UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2009
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-13447
ANNALY CAPITAL MANAGEMENT, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 22-3479661
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)
10036
(Zip Code)
(212) 696-0100
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
Yes X No
-----
Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T
(Section 232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files).
Yes __ No __
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer |X| Accelerated filer |_| Non-accelerated filer |_| Smaller reporting company |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date:
Class Outstanding at May 7, 2009
Common Stock, $.01 par value 544,344,030
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
FORM 10-Q
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Financial Condition at March 31, 2009
(Unaudited) and December 31, 2008 (Derived from the audited
consolidated statement of financial condition at December 31, 2008) 1
Consolidated Statements of Operations and Comprehensive Income
(Unaudited) for the quarters ended March 31, 2009 and 2008 2
Consolidated Statement of Stockholders' Equity (Unaudited) for
the quarter ended March 31, 2009 3
Consolidated Statements of Cash Flows (Unaudited) for the
quarters ended March 31, 2009 and 2008 4
Notes to Consolidated Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 37
Item 4. Controls and Procedures 38
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 1A. Risk Factors 39
Item 6. Exhibits 41
SIGNATURES 43
Part I
Item 1. Financial Statements
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
MARCH 31, 2009 AND DECEMBER 31, 2008
(dollars in thousands, except for share data)
March 31, 2009
(Unaudited) December 31, 2008(1)
-----------------------------------------
ASSETS
------
Cash and cash equivalents $1,035,118 $909,353
Reverse repurchase agreements with affiliate 452,480 562,119
Mortgage-Backed Securities, at fair value 58,785,456 55,046,995
Agency debentures, at fair value - 598,945
Available for sale equity securities, at fair value 51,418 52,795
Receivable for Investment Securities sold 33,009 75,546
Accrued interest and dividends receivable 291,347 282,532
Receivable from Prime Broker 16,886 16,886
Receivable for advisory and service fees 6,507 6,103
Intangible for customer relationships, net 11,399 12,380
Goodwill 27,917 27,917
Other assets 5,717 6,044
-----------------------------------------
Total assets $60,717,254 $57,597,615
=========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Repurchase agreements $48,951,178 $46,674,885
Payable for Investment Securities purchased 2,121,670 2,062,030
Accrued interest payable 112,457 199,985
Dividends payable 272,170 270,736
Accounts payable and other liabilities 23,970 8,380
Interest rate swaps, at fair value 1,012,574 1,102,285
-----------------------------------------
Total liabilities 52,494,019 50,318,301
-----------------------------------------
6.00% Series B Cumulative Convertible Preferred Stock:
4,600,000 shares authorized 2,607,564 and 3,963,525 shares
issued and outstanding respectively. 63,185 96,042
-----------------------------------------
Commitments and contingencies (Note 13) - -
Stockholders' Equity:
7.875% Series A Cumulative Redeemable Preferred Stock:
7,412,500 shares authorized, issued and outstanding 177,088 177,088
Common stock: par value $.01 per share; 987,987,500 shares
authorized, 544,339,785 and 541,475,366 issued and
outstanding, respectively 5,443 5,415
Additional paid-in capital 7,667,769 7,633,438
Accumulated other comprehensive income 1,121,551 252,230
Accumulated deficit (811,801) (884,899)
-----------------------------------------
Total stockholders' equity 8,160,050 7,183,272
-----------------------------------------
Total liabilities, Series B Cumulative Convertible
Preferred Stock and stockholders' equity $60,717,254 $57,597,615
=========================================
(1) Derived from the audited consolidated statement of financial condition
at December 31, 2008.
See notes to consolidated financial statements.
1
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
QUARTERS ENDED MARCH 31, 2009 AND 2008
(dollars in thousands, except per share amounts)
(Unaudited)
For the Quarter Ended For the Quarter Ended
March 31, 2009 March 31, 2008
--------------------------------------------
Interest income $716,015 $791,128
Interest expense 378,625 537,606
--------------------------------------------
Net interest income 337,390 253,522
--------------------------------------------
Other income:
Investment advisory and service fees 7,761 6,598
Gain on sale of Investment Securities 5,023 9,417
Income from trading securities - 1,854
Dividend income from available-for-sale equity securities 918 941
Unrealized gain on interest rate swaps 35,545 -
--------------------------------------------
Total other income 49,247 18,810
--------------------------------------------
Expenses:
Distribution fees 428 633
General and administrative expenses 29,882 23,995
--------------------------------------------
Total expenses 30,310 24,628
--------------------------------------------
356,327 247,704
Income before income taxes and noncontrolling interest
Income taxes 6,434 4,610
--------------------------------------------
Net income 349,893 243,094
Noncontrolling interest - 58
--------------------------------------------
Net income attributable to controlling interest 349,893 243,036
Dividends on preferred stock 4,626 5,373
--------------------------------------------
Net income available to common shareholders $345,267 $237,663
============================================
Net income available per share to common shareholders:
Basic $0.64 $0.54
============================================
Diluted $0.63 $0.53
============================================
Weighted average number of common shares outstanding:
Basic 542,903,110 443,812,432
============================================
Diluted 548,551,328 452,967,457
============================================
Net income attributable to controlling interest $349,893 $243,036
--------------------------------------------
Other comprehensive gain (loss):
Unrealized gain on available-for-sale securities 820,178 217,563
Unrealized gain (loss) on interest rate swaps 54,166 (391,763)
Reclassification adjustment for net gains included in net income (5,023) (9,417)
--------------------------------------------
Other comprehensive income (loss) 869,321 (183,617)
--------------------------------------------
Comprehensive income attributable to controlling interest $1,219,214 $59,419
============================================
See notes to consolidated financial statements.
2
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
QUARTER ENDED MARCH 31, 2009
(dollars in thousands, except per share data)
(Unaudited)
Accumulated
Common Additional Other
Preferred Stock Paid-In Comprehensive Accumulated
Stock Par Value Capital Income (Loss) Deficit Total
-------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2008 $177,088 $5,415 $7,633,438 $252,230 ($884,899) $7,183,272
Net income attributable to controlling interest - - - - 349,893 349,893
Other comprehensive income - - - 869,321 - 869,321
Exercise of stock options and stock grants - - 623 - - 623
Stock option expense and long-term compensation expense - - 879 - - 879
Conversion of Series B cumulative convertible Preferred
Stock - 28 32,829 - - 32,857
Preferred Series A dividends declared $0.492188 per share - - - - (3,648) (3,648)
Preferred Series B dividends declared $0.375 per share - - - - (978) (978)
Common dividends declared, $0.50 per share - - - - (272,169) (272,169)
-------------------------------------------------------------------------
BALANCE, MARCH 31, 2009 $177,088 $5,443 $7,667,769 $1,121,551 ($811,801) $8,160,050
=========================================================================
See notes to consolidated financial statements
3
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
QUARTERS ENDED MARCH 31, 2009 AND 2008
(dollars in thousands)
(Unaudited)
For the Quarter For the Quarter
Ended March 31, 2009 Ended March 31, 2008
------------------------------------------
Cash flows from operating activities:
Net income $349,893 $243,094
Adjustments to reconcile net income to net cash provided by operating
activities:
Net income attributable to noncontrolling interest - (58)
Amortization of Mortgage Backed Securities premiums and discounts, net 41,014 27,513
Amortization of intangibles 1,088 1,002
Amortization of trading securities premiums and discounts - (3)
Gain on sale of Investment Securities (5,023) (9,417)
Stock option and long-term compensation expense 879 322
Unrealized gain on interest rate swaps (35,545) -
Net realized gain on trading investments - (5,294)
Unrealized depreciation on trading investments - 4,427
Increase in accrued interest receivable (8,525) (15,309)
Decrease in trading sales receivables - 157
Decrease in other assets 220 196
Purchase of trading securities - (746)
Proceeds from sale of trading securities - 9,926
Purchase of trading securities sold, not yet purchased - (4,044)
Proceeds from securities sold, not yet purchased - 9,848
Increase in advisory and service fees receivable (404) (983)
Decrease in interest payable (87,528) (85,033)
Increase (decrease) in accrued expenses and other liabilities 15,590 (16,565)
Proceeds from repurchase agreements on from broker dealer 1,086,026 -
Payments on repurchase agreements, broker dealer (200,000) -
------------------------------------------
Net cash provided by operating activities 1,157,685 159,033
------------------------------------------
Cash flows from investing activities:
Purchase of Mortgage-Backed Securities (6,244,648) (10,453,627)
Proceeds from sale of Investment Securities 882,754 4,160,361
Principal payments of Mortgage-Backed Securities 2,502,807 2,536,577
Agency debentures called 602,000 -
Purchase of agency debentures - (500,000)
Purchase of equity securities - -
Purchase of reverse repurchase agreements - (800,000)
Payments on reverse repurchase Agreements 109,639 -
------------------------------------------
Net cash used in investing activities (2,147,448) (5,056,689)
------------------------------------------
Cash flows from financing activities:
Proceeds from repurchase agreements 89,786,336 114,589,490
Principal payments on repurchase agreements (88,396,069) (109,312,043)
Proceeds from exercise of stock options 623 1,635
Proceeds from direct purchase and dividend reinvestment - 54,557
Net proceeds from follow-on offerings - 1,080,831
Net proceeds from ATM programs - 71,832
Noncontrolling interest - (1,574)
Dividends paid (275,362) (141,991)
------------------------------------------
Net cash provided by financing activities 1,115,528 6,342,737
------------------------------------------
Net increase in cash and cash equivalents 125,765 1,445,081
------------------------------------------
Cash and cash equivalents, beginning of period 909,353 103,960
------------------------------------------
Cash and cash equivalents, end of period $1,035,118 $1,549,041
==========================================
Supplemental disclosure of cash flow information:
Interest paid $466,153 $622,639
==========================================
Taxes paid $8,357 $254
==========================================
Noncash financing activities:
Net change in unrealized gain (loss) on available-for-sale securities
and interest rate swaps, net of reclassification adjustment $869,321 ($183,617)
==========================================
Dividends declared, not yet paid $272,170 $224,823
==========================================
Noncash investing activities:
Receivable for Investment Securities Sold $33,009 $174,413
==========================================
Payable for Investment Securities Purchased $2,121,670 $828,235
==========================================
See notes to consolidated financial statements.
4
ANNALY CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS ENDED MARCH 31, 2009 AND 2008
--------------------------------------------------------------------------------
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Annaly Capital Management, Inc. ("Annaly" or the "Company") was
incorporated in Maryland on November 25, 1996. The Company commenced its
operations of purchasing and managing an investment portfolio of mortgage-backed
securities on February 18, 1997, upon receipt of the net proceeds from the
private placement of equity capital, and completed its initial public offering
on October 14, 1997. The Company is a real estate investment trust ("REIT")
under the Internal Revenue Code of 1986, as amended. Fixed Income Discount
Advisory Company ("FIDAC") is a registered investment advisor and is a wholly
owned taxable REIT subsidiary of the Company. During the third quarter of 2008,
the Company formed RCap Securities, Inc. ("RCap"). RCap was granted membership
in the Financial Industry Regulatory Authority ("FINRA") on January 26, 2009,
and operates as broker-dealer. RCap is a wholly owned taxable REIT subsidiary of
the Company. On October 31, 2008, the Company acquired Merganser Capital
Management, Inc. ("Merganser"). Merganser is a registered investment advisor and
is a wholly owned taxable REIT subsidiary of the Company.
A summary of the Company's significant accounting policies follows:
Basis of Presentation - The accompanying unaudited consolidated financial
statements have been prepared in conformity with the instructions to Form 10-Q
and Article 10, Rule 10-01 of Regulation S-X for interim financial statements.
Accordingly, they may not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America
("GAAP").
The consolidated interim financial statements are unaudited; however, in
the opinion of the Company's management, all adjustments, consisting only of
normal recurring accruals, necessary for a fair statement of the financial
positions, results of operations, and cash flows have been included. These
unaudited consolidated financial statements should be read in conjunction with
the audited consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2008. The nature of the
Company's business is such that the results of any interim period are not
necessarily indicative of results for a full year. The consolidated financial
statements include the accounts of the Company, FIDAC, Merganser, RCap and an
affiliated investment fund (the "Fund") which was a wholly owned subsidiary of
the Company. All intercompany balances and transactions have been eliminated.
The minority shareholder's interest in the earnings of the Fund is reflected as
minority interest in the consolidated financial statements.
Cash and Cash Equivalents - Cash and cash equivalents include cash on hand
and cash held in money market funds on an overnight basis.
Reverse Repurchase Agreements - The Company may invest its daily available
cash balances via reverse repurchase agreements to provide additional yield on
its assets. These investments will typically be recorded as short term
investments and will generally mature daily. Reverse repurchase agreements are
recorded at cost and are collateralized by mortgage-backed securities pledged by
the counterparty to the agreement. Reverse repurchase agreements entered into by
RCap are part of the subsidiary's daily matched book trading activity. These
reverse repurchase agreements are recorded on trade date at the contract amount,
are collateralized by mortgage backed securities and generally mature within 30
days. Margin calls are made by RCap as appropriate based on the daily valuation
of the underlying collateral versus the contract price. RCap generates income
from the spread between what is earned on the reverse repurchase agreements and
what is paid on the matched repurchase agreements. Cash flows related to RCap's
matchbook activity are included in cash flows from operating activity.
Mortgage-Backed Securities and Agency Debentures - The Company invests
primarily in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans, and certificates guaranteed by
the Government National Mortgage Association ("Ginnie Mae"), the Federal Home
Loan Mortgage Corporation ("Freddie Mac"), and the Federal National Mortgage
Association ("Fannie Mae") (collectively, "Mortgage-Backed Securities"). The
5
Company also invests in agency debentures issued by Federal Home Loan Bank
("FHLB"), Freddie Mac and Fannie Mae. The Mortgage-Backed Securities and agency
debentures are collectively referred to herein as "Investment Securities."
Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting
for Certain Investments in Debt and Equity Securities ("SFAS 115"), requires the
Company to classify its Investment Securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Investment Securities until
maturity, it may, from time to time, sell any of its Investment Securities as
part of its overall management of its portfolio. Accordingly, the Company
classifies all of its Investment Securities as available-for-sale. All assets
classified as available-for-sale are reported at estimated fair value, based on
market prices from independent sources, with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity. The Company's investment in Chimera Investment Corporation ("Chimera")
is accounted for as available-for-sale equity securities under the provisions of
SFAS 115.
Management evaluates securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market concerns
warrant such evaluation. Based on the guidance provided by Financial Accounting
Standards Board ("FASB"), the FASB issued FSP FAS 115-2 and FSP FAS 124-2,
Recognition and Presentation of Other Than Temporary Impairments. FSP FAS 115-2
and FSP FAS 124-2 are effective for interim and annual periods ending after June
15, 2009, with early adoption permitted for periods ending after March 15, 2009
and the Company decided to early adopt these two FSPs. Under these FSPs, the
Company determines if it has (1) the intent to sell the Investment Securities,
(2) it is more likely than not that it will be required to sell the securities
before recovery, or (3) it does not expect to recover the entire amortized cost
basis of the Investment Securities. Further, the security is analyzed for credit
loss (the difference between the present value of cash flows expected to be
collected and the amortized cost basis). The credit loss, if any, will then be
recognized in the statement of earnings, while the balance of impairment related
to other factors will be recognized in other comprehensive income ("OCI"). For
the quarters ended March 31, 2009 and 2008, the Company did not have unrealized
losses on Investment Securities that were deemed other than temporary.
SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
requires disclosure of the fair value of financial instruments for which it is
practicable to estimate that value. The estimated fair value of Investment
Securities, available-for-sale equity securities, trading securities, trading
securities sold, not yet purchased, receivable from prime broker and interest
rate swaps is equal to their carrying value presented in the consolidated
statements of financial condition. Cash and cash equivalents, reverse repurchase
agreements, accrued interest and dividends receivable, receivable for securities
sold, receivable for advisory and service fees, repurchase agreements with
maturities shorter than one year, payable for Investment Securities purchased,
dividends payable, accounts payable and other liabilities, and accrued interest
payable, generally approximates fair value as of March 31, 2009 due to the short
term nature of these financial instruments. The estimated fair value of long
term structured repurchase agreements is reflected in the Footnote 7 to the
financial statements.
Interest income is accrued based on the outstanding principal amount of the
Investment Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Investment Securities are amortized into
interest income over the projected lives of the securities using the interest
method. The Company's policy for estimating prepayment speeds for calculating
the effective yield is to evaluate historical performance, consensus prepayment
speeds, and current market conditions.
Investment Securities transactions are recorded on the trade date.
Purchases of newly-issued securities are recorded when all significant
uncertainties regarding the characteristics of the securities are removed,
generally shortly before settlement date. Realized gains and losses on sales of
Investment Securities are determined on the specific identification method.
Derivative Financial Instruments/Hedging Activity - Prior to the fourth
quarter of 2008, the Company designated interest rate swaps as cash flow hedges,
whereby the swaps were recorded at fair value on the balance sheet as assets and
liabilities with any changes in fair value recorded in OCI. In a cash flow
hedge, a swap would exactly match the pricing date of the relevant repurchase
agreement. Through the end of the third quarter of 2008 the Company continued to
be able to effectively match the swaps with the repurchase agreements therefore
entering into effective hedge transactions. However, due to the volatility of
the credit markets, it is no longer practical to match the pricing dates of both
the swaps and the repurchase agreements.
