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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from: ________ to ________
Commission File No. 001-13937
ANTHRACITE CAPITAL, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 13-3978906
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 East 52nd Street
New York, New York 10022
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(Address of principal executive office) (Zip Code)
(212) 810-3333
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $.001 PAR VALUE
(Title of each class) (Name of each exchange on
which registered)
Securities registered pursuant to Section 12(g) of the Act: Not Applicable
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No /_/
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /_/
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes |X| No /_/
The aggregate market value of the registrant's Common Stock, $.001 par value,
held by non-affiliates of the registrant, computed by reference to the closing
sale price of $11.98 as reported on the New York Stock Exchange on June 30,
2004, was $630,821,384 (for purposes of this calculation, affiliates include
only directors and executive officers of the registrant).
The number of shares of the registrant's Common Stock, $.001 par value,
outstanding as of March 16, 2005 was 53,296,678 shares.
Documents Incorporated by Reference: The registrant's Definitive Proxy
Statement for the 2005 Annual Meeting of Stockholders is incorporated by
reference into Part III.
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ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
PART I
Item 1. Business...........................................................4
Item 2. Properties ......................................................26
Item 3. Legal Proceedings ................................................26
Item 4. Submission of Matters to a Vote of
Security Holders .................................................26
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters ..................................27
Item 6. Selected Financial Data ..........................................28
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ....................29
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk ......................................................53
Item 8. Financial Statements and Supplementary Data ......................57
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ..........................106
Item 9A. Controls and Procedures..........................................106
PART III
Item 10. Directors and Executive Officers of the Registrant ..............107
Item 11. Executive Compensation ..........................................107
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Shareholder Matters ...........107
Item 13. Certain Relationships and Related Transactions ..................107
Item 14. Principal Accountant Fees and Services...........................107
PART IV
Item 15. Exhibits and Financial Statement Schedules ......................108
Signatures ..............................................................110
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained herein constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 with
respect to future financial or business performance, strategies or
expectations. Forward-looking statements are typically identified by words or
phrases such as "trend," "opportunity," "pipeline," "believe," "comfortable,"
"expect," "anticipate," "current," "intention," "estimate," "position,"
"assume," "potential," "outlook," "continue," "remain," "maintain," "sustain,"
"seek," "achieve" and similar expressions, or future or conditional verbs such
as "will," "would," "should," "could," "may" or similar expressions. Anthracite
Capital, Inc. (the "Company") cautions that forward-looking statements are
subject to numerous assumptions, risks and uncertainties, which change over
time. Forward-looking statements speak only as of the date they are made, and
the Company assumes no duty to and does not undertake to update forward-looking
statements. Actual results could differ materially from those anticipated in
forward-looking statements and future results could differ materially from
historical performance.
In addition to factors previously disclosed in the Company's Securities and
Exchange Commission (the "SEC") reports and those identified elsewhere in this
report, the following factors, among others, could cause actual results to
differ materially from forward-looking statements or historical performance:
(1) the introduction, withdrawal, success and timing of business
initiatives and strategies;
(2) changes in political, economic or industry conditions, the interest
rate environment or financial and capital markets, which could
result in changes in the value of the Company's assets;
(3) the relative and absolute investment performance and operations of
the Company's manager, BlackRock Financial Management, Inc. (the
"Manager");
(4) the impact of increased competition;
(5) the impact of capital improvement projects;
(6) the impact of future acquisitions and divestitures;
(7) the unfavorable resolution of legal proceedings;
(8) the extent and timing of any share repurchases;
(9) the impact, extent and timing of technological changes and the
adequacy of intellectual property protection;
(10) the impact of legislative and regulatory actions and reforms and
regulatory, supervisory or enforcement actions of government
agencies relating to the Company, the Manager or The PNC Financial
Services Group, Inc. ("PNC Bank");
(11) terrorist activities, which may adversely affect the general
economy, real estate, financial and capital markets, specific
industries, and the Company and the Manager;
(12) the ability of the Manager to attract and retain highly talented
professionals.
(13) fluctuations in foreign currency exchange rates; and
(14) the impact of changes to tax legislation and, generally, the tax
position of the Company.
Forward-looking statements speak only as of the date they are made. The Company
does not undertake, and specifically disclaims any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
PART I
ITEM 1. BUSINESS
All dollar figures expressed herein are expressed in thousands, except share or
per share amounts.
General
The Company, a Maryland corporation, is a real estate finance company that
generates income based on the spread between the interest income on its
mortgage loans and securities investments and the interest expense from
borrowings to finance its investments. The Company's primary activity is
investing in high yielding commercial real estate debt. The Company combines
traditional real estate underwriting and capital markets expertise to exploit
the opportunities arising from the continuing integration of these two
disciplines. The Company focuses on acquiring pools of performing loans in the
form of commercial mortgage-backed securities ("CMBS"), issuing secured debt
backed by CMBS and providing strategic capital for the commercial real estate
industry in the form of mezzanine loan financing. The Company commenced
operations on March 24, 1998.
The Company's common stock is traded on the New York Stock Exchange under the
symbol "AHR". The Company's primary long-term objective is to distribute
consistent dividends supported by earnings. The Company establishes its
dividend by analyzing the long-term sustainability of earnings given existing
market conditions and the current composition of its portfolio. This includes
an analysis of the Company's credit loss assumptions, general level of interest
rates and projected hedging costs.
The Company is managed by BlackRock Financial Management, Inc. (the "Manager"),
a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK) asset management
company with over $341,800,000 of assets under management as of December 31,
2004. The Manager provides an operating platform that incorporates significant
asset origination, risk management, and operational capabilities.
The Company's ongoing investment activities encompass two core investment
activities:
1) Commercial Real Estate Securities
2) Commercial Real Estate Loans
The commercial real estate securities portfolio provides diversification and
high yields that are adjusted for anticipated losses over a period of time
(typically, a ten-year weighted average life) and can be financed through the
issuance of secured debt that matches the life of the investment. Commercial
real estate loans provide attractive risk adjusted returns over shorter periods
of time through strategic investments in specific property types or regions.
The Company believes these portfolios can serve to provide stable earnings over
time.
During the third quarter of 2004, the Company completed its repositioning into
commercial real estate assets. As of December 31, 2004, CMBS and commercial
real estate loans represented 90% of portfolio assets while residential
mortgage-backed securities ("RMBS") represented 10%.
Commercial Real Estate Securities
The Company's principal activity is to underwrite and acquire high yielding
CMBS that are rated below investment grade. The Company's CMBS are securities
backed by pools of loans secured by first mortgages on commercial real estate
throughout the United States. The commercial real estate securing the first
mortgages consist of income producing properties including office buildings,
shopping centers, apartment buildings, industrial properties, healthcare
properties, and hotels, among others. The terms of a typical loan include a
fixed rate of interest, thirty-year amortization, some form of prepayment
protection, and a large interest rate increase if not paid off at maturity. The
loans are originated by various lenders and pooled together in trusts which
issue securities in the form of various classes of fixed rate debt secured by
the cash flows from the underlying loans. The securities issued by the trusts
are rated by one or more nationally recognized credit rating organizations and
are rated AAA down to CCC. The security that is affected first by loan losses
is not rated. The principal amount of the pools of loans securing the CMBS
securities varies.
Each trust has a designated special servicer. Special servicers are responsible
for carrying out loan loss mitigation strategies. A servicer will also advance
funds to a trust to maintain principal and interest cash flows on the trust's
securities provided it believes there is a significant probability of
recovering those advances from the underlying borrowers. The servicer is paid
interest on advanced funds and a fee for its efforts in carrying out loss
mitigation strategies.
The Company focuses on acquiring the securities rated below investment grade
(BB+ or lower). The most subordinated CMBS classes are the first to absorb
realized losses in the loan pools. To the extent there are losses in excess of
the most subordinated class' stated entitlement to principal and interest, then
the remaining CMBS classes will bear such losses in order of their relative
subordination. If a loss of face value, or par, is experienced in the
underlying loans, a corresponding reduction in the par of the lowest rated
security occurs, reducing the cash flow entitlement. The majority owner of the
first loss position has the right to control the workout process and therefore
designate the trust's special servicer. The Company will generally seek to
control the workout process in each of its CMBS transactions by purchasing the
majority of the trust's non-rated securities and sequentially rated securities
as high as BB+. Typically, the par amount of all securities that are rated
below investment grade represents 2.75% - 6.0% of the par of the underlying
loans of newly issued CMBS transactions. This is known as the subordination
level because 2.75% - 6.0% of the loan balance is subordinated to the senior,
investment grade rated securities.
The Company does not typically purchase a BB- rated security unless the Company
is involved in the new issue due diligence process and has a clear pari-passu
alignment of interest with the special servicer, or we can appoint the special
servicer. The Company purchases BB+ and BB rated securities at their original
issue or in the secondary market without necessarily having control of the
workout process. BB+ and BB rated CMBS do not absorb losses until the BB- and
lower rated securities have experienced losses of their entire principal
amounts. The Company believes the 2.5% - 4.0% subordination levels of these
securities provide additional credit protection and diversification with an
attractive risk return profile.
As of December 31, 2004, the Company owns 16 different trusts ("Controlling
Class") where the Company through its investment in subordinated CMBS of such
trusts is in the first loss position. As a result of this investment position,
the Company controls the workout process on $18,580,729 of underlying loans.
The total par amount owned of these subordinated Controlling Class securities
is $631,649. The Company does not own the senior securities that represent the
remaining par amount of the underlying mortgage loans. The special servicer on
11 of the 16 trusts is Midland Loan Services, Inc., the special servicer on two
trusts is GMAC Commercial Mortgage Management, Inc., and the special servicer
on the remaining three trusts is Lennar Partners, Inc.
The Company also purchases investment grade commercial real estate related
securities in the form of CMBS and unsecured debt of commercial real estate
companies. The addition of these higher rated securities is intended to add
greater stability to the long-term performance of the Company's portfolios as a
whole and to provide greater diversification to optimize secured financing
alternatives. The Company generally seeks to assemble a portfolio of high
quality issues that will maintain consistent performance over the life of the
security.
The Company also acquires CMBS interest only securities ("IOs"). These
securities represent a portion of the interest coupons paid by the underlying
loans. The Company views this portfolio as an attractive relative value versus
other alternatives. These securities do not have significant prepayment risk
because the underlying loans generally have prepayment restrictions.
Furthermore, the credit risk is also mitigated because the IO represents a
portion of all underlying loans, not solely the first loss.
Owning commercial real estate loans in these forms allows the Company to earn
its loss-adjusted returns over a period of time while achieving significant
diversification across geographic areas and property types.
On November 9, 2004, the Company closed its fourth collateralized debt
obligation ("CDO") secured by a portfolio of below investment grade CMBS ("CDO
HY1"). The transaction was accounted for as a sale in accordance with Statement
of Financial Accounting Standard ("SFAS") No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." The
Company received cash proceeds of $140,425 as well as all of the CDO HY1
preferred shares that had a fair market value of $15,885 as of December 31,
2004 in exchange for the collateral. The collateral was carried at a fair
market value of $109,933 on the Company's September 30, 2004 consolidated
statement of financial condition based on price quotes received from third
parties. The transaction raised reinvestable proceeds of $95,799. The following
table summarizes the impact of this transaction on fourth quarter 2004 results
and per share amounts:
Realized gain at closing of CDO HY1 $14,769 $0.28
Realized gain from subsequent sale of A- tranche 1,825 0.03
Increase in accumulated other comprehensive income 29,782 0.56
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Total book value impact $46,376 $0.87
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The following table indicates the amounts of each category of commercial real
estate securities the Company owns as of December 31, 2004. The dollar price
("Dollar Price") represents the estimated fair value or adjusted purchase price
of a security, respectively, relative to its par value.
Estimated Adjusted Loss
Fair Dollar Purchase Dollar Adjusted
Assets Par Value Price Price* Price Yield
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Investment Grade
Commercial Real
Estate Related Securities $ 668,101 $692,054 103.59 $674,167 100.91 5.83%
CMBS IOs 3,712,604 125,246 3.37 122,379 3.30 7.31%
Other Below Investment
Grade CMBS 332,225 313,282 94.30 290,771 87.52 8.51%
Controlling Class CMBS 661,483 473,521 71.58 452,086 68.34 9.48%
CDO Investments 203,182 19,836 9.76 19,450 9.57 56.65%
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Total $5,577,595 $1,623,939 29.12 $1,558,854 27.95 8.14%
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* The adjusted purchase price represents the amortized cost of the Company's investments.
The Company finances the majority of these portfolios with match funded,
secured term debt through CDO offerings. To accomplish this, the Company forms
a special purpose entity ("SPE") and contributes a portfolio of mostly below
investment grade CMBS, investment grade CMBS, and unsecured debt of commercial
real estate companies in exchange for the preferred equity interest in the SPE.
With the exception of CDO HY1, these transactions are considered financings and
the SPEs are fully consolidated on the Company's consolidated financial
statements. The SPE will then issue fixed and floating rate debt secured by the
cash flows of the securities in its portfolio. The SPE will enter into an
interest rate swap agreement to convert the floating rate debt issued to a
fixed interest rate, thus matching the cash flow profile of the underlying
portfolio. The structure of the CDO debt also eliminates the mark to market
requirement of other types of financing, thus eliminating the need to provide
additional collateral if the value of the underlying portfolio declines. The
debt issued by the SPE is generally rated AAA down to BB; due to its preferred
equity interest, the Company continues to manage the credit risk of the
underlying portfolio as it did prior to the assets being contributed to the
CDO. The CDO provides an optimal capital structure to maximize returns on these
types of portfolios on a non-recourse basis. Other forms of financing used for
these types of assets include multi-year committed financing facilities and
30-day reverse repurchase agreements.
The following table indicates the market values of each category of commercial
real estate securities collateralizing different types of borrowings as of
December 31, 2004:
Market Value Securing
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Reverse Committed Not
CDO Debt Repo Facilities Financed Total
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Investment Grade Commercial Real Estate
Related Securities $478,645 $182,165 $ - $31,243 $692,053
CMBS IOs - 115,214 - 10,032 125,246
Other Below Investment
Grade CMBS 286,748 1,483 - 25,051 313,282
Controlling Class CMBS 412,064 30,979 9,217 21,261 473,521
CDO Investments - - - 19,837 19,837
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Total $1,177,457 $329,841 $9,217 $107,424 $1,623,939
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Prior to acquiring Controlling Class securities, the Company performs a
significant amount of due diligence on the underlying loans to ensure their
risk profiles fit the Company's criteria. Loans that do not fit the Company's
criteria are either removed from the pool or price adjustments occur. The debt
service coverage ratios are evaluated to determine if they are appropriate for
each asset class. The average loan to value ratio ("LTV") of the underlying
loans is generally 70% at origination. Due to its greater levels of credit
protection, other below investment grade CMBS are subject to less comprehensive
due diligence than Controlling Class securities.
As part of the underwriting process, the Company assumes a certain amount of
loans will incur losses over time. In performing continuing credit reviews on
the 16 Controlling Class trusts, the Company estimates that $418,995 of
principal of the underlying loans will not be recoverable. This amount
represents 2.02% of the underlying loan pools and 66.3% of the par amount of
the subordinated Controlling Class securities owned by the Company. This loss
assumption is used to compute a loss adjusted yield, which is then used to
report income on the Company's consolidated financial statements. The weighted
average loss adjusted yield for all subordinated Controlling Class securities
is 9.56%. For all Controlling Class securities with a rating of BB- and below,
the weighted average loss adjusted yield is 10.3%. If the loss assumptions
prove to be consistent with actual loss experience, the Company will maintain
that level of income for the life of the security. As actual losses differ from
the original loss assumptions, yields are adjusted to reflect the updated
assumptions. A write down of the adjusted purchase price or write up of loss
adjusted yields of the security may also be required (See Item 7A
-"Quantitative and Qualitative Disclosures About Market Risk" for more
information on the sensitivity of the Company's income and adjusted purchase
price to changes in credit experience).
Once acquired, the Company uses a performance monitoring system to track the
credit experience of the mortgages in the pools securing both the Controlling
Class and the other below investment grade CMBS. The Company receives
remittance reports monthly from the trustees and closely monitors any
delinquent loans or other issues that may affect the performance of the loans.
The special servicer of a loan pool also assists in this process. The Company
reviews its loss assumptions every quarter using updated payment and debt
service coverage information on each loan in the context of economic trends on
both a national and regional level.
The Company's anticipated yields on its investments are based upon a number of
assumptions that are subject to certain business and economic uncertainties and
contingencies. Examples of such contingencies include, among other things, the
timing and severity of expected credit losses, the rate and timing of principal
payments (including prepayments, repurchases, defaults, liquidations, special
servicer fees, and other related expenses), the pass-through or coupon rate,
and interest rate fluctuations. Additional factors that may affect the
Company's anticipated yields on its Controlling Class CMBS include interest
payment shortfalls due to delinquencies on the underlying mortgage loans, the
timing and magnitude of credit losses on the mortgage loans underlying the
Controlling Class CMBS that are a result of the general condition of the real
estate market (including competition for tenants and their related credit
quality), and changes in market rental rates. As these uncertainties and
contingencies are difficult to predict and are subject to future events, which
may alter these assumptions, no assurance can be given that the Company's
anticipated yields to maturity will be maintained.
Commercial Real Estate Loans
The Company's loan activity is focused on providing mezzanine capital to the
commercial real estate industry. The Company targets well capitalized real
estate operators with strong track records and compelling business plans
designed to enhance the value of their real estate. These loans are generally
subordinated to a senior lender or first mortgage and are priced to reflect a
higher return. The Company has significant experience in closing large, complex
loan transactions and can deliver a timely and competitive financing package.
The types of investments in this class include subordinated participations in
first mortgages, loans secured by partnership interests, preferred equity
interests in real estate limited partnerships and loans secured by second
mortgages. The weighted average life of these investments is generally two to
three years and average leverage is 1:1 debt to equity generally funded with
committed financing facilities. These investments have fixed or floating rate
coupons and some provide additional earnings through an internal rate of return
("IRR") look back or gross revenue participation.
The Company performs significant due diligence before making investments to
evaluate risks and opportunities in this sector. The Company generally focuses
on strong sponsorship, attractive real estate fundamentals, and pricing and
structural characteristics that provide significant control over the underlying
asset.
Since 2001, the Company's activity in this sector has generally been conducted
through Carbon Capital, Inc. ("Carbon I") and Carbon Capital II, Inc. ("Carbon
II"and collectively with Carbon I, the "Carbon Capital Funds"), private
commercial real estate income opportunity funds. As of December 31, 2004, the
Company owned approximately 20% of Carbon I as well as approximately 20% of
Carbon II. Various institutional investors, an affiliate of the Manager and PNC
Bank own the remainder. The Manager also manages the Carbon Capital Funds. The
Company does not incur any additional management or incentive fees to the
Manager as a result of its investment in the Carbon Capital Funds. In certain
cases the Manager may be paid up to 1.0% of an investment's par as an
origination fee. The Company believes the use of the Carbon Capital Funds
allows it to invest in larger institutional quality assets with greater
diversification. The Company's consolidated financial statements include its
share of the net assets and income of the Carbon Capital Funds.
During 2001, the Company entered into a $50,000 commitment to acquire shares in
Carbon I, a private commercial real estate income opportunity fund managed by
the Manager. The Carbon I investment period ended on July 12, 2004. No
additional capital will be called. The Company's investment in Carbon I as of
December 31, 2004 was $39,563.
On October 6, 2004, the Company entered into a $30,000 commitment to acquire
shares in Carbon Capital II. On November 19, 2004 the Company entered into an
additional $32,067 commitment to acquire shares in Carbon II. During 2004, the
Company received capital call notices of $16,953. The proceeds were used by
Carbon II to purchase nine commercial mortgage loans. As of December 31, 2004,
the Company's investment in Carbon II was $17,249 and the Company's remaining
commitment to Carbon II is $45,114.
On December 31, 2004, the Company owned commercial real estate loans with a
carrying value of $375,811. The average yield of this portfolio at December 31,
2004 was 9.1%. The majority of these loans pay interest based on the one-month
London Interbank Offered Rate ("LIBOR"). Commercial real estate loans with a
carrying value of $102,694 were held in the Carbon Capital Funds and $273,117
were held directly. The Company and the Carbon Capital Funds each have
committed financing facilities used to finance these assets.
During the year ended December 31, 2004, the Company invested $226,997 in new
loans and received par payoffs of $23,285. In addition, during 2004, the Company
invested $29,453 in the Carbon Capital Funds and received a return of capital
of $6,719.
Hedging Activities
The Company enters into hedging transactions to protect its investment
portfolio and related borrowings from interest rate fluctuations and other
changes in market conditions. These transactions may include interest rate
swaps, the purchase or sale of interest rate collars, caps or floors, options,
and other hedging instruments. These instruments may be used to hedge as much
of the interest rate risk as the Manager determines is in the best interest of
the Company's stockholders, given the cost of such hedges. The Manager may
elect to have the Company bear a level of interest rate risk that could
otherwise be hedged when the Manager believes, based on all relevant facts,
that bearing such risk is advisable. The Manager has extensive experience in
hedging mortgages, mortgage-related assets and related borrowings with these
types of instruments.
Hedging instruments often are not traded on regulated exchanges, guaranteed by
an exchange or its clearinghouse, or regulated by any U.S. or foreign
governmental authorities. The Company will enter into these transactions only
with counter parties with long-term debt rated A or better by at least one
nationally recognized credit rating organization. The business failure of a
counter party with which the Company has entered into a hedging transaction
will most likely result in a default, which may result in the loss of
unrealized profits. Although the Company generally will seek to reserve for
itself the right to terminate its hedging positions, it may not always be
possible to dispose of or close out a hedging position without the consent of
the counter party, and the Company may not be able to enter into an offsetting
contract in order to cover its risk. There can be no assurance that a liquid
secondary market will exist for hedging instruments purchased or sold, and the
Company may be required to maintain a position until exercise or expiration,
which could result in losses.
The Company's hedging activities are intended to address both income and
capital preservation. Income preservation refers to maintaining a stable spread
between yields from mortgage assets and the Company's borrowing costs across a
reasonable range of adverse interest rate environments. Capital preservation
refers to maintaining a relatively steady level in the market value of the
Company's capital across a reasonable range of adverse interest rate scenarios.
However, no strategy can insulate the Company completely from changes in
interest rates.
From time to time, the Company may modify its exposure to market interest rates
by entering into various financial instruments that adjust portfolio duration
and short-term rate exposure. These financial instruments are intended to
mitigate the effect of changes in interest rates on the value of the Company's
assets and the cost of borrowing.
At December 31, 2004, the Company had no outstanding futures contracts. At
December 31, 2003, the Company had outstanding short positions of 30 five-year
and 73 ten-year U.S. Treasury Note future contracts. At December 31, 2004 and
2003, the Company had a forward LIBOR cap with a notional amount of $85,000 and
a fair value of $694 and $1,114, respectively.
Swap agreements as of December 31, 2004 and 2003 consisted of the following:
As of December 31, 2004
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Estimated Fair Unamortized Average Remaining
Notional Value Value Cost Term (years)
-------------------------------------------------------------------------
Cash flow hedges $452,600 $253 - 5.44
Trading swaps 16,000 (5) - 1.94
CDO cash flow hedges 718,120 (11,262) - 8.50
CDO timing swaps 223,445 145 - 8.08
As of December 31, 2003
-------------------------------------------------------------------------
Estimated Fair Unamortized Average Remaining
Notional Value Value Cost Term (years)
-------------------------------------------------------------------------
Cash flow hedges $611,300 $(4,442) - 6.53
Trading swaps 308,000 1,513 - 3.34
CDO cash flow hedges 454,778 (23,651) - 8.51
CDO timing swaps 171,545 29 - 8.61
The counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch
Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special
Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-,
respectively. The Company continually monitors the rating and overall credit
quality of its swap counterparties.
Financing and Leverage
The Company has financed its assets with the net proceeds of its stock
offerings, the issuance of common stock under the Company's Dividend
Reinvestment and Stock Purchase Plan (the "Dividend Reinvestment Plan"), the
issuance of preferred stock, long-term secured borrowings, short-term
borrowings under repurchase agreements, and the lines of credit discussed
below. In the future, operations may be financed by future offerings of equity
securities, as well as unsecured and secured borrowings. The Company expects
that, in general, it will employ leverage consistent with the type of assets
acquired and the desired level of risk in various investment environments. The
Company's governing documents do not explicitly limit the amount of leverage
that the Company may employ. Instead, the Board of Directors has adopted an
indebtedness policy for the Company that limits total leverage to a maximum 6.0
to 1 debt to equity ratio. Subsequent to December 31, 2004, the Board of
Directors adopted a new indebtedness policy for the Company that limits
recourse debt to a maximum of 3.0 to 1. The Company's recourse debt-to-equity
ratio of 1.6 to 1 was in compliance with the revised policy as of December 31,
2004. The Company anticipates that it will maintain recourse debt-to-equity
ratios between 1.0 to 1 and 3.0 to 1 in the foreseeable future, although this
ratio may be higher or lower at any time. The Board of Directors may change the
Company's indebtedness policy at any time in the future.
On May 29, 2002, the Company issued ten tranches of secured debt through a
collateralized debt obligation ("CDO I"). In this transaction, a wholly owned
subsidiary of the Company issued secured debt in the par amount of $419,185
secured by the subsidiary's assets. The adjusted issue price of the CDO I debt,
as of December 31, 2004, was $405,377. Five tranches were issued at a fixed
rate coupon and five tranches were issued at a floating rate coupon with a
combined weighted average remaining maturity of 7.29 years as of December 31,
2004. All floating rate coupons were swapped to fixed rate coupons resulting in
a total fixed rate cost of funds for CDO I of approximately 7.21%.
On December 10, 2002, the Company issued seven tranches of secured debt through
a second collateralized debt obligation ("CDO II"). In this transaction, a
wholly owned subsidiary of the Company issued secured debt in the par amount of
$280,783 secured by the subsidiary's assets. In July 2004, the Company issued a
bond with a par of $12,850 from CDO II that it had previously retained. Before
issuing this security, the Company amended the indenture to reduce the coupon
from 9.0% to 7.6%. The adjusted issue price of the CDO II debt as of December
31, 2004 was $293,167. Five tranches were issued at a fixed rate coupon and
three tranches were issued at a floating rate coupon with a combined weighted
average remaining maturity of 7.72 years as of December 31, 2004. All floating
rate coupons were swapped to fixed rate coupons, resulting in a total fixed
rate cost of funds for CDO II of approximately 5.79%.
