,978 - --------------------------------------------------------------------------------------------------------------------------- For the quarter ended December 31, 1998 $6,736 $187,444 $194,181 5.00 5.62 5.60 $2,717 - --------------------------------------------------------------------------------------------------------------------------- For the quarter ended March 31, 1999 $8,384 $170,633 $179,017 4.87 5.40 5.37 $2,404 - --------------------------------------------------------------------------------------------------------------------------- For the quarter ended June 30, 1999 $6,168 $157,679 $163,846 4.76 5.44 5.41 $2,216 - ---------------------------------------------------------------------------------------------------------------------------
The table below shows the Company's average daily borrowed funds and average daily cost of funds as compared to average one- and average three-month LIBOR.
Average Average Average One-month Cost of Cost of LIBOR Funds Funds Average Average Average Average Relative Relative Relative Daily Daily One- Three- to Average to Average to Average Borrowed Interest Cost of Month Month Three-month One-month Three-month In thousands Funds Expense Funds LIBOR LIBOR LIBOR LIBOR LIBOR - --------------------------------------------------------------------------------------------------------------- For the quarter ended June 30, 1998 $162,829 $2,318 5.70% 5.66% 5.69% (0.03)% 0.04% 0.01% - --------------------------------------------------------------------------------------------------------------- For the quarter ended Sept 30, 1998 182,954 2,611 5.71% 5.62% 5.62% 0.00% 0.09% 0.09% - --------------------------------------------------------------------------------------------------------------- For the quarter ended Dec 31, 1998 174,611 2,407 5.51% 5.36% 5.27% 0.09% 0.15% 0.24% - --------------------------------------------------------------------------------------------------------------- For the quarter ended Mar 31, 1999 157,555 2,036 5.24% 4.95% 5.00% (0.05)% 0.29% 0.24% - --------------------------------------------------------------------------------------------------------------- For the quarter ended June 30, 1999 144,828 1,816 5.09% 4.96% 5.08% (0.12)% 0.13% 0.01% - ---------------------------------------------------------------------------------------------------------------
Page 13 For the quarter ended June 30, 1999, the yield on the Company's total assets, including the impact of the amortization of premiums and discounts, was 5.41%. The Company's weighted average cost of funds at June 30, 1999, was 5.06%. The Company pays the Manager an annual base management fee, generally based on average net invested assets, as defined in the Management Agreement, payable monthly in arrears as follows: 1.0% of the first $300 million of Average Net Invested Assets, plus 0.8% of the portion above $300 million. In order for the Manager to earn a performance fee, the rate of return on the stockholders' investment, as defined in the Management Agreement, must exceed the average ten-year U.S. Treasury rate during the quarter plus 1%. During the second quarter of 1999, the Manager earned no performance fee. During the second quarter of 1999, the Company's return on stockholder's investment was 1.5% or, on an annualized basis, 6.3%. The ten-year U.S. Treasury rate for the corresponding period was 5.5%. The following table shows operating expenses as a percent of total assets: ANNUALIZED OPERATING EXPENSE RATIOS
Management Fee & Other Total G&A Expenses/ For The Expenses/ Performance Fee/ Total Assets Quarter Ended Total Assets Total Assets - ----------------------------------------------------------------------------------------------------------------------- Jun 30, 1998 0.23% 0.00% 0.23% - ----------------------------------------------------------------------------------------------------------------------- Sep 30, 1998 0.24% 0.00% 0.24% - ----------------------------------------------------------------------------------------------------------------------- Dec 31, 1998 0.09% 0.00% 0.09% - ----------------------------------------------------------------------------------------------------------------------- Mar 31, 1999 0.21% 0.00% 0.21% - ----------------------------------------------------------------------------------------------------------------------- Jun 30, 1999 0.21% 0.00% 0.21% - -----------------------------------------------------------------------------------------------------------------------
HEDGING The Company did not enter into any interest rate agreements to date. As part of its asset/liability management process, the Company may enter into interest rate agreements such as interest rate caps, floors and swaps. These agreements would be entered into to reduce interest rate risk and would be designed to provide income and capital appreciation to the Company in the event of certain changes in interest rates. The Company reviews the need for interest rate agreements on a regular basis consistent with its Capital Investment Policy. The Company has not experienced credit losses on its portfolio of ARM securities to date, but losses may be experienced in the future. At June 30, 1999, the Company had limited its exposure to credit losses on its portfolio of MBS by purchasing only Agency Certificates, which, although not rated, carry an implied "AAA" rating. COMMON