6
As a result, the Company voluntarily discontinued hedge accounting after
the third quarter of 2008 through a combination of de-designating previously
defined hedge relationships and not designating new contracts as cash flow
hedges. The de-designation of cash flow hedges was done in accordance with SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities, and
Derivatives Implementation Group "DIG" Issue Nos. G3, G17, G18 & G20, which
generally requires that the net derivative gain or loss related to the
discontinued cash flow hedge should continue to be reported in accumulated OCI,
unless it is probable that the forecasted transaction will not occur by the end
of the originally specified time period or within an additional two-month period
of time thereafter. The Company continues to hold repurchase agreements in
excess of swap contracts and has no indication that interest payments on the
hedged repurchase agreements are in jeopardy of discontinuing. Therefore, the
deferred losses related to these derivatives that have been de-designated will
not be recognized immediately and will remain in OCI. These losses are
reclassified into earnings during the contractual terms of the swap agreements
starting as of October 1, 2008. Changes in the unrealized gains or losses on the
interest rate swaps subsequent to September 30, 2008 are reflected in the
Company's statement of operations.
Credit Risk - The Company has limited its exposure to credit losses on its
portfolio of Investment Securities by only purchasing securities issued by
Freddie Mac, Fannie Mae, or Ginnie Mae and agency debentures issued by the FHLB,
Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie
Mac, and Fannie Mae Mortgage-Backed Securities are guaranteed by those
respective agencies, and the payment of principal and interest on the Ginnie Mae
Mortgage-Backed Securities are backed by the full faith and credit of the U.S.
government. Principal and interest on agency debentures are guaranteed by the
agency issuing the debenture. All of the Company's Investment Securities have an
actual or implied "AAA" rating. The Company faces credit risk on the portions of
its portfolio which are not Investment Securities.
Market Risk - The current situation in the mortgage sector and the current
weakness in the broader mortgage market could adversely affect one or more of
the Company's lenders and could cause one or more of the Company's lenders to be
unwilling or unable to provide additional financing. This could potentially
increase the Company's financing costs and reduce liquidity. If one or more
major market participants fails, it could negatively impact the marketability of
all fixed income securities, including agency mortgage securities. This could
negatively impact the value of the securities in the Company's portfolio, thus
reducing its net book value. Furthermore, if many of the Company's lenders are
unwilling or unable to provide additional financing, the Company could be forced
to sell its Investment Securities at an inopportune time when prices are
depressed. Even with the current situation in the mortgage sector, the Company
does not anticipate having difficulty converting its assets to cash or extending
financing terms due to the fact that its Investment Securities have an actual or
implied "AAA" rating and principal payment is guaranteed by Freddie Mac, Fannie
Mae, or Ginnie Mae.
Trading Securities and Trading Securities sold, not yet purchased - Trading
securities and trading securities sold, not yet purchased, are presented in the
consolidated statements of financial conditions as a result of consolidating the
financial statements of the Fund, and are carried at fair value. The realized
and unrealized gains and losses, as well as other income or loss from trading
securities, are recorded in the income from trading securities balance in the
accompanying consolidated statements of operations.
Repurchase Agreements - The Company finances the acquisition of its
Investment Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Repurchase agreements entered into by RCap are matched
with specific reverse repurchase agreements and are recorded on trade date with
the duration of such repurchase agreements mirroring those of the matched
reverse repurchase agreements. The repurchase agreements are recorded at the
contract amount and margin calls are filled by RCap as required based on any
deficiencies in collateral versus the contract price. RCap generates income from
the spread between what is earned on the reverse repurchase agreements and what
is paid on the repurchase agreements. Intercompany transactions are eliminated
in the statement of financial condition, statement of operations, and statement
of cash flows. Cash flows related to RCap's repurchase agreements are included
in cash flows from operating activity.
Cumulative Convertible Preferred Stock- The Company classifies its Series B
Cumulative Convertible Preferred Stock ("Series B Preferred Stock") on the
consolidated statements of financial condition using the guidance in SEC
Accounting Series Release No. 268, Presentation in Financial Statements of
"Redeemable Preferred Stocks," and Emerging Issues Task Force ("EITF") Topic
7
D-98, Classification and Measurement of Redeemable Securities. The Series B
Preferred Stock contains fundamental change provisions that allow the holder to
redeem the Series B Preferred Stock for cash if certain events occur. As
redemption under these provisions is not solely within the Company's control,
the Company has classified the Series B Preferred Stock as temporary equity in
the accompanying consolidated statements of financial condition.
The Company has analyzed whether the embedded conversion option should be
bifurcated under the guidance in SFAS No. 133 and EITF Issue No. 00-19,
Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock, and has determined that bifurcation is not
necessary.
Income Taxes - The Company has elected to be taxed as a REIT and intends to
comply with the provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), with respect thereto. Accordingly, the Company will not be subjected to
federal income tax to the extent of its distributions to shareholders and as
long as certain asset, income and stock ownership tests are met. The Company and
each of its subsidiaries, FIDAC, Merganser, and RCap have made separate joint
election to treat the subsidiaries as a taxable REIT subsidiary of the Company.
As such, each of the taxable REIT subsidiaries are taxable as a domestic C
corporation and subject to federal, state, and local income taxes based upon its
taxable income.
Use of Estimates - The preparation of the consolidated financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Goodwill and Intangible assets - The Company's acquisitions of FIDAC and
Merganser were accounted for using the purchase method. Under the purchase
method, net assets and results of operations of acquired companies are included
in the consolidated financial statements from the date of acquisition. In
addition, the costs of FIDAC and Merganser were allocated to the assets
acquired, including identifiable intangible assets, and the liabilities assumed
based on their estimated fair values at the date of acquisition. The excess of
purchase price over the fair value of the net assets acquired was recognized as
goodwill. Intangible assets are periodically (but not less frequently than
annually) reviewed for potential impairment. Intangible assets with an estimated
useful life are expected to amortize over a 10.8 year weighted average time
period. During the quarters ended March 31, 2009 and 2008, there were no
impairment losses.
Stock Based Compensation - The Company accounts for its stock-based
compensation in accordance with SFAS No. 123 (Revised 2004) - Share-Based
Payment ("SFAS 123R"). SFAS 123R requires the Company to measure and recognize
in the consolidated financial statements the compensation cost relating to
share-based payment transactions. The compensation cost should be reassessed
based on the fair value of the equity instruments issued.
The Company recognizes compensation expense on a straight-line basis over
the requisite service period for the entire award (that is, over the requisite
service period of the last separately vesting portion of the award). The Company
estimated fair value using the Black-Scholes valuation model.
Fair Value Measurement - In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a
framework for measuring fair value and requires enhanced disclosures about fair
value measurements. SFAS 157 requires companies to disclose the fair value of
their financial instruments according to a fair value hierarchy (i.e., levels 1,
2, and 3, as defined). Additionally, companies are required to provide enhanced
disclosure regarding instruments in the level 3 category (the valuation of which
require significant management judgment), including a reconciliation of the
beginning and ending balances separately for each major category of assets and
liabilities. SFAS 157 was adopted by the Company on January 1, 2008. SFAS 157
did not have an impact on the manner in which the Company estimates fair value,
but it requires additional disclosure, which is included in Note 6.
Recent Accounting Pronouncements - In February 2008, FASB issued FASB Staff
Position No. FAS 140-3 Accounting for Transfers of Financial Assets and
Repurchase Financing Transactions ("FSP FAS 140-3"). FSP FAS 140-3 addresses
whether transactions where assets purchased from a particular counterparty and
financed through a repurchase agreement with the same counterparty can be
considered and accounted for as separate transactions, or are required to be
8
considered "linked" transactions and may be considered derivatives under SFAS
133. FSP FAS 140-3 requires purchases and subsequent financing through
repurchase agreements be considered linked transactions unless all of the
following conditions apply: (1) the initial purchase and the use of repurchase
agreements to finance the purchase are not contractually contingent upon each
other; (2) the repurchase financing entered into between the parties provides
full recourse to the transferee and the repurchase price is fixed; (3) the
financial assets are readily obtainable in the market; and (4) the financial
instrument and the repurchase agreement are not coterminous. This FSP was
effective for the Company on January 1, 2009. The implementation of this FSP did
not have a material effect on the financial statements of the Company.
On January 1, 2009, the Company adopted SFAS 160, Noncontrolling Interests
in Consolidated Financial Statements, an Amendment of ARB No. 51, which requires
the Company to make certain changes to the presentation of its financial
statements. This standard requires us to classify noncontrolling interests
(previously referred to as "minority interest") as part of consolidated net
income and to include the accumulated amount of noncontrolling interests as part
of stockholders' equity. Similarly, in its presentation of stockholders' equity,
the Company distinguishes between equity amounts attributable to controlling
interest and amounts attributable to the noncontrolling interests - previously
classified as minority interest outside of stockholders' equity. For the quarter
ended March 31, 2009 and year-ended December 31, 2008 the Company do not have
any noncontrolling interest. In addition to these financial reporting changes,
SFAS 160 provides for significant changes in accounting related to
noncontrolling interests; specifically, increases and decreases in its
controlling financial interests in consolidated subsidiaries will be reported in
equity similar to treasury stock transactions. If a change in ownership of a
consolidated subsidiary results in loss of control and deconsolidation, any
retained ownership interests are remeasured with the gain or loss reported in
net earnings. Since the first quarter of 2008, the Company did not have any
noncontrolling interest in any of its subsidiaries. However, the retrospective
effect of the presentation and disclosure requirement under SFAS 160 will be
applied.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations, ("SFAS 141R") which replaces SFAS No. 141, Business Combinations.
SFAS 141R establishes principles and requirements for recognizing and measuring
identifiable assets and goodwill acquired, liabilities assumed and any
noncontrolling interest in a business combination at their fair value at
acquisition date. SFAS 141R alters the treatment of acquisition-related costs,
business combinations achieved in stages (referred to as a step acquisition),
the treatment of gains from a bargain purchase, the recognition of contingencies
in business combinations, the treatment of in-process research and development
in a business combination as well as the treatment of recognizable deferred tax
benefits. SFAS 141R is effective for business combinations closed in fiscal
years beginning after December 15, 2008. As SFAS 141R is applicable to business
acquisitions completed after January 1, 2009 and the Company did not make any
business acquisitions during the quarter ended March 31, 2009 the adoption of
SFAS 141R did not have a material impact on the Company's consolidated financial
statements.
In March 2008, the FASB issued SFAS No. 161 ("SFAS 161"), Disclosures about
Derivative Instruments and Hedging Activities, and an amendment of FASB
Statement No. 133. SFAS 161 attempts to improve the transparency of financial
reporting by mandating the provision of additional information about how
derivative and hedging activities affect an entity's financial position,
financial performance and cash flows. This statement changes the disclosure
requirements for derivative instruments and hedging activities by requiring
enhanced disclosure about (1) how and why an entity uses derivative instruments,
(2) how derivative instruments and related hedged items are accounted for under
SFAS 133 and its related interpretations, and (3) how derivative instruments and
related hedged items affect an entity's financial position, financial
performance, and cash flows. To meet these mandates, SFAS 161 requires
qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about fair value amounts, gains and losses on
derivative instruments, and disclosures about credit-risk-related contingent
features in derivative agreements. This disclosure framework is intended to
better convey the purpose of derivative use in terms of the risks that an entity
is intending to manage. SFAS 161 was effective for the Company as of January 1,
2009 and was adopted prospectively. The Company discontinued hedge accounting as
of September 30, 2008, and therefore the effect of the adoption of SFAS 161 will
be a minimal increase in footnote disclosures. A table of the effect of the
de-designated swap transactions will be included to indicate the effect on OCI
and Other Income (Expense) in footnote 8.
On October 10, 2008, FASB issued FASB Staff Position (FSP) 157-3,
Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active ("FSP 157-3"), in response to the deterioration of the credit
markets. This FSP provides guidance clarifying how SFAS 157 should be applied
when valuing securities in markets that are not active. The guidance provides an
illustrative example that applies the objectives and framework of SFAS 157,
9
utilizing management's internal cash flow and discount rate assumptions when
relevant observable data does not exist. It further clarifies how observable
market information and market quotes should be considered when measuring fair
value in an inactive market. It reaffirms the notion of fair value as an exit
price as of the measurement date and that fair value analysis is a transactional
process and should not be broadly applied to a group of assets. FSP 157-3 was
effective upon issuance including prior periods for which financial statements
have not been issued. FSP 157-3 did not have a material effect on the fair value
of its assets as the Company intends to continue to hold assets that can be
valued via level 1 and level 2 criteria, as defined under SFAS 157.
On October 3, 2008 the Emergency Economic Stabilization Act of 2008 (the
EESA) was signed into law. Section 133 of the EESA mandated that the Securities
and Exchange Commission (SEC) conduct a study on mark-to-market accounting
standards. The SEC provided its study to the US Congress on December 30, 2008.
Part of the recommendations within the study indicated that "fair value
requirements should be improved through development of application and best
practices guidance for determining fair value in illiquid or inactive markets."
As a result of this study and the recommendations therein, the FASB issued Staff
Position (FSP) FAS 157-4, Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly. This FSP provides additional guidance on
determining fair value when the volume and level of activity for the asset or
liability have significantly decreased when compared with normal market activity
for the asset or liability (or similar assets or liabilities). The FSP gives
specific factors to evaluate if there has been a decrease in normal market
activity and if so, provides a methodology to analyze transactions or quoted
prices and make necessary adjustments to fair value in accordance with Statement
157. The objective is to determine the point within a range of fair value
estimates that is most representative of fair value under current market
conditions. FSP FAS157-4 is effective for interim and annual reporting periods
ending after June 15, 2009 with early adoption permitted for periods ending
after March 15, 2009 and the Company decided to early adopt FSP FAS 157-4. The
implementation of FSP FAS157-4 has no major impact on the manner in which the
Company estimates fair value, nor does it have any impact on current disclosure.
Additionally, in conjunction with FSP 157-4, the FASB issued FAS 115-2 and
FAS 124-2, Recognition and Presentation of Other Than Temporary Impairments. The
objective of the new guidance is to make impairment guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments (OTTI) on debt and equity securities in financial statements. This
guidance was also the result of the SEC mark-to-market study mandated under the
EESA. The SEC's recommendation was to "evaluate the need for modifications (or
the elimination) of current OTTI guidance to provide for a more uniform system
of impairment testing standards for financial instruments". The guidance revises
the OTTI evaluation methodology. Previously the analytical focus was on whether
the company had the "intent and ability to retain its investment in the debt
security for a period of time sufficient to allow for any anticipated recovery
in fair value". Now the focus is on whether the Company has the (1) the intent
to sell the Investment Securities, (2) it is more likely than not that it will
be required to sell the Investment Securities before recovery, or (3) it does
not expect to recover the entire amortized cost basis of the Investment
Securities. Further, the security is analyzed for credit loss, (the difference
between the present value of cash flows expected to be collected and the
amortized cost basis). The credit loss, if any, will then be recognized in the
statement of earnings, while the balance of impairment related to other factors
will be recognized in OCI. FAS 115-2 and FAS 124-2 are effective for all interim
and annual periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009 and the Company decided to early adopt FSP
FAS 115-2 and FSP FAS 124-2. For the quarter ended March 31, 2009, the Company
did not have unrealized losses in Investment Securities that were deemed
other-than-temporary.
On April 9, 2009, the FASB also issued FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments. The rule/guideline
requires disclosures about fair value of financial instruments for interim
reporting periods as well as in annual financial statements. The effective date
of this rule/guideline is for interim reporting periods ending after June 15,
2009 with early adoption permitted for periods ending after March 15, 2009. The
Company's early adoption did not impact financial reporting as all financial
instruments are currently reported at fair value in both interim and annual
periods.
10
2. MORTGAGE-BACKED SECURITIES
The following tables present the Company's available-for-sale
Mortgage-Backed Securities portfolio as of March 31, 2009 and December 31, 2008
which were carried at their fair value:
Total
Federal Home Loan Federal National Government National Mortgage-Backed
March 31, 2009 Mortgage Corporation Mortgage Association Mortgage Association Securities
----------------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $19,993,488 $34,891,680 $1,833,236 $56,718,404
Unamortized discount (25,874) (33,931) (236) (60,041)
Unamortized premium 226,636 451,497 50,203 728,336
----------------------------------------------------------------------------------------
Amortized cost $20,194,250 $35,309,246 $1,883,203 $57,386,699
Gross unrealized gains 544,835 921,016 33,823 1,499,674
Gross unrealized losses (36,893) (63,515) (509) (100,917)
----------------------------------------------------------------------------------------
Estimated fair value $20,702,192 $36,166,747 $1,916,517 $58,785,456
========================================================================================
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value
----------------------------------------------------------------------------------------
(dollars in thousands)
Adjustable rate $19,734,089 $336,690 ($100,523) $19,970,256
Fixed rate 37,652,610 1,162,984 (394) 38,815,200
----------------------------------------------------------------------------------------
Total $57,386,699 $1,499,674 ($100,917) $58,785,456
========================================================================================
Total
Federal Home Loan Federal National Government National Mortgage-Backed
December 31, 2008 Mortgage Corporation Mortgage Association Mortgage Association Securities
----------------------------------------------------------------------------------------
(dollars in thousands)
Mortgage-Backed
Securities, gross $19,898,430 $32,749,123 $1,259,118 $53,906,671
Unamortized discount (26,733) (36,647) (787) (64,167)
Unamortized premium 212,354 381,433 25,694 619,481
----------------------------------------------------------------------------------------
Amortized cost 20,084,051 33,093,909 1,284,025 54,461,985
Gross unrealized gains 297,366 468,824 14,606 780,796
Gross unrealized losses (71,195) (123,443) (1,148) (195,786)
----------------------------------------------------------------------------------------
Estimated fair value $20,310,222 $33,439,290 $1,297,483 $55,046,995
========================================================================================
Amortized Cost Gross Unrealized Gain Gross Unrealized Loss Estimated Fair Value
----------------------------------------------------------------------------------------
(dollars in thousands)
Adjustable rate $19,509,017 $287,249 ($178,599) $19,617,667
Fixed rate 34,952,968 493,547 (17,187) 35,429,328
----------------------------------------------------------------------------------------
Total $54,461,985 $780,796 ($195,786) $55,046,995
========================================================================================
11
Actual maturities of Mortgage-Backed Securities are generally shorter than
stated contractual maturities because actual maturities of Mortgage-Backed
Securities are affected by the contractual lives of the underlying mortgages,
periodic payments of principal, and prepayments of principal. The following
table summarizes the Company's Mortgage-Backed Securities on March 31, 2009 and
December 31, 2008, according to their estimated weighted-average life
classifications:
March 31, 2009 December 31, 2008
Weighted-Average Life Fair Value Amortized Cost Fair Value Amortized Cost
(dollars in thousands)
----------------------------------------------------------------------------------------------------------------------
Less than one year $ 3,949,455 $ 3,915,546 $ 4,147,646 $ 4,181,282
Greater than one year and less than five years 41,960,853 40,859,762 37,494,312 37,102,706
Greater than or equal to five years 12,875,148 12,611,391 13,405,037 13,177,997
-------------------------------------------------------------------
Total $58,785,456 $57,386,699 $55,046,995 $54,461,985
===================================================================
The weighted-average lives of the Mortgage-Backed Securities at March 31,
2009 and December 31, 2008 in the table above are based upon data provided
through subscription-based financial information services, assuming constant
principal prepayment rates to the reset date of each security. The prepayment
model considers current yield, forward yield, steepness of the yield curve,
current mortgage rates, mortgage rate of the outstanding loans, loan age, margin
and volatility. The actual weighted average lives of the Mortgage-Backed
Securities could be longer or shorter than estimated.