Included in CDO II was a ramp facility that was utilized to fund the purchase
of an additional $50,000 of par of below investment grade CMBS. The Company
utilized the ramp in February 2003 and July 2003, to contribute $30,000 of par
of CSFB 03-CPN1 and $20,000 of par of GECMC 03-C2, respectively.
On March 30, 2004 the Company issued its third collateralized debt obligation
("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold
was $372,456. The adjusted issue price of the CDO III debt as of December 31,
2004 was $369,422. Five tranches were issued at a fixed rate coupon and six
tranches were issued at a floating rate coupon with a combined weighted average
remaining maturity of 8.39 years as of December 31, 2004. All floating rate
coupons were swapped to fixed rate coupons resulting in a total fixed rate cost
of funds for CDO I of approximately 5.03%. Included in CDO III was a $50,000
ramp facility that was fully utilized as of December 31, 2004.
The Company has a $200,000 committed credit facility with Deutsche Bank, AG
(the "Deutsche Bank Facility"), which matures on December 20, 2007. The
Deutsche Bank Facility can be used to replace existing reverse repurchase
agreement borrowings and to finance the acquisition of mortgage-backed
securities, loan investments, and investments in real estate joint ventures. As
of December 31, 2004 and 2003, the outstanding borrowings under this facility
were $126,349 and $82,406, respectively. Outstanding borrowings under the
Deutsche Bank Facility bear interest at a LIBOR based variable rate.
On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. Outstanding borrowings under this credit facility
bear interest at a LIBOR based variable rate. As of December 31, 2004,
outstanding borrowings under this facility were $24,527. As of December 31,
2003, outstanding borrowings under this facility were $7,530.
At December 31, 2004, the Company had outstanding borrowings of $12,800 under a
$13,000 committed credit facility with Morgan Stanley Mortgage Capital, Inc.
The Morgan Stanley Mortgage Capital, Inc. facility matures May 11, 2006.
The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth of $305,000 as determined under generally
accepted accounting principles in the United States of America ("GAAP"), a
debt-to-equity ratio not to exceed 5.5 to 1, a recourse debt-to-equity of 3.0
to 1, a minimum cash requirement based upon certain debt-to-equity ratios, a
minimum debt service coverage ratio of 1.5 and a minimum liquidity reserve of
$10,000. The Company received authorization from its lenders to permit debt to
equity ratios in excess of existing covenants and a debt service coverage ratio
less than 1.5. As of December 31, 2004 and 2003, the Company was in compliance
with all other covenants.
As part of the CORE Cap Inc. merger ("CORE Cap"), the Company authorized and
issued 2,261,000 shares of Series B Preferred Stock, $0.001 par value per share
("Series B Preferred Stock"), to CORE Cap stockholders. The Series B Preferred
Stock was perpetual, carried a 10% coupon, had a preference in liquidation as
of December 31, 2003 of $43,942, and was convertible into the Company's Common
Stock at a price of $17.09 per share, subject to adjustment.
At the end of the first quarter of 2004, the Board of Directors approved the
Company's decision to redeem its Series B Preferred Stock, $0.001 par value per
share ("Series B Preferred Stock"). The second quarter of 2004 earnings
includes a charge of $0.21 per share for the redemption of the Company's Series
B Preferred. All the Series B Preferred Stock was redeemed on May 6, 2004.
On May 29, 2003, the Company authorized and issued 2,300,000 shares of 9.375%
Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Stock"),
par value $0.001 per share. The Series C Preferred Stock is perpetual, carries
a 9.375% coupon, and has a preference in liquidation of $57,500. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $55,435.
For the year ended December 31, 2004, the Company issued 1,084,619 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $12,691. For the year ended December 31, 2003, the Company
issued 1,955,919 shares of Common Stock under its Dividend Reinvestment Plan.
Net proceeds to the Company were approximately $21,134.
For the years ended December 31, 2004 and 2003, the Company issued 294,400 and
45,000 shares of Common Stock under a sale agency agreement with Brinson
Patrick Securities Corporation. Net proceeds to the Company were approximately
$3,210 and $497, respectively.
The Company has entered into reverse repurchase agreements to finance its
securities that are not financed under its lines of credit or CDOs. The reverse
repurchase agreements collateralized by most of these securities bear interest
at rates that have historically moved in close relationship to LIBOR.
Further information with respect to the Company's collateralized borrowings at
December 31, 2004 is summarized as follows:
Commercial Total
Lines of Reverse Repurchase Mortgage Collateralized Collateralized
Credit Agreements Loan Pools Debt Obligations Borrowings
-------------- ------------------- -------------- ----------------- ----------------
Commercial Real Estate Securities
Outstanding Borrowings $5,798 $284,224 $- $1,083,471* $1,373,493
Weighted average borrowing rate 3.76% 2.62% - 6.04% 5.32%
Weighted average remaining
maturity days 192 30 - 2,942 2,328
Estimated fair value of assets
pledged $9,217 $339,073 $- $1,202,760 $1,551,050
Residential Mortgage-Backed Securities
Outstanding Borrowings - $356,451 $- - $356,451
Weighted average borrowing rate - 2.36% - - 2.36%
Weighted average remaining -
maturity days - 23 - 23
Estimated fair value of assets -
pledged - $372,071 $- $372,071
Commercial Mortgage Loan Pools
Outstanding Borrowings $773 - $1,294,058 - $1,294,830
Weighted average borrowing rate 3.61% - 3.76% - 3.76%
Weighted average remaining -
maturity days 189 - 2,587 2,585
Estimated fair value of assets -
pledged $1,339 - $1,312,045 $1,313,384
Commercial Real Estate Loans
Outstanding Borrowings $141,601 - - - $141,601
Weighted average borrowing rate 3.47% - - - 3.47%
Weighted average remaining - - -
maturity days 222 222
Estimated fair value of assets - - -
pledged $211,566 $211,566
* $15.054 of the Company's CDO debt is the financing of CDO bonds that the Company has chosen not to sell and
financed under its lines of credit.
At December 31, 2004, the Company's collateralized borrowings had the following remaining maturities:
Reverse Commercial Total
Lines of Repurchase Mortgage Loan Collateralized Collateralized
Credit Agreements Pools Debt Obligations Borrowings
---------------- ------------------- ------------------- ------------------- ------------------
Within 30 days $ - $605,944 $- $ - $605,944
31 to 59 days - 7,925 - - 7,925
Over 60 days 163,676 26,806 1,294,058 1,067,967 2,552,507
---------------- ------------------- ------------------- ------------------- ------------------
$163,676 $640,675 $1,294,058 $1,067,967 $3,166,376
================ =================== =================== =================== ==================
As of December 31, 2004, $73,651 of the Company's $200,000 Deutsche Bank
Facility was available for future borrowings and $50,473 of the Company's
$75,000 committed credit facility with Greenwich Capital, Inc. was available.
Certain information with respect to the Company's collateralized borrowings at
December 31, 2003 is summarized as follows:
Reverse Total
Lines of Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
------------ ---------------- ----------------- ----------------
Commercial Real Estate Securities
Outstanding Borrowings $67,226 $360,629 $684,970 $1,112,825
Weighted average borrowing rate 2.26% 1.46% 6.60% 4.68%
Weighted average remaining maturity days 562 17 3,033 1,906
Estimated fair value of assets pledged $110,652 $423,244 $770,575 $1,304,471
Residential Mortgage-Backed Securities
Outstanding Borrowings - $688,006 - $688,006
Weighted average borrowing rate - 1.12% - 1.12%
Weighted average remaining maturity days - 24 - 24
Estimated fair value of assets pledged - $714,296 - $714,296
Real Estate Joint Ventures
Outstanding Borrowings $513 - - $513
Weighted average borrowing rate 3.12% - - 3.12%
Weighted average remaining maturity days 212 - - 212
Estimated fair value of assets pledged $2,750 - - $2,750
Commercial Real Estate Loans
Outstanding Borrowings $22,197 - - $22,197
Weighted average borrowing rate 2.79% - - 2.79%
Weighted average remaining maturity days 254 - - 254
Estimated fair value of assets pledged $33,206 - - $33,206
At December 31, 2003, the Company's collateralized borrowings had the following remaining maturities:
Total
Lines of Reverse Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
-------------- --------------------- ------------------- ----------------
Within 30 days $ - $1,048,635 $ - $1,048,635
31 to 59 days - - - -
Over 60 days 89,936 - 684,970 774,906
-------------- --------------------- ------------------- ----------------
$89,936 $1,048,635 $684,970 $1,823,541
============== ===================== =================== ================
As of December 31, 2003, $102,594 of the Company's $185,000 Deutsche Bank
Facility was available for future borrowings and $67,470 of the Company's
$75,000 committed credit facility with Greenwich Capital, Inc. was available.
Under the lines of credit and the reverse repurchase agreements, the respective
lender retains the right to mark the underlying collateral to estimated market
value. A reduction in the value of pledged assets would require the Company to
provide additional collateral or fund cash margin calls. From time to time, the
Company may be required to provide additional collateral or fund margin calls.
The Company maintains adequate liquidity to meet such calls.
Risks
Risk is an inherent part of investing in high yielding commercial real estate
debt. Risk management is considered to be of paramount importance to the
Company's day-to-day operations. Consequently, the Company devotes significant
resources across all its operations to the identification, measurement,
monitoring, management and analysis of risk.
Risks related to our manager
Conflicts of interest of the Manager may result in decisions that do
not fully reflect stockholders' best interests.
The Company and the Manager have common officers and directors, which
may present conflicts of interest in the Company's dealings with the
Manager and its affiliates, including the Company's purchase of assets
originated by such affiliates. For example, the Company may purchase
certain mortgage assets from PNC Bank, an affiliate of PNC Bancorp,
Inc. which owns approximately 71% of the outstanding capital stock of
the Manager's parent company, BlackRock, Inc as of December 31, 2004.
The Manager and its employees may engage in other business activities
that could reduce the time and effort spent on the management of the
Company. The Manager also provides services to real estate investment
trusts ("REITs") not affiliated with us. As a result, there may be a
conflict of interest between the operations of the Manager and its
affiliates in the acquisition and disposition of mortgage assets. In
addition, the Manager and its affiliates may from time to time
purchase mortgage assets for their own account and may purchase or
sell assets from or to the Company. For example, BlackRock Realty
Advisors, Inc., a subsidiary of the Manager, provides real estate
equity and other real estate related products and services in a
variety of strategies to its institutional investor client base. In
doing so, it purchases real estate that may underlie the real estate
loans and securities the Company acquires, and consequently depending
on the factual circumstances involved, there may be conflicts between
the Company and those investors. Such conflicts may result in
decisions and allocations of mortgage assets by the Manager, or
decisions by the Manager's affiliates, that are not in the Company's
best interests.
Although the Company has adopted investment guidelines, these
guidelines give the Manager significant discretion in investing. The
Company's investment and operating policies and the strategies that
the Manager uses to implement those policies may be changed at any
time without the consent of stockholders.
The Company is dependent on the Manager, and the termination by the
Company of its management agreement with the Manager could result in a
termination fee.
The Company's success is dependent on the Manager's ability to attract
and retain quality personnel. The market for portfolio managers,
investment analysts, financial advisers and other professionals is
extremely competitive. There can be no assurance the Manager will be
successful in its efforts to recruit and retain the required
personnel.
The management agreement between the Company and the Manager provides
for base management fees payable to the Manager without consideration
of the performance of the Company's portfolio and also provides for
incentive fees based on certain performance criteria, which could
result in the Manager recommending riskier or more speculative
investments. Termination of the management agreement between the
Company and the Manager by the Company would result in the payment of
a substantial termination fee, which could adversely affect the
Company's financial condition. Termination of the management agreement
by the Company could also adversely affect the Company if the Company
were unable to find a suitable replacement.
There is a limitation on the liability of the Manager.
Pursuant to the management agreement, the Manager will not assume any
responsibility other than to render the services called for under the
management agreement and will not be responsible for any action of the
Company's board of directors in following or declining to follow its
advice or recommendations. The Manager and its directors and officers
will not be liable to the Company, any of its subsidiaries, its
unaffiliated directors, its stockholders or any subsidiary's
stockholders for acts performed in accordance with and pursuant to the
management agreement, except by reason of acts constituting bad faith,
willful misconduct, gross negligence or reckless disregard of their
duties under the management agreement. The Company has agreed to
indemnify the Manager and its directors and officers with respect to
all expenses, losses, damages, liabilities, demands, charges and
claims arising from acts of the Manager not constituting bad faith,
willful misconduct, gross negligence or reckless disregard of duties,
performed in good faith in accordance with and pursuant to the
management agreement.
Risks related to our business
Interest rate fluctuations will affect the value of the Company's
mortgage assets, net income and common stock.
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. Interest rate fluctuations can adversely affect the
income and value of the Company's common stock in many ways and
present a variety of risks, including the risk of a mismatch between
asset yields and borrowing rates, variances in the yield curve and
changing prepayment rates.
The Company's operating results depend in large part on differences
between the income from its assets (net of credit losses) and
borrowing costs. The Company funds a substantial portion of its assets
with borrowings that have interest rates that reset relatively
rapidly, such as monthly or quarterly. The Company anticipates that,
in most cases, the income from its assets will respond more slowly to
interest rate fluctuations than the cost of borrowings, creating a
potential mismatch between asset yields and borrowing rates.
Consequently, changes in interest rates, particularly short-term
interest rates, may significantly influence the Company's net income.
Increases in these rates tend to decrease the Company's net income and
market value of the Company's net assets. Interest rate fluctuations
that result in the Company's interest expense exceeding interest
income would result in the Company incurring operating losses.
The Company also invests in fixed-rate mortgage-backed securities. In
a period of rising interest rates, the Company's interest payments
could increase while the interest the Company earns on its fixed-rate
mortgage-backed securities would not change. This would adversely
affect the Company's profitability.
The relationship between short-term and long-term interest rates is
often referred to as the "yield curve." Ordinarily, short-term
interest rates are lower than long-term interest rates. If short-term
interest rates rise disproportionately relative to long-term interest
rates (a flattening of the yield curve), the Company's borrowing costs
may increase more rapidly than the interest income earned on the
Company's assets. Because the Company's borrowings will primarily bear
interest at short-term rates and the Company's assets will primarily
bear interest at medium-term to long-term rates, a flattening of the
yield curve tends to decrease the Company's net income and market
value of the Company's net assets. Additionally, to the extent cash
flows from long-term assets that return scheduled and unscheduled
principal are reinvested, the spread between the yields of the new
assets and available borrowing rates may decline and also may tend to
decrease the net income and market value of the Company's net assets.
It is also possible that short-term interest rates may adjust relative
to long-term interest rates such that the level of short-term rates
exceeds the level of long-term rates (a yield curve inversion). In
this case, the Company's borrowing costs may exceed the Company's
interest income and operating losses could be incurred.
Interest rate caps on the Company's mortgage-backed securities may
adversely affect the Company's profitability.
The Company's adjustable-rate mortgage-backed securities are typically
subject to periodic and lifetime interest rate caps. Periodic interest
rate caps limit the amount an interest rate can increase during any
given period. Lifetime interest rate caps limit the amount an interest
rate can increase through maturity of a mortgage-backed security. The
Company's borrowings are not subject to similar restrictions.
Accordingly, in a period of rapidly increasing interest rates, the
Company could experience a decrease in net income or a net loss
because the interest rates on its borrowings could increase without
limitation while the interest rates on its adjustable-rate
mortgage-backed securities would be limited by caps.
The Company's assets include subordinated CMBS which are subordinate
in right of payment to more senior securities.
The Company's assets include a significant amount of subordinated
CMBS, which are the most subordinate class of securities in a
structure of securities secured by a pool of loans and accordingly are
the first to bear the loss upon a restructuring or liquidation of the
underlying collateral and the last to receive payment of interest and
principal. The Company may not recover the full amount or, in extreme
cases, any of its initial investment in such subordinated interests.
Additionally, market values of these subordinated interests tend to be
more sensitive to changes in economic conditions than more senior
interests. As a result, such subordinated interests generally are not
actively traded and may not provide holders thereof with liquidity of
investment.
The Company's assets include mezzanine loans which have greater risks
of loss than more senior loans.
The Company's assets include a significant amount of mezzanine loans
that involve a higher degree of risk than long-term senior mortgage
loans. In particular, a foreclosure by the holder of the senior loan
could result in the mezzanine loan becoming unsecured. Accordingly,
the Company may not recover some or all of its investment in such a
mezzanine loan. Additionally, the Company may permit higher loan to
value ratios on mezzanine loans than it would on conventional mortgage
loans when the Company is entitled to share in the appreciation in
value of the property securing the loan.
Prepayment rates can increase which would adversely affect yields on
the Company's investments.
The yield on investments in mortgage loans and mortgage-backed
securities and thus the value of the Company's common stock is
sensitive to changes in prevailing interest rates and changes in
prepayment rates, which results in a divergence between the Company's
borrowing rates and asset yields, consequently reducing income derived
from the Company's investments.
The Company's ownership of non-investment grade mortgage assets
subjects the Company to an increased risk of loss.
The Company acquires mortgage loans and non-investment grade
mortgage-backed securities, which are subject to greater risk of
credit loss on principal and non-payment of interest in contrast to
investments in senior investment grade securities.
The Company's mortgage loans are subject to certain risks.
The Company acquires, accumulates and securitizes mortgage loans as
part of its investment strategy. While holding mortgage loans, the
Company is subject to risks of borrower defaults, bankruptcies, fraud
and special hazard losses that are not covered by standard hazard
insurance. Also, the costs of financing and hedging the mortgage loans
can exceed the interest income on the mortgage loans. In the event of
any default under mortgage loans held by the Company, the Company will
bear the risk of loss of principal to the extent of any deficiency
between the value of the mortgage collateral and the principal amount
of the mortgage loan. In addition, delinquency and loss ratios on the
Company's mortgage loans are affected by the performance of
third-party servicers and special servicers.
The Company invests in multifamily and commercial loans which involve
a greater risk of loss than single family loans.
The Company's investments include multifamily and commercial real
estate loans which are considered to involve a higher degree of risk
than single family residential lending because of a variety of
factors, including generally larger loan balances, dependency for
repayment on successful operation of the mortgaged property and tenant
businesses operating therein, and loan terms that include amortization
schedules longer than the stated maturity which provide for balloon
payments at stated maturity rather than periodic principal payments.
In addition, the value of multifamily and commercial real estate can
be affected significantly by the supply and demand in the market for
that type of property.
Limited recourse loans limit the Company's recovery to the value of
the mortgaged property.
A substantial portion of the mortgage loans the Company acquires may
contain limitations on the mortgagee's recourse against the borrower.
In other cases, the mortgagee's recourse against the borrower is
limited by applicable provisions of the laws of the jurisdictions in
which the mortgaged properties are located or by the mortgagee's
selection of remedies and the impact of those laws on that selection.
In those cases, in the event of a borrower default, recourse may be
limited to only the specific mortgaged property and other assets, if
any, pledged to secure the relevant mortgage loan. As to those
mortgage loans that provide for recourse against the borrower and
their assets generally, there can be no assurance that such recourse
will provide a recovery in respect of a defaulted mortgage loan
greater than the liquidation value of the mortgaged property securing
that mortgage loan.
The volatility of certain mortgaged property values may adversely
affect the Company's mortgage loans.
Commercial and multifamily property values and net operating income
derived from are subject to volatility and may be affected adversely
by a number of factors, including, but not limited to, national,
regional and local economic conditions (which may be adversely
affected by plant closings, industry slowdowns and other factors);
local real estate conditions (such as an oversupply of housing,
retail, industrial, office or other commercial space); changes or
continued weakness in specific industry segments; perceptions by
prospective tenants, retailers and shoppers of the safety,
convenience, services and attractiveness of the property; the
willingness and ability of the property's owner to provide capable
management and adequate maintenance; construction quality, age and
design; demographic factors; retroactive changes to building or
similar codes; and increases in operating expenses (such as energy
costs).
Leveraging the Company's investments may increase the Company's
exposure to loss.
The Company leverages its investments and thereby increases the
volatility of its income and net asset value that may result in
operating or capital losses. If borrowing costs increase, or if the
cash flow generated by the Company's assets decreases, the Company's
use of leverage will increase the likelihood that the Company will
experience reduced or negative cash flow and reduced liquidity.
The Company's investments may be illiquid and their value may decrease.
Many of the Company's assets are relatively illiquid. In addition,
certain of the mortgage-backed securities that the Company has
acquired or will acquire will include interests that have not been
registered under the relevant securities laws, resulting in a
prohibition against transfer, sale, pledge or other disposition of
those mortgage-backed securities except in a transaction that is
exempt from the registration requirements of, or otherwise in
accordance with, those laws. The Company's ability to vary its
portfolio in response to changes in economic and other conditions may
be relatively limited. No assurances can be given that the fair market
value of any of the Company's assets will not decrease in the future.
The Company's hedging transactions can limit the Company's gains and
increase the Company's exposure to losses.
The Company uses hedging strategies that involve risk and that may not
be successful in insulating the Company from exposure to changing
interest and prepayment rates. There can be no assurance that a liquid
secondary market will exist for hedging instruments purchased or sold,
and the Company may be required to maintain a position until exercise
or expiration, which could result in losses.
Failure to maintain REIT status would have adverse tax consequences.
To continue to qualify as a REIT, the Company must comply with
requirements regarding the nature of its assets and its sources of
income. If the Company is compelled to liquidate its mortgage-backed
securities, the Company may be unable to comply with these
requirements, ultimately jeopardizing its status as a REIT.
If in any taxable year the Company fails to qualify as a REIT:
o the Company would be subject to federal and state income tax on
its taxable income at regular corporate rates;
o the Company would not be allowed to deduct distributions to
stockholders in computing its taxable income; and
o unless the Company were entitled to relief under the United States
Internal Revenue Code of 1986, as amended (the "Code"), the
Company would also be disqualified from treatment as a REIT for
the four taxable years following the year during which the Company
lost qualification.
If the Company fails to qualify as a REIT, the Company might need to
borrow funds or liquidate some investments in order to pay the
additional tax liability. Accordingly, funds available for investment
or distribution to the Company's stockholders would be reduced for
each of the years involved.
Qualification as a REIT involves the application of highly technical
and complex provisions of the Code to the Company's operations and the
determination of various factual matters and circumstances not
entirely within the Company's control. There are only limited judicial
or administrative interpretations of these provisions. Although the
Company operates in a manner consistent with the REIT qualification
rules, there cannot be any assurance that the Company is or will
remain so qualified.
In addition, the rules dealing with federal income taxation are
constantly under review by persons involved in the legislative process
and by the Internal Revenue Service and the United States Department
of the Treasury. Changes to the tax law could adversely affect the
Company's stockholders. The Company cannot predict with certainty
whether, when, in what forms, or with what effective dates, the tax
laws applicable to the Company or its stockholders may be changed.
Competition may adversely affect the Company's ability to acquire
assets.
Because of competition, the Company may not be able to acquire
mortgage-backed securities at favorable yields.
Failure to maintain an exemption from the Investment Company Act of
1940 would restrict the Company's operating flexibility.
The Company conducts its business so as not to become regulated as an
investment company under the Investment Company Act of 1940, as
amended (the "Investment Company Act"). Accordingly, the Company does
not expect to be subject to the restrictive provisions of the
Investment Company Act. Failure to maintain an exemption from the
Investment Company Act would adversely affect the Company's ability to
operate.
The Company may become subject to environmental liabilities.
The Company may become subject to environmental risks when it acquires
interests in properties with material environmental problems. Such
environmental risks include the risk that operating costs and values
of these assets may be adversely affected by the obligation to pay for
the cost of complying with existing environmental laws, ordinances and
regulations, as well as the cost of complying with future legislation.
Such laws often impose liability regardless of whether the owner or
operator knows of, or was responsible for, the presence of such
hazardous or toxic substances. The costs of investigation, remediation
or removal of hazardous substances could exceed the value of the
property. The Company's income and ability to make distributions to
stockholders could be affected adversely by the existence of an
environmental liability with respect to the Company's properties.
Operating Policies
The Company has adopted compliance guidelines, including restrictions on
acquiring, holding, and selling assets, to ensure that the Company meets the
requirements for qualification as a REIT under the Code and is excluded from
regulation as an investment company. Before acquiring any asset, the Manager
determines whether such asset would constitute a "Real Estate Asset" under the
REIT provisions of the Code, as amended. The Company regularly monitors
purchases of mortgage assets and the income generated from such assets,
including income from its hedging activities, in an effort to ensure that at
all times the Company's assets and income meet the requirements for
qualification as a REIT and exclusion under the Investment Company Act.
In order to maintain the Company's REIT status, the Company generally intends
to distribute to its stockholders aggregate dividends equaling at least 90% of
its taxable income each year. The Code permits the Company to fulfill this
distribution requirement by the end of the year following the year in which the
taxable income was earned.
The Company's unaffiliated directors review all transactions on a quarterly
basis to ensure compliance with the Company's operating policies and to ratify
all transactions with PNC Bank (an affiliate of the Manager) and its
affiliates, except that the purchase of securities from PNC Bank and its
affiliates require prior approval. The unaffiliated directors rely
substantially on information and analysis provided by the Manager to evaluate
the Company's operating policies, compliance therewith, and other matters
relating to the Company's investments.
Regulation
The Company intends to continue to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. Under the
Investment Company Act, a non-exempt entity that is an investment company is
required to register with the SEC and is subject to extensive, restrictive, and
potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends, and transactions with
affiliates. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate" ("Qualifying Interests"). Under
current interpretation by the staff of the SEC, to qualify for this exemption,
the Company, among other things, must maintain at least 55% of its assets in
Qualifying Interests. Substantially all of the Company's interests in RMBS are
Qualifying Interests.
A portion of the CMBS acquired by the Company are collateralized by pools of
first mortgage loans where the Company can monitor the performance of the
underlying mortgage loans through loan management and servicing rights and when
the Company has appropriate workout/foreclosure rights with respect to the
underlying mortgage loans. When such arrangements exist, the Company believes
that the related Controlling Class CMBS constitute Qualifying Interests for
purposes of the Investment Company Act. Therefore, the Company believes that it
should not be required to register as an "investment company" under the
Investment Company Act as long as it continues to invest in a sufficient amount
of such Controlling Class CMBS and/or in other Qualifying Interests.
