-----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, V5AXYJnczFnGg9Y115IFuvGr5WEsbZUz36P0a5S/h2PlXv4+hiE+jZKn7eVTHP4U zWHOY96EvEJF3pabQelkpw== 0000950172-01-000397.txt : 20010409 0000950172-01-000397.hdr.sgml : 20010409 ACCESSION NUMBER: 0000950172-01-000397 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ANTHRACITE CAPITAL INC CENTRAL INDEX KEY: 0001050112 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 133978906 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13937 FILM NUMBER: 1591655 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-K 1 0001.txt 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from: ________ to ________ Commission File No. 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 29th Floor New York, New York 10154 ------------------ ----- (Address of principal executive office) (Zip Code) (212) 409-3333 -------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: Not Applicable Securities registered pursuant to Section 12(b) of the Act: COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE (NYSE) (Title of each class) (Name of each exchange on which registered) 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. Yes |X| No |_| Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| As of March 28, 2001, the aggregate market value of the registrant's Common Stock, $.001 par value, held by nonaffiliates of the registrant, computed by reference to the closing price of $9.65 as reported on the New York Stock Exchange as of the close of business on March 28, 2001: $287,492,964 (for purposes of this calculation affiliates include only directors and executive officers of the Company). The number of shares of the registrant's Common Stock, $.001 par value, outstanding as of March 28, 2001 was 29,792,017 shares. ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES 2000 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS ----------------- PAGE PART I Item 1. Business 4 Item 2. Properties 19 Item 3. Legal Proceedings 19 Item 4. Submission of Matters to a Vote of Security Holders 19 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 20 Item 6. Selected Financial Data 20 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 37 Item 8. Financial Statements and Supplementary Data 41 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 74 PART III Item 10. Directors and Executive Officers of the Registrant 75 Item 11. Executive Compensation 75 Item 12. Security Ownership of Certain Beneficial Owners and Management 75 Item 13. Certain Relationships and Related Transactions 75 PART IV Item 14. Exhibits 75 Signatures 76 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained herein are not, and certain statements contained in future filings by Anthracite Capital, Inc. (the "Company") with the SEC, in the Company's press releases or in the Company's other public or stockholder 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. 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 I ITEM 1. BUSINESS All dollar figures expressed herein are expressed in thousands, except per share amounts. GENERAL Anthracite Capital, Inc. (the "Company"), a Maryland corporation is a real estate finance company that generates income based on the spread between the interest income on its mortgage loans and securities investments and the interest expense from borrowings used to finance its investments. The Company seeks to earn high returns on a risk-adjusted basis to support a consistent quarterly dividend. The Company has elected to be taxed as a Real Estate Investment Trust, therefore, its income is largely exempt from corporate taxation. This allows the Company to generate a higher level of earnings than otherwise attainable by a taxable finance company making similar investments. The Company commenced operations on March 24, 1998. In the past five years the real estate finance markets have evolved significantly as the capital markets play a larger role along with the traditional commercial banking sources of capital. This has created opportunities for companies that have expertise in both areas. The Company's external manager, BlackRock Financial Management, Inc. (the "Manager" or "BlackRock"), provides significant experience in traditional real estate loan origination and servicing along with capital markets, investing and risk management expertise. The Company's three business activities are (i) originating high yield commercial real estate loans, (ii) investing in below investment grade commercial mortgage backed securities ("CMBS") where the Company has the right to control the foreclosure/workout process on the underlying loans, and (iii) acquiring investment grade real estate related securities. This represents an integrated strategy where each line of business supports the others and creates additional value for shareholders over and above operating each line in isolation. The commercial real estate loans provide high risk adjusted returns for shorter periods of time, the CMBS portfolio provides diversification and high loss adjusted returns over a weighted average life of approximately 10 years, and the investment grade securities investments is an actively managed portfolio that supports the liquidity needs of the Company while earning attractive returns. These strategies are pursued within an aggregate risk management framework that seeks to limit the exposure of the Company's equity and earnings to changes in interest rates and other exogenous factors beyond the Company's control. The day-to-day operations of the Company are managed by BlackRock, subject to the direction and oversight of the Company's board of directors (the "Board of Directors"). The Manager is a wholly owned subsidiary of BlackRock, Inc., which is listed for trading on the New York Stock Exchange ("NYSE") under the symbol "BLK". BlackRock, Inc. is 70% owned by PNC Bank, National Association ("PNC Bank"), which is itself a wholly owned subsidiary of PNC Bank Corp (NYSE: PNC). Established in 1988, the Manager is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the "Investment Advisers Act") and is one of the largest investment management firms in the United States. The Manager, in its discretion, subject to the supervision of the Board of Directors, evaluates and monitors the Company's assets and how long such assets should be held in the Company's portfolio. The Manager is permitted to actively manage the Company's assets, and such assets may or may not be held to maturity. Although the Company intends to manage its assets actively, it does not intend to acquire, hold or sell assets in such a manner that such assets would be characterized as dealer property for Federal income tax purposes. Commercial Real Estate Loans High yield commercial real estate loan originations represent the Company's efforts to take advantage of opportunities in the real estate finance markets on a targeted basis. The traditional first lien real estate lender has shifted its focus to originating loans that can be sold into a securitization in the capital markets. To achieve the best execution for this strategy first lien lenders will generally reduce their loan to value ratios. Borrowers continue to require the same leverage to achieve their required equity returns, so alternative sources of capital are needed fill the financing gap between the first lien lender and the borrower's equity. The Company's high yield commercial real estate loan originations, also known as mezzanine loans, fill this gap on a secured basis at very attractive prices and terms. An effective mezzanine-lending program can achieve superior risk adjusted returns versus alternative investments. The type of investments in this class include loans secured by second mortgages, subordinated participations in first mortgages, loans secured by partnership interests and preferred equity interests in real estate limited partnerships. The weighted average life of these investments is generally two to three years and average leverage is 1:1 debt to capital generally funded with the debt coterminous with the investment. These investments have fixed or floating rate coupons, and some provide additional earnings through an IRR look back or profit participation. The Company performs significant due diligence before making investments to evaluate risks and opportunities in this sector. The Company generally focuses on strong sponsorship, attractive real estate fundamentals, pricing and structural characteristics that provide significant control over the underlying asset. At December 31, 2000 the Company owned eight separate mezzanine investments with an average investment of $20,000 and is focused on adding to this on a strategic basis. The real estate underlying each of the Company's mezzanine investments is performing better than underwritten expectations. The typical current returns on Company's equity range from 18% - 20% with additional earning potential from profit participations and IRR return look back features. This asset class earns a high yield and allows the Company to maintain flexibility to move quickly in search of the highest risk adjusted returns. Commercial Mortgage Backed Securities The Company owns below investment grade classes of six different CMBS and has been an active bidder for this asset class. These CMBS investments are fixed rate securities backed by pools of first mortgage loans on commercial real estate assets located across the country. Owning commercial real estate loans in this form allows the company to earn attractive loss adjusted returns while achieving significant diversification across geographic areas and property types. The total par amount of these investments is $605,909, the total fair market value at year-end was $288,686 representing an average dollar price of 47.65. The unlevered yield on this portfolio is approximately 10.43% before adjusting for expected losses and 9.78% on a loss-adjusted basis. The Company anticipates receiving approximately two-thirds of its stated par amount with the remainder representing assumed credit losses. Income is reported to shareholders after taking into account this assumed credit losses. The Company uses a sophisticated Intranet based performance monitoring system to track the credit experience of the loans in the CMBS pools. The Company receives remittance reports monthly and can closely monitor any delinquent loans or other issues that may affect the performance of the loans. The Company also reviews its credit assumptions on quarterly basis using updated debt service coverage information on each loan in the pools and reviewing economic trends on both a national and regional level. Investment Grade Real Estate Related Securities A key element in managing the risk of a portfolio of mezzanine loans and below investment grade CMBS is to maintain sufficient liquid assets to support these investments during periods of reduced liquidity in the financial markets. This portfolio is generally comprised of government guaranteed residential fixed rate and adjustable rate mortgages and BBB or higher rated commercial mortgage backed securities. The portfolio is typically maintained at 50% of total assets or 20%-25% of the Company's equity (net of financing) and provides a ready source of cash that can be used to support the Company's other investment operations, if needed. This allows the Company to earn attractive returns on equity while still maintaining significant liquidity. This portfolio is leveraged more than the mezzanine and CMBS portfolios but significantly lower than a typical investment grade portfolio. At December 31, 2000 the Company's assets were allocated among these three categories as follows:
PERCENT OF DEBT TO INVESTED CAPITAL ASSETS LIABILITIES NET CAPITAL RATIO ------ ----------- ---------- ---------- ------- Cash and liquidity portfolio $562,327 $479,070 $83,257 28.2% 5.75 Below investment grade CMBS 288,686 161,608 127,078 43.0% 1.27 Mezzanine loans and Joint Ventures 163,541 78,664 84,877 28.8% 0.93 --------- --------- ---------- ---------- ------- Total Invested Assets 1,014,554 719,342 295,212 100.0% 2.44 ========= ========= ========== ========== =======
The Company's anticipated yields to maturity on its investments are based upon a number of assumptions that are subject to certain business and economic uncertainties and contingencies. Examples of such contingencies include, among other things, expectation of credit losses, 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 Company's anticipated yields to maturity will be achieved. The following is a summary of the types of assets, among others, that the Company may invest in from time to time. MORTGAGE BACKED SECURITIES. The Company acquires both investment grade and non-investment grade classes of MBS from various sources. MBS typically are divided into two or more interests, sometimes called "tranches" or "classes." The senior classes are often securities which, if rated, would have ratings ranging from low investment grade "BBB" to higher investment grades "A," "AA" or "AAA." The junior, subordinated classes typically would include one or more non-investment grade classes, which, if rated, would have ratings below investment grade "BBB." Such subordinated classes also typically include an unrated higher-yielding, credit support class (which generally is required to absorb the first losses on the underlying mortgage loans). MBS are generally issued either as "CMOs" or "Pass-Through Certificates." CMOs are debt obligations of special purpose corporations, owner trusts or other special purpose entities secured by commercial mortgage loans or MBS. Pass-Through Certificates evidence interests in trusts, the primary assets of which are mortgage loans. CMO Bonds and Pass-Through Certificates may be issued or sponsored by agencies or instrumentalities of the United States Government or private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment banks and other entities. MBS may not be guaranteed by an entity having the credit status of a governmental agency or instrumentality and in this instance are generally structured with one or more of the types of credit enhancements described below. In addition, MBS may be illiquid. The Company acquires both CMBS and RMBS. The mortgage collateral supporting CMBS may be pools of whole loans or other MBS, or both. Unlike RMBS, which typically are collateralized by thousands of single-family mortgage loans, CMBS are collateralized generally by a more limited number of commercial or multifamily mortgage loans with larger principal balances than those of single-family mortgage loans. As a result, a loss on a single mortgage loan underlying a CMBS will have a greater negative effect on the yield of such CMBS, especially the subordinated MBS in such CMBS. MORTGAGE LOANS. The Company acquires or originates fixed and adjustable-rate mortgage loans secured by senior, mezzanine or subordinate liens on multifamily residential, commercial, single-family (one-to-four unit) residential or other real property as a significant part of its investment strategy. ("Mortgage Loan") Mortgage loans may be originated by or purchased from various suppliers of mortgage assets throughout the United States and abroad, such as savings and loan associations, banks, mortgage bankers, home builders, insurance companies and other mortgage lenders. The Company acquires mortgage loans directly from originators and from entities holding mortgage loans originated by others. The Company also originates its own mortgage loans, particularly on mezzanine financing of mortgage loans and real property portfolios. The Company may invest in or provide loans used to finance construction, loans secured by real property and used as temporary financing, and loans secured by junior liens on real property. The Company may invest in multifamily and commercial mortgage loans that are in default or for which default is likely or imminent or for which the borrower is making monthly payments in accordance with a forbearance plan. The Company may provide mezzanine financing on commercial property that is subject to first lien mortgage debt. The Company's mezzanine financing takes the form of subordinated loans, commonly known as second mortgages, or, in the case of loans originated for securitization, partnership loans (also known as pledge loans) or preferred equity investments. For example, on a commercial property subject to a first lien mortgage loan with a principal balance equal to 70% of the value of the property, the Company could lend the owner of the property (typically a partnership) an additional 15% to 20% of the value of the property. Typically in a mezzanine mortgage loan, as security for its debt to the Company, the property owner would pledge to the Company either the property subject to the first lien (giving the Company a second lien position typically subject to an inter-creditor agreement) or the limited partnership and/or general partnership interest in the owner. If the owner's general partnership interest is pledged, then the Company would be in a position to take over the operation of the property in the event of a default by the owner. By borrowing against the additional value in their properties, the property owners obtain an additional level of liquidity to apply to property improve-ments or alternative uses. Mezzanine mortgage loans generally provide the Company with the right to receive a stated interest rate on the loan balance plus various commitment and/or exit fees. In certain instances, subject to the REIT Provisions of the Internal Revenue Code of 1986 (the "Code"), the Company may negotiate to receive a percentage of net operating income or gross revenues from the property, payable to the Company on an ongoing basis, and a percentage of any increase in value of the property, payable upon maturity or refinancing of the loan, or the Company will otherwise seek terms to allow the Company to charge an interest rate that would provide an attractive risk-adjusted return. Alternatively, the mezzanine mortgage loans can take the form of a non-voting preferred equity investment in a single purpose entity borrower with substan-tially similar terms. The Company may acquire or originate mortgage loans secured by real property located outside the United States or acquire such real property. The Company has no limitations on the geographic scope of its investments in foreign real properties and such investments may be made in a single foreign country or among several foreign countries as the Board of Directors may deem appropriate. Investing in real estate related assets located in foreign countries creates risks associated with the uncertainty of foreign laws and markets and risks related to currency conversion. The Company may be subject to foreign income tax with respect to its investments in foreign real estate related assets. Any foreign tax credit that otherwise would be available to the Company for Federal income tax purposes will not flow through to the Company's stockholders. MULTIFAMILY AND COMMERCIAL REAL PROPERTIES. The Company believes that under appropri-ate circumstances the acquisition of multifamily and commercial real properties may offer significant opportunities to the Company. The Company's policy is to conduct an investigation and evaluation of the real properties in a portfolio of real properties before purchasing such a portfolio. Prior to purchasing real estate related assets, the Manager generally will identify and contact real estate brokers and/or appraisers in the relevant market areas to obtain rent and sale comparables for the assets in a portfolio contemplated to be acquired. This information is used to supplement due diligence performed by the Manager's employees. The Company may acquire real properties with known material environmental problems and Mortgage Loans secured by such real properties subsequent to an environmental assessment that would reasonably indicate that the present value of the cost of clean-up or rededication would not exceed the realizable value from the disposition of the mortgage property. The Company may invest in net leased real estate on a leveraged basis. Net leased real estate is generally defined as real estate that is net leased to tenants who are customarily responsible for paying all costs of owning, operating, and maintaining the leased property during the term of the lease, in addition to paying a monthly net rent to the landlord for the use and occupancy of the premises ("Net Leased Real Estate"). The Company will consider investing in net leased real estate that is either leased to creditworthy tenants or is underlied by real estate that can be leased to other tenants in the event of a default of the initial tenant. OTHER REAL ESTATE RELATED ASSETS. The Company may invest in a variety of other real estate related investments, the principal features of which are summarized below. Pass-Through Certificates. The