DIVIDEND As a REIT, the Company is required to declare dividends amounting to 85% of each year's taxable income by the end of each calendar year and to have declared dividends amounting to 95% of its taxable income for each year by the time it files its applicable tax return. The Company therefore, generally passes through substantially all of its earnings to shareholders without paying federal income tax at the corporate level. Since the Company, as a REIT, pays its dividends based on taxable earnings, the dividends may at times be more or less than reported earnings. On June 17, 1999 the Company declared a dividend of $0.13 per share payable on July 12, 1999 to holders of record as of July 1, 1999. Page 14 LIQUIDITY AND CAPITAL RESOURCES The Company's primary source of funds for the quarter ended June 30, 1999 consisted of reverse repurchase agreements, which totaled $148 million at June 30, 1999. The Company's other significant source of funds for the quarter ended June 30, 1999 consisted of payments of principal and interest from its ARM securities portfolio in the amount of $14.4 million. In the future, the Company expects its primary sources of funds will consist of borrowed funds under reverse repurchase agreement transactions with one- to twelve-month maturities and of monthly payments of principal and interest on its ARM securities portfolio. The Company's liquid assets generally consist of unpledged ARM assets, cash and cash equivalents. The borrowings incurred during the quarter ended June 30, 1999 had a weighted average interest cost during the quarter of 5.1% compared with 5.7% for the quarter ended June 30, 1998. As of June 30, 1999, all of the Company's reverse repurchase agreements were fixed-rate term reverse repurchase agreements with original maturities that range from three months to one year. The Company has borrowing arrangements with ten different financial institutions and on June 30, 1999, had borrowed funds under reverse repurchase agreements with eight of these firms. Because the Company borrows money based on the fair value of its MBS and because increases in short-term interest rates can negatively impact the valuation of MBS, the Company's borrowing ability could be limited and lenders may initiate margin calls in the event short-term interest rates increase or the value of the Company's MBS declines for other reasons. During the quarter ended June 30, 1999, the Company had adequate cash flow, liquid assets and unpledged collateral with which to meet its margin requirements during the period. Further, the Company believes it will continue to have sufficient liquidity to meet its future cash requirements from its primary sources of funds for the foreseeable future without needing to sell assets. STOCKHOLDERS' EQUITY The Company uses "available-for-sale" treatment for its Mortgage-Backed Securities; these assets are carried on the balance sheet at fair value rather than historical amortized cost. Based upon such "available-for-sale" treatment, the Company's equity base at June 30, 1999 was $17.4 million, or $7.62 per share. If the Company had used historical amortized cost accounting, the Company's equity base at June 30, 1999 would have been $18.8 million, or $8.25 per share. With the Company's "available-for-sale" accounting treatment, unrealized fluctuations in fair values of assets do not impact GAAP or taxable income but rather are reflected on the balance sheet by changing the carrying value of the asset and reflecting the change in stockholders' equity under "Other comprehensive income, unrealized gain (loss) on available for sale securities." By accounting for its assets in this manner, the Company hopes 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, the book value and book value per share of the Company are likely to fluctuate far more than if the Company 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 be misleading. Unrealized changes in the fair value of Mortgage-Backed Securities have one significant and direct effect on the Company's potential earnings and dividends: positive mark-to-market changes will increase the Company's equity base and allow the Company to increase its borrowing capacity while negative changes will tend to limit borrowing capacity under the Company's Capital Investment Policy. A very large negative change in the net market value of the Company's Mortgage- Backed Securities might impair the Company's liquidity position, requiring the Company to sell assets with the likely result of realized losses upon sale. "Other comprehensive income, unrealized gain (loss) on available for sale securities" was $1.4 million, or 0.84% of the amortized cost of mortgage backed securities at June 30, 1999. Page 15 EFFECTS OF INTEREST RATE CHANGES The Company has invested in adjustable-rate mortgage securities. Adjustable- rate mortgage assets are typically subject to periodic and lifetime interest rate caps that limit the amount an adjustable-rate mortgage securities' interest rate can change during any given period. Adjustable-rate mortgage securities are also typically subject to a minimum interest rate payable. The Company borrowings will not be subject to similar restrictions. Hence, in a period of increasing interest rates, interest rates on its borrowings could increase without limitation by caps, while the interest rates on its mortgage assets could be so limited. This problem would be magnified to the extent the Company acquires mortgage assets that are not fully indexed. 