If the SEC or its staff were to take a different position with respect to
whether the Company's Controlling Class CMBS constitute Qualifying Interests,
the Company could be required to modify its business plan so that either (i) it
would not be required to register as an investment company or (ii) it would
comply with the Investment Company Act and be able to register as an investment
company. In such event, modification of (i) the Company's business plan so that
it would not be required to register as an investment company would likely
entail a disposition of a significant portion of the Company's Controlling
Class CMBS or the acquisition of significant additional assets, such as agency
pass-through and mortgage-backed securities, which are Qualifying Interests or
(ii) the Company's business plan to register as an investment company would
result in significantly increased operating expenses and would likely entail
significantly reducing the Company's indebtedness (including the possible
prepayment of the Company's short-term borrowings), which could also require it
to sell a significant portion of its assets. No assurances can be given that
any such dispositions or acquisitions of assets, or de-leveraging, could be
accomplished on favorable terms. Consequently, any such modification of the
Company's business plan could have a material adverse effect on the Company.
Further, if it were established that the Company were an unregistered
investment company, there would be a risk that the Company would be subject to
monetary penalties and injunctive relief in an action brought by the SEC, that
the Company would be unable to enforce contracts with third parties, and that
third parties could seek to obtain recession of transactions undertaken during
the period it was established that the Company was an unregistered investment
company. Any such results would be likely to have a material adverse effect on
the Company.
Competition
The Company's net income depends, in large part, on the Company's ability to
acquire mortgage assets at favorable spreads over the Company's borrowing
costs. In acquiring mortgage assets, the Company competes with other mortgage
REITs, specialty finance companies, savings and loan associations, banks,
mortgage bankers, insurance companies, mutual funds, institutional investors,
investment banking firms, other lenders, governmental bodies, and other
entities. In addition, there are numerous mortgage REITs with asset acquisition
objectives similar to the Company's, and others may be organized in the future.
The effect of the existence of additional REITs may be to increase competition
for the available supply of mortgage assets suitable for purchase by the
Company. Some of the Company's anticipated competitors are significantly larger
than the Company, have access to greater capital and other resources, and may
have other advantages over the Company. In addition to existing companies,
other companies may be organized for purposes similar to that of the Company,
including companies organized as REITs focused on purchasing mortgage assets. A
proliferation of such companies may increase the competition for equity capital
and thereby adversely affect the market price of the Company's Common Stock.
Employees
The Company does not have any employees. The Company's officers, each of whom
is a full-time employee of the Manager, perform the duties required pursuant to
the Management Agreement (as defined below) with the Manager and the Company's
bylaws.
Management Agreement
The Company is managed pursuant to a management agreement, dated March 27,
1998, between the Company and the Manager (the "Management Agreement"), and
pursuant to which the Manager is responsible for the day-to-day operations of
the Company and performs such services and activities relating to the assets
and operations of the Company as may be appropriate. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with the
approval of the unaffiliated directors, on terms similar to the prior agreement
with the following changes: (i) the incentive fee calculation would be based
upon GAAP earnings instead of funds from operations, (ii) the removal of the
four-year period to value the Management Agreement in the event of termination
and (iii) subsequent renewal periods of the Management Agreement would be for
one year instead of two years. Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., a national investment banking and financial advisory firm,
advised the Board of Directors in the 2002 renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year through
March 31, 2004. The terms of the renewed agreement were similar to the prior
agreement except for the incentive fee calculation that would provide for a
rolling four-quarter high watermark rather than a quarterly calculation. In
determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee, as defined, was greater than what was paid to the
Manager in the prior three quarters cumulatively. The Company phased in the
rolling four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee was based on GAAP earnings and adjusted to
exclude special one-time events pursuant to changes in GAAP accounting
pronouncements after discussion between the Manager and the unaffiliated
directors. The incentive fee threshold did not change. The high watermark
provided for the Manager to be paid 25% of the amount of earnings (calculated
in accordance with GAAP) per share that exceeds the product of the adjusted
issue price of the Company's Common Stock per share and the greater of 9.5% or
350 basis points over the ten-year Treasury note.
The Management Agreement was further extended for one year from March 31, 2004
through March 31, 2005. The base management fee was revised to equal 2% of the
quarterly average total stockholders' equity for the applicable quarter. The
incentive fee was revised to be 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's common stock per share ($11.37 as of December 31, 2004)
and the greater of 8.5% or 400 basis points over the ten-year Treasury note. On
March 10, 2004, the members of the Company's Board of Directors who are not
affiliated with the Manager approved an extension of the Company's management
agreement with the Manager for one additional year through March 31, 2006. The
terms of the extended agreement did not change.
During the third quarter of 2003, the Manager agreed to reduce its management
fees by 20% from its calculated amount for the third and fourth quarter of 2003
and the first quarter of 2004. This revision resulted in $1,046 in savings to
the Company during 2003 and $532 during 2004, respectively.
The Manager primarily engages in four activities on behalf of the Company: (i)
acquiring and originating mortgage loans and other real estate related assets;
(ii) asset/liability and risk management, hedging of floating rate liabilities,
and financing, management and disposition of assets, including credit and
prepayment risk management; (iii) surveillance and restructuring of real estate
loans and (iv) capital management, structuring, analysis, capital raising, and
investor relations activities. In conducting these activities, the Manager
formulates operating strategies for the Company, arranges for the acquisition
of assets by the Company, arranges for various types of financing and hedging
strategies for the Company, monitors the performance of the Company's assets,
and provides certain administrative and managerial services in connection with
the operation of the Company. At all times, the Manager is subject to the
direction and oversight of the Company's Board of Directors.
The Company may terminate, or decline to renew the term of, the Management
Agreement without cause at any time upon 60 days' written notice by a majority
vote of the unaffiliated directors. Although no termination fee is payable in
connection with a termination for cause, in connection with a termination
without cause, the Company must pay the Manager a termination fee, which could
be substantial. The amount of the termination fee will be determined by
independent appraisal of the value of the Management Agreement. Such appraisal
is to be conducted by a nationally-recognized appraisal firm mutually agreed
upon by the Company and the Manager.
During 2000, the Company completed the acquisition of CORE Cap, Inc. The merger
was a stock for stock acquisition where the Company issued 4,180,552 shares of
its Common Stock and 2,261,000 shares of its Series B Preferred Stock. At the
time of the CORE Cap acquisition, the Manager agreed to pay GMAC (CORE Cap,
Inc.'s external advisor) $12,500 over a ten-year period ("Installment Payment")
to purchase the right to manage the assets under the existing management
contract ("GMAC Contract"). The GMAC Contract had to be terminated in order to
allow for the Company to complete the merger, as the Company's management
agreement with the Manager did not provide for multiple managers. As a result,
the Manager offered to buy-out the GMAC Contract as the Manager estimated it
would receive incremental fees above and beyond the Installment Payment, and
thus was willing to pay for, and separately negotiate, the termination of the
GMAC Contract. Accordingly, the value of the Installment Payment was not
considered in the Company's allocation of its purchase price to the net assets
acquired in the acquisition of CORE Cap, Inc. The Company agreed that should
the Management Agreement with the Manager be terminated, not renewed or not
extended for any reason other than for cause, the Company would pay to the
Manager an amount equal to the Installment Payment less the sum of all payments
made by the Manager to GMAC. As of December 31, 2004, the Installment Payment
would be $6,500 payable over six years. The Company does not accrue for this
contingent liability.
In addition, the Company has the right at any time during the term of the
Management Agreement to terminate the Management Agreement without the payment
of any termination fee upon, among other things, a material breach by the
Manager of any provision contained in the Management Agreement that remains
uncured at the end of the applicable cure period.
Taxation of the Company
The Company has elected to be taxed as a REIT under the Code, commencing with
its taxable year ended December 31, 1998, and the Company intends to continue
to operate in a manner consistent with the REIT provisions of the Code. The
Company's qualification as a REIT depends on its ability to meet the various
requirements imposed by the Code, through actual operating results, asset
holdings, distribution levels, and diversity of stock ownership.
Provided the Company continues to qualify for taxation as a REIT, it generally
will not be subject to Federal corporate income tax on its net income that is
currently distributed to stockholders. This treatment substantially eliminates
the "double taxation" (at the corporate and stockholder levels) that generally
results from an investment in a corporation. If the Company fails to qualify as
a REIT in any taxable year, its taxable income would be subject to Federal
income tax at regular corporate rates (including any applicable alternative
minimum tax). Even if the Company qualifies as a REIT, it will be subject to
Federal income and excise taxes on its undistributed income.
If in any taxable year the Company fails to qualify as a REIT and, as a result,
incurs additional tax liability, the Company may need to borrow funds or
liquidate certain investments in order to pay the applicable tax, and the
Company would not be compelled to make distributions under the Code. Unless
entitled to relief under certain statutory provisions, the Company would also
be disqualified from treatment as a REIT for the four taxable years following
the year during which qualification is lost. Although the Company currently
intends to operate in a manner designated to qualify as a REIT, it is possible
that future economic, market, legal, tax, or other considerations may cause the
Company to fail to qualify as a REIT or may cause the Board of Directors to
revoke the Company's REIT election.
The Company and its stockholders may be subject to foreign, state, and local
taxation in various foreign, state, and local jurisdictions, including those in
which it or they transact business or reside. The state and local tax treatment
of the Company and its stockholders may not conform to the Company's Federal
income tax treatment.
Website
The Company's website address is www.anthracitecapital.com. The Company makes
available free of charge through its website its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments
to those reports as soon as reasonably practicable after such material is
electronically filed with or furnished to the SEC, and also makes available on
its website the charters for the Audit, Nominating and Corporate Governance
Committees of the Board of Directors and its Codes of Ethics, as well as its
corporate governance guidelines. Copies in print of these documents are
available upon request to the Secretary of the Company at the address indicated
on the cover of this report. To communicate with the Board of Directors
electronically, the Company has established an e-mail address,
anthracitebod@blackrock.com, to which stockholders may send correspondence to
the Board of Directors or any such individual directors or group or committee
of directors.
ITEM 2. PROPERTIES
The Company does not maintain an office and owns no real property. It does not
pay rent and utilizes the offices of the Manager, located at 40 East 52nd
Street, New York, New York 10022.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2004 there were no pending legal proceedings of which the
Company was a defendant or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 2004 through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been listed and traded on the New York Stock
Exchange under the symbol "AHR" since the initial public offering in March
1998. The following table sets forth, for the periods indicated, the high, low
and last sale prices in dollars on the New York Stock Exchange for the
Company's Common Stock and the dividends declared by the Company with respect
to the periods indicated as were traded during these respective time periods.
Dividends
2003 High Low Last Sale Declared
First Quarter................... 12.04 10.27 11.44 .35
Second Quarter.................. 12.89 11.00 12.06 .35
Third Quarter................... 12.55 9.26 9.65 .28
Fourth Quarter.................. 11.30 9.50 11.07 .28
2004
First Quarter................... 13.01 10.52 12.73 .28
Second Quarter.................. 13.00 10.51 11.98 .28
Third Quarter................... 12.14 10.50 11.12 .28
Fourth Quarter.................. 12.69 11.05 12.36 .28
On March 4, 2005, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $11.95. As of March 4, 2005, there
were approximately 1,114 record holders of the Common Stock. This figure does
not reflect beneficial ownership of shares held in nominee name.
The following table summarizes information about options outstanding under the
1998 Stock Option Plan:
Weighted
Average
Shares Exercise Price
-------------- ---------------
Outstanding at January 1, 2004 1,468,351 $14.75
Granted 5,000 11.81
Exercised (30,000) 8.44
Cancelled (25,500) 15.00
--------------
Outstanding at December 31, 2004 1,417,851 $14.87
==============
Options exercisable at December 31, 2004 1,417,851 $14.87
==============
Weighted-average fair value of
options granted during the
year ended December 31, 2004
(per option) $ 0.36
==============
Shares of Common Stock available for future grant under the 1998 Stock Option
Plan at December 31, 2004 were 774,502.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended
December 31, 2004, 2003, 2002, 2001, and 2000 has been derived from the
Company's audited financial statements. This information should be read in
conjunction with "Item 1. Business" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations", as well as the
audited financial statements and notes thereto included in "Item 8. Financial
Statements and Supplementary Data".
For the Year For the Year For the Year For the Year For the Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
2004 2003 2002 2001 2000
---------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data)
Operating Data:
Total income $203,866 $163,778 $162,445 $131,220 $97,642
Interest expense 128,166 83,249 65,018 59,400 51,112
Other operating expenses 12,383 11,707 14,850 12,736 9,727
Other gains (losses) (1) (20,125) (77,464) (28,949) (910) 2,523
Cumulative transition adjustment (2) - - 6,327 (1,903) -
Net income (loss) 43,192 (8,642) 59,955 56,271 39,326
Net income (loss) available to common
stockholders 25,768 (16,386) 54,793 47,307 32,261
Per Share Data:
Net income (loss):
Basic 0.50 (0.34) 1.18 1.41 1.37
Diluted 0.50 (0.34) 1.18 1.35 1.28
Dividends declared per common share 1.12 1.26 1.40 1.29 1.17
Balance Sheet Data:
Total assets 3,729,134 2,398,846 2,640,558 2,627,203 1,033,651
Long-term obligations 3,215,396 1,981,416 2,234,342 2,244,088 791,397
Total stockholders' equity 513,738 417,430 406,216 383,115 242,254
(1) Other gains (losses) for the year ended December 31, 2004 of $(20,125)
consist primarily of $(26,018) related to impairments on assets and a
loss of $(11,464) related to securities held-for-trading. Other gains
(losses) for the year ended December 31, 2003 of $(77,464) consist
primarily of a loss of $(32,426) related to impairments on assets and
a loss of $(38,206) related to securities held-for-trading. Other
gains (losses) for the year ended December 31, 2002 of $(28,949)
consist primarily of a loss of $(10,273) related to impairments on
assets, a loss of $(29,255) related to securities held-for-trading,
and a gain of $11,391 related to the sale of securities
available-for-sale. Other gains (losses) for the year ended December
31, 2001 of $(910) consist primarily of a loss of $(5,702) related to
impairments on assets, a loss of $(2,604) related to securities
held-for-trading, and a gain of $7,401 related to the sale of
securities available-for-sale.
(2) The cumulative transition adjustment represents the Company's
adoption of SFAS No. 142 and SFAS 133 for the years ended December
31, 2002 and 2001, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
All dollar figures expressed herein are expressed in thousands, except share
and per share amounts.
General
Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real
estate finance company that invests in high yielding commercial real estate
debt. The Company commenced operations on March 24, 1998.
The Company's primary focus is to invest in a diverse portfolio of commercial
real estate loans and commercial mortgage-backed securities ("CMBS"). The CMBS
that the Company purchases are fixed income instruments similar to bonds that
carry an interest coupon and stated principal. The cash flow used to pay the
interest and principal on the CMBS comes from a designated pool of first
mortgage loans on commercial real estate (the "Underlying Loans"). Underlying
Loans are usually originated by commercial banks or investment banks and are
secured by a first mortgage on office buildings, retail centers, apartment
buildings, hotels and other types of commercial real estate. A typical loan
pool may contain several hundred loans with principal amounts of as little as
$1,000 to over $100,000. The pooling concept also permits significant
geographic diversification. Converting loans into CMBS in this fashion allows
investors to purchase these securities in global capital markets and to
participate in the commercial real estate sector with significant
diversification among property types, sizes and locations in one fixed income
investment.
The type of CMBS issued from a typical loan pool is generally broken down by
credit rating. The highest rated CMBS will receive payments of principal first
and is therefore least exposed to the credit performance of the Underlying
Loan. These securities will carry a credit rating of AAA and will be issued
with a principal amount that represents some portion of the total principal
amount of the Underlying Loan pool.
The CMBS that receive principal payments last are generally rated below
investment grade (BB+ or lower.) As the last to receive principal these CMBS
are also the first to absorb any credit losses incurred in the Underlying Loan
pool. The principal amount of these below investment grade classes generally
represents 3.0-5.0% of the principal of the Underlying Loan pools. The investor
that owns the lowest rated, or non-rated, CMBS class is designated as the
controlling class representative for the underlying loan pool. This designation
allows the holder to assert a significant degree of control over any workouts
or foreclosures of defaulted Underlying Loans. These securities are generally
issued with a high yield to compensate for the credit risk inherent in owning
the CMBS class which is the first to absorb losses.
The Company's high yield commercial real estate loan strategy is based on a
similar concept of investing in a portion of the principal and interest of a
specific loan instead of a pool of loans as in CMBS. In this case the principal
amount of a single loan is separated into a senior interest ("A note") and a
junior interest ("B note"). Prior to a borrower default, the A note and the B
note receive principal and interest pari passu; however after a borrower
default, the A note would receive its principal and interest first and the B
note would absorb the credit losses that occur, if any, up to the full amount
of its principal. The B note holder generally has certain rights to control
workouts or foreclosures. The Company invests in B notes as they provide higher
yields with a degree of control over dispositions.
The Company also invests in mezzanine loans on commercial real estate. The
ownership interests in an entity that owns real estate secure mezzanine loans.
These loans are generally subordinated to a first mortgage and would absorb a
credit loss prior to the senior mortgage holder.
The Company is managed by BlackRock Financial Management, Inc. (the "Manager"),
a subsidiary of BlackRock, Inc., a publicly traded (NYSE: BLK) asset management
company with approximately $341,800,000 of assets under management as of
December 31, 2004. The Company believes that the trend toward highly structured
investment products requires significant expertise in traditional real estate
underwriting as well as in the capital markets. Through its external management
contract with the Manager, the Company can source and manage more opportunities
by taking advantage of a unique platform that combines these two disciplines.
The Company's common stock is traded on the New York Stock Exchange under the
symbol "AHR." The Company's primary long-term objective is to distribute
consistent dividends supported by earnings. The Company establishes its
dividend by analyzing the long-term sustainability of earnings given existing
market conditions and the current composition of its portfolio. This includes
an analysis of the Company's credit loss assumptions, general level of interest
rates and projected hedging costs.
During the third quarter of 2004, the Company completed its repositioning into
commercial real estate assets. As of December 31, 2004, CMBS and commercial
real estate loans represent 90% of portfolio assets while residential
mortgage-backed securities ("RMBS") represent 10%. During 2004, exclusive of
its investment in the Carbon Capital, Inc. ("Carbon I") and Carbon Capital II,
Inc. ("Carbon II"and collectively with Carbon I, the "Carbon Capital Funds")
and the commercial mortgage loan pools, the Company acquired commercial real
estate assets with a market value of $638,632, comprised primarily of $151,094
of below investment grade CMBS, $120,423 of investment grade CMBS, $67,507 of
investment grade REIT debt, and $227,773 of high yield commercial real estate
loans.
The table below is a summary of the Company's investments by asset class for
the last five years:
Carrying Value as of December 31,
2004 2003 2002 2001 2000
Amount % Amount % Amount % Amount % Amount %
-------------------------------------------------------------------------------------------------------------
Commercial real
estate securities $ 1,623,939 44.6% $1,393,010 62.8% $ 894,345 35.9% $453,953 20.8% $412,435 42.6%
Commercial mortgage
loan pools 1,312,045 36.1 - - - - - - - -
Commercial real
estate loans(1) 329,930 9.1 97,984 4.4 88,926 3.6 159,738 7.3 163,541 16.9
RMBS 372,071 10.2 726,717 32.8 1,506,450 60.5 1,570,009 71.9 337,222 34.9
U.S. Treasury
securities - - - - - - - - 54,043 5.6
-------------------------------------------------------------------------------------------------------------
Total $ 3,637,985 100.0% $2,217,711 100.0% $2,489,721 100.0% $2,183,700 100.0% $967,241 100.0%
=============================================================================================================
(1) Includes real estate joint ventures and an equity investment.
As of December 31, 2004, the Company owns 16 different trusts where it is in
the first loss position and is designated as the controlling class
representative by owning the lowest rate or non-rated CMBS class. The Company
considers the CMBS securities where it maintains the right to control the
foreclosure/workout process on the underlying loans its controlling class CMBS
("Controlling Class"). The Company divides its below investment grade CMBS
investment activity into two portfolios: Controlling Class CMBS and other below
investment grade CMBS.
Commercial Mortgage Loan Pools and Commercial Real Estate Securities Portfolio
Activity
The Company continues to increase its investments in commercial real estate
securities. Commercial real estate securities include CMBS, investment grade
real estate investment trusts ("REIT") debt and collateralized debt obligation
("CDO") investments. During the year ended December 31, 2004, the Company
increased its commercial real estate securities portfolio by 19% from
$1,366,508 to $1,623,939. This increase was primarily attributable to the
purchase of subordinated CMBS and investment grade CMBS that have a market
value as of December 31, 2004 of $133,760 and $84,702, respectively.
During the second quarter of 2004, the Company acquired subordinated CMBS in a
trust establishing a Controlling Class interest. As the Controlling Class
holder, the Company has the ability to control dispositions or workouts of any
defaulted loans in this trust. The Company negotiated for and obtained a
greater degree of discretion over the disposition of the commercial mortgage
loans than is typically granted to the special servicer. As a result of this
expanded discretion, Financial Accounting Standards Board ("FASB")
interpretation No. 46, "Consolidation of Variable Interest Entities" (revised
December 2003) ("FIN 46R") requires the Company to consolidate the net assets
and results of operations of the trust.
The CMBS securities acquired by the Company had a par value of $41,495 with
$13,890 not rated and the balance rated BBB- to B-. During the third quarter of
2004 the Company sold the BBB- rated security, which had the impact of
increasing the borrowings for the commercial loan pool by $5,848. As of
December 31, 2004, the CMBS securities owned by the Company have a par value of
$35,495.
The debt associated with the real estate mortgage investment conduit ("REMIC")
trust is non-recourse to the Company, and is secured only by the commercial
mortgage loan pools. As of December 31, 2004, the consolidation of the REMIC
trust results in an increase in the Company's total debt to capital ratio from
3.7:1 to 6.2:1, but has no effect on the Company's recourse debt to capital
ratio. The Company received authorization from its lenders to permit debt to
capital ratios in excess of existing covenants.
Approximately 45% of the par amount of the commercial mortgage loan pool is
comprised of loans that are shadow rated A2 or better by Moody's Investors
Service, Inc. and AA by Standard & Poor's Rating Group, a division of The
McGraw-Hill Companies, Inc. The Company has taken into account the credit
quality of the underlying loans in formulating its loss assumptions. Credit
losses assumed on the entire pool are 1.40% of the principal balance, or 2.53%
of the unrated principal balance. For income recognition purposes, the Company
accounts for the unrated commercial mortgage loans in the pool as a single
asset based on common credit risk characteristics.
Over the life of the commercial mortgage loan pools, the Company reviews and
updates its loss assumptions to determine the impact on expected cash flows to
be collected. A decrease in estimated cash flows will reduce the amount of
interest income recognized in future periods and may result in a loan loss
reserve depending upon the severity of the cash flow reductions. An increase in
estimated cash flows will first reduce the loan loss reserve and any additional
cash will increase the amount of interest income recorded in future periods.
The Company's CDO offerings allow the Company to match fund its commercial real
estate portfolio by issuing long-term debt to finance long-term assets. The CDO
debt is non-recourse to the Company; therefore, the Company's losses are
limited to its equity investment in the CDO. The CDO debt is also fully hedged
to protect the Company from an increase in short-term interest rates. As of
December 31, 2004, over 86% of the market value of the Company's subordinated
CMBS assets are match funded in the Company's CDOs in this manner.
The Company's first CDO transaction ("CDO I") was issued as Anthracite CDO 2002
CIBC-1 and closed on May 15, 2002. The Company issued $403,633 of debt secured
by a portfolio of commercial real estate securities with a total par of
$515,880 and an adjusted purchase price of $431,995.
On December 10, 2002, the Company issued another $280,607 of debt through
Anthracite CDO 2002-2 secured by a separate portfolio of commercial real estate
securities with a par of $313,444 and an average adjusted purchase price of
$289,197. Included in the Company's second collateralized debt obligation ("CDO
II") was a ramp facility that was utilized to fund the purchase of an
additional $50,000 of par of below investment grade CMBS. The Company utilized
the ramp in February 2003 and July 2003, to contribute $30,000 of par of CSFB
03-CPN1 and $20,000 of par of GECMC 03-C2, respectively. In July 2004, the
Company issued a bond with a par of $12,850 from CDO II. Before issuing this
security, the Company amended the indenture to reduce the coupon from 9.0% to
7.6%.
On March 30, 2004 the Company issued its third collateralized debt obligation
("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold
was $372,456. The total cost of funds on a fully hedged basis was 5.0%.
Included in CDO III was a $50,000 ramp facility that was fully utilized as of
December 31, 2004.
The Company retained 100% of the equity of CDOs I, II and III and recorded the
transactions on its consolidated financial statements as secured financing.
Collateral as of December 31, 2004 Debt as of December 31, 2004
--------------------------------------------------------------------------------
Adjusted Purchase Adjusted Issue Weighted Average
Price Loss Adjusted Yield Price Cost of Funds * Net Spread
-----------------------------------------------------------------------------------------------
CDO I $434,661 8.89% $405,377 7.21% 1.68%
CDO II 324,324 7.80% 293,167** 5.79% 2.01%
CDO III 377,154 7.09% 369,422** 5.03% 2.06%
-----------------------------------------------------------------------------------------------------------
Total ** $1,136,139 7.98% $1,067,967 6.06% 1.91%
* Weighted Average Cost of Funds is the current cost of funds plus hedging
expenses.
** The Company chose not to sell $10,000 of par of CDO II debt rated BB and
$13,069 of par of CDO III debt rated BB.