The following table presents the gross unrealized losses, and estimated
fair value of the Company's Mortgage-Backed Securities by length of time that
such securities have been in a continuous unrealized loss position at March 31,
2009 and December 31, 2008.
Unrealized Loss Position For:
(dollars in thousands)
-------------------------------------------------------------------------------------------
Less than 12 Months 12 Months or More Total
-------------------------------------------------------------------------------------------
Estimated Unrealized Estimated Unrealized Estimated Fair Unrealized
Fair Value Losses Fair Value Losses Value Losses
-------------------------------------------------------------------------------------------
March 31, 2009 $925,368 ($8,691) $4,559,464 ($92,226) $5,484,832 ($100,917)
December 31, 2008 $4,631,897 ($65,790) $4,267,448 ($129,996) $8,899,345 ($195,786)
The decline in value of these securities is solely due to market conditions
and not the quality of the assets. All of the Mortgage-Backed Securities are
"AAA" rated or carry an implied "AAA" rating. The investments are not considered
other-than-temporarily impaired because the Company currently does not have the
intent to sell the Investment Securities and more likely than not, the Company
will not be required to sell the Investment Securities before recovery of their
amortized cost basis, which may be maturity. The Company does not consider these
investments to be other-than-temporarily impaired at March 31, 2009. Also, the
Company is guaranteed payment of the principal amount of the securities by the
government agency which created them.
The adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every nine
months) and lifetime caps. The weighted average lifetime cap was 10.1% at March
31, 2009 and 10.0% at December 31, 2008.
During the quarter ended March 31, 2009, the Company sold $835.7 million of
Mortgage-Backed Securities, resulting in a realized gain of $5.0 million. During
the quarter ended March 31, 2008, the Company sold $4.1 billion of
Mortgage-Backed Securities, resulting in a realized gain of $9.4 million.
12
3. AVAILABLE FOR SALE EQUITY SECURITIES
All of the available-for-sale equity securities are shares of Chimera and
are reported at fair value. The Company owns approximately 15.3 million shares
of Chimera at a fair value of $51.4 million at March 31, 2009 and $52.8 million
at December 31, 2008. . At March 31, 2009 and December 31, 2008, the investment
in Chimera had an unrealized gain of $2.6 million and $4.0 million,
respectively.
4. REVERSE REPURCHASE AGREEMENT
At March 31, 2009 and December 31, 2008, the Company had lent $452.5
million and $562.1 million, respectively, to Chimera in an overnight reverse
repurchase agreement. This amount is included at the principal amount which
approximates fair value in the Company's Statement of Financial Condition. The
interest rate at March 31, 2009 and December 31, 2008 was at the market rate of
2.01% and 1.43%, respectively. The collateral for this loan is mortgage-backed
securities with a fair value of $532.1 million and $680.8 million at March 31,
2009 and December 31, 2008, respectively.
5. RECEIVABLE FROM PRIME BROKER
These net assets of the investment fund owned by the Company are subject to
English bankruptcy law, which governs the administration of Lehman Brothers
International (Europe) ("LBIE"), as well as the law of New York, which governs
the contractual documents. Until the Company's contractual documents with LBIE
are terminated, the value of the assets and liabilities in its account with LBIE
will continue to fluctuate based on market movements. The Company does not
intend to terminate these contractual documents until LBIE's administrators have
clarified the consequences of doing so. The Company has not received notice from
LBIE's administrators that LBIE has terminated the documents. LBIE's
administrators have advised the Company that they can provide no additional
information about the account at this time. As a result, the Company has
recorded a receivable from LBIE based on the fair value of its account with LBIE
as of September 15, 2008 of $16.9 million, which is the date of the last
statement it received from LBIE on the account's assets and liabilities. The
Company can provide no assurance, however, that it will recover all or any
portion of these assets following completion of LBIE's administration (and any
subsequent liquidation). Based on the information known at March 31, 2009, a
loss was not determined to be probable. If additional information indicates
otherwise and it is determined that the loss is probable, the estimated loss
will be reflected in the statement of operations.
6. FAIR VALUE MEASUREMENTS
SFAS 157 defines fair value, establishes a framework for measuring fair
value, establishes a three-level valuation hierarchy for disclosure of fair
value measurement and enhances disclosure requirements for fair value
measurements. The valuation hierarchy is based upon the transparency of inputs
to the valuation of an asset or liability as of the measurement date. The three
levels are defined as follow:
Level 1- inputs to the valuation methodology are quoted prices (unadjusted)
for identical assets and liabilities in active markets.
Level 2 - inputs to the valuation methodology include quoted prices for
similar assets and liabilities in active markets, and inputs that are
observable for the asset or liability, either directly or indirectly, for
substantially the full term of the financial instrument.
Level 3 - inputs to the valuation methodology are unobservable and
significant to overall fair value.
Available for sale equity securities are valued based on quoted prices
(unadjusted) in an active market. Mortgage-Backed Securities and interest rate
swaps are valued using quoted prices for similar assets and dealer quotes. The
dealer will incorporate common market pricing methods, including a spread
measurement to the Treasury curve or interest rate swap curve as well as
underlying characteristics of the particular security including coupon, periodic
and life caps, rate reset period and expected life of the security. Management
reviews all prices used to ensure that current market conditions are
represented. This review includes comparisons of similar market transactions and
comparisons to a pricing model. The Company's financial assets and liabilities
carried at fair value on a recurring basis are valued as follows:
13
Level 1 Level 2 Level 3
(dollars in thousands)
-----------------------------------------------------------------------------------------------------------------
Assets:
Mortgage-Backed Securities - $58,785,456 -
Available for sale equity securities $51,418 - -
Liabilities:
Interest rate swaps - $1,012,574 -
The classification of assets and liabilities by level remains unchanged at
March 31, 2009, when compared to the previous quarter.
7. REPURCHASE AGREEMENTS
The Company had outstanding $49.0 billion and $46.7 billion of repurchase
agreements with weighted average borrowing rates of 2.78% and 4.08%, after
giving effect to the Company's interest rate swaps, and weighted average
remaining maturities of 219 days and 238 days as of March 31, 2009 and December
31, 2008, respectively. Investment Securities pledged as collateral under these
repurchase agreements and interest rate swaps had an estimated fair value of
$55.1 billion at March 31, 2009 and $51.8 billion at December 31, 2008.
At March 31, 2009 and December 31, 2008, the repurchase agreements had the
following remaining maturities:
March 31, 2009 December 31, 2008
(dollars in thousands)
----------------------------------------------
Within 30 days $36,955,906 $32,025,186
30 to 59 days 2,815,272 5,205,352
60 to 89 days - 209,673
90 to 119 days - 254,674
Over 120 days 9,180,000 8,980,000
----------------------------------------------
Total $48,951,178 $46,674,885
==============================================
The Company did not have an amount at risk greater than 10% of the equity
of the Company with any counterparty as of March 31, 2009 or December 31, 2008.
The Company has entered into long- term repurchase agreements which provide
the counterparty with the right to call the balance prior to maturity date.
These repurchase agreements totaled $8.8 billion and the fair value of the
option to call was ($489.1 million) at March 31, 2009. These repurchase
agreements totaled $8.1 billion and the fair value of the option to call was
($574.3 million) at December 31, 2008. Management has determined that the call
option is not required to be bifurcated under the provisions of SFAS 133 as it
is deemed clearly and closely related to the debt instrument, therefore the fair
value of the option is not recorded in the consolidated financial statements.
8. INTEREST RATE SWAPS
In connection with the Company's interest rate risk management strategy,
the Company hedges a portion of its interest rate risk by entering into
derivative financial instrument contracts. As of March 31, 2009, such
instruments are comprised of interest rate swaps, which in effect modify the
cash flows on repurchase agreements. The use of interest rate swaps creates
exposure to credit risk relating to potential losses that could be recognized if
the counterparties to these instruments fail to perform their obligations under
the contracts. In the event of a default by the counterparty, the Company could
have difficulty obtaining its Mortgage-Backed Securities pledged as collateral
for swaps. The Company does not anticipate any defaults by its counterparties.
14
The Company's swaps are used to lock in the fixed rate related to a portion
of its current and anticipated future 30-day term repurchase agreements.
The location and fair value of derivative instruments reported in the
Consolidated Statement of Financial Position as of March 31, 2009 are as
follows:
Location on Net Estimated Fair
Statement of Notional Amount Weighted Weighted Value/Carrying Value
Financial (dollars in Average Pay Average (dollars in
Condition thousands) Rate Receive Rate thousands)
---------------------------------------------------------------------------------------------
March 31, 2009 Liabilities $17,339,850 4.55% 0.55% ($1,012,574)
The effect of derivatives on the Statement of Operations and Comprehensive
Income is as follows:
Location on Statement of Operations and Comprehensive Income
---------------------------------------------------------------------
Unrealized Gain on Interest
Interest Expense Rate Swaps
(dollars in thousands)
---------------------------------------------------------------------
For the Quarter Ended March 31, 2009 $200,738 $35,545
9. PREFERRED STOCK AND COMMON STOCK
(A) Common Stock Issuances
During the quarter ended March 31, 2009, 55,887 options were exercised, for
an aggregate exercise price of $623,000 and 7,550 shares of restricted stock
were issued under the Long-Term Stock Incentive Plan, or Incentive Plan. During
the quarter ended March 31, 2009, 1,355,961 shares of Series B Preferred Stock
were converted into 2,801,000 shares of common stock.
On May 13, 2008 the Company entered into an underwriting agreement pursuant
to which it sold 69,000,000 shares of its common stock for net proceeds
following underwriting expenses of approximately $1.1 billion. This transaction
settled on May 19, 2008.
On January 23, 2008 the Company entered into an underwriting agreement
pursuant to which it sold 58,650,000 shares of its common stock for net proceeds
following underwriting expenses of approximately $1.1 billion. This transaction
settled on January 29, 2008.
During the year ended December 31, 2008, the Company raised $93.7 million
by issuing 5.8 million shares, through the Direct Purchase and Dividend
Reinvestment Program.
During the year ended December 31, 2008, 300,000 options were exercised
under the Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate
exercise price of $2.8 million.
On August 3, 2006, the Company entered into an ATM Equity Offering(sm)
Sales Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner &
Smith Incorporated, relating to the sale of shares of the Company's common stock
from time to time through Merrill Lynch. Sales of the shares, if any, are made
by means of ordinary brokers' transaction on the New York Stock Exchange. During
the year ended December 31, 2008, 588,000 shares of the Company's common stock
were issued pursuant to this program, totaling $11.5 million in net proceeds.
On August 3, 2006, the Company entered into an ATM Equity Sales Agreement
with UBS Securities LLC, relating to the sale of shares of the Company's common
stock from time to time through UBS Securities. Sales of the shares, if any,
will be made by means of ordinary brokers' transaction on the New York Stock
Exchange. During the year ended December 31, 2008, 3.8 million shares of the
Company's common stock were issued pursuant to this program, totaling $60.3
million in net proceeds.
15
(B) Preferred Stock
At March 31, 2009 and December 31, 2008, the Company had issued and
outstanding 7,412,500 shares of Series A Cumulative Redeemable Preferred Stock
("Series A Preferred Stock"), with a par value $0.01 per share and a liquidation
preference of $25.00 per share plus accrued and unpaid dividends (whether or not
declared). The Series A Preferred Stock must be paid a dividend at a rate of
7.875% per year on the $25.00 liquidation preference before the common stock is
entitled to receive any dividends. The Series A Preferred Stock is redeemable at
$25.00 per share plus accrued and unpaid dividends (whether or not declared)
exclusively at the Company's option commencing on April 5, 2009 (subject to the
Company's right under limited circumstances to redeem the Series A Preferred
Stock earlier in order to preserve its qualification as a REIT). The Series A
Preferred Stock is senior to the Company's common stock and is on parity with
the Series B Preferred Stock with respect to dividends and distributions,
including distributions upon liquidation, dissolution or winding up. The Series
A Preferred Stock generally does not have any voting rights, except if the
Company fails to pay dividends on the Series A Preferred Stock for six or more
quarterly periods (whether or not consecutive). Under such circumstances, the
Series A Preferred Stock, together with the Series B Preferred Stock, will be
entitled to vote to elect two additional directors to the Board, until all
unpaid dividends have been paid or declared and set apart for payment. In
addition, certain material and adverse changes to the terms of the Series A
Preferred Stock cannot be made without the affirmative vote of holders of at
least two-thirds of the outstanding shares of Series A Preferred Stock and
Series B Preferred Stock. Through March 31, 2009, the Company had declared and
paid all required quarterly dividends on the Series A Preferred Stock.
At March 31, 2009 and December 31, 2008, the Company had issued and
outstanding 2,607,564 and 3,963,525 shares, respectively, of Series B Cumulative
Convertible Preferred Stock ("Series B Preferred Stock"), with a par value $0.01
per share and a liquidation preference of $25.00 per share plus accrued and
unpaid dividends (whether or not declared). The Series B Preferred Stock must be
paid a dividend at a rate of 6% per year on the $25.00 liquidation preference
before the common stock is entitled to receive any dividends. The Series B
Preferred Stock is not redeemable. The Series B Preferred Stock is convertible
into shares of common stock at a conversion rate that adjusts from time to time
upon the occurrence of certain events, including if the Company distributes to
its common shareholders in any calendar quarter cash dividends in excess of
$0.11 per share. Initially, the conversion rate was 1.7730 shares of common
shares per $25 liquidation preference. At March 31, 2009 and December 31, 2008,
the conversion ratio was 2.1228 and 2.0650 shares of common stock, respectively,
per $25 liquidation preference. Commencing April 5, 2011, the Company has the
right in certain circumstances to convert each Series B Preferred Stock into a
number of common shares based upon the then prevailing conversion rate. The
Series B Preferred Stock is also convertible into common shares at the option of
the Series B preferred shareholder at anytime at the then prevailing conversion
rate. The Series B Preferred Stock is senior to the Company's common stock and
is on parity with the Series A Preferred Stock with respect to dividends and
distributions, including distributions upon liquidation, dissolution or winding
up. The Series B Preferred Stock generally does not have any voting rights,
except if the Company fails to pay dividends on the Series B Preferred Stock for
six or more quarterly periods (whether or not consecutive). Under such
circumstances, the Series B Preferred Stock, together with the Series A
Preferred Stock, will be entitled to vote to elect two additional directors to
the Board, until all unpaid dividends have been paid or declared and set apart
for payment. In addition, certain material and adverse changes to the terms of
the Series B Preferred Stock cannot be made without the affirmative vote of
holders of at least two-thirds of the outstanding shares of Series B Preferred
Stock and Series A Preferred Stock. Through March 31, 2009, the Company had
declared and paid all required quarterly dividends on the Series B Preferred
Stock. During the quarter ended March 31, 2009, 1,355,961 shares of Series B
Preferred Stock were converted into 2,801,000 shares of common stock.
(C) Distributions to Shareholders
During the quarter ended March 31, 2009, the Company declared dividends to
common shareholders totaling $272.2 million or $0.50 per share, which were paid
to shareholders on April 29, 2009. During the quarter ended March 31, 2009, the
Company declared dividends to Series A Preferred shareholders totaling
approximately $3.6 million or $0.492188 per share, and Series B shareholders
totaling approximately $978,000 or $0.375 per share, which were paid to
shareholders on March 31, 2009.
10. NET INCOME PER COMMON SHARE
16
The following table presents a reconciliation of the net income and shares
used in calculating basic and diluted earnings per share for the quarters ended
March 31, 2009 and 2008.