Company's investments in mortgage assets are currently and expected to be concentrated in Pass-Through Certificates. The Pass-Through Certificates to be acquired by the Company will consist primarily of pass-through certificates issued by FNMA, FHLMC and GNMA, as well as privately issued adjustable-rate and fixed-rate mortgage pass-through certificates. The Pass-Through Certificates to be acquired by the Company will represent interests in mortgages that will be secured by liens on single-family (one-to-four units) residential properties, multifamily residential properties, and commercial properties. Pass-Through Certificates backed by adjustable-rate Mortgage Loans are subject to lifetime interest rate caps and to periodic interest rate caps that limit the amount an interest rate can change during any given period. The Company's borrowings are generally not subject to similar restrictions. In a period of increasing interest rates, the Company could experience a decrease in net income or incur losses because the interest rates on its borrowings could exceed the interest rates on adjustable-rate Pass-Through Certificates owned by the Company. The impact on net income of such interest rate changes will depend on the adjustment features of the mortgage assets owned by the Company, the maturity schedules of the Company's borrowings and related hedging. Privately Issued Pass-Through Certificates. Privately Issued Pass-Through Certificates are structured similar to the FNMA, FHLMC and GNMA pass-through certificates discussed below and are issued by originators of and investors in Mortgage Loans, including savings and loan associations, savings banks, commercial banks, mortgage banks, investment banks and special purpose subsidiaries of such institutions. Privately Issued Pass-Through Certificates are usually backed by a pool of conventional Mortgage Loans and are generally structured with credit enhancement such as pool insurance or subordination. However, Privately Issued Pass-Through Certificates are typically not guaranteed by an entity having the credit status of FNMA, FHLMC or GNMA guaranteed obliga-tions. FNMA Certificates. FNMA is a federally chartered and privately owned corporation. FNMA provides funds to the mortgage market primarily by purchasing Mortgage Loans on homes from local lenders, thereby replenishing their funds for additional lending. FNMA Certificates may be backed by pools of Mortgage Loans secured by single-family or multi-family residential properties. The original terms to maturity of the Mortgage Loans generally do not exceed 40 years. FNMA Certificates may pay interest at a fixed rate or adjustable rate. Each series of FNMA adjustable-rate certificates bears an initial interest rate and margin tied to an index based on all loans in the related pool, less a fixed percentage representing servicing compensation and FNMA's guarantee fee. The specified index used in each such series has included the Treasury Index, the 11th District Cost of Funds Index, LIBOR and other indices. Interest rates paid on fully-indexed FNMA adjustable-rate certificates equal the applicable index rate plus a specified number of basis points ranging typically from 125 to 250 basis points. In addition, the majority of FNMA adjustable-rate certificates issued to date have evidenced pools of Mortgage Loans with monthly, semi-annual or annual interest rate adjustments. Adjustments in the interest rates paid are generally limited to an annual increase or decrease of either 100 or 200 basis points and to a lifetime cap of 500 or 600 basis points over the initial interest rate. Certain FNMA programs include Mortgage Loans, which allow the borrower to convert the adjustable mortgage interest rate of its adjustable-rate Mortgage Loan to a fixed rate. Adjustable-rate Mortgage Loans which are converted into fixed rate Mortgage Loans are repurchased by FNMA, or by the seller of such loans to FNMA, at the unpaid principal balance thereof plus accrued interest to the due date of the last adjustable rate interest payment. FNMA guarantees to the registered holder of a FNMA Certificate that it will distribute amounts representing scheduled principal and interest (at the rate provided by the FNMA Certificate) on the Mortgage Loans in the pool underlying the FNMA Certificate, whether or not received, and the full principal amount of any such Mortgage Loan foreclosed or otherwise finally liquidated, whether or not the principal amount is actually received. The obligations of FNMA under its guarantees are solely those of FNMA and are not backed by the full faith and credit of the United States. If FNMA were unable to satisfy such obligations, distributions to holders of FNMA Certificates would consist solely of payments and other recoveries on the underlying Mortgage Loans and, accordingly, monthly distributions to holders of FNMA Certificates would be affected by delinquent payments and defaults on such Mortgage Loans. FHLMC Certificates. FHLMC is a privately owned corporate instrumentality of the United States created pursuant to an Act of Congress. The principal activity of FHLMC currently consists of the purchase of conforming Mortgage Loans or participation interests therein and the resale of the loans and participations so purchased in the form of guaranteed MBS. Each FHLMC Certificate issued to date has been issued in the form of a Pass-Through Certificate representing an undivided interest in a pool of Mortgage Loans purchased by FHLMC. The Mortgage Loans included in each pool are fully amortizing, conventional Mortgage Loans with original terms to maturity of up to 40 years secured by first liens on one-to-four unit family residential properties or multi-family properties. FHLMC guarantees to each holder of its certificates the timely payment of interest at the applicable pass-through rate and ultimate collection of all principal on the holder's pro rata share of the unpaid principal balance of the related Mortgage Loans, but does not guarantee the timely payment of scheduled principal of the underlying Mortgage Loans. The obligations of FHLMC under its guarantees are solely those of FHLMC and are not backed by the full faith and credit of the United States. If FHLMC were unable to satisfy such obligations, distributions to holders of FHLMC Certificates would consist solely of payments and other recoveries on the underlying Mortgage Loans and, accordingly, monthly distributions to holders of FHLMC Certificates would be affected by delinquent payments and defaults on such Mortgage Loans. GNMA Certificates. GNMA is a wholly owned corporate instrumentality of the United States within HUD. GNMA guarantees the timely payment of the principal of and interest on certificates that represent an interest in a pool of Mortgage Loans insured by the FHA and other loans eligible for inclusion in mortgage pools underlying GNMA Certificates. GNMA Certificates constitute general obligations of the United States backed by its full faith and credit. Collateralized Mortgage Obligations (CMOs). The Company invests, from time to time, in adjustable rate and fixed rate CMOs issued by private issuers or FHLMC, FNMA or GNMA. CMOs are a series of bonds or certificates ordinarily issued in multiple classes, each of which consists of several classes with different maturities and often complex priorities of payment, secured by a single pool of Mortgage Loans, Pass-Through Certificates, other CMOs or other mortgage assets. Principal prepayments on collateral underlying a CMO may cause it to be retired substantially earlier than the stated maturities or final distribution dates. Interest is paid or accrues on all interest bearing classes of a CMO on a monthly, quarterly or semi-annual basis. The principal and interest on underlying Mortgages Loans may be allocated among the several classes of a series of a CMO in many ways, including pursuant to complex internal leverage formulas that may make the CMO class especially sensitive to interest rate or prepayment risk. CMOs may be subject to certain rights of issuers thereof to redeem such CMOs prior to their stated maturity dates, which may have the effect of diminishing the Company's anticipated return on its investment. Privately-issued single-family, multi-family and commercial CMOs are supported by private credit enhancements similar to those used for Privately-Issued Certificates and are often issued as senior-subordinated mortgage securities. In general, the Company intends to only acquire CMOs or multi-class Pass-Through certificates that represent beneficial ownership in grantor trusts holding Mortgage Loans, or regular interests and residual interests in REMICs, or that otherwise constitute REIT Real Estate Assets. Mortgage Derivatives. The Company invests in Mortgage Derivatives, including Interest-Only securities (IOs), Inverse IOs, Sub IOs and floating rate derivatives, as market conditions warrant. Mortgage Deriva-tives provide for the holder to receive interest only, principal only, or interest and principal in amounts that are disproportionate to those payable on the underlying Mortgage Loans. Payments on Mortgage Derivatives are highly sensitive to the rate of prepayments on the underlying Mortgage Loans. In the event that prepayments on such Mortgage Loans occur more frequently than antici-pated, the rates of return on Mortgage Derivatives representing the right to receive interest only or a disproportionately large amount of interest, i.e., IOs, would be likely to decline. Conversely, the rates of return on Mortgage Derivatives representing the right to receive principal only or a disproportional amount of principal, i.e., POs, would be likely to increase in the event of rapid prepayments. Some IOs in which the Company may invest, such as Inverse IOs, bear interest at a floating rate that varies inversely with (and often at a multiple of) changes in a specific index. The yield to maturity of an Inverse IO is extremely sensitive to changes in the related index. The Company also may invest in inverse floating rate Mortgage Derivatives, which are similar in structure and risk to Inverse IOs, except they generally are issued with a greater stated principal amount than Inverse IOs. Other IOs in which the Company may invest, such as Sub IOs, have the characteristics of a Subordinated Interest. A Sub IO is entitled to no payments of principal; moreover, interest on a Sub IO often is withheld in a reserve fund or spread account to fund required payments of principal and interest on more senior tranches of mortgage securities. Once the balance in the spread account reaches a certain level, excess funds are paid to the holders of the Sub IO. These Sub IOs provide credit support to the senior classes and thus bear substantial credit risks. In addition, because a Sub IO receives only interest payments, its yield is extremely sensitive to the rate of prepayments (including prepayments as a result of defaults) on the underlying Mortgage Loans. IOs can be effective hedging devices because they generally increase in value as fixed-rate mortgage securities decrease in value. The Company also may invest in other types of derivatives currently available in the market and other Mortgage Derivatives that may be developed in the future if the Manager determines that such investments would be advantageous to the Company. FHA and GNMA Project Loans. The Company may invest in loan participations and pools of loans insured under a variety of programs administered by the Department of Housing and Urban Development ("HUD"). These loans will be insured under the National Housing Act and will provide financing for the purchase, construction or substantial rehabilitation of multifamily housing, nursing homes and intermediate care facilities, elderly and handicapped housing, and hospitals. Similar to CMBS, investments in FHA and GNMA Project Loans will be collateralized by a more limited number of loans, with larger average principal balances, than RMBS, and will therefore be subject to greater performance variability. Loan participations are most often backed by a single FHA-insured loan. Pools of insured loans, while more diverse, still provide much less diversification than pools of single-family loans. FHA insured loans will be reviewed on a case by case basis to identify and analyze risk factors, which may materially impact investment performance. Property-specific data such as debt service coverage ratios, loan-to-value ratios, HUD inspection reports, HUD financial statements and rental subsidies will be analyzed in determining the appropriateness of a loan for investment purposes. The Manager will also rely on the FHA insurance contracts and their anticipated impact on investment performance in evaluating and managing the investment risks. FHA insurance covers 99% of the principal balance of the underlying project loans. Additional GNMA credit enhancement may cover 100% of the principal balance. Other. The Company may invest in fixed-income securities that are not mortgage assets, including securities issued by corporations or issued or guaranteed by U.S. or sovereign foreign entities, loan participations, emerging market debt, high yield debt and collateralized bond obliga-tions. HEDGING ACTIVITIES The Company enters into hedging transactions to protect its investment portfolio from interest rate fluctuations and other changes in market conditions. These transactions may include interest rate swaps, the purchase or sale of interest rate collars, caps or floors, options, Mortgage Derivatives and other hedging instruments. These instruments may be used to hedge as much of the interest rate risk as the Manager determines is in the best interest of the Company's stockholders, given the cost of such hedges and the need to maintain the Company's status as a REIT. The Manager may elect to have the Company bear a level of interest rate risk that could otherwise be hedged when the Manager believes, based on all relevant facts, that bearing such risk is advisable. The Manager has extensive experience in hedging mortgages and mortgage-related assets with these types of instruments. Hedging instruments often are not traded on regulated exchanges, guaranteed by an exchange or its clearinghouse, or regulated by any U.S. or foreign governmental authorities. Consequently, there may be no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. The Company will enter into these transactions only with counterparties with long-term debt rated "A" or better by at least one nationally recognized statistical rating organization. The business failure of a counterparty with which the Company has entered into a hedging transaction will most likely result in a default, which may result in the loss of unrealized profits and force the Company to cover its resale commitments, if any, at the then current market price. Although generally the Company will seek to reserve for itself the right to terminate its hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the counterparty, and the Company may not be able to enter into an offsetting contract in order to cover its risk. There can be no assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and the Company may be required to maintain a position until exercise or expiration, which could result in losses. The Company's hedging activities are intended to address both income and capital preservation. Income preservation refers to maintaining a stable spread between yields from mortgage assets and the Company's borrowing costs across a reasonable range of adverse interest rate environments. Capital preservation refers to maintaining a relatively steady level in the market value of the Company's capital across a reasonable range of adverse interest rate scenarios. However, no strategy can insulate the Company completely from changes in interest rates. As of December 31, 2000, the Company's hedging transactions outstanding consisted of forward currency exchange contracts pursuant to which the Company agreed to exchange 8,000 (pounds sterling) for $12,137 (U.S. dollars) on January 18, 2001. On January 18, 2001, the Company agreed to exchange 8,000 (pounds sterling) for $11,782 on July 18, 2001. As of December 31, 1999, the Company agreed to exchange 8,000 (pounds sterling) for $12,702 (U.S. dollars) on January 18, 2000. Upon the maturity of this contract, the Company entered into a similar forward currency exchange contract. These contracts are intended to hedge currency risk in connection with the Company's investment in a commercial mortgage loan denominated in pounds sterling. The estimated fair value of the forward currency exchange contracts was an asset of $749 and a liability of $(221) at December 31, 2000 and 1999, respectively, which was recognized as a addition (reduction) of net foreign currency gains (losses). As of December 31, 1999, the Company had outstanding a short position of 186 thirty-year U.S. Treasury Bond future contracts and 1,080 five-year and 200 ten-year U.S. Treasury Note future contracts expiring in March 31, 2000, which represented $18,600 and $128,000 in face amount of U.S. Treasury Bonds and Notes, respectively. Realized gains and losses on closed contracts are recognized as a net adjustment to the basis of the hedged security. The estimated fair value of these contracts was approximately $1,925 at December 31, 1999 and is included in the carrying value of the hedged available for sale securities. At December 31, 2000 the Company did not have outstanding U.S. Treasury future contracts which were considered hedging instruments. Interest rate swap agreements as of December 31, 2000 consisted of the following: Notional Estimated Unamortized Average Value Fair Value Cost Remaining Term ------------------------------------------------------ Interest rate swap $ 226,000 $(12,505) $9,471 19.3 years agreements The Company did not have interest rate swap agreements at December 31, 1999. FINANCING AND LEVERAGE The Company has financed its assets with the net proceeds of its initial public and secondary offerings, through the issuance of preferred stock, through short-term borrowings under repurchase agreements, and the lines of credit discussed below. In the future, operations may be financed by future offerings of equity securities, and unsecured and secured borrowings. The Company expects that, in general, it will employ leverage consistent with the type of assets acquired and the desired level of risk in various investment environments. The Company's governing documents do not explicitly limit the amount of leverage that the Company may employ. Instead, the Board of Directors has adopted an indebtedness policy for the Company that gives the Manager extensive discretion as to the amount of leverage to be employed, depending on the Manager's assessment of acceptable risk and consistent with the nature of the assets then held by the Company, subject to periodic review by the Company's Board of Directors. At December 31, 2000 and 1999, the Company's debt-to-equity ratio for at-risk assets was approximately 3.2 to 1 and 3.0 to 1, respectively. The Company anticipates that it will maintain debt-to-equity ratios for at-risk assets of between 2.5 to 1 and 4.5 to 1 in the foreseeable future, although this ratio may be higher or lower from time to time. The Company considers its at-risk assets to be its core strategy operating portfolio and its non-core strategy liquidity portfolio. The Company's indebtedness policy may be changed by the Board of Directors in the future. In September 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 December 31, 2000 outstanding borrowings were $37,253. Outstanding borrowings under this facility bear interest at a LIBOR based variable rate. The Company has another agreeme nt with Merrill Lynch, which permits the Company to borrow up to $200,000. As of December 31, 2000 and December 31, 1999, the outstanding borrowings under this line of credit were $63,453, 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. On January 15, 2001, the facility was renewed 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 December 31, 2000 and December 31, 1999, the Company had drawn $17,500 and $14,131, respectively, 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 an $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 investments in real estate joint ventures. As of December 31, 2000 and December 31, 1999, the outstanding borrowings under this facility were $53,810 and $5,022, respectively. Outstanding borrowings under the Deutsche Bank Facility 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 Generele 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 December 31, 2000, outstanding borrowing under the ABN Amro facility was $30,115. 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 December 31, 2000 the Company was in compliance with all such covenants. On December 2, 1999 the Company authorized and issued 1,200,000 shares of Series A Preferred Stock for aggregate proceeds of $30,000. The new series of Preferred Stock carries a 10.5% coupon and is convertible into 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 for $28.50 per share. If converted, the Preferred Stock would convert into approximately 4,000,000 shares of the Company's common stock. On February 14, 2001 the Company completed a secondary offering of 4,000,000 shares of its Common Stock in an underwritten public offering. The aggregate net proceeds to the Company (after deducting underwriting fees and expenses) were $33,300. The Company had granted the underwriters an option, exercisable for 30 days, to purchase up to 600,000 additional shares of Common Stock to cover over-allotments. This option was exercised on March 13, 2001 and resulted in net proceeds to the Company of $5,000. The Company has entered into reverse repurchase agreements to finance most of its securities available for sale which 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 rates that have historically moved in close relationship to LIBOR. Certain information with respect to the Company's collateralized borrowings at December 31, 2000 is summarized as follows:
Lines of Reverse Total Credit and Repurchase Collateralized Term Loans Agreements Borrowings ------------------------------------------------- Outstanding borrowings $202,130 $517,212 $719,342 Weighted average borrowing rate 7.68% 6.57% 6.88% Weighted average remaining maturity 152 Days 22 Days 57 Days Estimated fair value of assets pledged $354,108 $588,657 $942,765
At December 31, 2000, $23,128 of borrowings outstanding under the line of credit was denominated in pounds sterling, and interest payable is based on sterling LIBOR. At December 31, 2000, the Company's collateralized borrowings had the following remaining maturities: Lines of Credit Reverse Total and Term Loan Repurchase Collateralized Agreements Borrowings ----------------------------------------------- Within 30 days $63,453 $376,588 $440,041 31 to 59 days - 140,624 140,624 Over 60 days 138,677 - 138,677 ----------------------------------------------- $202,130 $517,212 $719,342 =============================================== As of December 31, 2000, $131,190 of the Company's $185,000 committed credit facility with Deutsche Bank, AG was available for future borrowings, and $162,747 and $136,547 was available under each of the Company's $200,000 term facilities with Merrill Lynch. Under the line of credit and the reverse repurchase agreements, the 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 cash margin calls. From time to time, the Company expects that it will be required to provide such additional collateral or fund margin calls. The Company maintains adequate liquidity to meet such calls. OPERATING POLICIES The Company has adopted compliance guidelines, including restrictions on acquiring, holding and selling assets, to ensure that the Company meets the requirements for qualification as a REIT and is excluded from regulation as an investment company. Before acquiring any asset, the Manager determines whether such asset would constitute a REIT Real Estate Asset under the REIT Provisions of the Code. The Company regularly monitors purchases of mortgage assets and the income generated from such assets, including income from its hedging activities, in an effort to ensure that at all times the Company's assets and income meet the requirements for qualification as a REIT and exclusion under the Investment Company Act of 1940. The Company's unaffiliated directors review all transactions of the Company on a quarterly basis to ensure compliance with the operating policies and to ratify all transactions with PNC Bank and its affiliates, except that the purchase of securities from PNC and its affiliates require prior approval. The unaffiliated directors rely substantially on information and analysis provided by the Manager to evaluate the Company's operating policies, compliance therewith and other matters relating to the Company's investments. In order to maintain the Company's REIT status, the Company generally intends to distribute to stockholders aggregate dividends equaling at least 95% of its taxable income each year or 90% for years ending after 2000. REGULATION The Company intends to continue to conduct its business so as not to become regulated as an investment company under 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 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/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 indebted-ness (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 recission 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. COMPETITION The Company's net income depends, in large part, on the Company's ability to acquire mortgage assets at favorable spreads over the Company's borrowing costs. In acquiring mortgage assets, the Company competes with other mortgage REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, other lenders, governmental bodies and other entities. In addition, there are numerous mortgage REITs with asset acquisition objectives similar to the Company, and others may be organized in the future. The effect of the existence of additional REITs may be to increase competition for the available supply of mortgage assets suitable for purchase by the Company. Many of the Company's anticipated competitors are significantly larger than the Company, have access to greater capital and other resources and may have other advantages over the Company. In addition to existing companies, other companies may be organized for purposes similar to that of the Company, including companies organized as REITs focused on purchasing mortgage assets. A proliferation of such companies may increase the competition for equity capital and thereby adversely affect the market price of the Company's common stock. EMPLOYEES The Company does not have any employees other than officers, each of whom are full-time employees of the Manager, whose duties include performing administrative activities for the Company. MANAGEMENT AGREEMENT The Company is managed pursuant to a management agreement, dated March 27, 1998, between the Company and the Manager (the "Management Agreement"), pursuant to which, the Manager is responsible for the day-to-day operations of the Company and performs such services and activities relating to the assets and operations of the Company as may be appropriate. 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 Manager primarily engages in three activities on behalf of the Company: (i) acquiring and originating mortgage loans and other real estate related assets; (ii) asset/liability and risk management, hedging of floating rate liabilities, and financing, management and disposition of assets, including credit and prepayment risk management; and (iii) capital management, structuring, analysis, capital raising and investor relations activities. In conducting these activities, the Manager formulates operating strategies for the Company, arranges for the acquisition of assets by the Company, arranges for various types of financing and hedging strategies for the Company, monitors the performance of the Company's assets and provides certain administrative and managerial services in connection with the operation of the Company. At all times, the Manager is subject to the direction and oversight of the Company's Board of Directors. The Company may terminate, or decline to renew the term of, the Management Agreement without cause at any time after the first two years upon 60 days written notice by a majority vote of the unaffiliated directors. Although no termination fee is payable in connection with a termination for cause, in connection with a termination without cause, the Company must pay the Manager a termination fee, which could be substantial. The amount of the termination fee will be determined by independent appraisal of the value of the Management Agreement for the next four years. Such appraisal is to be conducted by a nationally-recognized appraisal firm mutually agreed upon by the Company and the Manager. In addition, the Company has the right at any time during the term of the Management Agreement to terminate the Management Agreement without the payment of any termination fee upon, among other things, a material breach by the Manager of any provision contained in the Management Agreement that remains uncured at the end of the applicable cure period. TAXATION OF THE COMPANY The Company has elected to be taxed as a REIT under the Code, commencing with its taxable year ended December 31, 1998, and the Company intends to continue to operate in a manner consistent with the REIT Provisions of the Code. The Company's qualification as a REIT depends on its ability to meet the various requirements imposed by the Code, through actual operating results, asset holdings, distribution levels, and diversity of stock ownership. Provided the Company qualifies for taxation as a REIT, it generally will not be subject to Federal corporate income tax on its net income that is currently distributed to stockholders. This treatment substantially eliminates the "double taxation" (at the corporate and stockholder levels) that generally results from an investment in a corporation. If the Company fails to qualify as a REIT in any taxable year, its taxable income would be subject to Federal income tax at regular corporate rates (including any applicable alternative minimum tax). Even if the Company qualifies as a REIT, it will be subject to Federal income and excise taxes on its undistributed income. If in any taxable year the Company fails to qualify as a REIT and, as a result, incurs additional tax liability, the Company may need to borrow funds or liquidate certain investments in order to pay the applicable tax, and the Company would not be compelled to make distributions under the Code. Unless entitled to relief under certain statutory provisions, the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost. Although the Company currently intends to operate in a manner designated to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause the Company to fail to qualify as a REIT or may cause the Board of Directors to revoke the Company's REIT election. The Company and its stockholders may be subject to foreign, state and local taxation in various foreign, state and local jurisdictions, including those in which it or they transact business or reside. The state and local tax treatment of the Company and its stockholders may not conform to the Company's Federal income tax treatment. ITEM 2. PROPERTIES The Company does not maintain an office and owns no real property. It utilizes the offices of the Manager, located at 345 Park Avenue, New York, New York 10154. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the fourth quarter of 2000, through the solicitation of proxies or otherwise. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has been listed and is traded on the New York Stock Exchange under the symbol "AHR" since the initial public offering in March 1998. The following table sets forth, for the periods indicated, the high, low and last sale prices in dollars on the New York Stock Exchange for the Company's Common Stock and the distributions declared by the Company with respect to the periods indicated as were traded during these respective time periods. Last Dividends 1999 High Low Sale Declared - ---- ---- --- ---- -------- First Quarter 7.938 6.38 7.50 .29 Second Quarter 7.689 6.5 6.563 .29 Third Quarter 7.125 6.50 6.875 .29 Fourth Quarter 6.938 6.00 6.375 .29 2000 - ---- First Quarter 7.50 6.25 7.125 .29 Second Quarter 7.625 6.625 7.125 .29 Third Quarter 8.625 6.813 8.125 .29 Fourth Quarter 8.188 7.125 7.750 .30 2001 - ---- First Quarter through March 28, 2001 9.91 7.50 9.65 .30 On March 28, 2001, the closing sale price for the Company's Common Stock, as reported on the New York Stock Exchange, was $9.65. As of March 28, 2001, there were approximately 193 record holders of the common stock and 22 record holders of the Preferred Stock. This figure does not reflect beneficial ownership of shares held in nominee name. ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below for the years ended December 31, 2000 and 1999, and the period March 24, 1998 (commencement of operations) through December 31, 1998 has been derived from the Company's audited financial statements. This information should be read in conjunction with "Item 1. Business" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as the audited financial statements and notes thereto included in "Item 8. Financial Statements and Supplementary Data".
For the Year For the Year March 24, 1998 (In thousands, except per share data) Ended Ended through December 31, December 31, December 31, 2000 1999 1998 - ---------------------------------------------------------------------------------------- Operating Data: - -------------- Total income $97,642 $57,511 $46,055 Expenses 60,839 33,280 29,004 Other gains (losses) 2,523 2,442 (18,440) Net income (loss) 39,326 26,673 (1,389) Net income (loss) available to common shareholders 32,261 26,389 (1,389) Per Share Data: - -------------- Net income (loss): Basic 1.37 1.27 (0.07) Diluted 1.28 1.26 (0.07) Dividends declared per common share 1.17 1.16 .92 Balance Sheet Data: - ------------------ Total assets 1,033,651 679,662 956,395 Total liabilities 760,993 481,379 774,666 Total stockholders' equity 242,254 168,261 181,729 Redeemable convertible preferred stock 30,404 30,022 -
The net loss in 1998 reflects realized losses of $18,262 resulting from the sale of a substantial portion of the Company's available for sales securities and termination of an interest rate swap agreement. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in thousands, except per share amounts) GENERAL: The Company's primary long-term objective is to produce high risk-adjusted dividends for shareholders supported by operating earnings determined under generally accepted accounting principals ("GAAP") before realized gains and hedging adjustments. Strong GAAP operating earnings are primarily maintained by consistent credit performance on the Company's investments and diversification and consistency of the Company's liability structures. In order to achieve these objectives the Company is focused on increasing its size and capital base because this should lead to both increased diversification of credit exposures and improved diversification of financing sources and structures. Where increased size can be achieved with limited dilution to common shareholders the Company will pursue it aggressively. In 2000 the Company focused on maintaining liquidity, increasing capital base and reducing risk where feasible. During the year the Company's cash and liquid assets portfolio increased by 29% and its capital base increased by 45%, both due primarily to the merger with CORE Cap Inc. An increase in hedging activity brought the Company's equity duration down from 9.3 years at December 31, 1999 to 4.5 years at December 31, 2000. Equity duration is the sensitivity of an assets value to changes in interest rates. This combination of accomplishments permitted the Company to increase GAAP earnings despite rising short-term interest rates. After paying out a $0.29 per share dividend for eight consecutive quarters the rising earnings level was able to support an increased dividend payout declared in the fourth quarter of $0.30 per share. On May 15, 2000 the Company completed the acquisition of CORE Cap, Inc. The merger was a stock for stock acquisition where the Company issued 4,180,000 shares of its common stock and 2,261,000 shares of its series B preferred stock. This transaction increased the total equity capital of the Company by $75,407. Immediately before the transaction CORE Cap owned a portfolio of investment grade real estate related securities. During the remainder of 2000 the Company sold off most of these assets and redeployed the proceeds into high yielding commercial real estate loans and preferred equity interests in partnerships that own commercial office properties. The most significant aspect of the transaction was the issuance of the Series B 10% perpetual, convertible preferred stock. The conversion price is $17.09 per share of AHR common stock. This represents permanent fixed rate capital at terms well below what would otherwise be available in the capital markets. While the liquidation preference of the stock is $56,525 the low coupon and high conversion price reduces the market value to 76.08% of that amount, or $43,004. This represents a discount of $13,521, which accrues to the benefit of the Anthracite common shareholders. The market value of the assets purchased was determined based on market bids and validated by significant sales. Therefore, the net asset value of the CORE Cap portfolio exceeded the value of the consideration paid by the Company. MARKET CONDITIONS RELEVANT TO COMPANY PERFORMANCE: Commercial Real Estate Credit: The Company considers delinquency information from the Lehman Brothers Conduit Guide for 1998 transactions to be the most relevant measure of market conditions applicable to its below investment grade CMBS holdings. The broader measure of all transactions tracked in the Conduit Guide since 1994 also provides relevant comparable information. The delinquency statistics are shown in the table below:
- --------------------------------------------------------------------------------------- LEHMAN BROTHERS CONDUIT GUIDE FOR LEHMAN BROTHERS CONDUIT GUIDE FOR ALL 1998 TRANSACTIONS TRANSACTIONS - --------------------------------------------------------------------------------------- DATE NUMBER OF COLLATERAL % NUMBER OF COLLATERAL % SECURITIZATIONS BALANCE DELINQUENT SECURITIZATIONS BALANCE DELINQUENT - --------------------------------------------------------------------------------------- 12/31/00 41 $52,890,768 0.77% 180 $158,597,044 0.77% - --------------------------------------------------------------------------------------- 12/31/99 41 54,338,032 0.47% 147 131,892,534 0.51% - --------------------------------------------------------------------------------------- 12/31/98 38 53,256,049 0.17% 106 94,839,000 0.34% - ---------------------------------------------------------------------------------------