The following table details the par, fair market value, adjusted purchase
price, and loss adjusted yield of the Company's commercial real estate
securities outside of the CDOs as of December 31, 2004:
Adjusted
Fair Market Dollar Purchase Dollar Loss Adjusted
Par Value Price Price Price Yield
--------------------------------------------------------------------------------
Investment grade CMBS $145,420 $146,467 100.72 $150,612 103.57 4.59%
Investment grade REIT debt 43,885 43,291 98.65 44,274 100.89 5.34%
CMBS rated BB+ to B 93,455 73,158 78.28 71,329 76.32 8.22%
CMBS rated B- or lower 74,740 14,833 19.85 16,120 21.57 11.00%
CDO Investments 203,182 19,837 9.76 19,450 9.57 56.65%
CMBS Interest Only securities
("IOs") 3,712,604 125,246 3.37 122,379 3.30 7.31%
Project Loans 23,082 23,649 102.46 24,092 104.38 5.65%
--------------------------------------------------------------------------------
Total $4,296,368 $446,481 10.39 $448,257 10.43 8.53%
The following table details the par, fair market value, adjusted purchase price
and loss adjusted yield of the Company's commercial real estate securities
outside of the CDOs as of December 31, 2003:
Adjusted
Fair Market Dollar Purchase Dollar Loss Adjusted
Par Value Price Price Price Yield
----------------------------------------------------------------------------------
Investment grade CMBS $277,276 $268,593 96.87 $272,853 98.40 4.9%
Investment grade REIT debt 29,000 29,567 101.95 30,210 104.17 5.0%
CMBS rated BB+ to B 186,217 133,868 71.89 150,775 80.97 8.9%
CMBS rated B- or lower 304,358 80,680 26.51 107,653 35.37 12.6%
CMBS IOs 2,623,456 84,493 3.22 83,704 3.19 7.5%
Other CMBS 20,266 20,142 99.39 20,264 99.99 5.7%
----------------------------------------------------------------------------------
Total $3,440,573 $617,343 17.94 $665,459 19.34 7.4%
On November 9, 2004, the Company closed its fourth collateralized debt
obligation ("CDO HY1") secured by a portfolio of below investment grade CMBS
with an average rating of CCC. The CMBS portfolio was carried at fair market
value of $109,933 on the Company's consolidated statement of financial
condition based on price quotes received from third parties. The transaction
was accounted for as a sale under relevant accounting guidelines. The Company
received cash proceeds of $140,425 as well as all of the CDO HY1 preferred
shares that had a fair market value of $15,885 as of December 31, 2004. The
transaction raised re-investable proceeds of $95,799. The following table
summarizes the impact of this transaction on fourth quarter 2004 results and
per share amounts:
Realized gain at closing of CDO HY1 $14,769 $0.28
Realized gain from subsequent sale of A- tranche 1,825 0.03
Increase in accumulated other comprehensive income 29,782 0.56
----------- ----------
Total book value impact $46,376 $0.87
=========== ==========
Below Investment Grade CMBS and Underlying Loan Performance
The Company divides its below investment grade CMBS investment activity into
two portfolios; Controlling Class CMBS and other below investment grade CMBS.
The distinction between the two is in the rights the Company obtains with its
investment in Controlling Class CMBS. Controlling Class rights allow the
Company to control the workout and/or disposition of defaults that occur in the
underlying loans. These securities absorb the first losses realized in the
underlying loan pools. The Company's other below investment grade CMBS have no
rights associated with its ownership to control the workout and/or disposition
of underlying loan defaults; however, these investments are not the first to
absorb losses in the underlying pools. The coupon payment on the non-rated
security can also be reduced for special servicer fees charged to the trust.
The next highest rated security in the structure will then generally be
downgraded to non-rated and become the first to absorb losses and expenses from
that point on.
During 2004, the Company acquired $39,597 of par of other below investment
grade CMBS and $239,290 of par of new Controlling Class CMBS. The total par of
the Company's other below investment grade CMBS at December 31, 2004 was
$332,225; the average credit protection, or subordination level, of this
portfolio is 5.91%. The total par of the Company's subordinated Controlling
Class CMBS securities at December 31, 2004 was $631,649 and the total par of
the loans underlying these securities was $18,580,729.
The Company's investment in its subordinated Controlling Class CMBS securities
by credit rating category at December 31, 2004 is as follows:
Adjusted
Fair Market Dollar Purchase Dollar Subordination
Par Value Price Price Price Level
-------------------------------------------------------------------------
BB+ $129,493 $ 122,294 $94.44 $112,754 $ 87.07 6.50%
BB 76,575 65,610 85.68 61,602 80.45 4.73%
BB- 118,144 91,919 77.80 90,307 76.44 4.16%
B+ 61,604 40,409 65.59 40,951 66.48 2.88%
B 171,093 106,455 62.22 102,893 60.14 2.64%
B- 7,809 4,478 57.35 4,552 58.29 1.41%
CCC 19,326 4,360 22.56 6,573 34.01 1.38%
NR 47,605 5,984 12.57 4,996 10.49 n/a
-------------------------------------------------------------------------
Total $631,649 $ 441,509 $69.90 $424,628 $ 67.23
During 2004, one of the Company's Controlling Class securities was upgraded
from BB+ to BBB and is not included in the chart above.
The Company's investment in its subordinated Controlling Class CMBS by credit
rating category at December 31, 2003 is as follows:
Adjusted
Fair Market Dollar Purchase Dollar Subordination
Par Value Price Price Price Level
------------------------------------------------------------------------------------
BB+ $ 84,503 $ 73,766 $ 87.29 $ 72,680 $ 86.01 7.54%
BB 89,945 75,349 83.77 76,842 85.43 6.04%
BB- 101,393 71,285 70.31 81,036 79.92 5.12%
B+ 44,314 28,904 65.22 31,179 70.36 3.43%
B 182,119 105,061 57.69 133,718 73.42 3.06%
B- 83,296 34,160 41.01 51,935 62.35 1.54%
CCC+ 11,924 5,595 46.92 7,129 59.78 1.53%
CCC 70,273 13,375 19.03 22,844 32.51 1.23%
C 8,940 2,531 28.31 2,734 30.58 0.62%
NR 129,925 25,003 19.24 23,011 17.71 n/a
------------------------------------------------------------------------------------
Total $806,632 $ 435,029 $ 53.93 $503,108 $ 62.37
------------------------------------------------------------------------------------
During 2004, servicers reduced the par amount of the Company's Controlling
Class CMBS in the amount of $32,157. Further delinquencies and losses may cause
the par reductions to continue and cause the Company to conclude that a change
in loss adjusted yield is required along with a write down of the adjusted
purchase price through the income statement according to Emerging Issue Task
Force ("EITF") 99-20. Also during 2004, the loan pools were paid down by
$451,662. Pay down proceeds are distributed to the highest rated CMBS class
first and reduce the percent of total underlying collateral represented by each
rating category.
For all of the Company's Controlling Class securities, the Company assumes that
a total of 2.02% of the original loan balance will not be recoverable. This
estimate was developed based on an analysis of individual loan characteristics
and prevailing market conditions at the time of origination. This loss estimate
equates to cumulative expected defaults of approximately 6% over the life of
the portfolio and an average assumed loss severity of 35% of the defaulted
loan balance. All estimated workout expenses including special servicer fees
are included in these assumptions. Actual results could differ materially from
these estimated results. See Item 7A -"Quantitative and Qualitative Disclosures
About Market Risk" for a discussion of how differences between estimated and
actual losses could affect Company earnings.
The Company monitors credit performance on a monthly basis and debt service
coverage ratios on a quarterly basis. Using these and other statistics, the
Company maintains watch lists for loans that are delinquent thirty days or more
and for loans that are not delinquent but have issues that the Company's
management believes require close monitoring.
During 2004, the Company completed a detailed re-underwriting of its 1998
vintage Controlling Class CMBS. Upon completion, the Company determined that
the Company's portfolio contained six 1998 vintage CMBS securities in four
separate CMBS transactions that required impairment charges at December 31,
2004 following the application of EITF 99-20. As a result, the Company recorded
a loss on impairment of assets of $26,018 in the fourth quarter of 2004. A
variety of factors influence updated yields for these securities, including
magnitude of credit loss, timing of credit loss, prepayments and servicer
advances. The magnitude of credit losses did not significantly change as a
result of this process, as total loss expectations on the underlying loans
moved from 2.06% to 2.04%. Changes in the timing of credit losses and
prepayments caused updated yields on these securities to decline by a weighted
average of 66 basis points. Market dislocations in 1998 caused disproportionate
unrealized losses in market value on these securities based on price quotes
received from third parties. The Company had recorded these unrealized losses
as other comprehensive loss on its consolidated statement of financial
condition since that time.
Based on current economic conditions and updated credit assumptions, the
Company believes these 1998 vintage CMBS securities will be repaid in full and
that the impairment charge of $25,355 with respect to five of the six
securities will be reflected in income over the remaining life of the bonds. In
addition, the Company increased underlying loan loss expectations on one
non-rated security resulting in an impairment charge of $663.
The Company considers delinquency information from the Lehman Brothers Conduit
Guide to be the most relevant benchmark to measure credit performance and
market conditions applicable to its Controlling Class CMBS holdings. The year
of issuance, or vintage year, is important, as older loan pools will tend to
have more delinquencies than newly underwritten loans. The Company owns
Controlling Class CMBS issued in 1998, 1999, 2001, 2002, 2003, and 2004.
Comparable delinquency statistics referenced by vintage year as a percentage of
par outstanding as of December 31, 2004 are shown in the table below:
Vintage Year Underlying Delinquencies Lehman Brothers
Collateral Outstanding Conduit Guide
----------------------------------------------------------------------
1998 $6,872,404 2.31% 1.85%
1999 691,576 1.80% 2.46%
2001 907,293 1.02% 1.62%
2002 1,179,256 0.52% 0.64%
2003 2,153,409 - 0.24%
2004 6,776,791 - 0.04%
----------------------------------------------------------
Total $18,580,729 1.01%* 0.94%*
* Weighted average based on current principal balance.
Morgan Stanley also tracks CMBS loan delinquencies for the specific CMBS
transactions with more than $200,000 of collateral and that have been seasoned
for at least one year. This seasoning criteria will generally adjust for the
lower delinquencies that occur in newly originated collateral. As of December
31, 2003, the Morgan Stanley index indicated that delinquencies on 243
securitizations were 2.47%, and as of December 31, 2004, this same index
indicated that delinquencies on 286 securitizations were 1.74%. See Item 7A -
"Quantitative and Qualitative Disclosures About Market Risks" for a detailed
discussion of how delinquencies and loan losses affect the Company.
Delinquencies on the Company's CMBS collateral as a percent of principal
increased in line with expectations. The Company's aggregate delinquency
experience is consistent with comparable data provided in the Lehman Brothers
Conduit Guide.
Of the 41 delinquent loans shown on the chart in Note 2 of the consolidated
financial statements, 2 loans were real estate owned and being marketed for
sale, no loans were in foreclosure, and the remaining 39 loans were in some
form of workout negotiations. Aggregate realized losses of $22,911 were
realized during year ended December 31, 2004. This brings cumulative realized
losses to $74,976, which is 17.9% of total estimated losses. These losses
include special servicer and other workout expenses. This experience to date is
in line with the Company's loss expectations. Realized losses and special
servicer expenses are expected to increase on the underlying loans as the
portfolio matures. Special servicer expenses are also expected to increase as
portfolios mature.
The Company manages its credit risk through disciplined underwriting,
diversification, active monitoring of loan performance and exercise of its
right to control the workout process for delinquent loans as early as possible.
The Company maintains diversification of credit exposures through its
underwriting process and can shift its focus in future investments by adjusting
the mix of loans in subsequent acquisitions. The comparative profiles of the
loans underlying the Company's CMBS by property type as of December 31, 2004
and for the two prior years are as follows:
12/31/04 Exposure 12/31/03 Exposure 12/31/02 Exposure
----------------------------------------------------------------------------------------------------
Property Type Loan Balance % of % of % of
Total Loan Balance Total Loan Balance Total
----------------------------------------------------------------------------------------------------
Multifamily $5,305,129 28.6% $3,770,944 33.2% $3,302,387 34.4%
Retail 6,026,472 32.4 3,446,371 30.4 2,704,952 28.1
Office 4,617,616 24.9 2,266,160 20.0 1,809,519 18.8
Lodging 915,369 4.9 786,920 6.9 834,854 8.7
Industrial 1,272,583 6.8 713,942 6.3 589,044 6.1
Healthcare 327,832 1.8 337,333 3.0 346,298 3.6
Other 115,728 0.6 25,611 0.2 29,743 0.3
----------------------------------------------------------------------------------
Total $18,580,729 100% $11,347,281 100% $9,616,797 100%
==================================================================================
As of December 31, 2004, the fair market value of the Company's holdings of
Controlling Class CMBS is $16,881 higher than the adjusted cost for these
securities which consists of a gross unrealized gain of $26,921 and a gross
unrealized loss of $10,040. The adjusted purchase price of the Company's
Controlling Class CMBS portfolio as of December 31, 2004 represents
approximately 67.2% of its par amount. The market value of the Company's
Controlling Class CMBS portfolio as of December 31, 2004 represents
approximately 69.9% of its par amount. As the portfolio matures, the Company
expects to recoup the $10,040 of unrealized loss, provided that the credit
losses experienced are not greater than the credit losses assumed in the
projected cash flow analysis. As of December 31, 2004, the Company believes
there has been no material deterioration in the credit quality of its portfolio
below current expectations.
As the portfolio matures and expected losses occur, subordination levels of the
lower rated classes of a CMBS investment will be reduced. This may cause the
lower rated classes to be downgraded, which would negatively affect their
market value and therefore the Company's net asset value. Reduced market value
will negatively affect the Company's ability to finance any such securities
that are not financed through a CDO or similar matched funding vehicle. In some
cases, securities held by the Company may be upgraded to reflect seasoning of
the underlying collateral and thus would increase the market value of the
securities. During 2004 the Company experienced nine rating upgrades and four
rating downgrades on its CMBS.
The Company's income calculated in accordance with generally accepted
accounting principles in the United States of America ("GAAP") for its CMBS
securities is computed based upon a yield, which assumes credit losses would
occur. The yield to compute the Company's taxable income does not assume there
would be credit losses, as a loss can only be deducted for tax purposes when it
has occurred. As a result, for the years 1998 through December 31, 2004, the
Company's GAAP income accrued on its CMBS assets was approximately $36,625
lower than the taxable income accrued on the CMBS assets.
Commercial Real Estate Loan Activity
The Company's commercial real estate loan portfolio generally emphasizes larger
transactions located in metropolitan markets, as compared to the typical loan
in the CMBS portfolio.
In June 2003, the borrower submitted payment in an attempt to fully repay the
loan on a Los Angeles office building in connection with the borrower's sale of
the property. Upon the sale of the property securing this loan, and pursuant to
the loan documents, the Company was entitled to a supplemental exit fee that
was to be paid upon repayment of the loan. The borrower has refused to pay the
supplemental exit fee. The Company filed suit on July 15, 2003 against the
co-borrowers, MP-555 West Fifth Mezzanine, LLC and MP-808 South Olive
Mezzanine, LLC, which are both affiliates of Maguire Properties, Inc. (NYSE:
MPG). The suit also names the Guarantor, Robert F. Maguire, III.
The following table summarizes the Company's commercial real estate loan
portfolio by property type as of December 31, 2004, 2003, and 2002:
Loan Outstanding
----------------------------------------------------------------------- Weighted Average
December 31, 2004 December 31, 2003 December 31, 2002 Coupon
Property ----------------------- ----------------------- ----------------------- --------------------------
Type Amount % Amount % Amount % 2004 2003 2002
----------------- ------------ ---------- ------------ ---------- ------------ ---------- -------- -------- --------
Office $ 100,344 35.5% $ 57,381 76.4% $ 69,431 91.4% 9.3% 9.4% 9.5%
Residential 15,959 5.7 2,794 3.7 3,013 4.0 10.7 3.8 3.6
Retail 61,316 21.7 - - 3,500 4.6 6.6 - 4.6
Hotel 104,678 37.1 14,951 19.9 - - 7.2 6.6 -
------------ ---------- ------------ ---------- ------------ ---------- -------- -------- --------
Total $ 282,297 100.0% $ 75,126 100.0% $ 75,944 100.0% 8.0% 8.6% 9.2%
------------ ---------- ------------ ---------- ------------ ---------- -------- -------- --------
Critical Accounting Estimates
Management's discussion and analysis of financial condition and results of
operations are based on the amounts reported in the Company's consolidated
financial statements. These financial statements are prepared in accordance
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 the Company's consolidated financial statements. The following is a
summary of the Company's accounting policies that are the most affected by
management judgments, estimates and assumptions:
Securities Available-for-sale
The Company has designated certain investments in mortgage-backed securities,
mortgage-related securities and certain other securities as available-for-sale.
Securities available-for-sale are carried at estimated fair value with the net
unrealized gains or losses reported as a component of accumulated other
comprehensive income (loss) in stockholders' equity. Many of these investments
are relatively illiquid, and management must estimate their values. In making
these estimates, management generally utilizes market prices provided by
dealers who make markets in these securities, but may, under certain
circumstances, adjust these valuations based on management's judgment. Changes
in the valuations do not affect the Company's reported net income or cash
flows, but impact stockholders' equity and, accordingly, book value per share.
Management must also assess whether unrealized losses on securities reflect a
decline in value that is other than temporary, and, accordingly, write the
impaired security down to its fair value, through earnings. Significant
judgment by management is required in this analysis, which includes, but is not
limited to, making assumptions regarding the collectability of the principal
and interest, net of related expenses, on the underlying loans.
Income on these securities is recognized based upon a number of assumptions
that are subject to uncertainties and contingencies. Examples include, among
other things, the rate and timing of principal payments (including prepayments,
repurchases, defaults and liquidations), the pass-through or coupon rate and
interest rate fluctuations. Additional factors that may affect the Company's
reported interest income on its mortgage securities include interest payment
shortfalls due to delinquencies on the underlying mortgage loans, the timing
and magnitude of credit losses on the mortgage loans underlying the securities
that are a result of the general condition of the real estate market (including
competition for tenants and their related credit quality) and changes in market
rental rates. These uncertainties and contingencies are difficult to predict
and are subject to future events that may alter the assumptions.
The Company recognizes interest income from its purchased beneficial interests
in securitized financial interests ("beneficial interests") (other than
beneficial interests of high credit quality, sufficiently collateralized to
ensure that the possibility of credit loss is remote, or that cannot
contractually be prepaid or otherwise settled in such a way that the Company
would not recover substantially all of its recorded investment) in accordance
with EITF 99-20. Accordingly, on a quarterly basis, when changes in estimated
cash flows from the cash flows previously estimated occur due to actual
prepayment and credit loss experience, the Company calculates a revised yield
based on the current amortized cost of the investment (including any
other-than-temporary impairments recognized to date) and the revised cash
flows. The revised yield is then applied prospectively to recognize interest
income.
For other mortgage-backed and related mortgage securities, the Company accounts
for interest income under SFAS No. 91, using the effective yield method which
includes the amortization of discount or premium arising at the time of
purchase and the stated or coupon interest payments.
As a result of the closing of CDO I at the end of the first quarter 2002, the
Company reclassified all of its subordinated CMBS on its consolidated statement
of financial condition from available-for-sale to held-to-maturity. The effect
of this reclassification changed the accounting basis for these securities,
prospectively, from fair market value to adjusted cost. However, in accordance
with the Statement of Financial Accounting Standard ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," ("SFAS No.
133"), the interest rate swap agreements entered into by the Company to hedge
the variable rate exposure of the debt of CDO I are required to be presented on
the balance sheet at their fair market value. Accordingly, the Company
determined that at December 31, 2002, and going forward, it would classify all
of its subordinated CMBS as available-for-sale securities and record them at
fair market value. This is consistent with the mark to market requirement for
the CDO's interest rate swap agreements.
The reclassification of these securities to available-for-sale from
held-to-maturity increased the recorded value of these securities from $558,522
to $610,713 at December 31, 2002 with the difference being recorded in other
comprehensive income. Under the various CDO indentures, the collateral
administrator to the CDO has an ongoing fiduciary obligation to monitor the
credit risk of the collateral securities contributed to the CDO. The collateral
administrator may sell collateral securities that have suffered a credit event
(such as a rating downgrade) or, in the collateral administrator's reasonable
business judgment, have a significant risk of declining in credit quality over
time. The Company has concluded there are circumstances under the various CDO
indentures that permit, and the reasonable exercise of business judgment would
warrant, the sale of one or more securities outside the boundaries of paragraph
8(a) of SFAS No. 115. The circumstance causing the Company to change this
classification was not considered a permitted circumstance as stated in SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
("SFAS No. 115"), and is therefore inconsistent with the Company's intent
regarding its held-to-maturity classification. Accordingly, the Company's
held-to-maturity classification has been tainted and the Company was prohibited
from classifying any securities as held-to-maturity for a period of two years
commencing December 31, 2002.
Securities Held-for-trading
The Company has designated certain other securities as held-for-trading.
Securities held-for-trading are also carried at estimated fair value, with
changes in fair value included in income. The valuations of these securities
and the interest income recognized are subject to the same uncertainties as
those discussed above.
Mortgage Loans
The Company purchases and originates commercial mortgage loans to be held as
long-term investments. The Company also has investments in private opportunity
funds that invest in commercial mortgage loans and are managed by the Manager.
Management must periodically evaluate each loan for possible impairment.
Impairment is indicated when it is deemed probable that the Company will not be
able to collect all amounts due according to the contractual terms of the loan.
If a loan were determined to be impaired, the Company would establish a reserve
for probable losses and a corresponding charge to earnings. Given the nature of
the Company's loan portfolio and the underlying commercial real estate
collateral, significant judgment of management is required in determining
impairment and the resulting loan loss allowance, which includes but is not
limited to making assumptions regarding the value of the real estate that
secures the mortgage loan. To date, the Company has determined that no loan
loss allowances have been necessary on the loans in its portfolio or held by
the opportunity funds.
Real Estate Joint Ventures
The Company makes investments in real estate entities over which the Company
exercises significant influence, but not control. The real estate held by such
entities must be regularly reviewed for impairment, and would be written down
to its estimated fair value, through earnings, if impairment were determined to
exist. This review involves assumptions about the future operating results of
the real estate and market factors, all of which are subjective and difficult
to predict. To date, the Company has determined that none of the real estate
held by its joint ventures is impaired.
Derivative Instruments
The Company utilizes various hedging instruments (derivatives) to hedge
interest rate and foreign currency exposures or to modify the interest rate or
foreign currency characteristics of related Company investments. All
derivatives are carried at fair value, generally estimated by management based
on valuations provided by the counterparty to the derivative contract. For
accounting purposes, the Company's management must decide whether to designate
these derivatives as either a hedge of an asset or liability, securities
available-for-sale, securities held-for-trading, or foreign currency exposure.
This designation decision affects the manner in which the changes in the fair
value of the derivatives are reported.
Impairment - Securities
In accordance with SFAS No. 115, when the estimated fair value of the security
classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has the
ability or intent to hold the security for the period of time over which the
Company expects the values to recover to amortized cost, the investment is
written down to its fair value. The resulting charge is included in income, and
a new cost basis is established. Additionally, under EITF 99-20, when changes
in estimated cash flows from the cash flows previously estimated occur due to
actual prepayment and credit loss experience, and the present value of the
revised cash flows using the current expected yield is less than the present
value of the previously estimated remaining cash flows (adjusted for cash
receipts during the intervening period), an other-than-temporary impairment is
deemed to have occurred. Accordingly, the security is written down to fair
value with the resulting change being included in income, and a new cost basis
established. In both instances, the original discount or premium is written off
when the new cost basis is established.
After taking into account the effect of an impairment charge, income is
recognized under EITF 99-20 or SFAS No. 91, as applicable, using the market
yield for the security used in establishing the write-down.
Recent Accounting Pronouncements
In December 2004, FASB issued SFAS No. 123R, "Share-Based Payment." This
statement is a revision to SFAS No. 123, "Accounting for Stock-Based
Compensation" and supercedes APB Opinion No. 25, "Accounting for Stock Issued
to Employees." This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services, primarily focusing on the accounting for transactions in which an
entity obtains employee services in share-based payment transactions. Entities
will be required to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period
during which an employee is required to provide service, the requisite service
period (usually the vesting period), in exchange for the award. The grant-date
fair value of employee share options and similar instruments will be estimated
using option-pricing models. If an equity award is modified after the grant
date, incremental compensation cost will be recognized in an amount equal to
the excess of the fair value of the modified award over the fair value of the
original award immediately before the modification. This statement is effective
as of the beginning of the first interim or annual reporting period that begins
after June 15, 2005. In accordance with the standard, the Company will adopt
SFAS No. 123R during the year ended December 31, 2005. The Company has
determined that this statement will not impact the Company's consolidated
financial statements, as there are no unvested options as of December 31, 2004
and the Company already applies the fair value method to all newly-issued
options.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets--An Amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions". SFAS No. 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets in paragraph
21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and
replaces it with an exception for exchanges that do not have commercial
substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. SFAS No. 153 is effective for the
fiscal periods beginning after June 15, 2005 and is required to be adopted by
the Company for the year ended December 31, 2006. The adoption of SFAS No. 153
is not expected to have a significant impact on the Company's financial
statements.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
the "recognition" provisions of Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
("EITF No. 03-1"). EITF No. 03-1 requires that a loss be recognized for an
impairment that is other-than-temporary. A three-step impairment model should
be applied to debt securities subject to SFAS No. 115, including those debt
securities subject to EITF No. 99-20, "Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets." On September 30, 2004, the FASB issued FASB Staff Position
(FSP) EITF No. 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No.
03-1," which delayed the effective date of the recognition provisions of EITF
No. 03-1 until the issuance of the final FSP EITF Issue 03-1-a, "Implementation
Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1." Until the
final FSP is issued, management is not able to evaluate whether the adoption of
the "recognition" provisions under such guidance will have a material effect on
our results of operations or financial position.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised 2003),
"Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R addresses
the application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," to variable interest entities ("VIE") and generally would require
that the assets, liabilities and results of operations of a VIE be consolidated
into the financial statements of the enterprise that has a controlling
financial interest in it. The interpretation provides a framework for
determining whether an entity should be evaluated for consolidation based on
voting interests or significant financial support provided to the entity
("variable interests").
An entity is classified as a VIE if total equity is not sufficient to permit
the entity to finance its activities without additional subordinated financial
support or its equity investors lack the direct or indirect ability to make
decisions about an entity's activities through voting rights, absorb the
expected losses of the entity if they occur or receive the expected residual
returns of the entity if they occur. Once an entity is determined to be a VIE,
its assets, liabilities and results of operations should be consolidated with
those of its primary beneficiary. The primary beneficiary of a VIE is the
entity that either will absorb a majority of the VIE's expected losses or has
the right to receive a majority of the VIE's expected residual returns. The
expected losses and residual returns of a VIE include expected variability in
its net income or loss, fees to decision makers and fees to guarantors of
substantially all VIE assets or liabilities and are calculated in accordance
with Statement of Financial Accounting Concept No. 7, "Using Cash Flow
Information and Present Value in Accounting Measurements."