For the Quarters Ended
-------------------------------------------
March 31, 2009 March 31,2008
-------------------------------------------
Net income attributable to controlling interest $349,893 $243,036
Less: Preferred stock dividends 4,626 5,373
------------------------------------------
Net income available to common shareholders, prior to adjustment for $345,267 $237,663
Series B dividends, if necessary
Add: Preferred Series B dividends, if Series B shares are dilutive 978 1,725
------------------------------------------
Net income available to common shareholders, as adjusted $346,245 $239,388
==========================================
Weighted average shares of common stock outstanding-basic 542,903 443,812
Add: Effect of dilutive stock options and 113 409
Series B Cumulative Convertible Preferred 5,535 8,746
Stock
------------------------------------------
Weighted average shares of common stock outstanding-diluted 548,551 452,967
===========================================
Options to purchase 4.5 million and 5,000 shares of common stock were
outstanding and considered anti-dilutive as their exercise price and option
expense exceeded the average stock price for the quarters ended March 31, 2009
and 2008, respectively.
11. LONG-TERM STOCK INCENTIVE PLAN
The Company has adopted a long term stock incentive plan for executive
officers, key employees and non-employee directors (the "Incentive Plan"). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including non-qualified options as well as incentive stock
options as defined under Section 422 of the Code. The Incentive Plan authorizes
the granting of options or other awards for an aggregate of the greater of
500,000 shares or 9.5% of the diluted outstanding shares of the Company's common
stock, up to ceiling of 8,932,921 shares. Stock options are issued at the
current market price on the date of grant, subject to an immediate or four year
vesting in four equal installments with a contractual term of 5 or 10 years. The
grant date fair value is calculated using the Black-Scholes option valuation
model.
For the Quarters Ended
--------------------------------------------------------------
March 31, 2009 March 31, 2008
--------------------------------------------------------------
Weighted
Average Weighted
Number of Exercise Number of Average
Shares Price Shares Exercise Price
--------------------------------------------------------------
Options outstanding at the beginning of quarter 5,180,164 $15.87 3,437,267 $15.23
Granted - - - -
Exercised (55,887) 11.17 (170,617) 9.58
Forfeited - - - -
Expired - - - -
--------------------------------------------------------------
Options outstanding at the end of the quarter 5,124,277 $15.92 3,266,650 $15.53
==============================================================
Options exercisable at the end of the quarter 2,241,702 $16.12 1,738,900 $15.78
==============================================================
The weighted average remaining contractual term was approximately 7.3 years
for stock options outstanding and approximately 5.5 years for stock options
exercisable as of March 31, 2009. As of March 31, 2009, there was approximately
$8.5 million of total unrecognized compensation cost related to nonvested
share-based compensation awards. That cost is expected to be recognized over a
weighted average period of 3.1 years.
17
The weighted average remaining contractual term was approximately 6.9 years
for stock options outstanding and approximately 5.8 years for stock options
exercisable as of March 31, 2008. As of March 31, 2008, there was approximately
$2.3 million of total unrecognized compensation cost related to nonvested
share-based compensation awards. That cost is expected to be recognized over a
weighted average period of 2.5 years.
During the quarter ended March 31, 2009, the Company granted 7,550 shares
of restricted common stock to certain of its employees. As of March 31, 2009,
5,663 of these restricted shares were unvested and subject to forfeiture. During
the year ended December 31. 2007, the Company granted 7,000 shares of restricted
common stock to certain of its employees. As of March 31, 2009, 3,360 of these
restricted shares were unvested and subject to forfeiture.
12. INCOME TAXES
As a REIT, the Company is not subject to federal income tax on earnings
distributed to its shareholders. Most states recognize REIT status as well. The
Company has decided to distribute the majority of its income and retain a
portion of the permanent difference between book and taxable income arising from
Section 162(m) of the Code pertaining to employee remuneration.
During the quarter ended March 31, 2009, the Company's taxable REIT
subsidiaries recorded $533,000 of income tax expense for income attributable to
those subsidiaries, and the portion of earnings retained based on Code Section
162(m) limitations. During the quarter ended March 31, 2009, the Company
recorded $5.9 million of income tax expense for a portion of earnings retained
based on Section 162(m) limitations. The effective tax rate was 54% for the
quarter ended March 31, 2009
During the quarter ended March 31, 2008, FIDAC, a taxable REIT subsidiary,
recorded $734,000 of income tax expense for income and for the portion of
earnings retained based on Code Section 162(m) limitations. During the quarter
ended March 31, 2008, the Company recorded $3.9 million of income tax expense
for a portion of earnings retained based on Section 162(m) limitations. The
effective tax rate was 51% for the quarter ended March 31, 2008.
The Company's effective tax rate was 54%, and 51% for the quarters ended
March 31, 2009 and 2008, respectively. These rates differed from the federal
statutory rate as a result of state and local taxes and permanent difference
pertaining to employee remuneration as discussed above.
The statutory combined federal, state, and city corporate tax rate is 45%.
This amount is applied to the amount of estimated REIT taxable income retained
(if any, and only up to 10% of ordinary income as all capital gain income is
distributed) and to taxable income earned at the taxable subsidiaries. Thus, as
a REIT, the Company's effective tax rate is significantly less as it is allowed
to deduct dividend distributions.
13. LEASE COMMITMENTS AND CONTINGENCIES
The Company has a non-cancelable lease for office space, which commenced in
May 2002 and expires in December 2009. The Company's aggregate future minimum
lease payments total $399,000. Merganser has a non-cancelable lease for office
space, which commenced on May 2003 and expires in May 2014. The following table
details the lease payments, net of sub-lease receipts
Year Ending December Lease Commitment Sublease Income Net Amount
----------------------------------------------------------------
(dollars in thousands)
----------------------------------------------------------------
2009 (remaining) $450 $101 $349
2010 608 56 552
2011 632 - 632
2012 642 - 642
2013 682 - 682
Thereafter 189 - 189
----------------------------------------------------------------
$3,203 $157 $3,046
================================================================
From time to time, the Company is involved in various claims and legal
actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a material
effect on the Company's consolidated financial statements and therefore no
accrual is required as of March 31, 2009 and December 31, 2008.
18
Merganser's prior owners may receive additional consideration as an
earn-out during 2012 if Merganser meets specific performance goals under the
merger agreement. The Company cannot currently calculate how much consideration
will be paid under the earn-out provisions because the payment amount will vary
depending upon whether and the extent to which Merganser achieves specific
performance goals. Any amounts paid under this provision will be recorded as
additional goodwill.
14. INTEREST RATE RISK
The primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company's control. Changes in the general level of
interest rates can affect net interest income, which is the difference between
the interest income earned on interest-earning assets and the interest expense
incurred in connection with the interest-bearing liabilities, by affecting the
spread between the interest-earning assets and interest-bearing liabilities.
Changes in the level of interest rates also can affect the value of the
Investment Securities and the Company's ability to realize gains from the sale
of these assets. A decline in the value of the Investment Securities pledged as
collateral for borrowings under repurchase agreements could result in the
counterparties demanding additional collateral pledges or liquidation of some of
the existing collateral to reduce borrowing levels. Liquidation of collateral at
losses could have an adverse accounting impact, as discussed in Note 1.
The Company seeks to manage the extent to which net income changes as a
function of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. The Company may seek to mitigate the potential impact
on net income of periodic and lifetime coupon adjustment restrictions in the
portfolio of Investment Securities by entering into interest rate agreements
such as interest rate caps and interest rate swaps. As of March 31, 2009, the
Company entered into interest rate swaps to pay a fixed rate and receive a
floating rate of interest, with a total notional amount of $17.3 billion.
Changes in interest rates may also have an effect on the rate of mortgage
principal prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes in the
mortgage principal repayment rate by balancing assets purchased at a premium
with assets purchased at a discount. To date, the aggregate premium exceeds the
aggregate discount on the Mortgage-Backed Securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce net income
compared to what net income would be absent such prepayments.
15. RELATED PARTY TRANSACTIONS
At March 31, 2009 and December 31, 2008, the Company had lent $452.5
million and $562.1 million, respectively, to Chimera in an overnight reverse
repurchase agreement. This amount is included at the principal amount which
approximates fair value in the Company's Statement of Financial Condition. The
interest rate at March 31, 2009 and December 31, 2008 was at the market rate of
2.01% and 1.43%, respectively. The collateral for this loan is mortgage-backed
securities with a fair value of $532.1 million and $680.8 million at March 31,
2009 and December 31, 2008, respectively.
At March 31, 2009 the Company had $885.7 million of repurchase agreements
outstanding with RCap. The weighted average interest rate is 0.80% and the terms
are one day to one month. These agreements are collateralized by agency mortgage
backed securities, with an estimated market value of $965.2 million.
17. SUBSEQUENT EVENTS
On April 21, 2009, the Company purchased approximately 25.0 million shares
of Chimera common stock for approximately $74.9 million in connection with
Chimera's secondary offering. Chimera is managed by FIDAC, and the Company owns
approximately 8.5% of Chimera's common stock.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-------------------------------------------------------------------------------
OF OPERATIONS
-------------
Special Note Regarding Forward-Looking Statements
Certain statements contained in this quarterly report, and certain
statements contained in our future filings with the Securities and Exchange
Commission (the "SEC" or the "Commission"), in our press releases or in our
other public or shareholder communications may not be based on historical facts
and are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. Forward-looking statements, which are based on various
assumptions, (some of which are beyond our control) may be identified by
reference to a future period or periods, or by the use of forward-looking
terminology, such as "may," "will," "believe," "expect," "anticipate,"
"continue," or similar terms or variations on those terms, or the negative of
those terms. Actual results could differ materially from those set forth in
forward-looking statements due to a variety of factors, including, but not
limited to, changes in interest rates, changes in the yield curve, changes in
prepayment rates, the availability of mortgage-backed securities and other
securities for purchase, the availability of financing, and, if available, the
terms of any financings, changes in the market value of our assets, changes in
business conditions and the general economy, changes in governmental regulations
affecting our business, and our ability to maintain our classification as a REIT
for federal income tax purposes, and risks associated with the investment
advisory business of our subsidiaries, including the removal by their clients of
assets they manage, their regulatory requirements, and competition in the
investment advisory business, and risks associated with the broker dealer
business of our subsidiary. For a discussion of the risks and uncertainties
which could cause actual results to differ from those contained in the
forward-looking statements, see our most recent Annual Report on Form 10-K and
any subsequent Quarterly Reports on Form 10-Q. We do not undertake and
specifically disclaim any obligation, to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
Overview
We are a REIT that owns and manages a portfolio of principally
mortgage-backed securities. Our principal business objective is to generate net
income for distribution to our stockholders from the spread between the interest
income on our investment securities and the costs of borrowing to finance our
acquisition of investment securities and from dividends we receive from our
taxable REIT subsidiaries. FIDAC and Merganser are our wholly-owned taxable REIT
subsidiaries that are registered investment advisors that generate advisory and
service fee income. RCap is our wholly- owned broker dealer taxable REIT
subsidiary which generates fee income.
We are primarily engaged in the business of investing, on a leveraged
basis, in mortgage pass-through certificates, collateralized mortgage
obligations and other mortgage-backed securities representing interests in or
obligations backed by pools of mortgage loans issued or guaranteed by Federal
Home Loan Mortgage Corporation ("Freddie Mac"), Federal National Mortgage
Association ("Fannie Mae") and the Government National Mortgage Association
("Ginnie Mae") (collectively, "Mortgage-Backed Securities"). We also invest in
Federal Home Loan Bank ("FHLB"), Freddie Mac and Fannie Mae debentures. The
Mortgage-Backed Securities and agency debentures are collectively referred to
herein as "Investment Securities."
Under our capital investment policy, at least 75% of our total assets must
be comprised of high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are rated within
one of the two highest rating categories by at least one of the nationally
recognized rating agencies, (2) are unrated but are guaranteed by the United
States government or an agency of the United States government, or (3) are
unrated but we determine them to be of comparable quality to rated high-quality
mortgage-backed securities.
The remainder of our assets, comprising not more than 25% of our total
assets, may consist of other qualified REIT real estate assets which are unrated
or rated less than high quality, but which are at least "investment grade"
(rated "BBB" or better by Standard & Poor's Corporation ("S&P") or the
equivalent by another nationally recognized rating agency) or, if not rated, we
determine them to be of comparable credit quality to an investment which is
rated "BBB" or better. In addition, we may directly or indirectly invest part of
20
this remaining 25% of our assets in other types of securities, including without
limitation, unrated debt, equity or derivative securities, to the extent
consistent with our REIT qualification requirements. The derivative securities
in which we invest may include securities representing the right to receive
interest only or a disproportionately large amount of interest, as well as
inverse floaters, which may have imbedded leverage as part of their structural
characteristics.
We may acquire Mortgage-Backed Securities backed by single-family
residential mortgage loans as well as securities backed by loans on
multi-family, commercial or other real estate-related properties. To date, all
of the Mortgage-Backed Securities that we have acquired have been backed by
single-family residential mortgage loans.
We have elected to be taxed as a REIT for federal income tax purposes.
Pursuant to the current federal tax regulations, one of the requirements of
maintaining our status as a REIT is that we must distribute at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain) to our stockholders, subject to
certain adjustments.
The results of our operations are affected by various factors, many of
which are beyond our control. Our results of operations primarily depend on,
among other things, our net interest income, the market value of our assets and
the supply of and demand for such assets. Our net interest income, which
reflects the amortization of purchase premiums and accretion of discounts,
varies primarily as a result of changes in interest rates, borrowing costs and
prepayment speeds, the behavior of which involves various risks and
uncertainties. Prepayment speeds, as reflected by the Constant Prepayment Rate,
or CPR, and interest rates vary according to the type of investment, conditions
in financial markets, competition and other factors, none of which can be
predicted with any certainty. In general, as prepayment speeds on our
Mortgage-Backed Securities portfolio increase, related purchase premium
amortization increases, thereby reducing the net yield on such assets. The CPR
on our Investment Securities portfolio averaged 16% and 15% for the quarters
ended March 31, 2009 and 2008, respectively. Since changes in interest rates may
significantly affect our activities, our operating results depend, in large
part, upon our ability to effectively manage interest rate risks and prepayment
risks while maintaining our status as a REIT.
The table below provides quarterly information regarding our average
balances, interest income, yield on assets, average repurchase agreement
balances, interest expense, cost of funds, net interest income and net interest
rate spreads for the quarterly periods presented.
Average Yield on Average
Investment Total Average Balance of Average Net Interest
Securities Interest Investment Repurchase Insert Cost of Interest Rate
Held (1) Income Securities Agreements Expense Funds Income Spread
--------------------------------------------------------------------------------------------------------------------
(ratios for the quarters have been annualized, dollars in thousands)
----------------------------------------------------------------------------------------------------------------------
Quarter Ended $54,763,268 $716,015 5.23% $48,497,444 $378,625 3.12% $337,390 2.11%
March 31, 2009
Quarter Ended
December 31, 2008 $53,838,665 $740,282 5.50% $47,581,332 $450,805 3.79% $289,477 1.71%
Quarter Ended
September 30, 2008 $57,694,277 $810,659 5.62% $51,740,645 $458,250 3.54% $352,409 2.08%
Quarter Ended
June 30, 2008 $56,197,550 $773,359 5.50% $50,359,825 $442,251 3.51% $331,108 1.99%
Quarter Ended
March 31, 2008 $56,119,584 $791,128 5.64% $51,399,101 $537,606 4.18% $253,522 1.46%
(1) Does not reflect unrealized gains/(losses).
The following table presents the CPR experienced on our Mortgage-Backed
Securities portfolio, on an annualized basis, for the quarterly periods
presented.
Quarter Ended CPR
------------- ---
March 31, 2009 16%
December 31, 2008 10%
September 30, 2008 11%
June 30, 2008 16%
March 31, 2008 15%
21
We believe that the CPR in future periods will depend, in part, on changes
in and the level of market interest rates across the yield curve, with higher
CPRs expected during periods of declining interest rates and lower CPRs expected
during periods of rising interest rates.
We continue to explore alternative business strategies, alternative
investments and other strategic initiatives to complement our core business
strategy of investing, on a leveraged basis, in high quality Investment
Securities. No assurance, however, can be provided that any such strategic
initiative will or will not be implemented in the future.
For the purposes of computing ratios relating to equity measures,
throughout this report, equity includes Series B preferred stock, which has been
treated under accounting principles generally accepted in the United States, or
GAAP, as temporary equity. For the discussion purposes in the Management
Discussion and Analysis of Financial Condition and Results of Operations, net
income attributable to controlling interest is referred to as net income.
Recent Developments
The liquidity crisis which commenced in August 2007 escalated throughout
2008 and during the first quarter of 2009. During this period of market
dislocation, fiscal and monetary policymakers have established new liquidity
facilities for primary dealers and commercial banks, reduced short-term interest
rates, and passed legislation that is intended to address the challenges of
mortgage borrowers and lenders. This legislation, the Housing and Economic
Recovery Act of 2008, seeks to forestall home foreclosures for distressed
borrowers and assist communities with foreclosure problems. Although these
aggressive steps are intended to protect and support the US housing and mortgage
market, we continue to operate under very difficult market conditions.
Subsequent to June 30, 2008, there were increased market concerns about
Freddie Mac and Fannie Mae's ability to withstand future credit losses
associated with securities held in their investment portfolios, and on which
they provide guarantees, without the direct support of the federal government.
In September 2008 Fannie Mae and Freddie Mac were placed into the
conservatorship of the Federal Housing Finance Agency, or FHFA, their federal
regulator, pursuant to its powers under The Federal Housing Finance Regulatory
Reform Act of 2008, a part of the Housing and Economic Recovery Act of 2008. As
the conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the
operations of Fannie Mae and Freddie Mac and may (1) take over the assets of and
operate Fannie Mae and Freddie Mac with all the powers of the shareholders, the
directors, and the officers of Fannie Mae and Freddie Mac and conduct all
business of Fannie Mae and Freddie Mac; (2) collect all obligations and money
due to Fannie Mae and Freddie Mac; (3) perform all functions of Fannie Mae and
Freddie Mac which are consistent with the conservator's appointment; (4)
preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and
(5) contract for assistance in fulfilling any function, activity, action or duty
of the conservator.
