-----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, WaCwVCyeoHu4ppZ8QF6A/cspxduCZJqJJUO1/acnmNz/IWtxmPx81o5sZPSzQa/U kjIxcXRkIBnsxkfam3HGBQ== /in/edgar/work/0000950172-00-500061/0000950172-00-500061.txt : 20001116 0000950172-00-500061.hdr.sgml : 20001116 ACCESSION NUMBER: 0000950172-00-500061 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ANTHRACITE CAPITAL INC CENTRAL INDEX KEY: 0001050112 STANDARD INDUSTRIAL CLASSIFICATION: [6798 ] IRS NUMBER: 133978906 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13937 FILM NUMBER: 768805 BUSINESS ADDRESS: STREET 1: 345 PARK AVENUE CITY: NEW YORK STATE: NY ZIP: 10154 BUSINESS PHONE: 2127545560 MAIL ADDRESS: STREET 1: 345 PARK AVENUE CITY: NEW YORK STATE: NY ZIP: 10154 FORMER COMPANY: FORMER CONFORMED NAME: ANTHRACITE MORTGAGE CAPITAL INC DATE OF NAME CHANGE: 19971121 10-Q 1 0001.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 Commission File Number 001-13937 ---------- ANTHRACITE CAPITAL, INC. ------------------------- (Exact name of registrant as specified in its charter) Maryland 13-3978906 ------------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 345 Park Avenue, New York, New York 10154 ----------------------------------- ----- (Address of principal executive offices) (Zip Code) (Registrant's telephone number including area code): (212) 409-3333 --------------- NOT APPLICABLE -------------- (Former name, former address, and former fiscal year if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes X No --- -- (2) Yes X No --- -- As of November 10, 2000, 25,135,986, shares of voting common stock ($.001 par value) were outstanding. ANTHRACITE CAPITAL, INC., FORM 10-Q INDEX PART I - FINANCIAL INFORMATION Page ---- Item 1. Interim Financial Statements.........................................3 Consolidated Statements of Financial Condition At September 30, 2000 (Unaudited) and December 31, 1999..............3 Consolidated Statements of Operations For the Three Months Ended September 30, 2000 and 1999 (Unaudited), and For the Nine Months Ended September 30, 2000 and 1999 (Unaudited)..........................................................4 Consolidated Statement of Changes in Stockholders' Equity For the Nine Months Ended September 30, 2000 (Unaudited).............5 Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2000 and 1999 (Unaudited)....6 Notes to Consolidated Financial Statements (Unaudited)...............7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...............................................30 Item 3. Quantitative and Qualitative Disclosures about Market Risk..........46 Part II - OTHER INFORMATION Item 1. Legal Proceedings...................................................52 Item 2. Changes in Securities and Use of Proceeds...........................52 Item 3. Defaults Upon Senior Securities.....................................52 Item 4. Submission of Matters to a Vote of Security Holders.................52 Item 5. Other Information...................................................52 Item 6. Exhibits and Reports on Form 8-K....................................52 SIGNATURES ...............................................................53 Financial Data Schedule......................................................54 Part I - FINANCIAL INFORMATION Item 1. Consolidated Financial Statements
ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS, EXCEPT PER SHARE DATA) - ------------------------------------------------------------------------------- September 30, 2000 December 31, 1999 ----------------- ----------------- Unaudited) ASSETS Cash and cash equivalents $ 13,397 $ 22,265 Securities available for sale, at fair value Subordinated commercial mortgage-backed securities (CMBS) $ 284,138 $ 272,733 Investment grade securities 607,682 304,462 --------- ------- Total securities available for sale 891,820 577,195 Mortgage loans held for sale 78,590 - Commercial mortgage loans, net 145,335 69,611 Investment in real estate joint ventures 5,074 - Other assets 16,466 10,591 -------------- --------------- Total Assets $1,150,682 $679,662 ============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Borrowings: Secured by pledge of subordinated CMBS $ 164,478 $162,738 Secured by pledge of other securities available for sale and other assets 555,954 272,289 Secured by pledge of mortgage loans held for sale 71,967 - Secured by pledge of commercial mortgage loans 57,566 36,506 ------------ -------------- Total borrowings $ 849,965 $471,533 Distributions payable 9,490 6,079 Other liabilities 16,500 3,767 -------------- --------------- Total Liabilities 875,955 481,379 -------------- --------------- 10.5% Series A preferred stock, redeemable convertible, liquidation preference $34,200 30,295 30,022 -------------- --------------- Commitments and Contingencies Stockholders' Equity: Common stock, par value $0.001 per share; 400,000 shares authorized; 25,136 shares issued and outstanding in 2000; and 20,961 shares issued and outstanding in 1999 25 21 10% Series B Preferred stock, liquidation preference $56,025 43,004 - Additional paid-in capital 315,532 287,486 Distributions in excess of earnings (14,868) (18,107) Accumulated other comprehensive loss (99,261) (101,139) -------------- --------------- Total Stockholders' Equity 244,432 168,261 -------------- --------------- Total Liabilities and Stockholders' Equity $ 1,150,682 $679,662 ============== =============== The accompanying notes are an integral part of these financial statements.
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - -------------------------------------------------------------------------------------------------------------------------------- For the Three Months Ended For the Nine Months Ended September 30, September 30, ----------------------------------------------------------------------- 2000 1999 2000 1999 ---------- ---------- --------- ------------ Interest Income: Securities available for sale $ 21,585 $ 11,127 $ 55,113 $ 34,075 Commercial mortgage loans 3,573 1,620 8,550 3,663 Mortgage loans held for sale 1,555 - 5,021 - Trading securities - 567 - 3,186 Cash and cash equivalents 255 104 909 404 ----------- ---------- --------- --------- Total interest income 26,968 13,418 69,593 41,328 ----------- ---------- --------- --------- Expenses: Interest 14,765 4,919 37,328 14,553 Interest-trading securities - 607 - 4,108 Management fee 2,060 1,050 5,050 3,173 Other expenses/(income) - net (20) 507 1,415 1,541 ----------- ---------- --------- --------- Total expenses 16,805 7,083 43,793 23,375 ----------- ---------- --------- --------- Other Gain (Losses): Gain (Loss) on sale of securities available for sale 994 (566) 1,700 (423) Gain on securities held for trading 191 739 519 2,992 Foreign currency gain (loss) 29 28 18 (55) ----------- ---------- --------- --------- Total other gain (loss) 1,214 201 2,237 2,514 ----------- ---------- --------- --------- Net Income 11,377 6,536 28,037 20,467 ----------- ---------- --------- --------- Dividends and accretion on Preferred stock 2,307 - 4,748 - ----------- ---------- --------- --------- Net Income Available to Common Shareholders $ 9,070 $ 6,536 $23,289 $ 20,467 =========== ========== ========= ========= Net income per share: Basic $0.36 $0.31 $1.01 $0.99 Diluted $0.34 $0.31 $0.95 $0.99 Weighted average number of shares outstanding: Basic 25,136 20,998 23,069 20,761 Diluted 29,218 20,998 27,150 20,761 The accompanying notes are an integral part of these financial statements.
ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 (IN THOUSANDS) - -------------------------------------------------------------------------------------------------------------------------------- Accumulated Common Additional Distributions Other Total Stock, Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders' Par Value Stock Capital Of Earnings Loss Income Equity ------------------------------------------------------------------------------------------- Balance at December 31, 1999 $ 21 $ 287,486 $ (18,107) $ (101,139) $ 168,261 Net income 28,037 $ 28,037 28,037 Other comprehensive income: Unrealized gain on securities, net of reclassification adjustment 1,878 1,878 1,878 ---------- Other comprehensive income 1,878 Comprehensive income $29,915 ========== Distributions declared on common stock (20,050) (20,050) Repurchase of common shares (39) (39) Issuance of common stock 4 28,085 28,089 Issuance of Series B Preferred Stock $43,004 43,004 Dividends to preferred shareholders (4,748) (4,748) --------------------------------------------------------------- ----------- Balance at September 30, 2000 $ 25 $43,004 $315,532 $(14,868) $(99,261) $ 244,432 =============================================================== =========== DISCLOSURE OF RECLASSIFICATION AMOUNT: Unrealized holding gains arising during the nine months ended September 30, 2000 3,578 Less: reclassification for realized gains previously recorded as unrealized at December 31, 1999. (1,700) ---------- Net unrealized gain on securities 1,878 ===== The accompanying notes are an integral part of these financial statements.
ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS) - ------------------------------------------------------------------------------------------------------------------------------- For the Nine For the Nine Months Ended Months Ended September 30, 2000 September 30, 1999 ------------------ ------------------ Cash flows from operating activities: Net income $ 28,037 $ 20,467 Adjustments to reconcile net income to net cash provided by operating activities: Net sale of trading securities and securities sold short 328 141,003 Amortization on negative goodwill (637) - Premium amortization (discount accretion), net (828) 172 Non-cash portion of net foreign currency loss 18 55 Net gain on sale of securities (2,219) (2,569) Earnings from real estate joint ventures (25) - Distributions real estate joint ventures 72 - Decrease in other assets 11,518 410 Decrease in other liabilities (6,553) (4,460) ------------ ---------- Net cash provided by operating activities 29,711 155,078 ------------ ---------- Cash flows from investing activities: Purchase of securities available for sale (1,312,487) (217,260) Funding of commercial mortgage loans (78,600) (28,261) Maturities of restricted cash equivalents - 3,242 Net payments from hedging securities (4,405) - Investment in real estate joint ventures (5,121) - Principal payments received on securities available for sale 63,951 63,436 Proceeds from sales of securities available for sale 2,122,735 45,367 Payable for securities purchased - 88,133 ------------ ---------- Net cash provided by (used in) investing activities 786,073 (45,343) ------------ ---------- Cash flows from financing activities: Net decrease in borrowings (831,774) (89,881) Proceeds from issuance of common stock - 6,726 Distributions on common stock (18,839) (17,973) Distributions on preferred stock (3,251) - Net cash acquired in merger 33,380 - Acquisition costs paid (4,129) - Repurchase of common shares (39) - ------------ ---------- Net cash used in financing activities (824,652) (101,128) ------------ ---------- Net (decrease) increase in cash and cash equivalents (8,868) 8,607 Cash and cash equivalents, beginning of period 22,265 1,087 ------------ ---------- Cash and cash equivalents, end of period $ 13,397 $ 9,694 ============ ========== $ 41,546 $ 21,675 Supplemental disclosure of cash flow information: Interest paid
Supplemental schedule of non-cash investing and financing activities: The Company purchased all of the assets of CORE Cap., Inc during the quarter ended June 30, 2000 primarily through issuance of the Company's common and preferred stock, as follows: Fair value of assets acquired $ 1,281,070 Liabilities assumed 1,216,967 Common stock issued in connection with acquisition 28,089 Preferred stock issued in connection with the acquisition 43,004 The accompanying notes are an integral part of these financial statements. ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Anthracite Capital, Inc. (the "Company") was incorporated in Maryland in November, 1997 and commenced operations on March 24, 1998. The Company's principal business activity is to invest in a diversified portfolio of multifamily, commercial and residential mortgage loans, mortgage-backed securities and other real estate related assets in the U.S. and non-U.S. markets. The Company is organized and managed as a single business segment. 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 for complete financial statements. These financial statements should be read in conjunction with the annual financial statements and notes thereto included in the Company's annual report on Form 10-K for 1999 filed with the Securities and Exchange Commission. In the opinion of management, the accompanying financial statements contain all adjustments, consisting of normal and recurring accruals, necessary for a fair presentation of the results for the interim periods. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the statements of financial condition and revenues and expenses for the periods covered. Actual results could differ from those estimates and assumptions. Significant estimates in the financial statements include the valuation of the Company's mortgage-backed securities and certain other investments. A summary of the Company's significant accounting policies follows: PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiaries. All significant balances and transactions have been eliminated in consolidation. SECURITIES AVAILABLE FOR SALE The Company has designated its investments in mortgage-backed securities, mortgage-related securities and certain other securities as assets available for sale because the Company may dispose of them prior to maturity. Securities available for sale are carried at estimated fair value with the net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses on securities that reflect a decline in value which is judged by management to be other than temporary, if any, are charged to earnings. At disposition the realized net gain or loss is included in income on a specific identification basis. The amortization of premiums and accretion of discounts are computed using the effective yield method after considering actual and estimated prepayment rates, if applicable, and credit losses. Actual prepayment and credit loss experience is reviewed quarterly and effective yields are recalculated when differences arise between prepayments and credit losses originally anticipated and amounts actually received plus anticipated future prepayments and credit losses. The Company may, in the future, acquire similar securities that it intends to hold to maturity, or change its intent with respect to certain securities currently in its portfolio, and designate such securities as "held to maturity." Securities so designated would be carried at amortized cost, subject to an impairment test. SECURITIES HELD FOR TRADING The Company has designated certain securities as assets held for trading because the Company intends to hold them for short periods of time. Securities held for trading are carried at estimated fair value with net unrealized gains or losses included in income. MORTGAGE LOANS The Company purchases and originates certain commercial mortgage loans to be held as long-term investments. Loans held for long-term investment are recorded at cost at the date of purchase. Premiums and discounts related to these loans are amortized over their estimated lives using the effective interest method. Any origination fee income, application fee income and direct costs associated with originating or purchasing commercial mortgage loans are deferred and the net amount is included in the basis of the loans on the statement of financial condition. The Company recognizes impairment on the loans when it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company measures impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The Company acquired certain residential mortgage loan pools in the CORE Cap merger (Note 2). These loan pools may be sold in the near term and are treated as available-for-sale debt securities and are carried at estimated fair value with net unrealized gains or losses reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Unrealized losses that reflect a decline in value which is judged by management to be other than temporary, if any, are charged to earnings. INVESTMENT IN REAL ESTATE JOINT VENTURES Investments in real estate entities over which the Company exercises significant influence, but not control, are accounted for under the equity method. The Company recognizes its share of each venture's income or loss, and reduces its investment balance by distributions received. Real estate held by such entities is regularly reviewed for impairment, and would be written down to its estimated fair value if impairment is determined to exist. SHORT SALES As part of its short-term trading strategies (see Note 4), the Company may sell securities that it does not own ("short sales"). To complete a short sale, the Company may arrange through a broker to borrow the securities to be delivered to the buyer. The proceeds received by the Company from the short sale are retained by the broker until the Company replaces the borrowed securities, generally within a period of less than one month. In borrowing the securities to be delivered to the buyer, the Company becomes obligated to replace the securities borrowed at their market price at the time of the replacement, whatever that price may be. A gain, limited to the price at which the Company sold the security short, or a loss, unlimited as to dollar amount, will be recognized upon the termination of a short sale if the market price is less than or greater than the proceeds originally received. The Company's liability under the short sales is recorded at fair value, with unrealized gains or losses included in net gain or loss on securities held for trading in the statement of operations. The Company is exposed to credit loss in the event of nonperformance by any broker that holds a deposit as collateral for securities borrowed. However, the Company does not anticipate nonperformance by any broker. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values of the Company's securities available for sale, securities held for trading, and securities sold short are based on market prices provided by certain dealers who make markets in these financial instruments. The fair values reported reflect estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange. FORWARD COMMITMENTS As part of its short-term trading strategies (see Note 4), the Company may enter into forward commitments to purchase or sell U.S. Treasury or agency securities, which obligate the Company to purchase or sell such securities at a specified date at a specified price. When the Company enters into such a forward commitment, it will, generally within sixty days or less, enter into a matching forward commitment with the same or a different counterparty which entitles the Company to sell (in instances where the original transaction was a commitment to purchase) or purchase (in instances where the original transaction was a commitment to sell) the same or similar securities on or about the same specified date as the original forward commitment. Any difference between the specified price of the original and matching forward commitments will result in a gain or loss to the Company. Changes in the fair value of open commitments are recognized on the statement of financial condition and included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). A corresponding amount is included as a component of net gain or loss on securities held for trading in the statement of operations. The Company is exposed to interest rate risk on these commitments, as well as to credit loss in the event of nonperformance by any other party to the Company's forward commitments. However, the Company does not anticipate nonperformance by any counterparty. FINANCIAL FUTURES CONTRACTS - TRADING As part of its short-term trading strategies (see Note 4), the Company may enter into financial futures contracts, which are agreements between two parties to buy or sell a financial instrument for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period that the futures contract is open, changes in the value of the contract are recognized as gains or losses on securities held for trading by "marking-to-market" on a daily basis to reflect the market value of the contract at the end of each day's trading. Variation margin payments are received or made, depending upon whether gains or losses are incurred. The Company is exposed to interest rate risk on the contracts, as well as to credit loss in the event of nonperformance by any other party to the contract. However, the Company does not anticipate nonperformance by any counterparty. HEDGING INSTRUMENTS As part of its asset/liability management activities, the Company may enter into interest rate swap agreements, forward currency exchange contracts and other financial instruments in order to hedge interest rate and foreign currency exposures or to modify the interest rate or foreign currency characteristics of related items in its statement of financial condition. The Company's portfolio of interest rate swap agreements involves the exchange of fixed interest payments for floating interest payments. Income and expenses from interest rate swap agreements that are, for accounting purposes, designated as hedging securities available for sale are recognized as a net adjustment to the interest income of the hedged item. During the term of the interest rate swap agreement, changes in fair value are recognized on the statement of financial condition and included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). A corresponding amount is included as a component of accumulated other comprehensive income (loss) in stockholders' equity. The Company accounts for revenues and expenses from the interest rate swap agreements under the accrual basis over the period to which the payment relates. Amounts paid to acquire these instruments are capitalized and amortized over the life of the instrument. Amortization of capitalized fees paid as well as payments received under these agreements are recorded as an adjustment to interest income. If the underlying hedged securities are sold, the amount of unrealized gain or loss in accumulated other comprehensive income (loss) relating to the corresponding interest rate swap agreement is included in the determination of gain or loss on the sale of the securities. If interest rate swap agreements are terminated, the associated gain or loss is deferred over the remaining term of the agreement, provided that the underlying hedged item still exists. Revenues and expenses from forward currency exchange contracts are recognized as a net adjustment to foreign currency gain or loss. During the term of the forward currency exchange contracts, changes in fair value are recognized on the statement of financial condition and included among assets (if there is an unrealized gain) or among liabilities (if there is an unrealized loss). A corresponding amount is included as a component of net foreign currency gain or loss in the statement of operations. Financial futures contracts that are, for accounting purposes, designated as hedging securities available for sale, are carried at fair value, with changes in fair value included in other comprehensive income (loss). Realized gains and losses on closed contracts are deferred and recognized in the basis of the hedged available for sale security, and amortized as a yield adjustment over the security's remaining term. The Company monitors its hedging instruments throughout their terms to ensure that they remain effective at their intended purpose. The Company is exposed to interest rate and/or currency risk on these hedging instruments, as well as to credit loss in the event of nonperformance by any other party to the Company's hedging instruments. However, the Company does not anticipate nonperformance by any counterparty. FOREIGN CURRENCIES Assets and liabilities denominated in foreign currencies are translated at the exchange rate in effect on the date of the statement of financial condition. Revenues, costs, and expenses denominated in foreign currencies are translated at average rates of exchange prevailing during the period. Foreign currency gains and losses resulting from this process are recognized in earnings. NEGATIVE GOODWILL Negative goodwill reflects the excess of the estimated fair value of the net assets acquired in the CORE Cap Inc. merger (Note 2) over the purchase price for such assets. Negative goodwill is amortized using the straight-line method from the date of acquisition over approximately 5.7 years, the weighted average lives of the assets acquired in the merger that the Company currently intends to retain. This amortization is included in other expenses/(income) - net. Negative goodwill, net, was $9,050 at September 30, 2000, and is included in other liabilities. NET INCOME (LOSS) PER SHARE Net income per share is computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share. Basic income (loss) per share is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted income (loss) per share is calculated using the weighted average number of common shares outstanding during the period plus the additional dilutive effect of common stock equivalents. The dilutive effect of outstanding stock options is calculated using the treasury stock method, and the dilutive effect of preferred stock is calculated using the "if converted" method.
For the Three Months Ended September 30, 2000 --------------------------------------------------------------------------------- Income Shares Per-Share (Numerator) (Denominator) Amount Net income available to common shareholders $9,070 -------------------------- Basic net income per share 9,070 25,135,986 $0.36 ------------------------ Effect of dilutive securities: 10.5% Series A Senior Cumulative Redeemable Preferred Stock 893 4,081,680 ------------------------------------------------------ Diluted net income per share $9,963 29,217,666 $0.34 ================================================================================= For the Nine Months Ended September 30, 2000 --------------------------------------------------------------------------------- Income Shares Per-Share (Numerator) (Denominator) Amount Net income available to common shareholders $23,290 -------------------------- Basic net income per share 23,290 23,068,624 $1.01 ------------------------ Effect of dilutive securities: 10.5% Series A Senior Cumulative Redeemable Preferred Stock 2,627 4,081,680 ------------------------------------------------------- Diluted net income per share $25,917 27,150,304 $0.95 ===============================================================================
The Company's stock options outstanding were antidilutive for all periods presented. For the three and nine months ended September 30, 1999, the Company had no preferred stock outstanding, so basic and diluted earnings per share were the same. INCOME TAXES The Company has elected to be taxed as a Real Estate Investment Trust ("REIT") and to comply with the provisions of the Internal Revenue Code of 1986, as amended, with respect thereto. Accordingly, the Company generally will not be subject to Federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and stock ownership tests are met. As of December 31, 1999, the Company had a capital loss carryover of $13,165 available to offset future capital gains. COMPREHENSIVE INCOME SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify items of "other comprehensive income", such as unrealized gains and losses on securities available for sale, by their nature in the financial statements and display the accumulated balance of other comprehensive income (loss) separately from retained earnings and additional paid-in capital in the stockholders' equity section of the statement of financial condition. In accordance with SFAS No. 130, cumulative unrealized gains and losses on securities available for sale are classified as accumulated other comprehensive income (loss) in stockholders' equity and current period unrealized gains and losses are included as a component of comprehensive income (loss). RECENT ACCOUNTING PRONOUNCEMENTS During 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that the Company recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge of the exposure to changes in the fair value of a recognized asset or liability, or a hedge of the exposure to variable cash flows. The accounting for changes in the fair value of a derivative (e.g., through earnings or outside of earnings, through comprehensive income) depends on the intended use of the derivative and the resulting designation. The Company will implement SFAS 133 (as amended by SFAS No. 137 and 138) on January 1, 2001. Company management is evaluating the impact that this statement will have on its hedging strategies and use of derivative instruments and is currently unable to predict the effect, if any, it will have on the Company's financial statements. In December of 1999, the staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." This bulletin summarizes certain of the staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company's management believes that the guidance expressed in the bulletin does not affect the Company's current revenue recognition policies. In July of 2000, the FASB's Emerging Issues Task Force reached a consensus on Issue 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Interests. This issue provides guidance on the appropriate methodology to be used in recognizing changes in the estimated yield on asset-backed securities, and in determining whether impairment exists. This consensus is to be applied in the first quarter of 2001. The Company's management does not believe that application of this consensus will have a material impact on the Company's financial statements, but it may require earlier recognition of impairment of CMBS investments than under previous guidance, should the Company experience credit losses on the loans underlying a CMBS investment in amounts greater than anticipated at acquisition. In September of 2000, the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. This statement replaces SFAS No. 125, which had the same name. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most SFAS No. 125's provisions without consideration. The Company's management does not believe that application of this statement will have a material impact on the Company's financial statements. RECLASSIFICATIONS Certain amounts from 1999 have been reclassified to conform to the 2000 presentation. NOTE 2 ACQUISITION OF CORE CAP, INC. On May 15, 2000, the Company acquired all of the outstanding capital stock of CORE Cap, Inc. ("CORE Cap"), a private real estate investment trust investing in mortgage loans and mortgage-backed securities, in exchange for 4,180,553 of the Company's common shares and 2,261,000 Series B preferred shares. The common and preferred shares issued by the Company were valued at approximately $71,093 on May 15, 2000. The acquisition was accounted for under the purchase method. Application of purchase accounting resulted in an excess of the value of the acquired net assets over the value of the Company's common and preferred shares issued in the acquisition, plus transaction costs. This deferred credit totaled $9,687 and is being amortized as described in "Negative Goodwill" above. The operations of CORE Cap are included in the Company's financial statements from May 15, 2000. NOTE 3 SECURITIES AVAILABLE FOR SALE The Company's securities available for sale are carried at estimated fair value. The amortized cost and estimated fair value of securities available for sale as of September 30, 2000 are summarized as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Security Description Cost Gain Loss Value - ------------------------------------------------------------------------------------------------------------------------------ Commercial mortgage-backed securities ("CMBS"): Investment grade rated securities $ 154,972 $ 9,259 - $164,231 Non-investment grade rated subordinated securities 340,430 112 $ (86,572) 253,970 Non-rated subordinated securities 38,360 475 (8,667) 30,168 ------------------------------------------------------------- Total CMBS 533,762 9,846 (95,239) 448,369 ------------------------------------------------------------- Single-family residential mortgage-backed securities ("RMBS"): Agency adjustable rate securities 112,720 329 (11) 113,038 Agency fixed rate securities 205,727 661 (1,306) 205,082 Privately issued investment grade rated fixed rate securities 124,892 1,404 (965) 125,331 ------------------------------------------------------------- Total RMBS 443,339 2,394 (2,282) 443,451 ------------------------------------------------------------- Total securities available for sale $977,101 $12,240 $ (97,521) $891,820 =============================================================