A public enterprise with a variable interest in a VIE must apply FIN 46R to
that VIE no later than the end of the first reporting period that ends after
March 15, 2004, with the exception of special purpose entities ("SPEs"), as
defined. A public enterprise with a variable interest in an SPE which has been
deemed a VIE must apply FIN 46R to that VIE no later than the end of the first
reporting period that ends after December 15, 2003. Additionally, if it is
reasonably possible that an enterprise will consolidate or disclose information
about a VIE when the guidance becomes effective, there are several disclosure
requirements effective for all financial statements issued after January 31,
2003.
The Company's ownership of the subordinated classes of CMBS from a single
issuer where it maintains the right to control the foreclosure/workout process
on the underlying loans ("Controlling Class CMBS") are variable interests in
SPEs which have been deemed VIEs and therefore subject to the FIN 46R
consolidation criteria. Provided in Paragraph 4(d) of FIN 46R, are exceptions
to the consolidation of VIE's specifically, that an enterprise that holds
variable interests in a qualifying special-purpose entity ("QSPE") shall not
consolidate that entity unless that enterprise has the unilateral ability to
cause the entity to liquidate or change the entity so that it not longer meets
the conditions in paragraph 25 or 35 of SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities. Pursuant
to FIN 46R, the Company's management has concluded that the trusts holding its
Controlling Class CMBS (except for LBUBS 2004-C2) are QSPEs and accordingly,
the Company did not consolidate these trusts. The Controlling Class CMBS that
have been deemed VIEs are detailed below. The Company's actual loss from its
Controlling Class CMBS investments is limited to the amounts invested in such
securities and further limited to such amounts not financed in its non-recourse
CDOs. The fair value of the subordinated Controlling Class securities financed
in the CDOs is $380,063; the total fair value of the Company's subordinated
Controlling Class CMBS is $441,509 (See Note 3 of the consolidated financial
statements for further discussion of LBUBS 2004-C2).
The table below details the purchase date, par of the Company's Controlling
Class securities and the entire par of each Controlling Class issuance owned by
the Company as of December 31, 2004.
Controlling Class Purchase Date Par Held by the Total CMBS Issued
Securities Company
------------------------------------------------------------------------------------------
Unconsolidated
CMAC 1998-C1 July 1998 $47,786 $1,192,239
CMAC 1998-C2 September 1998 88,140 2,891,309
DLJCM 1998-CG1 June 1998 65,747 1,564,253
GMAC 1998-C1 April 1998 24,737 1,438,000
LBCMT 1998-C1 May 1998 100,000 1,727,818
PNCMA 1999-CM1 November 1999 18,059 760,414
LBUBS 2002-C2 October 2004 30,060 1,210,453
CSFB 2001-CK6 December 2001 48,115 939,182
CSFB 2003-CPN1 February 2003 39,759 1,006,389
GECMC 2003-C2 July 2003 38,450 1,183,080
BACM 2004-1 March 2004 24,705 1,327,183
JPMCC 2004-PNC1 June 2004 21,949 1,097,416
BACM 2004-3 July 2004 23,103 1,253,168
GMACC 2004-C2 August 2004 22,177 933,735
BACM 2004-6 December 2004 38,862 956,589
----------------------------------------
Total Unconsolidated $ 631,649 $ 19,481,228
========================================
Consolidated
LBUBS 2004-C2 April 2004 35,495 1,237,113
----------------------------------------
Total Consolidated $ 35,495 $ 1,237,113
========================================
Total Controlling Class CMBS $ 667,144 $ 20,718,341
========================================
Results of Operations
Net income for the year ended December 31, 2004 was $43,192, or $0.50 per share
(basic and diluted). Net loss for the year ended December 31, 2003 was
$(8,642), or $(0.34) per share (basic and diluted). Net income for the year
ended December 31, 2002 was $59,995, or $1.18 per share (basic and diluted).
Interest Income: The following table sets forth information regarding the total
amount of income from certain of the Company's interest-earning assets and the
resulting average yields. Information is based on monthly average adjusted cost
basis during the period.
For the Year Ended December 31, 2004
--------------------------------------------------------
Interest Average Annualized
Income Balance Yield
----------------- ------------------ -------------------
Commercial real estate securities $123,860 $1,660,425 7.46%
Commercial mortgage loan pools 39,672 987,481 4.02%
Commercial real estate loans 11,896 105,305 11.30%
Residential mortgage-backed securities 18,901 543,257 3.48%
("RMBS")
Cash and cash equivalents 638 48,428 1.32%
----------------- ------------------ -------------------
Total $194,967 $3,344,896 5.83%
================= ================== ===================
For the Year Ended December 31, 2003
--------------------------------------------------------
Interest Average Annualized
Income Balance Yield
----------------- ------------------ -------------------
Commercial real estate securities $98,113 $1,128,689 8.69%
Commercial real estate loans 5,875 56,344 10.43%
RMBS 54,504 1,312,641 4.15%
Cash and cash equivalents 964 73,326 1.13%
----------------- ------------------ -------------------
Total $159,456 $2,571,000 6.20%
================= ================== ===================
For the Year Ended December 31, 2002
------------------------------------------------------------
Interest Average Annualized
Income Balance Yield
------------------------------------------------------------
Commercial real estate securities $72,205 $730,391 9.89%
Commercial real estate loans 13,997 128,385 10.90%
RMBS 72,524 1,392,389 5.21%
Cash and cash equivalents 1,473 95,996 1.53%
------------------------------------------------------------
Total $160,199 $2,347,161 6.83%
============================================================
The following chart reconciles interest income and total income for the years
ended December 31, 2004, 2003 and 2002.
For the Years Ended December 31,
2004 2003 2002
-------------------------------------------------
Interest Income $194,967 $159,456 $160,199
Earnings from real estate joint ventures 1,097 955 1,044
Earnings from equity investments 7,060 3,367 1,202
Other income 742 - -
-------------------------------------------------
Total Income $203,866 $163,778 $162,445
=================================================
At the end of the third quarter of 2003, the Company decided to accelerate its
strategic reduction of RMBS due to the volatility of interest rates and
structural changes in the RMBS market. As a result, the source of a significant
portion of the Company's income has shifted from RMBS to commercial real estate
assets. The Company completed its repositioning into commercial real estate
assets during the third quarter of 2004.
Interest Expense: The following table sets forth information regarding the
total amount of interest expense from certain of the Company's collateralized
borrowings. Information is based on daily average balances during the period;
the collateralized debt obligations for the year ended December 31, 2004 and
2003 includes the cost of hedging those transactions.
For the Year Ended December 31, 2004
---------------------------------------------
Interest Average Annualized
Expense Balance Rate
------------ ------------- -------------
Collateralized debt obligations $58,986 $969,586 6.08%
Commercial mortgage loan pools 37,527 1,297,057 2.89%
Reverse repurchase agreements 12,111 813,742 1.49%
Lines of credit and term loan 4,093 105,588 3.88%
------------ ------------- -------------
Total $112,717 $3,185,973 3.54%
============ ============= =============
For the Year Ended December 31, 2003
---------------------------------------------
Interest Average Annualized
Expense Balance Rate
------------ ------------- -------------
Collateralized debt obligations $ 44,226 $ 684,797 6.46%
Reverse repurchase agreements 18,614 1,460,049 1.27%
Lines of credit and term loan 2,325 45,199 5.14%
------------ ------------- -------------
Total $ 65,165 $ 2,190,045 2.98%
============ ============= =============
For the Year Ended December 31, 2002
---------------------------------------------
Interest Average Annualized
Expense Balance Rate
------------ ------------- -------------
Collateralized debt obligations $ 17,374 $ 263,242 6.60%
Reverse repurchase agreements 31,651 1,607,376 1.97%
Lines of credit and term loan 2,451 65,741 3.73%
------------ ------------- -------------
Total $ 51,476 $ 1,936,359 2.66%
============ ============= =============
The foregoing interest expense amounts for the year ended December 31, 2004 do
not include $1,015 of hedge ineffectiveness expense, as well as $14,434 of
interest expense related to interest rate hedges outside of the CDOs. The
foregoing interest expense amounts for the year ended December 31, 2003 do not
include $706 of hedge ineffectiveness income, as well as $18,790 of interest
expense related to interest rate hedges outside of the CDOs. The foregoing
interest expense amounts for the year ended December 31, 2002 do not include
hedge ineffectiveness income of $236, as well as $13,778 of interest expense
related to interest rate hedges outside of the CDOs. See Note 15 of the
consolidated financial statements, Derivative Instruments, for further
description of the Company's hedge ineffectiveness.
The Company issued the first of its three consolidated CDOs in the second
quarter of 2002. As the Company issued additional match funded liabilities, the
source of the Company's interest expense shifted from reverse repurchase
agreements and lines of credit to collateralized debt obligations.
Additionally, during 2004 the Company acquired subordinated CMBS in a trust
that, in accordance with FIN 46R, was required to be consolidated on the
Company's financial statements, resulting in interest expense from commercial
mortgage loan pools.
Net Interest Margin and Net Interest Spread from the Portfolio: The Company
considers its portfolio to consist of its securities available-for-sale,
securities held-for-trading, commercial mortgage loans, and cash and cash
equivalents because these assets relate to its core strategy of acquiring and
originating high yield loans and securities backed by commercial real estate,
while at the same time maintaining a portfolio of investment grade securities
to enhance the Company's liquidity.
Net interest margin from the portfolio is annualized net interest income
divided by the average market value of interest-earning assets. Net interest
income is total interest income less interest expense relating to
collateralized borrowings. Net interest spread equals the yield on average
assets for the period less the average cost of funds for the period. The yield
on average assets is interest income divided by average amortized cost of
interest earning assets. The average cost of funds is interest expense from the
portfolio divided by average outstanding collateralized borrowings.
The following chart describes the interest income, interest expense, net
interest margin and net interest spread for the Company's portfolio. The
following interest income and interest expense amounts exclude income and
expense related to real estate joint ventures, equity investments, hedge
ineffectiveness, and the effect of the consolidation of the commercial mortgage
loan pools.
For the Year Ended December 31,
2004 2003 2002
------------- -------------- --------------
Interest income $159,036 $159,456 $160,200
Interest expense $88,942 $83,930 $65,207
Net interest margin 3.16% 3.08% 4.40%
Net interest spread 2.45% 2.68% 4.05%
Other Expenses: Expenses other than interest expense consist primarily of
management fees and general and administrative expenses. Management fees paid
to the Manager of $8,956 for the year ended December 31, 2004 were comprised
entirely of base management fees. During the third quarter of 2003, the Manager
agreed to reduce the management fees by 20% from its calculated amount for the
third and fourth quarter of 2003 and the first quarter of 2004. This revision
resulted in $1,046 in savings to the Company during 2003 and $532 during 2004.
Management fees paid to the Manager of $9,411 for the year ended December 31,
2003 were comprised entirely of base management fees. Management fees paid to
the Manager of $12,527 for the year ended December 31, 2002 were comprised of
base management fees of $9,332 and incentive fees of $3,195. General and
administrative expense of $3,427 for the year ended December 31, 2004, $2,296
for the year ended December 31, 2003, and $2,323 for the year ended December
31, 2002 were comprised of accounting agent fees, custodial agent fees,
directors' fees, fees for professional services, insurance premiums, broken
deal expenses, and due diligence costs. General and administrative fees for the
year ended December 31, 2004 rose primarily due to an increase in professional
fees related to Sarbanes-Oxley Act compliance and legal fees in connection with
the Company's claim for a supplemental fee on a repaid commercial mortgage
loan.
Other Gains (Losses): During the year ended December 31, 2004, the Company sold
a portion of its securities available-for-sale for total proceeds of $503,898
resulting in a realized gain of $17,544. During the year ended December 31,
2003, the Company sold a portion of its securities available-for-sale for total
proceeds of $1,466,552, resulting in a realized loss of $6,832. During the year
ended December 31, 2002, the Company sold a portion of its securities
available-for-sale for total proceeds of $1,017,534, resulting in a realized
gain of $11,391. The loss on securities held-for-trading of $11,464, $38,206,
and $29,255 for the years ended December 31, 2004, 2003, and 2002,
respectively, consisted primarily of realized and unrealized gains and losses
on U.S. Treasury and Agency securities, forward commitments to purchase or sell
agency RMBS and hedges. The foreign currency loss of $187 and $812 for the
years ended December 31, 2004 and 2002, respectively, relates to the Company's
net investment in a commercial mortgage loan denominated in pounds sterling, a
commercial mortgage loan denominated in euros, and associated hedging. The loss
on impairment of assets of $26,018, $32,426, and $10,273, for the years ended
December 31, 2004, 2003, and 2002, respectively, were related to the Company's
write downs of Controlling Class CMBS and franchise loan backed securities.
Dividends Declared: During the year ended December 31, 2004, the Company
declared dividends to stockholders totaling $58,208, or $1.12 per share, of
which $43,287 was paid during the year and $14,921 was paid on February 1,
2005. During the year ended December 31, 2003, the Company declared dividends
to common stockholders totaling $61,088, or $1.26 per share, of which $47,238
was paid during the year and $13,850 was paid on February 2, 2004. For U.S.
Federal income tax purposes, the dividends are ordinary income to the Company's
stockholders.
Changes in Financial Condition
Securities Available-for-sale: The Company's securities available-for-sale,
which are carried at estimated fair value, included the following at December
31, 2004 and December 31, 2003:
December December
31, 2004 31, 2003
Estimated Estimated
Fair Fair
Security Description Value Percentage Value Percentage
------------------------------------------------------------------------------------------------------------
Commercial mortgage-backed securities:
CMBS IOs $ 125,246 7.1% $84,493 4.7%
Investment grade CMBS 389,813 22.1 333,454 18.5
Non-investment grade rated subordinated
securities 748,807 42.6 678,424 37.6
Non-rated subordinated securities 5,994 0.3 25,019 1.4
Credit tenant lease 25,251 1.4 25,696 1.4
Investment grade REIT debt 285,341 16.2 219,422 12.1
Project loans 23,650 1.3 26,502 1.4
CDO investments 19,837 1.1 - -
--------------------------------------------------------
Total CMBS 1,623,939 92.1 $1,393,010 77.1
--------------------------------------------------------
Single-family residential mortgage-backed
securities:
Agency adjustable rate securities 112,139 6.4 180,381 10.0
Agency fixed rate securities - - 222,500 12.3
Residential CMOs 1,407 0.1 3,464 0.2
Hybrid arms 25,606 1.5 6,645 0.4
--------------------------------------------------------
Total RMBS 139,153 7.9 412,990 22.9
--------------------------------------------------------
---------------------------------------------------------
Total securities available-for-sale $1,763,092 100.0% $1,806,000 100.0%
=========================================================
The decrease in RMBS is attributable to the Company's strategic reduction of
the RMBS portfolio.
Borrowings: As of December 31, 2004 and 2003, the Company's debt consisted of
line-of-credit borrowings, CDO debt, term loans and reverse repurchase
agreements, collateralized by a pledge of most of the Company's securities
available-for-sale, securities held-for-trading, and its commercial mortgage
loans. The Company's financial flexibility is affected by its ability to renew
or replace on a continuous basis its maturing short-term borrowings. As of
December 31, 2004 and 2003, the Company obtained financing in amounts and at
interest rates consistent with the Company's short-term financing objectives.
Under the lines of credit, term loans, and the reverse repurchase agreements,
the lender retains the right to mark the underlying collateral to market value.
A reduction in the value of its pledged assets would require the Company to
provide additional collateral or fund margin calls.
The following table sets forth information regarding the Company's
collateralized borrowings:
For the Year Ended
December 31, 2004
--------------------------------------------------------------------
December 31,
2004 Maximum Range of
Balance Balance Maturities
--------------------------------------------------------------------
CDO debt* $1,067,967 $1,068,210 6.9 to 9.1 years
Commercial mortgage loan pools 1,294,058 $1,298,984 3.1 to 9.8 years
Reverse repurchase agreements 640,675 1,148,306 4 to 143 days
Line of credit and term loan borrowings 163,676 391,511 188 to 496 days
--------------------------------------------------------------------
For the Year Ended
December 31, 2003
--------------------------------------------------------------------
December 31,
2003 Maximum Range of
Balance Balance Maturities
--------------------------------------------------------------------
CDO debt* $684,970 $685,239 7.9 to 9.7 years
Reverse repurchase agreements 1,048,635 1,858,434 2 to 29 days
Line of credit and term loan borrowings 89,936 89,936 100 to 562 days
--------------------------------------------------------------------
* Disclosed as adjusted issue price. Total par of the Company's CDO debt as of
December 31, 2004 and 2003 was $1,081,418 and $699,553, respectively.
Hedging Instruments: From time to time, the Company may modify its exposure to
market interest rates by entering into various financial instruments that
adjust portfolio duration and short-term rate exposure. These financial
instruments are intended to mitigate the effect of changes in interest rates on
the value of the Company's assets and the cost of borrowing.
At December 31, 2004, the Company had no outstanding future contracts. At
December 31, 2003, the Company had outstanding short positions of 30 five-year
and 73 ten-year U.S. Treasury Note future contracts. At December 31, 2004 and
2003, the Company had a forward London Interbank Offered Rate ("LIBOR") cap
with a notional amount of $85,000 and a fair value of $694 and $1,114,
respectively.
Swap agreements as of December 31, 2004 and 2003 consisted of the following:
As of December 31, 2004
-----------------------------------------------------------------------------------
Notional Estimated Fair Unamortized Average Remaining
Value Value Cost Term (years)
-----------------------------------------------------------------------------------
Cash flow hedges $452,600 $253 - 5.44
Trading swaps 16,000 (5) - 1.94
CDO cash flow hedges 718,120 (11,262) - 8.50
CDO timing swaps 223,445 145 - 8.08
As of December 31, 2003
-----------------------------------------------------------------------------------
Notional Estimated Fair Unamortized Average Remaining
Value Value Cost Term (years)
-----------------------------------------------------------------------------------
Cash flow hedges $611,300 $(4,442) - 6.53
Trading swaps 308,000 1,513 - 3.34
CDO cash flow hedges 454,778 (23,651) - 8.51
CDO timing swaps 171,545 29 - 8.61
The counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch
Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special
Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-,
respectively. The Company continually monitors the rating and overall credit
quality of its swap counterparties.
Capital Resources and Liquidity
Liquidity is a measurement of the Company's ability to meet cash requirements,
including ongoing commitments to repay borrowings, fund investments, loan
acquisition and lending activities, and for other general business purposes.
The primary sources of funds for liquidity consist of collateralized
borrowings, principal and interest payments on and maturities of securities
available-for-sale, securities held-for-trading, commercial mortgage loans, and
proceeds from the maturity or sales thereof.
The Company finances itself with its common equity, follow-on common equity
offerings, preferred stock offerings, secured term debt, committed financing
facilities, and reverse repurchase agreements. An important part of the
Company's risk analysis includes a thorough assessment of the financing
alternatives in the context of the assets being financed.
Reverse repurchase agreements are secured loans generally with a term of 30
days. The interest rate is based on 30-day LIBOR plus a spread that is
determined based on the asset pledged as security. The terms include a daily
mark to market provision that requires the posting of additional collateral if
the value of the pledged asset declines. After the 30-day period expires, there
is no obligation for the lender to extend credit for an additional period. This
type of financing is generally available only for more liquid securities. The
interest rate charged on reverse repurchase agreements is usually the lowest
relative to the alternatives due to the lower risk inherent in these
transactions.
Committed financing facilities represent multi-year agreements to provide
secured financing for a specific asset class. These facilities include a daily
mark to market provision requiring posting of additional collateral if the
value of the pledged asset declines in excess of a threshold amount. A
significant difference between committed financing facilities and reverse
repurchase agreements is the term of the financing. A committed facility
provider is generally required to provide financing for the full term of the
agreement, usually two to three years, rather than thirty days as generally
used in the reserve repurchase market. This longer term makes the financing of
less liquid assets viable.
Issuance of secured term debt is generally done through a CDO offering. This
entails creating a special purpose entity that holds assets used to secure the
payments required of the debt issued. With the exception of CDO HY1, these
transactions are considered financings and the special purpose entities ("SPE")
are fully consolidated on the Company's consolidated financial statements.
Asset cash flows are generally matched with the debt service requirements over
their respective lives and an interest rate swap is used to match the fixed or
floating rate nature of the coupon payments where necessary. This type of
transaction is usually referred to as "match funding" or "term financing" the
assets. There is no mark to market requirement in this structure and the debt
cannot be called or terminated by the bondholders. Furthermore, the debt issued
is non-recourse to the issuer therefore permanent reductions in value do not
affect the liquidity of the Company. However, since the Company expects to earn
a positive spread between the income generated by the assets and the expense of
the debt issued, a permanent impairment of any of the assets would negatively
affect the spread over time.
The Company may issue preferred stock from time to time as a source of
long-term or permanent capital. Preferred stock generally has a fixed coupon
and may have a fixed term in the form of a maturity date or other redemption or
conversion feature. The preferred stockholder typically has the right to a
preferential distribution for dividends and any liquidity proceeds.
Another source of permanent capital is the issuance of common stock through a
follow-on offering. This allows investors to purchase a large block of common
stock in one transaction. A common stock issuance can be accretive to the
Company's book value per share if the issue price per share exceeds the
Company's book value per share. It can also be accretive to earnings per share
if the Company deploys the new capital into assets that generate a risk
adjusted return that exceeds the return of the Company's existing assets.
Furthermore, earnings accretion can also be achieved at reinvestment rates that
are lower than the return on existing assets if common stock is issued at a
premium to book value.
The Company continuously evaluates the market for follow-on common stock
offerings as well as the available opportunities to deploy new capital on an
accretive basis. In 2004, the Company issued 2,415,000 shares of common stock
in a follow-on offering at $11.50 per share. During 2003, the Company did not
issue any common stock in follow-on equity offerings. Additionally, for the
years ended December 31, 2004 and 2003, respectively, the Company issued
1,084,619 and 1,955,919 shares of Common Stock under its Dividend Reinvestment
Plan. Net proceeds to the Company were approximately $12,691 and $21,134,
respectively.
At December 31, 2004, the Company's collateralized borrowings had the following
remaining maturities:
Reverse Commercial Collateralized Total
Lines of Repurchase Mortgage Loan Debt Collateralized
Credit Agreements Pools Obligations* Borrowings
-------------------------------------------------------------------------------------
Within 30 days $- $605,944 $- $- $605,944
31 to 59 days - 7,925 - - 7,925
60 days to less than 1 year 150,876 26,806 - - 177,682
1 year to 3 years 12,800 - - - 12,800
3 years to 5 years - - - - -
Over 5 years - - 1,294,058 1,067,967 2,362,025
----------------------------------------------------------------------------------
$163,676 $640,675 $1,294,058 $1,067,967 $3,166,376
==================================================================================
* Comprised of $405,377 of CDO debt with a weighted average remaining maturity
of 7.29 years as of December 31, 2004 and $293,167 of CDO debt with a weighted
average remaining maturity of 7.72 years as of December 31, 2004, and $369,422
of CDO debt with a weighted average remaining maturity of 8.39 years as of
December 31, 2004.
In addition, the Company has no off-balance sheet financing arrangements.
Cash provided by (used in) the Company's operating activities totaled $135,948,
$563,525 and $(787,464) for the years ended December 31, 2004, 2003 and 2002,
respectively, primarily through net income, offset by purchases of trading
securities in 2002.
Net cash flow (used in) provided by investing activities was $(110,901),
$(232,268) and $516,542 for the years ended December 31, 2004, 2003 and 2002,
respectively, primarily to purchase securities available for sale and to fund
commercial mortgage loans, offset by significant sales of securities during
2002.
Net cash flow (used in) provided by financing activities was $(22,097),
$(335,150) and $252,549 for the years ended December 31, 2004, 2003 and 2002,
respectively, primarily to decrease short-term borrowings and pay dividends,
offset by increases in collateralized debt obligations, and stock issuance. In
addition, at the end of the first quarter of 2004, the Board of Directors
approved the Company's decision to redeem its Series B Preferred Stock, $0.001
par value per share ("Series B Preferred Stock") for $43,930. The Series B
Preferred Stock was redeemed on May 6, 2004.
Contingent Liability
During 2000, the Company completed the acquisition of CORE Cap, Inc. The merger
was a stock for stock acquisition where the Company issued 4,180,552 shares of
its Common Stock and 2,261,000 shares of its Series B Preferred Stock. At the
time of the CORE Cap acquisition, BlackRock Financial Management, Inc. (the
"Manager") agreed to pay GMAC (CORE Cap, Inc.'s external advisor) $12,500 over
a ten-year period ("Installment Payment") to purchase the right to manage the
assets under the existing management contract ("GMAC Contract"). The GMAC
Contract had to be terminated in order to allow for the Company to complete the
merger, as the Company's management agreement with the Manager did not provide
for multiple managers. As a result the Manager offered to buy-out the GMAC
Contract as the Manager estimated it would receive incremental fees above and
beyond the Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with the Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment Payment
less the sum of all payments made by the Manager to GMAC. As of December 31,
2004, the Installment Payment would be $6,500 payable over six years. The
Company does not accrue for this contingent liability.
Transactions with Affiliates
The Company has a Management Agreement with the Manager, a majority owned
indirect subsidiary of The PNC Financial Services Group, Inc. ("PNC Bank") and
the employer of certain directors and officers of the Company, under which the
Manager manages the Company's day-to-day operations, subject to the direction
and oversight of the Company's Board of Directors. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with the
approval of the unaffiliated directors, on terms similar to the prior agreement
with the following changes: (i) the incentive fee calculation would be based on
GAAP earnings instead of funds from operations, (ii) the removal of the
four-year period to value the Management Agreement in the event of termination
and (iii) subsequent renewal periods of the Management Agreement would be for
one year instead of two years. Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., a national investment banking and financial advisory firm,
advised the Board in the 2002 renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year through
March 31, 2004. The terms of the renewed agreement were similar to the prior
agreement except for the incentive fee calculation that would provide for a
rolling four-quarter high watermark rather than a quarterly calculation. In
determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee, as defined, were greater than what was paid to the
Manager in the prior three quarters cumulatively. The Company phased in the
rolling four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee was based on GAAP earnings and adjusted to
exclude special one-time events pursuant to changes in GAAP accounting
pronouncements after discussion between the Manager and the unaffiliated
directors. The incentive fee threshold did not change. The high watermark
provided for the Manager to be paid 25% of the amount of earnings (calculated
in accordance with GAAP) per share that exceeds the product of the adjusted
issue price of the Company's Common Stock per share and the greater of 9.5% or
350 basis points over the ten-year Treasury note.