In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac,
(i) the U.S. Department of Treasury and FHFA have entered into preferred stock
purchase agreements between the U.S. Department of Treasury and Fannie Mae and
Freddie Mac pursuant to which the U.S. Department of Treasury will ensure that
each of Fannie Mae and Freddie Mac maintains a positive net worth; (ii) the U.S.
Department of Treasury has established a new secured lending credit facility
which will be available to Fannie Mae, Freddie Mac, and the Federal Home Loan
Banks, which is intended to serve as a liquidity backstop, which will be
available until December 2009; and (iii) the U.S. Department of Treasury has
initiated a temporary program to purchase mortgage-backed securities issued by
Fannie Mae and Freddie Mac. Given the highly fluid and evolving nature of these
events, it is unclear how our business will be impacted. Based upon the further
activity of the U.S. government or market response to developments at Fannie Mae
or Freddie Mac, our business could be adversely impacted.
The Emergency Economic Stabilization Act of 2008, or EESA, was recently
enacted. The EESA provides the U.S. Secretary of the Treasury with the authority
to establish a Troubled Asset Relief Program, or TARP, to purchase from
financial institutions up to $700 billion of equity or preferred securities,
residential or commercial mortgages and any securities, obligations, or other
instruments that are based on or related to such mortgages, that in each case
was originated or issued on or before March 14, 2008, as well as any other
financial instrument that the U.S. Secretary of the Treasury, after consultation
with the Chairman of the Board of Governors of the Federal Reserve System,
determines the purchase of which is necessary to promote financial market
stability, upon transmittal of such determination, in writing, to the
appropriate committees of the U.S. Congress. The EESA also provides for a
program that would allow companies to insure their troubled assets.
22
In addition, the U.S. Government, Federal Reserve and other governmental and
regulatory bodies have taken or are considering taking other actions to address
the financial crisis. The Term Asset-Backed Securities Loan Facility, or TALF,
was first announced by the U.S. Department of Treasury, or the Treasury, on
November 25, 2008, and has been expanded in size and scope since its initial
announcement. Under the TALF, the Federal Reserve Bank of New York makes
non-recourse loans to borrowers to fund their purchase of eligible assets,
currently certain asset-backed securities but not residential mortgage-backed
securities. In addition, on March 23, 2009 the government announced that the
Treasury in conjunction with the Federal Deposit Insurance Corporation, or FDIC,
and the Federal Reserve, would create the Public-Private Investment Program, or
PPIP. The PPIP aims to recreate a market for specific illiquid residential and
commercial loans and securities through a number of joint public and private
investment funds. The PPIP is designed to draw new private capital into the
market for these securities and loans by providing government equity
co-investment and attractive public financing. As these programs are still in
early stages of development, it is not possible for us to predict how these
programs will impact our business.
There can be no assurance that the EESA, TALF, PPIP or other policy
initiatives will have a beneficial impact on the financial markets, including
current extreme levels of volatility. We cannot predict whether or when such
actions may occur or what impact, if any, such actions could have on our
business, results of operations and financial condition.
The liquidity crisis could adversely affect one or more of our lenders and
could cause one or more of our lenders to be unwilling or unable to provide us
with additional financing. This could potentially increase our financing costs
and reduce liquidity. If one or more major market participants fails, it could
negatively impact the marketability of all fixed income securities, including
agency mortgage securities, and this could negatively impact the value of the
securities in our portfolio, thus reducing its net book value. Furthermore, if
many of our lenders are unwilling or unable to provide us with additional
financing, we could be forced to sell our Investment Securities at an
inopportune time when prices are depressed. Even with the current situation in
the sub-prime mortgage sector we do not anticipate having difficulty converting
our assets to cash or extending financing terms, due to the fact that our
investment securities have an actual or implied "AAA" rating and principal
payment is guaranteed.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported in our financial statements. These
financial statements are prepared in conformity with GAAP. In preparing the
financial statements, management is required to make various judgments,
estimates and assumptions that affect the reported amounts. Changes in these
estimates and assumptions could have a material effect on our financial
statements. The following is a summary of our policies most affected by
management's judgments, estimates and assumptions.
Fair Value of Investment Securities: All assets classified as
available-for-sale are reported at fair value, based on market prices. Although
we generally intend to hold most of our Investment Securities until maturity, we
may, from time to time, sell any of our Investment Securities as part our
overall management of our portfolio. Accordingly, we are required to classify
all of our Investment Securities as available-for-sale. Our policy is to obtain
fair values from independent sources. Fair values from independent sources are
compared to internal prices for reasonableness. Management evaluates securities
for other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such evaluation. The
determination of whether a security is other-than-temporarily impaired involves
judgments and assumptions based on subjective and objective factors.
Consideration is given to (1) the intent to sell the Investment Securities, (2)
it is more likely than not that it will be required to sell the Investment
Securities before recovery, or (3) it does not expect to recover the entire
amortized cost basis of the Investment Securities. Further, the security is
analyzed for credit loss, (the difference between the present value of cash
flows expected to be collected and the amortized cost basis). The credit loss,
if any, will then be recognized in the statement of earnings, while the balance
of impairment related to other factors will be recognized in other comprehensive
income ("OCI").
Interest Income: Interest income is accrued based on the outstanding
principal amount of the Investment Securities and their contractual terms.
Premiums and discounts associated with the purchase of the Investment Securities
are amortized or accreted into interest income over the projected lives of the
securities using the interest method. Our policy for estimating prepayment
speeds for calculating the effective yield is to evaluate historical
performance, Wall Street consensus prepayment speeds, and current market
conditions. If our estimate of prepayments is incorrect, we may be required to
make an adjustment to the amortization or accretion of premiums and discounts
that would have an impact on future income.
23
Derivative Financial Instruments/Hedging Activity : Prior to the fourth
quarter of 2008, we designated interest rate swaps as cash flow hedges, whereby
the swaps were recorded at fair value on the balance sheet as assets and
liabilities with any changes in fair value recorded in accumulated other
comprehensive income. In a cash flow hedge, a swap would exactly match the
pricing date of the relevant repurchase agreement. Through the end of the third
quarter of 2008, we continued to be able to match the swaps with the repurchase
agreements therefore entering into effective hedge transactions. However, due to
the volatility of the credit markets, it is no longer practical to match the
pricing dates of both the swaps and the repurchase agreements.
As a result, we voluntarily discontinued hedge accounting in the fourth
quarter of 2008 through a combination of de-designating previously defined hedge
relationships and not designating new contracts as cash flow hedges. The
de-designation of cash flow hedges was done in accordance with Derivatives
Implementation Group (DIG) Issue Nos. G3, G17, G18 & G20, which generally
require that the net derivative gain or loss related to the discontinued cash
flow hedge should continue to be reported in accumulated other comprehensive
income, unless it is probable that the forecasted transaction will not occur by
the end of the originally specified time period or within an additional
two-month period of time thereafter. As such we continue to hold repurchase
agreements in excess of swap contracts and have no indication that interest
payments on the hedged repurchase agreements are in jeopardy of discontinuing.
Therefore, the deferred losses related to these derivatives that have been
de-designated were not recognized immediately and are expected to be
reclassified into earnings during the contractual terms of the swap agreements
starting as of October 1, 2008. Changes in the unrealized gains or losses on the
interest rate swaps subsequent to September 30, 2008 are reflected in our income
statement.
Repurchase Agreements: We finance the acquisition of our Investment
Securities through the use of repurchase agreements. Repurchase agreements are
treated as collateralized financing transactions and are carried at their
contractual amounts, including accrued interest, as specified in the respective
agreements. Repurchase agreements entered into by RCap are matched with specific
reverse repurchase agreements and are recorded on trade date with the duration
of such repurchase agreements mirroring those of the matched reverse repurchase
agreements. These repurchase agreements are recorded at the contract amount and
margin calls are filled by RCap as required based on any deficiencies in
collateral versus the contract price. RCap generates income from the spread
between what is earned on the reverse repurchase agreements and what is paid on
the repurchase agreements. Cash flows related to RCap's matched book activity
are included in cash flows from operating activity.
Income Taxes: We have elected to be taxed as a REIT and intend to comply
with the provisions of the Internal Revenue Code of 1986, as amended (or the
Code), with respect thereto. Accordingly, we will not be subjected to federal
income tax to the extent of our distributions to shareholders and as long as
certain asset, income and stock ownership tests are met. We, FIDAC, Merganser,
and RCap have made a joint election to treat FIDAC, Merganser, and RCap as
taxable REIT subsidiaries. As such, FIDAC, Merganser, and RCap are taxable as
domestic C corporations and subject to federal and state and local income taxes
based upon their taxable income.
Impairment of Goodwill and Intangibles: Our acquisition of FIDAC and
Merganser were accounted for using the purchase method. The cost of FIDAC and
Merganser were allocated to the assets acquired, including identifiable
intangible assets and the liabilities assumed, based on their estimated fair
values at the date of acquisition. The excess of cost over the fair value of the
net assets acquired was recognized as goodwill. Goodwill and finite-lived
intangible assets are periodically reviewed for potential impairment. This
evaluation requires significant judgment.
Recent Accounting Pronouncements:
On January 1, 2009, we adopted SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51, which requires us
to make certain changes to the presentation of our financial statements. This
standard requires us to classify noncontrolling interests (previously referred
to as "minority interest") as part of consolidated net income and to include the
accumulated amount of noncontrolling interests as part of stockholders' equity.
The net income amounts we have previously reported are now presented as "Net
income attributable to controlling interest". Similarly, in our presentation of
stockholders' equity, we distinguish between equity amounts attributable to
controlling interest and amounts attributable to the noncontrolling interests -
previously classified as minority interest outside of stockholders' equity. For
24
the quarter ended March 31, 2009 and year-ended December 31, 2008 we do not have
any non controlling interest. In addition to these financial reporting changes,
SFAS 160 provides for significant changes in accounting related to
noncontrolling interests; specifically, increases and decreases in our
controlling financial interests in consolidated subsidiaries will be reported in
equity similar to treasury stock transactions. If a change in ownership of a
consolidated subsidiary results in loss of control and deconsolidation, any
retained ownership interests are remeasured with the gain or loss reported in
net earnings. Since December 31, 2008, we did not have any non controlling
interest in any of its subsidiaries. However, the retrospective effect of the
presentation and disclosure requirement under SFAS 160 will be applied.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations, ("SFAS 141R") which replaces SFAS No. 141, Business Combinations.
SFAS 141R establishes principles and requirements for recognizing and measuring
identifiable assets and goodwill acquired, liabilities assumed and any
noncontrolling interest in a business combination at their fair value at
acquisition date. SFAS 141R alters the treatment of acquisition-related costs,
business combinations achieved in stages (referred to as a step acquisition),
the treatment of gains from a bargain purchase, the recognition of contingencies
in business combinations, the treatment of in-process research and development
in a business combination as well as the treatment of recognizable deferred tax
benefits. SFAS 141R is effective for business combinations closed in fiscal
years beginning after December 15, 2008. As SFAS 141R is applicable to business
acquisitions completed after January 1, 2009 and we did not make any business
acquisitions during the quarter ended March 31, 2009, the adoption of SFAS 141R
did not have a material impact on our consolidated financial statements.
In February 2008, FASB issued FASB Staff Position No. FAS 140-3 Accounting
for Transfers of Financial Assets and Repurchase Financing Transactions ("FSP
FAS 140-3"). FSP FAS 140-3 addresses whether transactions where assets purchased
from a particular counterparty and financed through a repurchase agreement with
the same counterparty can be considered and accounted for as separate
transactions, or are required to be considered "linked" transactions and may be
considered derivatives under SFAS 133. FSP FAS 140-3 requires purchases and
subsequent financing through repurchase agreements be considered linked
transactions unless all of the following conditions apply: (1) the initial
purchase and the use of repurchase agreements to finance the purchase are not
contractually contingent upon each other; (2) the repurchase financing entered
into between the parties provides full recourse to the transferee and the
repurchase price is fixed; (3) the financial assets are readily obtainable in
the market; and (4) the financial instrument and the repurchase agreement are
not coterminous. This FSP was effective for us on January 1, 2009. The
implementation of this FSP did not have a material effect on our financial
statements.
In March 2008, the FASB issued SFAS No. 161 ("SFAS 161"), Disclosures about
Derivative Instruments and Hedging Activities, and an amendment of FASB
Statement No. 133. SFAS 161 attempts to improve the transparency of financial
reporting by mandating the provision of additional information about how
derivative and hedging activities affect an entity's financial position,
financial performance and cash flows. This statement changes the disclosure
requirements for derivative instruments and hedging activities by requiring
enhanced disclosure about (1) how and why an entity uses derivative instruments,
(2) how derivative instruments and related hedged items are accounted for under
SFAS Statement 133 and its related interpretations, and (3) how derivative
instruments and related hedged items affect an entity's financial position,
financial performance, and cash flows. To meet these mandates, SFAS 161 requires
qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about fair value amounts, gains and losses on
derivative instruments, and disclosures about credit-risk-related contingent
features in derivative agreements. This disclosure framework is intended to
better convey the purpose of derivative use in terms of the risks that an entity
is intending to manage. SFAS 161 was effective for us as of January 1, 2009 and
was adopted prospectively. We discontinued hedge accounting as of September 30,
2008 and therefore the effect of the adoption of SFAS 161 will be a minimal
increase in footnote disclosures. A table of the effect of the de-designated
swap transactions will be included to indicate the effect on OCI and Other
Income (Expense).
On October 10, 2008, FASB issued FASB Staff Position (FSP) 157-3,
Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active ("FSP 157-3"), in response to the deterioration of the credit
markets. This FSP provides guidance clarifying how SFAS 157 should be applied
when valuing securities in markets that are not active. The guidance provides an
illustrative example that applies the objectives and framework of SFAS 157,
utilizing management's internal cash flow and discount rate assumptions when
relevant observable data does not exist. It further clarifies how observable
market information and market quotes should be considered when measuring fair
value in an inactive market. It reaffirms the notion of fair value as an exit
price as of the measurement date and that fair value analysis is a transactional
process and should not be broadly applied to a group of assets. FSP 157-3 was
effective upon issuance including prior periods for which financial statements
have not been issued. FSP 157-3 does not have a material effect on the fair
value of our assets as we intend to continue to hold assets that can be valued
via level 1 and level 2 criteria, as defined under SFAS 157.
25
On October 3, 2008 the Emergency Economic Stabilization Act of 2008 (the
EESA) was signed into law. Section 133 of the EESA mandated that the Securities
and Exchange Commission (the SEC) conduct a study on mark-to-market accounting
standards. The SEC provided its study to the US Congress on December 30, 2008.
Part of the recommendations within the study indicated that "fair value
requirements should be improved through development of application and best
practices guidance for determining fair value in illiquid or inactive markets."
As a result of this study and the recommendations therein, the FASB issued Staff
Position (FSP) FAS157-4, Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly. This FSP provides additional guidance on
determining fair value when the volume and level of activity for the asset or
liability have significantly decreased when compared with normal market activity
for the asset or liability (or similar assets or liabilities). The FSP gives
specific factors to evaluate if there has been a decrease in normal market
activity and if so, provides a methodology to analyze transactions or quoted
prices and make necessary adjustments to fair value in accordance with Statement
157. The objective is to determine the point within a range of fair value
estimates that is most representative of fair value under current market
conditions. FSP FAS157-4 is effective for interim and annual reporting periods
ending after June 15, 2009 with early adoption permitted for periods ending
after March 15, 2009 and we decided to early adopt FSP FAS 157-4. The
implementation of FSP FAS157-4 has no major impact on the manner in which we
estimate fair value, nor does it have any impact on current disclosure.
Additionally, in conjunction with FSP 157-4, the FASB issued FAS 115-2 and
FAS 124-2, Recognition and Presentation of Other Than Temporary Impairments. The
objective of the new guidance is to make impairment guidance more operational
and to improve the presentation and disclosure of other-than-temporary
impairments (OTTI) on debt and equity securities in financial statements. This
EESA guidance was also the result of the SEC mark-to-market study mandated under
the EESA. The SEC's recommendation was to "evaluate the need for modifications
(or the elimination) of current OTTI guidance to provide for a more uniform
system of impairment testing standards for financial instruments". The guidance
revises the OTTI evaluation methodology. Previously the analytical focus was on
whether the company had the "intent and ability to retain its investment in the
debt security for a period of time sufficient to allow for any anticipated
recovery in fair value". Now the focus is on whether we have (1) the intent to
sell the Investment Securities, (2) it is more likely than not that it will be
required to sell the Investment Securities before recovery, or (3) it does not
expect to recover the entire amortized cost basis of the Investment Securities.
Further, the security is analyzed for credit loss, (the difference between the
present value of cash flows expected to be collected and the amortized cost
basis). The credit loss, if any, will then be recognized in the statement of
earnings, while the balance of impairment related to other factors will be
recognized in OCI. FAS 115-2 and FAS 124-2 are effective for all interim and
annual periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009 and we decided to early adopt FSP FAS 115-2
and FSP FAS 124-2. For the quarter ended March 31, 2009 we did not have
unrealized losses on Investment Securities that were deemed
other-than-temporary.