As of September 30, 2000, an aggregate of $866,253 in estimated fair value of the Company's securities available for sale was pledged to secure its borrowings. The amortized cost and estimated fair value of securities available for sale as of December 31, 1999 are summarized as follows:
Gross Gross Estimated Amortized Unrealized Gain Unrealized Fair Security Description Cost Loss Value - ----------------------------------------------------------------------------------------------------------------------------- Commercial mortgage-backed securities ("CMBS"): Non-investment grade rated subordinated securities $ 334,162 - $ (90,454) $ 243,708 Non-rated subordinated securities 38,882 - (9,857) 29,025 ------------------------------------------------------------- Total CMBS 373,044 - (100,311) 272,733 ------------------------------------------------------------- Single-family residential mortgage-backed securities ("RMBS"): Agency adjustable rate securities 57,826 $ 1,032 - 58,858 Agency fixed rate securities 166,323 - (498) 165,825 Privately issued investment grade rated fixed rate securities 78,091 - (1,270) 76,821 ------------------------------------------------------------- Total RMBS 302,240 1,032 (1,768) 301,504 ------------------------------------------------------------- Agency insured project loan 3,050 - (92) 2,958 ------------------------------------------------------------- Total securities available for sale $ 678,334 $ 1,032 $ (102,171) $ 577,195 =============================================================
At December 31, 1999, an aggregate of $392,831 in estimated fair value of the Company's securities available for sale was pledged to secure its borrowings. The aggregate estimated fair value by underlying credit rating of the Company's securities available for sale at September 30, 2000 is as follows:
September 30, 2000 December 31, 1999 Estimated Estimated Security Rating Fair Value Percentage Fair Value Percentage --------------------------------------------------------------------------------------------------------- Agency and agency insured securities $318,121 35.6% $227,641 39.5% AAA 125,330 14.0 76,821 13.3 BBB 164,231 18.4 - - BB+ 25,841 2.9 23,103 4.0 BB 25,496 2.9 22,051 3.8 BB- 47,273 5.3 50,412 8.7 B+ 14,792 1.7 14,173 2.5 B 85,333 9.6 84,830 14.7 B- 37,580 4.2 32,770 5.7 CCC 17,655 2.0 16,368 2.8 Not rated 30,168 3.4 29,026 5.0 ----------------------------------------------------------------- Total securities available for sale $ 891,820 100.0% $ 577,195 100.0% =================================================================
As of September 30, 2000, there were 1,761 loans underlying the subordinated CMBS held by the Company with a principle balance of $9,232,035. As of September 30, 2000 the mortgage loans underlying the subordinated CMBS held by the Company were secured by properties of the types and at the locations identified below: Property Type Percentage (1) Geographic Location Percentage (1) - ------------------------------------------------------------------------------- Multifamily 27.0% California 13.4% Retail 29.9 Texas 10.4 Office 16.8 New York 9.7 Lodging 9.5 Florida 7.0 Other 16.8 Other (2) 59.5 ------------------- ------------- Total 100.0% Total 100.0% =================== ============= (1) Based on a percentage of the total unpaid principal balance of the underlying loans. (2) No other individual state comprises more than 5% of the total. The following table sets forth certain information relating to the aggregate principal balance and payment status of delinquent mortgage loans underlying the subordinated CMBS held by the Company as of September 30, 2000 and December 31, 1999:
- ------------------------------------------------------------------------------------------------------------------------------ SEPTEMBER 30, 2000 DECEMBER 31, 1999 - ------------------------------------------------------------------------------------------------------------------------------ NUMBER OF % OF NUMBER OF % OF PRINCIPAL LOANS COLLATERAL PRINCIPAL LOANS COLLATERAL - ------------------------------------------------------------------------------------------------------------------------------ Past due 30 days to 60 days $11,167 5 0.14% $2,936 2 0.03% - ------------------------------------------------------------------------------------------------------------------------------ Past due 60 days to 90 days 18,527 3 0.18% 13,522 3 0.14% - ------------------------------------------------------------------------------------------------------------------------------ Past due 90 days or more 13,601 3 0.16% 34,631 6 0.36% - ------------------------------------------------------------------------------------------------------------------------------ Resolved Loans - - - 22,296 1 0.24% - ------------------------------------------------------------------------------------------------------------------------------ REO 10,181 2 0.11% - - - - ------------------------------------------------------------------------------------------------------------------------------ Total $53,476 12 0.59% $73,385 11 0.77% - ------------------------------------------------------------------------------------------------------------------------------
The Company's delinquency experience of 0.59% is in line with directly comparable collateral experience shown in the Lehman Brothers 1998 CMBS index at 0.57%. (See Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations for further information regarding delinquent mortgage loans). To the extent that realized losses, if any, or such resolutions are significantly worse than the Company's original loss estimates, it may be necessary to reduce the projected yield on the applicable CMBS investment to better reflect such investment's expected earnings net of expected losses, from the date of purchase. Such events would also indicate impairment of the affected asset, requiring the Company to write it down to its estimated fair value. While realized losses on individual assets may be higher or lower than original estimates, the Company currently believes its aggregate loss estimates and yields are appropriate. The CMBS held by the Company consist of subordinated securities collateralized by adjustable and fixed rate commercial and multifamily mortgage loans. The RMBS held by the Company consist of adjustable rate and fixed rate residential pass-through or mortgage-backed securities collateralized by adjustable and fixed rate single-family residential mortgage loans. Agency RMBS were issued by Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) or Government National Mortgage Association (GNMA). Privately issued RMBS were issued by entities other than FHLMC, FNMA or GNMA. The Company's securities available for sale are subject to credit, interest rate and/or prepayment risks. The CMBS owned by the Company provide credit support to the more senior classes of the related commercial securitization. Cash flow from the mortgages underlying the CMBS generally is allocated first to the senior classes, with the most senior class having a priority entitlement to cash flow. Then, any remaining cash flow is allocated generally among the other CMBS classes in order of their relative seniority. To the extent there are defaults and unrecoverable losses on the underlying mortgages, resulting in reduced cash flows, the most subordinated CMBS class will bear this loss first. To the extent there are losses in excess of the most subordinated class' stated entitlement to principal and interest, then the remaining CMBS classes will bear such losses in order of their relative subordination. As of September 30, 2000, the anticipated weighted average unleveraged yield to maturity based upon adjusted cost of the Company's subordinated CMBS was 9.82% per annum, and of the Company's other securities available for sale was 7.94% per annum. The Company's anticipated yields to maturity on its subordinated CMBS and other securities available for sale are based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples of these include, among other things, the rate and timing of principal payments (including prepayments, repurchases, defaults and liquidations), the pass-through or coupon rate and interest rate fluctuations. Additional factors that may affect the Company's anticipated yields to maturity on its subordinated CMBS include interest payment shortfalls due to delinquencies on the underlying mortgage loans, and the timing and magnitude of credit losses on the mortgage loans underlying the subordinated CMBS that are a result of the general condition of the real estate market (including competition for tenants and their related credit quality) and changes in market rental rates. As these uncertainties and contingencies are difficult to predict and are subject to future events, which may alter these assumptions, no assurance can be given that the anticipated yields to maturity, discussed above and elsewhere, will be achieved. The agency adjustable rate RMBS held by the Company are subject to periodic and lifetime caps that limit the amount such securities' interest rates can change during any given period and over the life of the loan. As of September 30, 2000, the unamortized net discount on securities available for sale was $1,025,201 which represented 36.81% of the then remaining face amount of such securities. During the nine months ended September 30, 2000, the Company sold securities available for sale for total proceeds of $2,122,735 resulting in a realized gain of $1,700. Of the securities sold, $1,806,022 of sales proceeds represents securities acquired in the CORE Cap merger. Any gain on the sale of securities acquired in the CORE Cap merger was attributable to market movements subsequent to the acquisition of such securities. NOTE 4 SECURITIES HELD FOR TRADING Securities held for trading reflect short-term trading strategies, which the Company employs from time to time, designed to generate economic and taxable gains. As part of its trading strategies, the Company may acquire long or short positions in U.S. Treasury or agency securities, forward commitments to purchase such securities, financial futures contracts and other fixed income or fixed income derivative securities. Any taxable gains from such strategies will be applied as an offset against the tax basis capital loss carry forward that the Company incurred during 1998 as a result of the sale of a substantial portion of its securities available for sale. The Company's securities held for trading are carried at estimated fair value. As of September 30, 2000 and December 31, 1999, the Company did not have any long or short positions in securities held for trading. During the nine months ended September 30, 2000 and September 30, 1999, aggregate net realized gains on securities held for trading were $519 and $2,992, respectively. The Company's trading strategies are subject to the risk of unanticipated changes in the relative prices of long and short positions in trading securities, but are designed to be relatively unaffected by changes in the overall level of interest rates. NOTE 5 COMMERCIAL MORTGAGE LOANS In August 1998, the Company along with a syndicate of other lenders originated a loan secured by a second lien on five luxury hotels in London, England and the surrounding vicinity (The "London Loan"). The loan has a five-year maturity and may be prepaid at any time. The London Loan is denominated in pounds sterling and bears interest at a rate based upon the London Interbank Offered Rate (LIBOR) for pounds sterling plus approximately 4%. The Company's investment in the London Loan is carried at amortized cost and translated into U.S. dollars at the exchange rate in effect on the reporting date. The amortized cost and certain additional information with respect to the Company's investment in the London Loan as of September 30, 2000, and December 31, 1999 (at the exchange rates in effect on such dates) are summarized as follows:
September 30, 2000 December 31, 1999 - ---------------------------------------------------------------------------------------------------------------------------- Interest Principal Unamortized Amortized Principal Unamortized Amortized Rate Balance Discount Cost Interest Balance Discount Cost Rate - ----------------------------------------------------------------------------------------------------------------------- 10.21% $31,480 $49 $31,431 10.11% $ 34,680 $67 $34,613