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 December 31, 1999 the MSDW delinquencies on 117 securitizations was 0.89%. As of December 31, 2000 this same index tracked 144 securitizations with delinquencies of 1.01%. See the section titled "Quantitative and Qualitative Disclosures About Market Risks" for a detailed discussion of how delinquencies and loan losses affect the Company. Real Estate: Against the backdrop of a slowing U.S. economy, the majority of markets remain near equilibrium. During 2000, demand was strong enough to absorb new supply and cause rent increases. Demand is expected to slow from the levels seen in 2000 but construction is also projected to slow for most, but not all, property types. Most market are expected to remain in balance while selected property types and markets may experience slower demand and reduced rent growth. Real Estate Capital Markets: Commercial real estate debt securities continued to exhibit modest spread tightening. This was due in part to low CMBS defaults relative to corporate bond defaults and growing use of CMBS in Collateralized Bond Obligations. Low default experience for CMBS has also led rating agencies to reduce levels of subordination required to support a designated credit rating. These lower credit support requirements have been applied to CMBS transactions issued in 1999 and 2000. Rating agencies have cited several factors to explain the reduction in credit support levels. CMBS collateral performance has been strong for the past seven years as measured by the MSDW index; furthermore the American Council of Life Insurers ("ACLI") data also shows historically low levels of commercial mortgage defaults. Rating agencies, most recently Fitch, have also noted the low level of defaults and delinquencies among CMBS relative to the rising levels of corporate bond defaults. When default rates are compared across bonds of the same rating, the conclusion is that ratings in prior years were conservative relative to the risk. CMBS credit spreads remain at historically wide levels despite continued strength in the commercial real estate credit markets. Corporate high yield spreads widened considerably at the end of 2000. The chart below compares the credit spreads for high yield CMBS to high yield corporate bonds. Average Credit Spreads (in basis points)* ------------------------------------------ BB CMBS BB Corporate Difference ------- ------------ ---------- As of December 31, 2000 558 523 35 As of December 31, 1999 550 349 201 B CMBS B Corporate Difference ------ ----------- ---------- As of December 31, 2000 987 978 9 As of December 31, 1999 915 496 419 * Source - Lehman Brothers CMBS High Yield Index & Lehman Brothers High Yield Index Interest Rates: During 2000 the yield on the ten-year U.S. Treasury Note dropped by 133 basis points from 6.44% to 5.11%. Short-term rates increased, as one month LIBOR increased by 74 basis points from 5.82% to 6.56%. Throughout the first three quarters of 2000 the Federal Reserve Board's concern about inflation kept upward pressure on short-term rates. Evidence of a slowing economy began to surface during the fourth quarter. At the beginning of 2001 the Fed began a dramatic reversal of short-term policy by reducing rates in 50 basis points increments. By the end of March 2001 the Fed had reduced short-term rates by 150 basis points. This caused one month LIBOR to drop to 5.05% by March 21, 2001. See below the section titled, "Quantitative and Qualitative Disclosures About Market Risk" for a detailed discussion of how interest rates and spreads affect the Company. EFFECT OF MARKET CONDITIONS ON COMPANY PERFORMANCE: Commercial Mortgage Backed Securities The Company's below investment grade CMBS represent approximately $602,759 of par collateralized by underlying pools of first lien commercial mortgages. The CMBS owned by the Company include 1,765 loans with an aggregate principal balance of over $9.1 billion as of December 31, 2000. The Company is in a first loss position with respect to these loans. The Company manages its credit risk through conservative underwriting, 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. Earnings are reported net of the assumption that credit losses will occur. Through December 31, 2000 the Company had expected to incur realized losses of approximately $1,800 and has actually incurred losses of approximately $1,600. Over the life of the portfolio the Company expects to realize principal losses on CMBS collateral of approximately $150,000 and lost coupon cash flow of approximately $70,000. The Company maintains diversification of credit exposures through its underwriting process and can shift its focus in future investments by adjusting the mix of loans in subsequent acquisitions. During 2000 the Company did not add CMBS so the change in exposures is not significant. The comparative profiles of the loans underlying the Company's CMBS by property type are: - ------------------------------------------------------------------ 12/31/00 12/31/99 EXPOSURE EXPOSURE - ------------------------------------------------------------------ PROPERTY TYPE LOAN BALANCE % OF TOTAL LOAN BALANCE % OF TOTAL - ------------------------------------------------------------------ Multifamily $3,176,330 34.7% $3,258,741 34.9% Retail 2,429,959 26.6% 2,467,237 26.6% Office 1,724,130 18.9% 1,751,756 18.8% Lodging 861,094 9.4% 877,945 9.4% Industrial 547,037 6.0% 561,406 6.0% Healthcare 367,989 4.2% 376,733 4.0% Parking 30,608 0.2% 30,937 0.3% - ------------------------------------------------------------------ TOTAL $9,137,150 100% 9,324,761 100% - ------------------------------------------------------------------ Active monitoring of loan performance is a critical function that is performed via electronic uploads of information gathered from the loan servicers, PNC Bank and external data providers. This worldwide web ("Web") 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 Web-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:
- ----------------------------------------------------------------------------------------------- 2000 1999 - ----------------------------------------------------------------------------------------------- NUMBER OF % OF NUMBER OF % OF PRINCIPAL LOANS COLLATERAL PRINCIPAL LOANS COLLATERAL - ----------------------------------------------------------------------------------------------- Past due 30 days to 60 days $6,319 3 0.07% $2,936 2 0.03% - ----------------------------------------------------------------------------------------------- Past due 60 days to 90 days 7,963 2 0.09% 13,522 3 0.14% - ----------------------------------------------------------------------------------------------- Past due 90 days or more 28,526 5 0.31% 34,631 6 0.37% - ----------------------------------------------------------------------------------------------- Resolved loans 0 0 0.00% 22,296 1 0.24% - ----------------------------------------------------------------------------------------------- Real Estate owned 10,145 2 0.11% 0 0 0.00% - ----------------------------------------------------------------------------------------------- TOTAL DELINQUENT $52,953 12 0.58% $73,385 12 0.78% - ----------------------------------------------------------------------------------------------- TOTAL PRINCIPAL BALANCE $9,137,150 1,765 $9,324,761 1,771 - -----------------------------------------------------------------------------------------------
Of the 12 delinquent loans as of December 31, 2000, three were delinquent due to technical reasons, two were REO and being marketed for sale, three were in foreclosure, and the remaining four loans were in some form of workout negotiations. One of the loans in foreclosure is the subject of litigation with the loan seller. The matter involves a significant breach of representations and warranties made when the loan was contributed to the securitization transaction. The Company caused the loan trust to file a claim against the seller for representing that a loan secured by a limited service hotel in Phoenix, AZ was a flagged hotel when, in fact, it was not. The Company believes strongly in the merits of the breach claim and has caused the special servicer to institute legal action against the loan seller. The Company's delinquency experience of 0.58% is slightly better than the 0.77% for directly comparable collateral experience shown in the Lehman Brothers Conduit Guide for 1998 Transactions. During 2000 the Company also experienced early payoffs of $81,695, representing 0.89% of the year-end pool balance. These loans were paid at par with no loss. The anticipated losses attributable to these loans will be reallocated to the loans remaining in the pools. Subsequent to December 31, 2000, two of the 12 delinquent loans were brought current. Additionally, three other loans with a total balance of $38,848 were paid off at par with no loss to the Company. The unrealized loss on the Company's holdings of CMBS at December 31, 2000 was $87,899. This decline in the value of the investment portfolio represents market valuation changes and is not due to credit experience or credit expectations. The adjusted purchase price of the Company's CMBS portfolio as of December 31, 2000 represents approximately 62% of its par amount. As the portfolio matures the Company expects to recoup the unrealized loss, 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 and will adjust them when it believes that credit experience or expectations justify such an adjustment. As of December 31, 2000 the Company concluded that real estate credit fundamentals remain solid, and the Company believes there has been no material change in the credit quality of its portfolio. As the portfolio matures and expected losses occur subordination levels of the lower rated classes of a CMBS investment will be reduced. This may cause the lower rated classes to be downgraded. This would negatively affect the market value and liquidity of the portfolio. Investment Grade Real Estate Related Securities As part of the acquisition of CORE Cap, Inc., in 2000 the Company inherited three securities backed by franchise loans originated by Franchise Mortgage Acceptance Corporation ("FMAC"). The Securities were the class B, C and D securities issued by the FMAC T1998 - BA trust. The respective credit ratings at the date of acquisition were AA, A and BBB. The Company sold the BBB rated class D security immediately after the acquisition. The trust is collateralized by loans on 365 properties to 75 borrowers. The quality of information provided by the servicer on underlying collateral has been poor. In October 2000 the Company sold 50% of its position in class C and recognized a loss of $991. Information on the collateral continues to be poor and in March 2001 class B was downgraded to A and class C was downgraded to BB. This will cause the prices of these bonds to be marked down further at March 31, 2001. The Company's current strategy is to force the servicer to provide timely and accurate information so the bonds may be properly evaluated. Commercial lending The Company also owns six mezzanine whole loans and two preferred equity interests in partnerships that own office buildings. The Company's commercial loan portfolio generally emphasizes larger transactions located in metropolitan markets as compared to the loans in the CMBS portfolio. Exposures based on asset type and geography follows: Principal % Property LTV DSCR Balance Type Location -------------------- -------------------------------------------------- Los Angeles $22,500 13.8% Office 78.0% 1.14 Santa Monica 35,000 21.4 Office 65.0 1.00 San Francisco 18,000 11.0 Hotel 69.0 1.20 London* 32,087 19.6 Hotel 65.0 1.15 New York City 30,600 18.7 Office 73.0 1.10 Chicago 15,000 9.2 Multifamily 90.0 1.10 Suburban Philadelphia 4,943 3.0 Office 90.0 1.21 Tallahassee 5,411 3.3 Office 75.0 1.20 ---------------------- --------------- Total $163,541 100% 72.0 1.11 ---------------------- --------------- Diversification by Asset Type Office 60.6% Full Service Lodging 30.2% Multifamily 9.2% * The London Loan is translated into US dollars using the December 29, 2000 sterling exchange rate of 0.668762 (pounds/sterling). The Los Angeles Loan, a $22,500 subordinate class of a $60,850 loan is secured by the borrower's interest in a 54-story office tower in downtown Los Angeles, California. The loan matures in two years, which may be extended at the borrower's option for two additional years. The Company expects to pay off its balance at maturity. The Santa Monica Loan is a $35 million second mortgage on an office construction project in Santa Monica, California. The building was completed on time in mid 2000. The building is currently 92% leased at gross rents averaging in the low $40's per square foot. This is higher than the base case expectations at origination. Furthermore, the real estate values for this class of office space in Santa Monica have increased significantly since origination. The borrower sold the property in the first quarter 2001, at which time the Company's loan was repaid. The San Francisco Loan is an $18,000 mezzanine loan, secured by a lien on the borrower's interest in a full service hotel located in San Francisco, California. The loan matures on May 1, 2003. The Company continues to expect this loan to pay off its balance at maturity. The London Loan is a 21,459 Sterling denominated loan that was funded in August of 1998. It is secured by five luxury hotel properties in and around London. The operations of the hotels have exceeded expectations. The underlying properties have performed well. As of December 31, 2000 the London Loan was valued at 97.0% of par, an increase from 92.0% of par as of December 31, 1999. The Company continues to expect this loan to pay off its balance at its maturity on June 30, 2002. The New York City Loan is a $30,600 subordinated participation in a first mortgage secured by a commercial office building located midtown Manhattan. The building is currently 98% leased. The Loan matures in December 2001. The Company continues to expect this loan to pay off its balance at maturity. The Chicago Loan was a $30,000 mezzanine loan originated in August of 2000. The loan is secured by a second mortgage on a condominium conversion project in Chicago, Illinois, and a first mortgage on an adjacent land parcel, as well as the borrower's partnership interest in the property. The Company originated this loan in September of 2000, for a 24-month term. Condominium unit sales at the project currently exceed expectations. Due to this strong demand the borrower paid off $15,000 of this loan with prepayment penalties in December of 2000. The Company expects this loan to pay off its balance on or prior to maturity. The suburban Philadelphia investment is a $5,121 preferred equity interest in a partnership that owns two office buildings totaling approximately 190,000 square feet. One property is in the western suburb of Paoli while the other is in the northern suburb of Newtown. The expected life of the investment is three years. The Tallahassee investment is a $5,149 preferred equity interest in a partnership that owns a 500,000 square foot mixed-use office/retail building. Primary office tenants include various Florida state government agencies on long-term leases. The expected life of the investment is four years. Interest Rates 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 bear 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. Approximately $137,273 of the Company's assets earn interest at rates that are determined with reference to LIBOR. All of the Company's borrowings bear 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 and hedges, the Company's earnings could be negatively affected. 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 ----------------------- --------- ---------- December 31, 2000 5.12% 6.56% 1.44% December 31, 1999 6.44% 5.82% 0.62% The increase in LIBOR from December 31, 1999 to December 31, 2000 had a negative impact on the Company's financing costs. RECENT EVENTS: Beginning on January 3, 2001 the Federal Reserve Board reversed its policy of increasing short-term interest rates. The Fed reduced rates by 50 basis points on each of January 3, January 31 and March 20, 2001. Each rate reduction was accompanied by a continuing bias towards additional rate eases. The Company benefits from rate reductions because its cost of financing is generally based on one month LIBOR. The Company has partially hedged its exposure to changes in short term interest rates using interest rate swaps. The Company expects earnings to increase as a result of the reductions in short term interest rates. On February 15, 2001 the Company completed a secondary offering of 4,000,000 common shares at a price of $8.75 per share. On a net basis this raised approximately $33,200 for the Company. On March 13, 2001 the Company issued an additional 600,000 shares of common stock pursuant to the underwriters over allotment option, raising an additional $5,000 of net capital. The effect of each issuance was accretive to the per share book value of the Company's common stock. In February 2000, 38,300 10% Series B cumulative redeemable convertible preferred shares with a liquidation preference of $958 were converted at the shareholder's option into 56,000 shares of the Company's common stock. In March 2001, the Company entered into an agreement to sell all of its mortgage loan pools with the settlement to occur in April 2001. There will be a slight gain to the Company. FUNDS FROM OPERATIONS (FFO): Most industry analysts, including the Company, consider FFO an appropriate supplementary measure of operating performance of a REIT. In general, FFO adjusts net income for non-cash charges such as depreciation, certain amortization expenses and gains or losses from debt restructuring and sales of property. However, 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 computes FFO in accordance with the definition recommended by the National Association of Real Estate Investment Trusts. 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 it applies to the Company. Accordingly, the Company includes gains or losses from sales of securities in its calculation of FFO. The Company's FFO for the year ended December 31, 2000 and 1999 was $39,326, and $26,673, respectively, which was the same as its reported GAAP net income for the periods. The Company reported cash flows provided by in operating activities of $115,734 and $188,735, cash flows provided by (used) in investing activities of $883,913 and of $(165,453) and cash flows used in financing activities of $(909,067) and $(2,104) in its statement of cash flows for the year ended December 31, 2000 and 1999, respectively. RESULTS OF OPERATIONS Net income for the year ended December 31, 2000 was $39,326 or $1.37 per share ($1.28 diluted). Net income for the year ended December 31, 1999 was $26,673, or $1.27 per share ($1.26 diluted). Net loss for the period March 24, 1998 through December 31, 1998 was $1,389, or $0.07 per share (basic and diluted). The increase in income in 2000 from 1999 is primarily due to the fact that the Company raised additional capital and was able to invest at high-risk adjusted yields. The increase in income in 1999 from 1998 is primarily due to significant losses recognized in 1998 resulting from the sale of securities. Further details of the changes are set forth below. INTEREST INCOME: The following table sets forth information regarding the total amount of income from certain of the Company's interest-earning assets and the resulting average yields. Information is based on monthly average balances during the period. For the Year Ended December 31, 2000 --------------------------------------------- Interest Average Annualized Income Balance Yield --------------------------------------------- CMBS $37,619 $372,465 10.10% Other securities available for sale 37,497 468,177 8.01% Commercial mortgage loans 14,359 110,287 13.01% Mortgage loan pools 6,481 85,501 7.58% Cash and cash equivalents 1,313 22,189 5.92% --------------------------------------------- Total $97,269 $1,058,619 9.19% ============================================= For the Year Ended December 31, 1999 --------------------------------------------- Interest Average Annualized Income Balance Yield --------------------------------------------- CMBS $33,788 $354,713 9.53% Other securities available for sale 14,318 223,410 6.41% Commercial mortgage loan 5,549 51,787 10.71% Cash and cash equivalents 670 11,473 5.84% --------------------------------------------- Total $54,325 $641,383 8.47% ============================================= For the Period March 24, 1998 Through December 31, 1998 --------------------------------------------- Interest Average Annualized Income Balance Yield --------------------------------------------- Securities available for sale $42,576 $749,396 7.33% Commercial mortgage loan 1,432 16,548 11.16% Cash and cash equivalents 679 15,552 5.63% --------------------------------------------- Total $44,687 $781,496 7.37% ============================================= In addition to the foregoing, the Company earned $25, $3,186 and $1,368 in interest income from securities held for trading during the years ended December 31, 2000, 1999 and for the period March 24, 1998 through December 31, 1998, respectively, and $348 in earnings from real estate joint ventures during the year ended December 31, 2000. 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 Year Ended December 31, 2000 --------------------------------------------- Interest Average Annualized Expense Balance Rate --------------------------------------------- Reverse repurchase agreements $34,249 $505,893 6.77% Lines of credit and term loan 16,849 229,863 7.35% --------------------------------------------- Total $51,098 $735,756 6.94% ============================================= For the Year Ended December 31, 1999 --------------------------------------------- Interest Average Annualized Expense Balance Rate --------------------------------------------- Reverse repurchase agreements $16,454 $283,322 5.81% Lines of credit and term loan 5,314 82,540 6.44% --------------------------------------------- Total $21,768 $365,862 5.95% ============================================= For the Period March 24, 1998 Through December 31, 1998 --------------------------------------------- Interest Average Annualized Expense Balance Rate --------------------------------------------- Reverse repurchase agreements $21,932 $482,409 5.86% Lines of credit borrowings 1,545 26,772 7.44% --------------------------------------------- Total $23,477 $509,181 5.95% ============================================= In addition to the foregoing, the Company incurred $14, $4,108 and $1,288 in interest expense from collateralized borrowings relating to its securities held for trading and securities sold short during the year ended December 31, 2000, 1999 and for the period March 24, 1998 through December 31, 1998, respectively. NET INTEREST MARGIN AND NET INTEREST SPREAD FROM THE PORTFOLIO: The Company considers its portfolio to consist of its securities available for sale, mortgage loan pools, commercial mortgage loans, and 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 Period For the Year For the Year March 24, 1998 Ended Ended Through December 31, 2000 December 31, 1999 December 31, 1998 ----------------------------------------------------------- Interest Income $97,294 $54,325 $44,687 Interest Expense $51,112 $21,768 $23,477 Net Interest Margin 5.55% 6.02% 3.95% Net Interest Spread 3.78% 2.59% .73%