On April 9, 2009, the FASB also issued FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments. The rule/guideline
requires disclosures about fair value of financial instruments for interim
reporting periods as well as in annual financial statements. The effective date
of this rule/guideline is for interim reporting periods ending after June 15,
2009. Our early adoption did not impact financial reporting as all financial
instruments are currently reported at fair value in both the interim and annual
reports.
Results of Operations: For the Quarters Ended March 31, 2008 and 2009
Net Income Summary
For the quarter ended March 31, 2009, our net income was $349.9 million or
$0.64 basic income per average share related to common shareholders, as compared
to $243.0 million net income or $0.54 basic net income per average share for the
quarter ended March 31, 2008. Net income per average share increased by $0.10
per average share available to common shareholders and total net income
increased $106.9 million for the quarter ended March 31, 2009, when compared to
the quarter ended March 31, 2008. We attribute the increase in total net income
for the quarter ended March 31, 2009 from the quarter ended March 31, 2008
primarily to increase in net interest income of $83.9 million and recording of
unrealized gain related to interest rate swaps in the first quarter of 2009. An
unrealized gain of $35.5 million was recorded in the income statement for the
26
quarter ended March 31, 2009 as the result of de-designation of cash flow
hedges. Prior to the fourth quarter of 2008, we recorded changes in the fair
values in our interest rate swaps in the Accumulated Other Comprehensive Income
in our Statement of Financial Condition.
Net Income Summary
(dollars in thousands, except for per share data)
Quarter Ended Quarter Ended
March 31, 2009 March 31, 2008
-----------------------------------
Interest income $716,015 $791,128
Interest expense 378,625 537,606
-----------------------------------
Net interest income 337,390 253,522
-----------------------------------
Other income:
Investment advisory and service fees 7,761 6,598
Gain on sale of investment securities 5,023 9,417
Income from trading securities - 1,854
Dividend income from available-for-sale equity securities 918 941
Unrealized gain on interest rate swaps 35,545 -
-----------------------------------
Total other income 49,247 18,810
-----------------------------------
Expenses:
Distribution fees 428 633
General and administrative expenses 29,882 23,995
-----------------------------------
Total expenses 30,310 24,628
-----------------------------------
Income before income taxes and noncontrolling interest 356,327 247,704
Income taxes 6,434 4,610
-----------------------------------
Net income 349,893 243,094
Noncontrolling interest - 58
-----------------------------------
Net Income attributable to controlling interest 349,893 243,036
Dividends on preferred stock 4,626 5,373
-----------------------------------
Net income available to common shareholders $345,267 $237,663
====================================
Weighted average number of basic common shares outstanding 542,903,110 443,812,432
Weighted average number of diluted common shares outstanding 548,551,328 452,967,457
Basic net income per average common share $0.64 $0.54
Diluted net income per average common share $0.63 $0.53
Average total assets $59,157,435 $56,827,604
Average equity $7,751,275 $5,835,604
Return on average total assets 2.37% 1.71%
Return on average equity 18.06% 16.66%
Interest Income and Average Earning Asset Yield
We had average earning assets of $54.8 billion for the quarter ended March
31, 2009. We had average earning assets of $56.1 billion for the quarter ended
March 31, 2008. Our primary source of income is interest income. Our interest
income was $716.0 million for the quarter ended March 31, 2009 and $791.1
million for the quarter ended March 31, 2008. The yield on average Investment
Securities was 5.23% and 5.64%, for the quarters ending March 31, 2009 and 2008,
27
respectively. The prepayment speeds increased to an average of 16% CPR for the
quarter ended March 31, 2009 from an average of 15% CPR for the quarter ended
March 31, 2008. Interest income for the quarter ended March 31, 2009, when
compared to interest income for the quarter ended March 31, 2008, declined by
$75.1 million due to the decline in the average earning assets of $1.3 billion
and the decline in the yield on earning assets of 41 basis points.
Interest Expense and the Cost of Funds
Our largest expense is the cost of borrowed funds. We had average borrowed
funds of $48.5 billion and total interest expense of $378.6 million for the
quarter ended March 31, 2009. We had average borrowed funds of $51.4 billion and
total interest expense of $537.6 million for the quarter ended March 31, 2008.
Our average cost of funds was 3.12% for the quarter ended March 31, 2009 and
4.18% for the quarter ended March 31, 2008. The cost of funds rate decreased by
106 basis points and the average borrowed funds decreased by $2.9 billion for
the quarter ended March 31, 2009 when compared to the quarter ended March 31,
2008. Interest expense for the quarter ended March 31, 2009 decreased by $159.0
million, when compared to the quarter ended March 31, 2008, due to the decrease
in the average borrowed funds and the average cost of funds rate. Since a
substantial portion of our repurchase agreements are short term, changes in
market rates are directly reflected in our interest expense. Our average cost of
funds was 2.66% above average one-month LIBOR and 1.38% above average six-month
LIBOR for the quarter ended March 31, 2009.
The table below shows our average borrowed funds and average cost of funds
as compared to average one-month and average six-month LIBOR for the quarter
ended March 31, 2009, the year ended December 31, 2008 and four quarters in
2008.
Average Cost of Funds
---------------------
(Ratios for the quarters have been annualized, dollars in thousands)
Average
One-Month Average Cost Average
LIBOR of Funds Cost of
Average Relative Relative to Funds
Average Cost Average Average to Average Average Relative to
Borrowed Interest of One-Month Six-Month Six-Month One-Month Average
Funds Expense Funds LIBOR LIBOR LIBOR LIBOR Six-Month LIBOR
-----------------------------------------------------------------------------------------------
For the Quarter Ended
March 31, 20099 $48,497,444 $378,625 3.12% 0.46% 1.74% (1.28%) 2.66% 1.38%
------------------------------------------------------------------------------------------------------------------------
For the Year Ended $50,270,226 $1,888,912 3.76% 2.68% 3.06% (0.38%) 1.08% 0.70%
December 31, 2008
For the Quarter Ended
December 31, 2008 $47,581,332 $450,805 3.79% 2.23% 2.94% (0.71%) 1.56% 0.85%
For the Quarter Ended
September 30, 2008 $51,740,645 $458,250 3.54% 2.62% 3.19% (0.57%) 0.92% 0.35%
For the Quarter Ended
June 30, 2008 $50,359,825 $442,251 3.51% 2.59% 2.93% (0.34%) 0.92% 0.58%
For the Quarter Ended
March 31, 2008 $51,399,101 $537,606 4.18% 3.31% 3.18% 0.13% 0.87% 1.00%
Net Interest Income
Our net interest income, which equals interest income less interest
expense, totaled $337.4 million for the quarter ended March 31, 2009 and $253.5
million for the quarter ended March 31, 2008. Our net interest income increased
for the quarter ended March 31, 2009, as compared to the quarter ended March 31,
2008, because of increased interest rate spread. Our net interest spread, which
equals the yield on our average assets for the period less the average cost of
funds for the period, was 1.46% for the quarter ended March 31, 2008 as compared
2.11% for the quarter ended March 31, 2009. This 65 basis point increase in
interest rate spread for first quarter of 2009 over the spread for first quarter
of 2008 was the result in the decrease in the average cost of funds of 106 basis
points, which was only partially offset by a decrease in average yield on
average interest earning assets of 41 basis points.
The table below shows our interest income by average Investment Securities
held, total interest income, yield on average interest earning assets, average
balance of repurchase agreements, interest expense, average cost of funds, net
interest income, and net interest rate spread for the quarter ended March 31,
2009, the year ended December 31, 2008 and four quarters in 2008.
28
Net Interest Income
-------------------
(Ratios for quarters have been annualized, dollars in thousands)
Average Average Average Net
Investment Total Interest Balance of Average Net Interest
Securities Interest Earning Repurchase Interest Cost of Interest Rate
Held Income Assets Agreements Expense Funds Income Spread
---------------------------------------------------------------------------------------------
For the Quarter Ended
March 31, 2009 $54,763,268 $716,015 5.23% $48,497,444 $378,625 3.12% $337,390 2.11%
--------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 2008 $55,962,519 $3,115,428 5.57% $50,270,226 $1,888,912 3.76% $1,226,516 1.81%
For the Quarter Ended
December 31, 2008 $53,838,665 $740,282 5.50% $47,581,332 $450,805 3.79% $289,477 1.71%
For the Quarter Ended
September 30, 2008 $57,694,277 $810,659 5.62% $51,740,645 $458,250 3.54% $352,409 2.08%
For the Quarter Ended
June 30, 2008 $56,197,550 $773,359 5.50% $50,359,825 $442,251 3.51% $331,108 1.99%
For the Quarter Ended
March 31, 2008 $56,119,584 $791,128 5.64% $51,399,101 $537,606 4.18% $253,522 1.46%
Investment Advisory and Service Fees
FIDAC and Merganser are registered investment advisors specializing in
managing fixed income securities. At March 31, 2009, FIDAC and Merganser had
under management approximately $8.5 billion in net assets and $16.3 billion in
gross assets, compared to $3.2 billion in net assets and $12.7 billion in gross
assets at March 31, 2008. Net investment advisory and service fees net of
distribution fees for the quarters ended March 31, 2009 and 2008 totaled $7.3
million and $6.0 million, respectively. Gross assets under management will vary
from time to time because of changes in the amount of net assets FIDAC and
Merganser manage as well as changes in the amount of leverage used by the
various funds and accounts FIDAC manages.
Gains and Losses on Sales of Investment Securities
For the quarter ended March 31, 2009, we sold Investment Securities with a
carrying value of $835.7 million for aggregate net gain of $5.0 million. For the
quarter ended March 31, 2008, we sold Investment Securities with a carrying
value of $4.1 billion for a net gain of $9.4 million. We do not expect to sell
assets on a frequent basis, but may from time to time sell existing assets to
move into new assets, which our management believes might have higher
risk-adjusted returns, or to manage our balance sheet as part of our
asset/liability management strategy.
Income from Trading Securities
For the quarter ended March 31, 2009, we did not have income from trading
securities. Gross income from trading securities totaled $1.9 million for the
quarter ended March 31, 2008.
Dividend Income from Available-For-Sale Equity Securities
Dividend income from our investment in Chimera totaled $918,000 and
$941,000 for the quarter ended March 31, 2009 and 2008, respectively.
General and Administrative Expenses
General and administrative (or G&A) expenses were $29.9 million for the
quarter ended March 31, 2009 and $24.0 million for the quarter ended March 31,
2008. G&A expenses as a percentage of average total assets was 0.20% and 0.17%,
for the quarters ended March 31, 2009 and 2008, respectively. The increase in
G&A expenses of $5.9 million for the quarter ended March 31, 2009 was primarily
the result of increased compensation, directors and officers insurance and
additional costs related to our subsidiaries. Our employees increased from 41 at
March 31, 2008 to 69 at March 31, 2009.
29
The table below shows our total G&A expenses as compared to average total
assets and average equity for the quarter ended March 31, 2009, the year ended
December 31, 2008 and four quarters in 2008.
G&A Expenses and Operating Expense Ratios
-----------------------------------------
(ratios for the quarters have been annualized, dollars in thousands)
Total G&A Total G&A
Expenses/Average Expenses/Average
Total G&A Expenses Assets Equity
----------------------------------------------------------
For the Quarter Ended March 31, 2009 $29,882 0.20% 1.54%
------------------------------------------------------------------------------------------------------
For the Year Ended December 31, 2008 $103,622 0.18% 1.55%
For the Quarter Ended December 31, 2008 $26,957 0.18% 1.50%
For the Quarter Ended September 30, 2008 $25,455 0.17% 1.40%
For the Quarter Ended June 30, 2008 $27,215 0.18% 1.59%
For the Quarter Ended March 31, 2008 $23,995 0.17% 1.64%
Net Income and Return on Average Equity
Our net income was $349.9 million for the quarter ended March 31, 2009 and
net income was $243.0 million for the quarter ended March 31, 2008. Our
annualized return on average equity was 18.06% for the quarter ended March 31,
2009 and 16.66% for the quarter ended March 31, 2008. Net interest income
increased by $83.9 million for the quarter ended March 31, 2009, as compared to
the quarter ended March 31, 2008, due to the increase in interest rate spread.
In addition to the increase in interest rate spread, an unrealized gain on
interest rate swaps of $35.5 million was recorded in the income statement for
the quarter ended March 31, 2009, as the result of de-designation of cash flow
hedges. Prior to the fourth quarter of 2008, we recorded changes in the fair
values in our interest rate swaps in Accumulated Other Comprehensive Income in
our Statement of Financial Condition.
The table below shows our net interest income, net investment advisory and
service fees, gain (loss) on sale of Mortgage-Backed Securities and termination
of interest rate swaps, loss on other-than-temporarily impaired securities,
income from trading securities, G&A expenses, income taxes, each as a percentage
of average equity, and the return on average equity for the quarter ended March
31, 2009, the year ended December 31, 2008 and four quarters in 2008.
Components of Return on Average Equity
--------------------------------------
(Ratios for the quarters have been annualized)
Gain/(Loss)
on Sale of
Mortgage-
Backed
Securities
and
Net Realized and Loss on Income Dividend
Investment Unrealized other-than- (loss) income
Net Advisory Gain/(Loss) temporarily from from
Interest and Interest impaired trading available- G&A Income Return
Income/ Service Rate Swaps/ securities/ securities for-sale Expenses/ Taxes/ (loss) on
Average Fees/Average Average Average /Average equity Average Average Average
Equity Equity Equity Equity Equity securities Equity Equity Equity
-----------------------------------------------------------------------------------------------------
For the Quarter Ended
March 31, 2009 17.41% 0.38% 2.09% - - 0.05% (1.54%) (0.33%) 18.06%
----------------------------------------------------------------------------------------------------------------------------
For the Year Ended
December 31, 2008 18.36% 0.39% (11.34%) (0.48%) 0.15% 0.04% (1.55%) (0.39%) 5.18%
For the Quarter Ended
December 31, 2008 16.06% 0.38% (42.63%) - (0.11%) 0.03% (1.50%) (0.35%) (28.12%)
For the Quarter Ended
September 30, 2008 19.52% 0.41% (0.07%) (1.76%) 0.42% 0.03% (1.40%) (0.42%) 16.73%
For the Quarter Ended
June 30, 2008 19.40% 0.35% 0.16% - 0.13% 0.03% (1.59%) (0.44%) 18.04%
For the Quarter Ended
March 31, 2008 17.38% 0.41% 0.64% - 0.13% 0.06% (1.64%) (0.32%) 16.66%
30
Financial Condition
Investment Securities, Available for Sale
All of our Mortgage-Backed Securities at March 31, 2009 and December 31,
2008 were adjustable-rate or fixed-rate mortgage-backed securities backed by
single-family mortgage loans. All of the mortgage assets underlying these
mortgage-backed securities were secured with a first lien position on the
underlying single-family properties. All of our mortgage-backed securities were
Freddie Mac, Fannie Mae or Ginnie Mae mortgage pass-through certificates or
CMOs, which carry an implied "AAA" rating. All of our agency debentures are
callable and carry an implied "AAA" rating. We carry all of our earning assets
at fair value. We accrete discount balances as an increase in interest income
over the life of discount Investment Securities and we amortize premium balances
as a decrease in interest income over the life of premium Investment Securities.
At March 31, 2009 and December 31, 2008 we had on our balance sheet a total of
$60.0 Million and, $64.4 million, respectively, of unamortized discount (which
is the difference between the remaining principal value and current historical
amortized cost of our Investment Securities acquired at a price below principal
value) and a total of $728.3 million and $619.5 million, respectively, of
unamortized premium (which is the difference between the remaining principal
value and the current historical amortized cost of our Investment Securities
acquired at a price above principal value).
We received mortgage principal repayments of $2.5 billion and $2.5 billion
for the quarters ended March 31, 2009 and March 31, 2008, respectively. The
average prepayment speed for the quarters ended March 31, 2009 and 2008 was 16%,
and 15%, respectively. During the quarter ended March 31, 2009, the average CPR
increased to 16% from 15% during the quarter ended March 31, 2008, due to an
increase in foreclosure and refinancing activity. Given our current portfolio
composition, if mortgage principal prepayment rates were to increase over the
life of our mortgage-backed securities, all other factors being equal, our net
interest income would decrease during the life of these mortgage-backed
securities as we would be required to amortize our net premium balance into
income over a shorter time period. Similarly, if mortgage principal prepayment
rates were to decrease over the life of our mortgage-backed securities, all
other factors being equal, our net interest income would increase during the
life of these mortgage-backed securities as we would amortize our net premium
balance over a longer time period.
The table below summarizes certain characteristics of our Investment
Securities at March 31, 2009, December 31, 2008, September 30, 2008, June 30,
2008, and March 31, 2008.
Investment Securities
---------------------
(dollars in thousands)
Fair
Amortized Value/ Weighted
Principal Net Amortized Cost/Principal Principal Average
Amount Premium Cost Amount Fair Value Amount Yield
----------------------------------------------------------------------------------------
At March 31, 2009 $56,718,404 $668,295 $57,386,699 101.18% $58,785,456 103.64% 4.98%
---------------------------------------------------------------------------------------------------------------------
At December 31, 2008 $54,508,672 $555,043 $55,063,715 101.02% $55,645,940 102.09% 5.15%
At September 30, 2008 $55,211,123 $525,394 $55,736,517 100.95% $55,459,280 100.45% 5.41%
At June 30, 2008 $58,304,678 $500,721 $58,805,399 100.86% $58,749,300 100.76% 5.33%
At March 31, 2008 $56,006,707 $383,334 $56,390,041 100.68% $56,853,862 101.51% 5.36%
The table below summarizes certain characteristics of our Investment
Securities at March 31, 2009, December 31, 2008, September 30, 2008, June 30,
2008, and March 31, 2008. The index level for adjustable-rate Investment
Securities is the weighted average rate of the various short-term interest rate
indices, which determine the coupon rate.