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 less cash income on its adjustable-rate mortgage assets than is required to pay interest on the related borrowings. These factors could lower the Company's net interest income or cause a net loss during periods of rising interest rates, which would negatively impact the Company's liquidity and its ability to make distributions to stockholders. The Company intends to fund the purchase of a substantial portion of its adjustable-rate mortgage securities with borrowings that may have interest rates based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of the mortgage assets. Thus, the Company anticipates that in most cases the interest rate indices and repricing terms of its mortgage assets and its funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. During periods of changing interest rates, such interest rate mismatches could negatively impact the Company's net income, dividend yield and the market price of the Common Stock. Prepayments are the full or partial repayment of principal prior to the original term to maturity of a mortgage loan and typically occur due to refinancing of mortgage loans. Prepayment rates on mortgage securities vary from time to time and may cause changes in the amount of the Company's net interest income. Prepayments of adjustable-rate mortgage loans usually can be expected to increase when mortgage interest rates fall below the then-current interest rates on such loans and decrease when mortgage interest rates exceed the then-current interest rate on such loans, although such effects are not predictable. Prepayment experience also may be affected by the conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage loans underlying mortgage securities. The purchase prices of mortgage securities are generally based upon assumptions regarding the expected amounts and rates of prepayments. Where slow prepayment assumptions are made, the Company may pay a premium for mortgage securities. To the extent such assumptions materially and adversely differ from the actual amounts of prepayments, the Company would experience losses. The total prepayment of any mortgage asset that had been purchased at a premium by the Company would result in the immediate write-off of any remaining capitalized premium amount and 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, its financial condition, cash flows and results of operations could be materially adversely affected. OTHER MATTERS As of June 30, 1999, the Company calculates its Qualified REIT Assets, as defined in the Internal Revenue Code of 1986, as amended (the "Code"), to be greater than 90% of its total assets, as compared to the Code requirement that at least 75% of its total assets must be Qualified REIT Assets. The Company also calculates that greater than 98% of its 1999 revenue for the quarter ended June 30, 1999 qualifies for both the 75% source of income test and the 95% source of income test under the REIT rules. The Company also met all REIT requirements regarding the ownership of its common stock and the distributions of its net income. Therefore, as of June 30, 1999, the Company believes that it will continue to qualify as a REIT under the provisions of the Code. The Company at all times intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act of 1940, as amended (the "Investment Company Act). If the Company were to become regulated as an investment company, then the Company's use of leverage would be substantially reduced. The Investment Company Act exempts entities that are "primarily engaged in the business of purchasing or Page 16 otherwise acquiring mortgages and other liens on and interests in real estate" ("Qualifying Interests"). Under current interpretation of the staff of the SEC, in order to qualify for this exemption, the Company must maintain at least 55% of its assets directly in Qualifying Interests. In addition, unless certain mortgage securities represent all of the certificates issued with respect to an underlying pool of mortgages, such mortgage securities may be treated as securities separate from the underlying mortgage loans and, thus, may not be considered Qualifying Interests for purposes of the 55% requirement. The Company calculates that it is in compliance with this requirement. YEAR 2000 The Company is subject to risks associated with the "Year 2000" problem, a term which refers to uncertainties about the ability of various data processing hardware and software to interpret dates correctly as we approach the Year 2000. To address these risks the Company has implemented a plan whereby it will evaluate its internal systems and, to a much larger extent, evaluate the readiness of the systems used by the Company's External Counterparties. The Company will develop contingency plans for implementation in the event of failure of any systems on which its business relies. Internal Systems - Currently, the Company uses a general ledger software application to prepare its books and records, as well as spreadsheet software to maintain subsidiary ledgers. Throughout the fourth quarter of 1998 and into the first and second quarters of 1999 the Company created parallel files within these