The exchange rate for the British pound at September 30, 2000 was (pound)0.681663 to US $1.00; at December 31, 1999 the exchange rate was (pound)0.61908. The entire principal balance of the Company's investment in the London Loan is pledged to secure line of credit borrowings. The borrower has made all payments when due. Toward the end of the first quarter of 2000, the Company funded a $30,600 subordinated participation in a first mortgage secured by a commercial office building located in New York City (the "Commercial Office Building Loan"). The Commercial Office Building Loan matures December, 2001, and payments are interest only based upon LIBOR plus approximately 6.5%. The Company will receive a 50 basis point exit fee related to the Commercial Office Building Loan, which is being amortized into interest income over the life of such loan. The entire principal balance of the Company's investment in the Commercial Office Building Loan is pledged to secure line of credit borrowings. As of September 30, 2000, the interest rate on the Commercial Office Building Loan was 13.18%, and the borrower has made all payments when due. During 1999, the Company funded its entire commitment, $35,000, under a floating rate commercial real estate construction loan secured by a second mortgage on an office complex located in Santa Monica, California (the "Santa Monica Loan"). The Santa Monica Loan matures August 2001, and payments are interest only, based upon LIBOR plus approximately 6.5%. The Santa Monica Loan provides for two one-year extensions through August 2003 at the borrower's option, subject to property performance. The Company received a $175 commitment fee relating to the commitment, which is being amortized into income over the expected two-and-one-half year life of such loan. The entire principal balance of the Santa Monica Loan is pledged to secure borrowings under a term financing agreement. As of September 30, 2000, the interest rate on the Santa Monica Loan was 13.13% and the borrower had made all payments when due. On August 15, 2000 the Company purchased an $18,000 mezzanine loan, secured by a lien on the borrower's interest in the Westin St. Francis Hotel, located in San Francisco, California (the "San Francisco Loan"). The loan matures on May 1, 2003, and may be extended by the borrower for two additional twelve-month periods. Payments are interest only based upon LIBOR plus 6.5%. Beginning June 1, 2001, principal payments will be required, based on a 25 year amortization schedule. As of September 30, 2000, the interest rate on the San Francisco Loan was 13.12% and the borrower has made all payments when due. On September 22, 2000 the Company funded a $15,000 senior mezzanine loan (the "Senior Chicago Loan") and a $15,000 junior mezzanine loan (the "Junior Chicago Loan"). These loans are secured by a second mortgage on a condominium conversion project in Chicago, Illinois, two land parcels, as well as the borrower's partnership interest. The Senior Chicago Loan has a four-month term, which may be extended in 90-day increments for up to one year at the borrower's option. The Junior Chicago Loan has a 24-month term, which may be extended in six-month increments for up to 36 months at the borrower's option. Both loans may be prepaid at any time. Payments are interest only based at 12%. Additional interest of 8% is due upon pay-off of each loan. NOTE 6 INVESTMENT IN REAL ESTATE JOINT VENTURES On July 20, 2000 the Company made an investment aggregating $5,121 in two limited partnerships for the purpose of purchasing a 99 thousand square foot office building and a 120 thousand square foot office building, both of which are located in located in suburban Philadelphia. The Company's ownership interest is 64.81% in each partnership. NOTE 7 COMMON STOCK On January 5, 2000, the Company repurchased 6,100 shares of its common stock for $39 in open market transactions. This purchase was made at a price of $6.42 per share (including commissions). The remaining number of shares authorized for repurchase is 2,713,519. In accordance with Maryland corporate regulations, all repurchased shares are retired. On March 31, 1999 the Company filed a $200,000 shelf registration statement with the SEC. The shelf registration statement will permit the Company to issue a variety of debt and equity securities in the public markets should appropriate opportunities arise. On March 16, May 22 and September 14, 2000, the Company declared distributions to its common shareholders of $0.29 per share, payable on April 28, July 28, and October 31, 2000 to stockholders of record on March 31, June 30, and September 29, 2000 respectively. For U.S. Federal income tax purposes, the dividends are ordinary income to the Company's stockholders. As part of the CORE Cap merger, the Company issued 4,180,552 shares of its common stock to CORE Cap shareholders. NOTE 8 PREFERRED STOCK On December 2, 1999 the Company authorized and issued 1,200,000 shares of 10.5% Series A Senior Cumulative Redeemable Preferred Stock ("Series A Preferred Stock"), $0.001 par value per share, for aggregate proceeds of $30,000. The Series A Preferred Stock carries a 10.5% coupon and is convertible into the Company's common stock at a price of $7.35. The Series A Preferred Stock has a seven-year maturity at which time, at the option of the holders, the shares may be converted into common shares or liquidated ("Liquidation Preference") for $28.50 per share. If converted, the Series A Preferred Stock would convert into approximately 4 million shares of the Company's common stock. The difference between the liquidation price and the proceeds received totals $4,200, and is being accreted to the carrying value of the Series A Preferred Stock over its seven-year life. The Series A Preferred Stock was privately placed by the Company, and there was no underwriting discount paid. At the closing of the CORE Cap merger, the Liquidation Preference was increased from $27.75 to $28.50 per share. As part of the CORE Cap merger, the Company authorized and issued 2,261,000 shares of 10% Series B Cumulative Redeemable Convertible Preferred Stock ("Series B Preferred Stock"), $0.001 par value per share to CORE Cap shareholders. The Series B Preferred Stock is perpetual, carries a 10% coupon, has a preference in liquidation of $56,025, and is convertible into the Company's common stock at a price of $17.09 per share, subject to adjustment. As of September 30, 2000, the Company has authorized and unissued preferred stock of 96,539,003 shares. NOTE 9 TRANSACTIONS WITH AFFILIATES The Company has a Management Agreement (the "Management Agreement") with BlackRock Financial Management, Inc. (the "Manager"), a majority owned indirect subsidiary of PNC Bank Corp. ("PNC") and the employer of certain directors and officers of the Company, under which the Manager manages the Company's day-to-day operations, subject to the direction and oversight of the Company's Board of Directors. The initial two year term of the Management Agreement was to expire on March 20, 2000; on March 16, 2000, the Management Agreement was extended for an additional two years, with the approval of a majority of the unaffiliated directors, on terms similar to the prior agreement. The Company pays the Manager an annual base management fee equal to a percentage of the average invested assets of the Company as defined in the Management Agreement. The base management fee is equal to 1% per annum of the average invested assets rated less than BB- or not rated, 0.75% of average invested assets rated BB- to BB+, and 0.35% of average invested assets rated above BB+. The Company accrued $2,060, $1,050, $5,050 and $3,173 in base management fees in accordance with the terms of the Management Agreement for the three months and nine months ended September 30, 2000 and September 30, 1999 respectively. In accordance with the provisions of the Management Agreement, the Company will reimburse the Manager for certain expenses incurred on behalf of the Company by the Manager. No expense reimbursement was incurred during the nine months ended September 30, 2000 and 1999. The Company will also pay the Manager, as incentive compensation, an amount equal to 25% of the funds from operations of the Company (as defined) plus gains (minus losses) from debt restructuring and sales of property, before incentive compensation, in excess of the amount that would produce an annualized return on equity equal to 3.5% over the Ten-Year U.S. Treasury Rate as defined in the Management Agreement. For purposes of the incentive compensation calculation, equity is generally defined as proceeds from issuance of common stock before underwriting discounts and commissions and other costs of issuance. The Company incurred $461 in incentive compensation for the three months and nine months ended September 30, 2000. The Company did not pay incentive compensation for the three months and nine months ended September 30, 1999. On March 17, 1999, the Company's Board of Directors approved an administration agreement with the Manager and the termination of a previous agreement with an unaffiliated third party. Under the terms of the administration agreement, the Manager provides financial reporting, audit coordination and accounting oversight services. The Company pays the Manager a monthly administrative fee at an annual rate of 0.06% of the first $125 million of average net assets, 0.04% of the next $125 million of average net assets and 0.03% of average net assets in excess of $250 million subject to a minimum annual fee of $120. The terms of the administrative agreement are substantially similar to the terms of the previous third-party agreement. For both the three months ended September 30, 2000 and September 30, 1999, the administration fee was $30. For both the nine months ended September 30, 2000 and September 30, 1999, the administration fee was $90. During the nine months ended September 30, 2000, the Company purchased certificates representing a 1% interest in Midland Commercial Mortgage Owner Trust IV, Midland Commercial Mortgage Owner Trust V, Midland Commercial Mortgage Owner Trust VI, and Midland Commercial Mortgage Owner Trust VII for $1,649, $851, $557 and $2,376 respectively. These Trusts were purchased from Midland Loan Services, Inc. ("Midland"), a wholly owned indirect subsidiary of PNC and the depositor to the Trusts. The assets of the Trusts consist of commercial mortgage loans originated or acquired by Midland. In connection with these transactions, the Company entered into a $4,500 committed line of credit from PNC Funding Corp., a wholly owned indirect subsidiary of PNC, to borrow up to 90% of the fair market value of the Company's interest in the Trusts. Outstanding borrowings against this line of credit bear interest at a LIBOR based variable rate. The Company earned $163 and $33 from the Trusts and paid interest of approximately $115 and $28 to PNC Funding Corp. during the nine and three months ended September 30, 2000 and September 30, 1999, respectively. These investments were all sold subsequent to September 30, 2000. The gain on sale of these investments was not significant. NOTE 10 STOCK OPTIONS The Company has adopted a stock option plan (the "1998 Stock Option Plan") that provides for the grant of both qualified incentive stock options that meet the requirements of Section 422 of the Code, and non-qualified stock options, stock appreciation rights and dividend equivalent rights. Stock options may be granted to the Manager, directors, officers and any key employees of the Company, directors, officers and key employees of the Manager and to any other individual or entity performing services for the Company. The exercise price for any stock option granted under the 1998 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. Each option must terminate no more than ten years from the date it is granted. Subject to anti-dilution provisions for stock splits, stock dividends and similar events, the 1998 Stock Option Plan authorizes the grant of options to purchase an aggregate of up to 2,470,453 shares of common stock. Pursuant to the 1998 Stock Option Plan, during 1998 certain officers, directors and employees of the Company and the Manager were granted options to purchase 1,163,967 shares of the Company's common stock and PNC Investment Corp., a wholly owned indirect subsidiary of PNC, was granted options to purchase 324,176 shares of the Company's common stock. The exercise price of these options is $15 per share. The remaining contractual life of each option is approximately 7.4 years at September 30, 2000. One half of these options, representing 744,072 shares, vested on March 31, 2000; the remaining options vest in equal installments on March 27, 2001 and March 27, 2002. 125,000 of these options have been terminated and none have been exercised as of September 30, 2000. During 1999 pursuant to the 1998 Stock Option Plan, options to purchase 270,000 shares of the Company's common stock were granted to certain officers of the Company and employees of the Manager who provide services to the Company. The exercise price of these options is $8.44 per share. The remaining contractual life of each option is approximately 8.4 years at September 30, 2000. One half of these options vested on March 31, 2000 and the remainder will vest on March 31, 2001. 40,000 of these options were terminated and none have been exercised as of September 30, 2000. In addition to the foregoing, in 2000 pursuant to the 1998 Stock Option Plan, options to purchase 70,000 shares of the Company's common stock were granted to certain officers of the Company and employees of the Manager who provide services to the Company. The exercise price of these options is $8.02 per share. The remaining contractual life of each option is approximately 9.4 years at September 30, 2000. The options vest in two equal installments on March 31, 2001 and March 31, 2002. 20,000 of these options were terminated as of September 30, 2000, and none have been exercised. In addition to the foregoing, on May 15, 2000 pursuant to the acquisition of CORE Cap, the Company granted stock options on the Company's stock to the directors of CORE Cap similar in term and vesting to the stock options the directors held immediately prior to the date of acquisition. The strike price was adjusted for the effect of the acquisition. The options granted are as follows: Number of Options Exercise % Granted Price Vested - --------------------------------------------------------- 76,998 15.58 66% 15,400 15.84 100% 15,400 9.11 100% 15,400 7.82 100% The fair value of the CORE-Cap option grants at the grant date was estimated by the Company using the Black-Scholes option-pricing model; the resulting valuation was negligible. None of these options have been terminated or exercised as of September 30, 2000. NOTE 11 BORROWINGS The Company's borrowings consist of lines of credit borrowings and reverse repurchase agreements. In September of 2000, the Company closed a $200,000, one year term facility with Merrill Lynch Mortgage Capital Inc. ("Merrill Lynch") which will be used to finance the Company's residential loan pools. As of September 30, 2000 outstanding borrowings under this facility were $34,464. Outstanding borrowings under this facility bear interest at a LIBOR based variable rate. The Company has another agreement with Merrill Lynch which permits the Company to borrow up to $200,000. As of September 30, 2000 and December 31, 1999, the outstanding borrowings under this line of credit were $60,810 and $64,575, respectively. The agreement requires assets to be pledged as collateral, which may consist of rated CMBS, rated RMBS, residential and commercial mortgage loans, and certain other assets. Outstanding borrowings under this line of credit bear interest at a LIBOR based variable rate. This facility matures on November 15, 2000. Subsequent to September 30, 2000, the Company obtained an agreement in principal from Merrill Lynch to renew the facility for a twelve month period. In June 1999, the Company closed a $17,500, three year term financing secured by the Company's $35,000 Santa Monica Loan. As of September 30, 2000 and December 31, 1999, the Company had drawn $14,131 under this loan. Outstanding borrowings under this term financing bear interest at a LIBOR based variable rate. On July 19, 1999, the Company entered into a $185,000 committed credit facility with Deutsche Bank, AG (the "Deutsche Bank Facility"). The Deutsche Bank Facility has a two-year term and provides for a one-year extension at the Company's option. The Deutsche Bank Facility can be used to replace existing reverse repurchase agreement borrowings and to finance the acquisition of mortgage-backed securities, loan investments, and real estate investments, which will be used to collateralize borrowings under the Deutsche Bank Facility. As of September 30, 2000 and December 31, 1999, the outstanding borrowings under this facility were $27,972 and $5,022, respectively. Outstanding borrowings under the Deutsche Bank Facility bear interest at a LIBOR based variable rate. In December 1999 the Company entered into a two-year $50,000 credit facility with an institutional lender. This facility can be used to finance the acquisition of mortgage-backed securities and loan investments, which are used to collateralize borrowings under this facility. As of September 30, 2000 and December 31, 1999, the Company borrowed $8,910 under this facility. Outstanding borrowings under this term financing bear interest at a LIBOR based variable rate. At the time of the CORE Cap acquisition, CORE cap was a party to commercial paper facility agreements with each of ABN Amro and Societe Generale which were used to finance residential and commercial loans, which are used to collateralize borrowings under the facilities. Following the CORE Cap acquisition, the Company has elected to renew the facility with ABN Amro, which facility is in the amount of $200,000, matures on June 18, 2001, and bears interest at a variable based LIBOR rate. As of September 30, 2000, outstanding borrowing under the ABN Amro facility was $37,503. Following the CORE Cap acquisition, the Company did not renew the facility with Societe Generale. The Company is subject to various covenants in its lines of credit, including maintaining a minimum GAAP net worth of $140,000, a debt-to-equity ratio not to exceed 4.5 to 1, a minimum cash requirement based upon certain debt to equity ratios, a minimum debt service coverage ratio of 1.5, and a minimum liquidity reserve of $10,000. Additionally, the Company's GAAP net worth cannot decline by more than 37% during the course of any two consecutive fiscal quarters. As of September 30, 2000 and December 31, 1999, the Company was in compliance with all such covenants. The Company has entered into reverse repurchase agreements to finance most of its securities available for sale that are not financed under its lines of credit. The reverse repurchase agreements are collateralized by most of the Company's securities available for sale and bear interest at a LIBOR based variable rate. Certain information with respect to the Company's collateralized borrowings at September 30, 2000 is summarized as follows:
Lines of Reverse Total Credit and Repurchase Collateralized Term Loans Agreements Borrowings ------------------------------------------------------ Outstanding borrowings $ 187,196 $662,769 $849,965 Weighted average borrowing rate 7.56% 6.88% 7.03% Weighted average remaining maturity 223 days 21 days 65 days Estimated fair value of assets pledged $ 264,790 $746,017 $1,010,807
As of September 30, 2000, $20,486 of borrowings outstanding under the lines of credit were denominated in pounds sterling and interest payable is based on sterling LIBOR. As of September 30, 2000, the Company's collateralized borrowings had the following remaining maturities: Lines of Reverse Total Credit and Repurchase Collateralized Term Loan Agreements Borrowings ------------------------------------------------------------ Within 30 days - $648,328 $648,328 31 to 59 days $ 60,810 14,441 75,251 Over 60 days 126,386 - 126,386 ------------------------------------------------------------ $187,196 $662,769 $849,965 ============================================================ Certain information with respect to the Company's collateralized borrowings as of December 31, 1999 is summarized as follows:
Lines of Reverse Total Credit and Repurchase Collateralized Term Loans Agreements Borrowings ---------------------------------------------- Outstanding borrowings $ 94,035 $ 377,498 $ 471,533 Weighted average borrowing rate 7.25% 6.32% 6.50% Weighted average remaining maturity 360 days 36 days 101 days Estimated fair value of assets pledged $133,301 $ 412,983 $ 546,284
As of December 31, 1999, $22,375 of borrowings outstanding under the line of credit were denominated in pounds sterling and interest payable based on sterling LIBOR. As of December 31, 1999, the Company's collateralized borrowings had the following remaining maturities: Lines of Reverse Total Credit and Term Repurchase Collateralized Loans Agreements Borrowings ------------------- ----------------------- ------------------ Within 30 days - $ 157,918 $ 157,918 31 to 59 days - 219,580 219,580 Over 60 days $94,035 - 94,035 ------------------- ----------------------- ------------------ $94,035 $ 377,498 $ 471,533 =================== ======================= ================== Under the lines of credit and the reverse repurchase agreements, the respective lender retains the right to mark the underlying collateral to estimated market value. A reduction in the value of its pledged assets will require the Company to provide additional collateral or fund margin calls. From time to time, the Company expects that it will be required to provide such additional collateral or fund margin calls. NOTE 12 HEDGING INSTRUMENTS As of September 30, 2000 the Company has entered into forward currency exchange contracts pursuant to which it has agreed to exchange (pound)8,000 (pounds sterling) for $12,137 (U.S. dollars) on January 18, 2001. In certain circumstances, the Company may be required to provide collateral to secure its obligations under the forward currency exchange contracts, or may be entitled to receive collateral from the counter party to the forward currency exchange contracts. At September 30, 2000, no collateral was required under the forward currency exchange contracts. The estimated fair value of the forward currency exchange contract was $282 as of September 30, 2000, which was recognized as part of net foreign currency gain. As of September 30, 2000, the Company had outstanding a long position of 298 ten-year U.S. Treasury Note future contracts expiring on December 29, 2000, which represented $29,800 in face amount of U.S. Treasury Notes. These contracts are designated as hedging certain of the Company's available-for-sale securities. The unrealized gain of these contracts was approximately $98 as of September 30, 2000 and is included in the carrying value of the hedged available-for-sale securities. During the nine months ended September 30, 2000 the Company had $2,654 of realized losses from futures contracts in U.S. Treasury securities, which increased the basis of the hedged available-for-sale securities. Interest rate swap agreements involve the exchange of fixed interest for floating interest payments. The Company pays fixed interest payments to the counterparty on a quarterly or semi-annual basis, in exchange for receiving floating interest payments on a quarterly basis from the counterparty. The Company has designated these swap agreements as hedging certain of the Company's available-for-sale securities. In July, 2000 the Company redesignated two interest rate agreements from hedging certain of the Company's available-for-sale securities to securities held for trading. These interest rate agreements were redesignated in September, 2000 back to hedging certain of the Company's available-for-sale securities. The loss in value of these interest rate agreements during the period they were designated as trading securities was $612 and is included in gain on securities held for trading in the statement of operations. Occasionally, counterparties will require the Company or the Company will require counterparties to provide collateral for the interest rate swap agreements in the form of margin deposits. Net deposits are recorded as a component of accounts receivable or other liabilities. Should the counterparty fail to return deposits paid, the Company would be at risk for the fair market value of that asset. At September 30, 2000 the balance of such net margin deposits received from counterparties as collateral under these agreements totaled $2,616. Interest rate agreements as of September 30, 2000 consist of the following:
Notional Estimated Fair Unamortized Remaining Strike Value Value Cost Term Rate ------------------------------------------------------------------------------- Interest rate floor agreement - $200,000 $0 0 75 days 5.50% purchased options Interest rate swap agreements 373,000 (3,654) 10,938 9.2 years n/a
For the quarter ended September 30, 2000, the Company owned a $200,000 (notional value) interest rate floor agreement. There was no cost associated with this agreement. The Company will receive cash payments should one-month LIBOR drop below the contract strike rate. These payments, if any, will be recorded as an adjustment to interest expense. For the quarter ended September 30, 2000 the Company did not receive cash payments under this agreement. Interest rate agreements contain an element of risk in the event that the counterparties to the agreements do not perform their obligations under the agreements. The Company minimizes its risk exposure by entering into agreements with parties rated at least A+ by Standard & Poor's Rating Services. Furthermore, the Company has interest rate agreements established with several different counterparties in order to reduce the risk of credit exposure to any one counterparty. Management does not expect any counterparty to default on their obligations and, therefore, does not expect to incur a loss. ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL: The Company was organized in November 1997 to invest in a diversified portfolio of multifamily, commercial and residential mortgage loans, mortgage-backed securities and other real estate related assets in the U.S. and non-U.S. markets. In March 1998, the Company received $296.9 million of net proceeds from the initial public offering of 20,000,000 shares and the private placement of 1,365,198 shares of its Common Stock, which the Company used to acquire its initial portfolio of investments. The Company commenced operations on March 24, 1998. The Company is a real estate finance company that generates income based on the spread between the interest income on its investments and the interest expense from borrowings used to finance its investments. Because the Company has elected to be taxed as a REIT its income is largely exempt from corporate taxation and the Company is able to generate a higher level of net interest earnings than otherwise obtainable by a taxable corporation making similar investments. The principal risks that the Company faces are (i) credit risk on the high yield real estate loans and securities it underwrites, (ii) interest rate risk on the spread between the rates (typically one month LIBOR) at which the Company borrows and the generally longer term rates (as represented by the U.S. Ten Year Treasury) at which the Company lends; and (iii) funding risk in the amount and cost of debt financing employed by the Company over time versus the level of such funding that is sustainable by the financing markets. These risks are discussed in more detail below, under the heading, "Quantitative and Qualitative Disclosures About Market Risk and under Capital Resources and Liquidity". The Company also provides financing through certain real estate loan arrangements that, because of their nature, qualify either as real estate or joint venture investments for financial reporting purposes. For a discussion of these arrangements, see the Company's consolidated financial statements and notes included herein. The following discussion should be read in conjunction with the financial statements and related notes. Dollar amounts are expressed in thousands, other than per share amounts. MARKET CONDITIONS: Credit: The Company considers the Lehman Brothers delinquency statistics for 1998 conduit transactions to be the most relevant for its CMBS holdings, because most of the Company's CMBS were originated during 1998. Pursuant to these statistics as of September 30, 2000, 41 different securitizations were included in the index and 0.57% of principal balances were delinquent. As of June 30, 2000, these 41 securitizations had 0.53% of principal balances delinquent. The broader Lehman Brothers CMBS collateral delinquency statistics representing all CMBS conduit deals dates back to 1993 originations. As of September 30, 2000, 165 securitizations were being monitored among the larger universe and 0.72% of outstanding balances were delinquent, compared to 161 securitizations included as of June 30, 2000 and 0.61% delinquent. Morgan Stanley Dean Witter (MSDW) also tracks CMBS loan delinquencies using a slightly smaller universe. Their index tracks all CMBS transactions with more than $200,000 of collateral that have been seasoned for at least one year. This will generally adjust for the lower delinquencies that occur in newly originated collateral. As of September 30, 2000, MSDW delinquencies on 132 securitizations were 0.88%. As of June 30, 2000 this same index tracked 120 securitizations with delinquencies of 0.83%. The indices do not show any trend that could affect credit outlook. Real Estate: The national real estate market is maintaining a healthy balance between supply and demand for space. Certain local/regional markets have shown significant increases in rents for office space and apartments. These markets tend to be located in or around cities which operate on a 24-hour schedule. Selectively, new construction in primarily Southeast and Southwestern markets has decreased rent growth and added to vacancies. The FDIC's Regional Outlook Third Quarter 2000 report served as a warning about levels of construction lending in 13 markets. While the report raised appropriate concerns, GDP growth in the range of 2%-3% and low unemployment rates have kept demand strong. Generally, regional real estate markets will be more sensitive to deliveries of new space during the time that the national economy is slowing. Interest Rates: The Federal Reserve has not changed short-term rates since the 50 basis points increase in May 2000. In response to news of economic slow-down and concern of smaller buybacks of Treasury bonds, Treasury yields declined and the yield curve moved to a less inverted position. Yields remain higher on 2-year notes than on 30-year bonds but by a much smaller margin than existed at the beginning of the quarter. One month LIBOR finished the quarter at 6.62%, down from 6.64% at June 30, 2000. Ten year Treasury yields fell from 6.02% to 5.80% at September 30, 2000. CMBS market prices are impacted by both Treasury yields and swap spreads. Ten year swap spreads also declined to 111 basis points from 123 basis points since June 30, 2000. The Fed continues to maintain a tightening bias against inflation. Oil price increases are a continuing concern, but also act as a damper on consumer spending and economic activity. CMBS: The credit spread curve for investment grade CMBS has remained relatively flat from AAA to BBB in a range of 78 to 88 basis points since June 30, 2000. BBB CMBS have benefited from demand from insurance companies and CBO issuers. Expected rule changes from the Department of Labor would further expand demand as investment grade CMBS - rated down to BBB - would become ERISA eligible investments. Demand for BB rated classes has kept spreads in a narrow range of 520 - 545 basis points. Spreads on single-B and unrated securities have remained relatively unchanged. The distinction between bidders for them has been primarily credit enhancement and loan pool kick-out stipulations at the time of new issue. Real Estate Capital Markets: Capital flow into the public real estate mutual funds improved in the third quarter 2000 with $519,000 of inflows compared to second quarter 2000 inflows of $389,000 and a first quarter 2000 outflow of $117,000. Public real estate companies have benefited from volatility in other equity market sectors like technology. Merger and acquisition activity among REITs has increased particularly among retail property owners. Mezzanine lending opportunities are expected from these corporate events and the portfolio restructuring which is expected in their aftermath. Average Credit Spreads (in basis points)* ---------------------------------------------- BB CMBS BB Corporate Difference As of September 30, 2000 556 430 126 As of June 30, 2000 588 454 134 As of March 31, 2000 571 438 133 B CMBS B Corporate Difference As of September 30, 2000 976 718 258 As of June 30, 2000 977 630 347 As of March 31, 2000 931 646 285 *Source - Lehman Brothers CMBS High Yield Index & Lehman Brothers High Yield Index EFFECT OF MARKET CONDITIONS ON COMPANY PERFORMANCE: The decrease in interest rates during the third quarter of 2000 led to a slight increase in the value of the Company's investment portfolio. The unrealized loss on the Company's holdings of CMBS decreased