The Management Agreement was further extended for one year from March 31, 2004
through March 31, 2005. The base management fee was revised to equal 2% of the
quarterly average total stockholders' equity for the applicable quarter. The
incentive fee was revised to be 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's Common Stock per share ($11.37 as of December 31, 2004)
and the greater of 8.5% or 400 basis points over the ten-year Treasury note. On
March 10, 2004, the members of the Company's Board of Directors who are not
affiliated with the Manager approved an extension of the Company's management
agreement with the Manager for one additional year through March 31, 2006. The
terms of the extended agreement did not change.
During the third quarter of 2003, the Manager agreed to reduce the management
fees by 20% from its calculated amount for the third and fourth quarter of 2003
and the first quarter of 2004. This revision resulted in $1,046 in savings to
the Company during 2003 and $532 during 2004, respectively.
The Company incurred $8,956, $9,411, and $9,332 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2004, 2003, and 2002, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements to
the Manager of $120, $66, and $14 for certain expenses incurred on behalf of
the Company during 2004, 2003, and 2002, respectively.
The Company has an administration agreement with the Manager. Under the terms
of the administration agreement, the Manager provides financial reporting,
audit coordination and accounting oversight services to the Company. Either
party can cancel the agreement upon 60-day written notice. The Company pays the
Manager a monthly administrative fee at an annual rate of 0.06% of the first
$125 million of average net assets, 0.04% of the next $125 million of average
net assets and 0.03% of average net assets in excess of $250 million subject to
a minimum annual fee of $120. For the years ended December 31, 2004, 2003, and
2002, the Company paid administration fees of $174, $173, and $168,
respectively.
The special servicer on 11 of the Company's 16 Controlling Class trusts is
Midland Loan Services, Inc. ("Midland"), a wholly owned indirect subsidiary of
PNC Bank. The Company's fees for Midland's services are at market rates.
During 2001, the Company entered into a $50,000 commitment to acquire shares in
Carbon I, a private commercial real estate income opportunity fund managed by
the Manager. The Carbon I investment period ended on July 12, 2004 and the
Company's investment in Carbon I as of December 31, 2004 was $39,563. The
Company does not incur any additional management or incentive fees to the
Manager as a result of its investment in Carbon I. On December 31, 2004, the
Company owned approximately 20% of the outstanding shares in Carbon I.
On October 13, 2004, the Company entered into a commitment of up to $30,000 to
acquire shares in Carbon Capital II, Inc. ("Carbon II"), a private commercial
real estate income opportunity fund managed by the Manager. On November 19,
2004 the Company entered into an additional $32,067 commitment to acquire
shares in Carbon II. During 2004, the Company received capital call notices of
$16,953. As of December 31, 2004, the Company's investment in Carbon II was
$17,249 and the Company's remaining commitment to Carbon II is $45,114. The
Company may commit up to the lower of 20% of the total of Carbon II's capital
commitments or $100,000. The Company does not incur any additional management
or incentive fees to the Manager as a result of its investment in Carbon II.
The Company's unaffiliated directors approved this transaction in September
2004.
REIT Status: The Company has elected to be taxed as a REIT and therefore must
comply with the provisions of the Code with respect thereto. Accordingly, the
Company generally will not be subject to Federal income tax to the extent of
its distributions to stockholders and as long as certain asset, income, and
stock ownership tests are met. The Company may, however, be subject to tax at
corporate rates or at excise tax rates on net income or capital gains not
distributed.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk: Market risk includes the exposure to loss resulting from changes
in interest rates, credit curve spreads, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks to which the
Company is exposed are interest rate risk and credit curve risk. Interest rate
risk is highly sensitive to many factors, including governmental, monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the control of the Company. Credit curve risk is
highly sensitive to the dynamics of the markets for commercial mortgage
securities and other loans and securities held by the Company. Excessive supply
of these assets combined with reduced demand will cause the market to require a
higher yield. This demand for higher yield will cause the market to use a
higher spread over the U.S. Treasury securities yield curve, or other benchmark
interest rates, to value these assets. Changes in the general level of the U.S.
Treasury yield curve can have significant effects on the market value of the
Company's portfolio.
The majority of the Company's assets are fixed rate securities valued based on
a market credit spread to U.S. Treasuries. As U.S. Treasury securities are
priced to a higher yield and/or the spread to U.S. Treasuries used to price the
Company's assets is increased, the market value of the Company's portfolio may
decline. Conversely, as U.S. Treasury securities are priced to a lower yield
and/or the spread to U.S. Treasuries used to price the Company's assets is
decreased, the market value of the Company's portfolio may increase. Changes in
the market value of the Company's portfolio may affect the Company's net income
or cash flow directly through their impact on unrealized gains or losses on
securities held-for-trading or indirectly through their impact on the Company's
ability to borrow. Changes in the level of the U.S. Treasury yield curve can
also affect, among other things, the prepayment assumptions used to value
certain of the Company's securities and the Company's ability to realize gains
from the sale of such assets. In addition, changes in the general level of the
LIBOR money market rates can affect the Company's net interest income. As of
December 31, 2004, all of the Company's liabilities outside of the CDOs are
floating rate based on a market spread to LIBOR. As the level of LIBOR
increases or decreases, the Company's interest expense will move in the same
direction.
The Company may utilize a variety of financial instruments, including interest
rate swaps, caps, floors and other interest rate exchange contracts, in order
to limit the effects of fluctuations in interest rates on its operations. The
use of these types of derivatives to hedge interest-earning assets and/or
interest-bearing liabilities carries certain risks, including the risk that
losses on a hedge position will reduce the funds available for payments to
holders of securities and that such losses may exceed the amount invested in
such instruments. A hedge may not perform its intended purpose of offsetting
losses or increased costs. Moreover, with respect to certain of the instruments
used as hedges, the Company is exposed to the risk that the counterparties with
which the Company trades may cease making markets and quoting prices in such
instruments, which may render the Company unable to enter into an offsetting
transaction with respect to an open position. If the Company anticipates that
the income from any such hedging transaction will not be qualifying income for
REIT income purposes, the Company may conduct part or all of its hedging
activities through a to-be-formed corporate subsidiary that is fully subject to
federal corporate income taxation. The profitability of the Company may be
adversely affected during any period as a result of changing interest rates.
The Company monitors and manages interest rate risk based on a method that
takes into consideration the interest rate sensitivity of the Company's assets
and liabilities, including its preferred stock. The Company's objective is to
acquire assets and match fund the purchase so that interest rate risk
associated with financing these assets is reduced or eliminated. The primary
risks associated with acquiring and financing these assets are mark to market
risk and short-term rate risk. Examples of these financing types include 30-day
repurchase agreements and committed borrowing facilities. Certain secured
financing arrangements provide for an advance rate based upon a percentage of
the market value of the asset being financed. Market movements that cause asset
values to decline would require a margin call or a cash payment to maintain the
relationship between asset value and amount borrowed. A cash flow based CDO is
an example of a secured financing vehicle that does not require a mark to
market to establish or maintain a level of financing. When financed assets are
subject to a mark to market margin call, the Company carefully monitors the
interest rate sensitivity of those assets. The duration of the assets financed
which are subject to a mark to market margin call was 2.21 years based on
reported GAAP book value as of December 31, 2004.
The Company's reported book value incorporates the market value of the
Company's interest bearing assets but it does not incorporate the market value
of the Company's interest bearing liabilities. The fixed rate interest bearing
liabilities and preferred stock will generally reduce the actual interest rate
risk of the Company from a pure economic perspective even though changes in the
value of these liabilities are not reflected in the Company's book value. The
fixed rate liabilities issued in CDO I, CDO II and CDO III reduce the Company's
economic duration by approximately 4.74 years. The Series C Preferred Stock
reduces the Company's economic duration by approximately 0.48 year. The
Company's reported book value is not reduced by these liabilities and therefore
is approximately 5.22 years longer than the economic duration. The Company's
duration management strategy focuses on the economic risk and maintains
economic duration within a band of 3.0 to 5.0 years. At December 31, 2004,
economic duration was 3.56 years. Earnings per share is analyzed using the
assumptions that interest rates, as defined by the LIBOR curve, increase or
decrease and that the yield curves of the LIBOR rate shocks will be parallel to
each other. Market value in this scenario is calculated using the assumption
that the U.S. Treasury yield curve remains constant even though changes in both
long- and short-term interest rates can occur simultaneously.
Regarding the table below, all changes in income and value are measured as
percentage changes from the respective values calculated in the scenario
labeled as "Base Case." The base interest rate scenario assumes interest rates
as of December 31, 2004. Actual results could differ significantly from these
estimates.
Projected Percentage Change In
Earnings Per Share
Given LIBOR Movements
Change in LIBOR, Projected Change in
+/- Basis Points Earnings per Share
--------------------------------------------------
-200 $0.074
-100 $0.037
-50 $0.018
Base Case
+50 $(0.018)
+100 $(0.037)
+200 $(0.074)
Credit Risk: The Company's portfolios of commercial real estate assets are
subject to a high degree of credit risk. Credit risk is the exposure to loss
from loan defaults. Default rates are subject to a wide variety of factors,
including, but not limited to, property performance, property management,
supply/demand factors, construction trends, consumer behavior, regional
economics, interest rates, the strength of the U.S. economy, and other factors
beyond the control of the Company.
All loans are subject to a certain probability of default. Before acquiring a
Controlling Class security, the Company will perform an analysis of the quality
of all of the loans proposed. As a result of this analysis, loans with
unacceptable risk profiles are either removed from the proposed pool or the
Company receives a price adjustment. The Company underwrites its Controlling
Class CMBS investments assuming the underlying loans will suffer a certain
dollar amount of defaults and these defaults will lead to some level of
realized losses. Loss adjusted yields are computed based on these assumptions
and applied to each class of security supported by the cash flow on the
underlying loans. The most significant variables affecting loss adjusted yields
include, but are not limited to, the number of defaults, the severity of loss
that occurs subsequent to a default and the timing of the actual loss. The
different rating levels of CMBS will react differently to changes in these
assumptions. The lowest rated securities (B- or lower) are generally more
sensitive to changes in timing of actual losses. The higher rated securities (B
or higher) are more sensitive to the severity of losses and timing of
cashflows.
The Company generally assumes that all of the principal of a non-rated security
and a significant portion, if not all, of CCC and a portion of B- rated
securities will not be recoverable over time. The loss adjusted yields of these
classes reflect that assumption; therefore, the timing of when the total loss
of principal occurs is the most important assumption in determining value. The
interest coupon generated by a security will cease when there is a total loss
of its principal regardless of whether that principal is paid. Therefore,
timing is of paramount importance because the longer the principal balance
remains outstanding, the more interest coupon the holder receives; which
results in a larger economic return. Alternatively, if principal is lost faster
than originally assumed, there is less opportunity to receive interest coupon;
which results in a lower or possibly negative return. Additional losses, which
occur due to greater severity, will not have a significant effect as all
principal is already assumed to be non-recoverable.
If actual principal losses on the underlying loans exceed assumptions, the
higher rated securities will be affected more significantly as a loss of
principal may not have been assumed. The Company generally assumes that all
principal will be recovered by classes rated B or higher. The Company manages
credit risk through the underwriting process, establishing loss assumptions and
careful monitoring of loan performance. After the securities have been
acquired, the Company monitors the performance of the loans, as well as
external factors that may affect their value.
Factors that indicate a higher loss severity or acceleration of the timing of
an expected loss will cause a reduction in the expected yield and therefore
reduce the earnings of the Company. Furthermore, the Company may be required to
write down a portion of the adjusted purchase price of the affected assets
through its consolidated statements of financial condition.
For purposes of illustration, a doubling of the losses in the Company's
Controlling Class CMBS, without a significant acceleration of those losses,
would reduce GAAP income going forward by approximately $0.18 per share of
Common Stock per year and cause a significant write down at the time the loss
assumption is changed. The amount of the write down depends on several factors,
including which securities are most affected at the time of the write down, but
is estimated to be in the range of $1.15 to $1.40 per share based on a
doubling of expected losses. A significant acceleration of the timing of these
losses would cause the Company's net income to decrease. The Company's exposure
to a write down is mitigated by the fact that most of these assets are financed
on a non-recourse basis in the Company's CDOs, where a significant portion of
the risk of loss is transferred to the CDO bondholders. As of December 31,
2004, securities with a total market value of $1,192,337 are collateralizing
the CDO borrowings of $1,083,471; therefore, the Company's preferred equity
interest in the three CDOs is $108,866 ($2.04 per share). The CDO borrowings
are not marked to market in accordance with GAAP even though their economic
value will change in response to changes in interest rates and/or credit
spreads.
Asset and Liability Management: Asset and liability management is concerned
with the timing and magnitude of the re-pricing and/or maturing of assets and
liabilities. It is the Company's objective to attempt to control risks
associated with interest rate movements. In general, management's strategy is
to match the term of the Company's liabilities as closely as possible with the
expected holding period of the Company's assets. This is less important for
those assets in the Company's portfolio considered liquid, as there is a very
stable market for the financing of these securities.
Other methods for evaluating interest rate risk, such as interest rate
sensitivity "gap" (defined as the difference between interest-earning assets
and interest-bearing liabilities maturing or re-pricing within a given time
period), are used but are considered of lesser significance in the daily
management of the Company's portfolio. Management considers this relationship
when reviewing the Company's hedging strategies. Because different types of
assets and liabilities with the same or similar maturities react differently to
changes in overall market rates or conditions, changes in interest rates may
affect the Company's net interest income positively or negatively even if the
Company were to be perfectly matched in each maturity category.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
Management's Responsibility for Financial Reporting ......................................58
Management's Report on Internal Control Over Financial Reporting..........................59
Report of Independent Registered Public Accounting Firm...................................60
Consolidated Financial Statements:
Consolidated Statements of Financial Condition at December 31, 2004 and 2003..............63
Consolidated Statements of Operations
For the Years Ended December 31, 2004, 2003 and 2002......................................64
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31 2004, 2003 and 2002.......................................65
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2004, 2003 and 2002......................................67
Notes to Consolidated Financial Statements................................................68
All schedules have been omitted because either the required information is not
applicable or the information is shown in the financial statements or notes
thereto.
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
Anthracite Capital, Inc. is responsible for the preparation, quality and fair
presentation of its published financial statements. The accompanying
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States and, as such,
include judgments and estimates of management. Anthracite Capital, Inc. also
prepared the other information included in the Annual Report and is
responsible for its accuracy and consistency with the consolidated financial
statements.
Management is responsible for establishing and maintaining effective internal
control over financial reporting. The internal control system is augmented by
written policies and procedures and by audits performed by the Manager's
internal audit staff. The internal audit staff reports to the Manager's Audit
Committee, and, for Anthracite Capital-related matters, to the Company's Audit
Committee. Internal auditors test the operation of the internal control system
and report findings to the Manager, management and as well as the Manager's
and the Company's Audit Committees, and corrective actions are taken to
address identified control deficiencies and other opportunities for improving
the internal control system. The Audit Committees, composed solely of outside
directors, provide oversight to the financial reporting process.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Anthracite Capital, Inc. is responsible for establishing and
maintaining adequate internal control over financial reporting. Internal
control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f)
under the Securities Exchange Act of 1934, as amended, as a process designed
by, or under the supervision of, the company's principal executive and
principal financial officers and effected by the Company's board of directors,
management and other personnel to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles and includes those policies and procedures that:
o pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the
assets of the company;
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the company; and
o provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the Company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
can provide only reasonable assurance with respect to financial statement
preparation and presentation. Projections of any evaluation of effectiveness to
future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control over
financial reporting as of December 31, 2004. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework.
Based on our assessment, management concluded that, as of December 31, 2004,
the Company's internal control over financial reporting is effective.
The Company's independent registered public accounting firm has issued a report
on our assessment of the Company's internal control over financial reporting.
This report begins on the following page.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Anthracite Capital, Inc.
New York, New York
We have audited the accompanying consolidated statements of financial
condition of Anthracite Capital, Inc. and subsidiaries (the "Company") at
December 31, 2004 and 2003, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2004. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Anthracite Capital, Inc. and
subsidiaries at December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2004, based on
the criteria established in Internal Control--Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 14, 2005 expressed an unqualified opinion on management's
assessment of the effectiveness of the Company's internal control over
financial reporting and an unqualified opinion on the effectiveness of the
Company's internal control over financial reporting.
/s/ Deloitte & Touche LLP
New York, New York
March 14, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Anthracite Capital, Inc.
New York, New York
We have audited management's accompanying assessment, included in the December
31, 2004 Form 10-K of Anthracite Capital, Inc. and subsidiaries (the "Company")
under the heading Management's Report on Internal Control over Financial
Reporting, that the Company maintained effective internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by
the company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company's assets that could have a material effect on the financial
statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2004, is fairly
stated, in all material respects, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statement of
financial condition of at December 31, 2004, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
the year ended December 31, 2004 of the Company and our report dated March 14,
2005 expressed an unqualified opinion on those financial statements.
/s/ Deloitte & Touche LLP
New York, New York
March 14, 2005
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except per share data)
----------------------------------------------------------------------------------------------------------------------------------
December 31, 2004 December 31, 2003
----------------- -----------------
ASSETS
Cash and cash equivalents $ 23,755 $ 20,805
Restricted cash equivalents 19,680 12,845
Securities available-for-sale, at fair value
Subordinated commercial mortgage-backed securities ("CMBS") $ 774,638 $ 703,443
Residential mortgage-backed securities ("RMBS") 139,153 412,990
Investment grade securities 849,302 689,567
------------- -----------------
Total securities available-for-sale 1,763,093 1,806,000
Commercial mortgage loan pools, at amortized cost 1,312,045 -
Securities held-for-trading, at fair value 232,918 313,727
Commercial mortgage loans, net 268,086 61,668
Equity investment in the Carbon Capital Funds 56,812 28,493
Investments in real estate joint ventures 5,031 7,823
Receivable for investments sold - 99,056
Other assets 47,714 48,429
--------------- -----------------
Total Assets $3,729,134 $2,398,846
=============== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings:
Collateralized debt obligations ("CDOs") $1,067,967 $684,970
Secured by pledge of subordinated CMBS 29,358 100,892
Secured by pledge of other securities available-for-sale
and cash equivalents 408,832 710,968
Secured by pledge of commercial mortgage loan pools 1,294,830 -
Secured by pledge of securities held-for-trading 223,788 304,001
Secured by pledge of investments in real estate joint ventures - 513
Secured by pledge of commercial mortgage loans 141,601 22,197
------------- -----------------
Total borrowings $3,166,376 $1,823,541
Securities sold, not yet settled - 99,551
Distributions payable 15,819 14,749
Other liabilities 33,201 43,575
--------------- -----------------
Total Liabilities $3,215,396 $1,981,416
--------------- -----------------
Commitments and Contingencies
Stockholders' Equity:
Common Stock, par value $0.001 per share; 400,000 shares
authorized;
53,289 shares issued and outstanding in 2004;
49,464 shares issued and outstanding in 2003 53 49
10% Series B Preferred Stock, liquidation preference $43,942 in 2003 - 33,431
9.375% Series C Preferred stock, liquidation preference $57,500
in 2004 and 2003 55,435 55,435
Additional paid-in capital 578,919 536,333
Distributions in excess of earnings (134,075) (101,635)
Accumulated other comprehensive income (loss) 13,406 (106,183)
--------------- -----------------
Total Stockholders' Equity 513,738 417,430
--------------- -----------------
Total Liabilities and Stockholders' Equity $3,729,134 $2,398,846
=============== =================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
For the year ended For the year ended For the year ended
December 31, 2004 December 31, 2003 December 31, 2002
------------------ ------------------ ------------------
Income:
Interest from securities available-for-sale $ 131,342 $ 120,430 $99,308
Interest from commercial mortgage loans 11,896 5,875 13,997
Interest from commercial mortgage loan pools 39,672 - -
Interest from securities held-for-trading 11,419 32,187 45,421
Earnings from real estate joint ventures 1,097 955 1,044
Earnings from equity investments 7,060 3,367 1,202
Interest from cash and cash equivalents 638 964 1,473
Other income 742 - -
------------ ------------ ------------
Total income 203,866 163,778 162,445
------------ ------------ ------------
Expenses:
Interest 124,289 76,093 50,987
Interest - securities held-for-trading 3,877 7,156 14,031
Management and incentive fee 8,956 9,411 12,527
General and administrative expense 3,427 2,296 2,323
------------ ------------ ------------
Total expenses 140,549 94,956 79,868
------------ ------------ ------------
Other gains (losses):
Sale of securities available-for-sale 17,544 (6,832) 11,391
Securities held-for-trading (11,464) (38,206) (29,255)
Foreign currency loss (187) - (812)
Loss on impairment of assets (26,018) (32,426) (10,273)
------------ ------------ ------------
Total other losses (20,125) (77,464) (28,949)
------------ ------------ ------------
Income (Loss) before cumulative transition adjustments 43,192 (8,642) 53,628
Cumulative transition adjustment-SFAS No. 142 - - 6,327
Net income (loss) 43,192 (8,642) 59, 955
------------ ------------ ------------
Dividends and accretion on Preferred Stock 6,916 7,744 5,162
Cost to retire preferred stock in excess of carrying value 10,508 - -
------------ ------------ ------------
Net income (loss) available to Common Stockholders $25,768 $(16,386) $54,793
============ ============ ============
Net income (loss) per common share, basic:
Income (Loss) before cumulative transition adjustment $0.50 $(0.34) $ 1.04
Cumulative transition adjustment - SFAS No. 142 - - 0.14
Net income (loss) $0.50 $(0.34) $1.18
============ ============ ============
Net income (loss) per common share, diluted:
Income (Loss) before cumulative transition $0.50 $(0.34) $ 1.04
adjustment
Cumulative transition adjustment - SFAS No. 142 - - 0.14
Net income (loss) $0.50 $(0.34) $1.18
============ ============ ============
Weighted average number of shares outstanding:
Basic 51,767 48,246 46,411
Diluted 51,776 48,246 46,452
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Series Series Accumulated
Common B C Additional Distributions Other Total
Stock, Preferred Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders'
Par Value Stock Stock Capital Of Earnings Income (Loss) Income Equity
Balance at January 1, 2002 $45 $42,086 $492,531 $(13,588) $ (137,959) $383,115
Net Income 59,955 $59,955 59,955
Unrealized loss on cash flow hedges (56,769) (56,769) (56,769)
Reclassification adjustments from
cash flow hedges included in net
income 5,619 5,619 5,619
Change in net unrealized loss on
securities available-for-sale, net
of reclassification adjustment 67,880 67,880 67,880
-------
Other comprehensive income 16,730
-------
Comprehensive income $76,685
=======
Dividends declared-common stock (65,366) (65,366)
Dividends declared-preferred stock (5,162) (5,162)
Issuance of common stock 1 16,685 16,686
Conversion of Series B preferred
stock to common stock 1 (5,707) 5,706
Conversion of Series A preferred
stock to common stock 258 258
----------------------------------------------------------------------------------------------------
Balance at December 31, 2002 47 36,379 515,180 (24,161) (121,229) 406,216
Net Income (8,642) $(8,642) (8,642)
Unrealized gain on cash flow hedges 12,474 12,474 12,474
Reclassification adjustments from
cash flow hedges included in net
loss 7,704 7,704 7,704
Change in net unrealized loss on
securities available-for-sale, net
of reclassification adjustment (5,132) (5,132) (5,132)
-------
Other comprehensive income 15,046
-------
Comprehensive income $6,404
=======
Dividends declared-common stock (61,088) (61,088)
Dividends on preferred stock (7,744) (7,744)
Issuance of common stock 2 22,079 22,081
Issuance of Series C preferred
stock 55,435 55,435
Redemption of Series B preferred
stock (2,948) (926) (3,874)
----------------------------------------------------------------------------------------------------
Balance at December 31, 2003 49 33,431 55,435 536,333 (101,635) (106,183) 417,430
Net Income 43,192 43,192 43,192
Unrealized gain on cash flow hedges 1,078 1,078 1,078
Reclassification adjustments from
cash flow hedges included in net
income 6,133 6,133 6,133
Change in net unrealized loss on
securities available-for-sale, net
of reclassification adjustment 112,378 112,378 112,378
-------
Other comprehensive income 119,589
-------
Comprehensive income 162,781
-------
Dividends declared-common stock (58,208) (58,208)
Dividends on preferred stock (6,916) (6,916)
Issuance of common stock 4 42,577 42,581
Conversion of Series B preferred
stock to common stock (9) 9 -
Redemption of Series B preferred
stock (33,422) (10,508) (43,930)
----------------------------------------------------------------------------------------------------
Balance at December 31, 2004 $53 $- $55,435 $578,919 $(134,075) $13,406 $513,738
====================================================================================================
DISCLOSURE OF RECLASSIFICATION
ADJUSTMENT: Years ended December 31,
--------------------------------------
2004 2003 2002
--------------------------------------
Unrealized holding gain (loss) on
securities available-for-sale $94,834 $ 1,700 $ 56,489
Reclassification for realized
gains previously recorded
as unrealized 17,544 (6,832) 11,391
--------------------------------------
$112,378 $(5,132) $ 67,880
======================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW (in thousands)
Years Ended December 31,
------------------------
2004 2003 2002
--------------------------------------
Cash flows from operating activities:
Net income (loss) $ 43,192 $ (8,642) $ 59,955
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Net sale (purchase) of trading securities 69,345 502,577 (878,980)
Net (gain) loss on sale of securities (6,080) 45,038 17,864
Amortization of CDO issuance costs 2,083 1,607 624
Cumulative transition adjustment - - (6,327)
Discount accretion, net (4,060) (2,313) (9,295)
Loss on impairment of assets 26,018 32,426 10,273
Unrealized net foreign currency loss 6 - 276
Decrease in other assets 16,286 9,083 1,079
(Decrease) increase in other liabilities (10,842) (16,251) 17,067
--------------------------------------
Net cash provided by (used in) operating activities 135,948 563,525 (787,464)
--------------------------------------
Cash flows from investing activities:
Purchase of securities available-for-sale (428,876) (2,043,765) (686,710)
Purchase of commercial mortgage loan pools (22,669) - -
Sale of commercial mortgage loan pools 5,847 - -
Principal payments received on securities available-for-sale 79,157 299,858 167,570
Funding of commercial mortgage loans (226,997) (18,520) (3,370)
Repayments received from commercial mortgage loans 23,285 13,851 82,865
Increase (decrease) in restricted cash equivalents (6,835) 71,640 (47,109)
Distributions (earnings) from equity investments and
joint ventures in excess of earnings 3,925 (973) (61)
Investment in Carbon Capital Funds (29,453) (12,081) (6,100)
Proceeds from sale of securities available-for-sale 503,898 1,466,552 1,017,534
Net payments under hedging securities (12,183) (8,830) (8,077)
--------------------------------------
Net cash (used in) provided by investing activities (110,901) (232,268) 516,542
--------------------------------------
Cash flows from financing activities:
Net decrease in borrowings (334,219) (338,500) (361,625)
Net increase in collateralized debt obligations 382,997 380 684,590
CDO issuance costs (5,472) - (15,918)
Proceeds from issuance of Series C preferred stock, net of offering costs - 55,435 -
Proceeds from issuance of common stock, net of offering costs 42,581 22,081 16,686
Redemption of Series B preferred stock (43,930) (3,874) -
Dividends paid on common stock (57,138) (63,826) (64,633)
Dividends paid on preferred stock (6,916) (6,846) (6,551)
--------------------------------------
Net cash (used in) provided by financing activities (22,097) (335,150) 252,549
--------------------------------------
Net (decrease) increase in cash and cash equivalents 2,950 (3,893) (18,373)
Cash and cash equivalents, beginning of year 20,805 24,698 43,071
--------------------------------------
Cash and cash equivalents, end of year $ 23,755 $ 20,805 $ 24,698
======================================
Supplemental disclosure of cash flow information:
Interest paid $ 89,733 $ 83,159 $ 71,746
Investments purchased not settled $ - $ - $ 524
Investments sold not settled $ - $ 99,056 $ -
Supplemental disclosure of non-cash investing and financing activities:
The Company purchased the controlling class securities of a REMIC trust
During the year ended December 31, 2004:
Carrying value of assets acquired $1,329,777
Liabilities assumed $1,306,724
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
ANTHRACITE CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
-----------------------------------------------------------------------------
Note 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Maryland in November 1997 and commenced
operations on March 24, 1998. The Company's principal business activity is
to invest in a diversified portfolio of CMBS, multifamily and commercial
mortgage loans, and other real estate related assets in the U.S. and
non-U.S. markets. The Company is organized and managed as a single business
segment.