applications to test these packages' ability to interpret the year 2000 in various data fields on which calculations are made. The application was found to perform calculations correctly when computing results using dates after December 31, 1999. To date, the Company has not incurred any additional expense in connection with the evaluation of internal systems. Since the Company is externally managed, the testing and potential software replacement referred to above should not result in additional cost to the Company. External Counterparties - The Company been communicating with its External Counterparties regarding the state of readiness of their Year 2000 plans. During the fourth quarter of 1998, the Company compiled a list of these counterparties and solicited information from each one regarding their Year 2000 plans. Many of these counterparties are prominent broker-dealers and investment banks or government mortgage agencies who are known by the Company to be involved in Year 2000 review processes currently being performed by securities industry regulators (such as the New York Stock Exchange or the Securities and Exchange Commission) and self-regulatory organizations. The Company intends to measure the progress of each of these counterparties over the course of the third quarter of 1999 and report to shareholders regarding progress made by these counterparties. Contingency Plans - During the third quarter of 1999, after gathering data through the processes described above, the Company will develop plans to address any potential failure in internal or external systems. In its normal course of business the Company relies heavily on the accurate functioning of many computer applications. The Company's ability to perform its normal business functions depends heavily on the Company's ability to perform mathematical calculations quickly and accurately and its ability to send and receive funds quickly and accurately. While the Company believes that completion of its Year 2000 Plan will reduce some of the uncertainty that currently surrounds the Year 2000 problem, the Company acknowledges that Year 2000-related breakdowns in either the internal or external systems on which the Company depends could cause significant disruptions in the Company's operations. PART II. OTHER INFORMATION Item 1. Legal Proceedings At June 30, 1999, there were no pending legal proceedings to which the Company was a party or of which any of its property was subject. Page 17 Item 2. Changes in Securities Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders (a) The Company's Annual Meeting of Stockholders was held on June 17, 1999. (c) Proposal 1. Election of Board of Directors to serve until the 2000 Annual Meeting.
Director For Withheld -------- --- -------- Lloyd McAdams 2,046,161 0 Joe E. Davis 2,046,161 0 Charles H. Black 2,045,611 550
Proposal 2. To ratify McGladrey & Pullen LLP as independent accountants of the Company for the year ending December 31, 1999.
For Against Abstain --- ------- ------- 2,019,241 15,520 11,400
Item 5. Other Information At its June 17, 1999 meeting the Board of Directors approved new operating policies for the Company. Effective upon the filing of this quarterly report, the Company will begin to modify its policy of investing primarily in adjustable rate mortgage assets. The new policy allows the Company to invest substantially more of its assets in fixed rate mortgage securities. Depending on mortgage market conditions, these purchases may or may not be accompanied by the purchase of hedging instruments intended to mitigate the attendant interest rate risk. The Company will target an overall one year duration for the portfolio, taking all assets and hedging instruments into account. See "Statement of Operating Policies" below. The Company has established these policies in response to the current interest rate environment. The Company believes that, given the current shape of the yield curve and current conditions in the mortgage markets, it may be able to increase earnings by implementing these new policies. These policies may be modified or waived by the Board of Directors at any time without consent of the Company's stockholders. The ultimate effect of any such changes is uncertain. The following Statement of Operating Policies shall become effective upon the filing of this Quarterly Report on Form 10-Q: STATEMENT OF OPERATING POLICIES MISSION STATEMENT The principal business objective of the Company is to provide investors with a competitive yield through the management of Mortgage Assets and their risks, the use of leverage, the active management of the asset/liability yield spread, and employment of the Company's risk management strategies. The Company's structure is intended to provide shareholders with a vehicle to participate in the mortgage finance market, while providing professional management of mortgage market risks. The Company's Mortgage Assets will be held primarily for Page 18 investment. The Company intends generally to buy and hold Mortgage Assets to maturity and, therefore, will seek to have a low portfolio turnover rate. The Company's Board of Directors has adopted the investment policies set forth below as its investment policies to be followed by Management. The Board of Directors acknowledges that depending upon market conditions, government regulation and other