from $101,399 at June 30, 2000 to $99,261 at September 30, 2000. Short-term rates were stable but the Company's cost of funds increased slightly as the full effect of the last Fed tightening was felt in the third quarter. The Company's earnings depend, in part, on the relationship between long-term interest rates and short-term interest rates. A significant part of Company's investments earn interest at fixed rates determined by reference to the yields of medium or long-term U.S. Treasury securities or at adjustable rates determined by reference (with a lag) to the yields on various short-term instruments. As a hedge, the Company focused on the origination of more LIBOR based floating rate assets. Approximately $118,000 of the Company's assets earn interest at rates that are determined with reference to LIBOR. All of the Company's borrowings earn interest at rates that are determined with reference to LIBOR. To the extent that interest rates on the Company's borrowings increase without an offsetting increase in the interest rates earned on the Company's investments, the Company's earnings would be negatively affected. During the third quarter 2000 the Company reduced leverage on fixed rate assets by approximately $125,000. At September 30, 2000 the company had $373,000 of notional amount of swaps where the company pays fixed rates and receives a LIBOR based floating rate. This represents a reduction of $129,000 from June 30, 2000. This hedging strategy effectively converts fixed rate assets into floating rate assets thereby protecting against short-term rate increases. The chart below compares the rate for the ten-year U.S. Treasury securities to the one-month LIBOR rate. Ten Year One month U.S Treasury Securities LIBOR Difference ----------------------- --------- ---------- September 30, 2000 5.80% 6.62% (0.82%) June 30, 2000 6.03% 6.66% (0.63%) March 31, 2000 6.02% 6.13% (0.11%) June 30, 1999 5.81% 5.22% 0.59% The decrease in LIBOR from June 30, 2000 to September 30, 2000 had an insignificant impact on the Company's financing costs. At the end of October 2000, the ten-year U.S. Treasury yield had decreased slightly from its September 30, 2000 level to 5.79%, and one month LIBOR remained unchanged during the same period. The Company purchased its CMBS portfolio at prices that reflect the assumption that credit losses will occur. The adjusted purchase price of the Company's CMBS portfolio as of September 30, 2000 represents 61% of its par amount, while the market value is 46% of par. As the portfolio matures the Company expects to recoup this difference provided that the credit losses experienced are not greater than the credit losses assumed in the purchase analysis. The Company performs a detailed review of its loss assumptions on a quarterly basis. As of September 30, 2000 the Company determined that there has been no material change in the credit quality of its portfolio. The Company's CMBS represents approximately $600,000 of par collateralized by underlying pools of commercial mortgages with a principal balance of over $9.2 billion as of September 30, 2000. The Company is in a first loss position with respect to these loans. The Company manages its credit risk through conservative underwriting at time of purchase, diversification, active monitoring of loan performance, and exercise of its right to control the workout process as early as possible. All of these processes are based on the extensive intranet-based analytic systems developed by BlackRock. In underwriting loans, the Company performs site inspections and/or desktop reviews of all loans in the pools. This process includes detailed analysis of regional economic factors, industry outlooks, project viability and documentation. Unacceptable risks are removed from the pool. An assumption of expected losses is developed and the securities are priced accordingly. Active monitoring of loan performance is a critical function that is performed via electronic uploads of information gathered from the master and special servicers of each deal, PNC Bank and external data providers. This internet-based system allows the Company to monitor payments, debt service coverage ratios, regional economic statistics, general real estate market trends and other relevant factors. The Company also uses the internet-based system to monitor delinquencies. The Company updates this information monthly allowing for more detailed analysis of loans before problems develop. The following table shows the comparison of delinquencies:
09/30/00 06/30/00 NUMBER OF % OF NUMBER OF % OF PRINCIPAL LOANS/REO COLLATERAL PRINCIPAL LOANS COLLATERAL Past due 30 days to 60 days $ 11,167 5 0.14% $ 21,355 4 0.23% Past due 60 days to 90 days 18,527 3 0.18 5,262 3 0.06 Past due 90 days or more 13,601 3 0.16 17,487 4 0.19 REO 10,181 2 0.11 10,214 2 0.11 ------------- ------------------ -------------- -------------- ---------------- -------------- TOTAL 53,476 13 0.59% $ 54,318 13 0.59% ============= ================== ============== ============== ================ ==============
Of the 11 delinquent loans at September 30, 2000, one is delinquent due to technical reasons and six are in foreclosure proceedings or workout negotiations. Regarding one of the loans, the party which originally contributed the loan to the CMBS trust has indemnified the trust against a loss of up to $1,300. This loan has a principal balance of $8,984. The Company's delinquency experience of 0.59% is in line with directly comparable collateral experience shown in the Lehman Brothers 1998 CMBS index at 0.57%. On September 29, 2000 Fitch, a major international credit rating agency, announced a downgrade of certain of the GMAC 98 C1 CMBS securities. The Company owns five of the securities from this transaction totaling $51,300 of par value. Three of the five securities were down graded from BB-, B and B-, to B, B- and CCC respectively. The credit action was precipitated by loan collateralized by a diverse portfolio of nursing homes and assisted living facilities. The debt service coverage ratio of the properties declined significantly during 1999. The manager of the properties has since been replaced and operating improvements are expected. A subsidiary of Zurich Reinsurance Centre Holdings, Inc., an A rated insurance company, credit enhanced 67% of the loan balance. The Company does not anticipate a loss from this loan; therefore, the Company has not changed its loss adjusted yield on these securities. As a result of the downgrade one of the securities became ineligible for the Company's financing facility thus the amount being borrowed (approximately $2,300) was paid off with available cash. The Company also owns five mezzanine whole loans. The Santa Monica Loan is a $35,000 second mortgage on an office construction project in Santa Monica, California. The building was largely completed (except certain tenant improvements) and was completed on time during the third quarter. As of October 31, 2000 approximately 90% of the building is pre-leased at average rents of over $40 per square foot. The first group of tenants moved in their space in July 2000. The percentage of the property leased and the dollar per square foot being attained is greater than the base case expectations at the time the Company originated the loan. Furthermore, the real estate values for this class of office space in Santa Monica have increased significantly since origination. The London Loan is a (pound)21,459 Sterling denominated loan that was funded in August of 1998. It is secured by five luxury hotel properties in and around London, England. The operations of the hotels continue to meet expectations. While the underlying properties have performed well, the loan's estimated liquidation value as of September 30, 2000 was 96% of par. The Commercial Office Building Loan is a $30.6 million subordinated participation in a first mortgage secured by a 545 thousand square foot, 100% leased, class A office building in Midtown Manhattan. The Loan was originated at the end of the first quarter and is scheduled to mature in December, 2001. The $15,000 Senior Chicago Loan and $15,000 Junior Chicago Loan are secured by a second mortgage on a condominium conversion project in Chicago, Illinois, two land parcels and the borrower's partnership interest. Interest in purchasing the condominium apartments is ahead of expectations; as a result, conversion of the building to condominium is anticipated to begin in December 2000. At conversion, the Senior Chicago Loan is expected to be paid-off with accrued interest, and prepayment penalties. The Junior Chicago Loan provides for a 24-month term, which may be extended in six-month increments for up to 36 months. The San Francisco Loan is an $18,000 loan is secured by a lien on the borrower's interest in a full service hotel located in San Francisco, California. The hotel is a 1,192-room full service hotel originally constructed in 1904 and expanded in 1913 and 1972. It is centrally located in downtown San Francisco and borders Union Square, the hub of the city shopping and theater district. The loan was originated in August 2000 and matures May 1, 2003, and may be extended by the borrower for two additional twelve-month periods. On July 20, 2000 the Company made an investment aggregating $5,121 in the preferred equity interests of two limited partnerships that own a 99 thousand square foot office building and a 120 thousand square foot office building, both of which are located in suburban Philadelphia. Leasing activity is ahead of expectations. The Company's ownership interest is 64.81% in each partnership. RECENT EVENTS: Subsequent to the quarter end, the Company financed its San Francisco Loan and its investment in real estate joint ventures for $15,085 under the Deutsche Bank Facility. The Company borrowed an additional $3,191 secured by the Santa Monica Loan. The Company sold its investment in Midland Commercial Mortgage Owner Trust IV, V, VI, and VII in October, 2000, and repaid its borrowings to PNC Funding Corp. The gain on sale of these investments is insignificant. Subsequent to the quarter end, the Company reached an agreement to renew its agreement with Merrill Lynch for a one year period. FUNDS FROM OPERATIONS (FFO): The Company calculates FFO based upon guidance from the National Association of Real Estate Investment Trusts ("NAREIT"). FFO is defined as net income, excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization and after adjustments for unconsolidated joint ventures. Most industry analysts, including the Company, consider FFO an appropriate supplementary measure of operating performance of a REIT. FFO does not represent cash provided by operating activities in accordance with GAAP and should not be considered an alternative to net income as an indication of the results of the Company's performance or to cash flows as a measure of liquidity. The Company believes that the exclusion from FFO of gains or losses from sales of property was not intended to address gains or losses from sales of securities as they apply to the Company. Accordingly, the Company includes gains or losses from sales of securities in its calculation of FFO. The table below sets forth the adjustments which were made to the net income of the Company in the calculation of FFO for the three and nine months ended September 30, 2000 and 1999. Although the Company believes that this table is a full and fair presentation of the Company's FFO, similarly captioned items may be defined differently by other REITs, in which case direct comparisons may not be possible. Funds from Operations --------------------- Three Months Ended Nine Months Ended September 30, September 30, 2000 1999 2000 1999 ----------- --------- --------- -------- Net Income Available to $ 9,070 $6,536 $23,290 == $20,467 Common Shareholders: Proportionate share of Adjustments to earnings from real estate joint ventures: Depreciation and amortization 77 - 77 - Funds from operations $9,147 $6,536 $23,367 $20,467 =========== ========= ========= ========= Cash flow provided by (used for) Operating Activities $29,711 $155,078 Investing Activities $786,073 $ (45,343) Financing Activities $(824,652) $(101,128) RESULTS OF OPERATIONS Net income for the three and nine months ended September 30, 2000 was $11,377, or $0.36 per share ($0.34 diluted) and $28,037 or $1.01 per share ($0.95 diluted), respectively. Further details of the changes are set forth below. Net income for the three and nine months ended September 30, 1999 was $6,536, or $0.31 per share (base and diluted) and $20,467, or $0.99 per share (base and diluted), respectively. Further details of the changes are set forth below. INTEREST INCOME: The following tables sets forth information regarding the total amount of income from certain of the Company's interest-earning assets and the resulting average yields. Interest income for the three and nine months ended September 30, 2000 on securities available for sale includes the net interest income/expenses of swaps. There were no swaps in 1999. Information is based on monthly average balances during the period.
For the Three Months Ended September 30, 2000 ------------------------------------------------------------------ Interest Average Annualized Income Balance Yield ---------------------- --------------------- --------------------- CMBS $9,489 $377,612 10.05% Securities available for sale 12,096 613,822 7.88% Commercial mortgage loans 3,573 111,796 12.78% Mortgage loans held for sale 1,555 82,055 7.58% Cash and cash equivalents 255 15,098 6.76% ---------------------- --------------------- --------------------- Total $26,968 $1,200,383 8.99% ====================== ===================== =====================
For the Nine Months Ended September 30, 2000 ------------------------------------------------------------------ Interest Average Annualized Income Balance Yield ---------------------- --------------------- --------------------- CMBS $ 27,915 $ 375,481 9.91% Securities available for sale 27,198 442,142 8.20% Commercial mortgage loans 8,550 95,988 11.88% Mortgage loans held for sale 5,021 88,312 7.58% Cash and cash equivalents 909 19,699 6.16% ---------------------- --------------------- --------------------- Total $ 69,593 $ 1,021,622 9.08% ====================== ===================== =====================
For the Three Months Ended September 30, 1999 ---------------------- --------------------- --------------------- Interest Average Annualized Income Balance Yield ---------------------- --------------------- --------------------- CMBS $ 8,373 $ 352,923 9.49% Securities available for sale 2,754 206,881 5.32% Commercial mortgage loan 1,620 56,264 11.52% Cash and cash equivalents 104 7,785 5.34% ---------------------- --------------------- --------------------- Total $ 12,851 $ 623,853 8.24% ====================== ===================== =====================
For the Nine Months Ended September 30, 1999 ------------------------------------------------------------------ Interest Average Annualized Income Balance Yield ---------------------- --------------------- --------------------- CMBS $ 25,112 $ 352,880 9.49% Other securities available for sale 8,963 201,547 5.93% Commercial mortgage loans 3,663 46,373 10.53% Cash and cash equivalents 404 10,630 5.10% ---------------------- --------------------- --------------------- Total $ 38,142 $ 611,430 8.32% ====================== ===================== =====================
In addition to the foregoing, the Company earned $567 and $3,186 in interest income from securities held for trading during the three and nine months ended September 30, 1999. INTEREST EXPENSE: The following table sets forth information regarding the total amount of interest expense from certain of the Company's collateralized borrowings. Information is based on daily average balances during the period.