Adjustable-Rate Investment Security Characteristics
---------------------------------------------------
(dollars in thousands)
Principal Amount
Weighted Weighted Weighted at Period End as
Average Average Term Weighted Average % of Total
Principal Coupon to Next Average Asset Investment
Amount Rate Adjustment Lifetime Cap Yield Securities
-------------------------------------------------------------------------------------
At March 31, 2009 $19,558,480 4.66% 34 months 10.06% 3.74% 34.48%
----------------------------------------------------------------------------------------------------------------
At December 31, 2008 $19,540,152 4.75% 36 months 10.00% 3.93% 35.85%
At September 30, 2008 $19,310,012 5.27% 37 months 9.98% 4.65% 34.97%
At June 30, 2008 $18,418,637 5.16% 36 months 9.89% 4.54% 31.59%
At March 31, 2008 $17,487,518 5.19% 35 months 9.73% 4.40% 31.22%
31
Fixed-Rate Investment Security Characteristics
----------------------------------------------
(dollars in thousands)
Principal Amount at
Weighted Average Weighted Average Period End as % of Total
Principal Amount Coupon Rate Asset Yield Investment Securities
--------------------------------------------------------------------------------------
At March 31, 2009 $37,159,924 6.08% 5.64% 65.52%
------------------------------------------------------------------------------------------------------------------
At December 31, 2008 $34,968,520 6.13% 5.84% 64.15%
At September 30, 2008 $35,901,111 6.06% 5.82% 65.03%
At June 30, 2008 $39,886,041 6.00% 5.70% 68.41%
At March 31, 2008 $38,519,189 5.98% 5.80% 68.78%
At March 31, 2009 and December 31, 2008, we held Investment Securities with
coupons linked to various indices. The following tables detail the portfolio
characteristics by index.
Adjustable-Rate Investment Securities by Index
----------------------------------------------
March 31, 2009
11th Monthly
One- Six- Twelve 12-Month District 1-Year Federal
Month Month Month Moving Cost of Treasury Cost of Other
Libor Libor Libor Average Funds Index Funds Indexes(1)
---------------------------------------------------------------------------
Weighted Average Term to Next 1 mo. 23 mo. 51 mo. 1 mo. 1 mo. 38 mo. 1 mo. 14 mo.
Adjustment
Weighted Average Annual Period Cap 6.39% 1.61% 2.01% 0.02% 1.05% 1.94% 0.00% 1.84%
Weighted Average Lifetime Cap at
March 31, 2009 7.04% 11.20% 10.89% 9.19% 10.78% 10.83% 13.43% 11.95%
Investment Principal Value as
Percentage of Investment Securities 7.10% 1.98% 19.48% 1.14% 0.66% 3.94% 0.11% 0.07%
at March 31, 2009
(1) Combination of indexes that account for less than 0.05% of total
investment securities.
Adjustable-Rate Investment Securities by Index
----------------------------------------------
December 31, 2008
11th Monthly
One- Six- Twelve 12-Month District 1-Year Federal
Month Month Month Moving Cost of Treasury Cost of Other
Libor Libor Libor Average Funds Index Funds Indexes(1)
---------------------------------------------------------------------------
Weighted Average Term to Next 1 mo. 25 mo. 55 mo. 1 mo. 1 mo. 37 mo. 1 mo. 14 mo.
Adjustment
Weighted Average Annual Period Cap 6.28% 1.95% 1.98% 0.00% 1.26% 1.93% 0.00% 1.94%
Weighted Average Lifetime Cap at
December 31, 2008 7.07% 10.87% 10.92% 8.86% 11.35% 10.86% 13.44% 11.98%
Investment Principal Value as
Percentage of Investment Securities 8.11% 2.53% 19.32% 0.99% 0.60% 4.12% 0.11% 0.07%
at December 31, 2008
(1) Combination of indexes that account for less than 0.05% of total
investment securities.
Reverse Repurchase Agreements
At March 31, 2009 and December 31, 2008, we lent $452.5 million and $562.1
million, respectively, to Chimera in an overnight reverse repurchase agreement.
This amount is included at fair value in our Statement of Financial Condition.
The interest rate at March 31, 2009 and December 31, 2008 was at the market rate
of 2.01% and 1.43%, respectively. The collateral for this loan is
mortgage-backed securities.
Receivable from Prime Broker on Equity Investment
The net assets of the investment fund are subject to English bankruptcy
law, which governs the administration of Lehman Brothers International (Europe)
(LBIE), as well as the law of New York, which governs the contractual documents.
Until our contractual documents with LBIE are terminated, the value of the
assets and liabilities in our account with LBIE will continue to fluctuate based
on market movements. We do not intend to terminate these contractual documents
until LBIE's administrators have clarified the consequences of us doing so. We
have not received notice from LBIE's administrators that LBIE has terminated the
documents. LBIE's administrators have advised us that they can provide us with
no additional information about our account at this time. As a result, we have
presented the market value of our account with LBIE as of September 15, 2008 of
$16.9 million, which is the date of the last statement we received from LBIE on
the account's assets and liabilities. We can provide no assurance, however, that
we will recover all or any portion of these assets following completion of
LBIE's administration (and any subsequent liquidation). Based on the information
known at March 31, 2009, a loss was not determined to be probable. If
additional information indicates otherwise and it is determined that the loss is
probable, the estimated loss will be reflected in the statement of operations
32
Borrowings
To date, our debt has consisted entirely of borrowings collateralized by a
pledge of our Investment Securities. These borrowings appear on our statement of
financial condition as repurchase agreements. At March 31, 2009, we had
established uncommitted borrowing facilities in this market with 30 lenders in
amounts which we believe are in excess of our needs. All of our Investment
Securities are currently accepted as collateral for these borrowings. However,
we limit our borrowings, and thus our potential asset growth, in order to
maintain unused borrowing capacity and thus increase the liquidity and strength
of our financial condition.
At March 31, 2009, the term to maturity of our borrowings ranged from one
day to ten years. Additionally, we have entered into structured borrowings
giving the counterparty the right to call the balance prior to maturity. The
weighted average original term to maturity of our borrowings was 263 days at
March 31, 2009. At March 31, 2008, the term to maturity of our borrowings ranged
from one day to ten years, with a weighted average original term to maturity of
266 days.
At March 31, 2009, the weighted average cost of funds for all of our
borrowings was 2.78%, including the effect of the interest rate swaps, and the
weighted average term to next rate adjustment was 219 days. At March 31, 2008,
the weighted average cost of funds for all of our borrowings 3.85% and the
weighted average term to next rate adjustment was 229 days.
Liquidity
Liquidity, which is our ability to turn non-cash assets into cash, allows
us to purchase additional investment securities and to pledge additional assets
to secure existing borrowings should the value of our pledged assets decline.
Potential immediate sources of liquidity for us include cash balances and unused
borrowing capacity. Unused borrowing capacity will vary over time as the market
value of our investment securities varies. Our non-cash assets are largely
actual or implied AAA assets, and accordingly, we have not had, nor do we
anticipate having, difficulty in converting our assets to cash. Our balance
sheet also generates liquidity on an on-going basis through mortgage principal
repayments and net earnings held prior to payment as dividends. Should our needs
ever exceed these on-going sources of liquidity plus the immediate sources of
liquidity discussed above, we believe that in most circumstances our Investment
Securities could be sold to raise cash. The maintenance of liquidity is one of
the goals of our capital investment policy. Under this policy, we limit asset
growth in order to preserve unused borrowing capacity for liquidity management
purposes.
Borrowings under our repurchase agreements increased by $2.3 billion to
$49.0 billion at March 31, 2009, from $46.7 billion at December 31, 2008.
We anticipate that, upon repayment of each borrowing under a repurchase
agreement, we will use the collateral immediately for borrowing under a new
repurchase agreement. We have not at the present time entered into any
commitment agreements under which the lender would be required to enter into new
repurchase agreements during a specified period of time, nor do we presently
plan to have liquidity facilities with commercial banks.
Under our repurchase agreements, we may be required to pledge additional
assets to our repurchase agreement counterparties (i.e., lenders) in the event
the estimated fair value of the existing pledged collateral under such
agreements declines and such lenders demand additional collateral (a "margin
call"), which may take the form of additional securities or cash. Similarly, if
the estimated fair value of our pledged collateral increases due to changes in
market interest rates of market factors, lenders may release collateral back to
us. Specifically, margin calls result from a decline in the value of the our
Mortgage-Backed Securities securing our repurchase agreements, prepayments on
the mortgages securing such Mortgage-Backed Securities and to changes in the
estimated fair value of such Mortgage-Backed Securities generally due to
principal reduction of such Mortgage-Backed Securities from scheduled
amortization and resulting from changes in market interest rates and other
market factors. Through March 31, 2009, we did not have any margin calls on our
repurchase agreements that we were not able to satisfy with either cash or
additional pledged collateral. However, should prepayment speeds on the
mortgages underlying our Mortgage-Backed Securities and/or market interest rates
suddenly increase, margin calls on our repurchase agreements could result,
causing an adverse change in our liquidity position.
33
The following table summarizes the effect on our liquidity and cash flows
from contractual obligations for repurchase agreements, interest expense on
repurchase agreements, the non-cancelable office lease and employment agreements
at March 31, 2009. The table does not include the effect of net interest rate
payments under our interest rate swap agreements. The net swap payments will
fluctuate based on monthly changes in the receive rate, At March 31, 2009, the
interest rate swaps had a negative fair value of $1.0 billion.
(dollars in thousands)
Within One One to Three Three to More than
Contractual Obligations Year Years Five Years Five Years Total
---------------------------------------------------------------------------------------------------------------------
Repurchase agreements $41,771,178 $4,630,000 $950,000 $1,600,000 $48,951,178
Interest expense on repurchase
agreements, based on rates at March 31, 292,698 366,702 157,761 196,229 1,013,390
2009
Long-term operating lease obligations 886 1,207 1,352 - 3,445
Employment contracts 79,421 16,765 - - 96,186
--------------------------------------------------------------------------
Total $42,144,183 $5,014,674 $1,109,113 $1,796,229 $50,064,199
==========================================================================
Stockholders' Equity
During the quarter ended March 31, 2009, we declared dividends to common
shareholders totaling $272.2 million or $0.50 per share, which were paid on
April 29, 2009. During the quarter ended March 31, 2009, we declared and paid
dividends to Series A Preferred shareholders totaling $3.6 million or $0.492188
per share, and Series B Preferred shareholders totaling $978,000 or $0.375 per
share.
During the quarter ended March 31, 2009, 55,887 options for an aggregate
exercise price of $623,000 were exercised and 7,550 restricted shares were
issued under the Long-Term Stock Incentive Plan, or Incentive Plan. During the
quarter ended March 31, 2009, 1,355,961 shares of Series B Preferred Stock were
converted into 2,801,000 shares of common stock.
On May 13, 2008 we entered into an underwriting agreement pursuant to which
we sold 69,000,000 shares of our common stock for net proceeds following
underwriting expenses of approximately $1.1 billion. This transaction settled on
May 19, 2008.
On January 23, 2008 we entered into an underwriting agreement pursuant to
which we sold 58,650,000 shares of our common stock for net proceeds following
underwriting expenses of approximately $1.1 billion. This transaction settled on
January 29, 2008.
During the year ended December 31, 2008, we raised $93.7 million by issuing
5.8 million shares through our Direct Purchase and Dividend Reinvestment
Program.
On August 3, 2006, we entered into an ATM Equity Offering(sm) Sales
Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner & Smith
Incorporated, relating to the sale of shares of our common stock from time to
time through Merrill Lynch. Sales of the shares, if any, are made by means of
ordinary brokers' transaction on the New York Stock Exchange. During the year
ended December 31, 2008, 588,000 shares of our common stock were issued pursuant
to this program, totaling $11.5 million in net proceeds.
On August 3, 2006, we entered into an ATM Equity Sales Agreement with UBS
Securities LLC, relating to the sale of shares of our common stock from time to
time through UBS Securities. Sales of the shares, if any, are made by means of
ordinary brokers' transaction on the New York Stock Exchange. During the year
ended December 31, 2008, 3.8 million shares of our common stock were issued
pursuant to this program, totaling $60.3 million in net proceeds.
34
During the year ended December 31, 2008, 300,000 options were exercised
under the Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate
exercise price of $2.8 million.
Unrealized Gains and Losses
With our "available-for-sale" accounting treatment, unrealized fluctuations
in market values of assets do not impact our GAAP or taxable income but rather
are reflected on our statement of financial condition by changing the carrying
value of the asset and stockholders' equity under "Accumulated Other
Comprehensive Income (Loss)." As a result of the de-designation of interest rate
swaps as cash flow hedges during the quarter ended December 31, 2008, unrealized
gains and losses in our interest rate swaps impact our GAAP income.
As a result of this mark-to-market accounting treatment, our book value and
book value per share are likely to fluctuate far more than if we used historical
amortized cost accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may not be
meaningful.
The table below shows unrealized gains and losses on the Investment
Securities, available-for-sale equity securities and interest rate swaps in our
portfolio prior to de-designation.
Unrealized Gains and Losses
(dollars in thousands)
March 31, December 31, September 30, June 30, March 31,
2009 2008 2008 2008 2008
-------------------------------------------------------------------------
Unrealized gain $1,502,319 $785,087 $217,710 $324,612 $654,506
Unrealized loss (380,768) (532,857) (879,208) (803,403) (990,320)
-------------------------------------------------------------------------
Net Unrealized gain (loss) $1,121,551 $252,230 ($661,498) ($478,791) ($335,814)
=========================================================================
Unrealized changes in the estimated net fair value of investment securities
have one direct effect on our potential earnings and dividends: positive changes
increase our equity base and allow us to increase our borrowing capacity while
negative changes tend to limit borrowing capacity under our capital investment
policy. A very large negative change in the net fair value of our investment
securities might impair our liquidity position, requiring us to sell assets with
the likely result of realized losses upon sale.
Leverage
Our debt-to-equity ratio at March 31, 2009 and December 31, 2008 was 6.0:1
and 6.4:1, respectively. We generally expect to maintain a ratio of
debt-to-equity of between 8:1 and 12:1, although the ratio may vary from this
range from time to time based upon various factors, including our management's
opinion of the level of risk of our assets and liabilities, our liquidity
position, our level of unused borrowing capacity and over-collateralization
levels required by lenders when we pledge assets to secure borrowings.
Our target debt-to-equity ratio is determined under our capital investment
policy. Should our actual debt-to-equity ratio increase above the target level
due to asset acquisition or market value fluctuations in assets, we would cease
to acquire new assets. Our management will, at that time, present a plan to our
board of directors to bring us back to our target debt-to-equity ratio; in many
circumstances, this would be accomplished over time by the monthly reduction of
the balance of our Mortgage-Backed Securities through principal repayments.
Asset/Liability Management and Effect of Changes in Interest Rates
We continually review our asset/liability management strategy with respect
to interest rate risk, mortgage prepayment risk, credit risk and the related
issues of capital adequacy and liquidity. Our goal is to provide attractive
risk-adjusted stockholder returns while maintaining what we believe is a strong
balance sheet.
We seek to manage the extent to which our net income changes as a function
of changes in interest rates by matching adjustable-rate assets with
variable-rate borrowings. In addition, we have attempted to mitigate the
potential impact on net income of periodic and lifetime coupon adjustment
restrictions in our portfolio of investment securities by entering into interest
35
rate swaps. At March 31, 2009, we had entered into swap agreements with a total
notional amount of $17.3 billion. We agreed to pay a weighted average pay rate
of 4.55% and receive a floating rate based on one month LIBOR. At December 31,
2008, we entered into swap agreements with a total notional amount of $17.6
billion. We agreed to pay a weighted average pay rate of 4.66% and receive a
floating rate based on one month LIBOR. We may enter into similar derivative
transactions in the future by entering into interest rate collars, caps or
floors or purchasing interest only securities.
Changes in interest rates may also affect the rate of mortgage principal
prepayments and, as a result, prepayments on mortgage-backed securities. We seek
to mitigate the effect of changes in the mortgage principal repayment rate by
balancing assets we purchase at a premium with assets we purchase at a discount.
To date, the aggregate premium exceeds the aggregate discount on our
mortgage-backed securities. As a result, prepayments, which result in the
expensing of unamortized premium, will reduce our net income compared to what
net income would be absent such prepayments.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities, which would have been established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. Further, we have not guaranteed any obligations of
unconsolidated entities nor do we have any commitment or intent to provide
funding to any such entities. As such, we are not materially exposed to any
market, credit, liquidity or financing risk that could arise if we had engaged
in such relationships.
Capital Resources
At March 31, 2009, we had no material commitments for capital expenditures.
Inflation
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates and other factors drive our performance far more than
does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our financial statements are
prepared in accordance with GAAP and our dividends are based upon our net income
as calculated for tax purposes; in each case, our activities and balance sheet
are measured with reference to historical cost or fair market value without
considering inflation.