factors, it may be necessary or desirable from time to time to revise the operating policies, in whole or in part, within the framework of the REIT Provisions of the Code. The operating policies may be changed at any time by the Board of Directors (subject to approval by a majority of Unaffiliated Directors) without the consent of the Company's stockholders. Capitalized terms used herein have the meanings ascribed to such terms in the "Definitions" section at the end of this Statement of Operating Policies. OPERATING STRATEGY . To achieve its objectives the Company's strategy is to purchase primarily single-family adjustable and fixed rate Mortgage Assets and; . Finance purchases of Mortgage Assets with the net proceeds of equity offerings and, to the extent permitted by the Company's capital and leverage policy, to utilize leverage to increase potential returns to its stockholders through borrowings (including but not limited to reverse repurchase agreements and dollar rolls); . Manage the credit risk of its Mortgage Assets according to the Company's credit risk management policy; . Manage the interest rate risk of its Mortgage Assets and borrowings according to the Company's interest rate risk management policy; . Utilize interest rate caps, swaps, futures and similar financial instruments to mitigate interest rate risks; . Seek to minimize prepayment risk primarily through structuring a diversified portfolio with respect to prepayment characteristics; . Maintain its REIT status by complying with the Company's REIT compliance policy. MANAGEMENT POLICIES The Company has established the following policies to implement its mission statement. These policies supercede the operating policies and programs stated in the Company's prospectus dated March 12, 1998. Asset Acquisition Policy The Company intends to acquire assets when it believes that such assets will improve expected shareholder returns after taking into account all associated financing and hedging costs. The Company has established the following guidelines relative to the type of assets that it will acquire: Category I - ---------- At least 60% of the Company's total assets are expected to be adjustable or fixed rate Mortgage Securities and Short-Term Investments. In addition, the Mortgage Securities in this category will either be rated within one of the two highest rating categories by at least one nationally recognized statistical rating organization (such as Moody's, Fitch or Standard & Poors), or if not rated will be obligations guaranteed by the United States government, its agencies, Fannie Mae or Freddie Mac. Page 19 Category II - ----------- At least 90% of the Company's assets are expected to be investments that qualify for Category I or Mortgage Assets including (i) unrated Mortgage Loans and, (ii) Mortgage Securities rated at least Investment Grade by at least one nationally recognized statistical rating organization. Category III - ------------ All other assets shall be less than 10% of the Company's assets. Among the types of assets which genrally will be assigned to this category are: (i) Mortgage Securities rated below Investment Grade, (ii) leveraged Mortgage Derivative Securities, and (iii) shares of other REITS or mortgage related companies. Capital and Leverage Policy The Company shall finance its purchase of Mortgage Assets with Common Stock equity of its and primarily by borrowing against existing Mortgage Assets and using the proceeds to acquire additional Mortgage Assets. The borrowings may be in the form of reverse repurchase agreements, dollar roll agreements, loan agreements, lines of credit and other credit facilities, and the Company's borrowings generally shall be secured by Mortgage Assets owned by the Company. The Company shall employ a leveraging strategy to increase its investment assets by borrowing against existing Mortgage Assets and using the proceeds to acquire additional Mortgage Assets. The Company shall generally maintain a ratio of debt-to-equity of between 8:1 and 12: 1, although the ratio may vary from time to time depending on market conditions and other factors deemed relevant by Management and the Board of Directors. The Company will enter into the collateralized borrowings described herein only with financially sound institutions and will monitor the financial condition of such institutions on a regular, periodic basis. Upon repayment of each reverse repurchase agreement or other credit instrument, or repurchase pursuant to a dollar-roll agreement, the collateral therefor may immediately be pledged to secure a new reverse repurchase agreement or may be sold pursuant to a new dollar roll agreement or may be pledged to secure other types of borrowings. Credit Risk Management Policy Management shall review credit risk and other risks of loss associated with each investment. The Company shall seek to reduce certain risks from sellers and servicers through representations and warranties. The Company's Board of Directors shall monitor the overall portfolio risk and appropriate levels of provision for loss through reports provided to it by the Manager. Management shall review the quality of Mortgage Loans at the time of acquisition and on an ongoing basis. Because of the risks of borrower defaults and bankruptcies and special hazard losses that are not covered by standard hazard insurance, the