For the Three Months Ended September 30, 2000 ------------------------------------------------------------------ Interest Average Annualized Expense Balance Rate ---------------------- --------------------- --------------------- Reverse repurchase agreements $ 11,488 $656,477 7.00% Lines of credit and term loan 3,277 175,222 7.48% ---------------------- --------------------- --------------------- Total $ 14,765 $ 831,699 7.10% ====================== ===================== =====================
For the Nine Months Ended September 30, 2000 ------------------------------------------------------------------ Interest Average Annualized Expense Balance Rate ---------------------- --------------------- --------------------- Reverse repurchase agreements $27,579 $538,495 6.83% Lines of credit and term loan 9,749 179,979 7.22% ---------------------- --------------------- --------------------- Total $37,328 $718,473 6.93% ====================== ===================== =====================
For the Three Months Ended September 30, 1999 ------------------------------------------------------------------ Interest Average Annualized Expense Balance Rate ---------------------- --------------------- --------------------- Reverse repurchase agreements $ 4,133 $ 278,045 5.90% Lines of credit borrowings 786 48,136 6.48% ---------------------- --------------------- --------------------- Total $ 4,919 $ 326,181 6.03% ====================== ===================== =====================
For the Nine Months Ended September 30, 1999 ------------------------------------------------------------------ Interest Average Annualized Expense Balance Rate ---------------------- --------------------- --------------------- Reverse repurchase agreements $ 10,765 $ 251,390 5.75% Lines of credit borrowings 3,788 80,959 6.28% ---------------------- --------------------- --------------------- Total $ 14,553 $ 332,349 5.84% ====================== ===================== =====================
In addition to the foregoing, the Company incurred $607 and $4,108 in interest expense from short-term borrowings relating to its securities held for trading and securities sold short during the three months and nine months ended September 30, 1999, respectively. NET INTEREST MARGIN AND NET INTEREST SPREAD FROM THE PORTFOLIO: The Company considers its portfolio to consist of its securities available for sale, its mortgage loans held for sale its commercial mortgage loans and its cash and cash equivalents because these assets relate to its core strategy of acquiring and originating high yield loans and securities backed by commercial real estate, while at the same time maintaining a portfolio of liquid investment grade securities to enhance the Company's liquidity. Net interest margin from the portfolio is annualized net interest income from the portfolio divided by the average market value of interest-earning assets in the portfolio. Net interest income from the portfolio is total interest income from the portfolio less interest expense relating to collateralized borrowings. Net interest spread from the portfolio equals the yield on average assets for the period less the average cost of funds for the period. The yield on average assets is interest income from the portfolio divided by average amortized cost of interest earning assets in the portfolio. The average cost of funds is interest expense from the portfolio divided by average outstanding collateralized borrowings. The following chart describes the interest income, interest expense, net interest margin, and net interest spread for the Company's portfolio. For the Three Months For the Three Months Ended Ended September 30, 2000 September 30, 1999 ----------------------------- --------------------------- Interest Income $26,968 $12,851 Interest Expense $14,765 $ 4,919 Net Interest Margin 4.44% 6.14% Net Interest Spread 2.71% 2.31% OTHER EXPENSES: Expenses other than interest expense consist primarily of management fees and general and administrative expenses. Management fees of $2,060 and $5,050 for the three and nine months ended September 30, 2000 and $1,050 and $3,173 for the three and nine months ended September 30, 1999, respectively, were paid to the Manager in accordance with the management agreement between the Manager and the Company. The Manager earned $375 and $462 in incentive management fees for the three and nine months ended September 30, 2000. No incentive management fees were earned in 1999. Other expenses/(income) - net of $(20) and $1,415 for the three and nine months ended September 30, 2000 and $507 and $1,541 for the three and nine months ended September 30, 1999, respectively, were comprised of accounting agent fees, custodial agent fees, directors' fees, fees for professional services, insurance premiums, broken deal expenses, due diligence costs, amortization of prepaid expenses, and other miscellaneous expenses. Other expenses/(income) - net in the year 2000 includes the amortization of negative goodwill. OTHER GAINS (LOSSES): During the three and nine months ended September 30, 2000 the Company sold a portion of its securities available-for-sale for total proceeds of $812,279 and $2,122,735 resulting in a realized gain of $994 and $1,700. For the three and nine months ended September 30, 1999, the Company sold securities available-for-sale for total proceeds of $23,855 and $45,367, resulting in realized losses of $566 and $423. The gains on securities held for trading were $191 and $739 for the three months ended September 30, 2000 and 1999, respectively, and $519 and $2,992 for the nine months ended September 30, 2000 and 1999, respectively. The foreign currency gains (losses) of $29 and $28 for the three months and $118 and $(55) for the nine months ended September 30, 2000 and 1999, respectively relate to the Company's net investment in a commercial mortgage loan denominated in pounds sterling and associated hedging. DIVIDENDS DECLARED: On March 16, May 22 and September 14, 2000, the Company declared distributions to its shareholders of $0.29 per share, payable on April 28, July 28, and October 31, 2000 to shareholders of record on March 31, June 30, and September 29, 2000 respectively. For U.S. Federal income tax purposes, the dividends are ordinary income to the Company's shareholders. TAX BASIS NET INCOME AND GAAP NET INCOME: For tax purposes the fourth quarter 1998 dividend of $0.29 is treated as a 1999 distribution. Thus, for tax purposes the total dividends paid year to date in each of 2000 and 1999 were $0.58 and $0.87, respectively. Differences between tax basis net income and GAAP net income arise for various reasons. For example, in computing income from its subordinated CMBS for GAAP purposes, the Company takes into account estimated credit losses on the underlying loans whereas for tax basis income purposes, only actual credit losses are taken into account. As there were no actual credit losses incurred in the three months ended September 30, 2000, tax basis income is higher than GAAP income. Certain general and administrative expenses may differ due to differing treatment of the deductibility of such expenses for tax basis income. Also, differences could arise in the treatment of premium and discount amortization on the Company's securities available for sale. A reconciliation of GAAP net income to tax basis net income is as follows:
For the Three Months For the Nine Ended September 30, 2000 Months Ended September 30, 2000 --------------------------------------------------- GAAP net income $11,377 $28,037 Subordinate CMBS income differences 507 2,158 Use of capital loss carryforward (602) (1,625) CORE Cap merger expenses - (2,300) --------------------------------------------------- Tax basis net income $11,282 $26,270 ===================================================
For the Nine For the Three Months Months Ended Ended September 30, 1999 September 30, 1999 ---------------------------------------------------- GAAP net income $6,536 $20,467 Subordinate CMBS income differences 2,831 4,875 General and administrative expense differences 372 - ---------------------------------------------------- Tax basis net income $9,739 $25,342 ====================================================
CHANGES IN FINANCIAL CONDITION SECURITIES AVAILABLE FOR SALE: At September 30, 2000 and December 31, 1999, an aggregate of $99,261 and $101,139, respectively, in unrealized losses on securities available for sale was included as a component of accumulated other comprehensive income (loss) in stockholders' equity. The Company's securities available-for-sale, which are carried at estimated fair value, included the following at September 30, 2000:
Estimated Fair Security Description Value Percentage - --------------------------------------------------------------------------- ----------------- ---------------- Commercial mortgage-backed securities: Investment grade rated securities $164,231 18.4% Non-investment grade rated subordinated securities 253,970 28.5 Non-rated subordinated securities 30,168 3.4 ----------------- ---------------- 448,369 50.3% ----------------- ---------------- Single-family residential mortgage-backed securities: Agency adjustable rate securities 113,038 12.7% Agency fixed rate securities 205,082 23.0 Privately issued investment grade rated fixed rate securities 125,331 14.0 ----------------- ---------------- 443,451 49.7% ----------------- ---------------- $891,820 100.0% ================= ================
The Company's securities available-for-sale included the following at December 31, 1999:
Estimated Fair Security Description Value Percentage - ------------------------------------------------------------------------- ------------------- ---------------- Commercial mortgage-backed securities: Non-investment grade rated subordinated securities $243,708 42.7% Non-rated subordinated securities 29,025 4.6 ------------------- ---------------- 272,733 47.3 ------------------- ---------------- Single-family residential mortgage-backed securities: Agency adjustable rate securities 58,858 10.2 Agency fixed rate securities 165,825 28.7 Privately issued investment grade rated fixed rate securities 76,821 13.3 ------------------- ---------------- 301,504 52.2 ------------------- ---------------- Agency insured project loan 2,958 0.5 ------------------- ---------------- $577,195 100.0% =================== ================
BORROWINGS: As of September 30, 2000, the Company's debt consisted of line-of-credit borrowings, term loans and reverse repurchase agreements, collateralized by a pledge of most of the Company's securities available for sale, securities held for trading, mortgage loans held for sale and its commercial mortgage loans. The Company's financial flexibility is affected by its ability to renew or replace on a continuous basis its maturing short-term borrowings. As of September 30, 2000, the Company has obtained financing in amounts and at interest rates consistent with the Company's short-term financing objectives. Under the lines of credit, term loans, and the reverse repurchase agreements, the lender retains the right to mark the underlying collateral to market value. A reduction in the value of its pledged assets will require the Company to provide additional collateral or fund margin calls. From time to time, the Company expects that it will be required to provide such additional collateral or fund margin calls. The following tables set forth information regarding the Company's collateralized borrowings.
For the Nine Months Ended September 30, 2000 ------------------------------------------------------------------- September 30, 2000 Maximum Range of Balance Balance Maturities ---------------------- --------------------- ---------------------- Reverse repurchase agreements $662,769 $1,206,696 6 to 51 days Line of credit and term loan borrowings 187,196 $453,841 45 to 441 days ---------------------- --------------------- ----------------------
HEDGING INSTRUMENTS: The Company's hedging policy with regard to its sterling denominated commercial mortgage loan is to minimize its exposure to fluctuations in the sterling exchange rate. At September 30, 2000, the Company's hedging transactions outstanding consisted of forward currency exchange contracts pursuant to which the Company agreed to exchange (pound)8,000 (pounds sterling) for U.S. $12,137 on January 18, 2001. The estimated fair value of the forward currency exchange contract was $282 at September 30, 2000, which was recognized as a part of net foreign currency gains. From time to time the Company may reduce its exposure to market interest rates by entering into various financial instruments that shorten portfolio duration. These financial instruments are intended to mitigate the effect of interest rates on the value of certain assets in the Company's portfolio. At September 30, 2000, the Company had outstanding a long position of 298 ten-year U.S. Treasury Note future contracts expiring on December 29, 2000, which represented $29,800 in face amount of U.S. Treasury Notes. The unrealized gain of these contracts was approximately $98 at September 30, 2000. The Company acquired interest rate swap agreements through the CORE Cap merger and assigned a cost to each contract equal to the fair market value of each contract. The amortized cost of these agreements was $10,326 at September 30, 2000, and their fair value included in other assets was $2,621. The cost of the swaps will be amortized into interest income over the remaining life of the swaps. At September 30, 2000 accrued net interest payable equaled $209. As of September 30, the weighted average interest rate receivable and payable is 6.43% and 6.99%, respectively. In July, 2000 the Company redesignated two interest rate agreements from hedging certain of the Company's available-for-sale securities to securities held for trading. These interest rate agreements were redesignated in September, 2000 back to hedging certain of the Company's available-for-sale securities. The loss in value of the interest rate agreements during the period they were designated as trading securities was $612 and is included in gain on securities held for trading in the statements of operations. CAPITAL RESOURCES AND LIQUIDITY: Liquidity is a measurement of the Company's ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund investments, loan acquisition and lending activities and for other general business purposes. The primary sources of funds for liquidity consist of issuance of common and preferred stock, collateralized borrowings, principal and interest payments on and maturities of securities available for sale, securities held for trading and commercial mortgage loans, and proceeds from sales thereof. If the Company is unable to maintain its borrowings at their current level due to changes in the financing markets for the Company's assets, then the Company may be required to sell assets in order to achieve lower borrowings levels. In this event, the Company's level of net earnings would decline. The Company's principal strategies for mitigating this risk are to maintain portfolio leverage at levels it believes are sustainable and to diversify the sources and types of available borrowing and capital. The Company has utilized committed bank facilities and preferred stock, and will consider resecuritization or other achievable term funding of existing assets to diversify its existing capital base. On March 31, 1999, the Company filed a $200,000 shelf registration statement with the SEC. The shelf registration statement will permit the Company to issue a variety of debt and equity securities in the public markets. There can be no certainty, however, that the Company will be able to issue, on terms favorable to the Company, or at all, any of the securities so registered. As of September 30, 2000, $157,028 was available for future borrowings under the $185,000 Deutsche Bank Facility, $41,090 was available for future borrowings under the Company's $50,000 credit facility, $3,369 was available for future borrowings under the Company's term financing secured by the Santa Monica Loan, $162,497 was available for future borrowings under the Company's facility with ABN Amro Bank, and $165,536 was available for future borrowings under the Company's residential facility with Merrill Lynch. On May 15, 2000 as part of the CORE Cap acquisition the Company issued 4,180,552 shares of common stock and 2,260,997 shares of Series B Preferred Stock. The Company's operating activities provided cash of $29,617 and $155,078 during the nine months ended September 30, 2000, and 1999, respectively, primarily through net income, and in 1999, through sales of trading securities in excess of purchases. The Company's investing activities provided (used) cash totaling $786,167 and $(45,343) during the nine months ended September 30, 2000, and 1999, respectively, primarily to purchase securities available-for-sale and to fund commercial mortgage loans, offset by principal payments received on securities available-for-sale and proceeds from sales of securities available-for-sale. The Company's financing activities used cash of $824,652 during the nine months ended September 30, 2000, primarily to reduce the level of borrowings assumed in the CORE Cap merger and to pay distributions. The Company's financing activities used cash of $101,128 during the nine months ended September 30, 1999 primarily to reduce the level of short-term borrowings and to pay distributions. Although the Company's portfolio of securities available-for-sale was acquired at a net discount to the face amount of such securities, the Company has received to date and expects to continue to receive sufficient cash flows from these securities to fund distributions to the Company's stockholders. The Company is subject to various covenants in its lines of credit, including maintaining a minimum GAAP net worth of $140,000, a debt-to-equity ratio not to exceed 4.5 to 1, a minimum cash requirement based upon certain debt to equity ratios, a minimum debt service coverage ratio of 1.5, and a minimum liquidity reserve of $10,000. Additionally, the Company's GAAP net worth cannot decline by more than 37% during the course of any two consecutive fiscal quarters. As of September 30, 2000 and December 31, 1999, the Company was in compliance with all such covenants. The Company's ability to execute its business strategy depends to a significant degree on its ability to obtain additional capital. Factors which could affect the Company's access to the capital markets, or the costs of such capital, include changes in interest rates, general economic conditions and perception in the capital markets of the Company's business, covenants under the Company's current and future credit facilities, results of operations, leverage, financial conditions and business prospects. Current conditions in the capital markets for REITs such as the Company have made permanent financing transactions more difficult