Other Matters
We calculate that at least 75% of our assets were qualified REIT assets, as
defined in the Code for the quarters ended March 31, 2009 and 2008. We also
calculate that our revenue qualifies for the 75% source of income test and for
the 95% source of income test rules for the quarters ended March 31, 2009 and
2008. Consequently, we met the REIT income and asset test. We also met all REIT
requirements regarding the ownership of our common stock and the distribution of
our net income. Therefore, as of March 31, 2009 and December 31, 2008, we
believe that we qualified as a REIT under the Code.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act of 1940, or
the Investment Company Act. If we were to become regulated as an investment
company, then our use of leverage would be substantially reduced. 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 of the staff
of the SEC, in order to qualify for this exemption, we must maintain at least
55% of our assets directly in qualifying interests and at least 80% of our
assets in qualifying interests plus other real estate related assets. In
addition, unless certain mortgage securities represent all the certificates
issued with respect to an underlying pool of mortgages, the Mortgage-Backed
Securities may be treated as securities separate from the underlying mortgage
loans and, thus, may not be considered qualifying interests for purposes of the
55% requirement. We calculate that as of March 31, 2009 and December 31, 2008,
we were in compliance with this requirement.
36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
MARKET RISK
Market risk is the exposure to loss resulting from changes in interest
rates, foreign currency exchange rates, commodity prices and equity prices. The
primary market risk to which we are exposed is interest rate risk, which is
highly sensitive to many factors, including governmental monetary and tax
policies, domestic and international economic and political considerations and
other factors beyond our control. Changes in the general level of interest rates
can affect our net interest income, which is the difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing liabilities. Changes in
the level of interest rates also can affect the value of our Mortgage-Backed
Securities and our ability to realize gains from the sale of these assets. We
may utilize a variety of financial instruments, including interest rate swaps,
caps, floors, inverse floaters and other interest rate exchange contracts, in
order to limit the effects of interest rates on our operations. When we use
these types of derivatives to hedge the risk of interest-earning assets or
interest-bearing liabilities, we may be subject to certain risks, including the
risk that losses on a hedge position will reduce the funds available for
payments to holders of securities and that the losses may exceed the amount we
invested in the instruments.
Our profitability and the value of our portfolio (including interest rate
swaps) may be adversely affected during any period as a result of changing
interest rates. The following table quantifies the potential changes in net
interest income, portfolio value should interest rates go up or down 25, 50 and
75 basis points, assuming the yield curves of the rate shocks will be parallel
to each other and the current yield curve. All changes in income and value are
measured as percentage changes from the projected net interest income and
portfolio value at the base interest rate scenario. The base interest rate
scenario assumes interest rates at March 31, 2009 and various estimates
regarding prepayment and all activities are made at each level of rate shock.
Actual results could differ significantly from these estimates.
Projected Percentage Change in
Projected Percentage Change in Portfolio Value, with Effect of
Change in Interest Rate Net Interest Income Interest Rate Swaps
--------------------------------------------------------------------------------------------------
-75 Basis Points 2.33% 1.75%
-50 Basis Points 1.15% 1.68%
-25 Basis Points 0.01% 1.51%
Base Interest Rate - -
+25 Basis Points (1.58%) 0.86%
+50 Basis Points (3.39%) 0.39%
+75 Basis Points (5.20%) (0.19%)
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and magnitude
of the repricing of assets and liabilities. We attempt to control risks
associated with interest rate movements. Methods for evaluating interest rate
risk include an analysis of our interest rate sensitivity "gap", which is the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest-rate sensitive assets exceeds the amount of
interest-rate sensitive liabilities. A gap is considered negative when the
amount of interest-rate sensitive liabilities exceeds interest-rate sensitive
assets. During a period of rising interest rates, a negative gap would tend to
adversely affect net interest income, while a positive gap would tend to result
in an increase in net interest income. During a period of falling interest
rates, a negative gap would tend to result in an increase in net interest
income, while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
37
The following table sets forth the estimated maturity or repricing of our
interest-earning assets and interest-bearing liabilities at March 31, 2009. The
amounts of assets and liabilities shown within a particular period were
determined in accordance with the contractual terms of the assets and
liabilities, except adjustable-rate loans, and securities are included in the
period in which their interest rates are first scheduled to adjust and not in
the period in which they mature and does include the effect of the interest rate
swaps. The interest rate sensitivity of our assets and liabilities in the table
could vary substantially based on actual prepayment experience.
More than 1
Within 3 Months 4-12 Months Year to 3 Years 3 Years and Over Total
(dollars in thousands)
--------------------------------------------------------------------------------
Rate Sensitive Assets:
Investment Securities (Principal) $5,385,767 $2,607,636 $3,486,223 $45,238,778 $56,718,404
Cash Equivalents 1,035,118 - - - 1,035,118
Reverse Repurchase Agreements 452,480 - - - 452,480
--------------------------------------------------------------------------------
Total Rate Sensitive Assets 6,873,365 2,607,636 3,486,223 45,238,778 58,206,002
Rate Sensitive Liabilities:
Repurchase Agreements, with the
effect of swaps 23,262,528 6,160,650 13,052,350 6,475,650 48,951,178
--------------------------------------------------------------------------------
Interest rate sensitivity gap
($16,389,163) ($3,553,014) ($9,566,127) $38,763,128 $9,254,824
================================================================================
Cumulative rate sensitivity gap ($16,389,163) ($19,942,177) ($29,508,304) $9,254,824
=================================================================
Cumulative interest rate sensitivity
gap as a percentage of total
rate-sensitive assets (29%) (35%) (52%) 16%
=================================================================
Our analysis of risks is based on management's experience, estimates,
models and assumptions. These analyses rely on models which utilize estimates of
fair value and interest rate sensitivity. Actual economic conditions or
implementation of investment decisions by our management may produce results
that differ significantly from the estimates and assumptions used in our models
and the projected results shown in the above tables and in this report. These
analyses contain certain forward-looking statements and are subject to the safe
harbor statement set forth under the heading, "Special Note Regarding
Forward-Looking Statements."
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
Our management, including our Chief Executive Officer (the "CEO") and Chief
Financial Officer (the "CFO"), reviewed and evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of
the period covered by this quarterly report. Based on that review and
evaluation, the CEO and CFO have concluded that our current disclosure controls
and procedures, as designed and implemented, (1) were effective in ensuring that
information regarding the Company and its subsidiaries is made known to our
management, including our CEO and CFO, by our employees, as appropriate to allow
timely decisions regarding required disclosure and (2) were effective in
providing reasonable assurance that information the Company must disclose in its
periodic reports under the Securities Exchange Act is recorded, processed,
summarized and reported within the time periods prescribed by the SEC's rules
and forms. There have been no changes in our internal control over financial
reporting that occurred during the last fiscal quarter that have materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
38
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
-----------------
From time to time, we are involved in various claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material effect on our
consolidated financial statements.
Item 1A. RISK FACTORS
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2008, which could
materially affect our business, financial condition or future results. The
materialization of any risks and uncertainties identified in our forward looking
statements contained in this report together with those previously disclosed in
the Form 10-K or those that are presently unforeseen could result in significant
adverse effects on our financial condition, results of operations and cash
flows. See Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Special Note Regarding Forward Looking Statements"
in this quarterly report on Form 10-Q. The information presented below updates
and should be read in conjunction with the risk factors and information
disclosed in that Form 10-K.
The conservatorship of Fannie Mae and Freddie Mac and related efforts, along
with any changes in laws and regulations affecting the relationship between
Fannie Mae and Freddie Mac and the federal government, may adversely affect our
business.
Due to increased market concerns about Fannie Mae and Freddie Mac's ability
to withstand future credit losses associated with securities held in their
investment portfolios, and on which they provide guarantees, without the direct
support of the federal government, on July 30, 2008, the government passed the
Housing and Economic Recovery Act of 2008, or the HERA. Among other things, the
HERA established the Federal Housing Finance Agency, or FHFA, which has broad
regulatory powers over Fannie Mae and Freddie Mac. On September 7, 2008, the
FHFA placed Fannie Mae and Freddie Mac into conservatorship and, together with
the Treasury, established a program designed to boost investor confidence in
Fannie Mae's and Freddie Mac's debt and mortgage-backed securities. As the
conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the
operations of Fannie Mae and Freddie Mac and may (1) take over the assets of and
operate Fannie Mae and Freddie Mac with all the powers of the shareholders, the
directors and the officers of Fannie Mae and Freddie Mac and conduct all
business of Fannie Mae and Freddie Mac; (2) collect all obligations and money
due to Fannie Mae and Freddie Mac; (3) perform all functions of Fannie Mae and
Freddie Mac which are consistent with the conservator's appointment; (4)
preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and
(5) contract for assistance in fulfilling any function, activity, action or duty
of the conservator. A primary focus of this new legislation is to increase the
availability of mortgage financing by allowing Fannie Mae and Freddie Mac to
continue to grow their guarantee business without limit, while limiting net
purchases of agency mortgage-backed securities to a modest amount through the
end of 2009. It is currently planned for Fannie Mae and Freddie Mac to reduce
gradually their agency mortgage-backed securities portfolios beginning in 2010.
In addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac,
the Treasury has taken three additional actions: (i) the Treasury and FHFA have
entered into preferred stock purchase agreements between the Treasury and Fannie
Mae and Freddie Mac pursuant to which the Treasury will ensure that each of
Fannie Mae and Freddie Mac maintains a positive net worth; (ii) the Treasury has
established a new secured lending credit facility which will be available to
Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which is intended to
serve as a liquidity backstop, which will be available until December 2009; and
(iii) the Treasury has initiated a temporary program to purchase agency
mortgage-backed securities issued by Fannie Mae and Freddie Mac.
Although the Treasury has committed capital to Fannie Mae and Freddie Mac,
there can be no assurance that these actions will be adequate for their needs.
If these actions are inadequate, Fannie Mae and Freddie Mac could continue to
suffer losses and could fail to honor their guarantees and other obligations.
The future roles of Fannie Mae and Freddie Mac could be significantly reduced
and the nature of their guarantees could be considerably limited relative to
historical measurements. Any changes to the nature of the guarantees provided by
Fannie Mae and Freddie Mac could redefine what constitutes agency
mortgage-backed securities and could have broad adverse market implications.
39
On November 25, 2008, the Federal Reserve announced that it will initiate a
program to purchase $100 billion in direct obligations of Fannie Mae, Freddie
Mac and the Federal Home Loan Banks and $500 billion in agency mortgage-backed
securities backed by Fannie Mae, Freddie Mac and Ginnie Mae. The Federal Reserve
stated that its actions are intended to reduce the cost and increase the
availability of credit for the purchase of houses, and are meant to support
housing markets and foster improved conditions in financial markets more
generally. The purchases of direct obligations began during the first week of
December 2008, and the purchases of agency mortgage-backed securities began in
early January 2009. The Federal Reserve has announced an expansion of this
program to purchase another $750 million in agency mortgage-backed securities
through the end of 2009. The Federal Reserve's program to purchase agency
mortgage-backed securities could cause an increase in the price of agency
mortgage-backed securities, which could help the value of the assets in our
portfolio but may negatively impact the net interest margin with respect to new
agency mortgage-backed securities we may purchase.
The size and timing of the federal government's agency mortgage-backed
securities purchase program is subject to the discretion of the Treasury and the
Federal Reserve. Purchases under these programs have already begun, but there is
no certainty that they will continue. It is possible that a change in the
Treasury's and the Federal Reserve's commitment to purchase agency
mortgage-backed securities in the future could negatively affect the pricing of
agency mortgage-backed securities that we seek to acquire. Given the highly
fluid and evolving nature of events, it is unclear how our business may be
impacted. Further activity of the U.S. Government or market response to
developments at Fannie Mae and Freddie Mac could adversely impact our business.
Mortgage loan modification programs, future legislative action and changes in
the requirements necessary to qualify for refinancing a mortgage with Fannie
Mae, Freddie Mac or Ginnie Mae may adversely affect the value of, and the
returns on, the assets in which we invest.
During the second half of 2008 and in early 2009, the U.S. government,
through the Federal Housing Administration, or FHA, and the FDIC, commenced
implementation of programs designed to provide homeowners with assistance in
avoiding residential mortgage loan foreclosures including the Hope for
Homeowners Act of 2008, which allows certain distressed borrowers to refinance
their mortgages into FHA-insured loans. The programs may also involve, among
other things, the modification of mortgage loans to reduce the principal amount
of the loans or the rate of interest payable on the loans, or to extend the
payment terms of the loans. Members of the U.S. Congress have indicated support
for additional legislative relief for homeowners, including an amendment of the
bankruptcy laws to permit the modification of mortgage loans in bankruptcy
proceedings. These loan modification programs, future legislative or regulatory
actions, including amendments to the bankruptcy laws, that result in the
modification of outstanding mortgage loans, as well as changes in the
requirements necessary to qualify for refinancing a mortgage with Fannie Mae,
Freddie Mac or Ginnie Mae may adversely affect the value of, and the returns on,
our Investment Securities. Depending on whether or not we purchased an
instrument at a premium or discount, the yield we receive may be positively or
negatively impacted by any modification.
The actions of the U.S. government, Federal Reserve and Treasury, including the
establishment of the TALF and the PPIP, may adversely affect our business.
The TALF was first announced by the Treasury on November 25, 2008, and has
been expanded in size and scope since its initial announcement. Under the TALF,
the Federal Reserve Bank of New York makes non-recourse loans to borrowers to
fund their purchase of eligible assets, currently certain asset backed
securities but not mortgage-backed securities. The nature of the eligible assets
has been expanded several times. The Treasury has stated that through its
expansion of the TALF, non-recourse loans will be made available to investors to
certain fund purchases of legacy securitization assets. On March 23, 2009, the
Treasury in conjunction with the FDIC, and the Federal Reserve, announced the
PPIP. The PPIP aims to recreate a market for specific illiquid residential and
commercial loans and securities through a number of joint public and private
investment funds. The PPIP is designed to draw new private capital into the
market for these securities and loans by providing government equity
co-investment and attractive public financing.
40
These programs are still in early stages of development, and it is not
possible to predict how the TALF, the PPIP, or other recent U.S. government
actions will impact the financial markets, including current significant levels
of volatility, or our current or future investments. To the extent the market
does not respond favorably to these initiatives or they do not function as
intended, our business may not receive any benefits from this legislation. In
addition, the U.S. government, Federal Reserve, Treasury and other governmental
and regulatory bodies have taken or are considering taking other actions to
address the financial crisis. We cannot predict whether or when such actions may
occur, and such actions could have a dramatic impact on our business, results of
operations and financial condition.
Item 6. EXHIBITS
--------
Exhibits:
The exhibits required by this item are set forth on the Exhibit Index attached
hereto.
EXHIBIT INDEX
Exhibit Exhibit Description
Number
3.1 Articles of Amendment and Restatement of the Articles of Incorporation
of the Registrant (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-11 (Registration No.
333-32913) filed with the Securities and Exchange Commission on August
5, 1997).
3.2 Articles of Amendment of the Articles of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.1 of the
Registrant's Registration Statement on Form S-3 (Registration
Statement 333-74618) filed with the Securities and Exchange Commission
on June 12, 2002).
3.3 Articles of Amendment of the Articles of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.1 of the
Registrant's Form 8-K (filed with the Securities and Exchange
Commission on August 3, 2006).
3.4 Articles of Amendment of the Articles of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.4 of the
Registrant's Form 10-Q (filed with the Securities and Exchange
Commission on May 7, 2008).
3.5 Form of Articles Supplementary designating the Registrant's 7.875%
Series A Cumulative Redeemable Preferred Stock, liquidation preference
$25.00 per share (incorporated by reference to Exhibit 3.3 to the
Registrant's 8-A filed April 1, 2004).
3.6 Articles Supplementary of the Registrant's designating an additional
2,750,000 shares of the Company's 7.875% Series A Cumulative
Redeemable Preferred Stock, as filed with the State Department of
Assessments and Taxation of Maryland on October 15, 2004 (incorporated
by reference to Exhibit 3.2 to the Registrant's 8-K filed October 4,
2004).
3.7 Articles Supplementary designating the Registrant's 6% Series B
Cumulative Convertible Preferred Stock, liquidation preference $25.00
per share (incorporated by reference to Exhibit 3.1 to the
Registrant's 8-K filed April 10, 2006).
3.8 Bylaws of the Registrant, as amended (incorporated by reference to
Exhibit 3.3 to the Registrant's Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
4.1 Specimen Common Stock Certificate (incorporated by reference to
Exhibit 4.1 to Amendment No. 1 to the Registrant's Registration
Statement on Form S-11 (Registration No. 333-32913) filed with the
Securities and Exchange Commission on September 17, 1997).
4.2 Specimen Preferred Stock Certificate (incorporated by reference to
Exhibit 4.2 to the Registrant's Registration Statement on Form S-3
(Registration No. 333-74618) filed with the Securities and Exchange
Commission on December 5, 2001).
4.3 Specimen Series A Preferred Stock Certificate (incorporated by
reference to Exhibit 4.1 of the Registrant's Registration Statement on
Form 8-A filed with the SEC on April 1, 2004).
4.4 Specimen Series B Preferred Stock Certificate (incorporated by
reference to Exhibit 4.1 to the Registrant's Form 8-K filed with the
Securities and Exchange Commission on April 10, 2006).
41
31.1 Certification of Michael A.J. Farrell, Chairman, Chief Executive
Officer, and President of the Registrant, pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification of Kathryn F. Fagan, Chief Financial Officer and
Treasurer of the Registrant, pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Michael A.J. Farrell, Chairman, Chief Executive
Officer, and President of the Registrant, pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Kathryn F. Fagan, Chief Financial Officer and
Treasurer of the Registrant, pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANNALY CAPITAL MANAGEMENT, INC.
Dated: May 7, 2009 By: /s/ Michael A.J. Farrell
------------------------
Michael A.J. Farrell
(Chairman of the Board, Chief Executive
Officer, President and authorized
officer of registrant)
Dated: May 7, 2009 By: /s/ Kathryn F. Fagan
--------------------
Kathryn F. Fagan
(Chief Financial Officer and Treasurer
and principal financial and chief
accounting officer)
43