Company should generally obtain credit enhancements such as mortgage pool or special hazard insurance for its Mortgage Loans or establish appropriate reserve accounts. Interest-Rate Risk Management. To the extent consistent with its election to qualify as a REIT, the Company shall attempt to protect its portfolio of Mortgage Assets and related debt against the effects of major interest rate changes. Page 20 The Company intends to manage the interest rate risk of its Mortgage Assets and borrowings by targeting the difference between the market weighted average effective duration of its Mortgage Assets financed with borrowings and the market weighted average duration of such borrowings to one year or less, taking into account all hedging transactions. The Company generally does not intend to have any specific duration target for the portion of its Mortgage Assets that are not funded by borrowings. The Company may implement its interest rate risk management policy by utilizing various hedging transactions, including interest rate swaps, interest rate swaptions, interest rate caps, interest rate floors, financial futures contracts, options on financial futures contracts, and other structured transactions. The Company does not intend to enter into such transactions for speculative purposes. There can be no assurance that the Company will be able to limit such duration differences and there may be periods of time when the duration difference will be greater than one year. Prepayment Risk Management The Company shall attempt to minimize the effects of faster or slower than anticipated prepayment rates through structuring a diversified portfolio with a variety of prepayment characteristics. The Company will attempt to invest in Mortgage Assets that on a portfolio basis do not have significant purchase price premiums. Under normal market conditions, the Company expects to keep the aggregate capitalized purchase premium of the portfolio to 3% or less. Prepayment risk shall be monitored by Management and the Company's Board of Directors through periodic review of the impact of a variety of prepayment scenarios on the Company's revenues, net earnings, dividends, cash flow and net balance sheet market value. REIT Compliance Policy The Company intends to operate its business in compliance with the REIT Provisions of the Code. Accordingly, all of the provisions outlined in the Company's operating policies are subordinate to the REIT Provisions of the Code if any conflicts arise. To qualify for tax treatment as a REIT, the Company must meet certain tests as fully described in sections 856 and 857 of the Code. A summary of the requirements for qualification as a REIT is described immediately below. In the event of non-compliance with any of the following tests the Board of Directors shall be immediately notified. STOCK OWNERSHIP TESTS. The capital stock of the Company must be held by at least 100 persons and no more than 50% of the value of such capital stock may be owned, directly or indirectly, by five or fewer individuals at all times during the last half of the taxable year. Tax-Exempt Entities, other than private foundations and certain unemployment compensation trusts, are generally not treated as individuals for these purposes. The stock ownership requirements must be satisfied in the Company's second taxable year and in each subsequent taxable year. ASSET TESTS. The Company must generally meet the following asset tests at the close of each quarter of each taxable year. At least 75% of the value of the Company's total assets must consist of Qualified REIT Real Estate Assets, U.S. Government securities, cash and cash items (the "75% Asset Test"). The value of securities held by the Company but not taken into account for purposes of the 75% Asset Test must not exceed (i) 5% of the value of the Company's total assets in the case of securities of any one non-government issuer, or (ii) 10% of the outstanding voting securities of any such issuer. INCOME TESTS. The Company must generally meet certain gross income tests for each taxable year. At least 75% of the Company's gross income must be derived from certain specified real estate sources, including interest income and gain from the disposition of Qualified REIT Real Estate Assets or Qualified Page 21 Temporary Investment Income (the "75% Gross Income Test"). At least 95% of the Company's gross income for each taxable year must be derived from sources of income qualifying for the 75% Gross Income Test, dividends, interest unrelated to real estate, and gains from the sale of stock or other securities (including certain interest rate swap and cap agreements entered into to hedge variable rate debt incurred to acquire Qualified REIT Real Estate Assets) not held for sale in the ordinary course of business (the "95% Gross Income Test"). DIVIDEND DISTRIBUTION REQUIREMENTS. The Company must generally distribute to its stockholders an amount equal to at least 95% of the Company's taxable income before deductions of dividends paid and excluding net capital gains. The Company has until January 31 following the end of the fiscal year to pay the dividends out to shareholders and is permitted to offer a special dividend in order to meet the 95% requirement. FUTURE REVISIONS IN POLICIES AND STRATEGIES The Company's Board of Directors has established the policies and strategies