and more expensive than at the time of the Company's initial public offering. Consequently, there can be no assurance that the Company will be able to effectively fund future growth through the capital markets. Except as discussed herein, management is not aware of any other trends, events, commitments or uncertainties that may have a significant effect on liquidity. REIT STATUS: The Company has elected to be taxed as a REIT and to comply with the provisions of the Internal Revenue Code of 1986, as amended, with respect thereto. Accordingly, the Company generally will not be subject to Federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and stock ownership tests are met. The Company may, however, be subject to tax at corporate rates or at excise tax rates on net income or capital gains not distributed. INVESTMENT COMPANY ACT: The Company 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"). Under the Investment Company Act, a non-exempt entity that is an investment company is required to register with the Securities and Exchange Commission ("SEC") and is subject to extensive, restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends and transactions with affiliates. The Investment Company Act exempts entities that are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate" ("Qualifying Interests"). Under current interpretation by the staff of the SEC, to qualify for this exemption, the Company, among other things, must maintain at least 55% of its assets in Qualifying Interests. Pursuant to such SEC staff interpretations, certain of the Company's interests in agency pass-through and mortgage-backed securities and agency insured project loans are Qualifying Interests. In general, the Company will acquire subordinated interests in commercial mortgage-backed securities ("subordinated CMBS") only when such mortgage securities are collateralized by pools of first mortgage loans, when the Company can monitor the performance of the underlying mortgage loans through loan management and servicing rights, and when the Company has appropriate workout or foreclosure rights with respect to the underlying mortgage loans. When such arrangements exist, the Company believes that the related subordinated CMBS constitute Qualifying Interests for purposes of the Investment Company Act. Therefore, the Company believes that it should not be required to register as an "investment company" under the Investment Company Act as long as it continues to invest primarily in such subordinated CMBS and/or in other Qualifying Interests. However, if the SEC or its staff were to take a different position with respect to whether the Company's subordinated CMBS constitute Qualifying Interests, the Company could be required to modify its business plan so that either (i) it would not be required to register as an investment company or (ii) it would comply with the Investment Company Act and be able to register as an investment company. In such event, (i) modification of the Company's business plan so that it would not be required to register as an investment company would likely entail a disposition of a significant portion of the Company's subordinated CMBS or the acquisition of significant additional assets, such as agency pass-through and mortgage-backed securities, which are Qualifying Interests or (ii) modification of the Company's business plan to register as an investment company would result in significantly increased operating expenses and would likely entail significantly reducing the Company's indebtedness (including the possible prepayment of the Company's short-term borrowings), which could also require it to sell a significant portion of its assets. No assurances can be given that any such dispositions or acquisitions of assets, or deleveraging, could be accomplished on favorable terms. Consequently, any such modification of the Company's business plan could have a material adverse effect on the Company. Further, if it were established that the Company were an unregistered investment company, there would be a risk that the Company would be subject to monetary penalties and injunctive relief in an action brought by the SEC, that the Company would be unable to enforce contracts with third parties and that third parties could seek to obtain rescission of transactions undertaken during the period it was established that the Company was an unregistered investment company. Any such results would be likely to have a material adverse effect on the Company. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK: Market risk is the exposure to loss resulting from changes in interest rates, credit curve spreads, foreign currency exchange rates, commodity prices and equity prices. The primary market risks to which the Company is exposed are interest rate risk and credit curve risk. Interest rate risk is highly sensitive to many factors, including governmental, monetary and tax policies, domestic and international economic and political considerations and other factors beyond the control of the Company. Credit risk is highly sensitive to dynamics of the markets for commercial mortgage securities and other loans and securities held by the Company. Excessive supply of these assets combined with reduced demand will cause the market to require a higher yield. This demand for higher yield will cause the market to use a higher spread over the U.S. Treasury securities yield curve, or other benchmark interest rates, to value these assets. Changes in the general level of the U.S. Treasury yield curve can have significant effects on the market value of the Company's portfolio. The majority of the Company's assets are fixed rate securities valued based on a market credit spread to U.S. Treasuries. As U.S. Treasury securities are priced to a higher yield and/or the spread to U.S. Treasuries used to price the Company's assets is increased, the market value of the Company's portfolio may decline. Conversely, as U.S. Treasury securities are priced to a lower yield and/or the spread to U.S. Treasuries used to price the Company's assets is decreased, the market value of the Company's portfolio may increase. Changes in the market value of the Company's portfolio may affect the Company's net income or cash flow directly through their impact on unrealized gains or losses on securities held for trading or indirectly through their impact on the Company's ability to borrow. Changes in the level of the U.S. Treasury yield curve can also affect, among other things, the prepayment assumptions used to value certain of the Company's securities and the Company's ability to realize gains from the sale of such assets. In addition, changes in the general level of the LIBOR money market rates can affect the Company's net interest income. The majority of the Company's liabilities are floating rate based on a market spread to U.S. LIBOR. As the level of LIBOR increases or decreases, the Company's interest expense will move in the same direction. The Company 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 fluctuations in interest rates on its operations. The use of these types of derivatives to hedge interest-earning assets and/or interest-bearing liabilities carries certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of securities and, indeed, that such losses may exceed the amount invested in such instruments. A hedge may not perform its intended purpose of offsetting losses or increased costs. Moreover, with respect to certain of the instruments used as hedges, the Company is exposed to the risk that the counterparties with which the Company trades may cease making markets and quoting prices in such instruments, which may render the Company unable to enter into an offsetting transaction with respect to an open position. If the Company anticipates that the income from any such hedging transaction will not be qualifying income for REIT income test purposes, the Company may conduct part or all of its hedging activities through a to-be-formed corporate subsidiary that is fully subject to federal corporate income taxation. The profitability of the Company may be adversely affected during any period as a result of changing interest rates. The following tables quantify the potential changes in the Company's net portfolio value and net interest income under various interest rate and credit spread scenarios. Net portfolio value is defined as the value of interest-earning assets net of the value of interest-bearing liabilities. It is evaluated using an assumption that interest rates, as defined by the U.S. Treasury yield curve, increase or decrease up to 300 basis points and the assumption that the yield curves of the rate shocks will be parallel to each other. Net interest income is defined as interest income earned from interest-earning assets net of the interest expense incurred by the interest bearing liabilities. It is evaluated using the assumptions that interest rates, as defined by the U.S. LIBOR curve, increase or decrease by 200 basis points and the assumption that the yield curve of the LIBOR rate shocks will be parallel to each other. Market value in this scenario is calculated using the assumption that the U.S. Treasury yield curve remains constant. All changes in income and value are measured as percentage changes from the respective values calculated in the scenario labeled as "Base Case". The base interest rate scenario assumes interest rates as of September 30, 2000. Actual results could differ significantly from these estimates. PROJECTED PERCENTAGE CHANGE IN PORTFOLIO NET MARKET VALUE GIVEN U.S. TREASURY YIELD CURVE MOVEMENTS - -------------------------------------------------------- Change in Projected Change in Treasury Yield Curve, Portfolio +/- Basis Points Net Market Value - ------------------------------- ------------------------ -300 11.8% -200 8.9% -100 4.9% Base Case 0 +100 (5.9)% +200 (12.8)% +300 (20.7)% PROJECTED PERCENTAGE CHANGE IN PORTFOLIO NET MARKET VALUE GIVEN CREDIT SPREAD MOVEMENTS - -------------------------------------------------------- Change in Projected Change in Credit Spreads, Portfolio +/- Basis Points Net Market Value - ------------------------------- ------------------------ -300 52.9% -200 34.5% -100 16.9% Base Case 0 +100 (16.1)% +200 (31.5)% +300 (46.2)% PROJECTED PERCENTAGE CHANGE IN PORTFOLIO NET INTEREST INCOME GIVEN LIBOR MOVEMENTS - --------------------------------------------------------- Projected Change in Change in LIBOR, Portfolio +/- Basis Points Net Interest Income - ------------------------------- ------------------------- -200 12.9% -100 6.4% Base Case 0 +100 (6.4)% +200 (12.9)% CREDIT RISK: Credit risk is the exposure to loss from loan defaults. Default rates are subject to a wide variety of factors, including, but not limited to, property performance, property management, supply and demand factors, construction trends, consumer behavior, regional economics, interest rates, the strength of the American economy, and other factors beyond the control of the Company. All loans are subject to a certain probability of default. The nature of the CMBS assets owned are such that all losses experienced by a pool of mortgages will be borne by the Company. Changes in the expected default rates of the underlying mortgages will significantly affect the value of the Company, the income it accrues and the cash flow it receives. An increase in default rates will reduce the book value of the Company's assets and the Company's earnings and cash flow available to fund operations and pay dividends. The Company manages credit risk through the underwriting process, establishing loss assumptions, and careful monitoring of loan performance. Before acquiring a security that represents a pool of loans, the Company will perform a rigorous analysis of the quality of substantially all of the loans proposed for that security. As a result of this analysis, loans with unacceptable risk profiles will be removed from the proposed security. Information from this review is then used to establish loss assumptions. The Company will assume that a certain portion of the loans will default and calculate an expected, or loss adjusted yield, based on that assumption. After the securities have been acquired, the Company monitors the performance of the loans, as well as external factors that may affect their value. Factors that indicate a higher loss severity or timing experience is likely to cause a reduction in the expected yield, and therefore reduce the earnings of the Company and may require a significant write down of assets. For purposes of illustration, a doubling of the losses in the Company's credit sensitive portfolio, without a significant acceleration of those losses would reduce the expected yield from approximately 10.05% to approximately 8.40%. This would reduce GAAP income going forward and cause a significant write down in assets at the time the loss assumption is changed. ASSET AND LIABILITY MANAGEMENT: Asset and liability management is concerned with the timing and magnitude of the repricing and/or maturing of assets and liabilities. It is the objective of the Company to attempt to control risks associated with interest rate movements. In general, management's strategy is to match the term of the Company's liabilities as closely as possible with the expected holding period of the Company's assets. This is less important for those assets in the Company's portfolio considered liquid, as there is a very stable market for the financing of these securities. The Company uses interest rate duration as its primary measure of interest rate risk. This metric, expressed when considering any existing leverage, allows the Company's management to approximate changes in the net market value of the Company's portfolio given potential changes in the U.S. Treasury yield curve. Interest rate duration considers both assets and liabilities. As of September 30, 2000, the Company's duration on equity was approximately 5.7 years. This implies that a parallel shift of the U.S. Treasury yield curve of 100 basis points would cause the Company's net asset value to increase or decrease by approximately 5.7%. Because the Company's assets, and their markets, have other, more complex sensitivities to interest rates, the Company's management believes that this metric represents a good approximation of the change in portfolio net market value in response to changes in interest rates, though actual performance may vary due to changes in prepayments, credit spreads and the cost of increased market volatility. Other methods for evaluating interest rate risk, such as interest rate sensitivity "gap" (defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period), are used but are considered of lesser significance in the daily management of the Company's portfolio. The majority of the Company's assets pay a fixed coupon and the income from such assets are relatively unaffected by interest rate changes. The majority of the Company's liabilities are borrowings under its line of credit or reverse repurchase agreements that bear interest at variable rates that reset monthly. Given this relationship between assets and liabilities, the Company's interest rate sensitivity gap is highly negative. This implies that a period of falling short-term interest rates will tend to increase the Company's net interest income while a period of rising short-term interest rates will tend to reduce the Company's net interest income. Management considers this relationship when reviewing the Company's hedging strategies. Because different types of assets and liabilities with the same or similar maturities react differently to changes in overall market rates or conditions, changes in interest rates may affect the Company's net interest income positively or negatively even if the Company were to be perfectly matched in each maturity category. The Company currently has positions in forward currency exchange contracts to hedge currency exposure in connection with its commercial mortgage loan denominated in pounds sterling. The purpose of the Company's foreign currency-hedging activities is to protect the Company from the risk that the eventual U.S. dollar net cash inflows from the commercial mortgage loan will be adversely affected by changes in exchange rates. The Company's current strategy is to roll these contracts from time to time to hedge the expected cash flows from the loan. Fluctuations in foreign exchange rates are not expected to have a material impact on the Company's net portfolio value or net interest income. FORWARD-LOOKING STATEMENTS: Certain statements contained herein are not, and certain statements contained in future filings by the Company with the SEC in the Company's press releases or in the Company's 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 the Company's 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, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, the financial and securities markets and the availability of and costs associated with sources of liquidity. Additional information regarding these and other important factors that could cause actual results to differ from those in the Company's forward looking statements are contained under the section entitled "Risk Factors" in the Company's Registration Statement on Form S-3 (File No. 333-32155), as filed with the SEC on March 10, 2000 and in the Company's Registration Statement on Form S-4 (File No.333-33596), as filed with the SEC on March 30, 2000, as amended by Amendment No.1 to the Company's Registration Statement on Form S-4, as filed with the SEC on April 11, 2000. The Company hereby incorporates by reference those risk factors in this Form 10-Q. The Company does not undertake, and specifically disclaims 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. Part II - OTHER INFORMATION Item 1. Legal Proceedings At September 30, 2000 there were no pending legal proceedings to which the Company was a party or of which any of its property was subject. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 27.1 - Financial Data Schedule (filed herewith) (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. ANTHRACITE CAPITAL, INC. Dated: November 13, 2000 By: /s/ Hugh R. Frater --------------------- Name: Hugh R. Frater Title:President and Chief Executive Officer (authorized officer of registrant) Dated: November 13, 2000 By: /s/ Richard M. Shea --------------------- Name: Richard M. Shea Title: Chief Operating Officer and Chief Financial Officer (principal accounting officer) EX-27 2 0002.txt EXHIBIT 27.1 - FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE SEPTEMBER 30, 2000 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH QUARTERLY REPORT ON FORM 10-Q. 1,000 9-MOS SEP-30-2000 JAN-10-2000 SEP-30-2000 13,397 1,120,819 42 0 0 0 0 0 1,150,682 875,955 0 315,532 0 73,299 (114,129) 1,150,682 0 69,593 0 0 6,465 0 37,328 28,037 0 28,037 0 0 0 28,037 1.01 0.95
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