OTHER EXPENSES: Expenses other than interest expense consist primarily of management fees and general and administrative expenses. Management fees of $7,450 for the year ended December 31, 2000 were comprised of base management fees of $6,483 and incentive fees of $967. Management fees of $4,565 and $3,474 for the year ended December 31, 1999 and for the period March 24, 1998 through December 31, 1998, respectively, were comprised solely of the base management fee paid to the Manager for such periods (as provided pursuant to the management agreement between the Manager and the Company), as the Manager earned no incentive fee for such periods. Other expenses/income-net of $2,277 for the year ended December 31, 2000, and $2,839 for the year ended December 31, 1999, and $765 for the period March 24, 1998 through December 31, 1998, respectively, were comprised of accounting agent fees, custodial agent fees, directors' fees, fees for professional services, insurance premiums, broken deal expenses, and due diligence costs. Other expenses/income-net in the year 2000 includes the amortization of negative goodwill. OTHER GAINS (LOSSES): During the year ended December 31, 2000, the Company sold a portion of its securities available for sale for total proceeds of $3,176,357, resulting in a realized gain of $3,212. During the year ended December 31, 1999 the Company sold a portion of its securities available for sale for total proceeds of $47,843, resulting in a realized loss of $516. The loss on sale of securities available for sale of $18,262 for the period March 24, 1998 to December 31, 1998 consisted of a loss of $15,491 on the sale of securities available for sale and $2,771 of associated termination costs on an interest rate swap transaction. The (loss) gain on securities held for trading of $(647), 2,992 and $(231) for the years ended December 31, 2000, 1999 and for the period March 24, 1998 through December 31, 1998, respectively, consisted primarily of realized and unrealized gains and losses on U.S. Treasury and agency securities, forward commitments to purchase or sell Agency RMBS, and financial futures contracts. The foreign currency (loss) gain of $(42), $(34) and $53 for the years ended December 31, 2000, 1999 and for the period March 24, 1998 through December 31, 1998, respectively, relates to the Company's net investment in a commercial mortgage loan denominated in pounds sterling and associated hedging. DIVIDENDS DECLARED: During the year ended December 31, 2000, the Company declared dividends to shareholders totaling $27,591 or $1.17 per share, of which $20,050 was paid during the year and $7,541 was paid on January 31, 2001. On March 15, 2001, the Company declared distributions to its shareholders of $.30 per share, payable on April 30, 2001 to shareholders of record on March 30, 2001. For U.S. Federal Income Tax purposes, the dividends are ordinary income to the Company shareholders. During the year ended December 31, 1999, the Company declared dividends to shareholders totaling $24,348 or $1.16 per share, of which $18,270 was paid during the year and $6,078 was paid on January 17, 2000. During the period March 24, 1998 through December 31, 1998 the Company declared dividends to shareholders totaling $18,759, $.092 per share, of which $12,963 was paid during the period and $5,796 was paid on January 15, 1999. For U.S. Federal income tax purposes, the dividends are ordinary income to the Company's stockholders. TAX BASIS NET INCOME AND GAAP NET INCOME: Net income as calculated for tax purposes (tax basis net income) was estimated at $35,942, or $1.22 ($1.16 diluted) per share, for the year ended December 31, 2000, compared to a net income as calculated in accordance with GAAP of $39,319, or $1.37 ($1.28 diluted) per share. Tax basis income was $28,347, or $1.36 ($1.34 diluted) per share, for the year ended December 31, 1999, compared to a net income as calculated in accordance with GAAP of $26,673 or $1.27 ($1.26 diluted) per share. Tax basis income was $14,518 or $0.70 per share (basic and diluted) for the period March 24, 1998 through December 31, 1998, compared to a net loss calculated in accordance with GAAP of $1,389 or $0.07 per share (basic and diluted). 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 2000, tax basis income for subordinate CMBS is higher the GAAP income. Additionally, payments made to GMAC Asset Management, Inc. to terminate its management contract with Core Cap, Inc. were deducted for tax purposes. 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 loss to tax basis net income is as follows:
For the Period For the Year For the Year March 24, 1998 Ended December Ended December Through 31, 2000 31, 1999 December 31, 1998 --------------------------------------------------- GAAP net income $39,326 $26,673 $(1,389) Net (gain) on securities available (3,516) (2,476) 14,459 for sale Subordinate CMBS income differences 2,432 3,500 1,230 Contract termination payment (2,300) - - Other differences - 650 218 --------------------------------------------------- Tax basis net income $35,942 $28,347 $14,518 ===================================================
In the reconciliation of GAAP net income to tax basis net income the GAAP net gain on securities available for sale of $3,516 is deducted from GAAP income as the Company had a capital loss carry forward of $13,248 at December 31, 1999. CHANGES IN FINANCIAL CONDITION SECURITIES AVAILABLE FOR SALE: At December 31, 2000 and 1999, respectively, an aggregate of $102,871 and $101,139 in unrealized losses on securities available for sale was included as a component of accumulated other comprehensive income (loss) in shareholders' equity. The Company's securities available for sale, which are carried at estimated fair value, included the following at December 31, 2000 and 1999:
December December 31, 2000 31, 1999 Estimated Estimated Fair Fair Security Description Value Percentage Value Percentage - --------------------------------------------------------------------------------------------- Commercial mortgage-backed securities: CMBS IO's $ 68,844 10.2% - - % Investment grade CMBS 54,905 8.1 - - Non-investment grade rated subordinated securities 261,489 38.5 $243,708 42.7 Non-rated subordinated securities 27,197 4.0 29,025 4.6 ------------------------------------------------ 412,435 60.8 272,733 47.3 ------------------------------------------------ Single-family residential mortgage-backed securities: Agency adjustable rate securities 160,928 23.7 58,858 10.2 Agency fixed rate securities 104,759 15.5 165,825 28.7 Privately issued investment grade rated - - 76,821 13.3 ------------------------------------------------ 265,687 39.2 301,504 52.2 ------------------------------------------------ Agency insured project loan - - 2,958 0.5 ------------------------------------------------ $678,122 100.0% $577,195 100.0% ================================================
SHORT-TERM BORROWINGS: To date, the Company's debt has consisted of preferred stock and line-of-credit borrowings, term loans and reverse repurchase agreements, which have been collateralized by a pledge of most of the Company's securities available for sale, securities held for trading 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. To date, the Company has obtained short-term financing in amounts and at interest rates consistent with the Company's 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 Year Ended December 31, 2000 --------------------------------------------- December 31, 2000 Maximum Range of Balance Balance Maturities --------------------------------------------- Reverse repurchase agreements $517,212 $1,202,696 3 to 55 days Line of credit and term loan borrowings 202,130 453,841 15 to 261 days ============================================= For the Year Ended December 31, 1999 --------------------------------------------- December 31, 1999 Maximum Range of Balance Balance Maturities --------------------------------------------- Reverse repurchase agreements $377,498 $404,043 3 to 62 days Line of credit and term loan borrowings 94,035 167,599 77 to 931 days ============================================= HEDGING INSTRUMENTS: The Company's hedging policy with regard to its sterling denominated London Loan is to minimize its exposure to fluctuations in the sterling exchange rate. As of December 31, 2000 the Company agreed to exchange 8,000 (pounds sterling) for $12,137 (U.S. dollars) on January 18, 2001. On January 18, 2001 the Company agreed to exchange 8,000 (pounds sterling) for $11,782 on July 18, 2001. As of December 31, 1999, the Company agreed to exchange 8,000 (pounds sterling) for $12,702 on January 18, 2000. Upon the maturity of this contract, the Company entered into a similar forward currency exchange contract. These contracts are intended to hedge currency risk in connection with the Company's investment in the London Loan which is denominated in pounds sterling. The estimated fair value of the forward currency exchange contracts was an asset of $749 and a liability of $221 at December 31, 2000 and 1999, respectively, which was recognized as an addition (reduction) of net foreign currency gains (losses). Interest rate swap agreements as of December 31, 2000 consist of the following: Notional Estimated Amortized Remaining Amount Fair Value Cost Term ---------------------------------------------- Interest rate swap agreements $ 226,000 $(12,505) $9,471 19.3 years As of December 31, 2000 the Company uses its interest rate swap agreements to hedge it's available for sale assets for GAAP purposes and floating rate liabilities for tax purposes. 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 December 31, 1999, the Company had outstanding, a short position of 186 thirty-year U.S. Treasury Bond future contracts and 1,080 five-year and 200 ten-year U.S. Treasury Note future contracts expiring in March 31, 2000, which represented $18,600 and $128,000 in face amount of U.S. Treasury Bond and Notes, respectively. The estimated fair value of these contracts was approximately $1,925 at December 31, 1999. At December 31, 2000 the Company did not have U.S. Treasury future contracts. The Financial Accounting Standards Board ("FASB") has issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement, as amended and interpreted, 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. SFAS 133 also defines new requirements for designation and documentation of hedging relationships as well as ongoing effectiveness assessments in order to use hedge accounting. For a derivative that does not qualify as a hedge, changes in fair value will be recognized in earnings. The Company adopted SFAS 133 on January 1, 2001. On that date, the Company reclassified certain of its agency adjustable rate debt securities, with an amortized cost of $64,432 from available-for-sale to trading. An interest rate swap agreement with a $25 million notional amount that had been designated as hedging these debt securities was similarly reclassified. The unrealized gain of $895 related to the agency adjustable rate debt securities and the unrealized loss of $2,830 related to the interest rate swap were removed from accumulated other comprehensive income and recorded as the cumulative transition adjustment to earnings upon adoption of SFAS 133. On an ongoing basis, these debt securities and the interest rate swap will be recorded at fair value, with changes in fair value recorded in earnings. In addition, on January 1, 2001, the Company redesignated certain other interest rate swap agreements that had been hedging available-for-sale debt securities as cash flow hedges of its variable rate borrowings under reverse repurchase agreements. To the extent that these interest rate swaps effectively hedge these variable cash flows, the change in their fair value will be recorded in other comprehensive income; any change in value resulting from over hedging will be recorded in earnings. 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 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. To the extent that the Company may become 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, preferred stock, and will consider resecuritization or other achievable term funding of existing assets. 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. On December 2, 1999, the Company authorized and issued 1,200,000 shares of Series A Preferred Stock 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 stock or liquidated for $28.50 per share. If converted, the Series A Preferred Stock would convert into approximately 4,000,000 shares of common stock. On February 14, 2001 the Company completed a secondary offering of 4,000,000 shares of Company Common Stock in an underwritten public offering. The aggregate net proceeds to the Company (after deducting underwriting fees and expensed) were $33,300. The Company had granted the underwriters an option, exercisable for 30 days, to purchase up to 600 additional shares of Common Stock to cover over-allotments. This option was exercised on March 13, 2001 and resulted in net proceeds to the Company of $5,000. As of December 31, 2000 $131,190 of the Company's $185,000 committed credit facility with Deutsche Bank, AG was available for future borrowings, and $162,747 and $136,547 was available under each of the Company's $200,000 term facilities, with Merrill Lynch. The Company's operating activities provided cash flows of $115,734 and $188,735 during the years ended December 31, 2000 and 1999, respectively, primarily through net income and sales of trading securities in excess of purchases. The Company's investing activities provided (used) cash flows totaling $883,913 and $(165,453), during the years ended December 31, 2000 and 1999,respectively, primarily to purchase securities available for sale and to fund commercial mortgage loans, offset by significant sales of securities during 2000. The Company's financing activities used $909,067 and $2,104 during the years ended December 31, 2000 and 1999, respectively, primarily to reduce the level of short-term borrowings related to the Company's trading portfolio. 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 have sufficient cash flows from its portfolio to fund distributions to 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 December 31, 2000, 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 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. 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 Code, 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. ITEM 7A. 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 rates 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 December 31, 2000 and 1999. Actual results could differ significantly from these estimates. PROJECTED PERCENTAGE CHANGE IN PORTFOLIO NET MARKET VALUE GIVEN U.S. TREASURY YIELD CURVE MOVEMENTS 2000 1999 Projected Change Change in Projected Change in Portfolio Treasury Yield Curve, in Portfolio Net Market Value +/- Basis Points Net Market Value - ------------------------------------------------------------------------- 4.0% -300 27.1% 4.1% -200 18.3% 2.8% -100 9.3% 0 Base Case 0 (4.3)% +100 (9.6)% (10.1)% +200 (19.4)% (17.5)% +300 (29.6)% PROJECTED PERCENTAGE CHANGE IN PORTFOLIO NET MARKET VALUE GIVEN CREDIT SPREAD MOVEMENTS 2000 1999 Projected Change in Change in Projected Change in Portfolio Credit Spreads, Portfolio Net Market Value +/- Basis Points Net Market Value - ------------------------------------------------------------------------- 39.8% -300 36.7% 25.5% -200 23.2% 12.3% -100 11.0% 0 Base Case 0 (11.3)% +100 (9.7)% (21.5)% +200 (18.6)% (30.8)% +300 (26.6)% PROJECTED PERCENTAGE CHANGE IN PORTFOLIO NET INTEREST INCOME GIVEN LIBOR MOVEMENTS 2000 1999 Projected Change in Projected Change in Portfolio Change in LIBOR, Portfolio Net Interest Income +/- Basis Points Net Interest Income ----------------------------------------------------------------- 16.3% -200 21.4% 8.2% -100 10.7% 0 Base Case 0 (8.2)% +100 (10.7)% (16.3)% +200 (21.4)% Applying the above percentages to the change in earnings available to common shareholder requires an adjustment to take into account the effect of the fixed rate coupons on the Company's preferred stock. This adjustment is the ratio of the total stock outstanding divided by common stock outstanding giving a multiplier of 1.37. Therefore, the effect of a 100 basis point change in short rates on common earnings per share is 11.23%. 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/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 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 on adjusted purchase price from 9.78% to 8.35%. This would reduce GAAP income going forward by approximately $0.20 per common share 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 December 31, 2000, and 1999 the Company's duration on equity was approximately 4.2 and 9.2 years, respectively. 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 4.2% and 9.2%, respectively. 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PAGE ---- Independent Auditors' Report 42 Financial Statements: Consolidated Statements of Financial Condition at December 31, 2000 and 1999 43 Consolidated Statements of Operations For the Years Ended December 31, 2000 and 1999 and For the Period March 24, 1998 (Commencement of Operations) Through December 31, 1998 44 Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December, 31, 2000 and 1999 and For the Period March 24, 1998 (Commencement of Operations) Through December 31, 1998 45 Consolidated Statements of Cash Flows For the Years Ended December 31, 2000 and 1999 and For the Period March 24, 1998 (Commencement of Operations) Through December 31, 1998 46 Notes to Financial Statements 48 All schedules have been omitted because either the required information is not applicable or the information is shown in the financial statements or notes thereto. INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Anthracite Capital, Inc. We have audited the accompanying consolidated statements of financial condition of Anthracite Capital, Inc. and subsidiaries (the "Company") at December 31, 2000 and 1999, and the related statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 2000 and 1999 and the period March 24, 1998 (commencement of operations) through December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Anthracite Capital, Inc. and subsidiaries at December 31, 2000 and 1999 and the results of their operations and their cash flows for the years ended December 31, 2000 and 1999 and the period March 24, 1998 (commencement of operations) through December 31, 1998 in conformity with accounting principles generally accepted in the United States of America. /s/ Deloitte & Touche LLP New York, New York March 21, 2001
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS, EXCEPT PER SHARE DATA) - ------------------------------------------------------------------------------------------- December 31, 2000 December 31, 1999 ASSETS Cash and cash equivalents $ 37,829 $ 22,265 Restricted cash equivalents 9,484 - Securities available for sale, at fair value Subordinated commercial mortgage-backed securities (CMBS) $ 288,686 $ 272,733 Investment grade securities 389,436 304,462 --------- --------- Total securities available for sale 678,122 577,195 Securities held for trading, at fair value 54,043 - Mortgage loan pools available for sale, at fair value 71,535 - Commercial mortgage loans, net 153,187 69,611 Investments in real estate joint ventures 10,354 - Other assets 19,097 10,591 ----------- ----------- Total Assets $1,033,651 $ 679,662 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Borrowings: Secured by pledge of subordinated CMBS $ 161,608 $ 162,738 Secured by pledge of other securities available for sale and cash equivalents 356,491 272,289 Secured by mortgage loan pools 67,367 - Secured by pledge of securities held for trading 55,212 - Secured by pledge of commercial mortgage loans 78,664 36,506 --------- ----------- Total borrowings $ 719,342 $ 471,533 Distributions payable 9,741 6,079 Other liabilities 31,910 3,767 ----------- ----------- Total Liabilities 760,993 481,379 ----------- ----------- 10.5% Series A Preferred Stock, redeemable convertible, liquidation preference $34,200 30,404 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; 20,961 shares issued and outstanding in 1999 25 21 10% Series B Preferred stock, liquidation preference $56,525 43,004 - Additional paid-in capital 315,533 287,486 Distributions in excess of earnings (13,437) (18,107) Accumulated other comprehensive loss (102,871) (101,139) ----------- ----------- Total Stockholders' Equity 242,254 168,261 ----------- ----------- Total Liabilities and Stockholders' Equity $1,033,651 $ 679,662 =========== =========== The accompanying notes are an integral part of these financial statements.