A summary of the Company's significant accounting policies follows:
Use of Estimates
In preparing the consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America
("GAAP"), management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the statements of
financial condition and revenues and expenses for the periods covered.
Actual results could differ from those estimates and assumptions.
Significant estimates in the consolidated financial statements include the
valuation of the Company's investments and an estimate of credit performance
on CMBS investments.
Principles of Consolidation
The consolidated financial statements include the financial statements of
the Company and its subsidiaries, which are wholly-owned or controlled by
the Company or entities which are VIEs in which the Company is the primary
beneficiary under FIN 46R. FIN 46R requires a VIE to be consolidated by its
primary beneficiary. The primary beneficiary is the party that absorbs the
majority of the VIE's anticipated losses and/or the majority of the expected
returns. The Company has evaluated its investments for potential variable
interests by evaluating the sufficiency of the entities equity investment at
risk to absorb losses. All significant inter-company balances and
transactions have been eliminated in consolidation.
Cash and Cash Equivalents
All highly liquid investments with original maturities of three months or
less are considered to be cash equivalents.
Deferred Financing Costs
Deferred financing costs, which are included in other assets on the
Company's consolidated statements of financial condition, includes issuance
costs related to the Company's debt and is amortized using the effective
interest method.
Securities Available-for-Sale
The Company has designated certain investments in mortgage-backed
securities, mortgage-related securities and certain other securities as
assets available-for-sale because the Company may dispose of them prior to
maturity and does not hold them principally for the purpose of selling them
in the near term. Securities available-for-sale are carried at estimated
fair value with the net unrealized gains or losses reported as a component
of accumulated other comprehensive income (loss) in stockholders' equity.
Unrealized losses on securities that reflect a decline in value that is
judged by management to be other than temporary, if any, are charged to
earnings. At disposition, the realized net gain or loss is included in
income on a specific identification basis.
As a result of the closing of the Company's CDO I, at the end of the first
quarter 2002, the Company reclassified all of its subordinated CMBS on the
balance sheet from available-for-sale to held-to-maturity. The effect of
this reclassification changed the accounting basis of these securities,
prospectively, from fair market value to adjusted cost. However, in
accordance with SFAS No. 133, as amended and interpreted, the interest rate
swap agreements entered into by the Company to hedge the variable rate
exposure of the debt of CDO I are required to be presented on the balance
sheet at their fair market value. This difference in treatment caused
fluctuations in the book value of the Company. Accordingly, the Company
determined that at December 31, 2002, and going forward, it will classify
all of its subordinated CMBS as available-for-sale securities and record
them at fair market value. This treatment is consistent with the mark to
market requirement for CDO I's interest rate swap agreements.
The reclassification of these securities to available-for-sale from
held-to-maturity increased the recorded value of these securities from
$558,522 to $610,713 at December 31, 2002 with the difference being recorded
in other comprehensive income. Under the various CDO indentures, the
collateral administrator to the CDO has an ongoing fiduciary obligation to
monitor the credit risk of the collateral securities contributed to the CDO.
The collateral administrator may sell collateral securities that have
suffered a credit event (such as a rating downgrade) or, in the collateral
administrator's reasonable business judgment, have a significant risk of
declining in credit quality over time. The Company has concluded there are
circumstances under the various CDO indentures that permit, and the
reasonable exercise of business judgment would warrant, the sale of one or
more securities outside the boundaries of paragraph 8(a) of SFAS No. 115.
The circumstance that caused the Company to change this classification was
not considered a permitted circumstance as stated in SFAS No. 115, and is
therefore inconsistent with the Company's intent regarding its
held-to-maturity classification. Accordingly, the Company's held-to-maturity
classification has been tainted and the Company was prohibited from
classifying any securities as held-to-maturity for a period of two years
commencing December 31, 2002.
The Company recognizes interest income from its purchased beneficial
interests in securitized financial interests ("beneficial interests") (other
than beneficial interests of high credit quality, sufficiently
collateralized to ensure that the possibility of credit loss is remote, or
that cannot contractually be prepaid or otherwise settled in such a way that
the Company would not recover substantially all of its recorded investment)
in accordance with EITF 99-20. Accordingly, on a quarterly basis, when
changes in estimated cash flows from the cash flows previously estimated
occur due to actual prepayment and credit loss experience, the Company
calculates a revised yield based on the current amortized cost of the
investment (including any other-than-temporary impairments recognized to
date) and the revised cash flows. The revised yield is then applied
prospectively to recognize interest income.
For other mortgage-backed and related mortgage securities, the Company
accounts for interest income under SFAS No. 91, using the effective yield
method which includes the amortization of discount or premium arising at the
time of purchase and the stated or coupon interest payments. Actual
prepayment and credit loss experience is reviewed quarterly and effective
yields are recalculated when differences arise between prepayments and
credit losses originally anticipated and amounts actually received plus
anticipated future prepayments and credit losses.
In accordance with SFAS No. 115, when the estimated fair value of the
security classified as available-for-sale has been below amortized cost for
a significant period of time and the Company concludes that it no longer has
the ability or intent to hold the security for the period of time over which
the Company expects the values to recover to amortized cost, the investment
is written down to its fair value. The resulting charge is included in
income, and a new cost basis established. Additionally, under EITF 99-20,
when changes in estimated cash flows from the cash flows previously
estimated occur due to actual prepayment and credit loss experience, and the
present value of the revised cash flows using the current expected yield is
less than the present value of the previously estimated remaining cash flows
(adjusted for cash receipts during the intervening period), an
other-than-temporary impairment is deemed to have occurred. Accordingly, the
security is written down to fair value with the resulting change being
included in income, and a new cost basis established. In both instances, the
original discount or premium is written off when the new cost basis is
established.
After taking into account the effect of the impairment charge, income is
recognized under EITF 99-20 or SFAS No. 91, as applicable, using the market
yield for the security used in establishing the write-down.
Securities Held-for-Trading
The Company has designated certain securities as assets held-for-trading
because the Company intends to sell them in the near term. Securities
held-for-trading are carried at estimated fair value with net unrealized
gains or losses included in the consolidated statements of operations.
Commercial Mortgage Loans and Loan Pools
The Company purchases and originates certain commercial mortgage loans to be
held as long-term investments. In accordance with SFAS No. 65 "Accounting
for Certain Mortgage Banking Activities", commercial mortgage loans and loan
pools are classified as long term investments because the Company has the
ability and the intent to hold these loans to maturity. Loans are recorded
at cost at the date of purchase. Premiums and discounts related to these
loans are amortized over their estimated lives using the effective interest
method. Any origination fee income and application fee income, net of direct
costs, associated with originating or purchasing commercial mortgage loans
are deferred and included in the basis of the loans on the consolidated
statements of financial condition. The net fees are amortized over the life
of the loans using the effective interest method. The Company recognizes
impairment on the loans when it is probable that the Company will not be
able to collect all amounts due according to the contractual terms of the
loan agreement. The Company measures impairment (both interest and
principle) based on the present value of expected future cash flows
discounted at the loan's effective interest rate or the fair value of the
collateral if the loan is collateral dependent.
Equity Investments and Real Estate Joint Ventures
Investments in real estate entities over which the Company exercises
significant influence, but not control, are accounted for under the equity
method. The Company recognizes its share of each venture's income or loss,
and reduces its investment balance by distributions received. Real estate
held by such entities is regularly reviewed for impairment, and would be
written down to its estimated fair value if impairment were determined to
exist.
Short Sales
As part of its short-term trading strategies, the Company may sell
securities that it does not own ("short sales"). To complete a short sale,
the Company may arrange through a broker to borrow the securities to be
delivered to the buyer. The broker retains the proceeds received by the
Company from the short sale until the Company replaces the borrowed
securities, generally within a period of less than one month. In borrowing
the securities to be delivered to the buyer, the Company becomes obligated
to replace the securities borrowed at their market price at the time of the
replacement, whatever that price may be. A gain, limited to the price at
which the Company sold the security short, or a loss, unlimited as to dollar
amount, will be recognized upon the termination of a short sale if the
market price is less than or greater than the proceeds originally received.
The Company's liability under the short sales is recorded at fair value,
with unrealized gains or losses included in net gain or loss on securities
held-for-trading in the consolidated statement of operations.
Any broker that holds a deposit as collateral for securities borrowed
exposes the Company to credit loss in the event of nonperformance. However,
the Company does not anticipate nonperformance by any broker.
Forward Commitments - Trading
As part of its short-term trading strategies, the Company may enter into
forward commitments to purchase or sell U.S. Treasury securities or
securities issued by Federal Home Loan Mortgage Corporation ("FHLMC"),
Federal National Mortgage Association ("FNMA") or Government National
Mortgage Association ("GNMA") (collectively "Agency Securities"), which
obligate the Company to purchase or sell such securities at a specified date
at a specified price. When the Company enters into such a forward
commitment, it will, generally within sixty days or less, enter into a
matching forward commitment with the same or a different counterparty which
entitles the Company to sell (in instances where the original transaction
was a commitment to purchase) or purchase (in instances where the original
transaction was a commitment to sell) the same or similar securities on or
about the same specified date as the original forward commitment. Any
difference between the specified price of the original and matching forward
commitments will result in a gain or loss to the Company. Changes in the
fair value of open commitments are recognized on the consolidated statement
of financial condition and included among assets (if there is an unrealized
gain) or among liabilities (if there is an unrealized loss). A corresponding
amount is included as a component of net gain or loss on securities
held-for-trading in the consolidated statement of operations.
The Company is exposed to interest rate risk on these commitments, as well
as to credit loss in the event of nonperformance by any other party to the
Company's forward commitments. However, the Company does not anticipate
nonperformance by any counterparty.
Financial Futures Contracts - Trading
As part of its short-term trading strategies, the Company may enter into
financial futures contracts, which are agreements between two parties to buy
or sell a financial instrument for a set price on a future date. Initial
margin deposits are made upon entering into futures contracts and can be
either cash or securities. During the period that the futures contract is
open, changes in the value of the contract are recognized as gains or losses
on securities held-for-trading by "marking-to-market" on a daily basis to
reflect the market value of the contract at the end of each day's trading.
Variation margin payments are received or made, depending upon whether gains
or losses are incurred.
The Company is exposed to interest rate risk on the contracts, as well as to
credit loss in the event of nonperformance by any other party to the
contract. However, the Company does not anticipate nonperformance by any
counterparty.
Derivative Instruments
As part of its asset/liability risk management activities, the Company may
enter into interest rate swap agreements, forward currency exchange
contracts and other financial instruments in order to hedge interest rate
and foreign currency exposures or to modify the interest rate or foreign
currency characteristics of related items in its consolidated statement of
financial condition.
Income and expense from interest rate swap agreements that are, for
accounting purposes, designated as cash flow hedges are recognized as a net
adjustment to the interest expense of the hedged item and changes in fair
value are recognized as a component of accumulated other comprehensive
income (loss) in stockholder's equity. The fair market value of all swaps is
included among assets (if there is an unrealized gain) or among liabilities
(if there is an unrealized loss). Changes in fair value are collateralized
with cash or cash equivalents and are recorded in the consolidated
statements of financial condition as restricted cash. A corresponding amount
is included as a component of accumulated other comprehensive income (loss)
in stockholders' equity. Ineffective portions of changes in the fair value
of cash flow hedges are recognized in earnings. The Company accounts for
revenue and expense from the interest rate swap agreements designated as
cash flow hedges under the accrual basis over the period to which the
payment relates. Amounts paid to acquire these instruments are capitalized
and amortized over the life of the instrument. Amortization of capitalized
fees paid as well as payments received under these agreements is recorded as
an adjustment to interest expense. If the underlying hedged securities are
sold, the amount of unrealized gain or loss in accumulated other
comprehensive income (loss) relating to the corresponding interest rate swap
agreement is included in the determination of gain or loss on the sale of
the securities. If interest rate swap agreements are terminated, the
associated gain or loss is deferred over the shorter of the remaining term
of the swap agreement, or the underlying hedged item, provided that the
underlying hedged item has not been sold.
Income and expense from interest rate swap agreements that are, for
accounting purposes, designated as trading derivatives are recognized as a
net adjustment to total other gain (loss). During the term of the interest
rate swap agreement, changes in fair value are recognized in the
consolidated statements of operations and included among assets (if there is
an unrealized gain) or among liabilities (if there is an unrealized loss).
Changes in fair value are collateralized with cash or cash equivalents and
are recorded in the consolidated statements of financial condition as
restricted cash. A corresponding amount is included as loss on securities
held for trading in the consolidated statement of operations. The Company
accounts for revenue and expense from the interest rate swap agreements
classified as trading derivatives under the accrual basis over the period to
which the payment relates. Amounts paid to acquire these instruments are
capitalized and amortized over the life of the instrument. Amortization of
capitalized fees paid as well as payments received under these agreements is
recorded as an adjustment to loss on securities held for trading in the
consolidated statement of operations.
Revenue and expense from forward currency exchange contracts are recognized
as a net adjustment to foreign currency gain or loss. During the term of the
forward currency exchange contracts, changes in fair value are recognized in
the consolidated statement of financial condition and included among assets
(if there is an unrealized gain) or among liabilities (if there is an
unrealized loss). A corresponding amount is included as a component of net
foreign currency gain or loss in the consolidated statement of operations.
Financial futures contracts that are, for accounting purposes, designated as
hedging securities held-for-trading, are carried at fair value, with changes
in fair value included in the consolidated statement of operations.
The Company monitors its hedging instruments throughout their terms to
ensure that they remain effective for their intended purpose. The Company is
exposed to interest rate and/or currency risk on these hedging instruments,
as well as to credit loss in the event of nonperformance by any other party
to the Company's hedging instruments. The Company's policy is to enter into
hedging agreements with counterparties rated A or better.
Stock Options
The options issued under the 1998 Stock Option Plan, options covering
979,426 shares of the Company's Common Stock, were granted prior to December
15, 1998 to individuals deemed to be employees. The Company adopted the
disclosure-only provisions of SFAS No. 123 for such options. No compensation
cost for these options has been recorded in the consolidated statement of
operations because all options granted had an exercise price equal to or
above the market value of the underlying Common Stock on the date of grant.
Had compensation cost for these options been determined based on the fair
value of the options at the grant date consistent with the provisions of
SFAS No. 123, the Company's net income per share would not have changed in
any period preceded.
For the options to purchase 786,915 shares of the Company's Common Stock,
granted to non-employees under the 1998 Stock Option Plan, compensation cost
is accrued based on the estimated fair value of the options issued and
amortized over the vesting period. Because vesting of the options is
contingent upon the recipient continuing to provide services to the Company
to the vesting date, the Company estimates the fair value of the
non-employee options at each period end, up to the vesting date, and adjusts
expensed amounts accordingly. The value of these non-employee options at
each period end was negligible and all options were fully vested by March
2002.
Negative Goodwill
Negative goodwill reflected the excess of the estimated fair value of the
net assets acquired in the CORE Cap Inc. merger over the purchase price for
such assets. Negative goodwill was being amortized using the straight-line
method from the date of acquisition over the weighted average lives of the
assets acquired in the merger that the Company intended to retain. Negative
goodwill, net, was $6,327 at December 31, 2001. Pursuant to the
implementation of SFAS No. 142 (See Recently Adopted Accounting
Pronouncements), the Company recognized the unamortized negative goodwill
balance in income during the first quarter of 2002 as a transition
adjustment.
Income Taxes
The Company has elected to be taxed as a REIT and to comply with the
provisions of the Code with respect thereto. Accordingly, the Company
generally will not be subject to Federal income tax to the extent of its
distributions to stockholders and as long as certain asset, income and stock
ownership tests are met. As of December 31, 2004, the Company had a Federal
capital loss carryover of approximately $62,430 available to offset future
capital gains.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." This
statement is a revision to SFAS No. 123, "Accounting for Stock-Based
Compensation" and supercedes APB Opinion No. 25, "Accounting for Stock
Issued to Employees." This statement establishes standards for the
accounting for transactions in which an entity exchanges its equity
instruments for goods or services, primarily focusing on the accounting for
transactions in which an entity obtains employee services in share-based
payment transactions. Entities will be required to measure the cost of
employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award (with limited exceptions).
That cost will be recognized over the period during which an employee is
required to provide service, the requisite service period (usually the
vesting period), in exchange for the award. The grant-date fair value of
employee share options and similar instruments will be estimated using
option-pricing models. If an equity award is modified after the grant date,
incremental compensation cost will be recognized in an amount equal to the
excess of the fair value of the modified award over the fair value of the
original award immediately before the modification. This statement is
effective as of the beginning of the first interim or annual reporting
period that begins after June 15, 2005. In accordance with the standard, the
Company will adopt SFAS No. 123R during the year ended December 31, 2005.
The Company has determined that this statement will not impact the Company's
consolidated financial statements, as there are no unvested options as of
December 31, 2004 and the Company already applies the fair value method to
all newly-issued options.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets--An Amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions". SFAS No. 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets in
paragraph 21(b) of APB Opinion No. 29, "Accounting for Nonmonetary
Transactions," and replaces it with an exception for exchanges that do not
have commercial substance. SFAS No. 153 specifies that a nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. SFAS No. 153
is effective for the fiscal periods beginning after June 15, 2005 and is
required to be adopted by the Company for the year ended December 31, 2006.
The adoption of SFAS No. 153 is not expected to have a significant impact on
the Company's financial statements.
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus
on the "recognition" provisions of Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments"
("EITF No. 03-1"). EITF No. 03-1 requires that a loss be recognized for an
impairment that is other-than-temporary. A three-step impairment model
should be applied to debt securities subject to SFAS No. 115, including
those debt securities subject to EITF No. 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets." On September 30, 2004, the FASB issued FASB
Staff Position (FSP) EITF No. 03-1-1, "Effective Date of Paragraphs 10-20 of
EITF Issue No. 03-1," which delayed the effective date of the recognition
provisions of EITF No. 03-1 until the issuance of the final FSP EITF Issue
03-1-a, "Implementation Guidance for the Application of Paragraph 16 of EITF
Issue No. 03-1." Until the final FSP is issued, management is not able to
evaluate whether the adoption of the "recognition" provisions under such
guidance will have a material effect on our results of operations or
financial position.
In December 2003, the FASB issued FASB Interpretation No. 46 (revised 2003),
"Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R addresses
the application of Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," to variable interest entities ("VIE") and generally
would require that the assets, liabilities and results of operations of a
VIE be consolidated into the financial statements of the enterprise that has
a controlling financial interest in it. The interpretation provides a
framework for determining whether an entity should be evaluated for
consolidation based on voting interests or significant financial support
provided to the entity ("variable interests").
An entity is classified as a VIE if total equity is not sufficient to permit
the entity to finance its activities without additional subordinated
financial support or its equity investors lack the direct or indirect
ability to make decisions about an entity's activities through voting
rights, absorb the expected losses of the entity if they occur or receive
the expected residual returns of the entity if they occur. Once an entity is
determined to be a VIE, its assets, liabilities and results of operations
should be consolidated with those of its primary beneficiary. The primary
beneficiary of a VIE is the entity that either will absorb a majority of the
VIE's expected losses or has the right to receive a majority of the VIE's
expected residual returns. The expected losses and residual returns of a VIE
include expected variability in its net income or loss, fees to decision
makers and fees to guarantors of substantially all VIE assets or liabilities
and are calculated in accordance with Statement of Financial Accounting
Concept No. 7, "Using Cash Flow Information and Present Value in Accounting
Measurements."
A public enterprise with a variable interest in a VIE must apply FIN 46R to
that VIE no later than the end of the first reporting period that ends after
March 15, 2004, with the exception of special purpose entities ("SPEs"), as
defined. A public enterprise with a variable interest in an SPE which has
been deemed a VIE must apply FIN 46R to that VIE no later than the end of
the first reporting period that ends after December 15, 2003. Additionally,
if it is reasonably possible that an enterprise will consolidate or disclose
information about a VIE when the guidance becomes effective, there are
several disclosure requirements effective for all financial statements
issued after January 31, 2003.
The Company's ownership of the subordinated classes of CMBS from a single
issuer where it maintains the right to control the foreclosure/workout
process on the underlying loans ("Controlling Class CMBS") are variable
interests in SPEs which have been deemed VIEs and therefore subject to the
FIN 46R consolidation criteria. Provided in Paragraph 4(d) of FIN 46R, are
exceptions to the consolidation of VIE's specifically, that an enterprise
that holds variable interests in a qualifying special-purpose entity
("QSPE") shall not consolidate that entity unless that enterprise has the
unilateral ability to cause the entity to liquidate or change the entity so
that it not longer meets the conditions in paragraph 25 or 35 of SFAS No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. Pursuant to FIN 46R, the Company's
management has concluded that the trusts holding its Controlling Class CMBS
(except for LBUBS 2004-C2) are QSPEs and accordingly, the Company did not
consolidate these trusts. The Controlling Class CMBS that have been deemed
VIEs are detailed below. The Company's actual loss from its Controlling
Class CMBS investments is limited to the amounts invested in such securities
and further limited to such amounts not financed in its non-recourse CDOs.
The fair value of the subordinated Controlling Class securities financed in
the CDOs is $380,063; the total fair value of the Company's subordinated
Controlling Class CMBS is $441,509 (See Note 3 of the consolidated financial
statements for further discussion of LBUBS 2004-C2).
The table below details the purchase date, par of the Company's Controlling
Class securities and the entire par of each Controlling Class issuance owned
by the Company as of December 31, 2004.
Controlling Class Purchase Par Held by Total
Securities Date the Company CMBS Issued
-----------------------------------------------------------------------------
Unconsolidated
----------------
CMAC 1998-C1 July 1998 $47,786 $1,192,239
CMAC 1998-C2 September 1998 88,140 2,891,309
DLJCM 1998-CG1 June 1998 65,747 1,564,253
GMAC 1998-C1 April 1998 24,737 1,438,000
LBCMT 1998-C1 May 1998 100,000 1,727,818
PNCMA 1999-CM1 November 1999 18,059 760,414
LBUBS 2002-C2 October 2004 30,060 1,210,453
CSFB 2001-CK6 December 2001 48,115 939,182
CSFB 2003-CPN1 February 2003 39,759 1,006,389
GECMC 2003-C2 July 2003 38,450 1,183,080
BACM 2004-1 March 2004 24,705 1,327,183
JPMCC 2004-PNC1 June 2004 21,949 1,097,416
BACM 2004-3 July 2004 23,103 1,253,168
GMACC 2004-C2 August 2004 22,177 933,735
BACM 2004-6 December 2004 38,862 956,589
-----------------------------------
Total Unconsolidated $ 631,649 $ 19,481,228
-----------------------------------
Consolidated
-------------
LBUBS 2004-C2 April 2004 35,495 1,237,113
-------------------------------------
Total Consolidated $ 35,495 $ 1,237,113
-------------------------------------
Total Controlling Class CMBS $ 667,144 $ 20,718,341
=====================================
Reclassifications
Certain items previously reported have been reclassified to conform to the
current year's presentation.
Note 2 SECURITIES AVAILABLE-FOR-SALE
The Company's securities available-for-sale are carried at estimated fair
value. The amortized cost and estimated fair value of securities
available-for-sale as of December 31, 2004 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
-------------------------------------------------------------------------------------------------------------------------------
CMBS:
CMBS IOs $ 122,379 $ 4,304 $ (1,437) $ 125,246
Investment grade CMBS 380,673 14,302 (5,162) 389,813
Non-investment grade rated subordinated securities 710,403 48,578 (10,174) 748,807
Non-rated subordinated securities 4,996 998 - 5,994
Credit tenant lease 25,517 448 (714) 25,251
Investment grade REIT debt 271,344 15,456 (1,458) 285,342
Project loans 24,092 - (442) 23,650
CDO investments 19,450 387 - 19,837
----------------------------------------------------------------------
Total CMBS 1,558,854 84,473 (19,387) 1,623,940
----------------------------------------------------------------------
RMBS:
Agency adjustable rate securities 112,010 318 (189) 112,139
Residential CMOs 1,342 66 - 1,408
Hybrid adjustable rate mortgages ("ARMs") 25,934 - (328) 25,606
----------------------------------------------------------------------
Total RMBS 139,286 384 (517) 139,153
----------------------------------------------------------------------
Total securities available-for-sale $ 1,698,140 $84,857 $ (19,904) $ 1,763,093
======================================================================
As of December 31, 2004, an aggregate of $1,695,097 in estimated fair value
of the Company's securities available-for-sale was pledged to secure its
collateralized borrowings.