set forth in this report. The Board of Directors has the power to modify or waive such policies and strategies without the consent of the stockholders. The Company's Board of Directors will at least annually establish and approve the policies and strategies of the Company. Distribution Policy The Company shall distribute substantially all of its taxable income to stockholders in each year (which does not ordinarily equal net income as calculated in accordance with GAAP). The Company shall declare four regular quarterly distributions. In addition, taxable income, if any, not distributed through regular quarterly dividends may be distributed annually, at or near year end, in a special dividend. The distribution policy is subject to revision at the discretion of the Board of Directors. All distributions will be made by the Company at the discretion of the Board of Directors and.will depend on the earnings of the Company, the financial condition of the Company, maintenance of REIT status and such other factors as the Board of Directors deems relevant. DEFINITIONS "Agency Certificates" means GNMA Certificates, Fannie Mae Certificates and Freddie Mac Certificates. "ARM" means a Mortgage Loan or any mortgage loan underlying a Mortgage Security that features adjustments of the underlying interest rate at predetermined times based on an agreed margin to an established index. An ARM is usually subject to periodic and lifetime interest rate and/or payment caps. "CMOs" means debt obligations (bonds) that are collateralized by mortgage loans or mortgage certificates. CMOs are structured so that principal and interest payments received on the collateral are sufficient to make principal and interest payments on the bonds. Such bonds may be issued by United States government agencies or private issuers in one or more classes with fixed or variable interest rates, maturities and degrees of subordination which are characteristics designed for the investment objectives of different bond purchasers. "Code" means the Internal Revenue Code of 1986, as amended. "Collateral" means Mortgage Assets, debt service funds and reserve funds, insurance policies, servicing agreements or master servicing agreements. "Common Stock" means the Company's shares of Common Stock, $0.01 par value per share. "Company" means Anworth Mortgage Asset Corporation, a Maryland corporation. Page 22 "Conforming Mortgage Loans" means conventional Mortgage Loans that either comply with requirements for inclusion in credit support programs sponsored by Freddie Mac, Fannie Mae or GNMA or are FHA or VA Loans, all of which are secured by first mortgages or deeds of trust on single-family (one to four units) residences. "Excess Servicing Rights" means contractual rights to receive a portion of monthly mortgage payments, of interest remaining after those payments of interest have already been applied, to the extent required, to Pass-Through Certificates and the administration of mortgage servicing. The mortgage interest payments are secured by an interest in real property. "Fannie Mae" means the Fannie Mae corporation. "Fannie Mae Certificates" means guaranteed mortgage pass-through certificates issued by Fannie Mae either in certified or book-entry form. "FHA" means the United States Federal Housing Administration. "FHA Loans" means Mortgage Loans insured by the FHA. "Freddie Mac" means the Freddie Mac corporation. "Freddie Mac Certificates" means mortgage participation certificates issued by Freddie Mac, either in certificated or book-entry form. "GNMA" means the Government National Mortgage Association. "GNMA Certificates" means fully modified pass-through mortgage backed certificates guaranteed by GNMA and issued either in certificated or book-entry form. "Investment Grade" means a security rating of BBB or better by Standard & Poor's or Baa or better by Moody's Investors Service, Inc., or, as to unrated Pass-Through Certificates and CMOs backed by single-family, multi-family, or commercial properties, a determination that the security is of comparable quality to a rated Investment Grade security on the basis of credit enhancement features that meet Investment Grade credit criteria approved by the Company's Board of Directors, including approval by a majority of the Unaffiliated Directors. "Issuers" means those entities that issue Mortgage Securities, including trusts or subsidiaries organized by the Company and Affiliates of the Manager. "Manager" means Anworth Mortgage Advisory Corporation, a California corporation. "Mortgage Assets" means (i) Mortgage Securities, (ii) Mortgage Loans and (iii) Short-Term Investments. "Mortgage Derivative Securities" means Mortgage Securities which provide for the holder to receive interest only, principal only, or interest and principal in amounts that are disproportionate to those payable on the underlying Mortgage Loans. "Mortgage Loans" means Conforming and Nonconforming Mortgage Loans, FHA Loans and VA Loans. All Mortgage Loans to be acquired by the Company will be secured by first mortgages or deeds of trust on single-family (one-to-four units) residential properties. "Mortgage Securities" means (i) Pass-Through Certificates, (ii) CMOs, and (iii) Other Mortgage Securities. "Mortgage Warehouse Participations" means participations in lines of credit to mortgage originators that are secured by recently