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) - ------------------------------------------------------------------------------------------ For the period March 24, 1998 For the year ended For the year ended through December 31, 2000 December 31, 1999 December 31, 1998 ------------------ ------------------ ----------------- Income: Securities available for sale $ 75,116 $ 48,106 $ 42,576 Commercial mortgage loans 14,359 5,549 1,432 Mortgage loan pools 6,481 - - Trading securities 25 3,186 1,368 Earnings from real estate joint ventures 348 - - Cash and cash equivalents 1,313 670 679 ------------------ ------------------ ----------------- Total income 97,642 57,511 46,055 ------------------ ------------------ ----------------- Expenses: Interest 51,112 21,768 23,477 Interest-trading securities - 4,108 1,288 Management and incentive fee 7,450 4,565 3,474 Other expenses / income - net 2,277 2,839 765 ------------------ ------------------ ----------------- Total expenses 60,839 33,280 29,004 ------------------ ------------------ ----------------- Other gains (losses): Gain (loss) on sale of securities available for sale 3,212 (516) (18,262) Gain (loss) on securities held for trading (647) 2,992 (231) Foreign currency gain (loss) (42) (34) 53 ------------------ ------------------ ----------------- Total other gain (loss) 2,523 2,442 (18,440) ------------------ ------------------ ----------------- Net Income (Loss) 39,326 26,673 (1,389) ------------------ ------------------ ----------------- Dividends and accretion on Preferred Stock 7,065 284 - ------------------ ------------------ ----------------- Net Income (Loss) Available to Common Shareholders $ 32,261 $ 26,389 $ (1,389) Net Income (Loss) Per Share: Basic $ 1.37 $ 1.27 $ (0.07) Diluted 1.28 1.26 (0.07) Weighted average number of shares outstanding: Basic 23,587 20,814 20,658 Diluted 27,668 21,150 20,658 The accompanying notes are an integral part of these financial statements.
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999, AND THE PERIOD MARCH 24, 1998 (COMMENCEMENT OF OPERATIONS) THROUGH DECEMBER 31, 1998 (IN THOUSANDS) Accumulated Common Series B Additional Distributions Other Total Stock, Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders' Par Value Stock Capital Of Earnings Loss Income Equity ----------------------------------------------------------------------------------------------------- Balance at March 24, 1998 $ - $ - $200 $ - $ - $200 Issuance of common stock 21 296,867 296,888 Net loss (1,389) $(1,389) (1,389) Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustments (79,137) (79,137) (79,137) ------------- Other Comprehensive loss (79,137) Comprehensive loss $(80,528) Dividends declared-common stock Cost of Dividend Reinvestment and Stock (30) (18,759) (30) Purchase Plan Offering ============= Purchase of common stock (1) (16,043) (16,044) ----------------------------------------------------------------------------------------------------- Balance at December 31, 1998 20 280,994 (20,148) (79,137) 181,729 Net income 26,673 26,673 $26,673 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment (22,002) (22,002) (22,002) Other Comprehensive Loss ========= (22,002) Comprehensive Income $4,671 Dividends declared-common stock (24,348) (24,348) Dividends and accretion on preferred stock (284) (284) Purchase of common stock (234) (234) Shares issued under Dividend Reinvestment and Stock Purchase Plan 1 6,726 6,727 ----------------------------------------------------------------------------------------------------- Balance at December 31, 1999 21 287,486 (18,107) (101,139) 168,261 Purchase of common shares (39) (39) Net income 39,326 $39,326 39,326 Change in net unrealized gain (loss) on securities available for sale, net of reclassification adjustment (1,732) (1,732) (1,732) -------------- Other Comprehensive Loss (1,732) Comprehensive Income $37,594 ============== Dividends declared-common stock (27,591) (27,591) Dividends and accretion on preferred stock (7,065) (7,065) Issuance of common stock 4 28,086 28,090 Issuance of Series B preferred stock $43,004 $43,004 -------------------------------------------------------------------------------------------------- Balance at December 31, 2000 $25 $43,004 $315,533 ($13,437) ($102,871) $242,254 ================================================================================================== DISCLOSURE OF RECLASSIFICATION ADJUSTMENT: Years ended December 31, 2000 1999 1998* ---- ---- ----- Unrealized holding loss $(3,643) $(21,486) $(60,875) Less: reclassification for realized gains previously recorded as unrealized 3,212 (516) (18,262) ------------------------------------------------ Net unrealized loss on securities $(1,732) $(22,002) $(79,137) ================================================ *commencement of operations, March 24, 1998 through December 31, 1998
ANTHRACITE CAPITAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (IN THOUSANDS) - ------------------------------------------------------------------------------------------ Years Ended December 31 2000 1999 1998* ---- ---- ----- Cash flows from operating activities: Net income (loss) $ 39,326 $ 26,673 $ (1,389) Adjustments to reconcile net income to net cash provided (used) by operating activities: Net sale (purchase) of trading securities and securities sold short 52,751 168,367 (165,254) Amortization of negative goodwill (1,062) - - Noncash portion of gain on securities held for trading - - (662) Premium amortization (discount accretion), net 5,420 (274) 7,914 Noncash portion of net foreign currency loss (gain) 42 34 (429) Net gain (loss) on sale of securities (1,732) 516 18,262 Earnings from real estate joint ventures (348) - - Distribution from real estate joint ventures 264 - - Decrease (increase) in other assets 8,316 (2,627) (7,964) Increase (decrease) in other liabilities 12,757 (3,954) 7,721 ----------- ------------ ----------- Net cash provided by (used in) operating activities 115,734 188,735 (141,801) ----------- ------------ ----------- Cash flows from investing activities: Purchase of securities available for sale (991,191) (265,174) (1,386,724) Funding of commercial mortgage loans (101,100) (35,000) (35,131) Repayments received from commercial mortgage loans 17,524 970 - Decrease (increase) in restricted cash equivalents (9,484) 3,242 (3,242) Investment in real estate joint ventures (10,270) - - Principal payments received on securities available for sale 102,950 78,719 80,982 Principal payment received on mortgage loan pools 20,274 - - Proceeds from sale of mortgage loan pools 253,302 - - Net cash acquired in merger 33,379 - - Acquisition costs 4,129 - - Proceeds from sales of securities available for sale 1,568,805 47,843 736,744 Net proceeds (payments) from sales or termination of hedging securities (4,405) 3,947 (3,804) ----------- ------------ ----------- Net cash provided (used) in investing activities 883,913 (165,453) (611,175) ----------- ------------ ----------- Cash flows from financing activities: Net increase (decrease) in borrowings (962,396) (14,531) 486,064 Proceeds from issuance of common stock, net of offering costs - 6,727 296,836 Proceeds from issuance of redeemable convertible preferred stock - 30,000 - Distribution on common stock (26,130) (24,066) (12,963) Distributions on preferred stock 4,482 - - Purchase of common shares (39) (234) (16,074) ----------- ------------ ----------- Net cash provided (909,067) (2,104) 753,863 (used) by financing activities ----------- ------------ ----------- Net increase in cash and cash equivalents 15,564 21,178 887 Cash and cash equivalents, beginning of period 22,265 1,087 200 ----------- ------------ ----------- Cash and cash equivalents, end of period $ 37,829 $ 22,265 $1,087 =========== ============ =========== Supplemental disclosure of cash flow information: Interest paid $ 47,504 $ 24,309 $21,354 =========== ============ ===========
Supplemental schedule of non-cash investing and financing activities: The Company purchased all of the assets of CORE Cap., Inc during the Year end December 31, 2000 primarily through issuance of the Company's common and preferred stock, as follows: Fair value of assets acquired $ 1,281,070 Cash included in acquired assets 33,379 Liabilities assumed 1,215,534 Common Stock issued in connection with acquisition 28,090 Preferred stock issued in connection with the acquisition 43,004 * Commencement of operations, March 24, 1998 through December 31, 1998 The accompanying notes are an integral part of these financial statements. ANTHRACITE CAPITAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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. In preparing the financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP), 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. CASH AND CASH EQUIVALENTS All highly liquid investments with original maturities of three months or less are considered to be cash equivalents. 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. 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. 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 shorter of the remaining term of the swap agreement, or the underlying hedged item, provided that the underlying hedged item has not been sold. 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 intended to retain. This amortization is included in other expenses/income - net. Negative goodwill, net, was $8,625 at December 31, 2000, and is included in other liabilities. 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, 2000, the Company had a capital loss carryover of $9,731 available to offset future capital gains. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") has issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement, as amended and interpreted, 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. SFAS 133 also defines new requirements for designation and documentation of hedging relationships as well as ongoing effectiveness assessments in order to use hedge accounting. For a derivative that does not qualify as a hedge, changes in fair value will be recognized in earnings. The Company adopted SFAS 133 on January 1, 2001. On that date, the Company reclassified certain of its agency adjustable rate debt securities, with an amortized cost of $64,432 from available-for-sale to trading. An interest rate swap agreement with a $25,000 notional amount that had been designated as hedging these debt securities was similarly reclassified. The unrealized gain of $895 related to the agency adjustable rate debt securities and the unrealized loss of $2,830 related to the interest rate swap were removed from accumulated other comprehensive income and recorded as the cumulative transition adjustment to earnings upon adoption of SFAS 133. On an ongoing basis, these debt securities and the interest rate swap will be recorded at fair value, with changes in fair value recorded in earnings. In addition, on January 1, 2001, the Company redesignated certain other interest rate swap agreements that had been hedging available-for-sale debt securities as cash flow hedges of its variable rate borrowings under reverse repurchase agreements. To the extent that these interest rate swaps effectively hedge these variable cash flows, the change in their fair value will be recorded in other comprehensive income; any ineffectiveness will be recorded in earnings. 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 reconsideration. 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 and 1998 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 4,181,000 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 $71,094 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. The following unaudited consolidated proforma results of operations for the years ended December 31, 2000 and 1999 assume the CORE Cap acquisition occurred as of the beginning of each period presented: 2000 1999 -------------------------------------------------- Total income $131,482 $174,441 Net income 44,427 48,693 Net income available to 35,242 41,587 common shareholders Earnings per share: Basic 1.49 1.66 Diluted 1.39 1.70 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 December 31, 2000 are summarized as follows:
Gross Gross Estimated Amortized Unrealized Unrealized Fair Security Description Cost Gain Loss Value -------------------------------------------------------------------------------------- Commercial mortgage-backed securities ("CMBS"): CMB IO's $ 66,711 $ 2,133 $ - $68,844 Investment grade CMBS 52,071 2,834 - 54,905 Non-investment grade rated subordinated 341,445 754 (80,710) 261,489 securities Non-rated subordinated securities 35,140 436 (8,379) 27,197 --------------------------------------------- Total CMBS 495,367 6,157 (89,089) 412,435 Single-family residential mortgage-backed securities ("RMBS"): Agency adjustable rate securities 159,673 1,269 (14) 160,928 Agency fixed rate securities 104,665 408 (314) 104,759 --------------------------------------------- Total RMBS 264,338 1,677 (328) 265,687 --------------------------------------------- Total securities available for sale $759,705 $ 7,834 $ (89,417) $678,122 =============================================
As of December 31, 2000, an aggregate of $620,067 in estimated fair value of the Company's securities available for sale was pledged to secure its collateralized 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 Unrealized Fair Security Description Cost Gain 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 =============================================
As of December 31, 1999, an aggregate of $497,542 in estimated fair value of the Company's securities available for sale was pledged to secure its collateralized borrowings. The following subordinate CMBS securities were owned by the Company as of December 31, 2000 and December 31, 1999:
12/31/00 12/31/99 Security Description Cusip Rating Coupon Face Face Amount Amount ------------------------------------------------------------------------------- CMAC_98-C1 H 201728DC3 BB- 6.210% $ 8,942 $ 8,942 CMAC_98-C1 J 201728DD1 B+ 6.210% 14,905 14,905 CMAC_98-C1 K 201728DE9 B 6.210% 8,939 8,939 CMAC_98-C1 L 201728DF6 B- 6.210% 11,924 11,924 CMAC_98-C1 M 201728DG4 CCC 6.210% 8,940 8,940 CMAC_98-C1 N 201728DH2 NR 6.210% 11,926 11,926 CMAC_98-C2 H 201728DU3 BB- 5.440% 36,141 36,141 CMAC_98-C2 J 201728DV1 B 5.440% 65,054 65,054 CMAC_98-C2 K 201728DW9 B- 5.440% 21,684 21,684 CMAC_98-C2 L 201728DX7 CCC 5.440% 21,685 21,685 CMAC_98-C2 M 201728DY5 NR 5.440% 43,402 43,402 DLJCM_98-CG1 C 23322BCT3 NR 6.700% 23,464 23,464 DLJCM_98-CG1 B5 23322BCR7 BB- 6.300% 15,642 15,642 DLJCM_98-CG1 B6 23322BCS5 B 6.300% 27,374 27,374 DLJCM_98-CG1 B7 23322BCW6 B- 6.300% 15,643 15,643 GMACC_98-C1 J 361849DP4B 7.155% 9,300 9,300 GMACC_98-C1 K 361849DQ2 B- 6.700% 16,400 16,400 GMACC_98-C1 L 361849DR0 CCC 6.700% 9,300 9,300 GMACC_98-C1 M 361849DS8 CCC 6.700% 7,000 7,000 GMACC_98-C1 N 361849DT6 NR 6.700% 9,300 9,300 LBCMT_98-C1 F 501773BG9 BB+ 6.300% 34,834 34,834 LBCMT_98-C1 G 501773BH7 BB 6.300% 34,556 34,556 LBCMT_98-C1 H 501773BJ3 BB- 6.300% 17,278 17,278 LBCMT_98-C1 J 501773BK0 B 6.300% 43,195 43,195 LBCMT_98-C1 K 501773BL8 B- 6.300% 11,231 11,231 LBCMT_98-C1 L 501773BM6 CCC 6.300% 11,231 11,231 LBCMT_98-C1 M 501773BN4 NR 6.300% 19,664 19,664 PNCMAC_99-CM1 B6 69348HAM0 B+ 6.850% 10,455 10,455 PNCMAC_99-CM1 B7 69348HAN8 B 6.850% 7,604 7,604 PNCMAC_99-CM1 B8 69348HAP3 B- 6.850% 5,703 5,703 PNCMAC_99-CM1 C 69348HAQ1 CCC 6.850% 7,605 7,605 PNCMAC_99-CM1 D 69348HAR9 NR 6.850% 9,505 9,505 Midland Conduit III N/A NR 8.030% - 1,596 PNC Loan Trust VII N/A NR 8.080% 1,282 - PNC Loan Trust VII N/A NR 5.440% 270 - CMAC 98-C2-F 201728058 CCC 2,000 - DLJCM 98-CGI-B4 23322BCQ9 BB 7.150% 2,531 - ------------------------------ Total CMBS $ 605,909 $ 601,422 ==============================
As of December 31, 2000 and 1999 there were 1,765 and 1,771 loans underlying the subordinated CMBS held by the Company, with a principal balance of $9,137,000 and $9,325,000, respectively. As of December 31, 2000, and 1999, the aggregate estimated fair value by underlying credit rating of the Company's securities available for sale are as follows: December 31, 2000 December 31, 1999 Estimated Estimated Security Rating Fair Value Percentage Fair Value Percentage --------------------------------------------------------------------------- Agency and agency insured securities $203,073 30.0% $227,641 39.5% AAA 68,844 10.2 76,821 13.3 AA 62,613 9.2 - - A 7,743 1.1 - - BBB 47,163 7.0 - - BB+ 25,870 3.8 23,103 4.0 BB 26,876 4.0 22,051 3.8 BB- 48,581 7.1 50,412 8.7 B+ 15,487 2.3 14,173 2.5 B 87,763 12.9 84,830 14.7 B- 38,351 5.7 32,770 5.7 CCC 18,561 2.7 16,368 2.8 Not rated 21,197 4.0 29,026 5.0 ------------------------------------------------ Total securities available for sale $678,122 100.0% $577,195 100.0% ================================================ As of December 31, 2000 and 1999, the mortgage loans underlying the CMBS held by the Company were secured by properties of the types and at the locations identified below: Percentage (1) Percentage (1) -------------------------------------------------------------------------- Property Type 2000 1999 Geographic 2000 1999 Location -------------------------------------------------------------------------- Multifamily 34.7% 34.9% California 13.4% 13.6% Retail 26.6 26.6 Texas 10.3 10.4 Office 18.9 18.8 New York 9.6 9.6 Lodging 9.4 9.4 Florida 7.0 6.9 Other 10.4 10.3 Illinois 5.1 5.1 ------------------- Total 100.0% 100.0% Other (2) 54.6 55.4 =================== --------------------- Total 100.0% 100.0% ===================== Based on a percentage of the total unpaid principal balance of the underlying loans. 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 December 31:
- ------------------------------------------------------------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------------- Number of % of Number of % of Principal Loans Collateral Principal Loans Collateral - ------------------------------------------------------------------------------------------- Past due 30 days to 60 days $6,319 3 0.07% $2,936 2 0.03% - ------------------------------------------------------------------------------------------- Past due 60 days to 90 days 7,963 2 0.09% 13,522 3 0.14% - ------------------------------------------------------------------------------------------- Past due 90 days or more 28,526 5 0.31% 34,631 6 0.37% - ------------------------------------------------------------------------------------------- Resolved loans 0 0 0.00% 22,296 1 0.24% - ------------------------------------------------------------------------------------------- Real Estate owned 10,145 2 0.11% 0 0 0.00% - ------------------------------------------------------------------------------------------- Total Delinquent $52,953 12 0.58% $73,385 12 0.79% - ------------------------------------------------------------------------------------------- Total Principal Balance $9,137,150 $9,324,761
Of the 12 delinquent loans as of December 31, 2000, three were delinquent due to technical reasons, two were REO and being marketed for sale, three were in foreclosure, and the remaining four loans were in some form of workout negotiations. One of the loans in foreclosure is the subject of litigation with the loan seller. The matter involves a significant breach of representations and warranties made when the loan was contributed to the securitization transaction. The Company caused the loan trust to file a claim against the seller for representing that a loan secured by a limited service hotel in Phoenix AZ was a flagged hotel when, in fact, it was not. The Company believes strongly in the merits of the breach claim and has caused the special servicer to institute legal action against the loan seller. The Company's delinquency experience of 0.58% is slightly better than the 0.77% for directly comparable collateral experience shown in the Lehman Brothers CMBS 1998 vintage collateral delinquency index. During 2000 the Company also experienced early payoffs of $81,695, representing 0.89% of the year-end pool balance. These loans were paid at par with no loss. The anticipated losses attributable to these loans will be reallocated to the loans remaining in the pools. During 1999 the Company addressed delinquency issues with regard to 25 different loans including the two outstanding on December 31, 1998. During 1999 one loan was put back to the originator for documentation concerns and twelve were brought current without experiencing a loss. One loan, in the principal amount of $22,296 was resolved in November 1999 with slightly modified payment terms at no loss to the Company. To the extent that realized losses, if any, or such resolutions differ significantly from the Company's original loss estimates, it may be necessary to reduce the projected GAAP yield on the applicable CMBS investment to better reflect such investment's expected earnings net of expected losses, from the date of purchase. While realized losses on individual assets may be higher or lower than original estimates, the Company currently believes its aggregate loss estimates and GAAP 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 agency insured project loan held by the Company consists of a participation interest in a mortgage loan guaranteed by the Federal Housing Administration (FHA). 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 December 31, 2000 and 1999, the anticipated weighted average unleveraged yield to maturity based upon adjusted cost of the Company's subordinated CMBS was 9.78% and 9.90% per annum, respectively, and of the Company's other securities available for sale was 7.46% and 7.29% per annum, respectively. 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. The Company's mortgage loan pools consist of 191 loans secured by first mortgages on single-family homes. As of December 31, 2000 amortized cost of these pools is $70,698, the balance owed is $70,787, the weighted average maturity is 27.68 years, the weighted average coupon is 7.36%, the minimum interest payable is 5.125%, and the maximum interest payable is 9.375%. The top five largest geographical concentrations are Michigan, California, Colorado, Florida and Illinois, representing 60% of the balance owed for the mortgage loan pools. The estimated fair value of the mortgage loan pools at December 31, 2000 was $71,535, resulting in an unrealized gain of $837. In March 2001, the Company entered into an agreement to sell all of the mortgage loan pools with the settlement to occur in April 2001. There will be a slight gain to the Company. As of December 31, 2000, the unamortized net discount on all securities available for sale was $1,303,814, which represented 56.09% of the then remaining face amount of such securities. During 2000, the Company sold securities available for sale for total proceeds of $3,176 resulting in a realized gain of $3,212. During 1999, the Company sold securities available for sale for total proceeds of $47,843, resulting in a realized loss of $516. During 1998, the Company sold securities available for sale for total proceeds of $736,744, resulting in a realized loss of $18,262. 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. At December 31, 2000, the Company's securities held for trading consisted of U.S. Treasury securities with an estimated fair value of $54,179 and a long position of 13 ten-year U.S. Treasury Note future contracts expiring March 30, 2001 which represented $1,300 in face amount of U.S. Treasury notes. The estimated value at December 31, 2000 of the future contracts was $(136). The Company did not have any long or short positions in securities held for trading at December 31,1999. 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 On August 26, 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 a spread of 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 December 31, 2000, and December 31, 1999 (at the exchange rates in effect on such dates) are summarized as follows:
December 31, 2000 December 31, 1999 - -------------------------------------------------------------------------------------- Interest Principal Unamortized Amortized Interest Principal Unamortized Amortized Rate Balance Discount Cost Rate Balance Discount Cost - -------------------------------------------------------------------------------------- 9.92% $32,087 $46 $32,041 10.11% $ 34,680 $67 $34,613
The exchange rate for the British pound at December 31, 2000 was (pound)0.668762 to US $1.00; at December 31, 1999 the exchange rate was (pound)0.61908 U.S. $1.00. 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. 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 a spread. 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 December 31, 2000, the interest rate on the Santa Monica Loan was 13.3% and the borrower had made all payments when due. The borrower sold the property in the first quarter 2001, at which time the Company's loan was repaid in full and the unamortized commitment fee will be earned. On March 28, 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 "New York City Loan"). The New York City Loan matures December 2001, and payments are interest only based upon LIBOR plus a spread. The Company will receive a 50 basis point exit fee upon maturity of the New York City Loan, which is being amortized into interest income over the life of the loan. The entire principal balance of the Company's investment in the New York City Loan is pledged to secure line of credit borrowings. As of December 31, 2000, the interest rate on the New York City Loan was 12.49%, and the borrower has 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. Currently payments are interest only based upon LIBOR plus a spread. Beginning June 1, 2001, principal payments will be required, based on a 25-year amortization schedule. As of December 31, 2000, the interest rate on the San Francisco Loan was 13.21% 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 were 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 was satisfied in full on December 14, 2000, together with all unpaid interest, pre-payment penalties and fees. The Junior Chicago Loan provides for a 24-month term, which may be extended in six-month increments for up to 36 months at the borrower' s option, and may be prepaid at any time. Payments are interest only based at 12% and the borrower made all payments when due. Additional interest of 8% is due upon pay-off. On December 20, 2000, the Company funded a $22,500 subordinate tranche of a $60,850 mezzanine loan, secured by the borrower's interest in a 54-story, 1,368 square foot office tower in Los Angeles, California (the "Los Angeles Loan"). The tranche bears interest based upon LIBOR plus a spread for two years, which may, at the borrower's option, may be extended for two additional years for an additional 1% each year. Payments are interest only, and the borrower has made all payments when due. As of December 31, 2000 the interest rate on the loan was 16.9%. 2000 1999 1998 ------------- -------------- ----------- Reconciliation of commercial mortgage loans: Balance at beginning of period $69,611 $35,581 $ -- Advances made during the period 101,100 35,000 35,581 Proceeds from repayment of mortgage loans 17,524 970 -- Investment in commercial mortgage loans - December 31, $153,187 $69,611 $35,581 ============= ============== =========== 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 suburban Philadelphia. The Company's ownership interest is 64.81% in each partnership. The Company receives a preferred return of 12% compounded, on its unreturned capital, payable monthly and a share of the proceeds from a sale or refinancing. On December 14, 2000, the Company made an investment aggregating approximately $5,149 in a limited liability company for the purpose of acquiring a 500 thousand square foot office and retail complex in Tallahassee, Florida. The Company receives a preferred return of 13.25% and a return of capital of $3, payable monthly. NOTE 7 FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments" (FAS No. 107") requires the disclosure of the estimated fair value of on- and off-balance sheet financial instruments. The following table presents the amortized cost and estimated carrying values of financial instruments as of December 31, 2000 and 1999:
2000 1999 ------------------------------------------------------------- Notional Carrying Fair Notional Carrying Fair Amount Value Value Amount Value Value ------------------------------------------------------------- Recorded financial instruments: Securities available for sale $ - $678,122 $678,122 $ - 577,195 $577,195 Securities held for trading - 54,179 54,179 - - - Mortgage loan pools - 71,535 71,535 - - - Commercial mortgage loans - 153,187 152,225 - 72,380 69,611 Secured borrowings - (719,342) (719,342) - (471,533) (471,533) Currency forward contracts 12,137 749 749 12,702 (221) (221) Interest rate swap agreements 226,000 (12,505) (12,505) - -
Notional amounts are a unit of measure specified in a derivative instrument. The fair values of the Company's securities available for sale, securities held for trading, mortgage loan pools, currency forward contracts, and interest rate swap agreements 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 by indicative of the amounts the Company could realize in a current market exchange. Commercial mortgage loans and secured borrowings are floating rate instruments. Therefore their carrying value is approximate fair value. NOTE 8 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. During 1999, the Company repurchased 36,800 shares of its Common Stock for $234 in open market transactions; these purchases were made at an average price of $6.35 per share. In accordance with Maryland corporate regulations, all repurchased shares are retired. As part of the CORE Cap merger, the Company issued 4,180,552 shares of its Common Stock to CORE Cap shareholders on May 15, 2000. 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 February 14, 2001 the Company completed a secondary offering of 4,000,000 shares of its common stock in an underwritten public offering. The aggregate net proceeds to the Company (after deducting underwriting fees and expenses) were $33,300. The Company had granted the underwriters an option, exercisable for 30 days, to purchase up to 600,000 additional shares of Common Stock to cover over-allotments. This option was exercised on March 13, 2001 and resulted in net proceeds to the Company of $5,000. During the year ended December 31, 2000, the Company declared dividends to shareholders totaling $27,591 or $1.17 per share, of which $20,005 was paid during the year and $7,541 was paid on January 31, 2001. On March 15, 2001, the Company declared distributions to its shareholders of $.30 per share, payable on April 30, 2001 to stockholders of record on March 30, 2001. For U.S. Federal income tax purposes, the dividends are ordinary income to the Company's stockholders. During the year ended December 31, 1999, the Company declared dividends to shareholders totaling $24,348 or $1.16 per share, of which $18,270 was paid during the year and $6,078 was paid on January 17, 2000. For U.S. Federal income tax purposes, the dividends are ordinary income to the Company stockholders. During the period March 24, 1998 through December 31, 1998, the Company declared dividends to shareholders totaling $18,759, $.92 per share, of which $12,963 was paid during the period and $5,796 was paid on January 15, 1999. For Federal income tax purposes, the dividends are ordinary income to the Company's stockholders. NOTE 9 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 $56,525, and is convertible into the Company's Common Stock at a price of $17.09 per share, subject to adjustment. If converted, the Series B Preferred Stock would convert into approximately 3,308,000 shares of the Company's common stock. In February 2001, 38,300 shares of 10% Series B Cumulative Redeemable convertible preferred stock with a liquidation preference of $958 were converted at the shareholder's option into 56,000 shares of the Company's Common Stock. As of December 31, 2000, the Company has authorized and un-issued preferred stock of 96,539 shares. NOTE 10 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 incurred $6,569 and $4,565 and $3,474 in base management fees in accordance with the terms of the Management Agreement for the years ended December 31, 2000, 1999 and 1998 respectively. In accordance with the provisions of the Management Agreement, the Company recorded reimbursements to the manager of $120, $333 and $250 for certain expenses incurred on behalf of the Company during 2000, 1999 and 1998, respectively. 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 $967 in incentive compensation for the year ended December 31, 2000. The Company did not pay incentive compensation during 1999 and 1998. 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 years ended December 31, 2000 and 1999, the administration fee was $120. During the year ended December 31, 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, Commercial Mortgage Owner Trust VII, PNC Loan Trust VII, and PNC Loan Trust VIII for an aggregate investment of $7,021. These Midland Trusts were purchased from Midland Loan Services, Inc. and the PNC trusts were purchased from PNC Bank. Midland is 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 and PNC. 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. As of December 31, 2000 there were no outstanding borrowings under this line of credit. The Company earned $163 and $33 from the Trusts and paid interest of approximately $138 and $20 to PNC Funding Corp. during years ended December 31, 2000 and 1999, respectively. These Midland Trusts were all sold prior to December 31, 2000. The gain on sale of these investments was not significant. During 1999, the Company purchased certificates representing 1% interests in Midland Commercial Mortgage Owner Trust I, Midland Commercial Mortgage Owner Trust II, and Midland Commercial Mortgage Owner Trust III (the "Trusts") from Midland for an aggregate investment of $5,346. During 1999 the Company's interests in the Midland Commercial Mortgage Owner Trust I and II were sold for $3,876 resulting in a realized gain of $87. In connection with these transactions, the Company entered into a $4,500 committed line of credit from PNC Funding Corp. 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 paid interest of approximately $20 to PNC Funding Corp. during the year ended December 31, 1999. PNC Investment Corp., a wholly owned indirect subsidiary of PNC, purchased, in a private placement, 648 shares of the Company's common stock at $13.95 per share for a total of $9,045. The sale of these shares was consummated at the time of the closing of the Company's initial public offering. During 1998, the Company purchased, in private placements, 11 classes of subordinated CMBS for a total of $142,855 in two securitization transactions in which PNC Bank, N.A. ("PNC Bank"), a wholly owned subsidiary of PNC, and/or Midland Loan Services, Inc., participated as sellers of a portion of the commercial mortgage loans underlying the CMBS. The Company reimbursed PNC Bank and Midland for $1,243 in due diligence costs incurred on behalf of the Company during 1998. NOTE 11 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. For option grants prior to December 15, 1998, the Company considered its officers and directors to be employees for the purposes of stock option accounting. In accordance with the FASB's Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, the Company's officers and directors are not considered to be employees for grants made subsequent to that date. Of the options issued under the 1998 Stock Option Plan, options covering 979,426 shares of the Company's common stock were granted prior to December 15, 1998 to individuals deemed to be employees. The Company adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for such options. Accordingly, no compensation cost for these options has been recorded in the statement of operations. Had compensation cost for these options been determined based on the fair value of the options at the grant date consistent with the provisions of SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have changed to the pro forma amounts indicated below: 2000 1999 1998 ------------------------------------- Net income (loss) - as reported $39,319 $26,673 $(1,389) Net income (loss) - pro forma 39,158 26,348 (1,856) Basic income (loss) per share - as reported 1.37 1.27 (0.07) Basic income (loss) per share - pro forma 1.36 1.25 (0.09) Diluted income (loss) per share - as reported 1.28 (0.07) 1.26 Diluted income (loss) per share - pro forma 1.28 1.25 (0.09) For the Company's pro forma net loss, the compensation cost is amortized over the vesting period of the options. For the options to purchase 786,915 shares of the Company's common stock granted to non employees under the 1998 Stock Option Plan, compensation cost is accrued based on the estimated fair value of the options issued, and amortized over the vesting period. Because vesting of the options is contingent upon the recipient continuing to provide services to the Company to the vesting date, the Company estimates the fair value of the non-employee options at each period end, up to the vesting date, and adjusts expensed amounts accordingly. The value of these non-employee options at each period end was negligible. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the periods ending December 31, 2000, 1999 and 1998. December 31, ------------------------------------------ 2000 1999 1998 ------------------------------------------ Estimated volatility 25% 25% 25% Expected life 7 years 8 years 10 years Risk-free interest rate 6.0% 5.82% 5.19% Expected dividend yield 11.35% 15.91% 12% 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 15.58 100% 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. The following table summarizes information about options outstanding under the Plan:
2000 1999 1998 ------------------------- ---------------------- ----------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------------------------- ---------------------- ----------------------- Outstanding at January 1 1,718,143 $14.03 1,488,143 $15.00 0 $15.00 Granted 193,198 11.73 270,000 8.44 1,488,143 Exercised 0 0 0 Cancelled (145,000) 12.91 (40,000) 12.54 0 --------- --------- --------- Outstanding at December 31 1,766,341 $13.87 1,718,143 $14.03 1 ,488,143 $15.00 --------- --------- --------- Options exercisable at December 31 919,770 $14.02 365,786 $15.00 0 ========= ========= Weighted-average fair value of options granted during the year ended December 31 (per option) $ 0.12 $ 0.06 $ 1.06 --------- --------- ---------
The following table summarizes information about options outstanding under the Plan at December 31, 2000: Options Options Outstanding Exercisable at Remaining at Exercise December 31, Contractual December 31, Price 2000 Life 2000 -------- ------------- ----------- ------------ 7.82 15,400 9.1 Years 15,400 8.02 50,000 9.2 Years 0 8.44 230,000 8.2 Years 115,000 9.11 15,400 8.2 Years 15,400 15.00 1,363,143 7.2 Years 681,572 15.58 76,998 6.7 Years 76,998 15.83 15,400 7.2 Years 15,400 --------- --------- 7.82-$15.83 1,766,341 7.43 Years 919,770 ========= ========= Shares available for future grant under the plan at December 31, 2000 were 704,112. Options to purchase 246,544 shares of the Company's common stock that were granted to certain officers, directors and employees of the Company and the Manager in connection with the Company's initial public offering expired unexercised on March 30, 1999. NOTE 12 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 mortgage loan pools. As of December 31, 2000 outstanding borrowings under this facility were $37,253. 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 December 31, 2000 and December 31, 1999, the outstanding borrowings under this line of credit were $63,453, 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. On January 15, 2001, the facility was renewed 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 December 31, 2000 and December 31, 1999, the Company had drawn $17,500 and $14,131, respectively 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 an $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 investments in real estate joint ventures. As of December 31, 2000 and December 31, 1999, the outstanding borrowings under this facility were $53,810 and $5,022, respectively. Outstanding borrowings under the Deutsche Bank Facility 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 Generele 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 December 31, 2000, outstanding borrowing under the ABN Amro facility was $30,115. 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 December 31, 2000, 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 December 31, 2000 is summarized as follows:
Lines of Reverse Total Credit and Repurchase Collateralized Term Loans Agreements Borrowings ----------------------------------------------------- Outstanding borrowings $ 202,130 $517,212 $719,342 Weighted average borrowing rate 7.71% 7.06% 6.89% Weighted average remaining maturity 152 days 22 days 57 days Estimated fair value of assets pledged $354,108 $588,657 $942,765
As of December 31, 2000, $23,129 of borrowings outstanding under the lines of credit were denominated in pounds sterling and interest payable is based on sterling LIBOR. As of December 31, 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 $63,453 $376,588 $440,041 31 to 59 days - 140,624 140,624 Over 60 days 138,677 - 138,677 ------------------------------------------------ $202,130 $517,212 $719,342 ================================================ Certain information with respect to the Company's collateralized borrowings as of December 31, 1999 is summarized as follows:
Lines of Credit Reverse Total and Term Repurchase Collateralized 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 13 HEDGING INSTRUMENTS As of December 31, 2000, the Company had forward currency exchange contracts pursuant to which the Company has agreed to exchange (pound)8,000 (pounds sterling) for $12,137 (U.S. dollars) on January 18, 2001. On January 18, 2001, the Company agreed to exchange (pound)8,000 (pounds sterling) for $11,782 on July 18, 2001. As of December 31, 1999, the Company has agreed to exchange (pound)8,000 (pounds sterling) for $12,702 (U.S. dollars) on January 18, 2000. These contracts are intended to hedge currency risk in connection with the Company's investment in a commercial mortgage loan denominated in pounds sterling. The estimated fair value of the forward currency exchange contracts was an asset of $749 and a liability of $(221) at December 31, 2000 and 1999, respectively, which was recognized as a addition (reduction) of net foreign currency gains (losses). 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 December 31, 2000 and 1999 no collateral was required under the forward currency exchange contracts. As of December 31, 1999, the Company had outstanding a short position of 186 thirty-year U.S. Treasury Bond future contracts and 1,080 five-year and 200 ten-year U.S. Treasury Note future contracts expiring in March 31, 2000, which represented $18,600 and $128,000 in face amount of U.S. Treasury Bonds and Notes, respectively. Realized gains and losses on closed contracts re recognized as a net adjustment to the basis of the hedged security. The estimated fair value of these contracts was approximately $1,925 at December 31, 1999 and is included in the carrying value 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 December 31, 2000 the balance of such net margin deposits owed to counterparties as collateral under these agreements totaled $81. Interest rate swap agreements as of December 31, 2000 consist of the following: Notional Estimated Amortized Remaining Amount Fair Value Cost Term ---------------------------------------------- Interest rate swap $ 226,000 $(12,505) $9,471 19.3 years agreements There were no interest rate swap agreements at December 31, 1999. Interest rate swap 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. NOTE 14 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 Year Ended December 31, 2000 ------------------------------------------------ Income Shares Per-Share (Numerator) (Denominator) Amount Net income available to common shareholders $32,261 ------------------ Basic net income per share 32,261 23,586,873 $1.37 ============ Effect of dilutive securities: 10.5% Series A Senior Cumulative Redeemable Preferred Stock 3,232 4,081,680 --------------------------------- Diluted net income per share $35,493 27,668,553 $1.28 ================================================ For the Year Ended December 31, 1999 ------------------------------------------------ Income Shares Per-Share (Numerator) (Denominator) Amount Net income available to common shareholders $26,389 ------------------ Basic net income per share 26,389 20,814,000 $1.27 ============ Effect of dilutive securities: 10.5% Series A Senior Cumulative Redeemable Preferred Stock 284 336.000 --------------------------------- Diluted net income per share $26,673 21,150,000 $1.26 ================================================ The Company's stock options and Series B Preferred Stock outstanding were antidilutive for all periods presented. NOTE 15 SUMMARIZED QUARTERLY RESULTS (UNAUDITED) The following is a presentation of quarterly results of operations.
Quarters Ending March 31 June 30 September 30 December 31 2000 1999 2000 1999 2000 1999 2000 1999 --------------------------------------------------------------------- Interest Income $16,622 $13,958 $26,003 $13,951 $26,968 $13,418 $28,049 $16,184 --------------------------------------------------------------------- Expenses: Interest 7,467 7,123 15,096 6,011 14,765 5,526 13,784 7,216 Management fee and other 2,177 1,350 2,248 1,807 2,040 1,557 3,262 2,690 --------------------------------------------------------------------- Total Expenses 9,644 8,473 17,344 7,818 16,805 7,083 17,046 9,906 --------------------------------------------------------------------- Gain (loss) on sale of securities available for sale 24 136 682 7 994 (566) 1,512 (93) Gain (loss) on securities held for trading 328 1,181 - 1,072 191 739 (1,166) - Foreign currency (loss) gain (4) (67) (7) (16) 29 28 (60) 21 --------------------------------------------------------------------- Net income $7,326 $6,735 $9,334 $7,196 $11,377 $6,536 $11,289 $6,206 --------------------------------------------------------------------- Dividends and accretion on redeemable convertible 866 - 1,575 - 2,307 - 2,317 (284) preferred stock --------------------------------------------------------------------- Net income available to common shareholders $6,460 $6,735 $7,759 $7,196 $9,070 $6,536 $8,972 $5,922 ===================================================================== Net income per share: Basic $0.31 $0.33 $0.34 $0.34 $0.36 $0.31 $0.36 $0.28 Diluted $0.29 $0.33 $0.32 $0.34 $0.34 $0.31 $0.34 $0.28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference to the Company's annual report to security holders for the year ended December 31, 2000 ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference to the Company's annual report to security holders for the year ended December 31, 2000 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference to the Company's annual report to security holders for the year ended December 31, 2000 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference to the Company's annual report to security holders for the year ended December 31, 2000 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(3) Exhibit Index **3.1 Articles of Amendment and Restatement of the Registrant **3.2 Bylaws of the Registrant **10.1 Management Agreement between the Registrant and BlackRock Financial Management, Inc. **10.2 Form of 1998 Stock Option Incentive Plan 21.1 Subsidiaries of the Registrant Consent of Deloitte & Touche 24.1 Power of Attorney (included on signature page hereto) - --------------------------------------------------------------------- ** Previously filed. 1. Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the Company's fiscal year ended December 31, 2000. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ANTHRACITE CAPITAL, INC. Date: March 30, 2001 By: /s/ Hugh R. Frater --------------------------------- Hugh R. Frater President and Chief Executive Officer and Director (duly authorized representative) KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints Richard M. Shea his true and lawful attorney-in-fact and agents with full power of substitution and resubstitution, for his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Form 10-K and to file the same with all exhibits thereto, and all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This power of attorney may be executed in counterparties. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 30, 2001 By: /s/ Hugh R. Frater ------------------------------------ Hugh R. Frater President and Chief Executive Officer and Director Date: March 30, 2001 By: /s/ Laurence D. Fink ----------------------------------- Laurence D. Fink Chairman of the Board of Directors Date: March 30, 2001 By: /s/ Donald G. Drapkin ---------------------------------- Donald G. Drapkin Director Date: March 30, 2001 By: /s/ Carl F. Guether ---------------------------------- Carl F. Guether Director Date: March 30, 2001 By: /s/ Jeffrey C. Keil ---------------------------------- Jeffrey C. Keil Director Date: March 30, 2001 By: /s/ Kendrick R. Wilson, III ---------------------------------- Kendrick R. Wilson, III Director Date: March 30, 2001 By: /s/ Andrew P. Rifkin ---------------------------------- Andrew P. Rifkin Director Date: March 30, 2001 By: /s/ David M. Applegate ---------------------------------- David M. Applegate Director Date: March 30, 2001 By: /s/ Leon T. Kendall ---------------------------------- Leon T. Kendall Director EX-21 2 0002.txt EXHIBIT 21.1 EXHIBIT 21.1 List of Subsidiaries Newpa/AHR Equity, LP Newpa/AHR GP, LLC Newpa/AHA Equity GP LLC Northwoods Anthracite Funding ML LLC Anthracite Funding, LLC Core Cap, Inc. EX-23 3 0003.txt EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-75473 of Anthracite Capital, Inc. on Form S-3 and in Registration Statement No. 333-32166 of Anthracite Capital, Inc. on Form S-3, of our report dated March 21, 2001, appearing in this Annual Report on Form 10-K of Anthracite Capital, Inc. for the year ended December 31, 2000. /s/ Deloitte & Touche LLP New York, New York April 2, 2001 -----END PRIVACY-ENHANCED MESSAGE-----