originated Mortgage Loans which are in the process of being either securitized or sold to permanent investors. Page 23 "Nonconforming Mortgage Loans" means conventional Mortgage Loans that do not conform to one or more requirements of FHA, Freddie Mac, Fannie Mae, GNMA or VA for participation in one or more of such agencies' mortgage loan credit support programs, such as the principal amounts financed or the underwriting guidelines used in making the loan. "Other Mortgage Securities" means securities representing interests in, or secured by mortgages on, real property other than Pass-Through Certificates and CMOs and may include non-primary certificates and other securities collateralized by single-family, multifamily or commercial loans, Mortgage Warehouse Participations, Mortgage Derivative Securities, Subordinated Interests and other mortgage-backed and mortgage-collateralized obligations. "Pass-Through Certificates" means securities (or interests therein) other than Mortgage Derivative Securities and Subordinated Interests evidencing undivided ownership interests in a pool of mortgage loans, the holders of which receive a "pass-through" of the principal and interest paid in connection with the underlying mortgage loans in accordance with the holders' respective, undivided interests in the pool. Pass-Through Certificates include Agency Certificates, as well as other certificates evidencing interests in loans secured by single-family, multi-family, commercial and/or other real estate related properties. "Qualified REIT Real Estate Assets" means Pass-Through Certificates, Mortgage Loans, Agency Certificates, and other assets of the type described in Section 856(c)(6)(B) of the Code. "Qualified REIT Subsidiary" means a corporation whose stock is entirely owned by the REIT at all times during such corporation's existence. "Qualified Temporary Investment Income" means income attributable to stock or debt instruments acquired with new capital of the Company received during the one-year period beginning on the day such proceeds were received. "REIT" means Real Estate Investment Trust. "REIT Provisions of the Code" means Sections 856 through 860 of the Code. "REMIC" means Real Estate Mortgage Investment Conduit. The Company will limit the REMIC interests that it acquires to interests issued by REMICs, at least 95 percent of whose assets consist of Qualified REIT Real Estate Assets. "Service" means the Internal Revenue Service. "Servicers" means those entities that perform the servicing functions with respect to Mortgage Loans or Excess Servicing Rights owned by the Company. "Servicing Agreements" means the various agreements the Company will enter into with Servicers. "Short-Term Investments" means short-term bank certificates of deposit, short-term United States treasury securities, short-term United States government agency securities, commercial paper, repurchase agreements, short- term CMOs, short-term asset-backed securities and other similar types of short- term investment instruments, all of which will have maturities or average lives of less than one (1) year. "Subordinated Interests" means a class of Mortgage Securities that is subordinated to one or more other classes of Mortgage Securities, all of which classes share the same Collateral. The Company will only acquire Subordinated Interests that are beneficial interests in grantor trusts holding Mortgage Loans, or are regular interests issued by REMICs, or that otherwise constitute Qualified REIT Real Estate Assets (provided the Company has obtained a favorable opinion of counsel to that effect). Page 24 "Tax Exempt Entity" means a qualified pension, profit-sharing or other employee retirement benefit plans, bank commingled trust funds for such plans, and IRAs, and other similar entities intended to be exempt from federal income taxation. "Unaffiliated Directors", means those directors that are not affiliated, directly, or indirectly, with the Manager, whether by ownership of, ownership interest in, employment by, any material business or professional relationship with, or serving as an officer or director of the Manager or an affiliated business entity of the Manager. "VA" means the United States Veterans Administration. "VA Loans" means Mortgage Loans partially guaranteed by the VA under the Servicemen's Readjustment Act of 1944, as amended. Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits Exhibit 27 - Financial Date Schedule (b) Reports on Form 8-K None 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, ANWORTH MORTGAGE ASSET CORPORATION Dated: July 29, 1999 By: /s/ Lloyd McAdams _________________________ Lloyd McAdams President (authorized officer of registrant) Dated: July 29, 1999 By: /s/ Pamela J. Watson _________________________ Pamela J. Watson, Chief Financial Officer and Treasurer (principal accounting officer) Page 25 FINANCIAL DATA SCHEDULE This schedule contains summary financial information extracted from the June 30, 1999 Form 10-Q and is qualified in its entirety by reference to such financial statements. Page 26 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM JUNE 30, 1999 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 3,441 172,386 1,175 0 0 4,659 0 0 177,045 159,695 0 0 0 18,765 (1,415) 177,045 0 4,615 0 0 184 0 3,852 579 0 579 0 0 0 579 .25 .25
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