The amortized cost and estimated fair value of securities available-for-sale
as of December 31, 2003 are summarized as follows:
Security Description Amortized Gross Gross Estimated Fair
Cost Unrealized Gain Unrealized Loss Value
-------------------------------------------------------------------------------------------------------------------------
CMBS:
CMBS IOs $ 83,704 $ 1,566 $ (777) $ 84,493
Investment grade CMBS 332,342 7,353 (6,241) 333,454
Non-investment grade rated subordinated securities 742,923 19,322 (83,821) 678,424
Non-rated subordinated securities 23,011 4,840 (2,832) 25,019
Credit tenant lease 25,861 - (165) 25,696
Investment grade REIT debt 204,382 15,736 (696) 219,422
Project Loans 25,969 543 (10) 26,502
--------------------------------------------------------------------
Total CMBS 1,438,192 49,360 (94,542) 1,393,010
--------------------------------------------------------------------
RMBS:
Agency adjustable rate securities 179,917 464 - 180,381
Agency fixed rate securities 226,842 47 (4,389) 222,500
Residential CMOs 3,404 89 (29) 3,464
ARMs 6,682 - (37) 6,645
--------------------------------------------------------------------
Total RMBS 416,845 600 (4,455) 412,990
--------------------------------------------------------------------
--------------------------------------------------------------------
Total Available-For-Sale $ 1,855,037 $ 49,960 $ (98,997) $ 1,806,000
====================================================================
As of December 31, 2003, an aggregate of $1,683,952 in estimated fair value
of the Company's securities available-for-sale was pledged to secure its
collateralized borrowings.
As of December 31, 2004 and 2003, the aggregate estimated fair values by
underlying credit rating of the Company's securities available-for-sale are
as follows:
December 31, 2004 December 31, 2003
Estimated Estimated
Security Rating Fair Value Percentage Fair Value Percentage
--------------------------------------------------------------------------------------------------------------------
Agency and agency insured securities $159,892 9% $426,915 24%
AAA 222,203 13 238,382 13
AA- 1,886 - - -
A+ 9,155 1 - -
A 22,283 1 15,643 1
A- 23,354 1 23,126 1
BBB+ 119,214 7 106,752 6
BBB 217,968 12 146,072 8
BBB- 195,050 11 126,313 7
BB+ 372,347 21 284,081 16
BB 119,559 7 129,401 7
BB- 100,831 6 75,316 4
B+ 40,660 2 28,904 2
B 106,571 6 105,061 6
B- 4,478 1 34,160 2
CCC+ - - 5,595 -
CCC 4,360 - 13,375 1
C - - 2,531 -
Not rated 43,281 2 44,373 2
---------------------------------------------------------------------
Total securities available-for-sale $1,763,092 100% $1,806,000 100%
=====================================================================
The following table shows the Company's fair value and gross unrealized losses,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2004.
Less than 12 Months 12 Months or More Total
-------------------------------------------------------------------------------------------
Gross Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value (Losses) Value Losses Value Losses
-------------------------------------------------------------------------------------------
CMBS IOs $ 19,120 $ (1,117) $ 2,061 $ (320) $ 21,181 $ (1,437)
Investment grade CMBS 52,754 (654) 98,952 (4,508) 151,706 (5,162)
Non-investment grade rated
subordinated securities 37,098 (604) 60,548 (9,570) 97,646 (10,174)
Credit tenant lease - - 16,168 (714) 16,168 (714)
Investment grade REIT debt 35,290 (311) 37,794 (1,147) 73,084 (1,458)
Project loans 22,367 (340) 1,282 (102) 23,649 (442)
Agency adjustable rate securities
11,692 (189) - - 11,692 (189)
ARMs 25,606 (328) - - 25,606 (328)
-------------------------------------------------------------------------------------------
Total temporarily impaired
securities $203,927 $(3,543) $216,805 $(16,361) $420,732 $(19,904)
===========================================================================================
The temporary impairment of the available-for-sale securities results from the
fair value of the securities falling below the amortized cost basis. Management
possesses both the intent and the ability to hold the securities until the
Company has recovered amortized cost. As such, management does not believe any
of the securities held are impaired other than those for which the Company
recorded an impairment charge in 2003 and 2004 (see Note 9 of the consolidated
financial statements).
As of December 31, 2004 and 2003, the mortgage loans underlying the Controlling
Class CMBS held by the Company were secured by properties of the types and at
the locations identified below:
Percentage (1) Percentage (1)
-------------------------------------------------------------------------------
Geographic
Property Type 2004 2003 Location 2004 2003
-------------------------------------------------------------------------------
Multifamily 28.6% 33.2% California 13.7% 11.7%
Retail 32.4 30.4 Texas 10.1 10.9
Office 24.9 20.0 New York 11.7 9.8
Lodging 4.9 6.9 Florida 8.4 6.0
Other (2) 9.2 9.5 Other (2) 56.1 61.6
-------------------- ---------------------
Total 100.0% 100.0% Total 100.0% 100.0%
==================== =====================
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No other individual category comprises more than 5% of the total.
The following table sets forth certain information relating to the aggregate
principal balance and payment status of delinquent mortgage loans underlying
the Controlling Class CMBS held by the Company as of December 31, 2004 and
2003:
2004 2003
---------------------------------------------------------------------------------------------
Number of % of Number of % of
Principal Loans Collateral Principal Loans Collateral
---------------------------------------------------------------------------------------------
Past due 30 days to 60 days $20,288 10 0.11% $13,773 3 0.12%
Past due 60 days to 90 days 67,902 12 0.37 12,162 3 0.11
Past due 90 days or more 93,453 17 0.50 123,242 16 1.08
Resolved loans - - - - - -
Real Estate owned 5,310 2 0.03 18,354 4 0.17
---------------------------------------------------------------------------------------------
Total Delinquent $186,953 41 1.01% $167,531 26 1.48%
=============================================================================================
Total Principal Balance $18,580,729 2,864 $11,347,281 2,163
Of the 41 delinquent loans as of December 31, 2004, 2 loans were real estate
owned and being marketed for sale, no loans were in foreclosure and the
remaining 39 loans were in some form of workout negotiations.
The Controlling Class CMBS owned by the Company have a delinquency rate of
1.01%, which is consistent with industry averages. During 2004, the Company
experienced early payoffs of $451,662 that represents 2.43% of the year-end
pool balance. These loans were paid-off at par with no loss.
To the extent that realized losses, if any, or such resolutions differ from the
Company's original loss estimates, it may be necessary to reduce or increase
the projected yield on the applicable CMBS investment to better reflect such
investment's expected earnings net of expected losses, from the date of
purchase. While realized losses on individual assets may be higher or lower
than original estimates, the Company currently believes its aggregate loss
estimates and yields remain appropriate.
The CMBS held by the Company consist of subordinated securities collateralized
by adjustable and fixed rate commercial and multifamily mortgage loans. The
RMBS held by the Company consist of adjustable rate and fixed rate residential
pass-through or mortgage-backed securities collateralized by adjustable and
fixed rate single-family residential mortgage loans. Agency RMBS were issued by
FHLMC, FNMA or GNMA. Privately issued RMBS were issued by entities other than
FHLMC, FNMA or GNMA. The Company's securities available-for-sale are subject to
credit, interest rate, and/or prepayment risks.
The CMBS owned by the Company provide credit support to the more senior classes
of the related commercial securitization. The Company generally does not own
the senior classes of its below investment grade CMBS. Cash flow from the
mortgages underlying the CMBS generally is allocated first to the senior
classes, with the most senior class having a priority entitlement to cash flow.
Then, any remaining cash flow is allocated generally among the other CMBS
classes in order of their relative seniority. To the extent there are defaults
and unrecoverable losses on the underlying mortgages, resulting in reduced cash
flows, the most subordinated CMBS class will bear this loss first. To the
extent there are losses in excess of the most subordinated class' stated
entitlement to principal and interest, then the remaining CMBS classes will
bear such losses in order of their relative subordination.
As of December 31, 2004 and 2003, the anticipated weighted average unleveraged
based upon adjusted cost of the Company's entire subordinated CMBS portfolio
was 10.4% and 9.7% per annum, respectively, and of the Company's other
securities available-for-sale was 5.8% and 5.1% per annum, respectively. The
Company's anticipated yields to maturity on its subordinated CMBS and other
securities available-for-sale are based upon a number of assumptions that are
subject to certain business and economic uncertainties and contingencies.
Examples of these include, among other things, the rate and timing of principal
payments (including prepayments, repurchases, defaults, liquidations, and
related expenses), the pass-through or coupon rate, and interest rate
fluctuations. Additional factors that may affect the Company's anticipated
yields to maturity on its Controlling Class CMBS include interest payment
shortfalls due to delinquencies on the underlying mortgage loans, and the
timing and magnitude of credit losses on the mortgage loans underlying the
Controlling Class CMBS that are a result of the general condition of the real
estate market (including competition for tenants and their related credit
quality), and changes in market rental rates. As these uncertainties and
contingencies are difficult to predict and are subject to future events that
may alter these assumptions, no assurance can be given that the anticipated
yields to maturity, discussed above and elsewhere, will be achieved.
The agency adjustable rate RMBS held by the Company is subject to periodic and
lifetime caps that limit the amount the interest rates of such securities can
change during any given period and over the life of the loan. As of December
31, 2004 and 2003, adjustable rate RMBS with a market value of $139,513 and
$27,419, respectively, is included in securities available-for-sale on the
consolidated statement of financial condition.
As of December 31, 2004, the unamortized net discount on all securities
available-for-sale was $425,982, which represented 21.3% of the then
remaining face amount of such securities.
During 2004, the Company sold securities available-for-sale for total proceeds
of $503,898, resulting in a realized gain of $17,544. During 2003, the Company
sold securities available-for-sale for total proceeds of $1,466,552, resulting
in a realized loss of $(6,832). During 2002, the Company sold securities
available-for-sale for total proceeds of $1,017,534, resulting in a realized
gain of $11,391.
Note 3 COMMERCIAL MORTGAGE LOAN POOLS
During the second quarter of 2004, the Company acquired subordinated CMBS in a
trust establishing a Controlling Class interest. As the Controlling Class
holder, the Company has the ability to control dispositions or workouts of any
defaulted loans in this trust. The Company negotiated for and obtained a
greater degree of discretion over the disposition of the commercial mortgage
loans than is typically granted to the special servicer. As a result of this
expanded discretion, FASB FIN 46R requires the Company to consolidate the net
assets and results of operations of the trust.
The CMBS securities acquired by the Company had a par value of $41,495 with
$13,890 not rated and the balance rated BBB- to B-. During the third quarter
the Company sold the BBB- rated security, which had the impact of increasing
the borrowings for the commercial loan pool by $5,848. As of December 31, 2004,
the CMBS securities owned by the Company have a par value of $35,495.
The debt associated with the REMIC trust is non-recourse to the Company, and is
secured only by the commercial mortgage loan pools. As of December 31, 2004,
the consolidation of the REMIC trust results in an increase in the Company's
total debt to capital ratio from 3.7:1 to 6.2:1, but has no effect on the
Company's recourse debt to capital ratio. The Company received authorization
from its lenders to permit debt to capital ratios in excess of existing
covenants.
Approximately 45% of the par amount of the commercial mortgage loan pool is
comprised of loans that are shadow rated A2 or better by Moody's Investors
Service, Inc. and AA by Standard & Poor's Rating Group, a division of the
McGraw-Hill Companies, Inc. The Company has taken into account the credit
quality of the underlying loans in formulating its loss assumptions. Credit
losses assumed on the entire pool are 1.40% of the principal balance, or 2.53%
of the unrated principal balance. For income recognition purposes, the Company
accounts for the unrated commercial mortgage loans in the pool as a single
asset based on common credit risk characteristics.
Over the life of the commercial mortgage loan pools, the Company reviews and
updates its loss assumptions to determine the impact on expected cash flows to
be collected. A decrease in estimated cash flows will reduce the amount of
interest income recognized in future periods and may result in a loan loss
reserve depending upon the severity of the cash flow reductions. An increase in
estimated cash flows will first reduce the loan loss reserve and any additional
cash will increase the amount of interest income recorded in future periods.
Note 4 SECURITIZATION TRANSACTION
During 2004, the Company sold non-investment grade CMBS with a fair market
value of $109,933 to a qualifying special purpose entity (the "CDO HY1"). These
CMBS were securitized into various classes of non-recourse bonds and preferred
equity. CDO HY1 sold the investment grade rated bonds to unrelated third
parties for net proceeds of $121,547. In accordance with SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," a gain of $14,769 was recognized on the sale of the CMBS
collateral to CDO HY1. At closing, the Company retained the A- rated bond and
the preferred equity in CDO HY1. Subsequently, the A- rated bond was sold at a
gain of $1,825 during the fourth quarter of 2004.
The table below summarizes the cash flows received from CDO HY1 during the year
ended December 31, 2004.
2004
------------
Proceeds from CDO HY1 $ 121,547
Subsequent sale of A- bond $18,879
Cash flow on preferred equity (1) $0
(1) The preferred equity pays interest quarterly and its first scheduled
quarterly payment was in January 2005.
Key economic assumptions used in measuring the fair value of the preferred
equity at the date of the securitization was as follows:
2004
------------
Weighted average life 11.5 years
Preferred equity pre-loss cash flows discount rate 67.4%
When subsequently measuring the fair value of the preferred equity, the Company
applies certain key assumptions to loss adjusted cash flows. The Company
estimated credit losses and the timing of losses for each loan underlying the
CMBS collateral, and accordingly does not apply a constant default rate to the
portfolio. At December 31, 2004, the amortized cost of the preferred equity was
$14,513, with an estimated fair value of $15,884, based on key economic
assumptions. The sensitivity of the preferred equity to immediate adverse
changes in those assumptions follows:
2004
---------
Reduction of income per share:
50% adverse change in credit losses $0.02
100% adverse change in credit losses $0.04
Writedown per share:
50% adverse change in credit losses $0.04
100% adverse change in credit losses $0.07
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a variation in key assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in fair value may not be linear. This non-linear
relationship exists because we apply our key assumptions on a loan-by-loan
basis to the assets underlying the CMBS collateral. Also, in this table, the
effect of a variation in a particular assumption on the fair value of the
preferred equity was calculated without changing any other assumption; in
reality, changes in one factor may result in changes to another, which might
magnify or counteract the sensitivities. The Company reviews all major
assumptions periodically using the most recent empirical and market data
available, and makes adjustments where warranted.
Note 5 SECURITIES HELD-FOR-TRADING
Securities classified as held-for-trading include investments that the Company
intends to hold for a short period of time, usually less than one year. This
classification generally includes highly liquid securities that the Company
acquires to earn net interest income until the Company redeploys that capital
into credit sensitive commercial real estate opportunities.
The Company's securities held-for-trading are carried at estimated fair value.
At December 31, 2004, the Company's securities held-for-trading consisted of
FNMA and FHLMC mortgage pools with an estimated fair value of $232,918. At
December 31, 2003, the Company's securities held-for-trading consisted of FNMA
and FHLMC mortgage pools with an estimated fair value of $313,727 and short
positions of 30 five-year and 73 ten-year U.S. Treasury Note future contracts,
which represented $3,000 and $7,300 in face amount of U.S. Treasury Notes,
respectively. The estimated fair value of the contracts was approximately
$(11,436) at December 31, 2003.
As of December 31, 2004, securities held-for-trading consisted entirely of
hybrid adjustable rate mortgages and adjustable rate securities. As of December
31, 2003, adjustable rate RMBS with a market value of $255,557 are included in
securities held-for-trading on the consolidated statements of financial
condition.
The Company's trading strategies are subject to the risk of unanticipated
changes in the relative prices of long and short positions in trading
securities, but are designed to be relatively unaffected by changes in the
overall level of interest rates.
Note 6 COMMERCIAL MORTGAGE LOANS
The following table summarizes the Company's loan investments at December 31,
2004 and 2003:
Date of
Initial Scheduled Property Property Par Book Value Interest Rate Yield
Investment Maturity Name/ Location Type
2004 2003 2004 2003 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------------------
11/7/01 11/11/07 Landmark Bldg. Office $10,724 $10,820 $10,434 $11,355 7.2% 7.2% F 7.2% 7.2%
San Francisco, CA
(2)
11/7/01 11/11/07 Landmark Bldg. Office 9,651 9,737 9,694 10,055 6.7 6.7 F 6.7 6.7
San Francisco, CA
(2)
12/17/01 4/9/04 Greensboro Center Office - 22,000 - 22,000 - 8.2 L - 8.9
Tyson's Corner, VA
5/17/02 12/11/05 Alliance I/O Residential 2,479 2,795 - 52 2.6 3.8 L - -
Southwest (3)
6/30/03 6/1/10 Windsor Hotel(1)(4) Hotel 14,678 14,916 12,645 11,206 6.6 6.6 L 11.8 11.8
10/28/03 03/09/05 Woolworth Building Office 7,000 7,000 7,000 7,000 16.8 16.8 L 16.8 16.8
New York, NY (5)
03/31/04 01/01/11 PPG Place Office 19,814 - 19,992 - 11.8 - F 11.8 -
Pittsburgh, PA
(1)(6)
04/07/04 12/11/18 Cumberland Place Retail 192 - 192 - 11.0 - F 11.0 -
Smyma, GA
04/20/04 08/05/18 GGP Portfolio(1)(7) Retail 17,124 - 14,878 - 6.3 - F 6.3 -
06/02/04 11/15/10 Eiger Trust Various 4,580 - 4,580 - 8.6 - F 8.6 -
Switzerland(8)
07/14/04 04/01/14 17 State Street(1) Office 22,425 - 20,072 - 7.3 - F 7.5 -
New York, NY
08/03/04 06/30/06 Fordgate Office Office 21,119 - 21,119 - 8.1 - L 8.1 -
Portfolio(9)
8/26/04 8/9/06 Windsor Hotel II Hotel 25,000 - 25,000 - 8.7 - L 8.7 -
(1)(10)(11)
09/15/04 07/09/06 Strategic Hotel Hotel 30,000 - 30,000 - 6.4 - L 6.4 -
Portfolio -
(1)(11)(12)
09/29/04 05/11/08 Lembi Apartments(1) Residential 9,980 - 9,980 - 10.5 - F 10.5 -
09/29/04 03/11/09 Lembi Nob Hill Residential 3,500 - 3,500 - 17.0 - F 17.0 -
Apartments, San
Francisco, CA
09/30/04 10/09/05 Palladium at City Retail 10,000 - 10,000 - 11.8 - L 11.8 -
Place West Palm
Beach, FL(1)(13)
10/19/04 07/12/06 Lake Las Vegas Hotel 10,000 - 10,000 5.4 - L 5.4 -
Hyatt, Henderson,
NV(1)(14)
10/28/04 12/09/05 Hotel Del Coronado, Hotel 25,000 - 25,000 - 7.7 - L 7.7 -
San Diego, CA(1)
10/28/04 11/09/05 The Maine Mall, Retail 34,000 - 34,000 5.2 - L 5.2 -
Portland, ME
(1)(11)(15)
--------------------------------------------------------------------------------------
Totals $277,266 $67,268 $268,086 $61,668
F - Fixed Rate; L - LIBOR based floating rate
(1)The entire principal balance of the Company's investment is pledged to
secure line of credit borrowing agreements.
(2) Two subordinate interests in a $125,000 note secured by one 11-story office
building. The entire principal balance of the Company's investment is pledged
to secure collateralized debt obligations.
(3) Represents a 1.46% interest only strip off of a B Note secured by a
portfolio of apartments (5,389 units). Payments received are the greater of
1.5% or 9.5% less LIBOR+450, based upon a notional par value.
(4) Represents a subordinate position in a $125,000 first mortgage, secured by
six hotels in California and one hotel in Michigan.
(5) Represents a subordinate interest in a $26,000 mezzanine loan, secured by
partnership interests in a 54 story, landmark office building.
(6) PPG is a junior participation in a $59.00MM Mezzanine Note. The Mezzanine
Note is secured by 100% of the partnership interests in the entity that owns a
1.5 million square foot office complex, known as PPG Place.
(7) GGP is a junior participation in an $115,000 first mortgage loan secured by
three regional malls. The Properties are located in Bowling Green, Kentucky,
Springfield, Oregon, and Jefferson City, Missouri.
(8) Eiger is a 50% interest in the most subordinate tranche of a loan,
indirectly secured by 112 office and light industrial buildings. Since
origination over 30 properties have been disposed with approximately 75
properties remaining. The collateral is primarily occupied by SwissCom
(majority-owned by the Swiss Government) and the Swiss Postal Service, and is
located throughout Switzerland with the largest concentrations in Bern and
Zurich.
(9) Fordgate is a subordinate interest in a first mortgage on a Portfolio of
seven office buildings located in London and Edinburgh and Aberdeen, Scotland.
The loan may be extended at the borrower's options for an additional three-year
term.
(10) Represents a junior mezzanine loan, secured by the borrower's pledge of
its ownership interests in a portfolio of nine Embassy Suites hotels consisting
of 2,150 rooms, located in six states and seven metropolitan areas.
(11) May be extended at the borrower's option for three additional twelve-month
periods, subject to certain performance hurdles.
(12) Represents a pari-passu participation in a $100,000 senior mezzanine loan,
secured by the pledge of the equity in seven luxury, business, and group
oriented hotel properties located in New York (2), Northern California (3), and
Southern California (2). The portfolio totals 3,451 rooms.
(13) Palladium at City Place is a mezzanine loan secured by a pledge of 100% of
the equity interests in the owner of the Palladium at CityPlace , a 626 square
foot open-air entertainment/retail center with 110 residential/commercial units
in the downtown area of West Palm Beach, Florida. The loan is also
collateralized by two additional parcels it the CityPlace development.
(14) May be extended at the borrower's option for three additional twelve-month
periods, subject to certain performance hurdles and an extension fee for the
second and third extension.
(15) Represents a $34,000 mezzanine loan secured by a pledge in the ownership
interests in the owners of The Maine Mall, a four-anchor super-regional mall
located in South Portland, Maine. The total mall size is approximately 1.,005
square feet, of which 759 square feet is collateral for the loan.
Reconciliation of commercial mortgage loans: Par Book Value
------------- ---------------
Balance at January 1, 2003 $67,679 $ 65,664
Discount accretion - 264
Proceeds from repayment of mortgage loans (22,195) (22,780)
Reduction in notional par value (218) -
Investments in commercial mortgage loans 22,002 18,520
------------- --------------
Balance at December 31, 2003 $67,268 $ 61,668
Discount accretion - 2,706
Proceeds from repayment of mortgage loans (23,285) (23,285)
Reduction in notional par value (316) -
Investments in commercial mortgage loans 233,599 226,997
------------- --------------
Balance at December 31, 2004 $277,266 $268,086
============= ==============
Note 7 EQUITY INVESTMENTS AND REAL ESTATE JOINT VENTURES
On July 20, 2000, the Company made an investment aggregating $5,121 in two
limited partnerships for the purpose of purchasing a ninety-nine thousand
square foot office building and a one hundred twenty thousand square foot
office building, both of which are located in suburban Philadelphia. The
Company exercised significant influence, but not control, and accounted for its
investment under the equity method. The Company's ownership interest was 64.81%
in each partnership. The Company received a preferred return of 12% compounded
on its unreturned capital, paid monthly. On June 30, 2004, the Company received
the return of its capital and an additional 3% return representing its share of
the proceeds from refinancing. The book value of the investment in the
partnerships at December 31, 2003 was $2,750.
On December 14, 2000, the Company made an investment aggregating approximately
$5,149 in a limited liability company for the purpose of acquiring a five
hundred thousand square foot office and retail complex in Tallahassee, Florida.
The Company exercises significant influence, but not control, and accounts for
its investment under the equity method. The Company's ownership interest is
36.4% of the limited liability company. The Company receives a preferred return
of 13.25% and a return of capital of $3, which is payable monthly. The book
value of the investment at December 31, 2004 and 2003 was $5,031 and $5,073,
respectively. On January 13, 2005, the Company received the return of its
remaining capital.
As of December 31, 2004 and 2003, the Company owns approximately 20% of Carbon
I. As of December 31, 2004, the Company also owns approximately 20% of Carbon
II. Collectively, the Carbon Capital Funds are private commercial real estate
income opportunity funds managed by the Manager (see Note 12 of the
consolidated financial statements).
The Company entered into a $50,000 commitment on July 20, 2001 to acquire
shares in Carbon I. On July 12, 2004, the investment period expired. No
additional capital will be called. Shares purchased by the Company are as
follows:
Number of
Date Stock issued Shares Issued Amount
---- ------------ ------------- ------
November 19, 2001 Series K Common 8,784 $8,784
October 30, 2002 Series K Common 6,100 6,100
February 6, 2003 Series K Common 2,680 2,680
September 15, 2003 Series K Common 5,265 5,265
October 9, 2003 Series K Common 4,137 4,137
March 17, 2004 Series K Common 4,349 4,349
April 20, 2004 Series K Common 4,784 4,784
May 17, 2004 Series K Common 2,968 2,968
June 24, 2004 Series K Common 7,117 7,117
The Company's investment in Carbon I as of December 31, 2004 and 2003 was
$39,563 and $28,493, respectively.
On October 6, 2004, the Company entered into a $30,000 commitment to acquire
shares in Carbon II. On November 19, 2004 the Company entered into an
additional $32,067 commitment. Shares purchased by the Company are as follows:
Number of
Date Stock issued Shares Issued Amount
---- ------------ ------------- ------
December 6, 2004 Series K Common 4,986 $4,986
December 28, 2004 Series K Common 11,967 11,967
The Company's investment in Carbon II as of December 31, 2004 was $17,249. The
Company's remaining commitment as of December 31, 2004 was $45,114.
The following table summarizes the loan investments held by the Carbon Capital
Funds at December 31, 2004 and 2003.
Date of
Initial Scheduled Property Property Par Book Value Interest Rate Yield
Investment Maturity Name/ Location Type
2004 2003 2004 2003 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------------------------------
11/19/01 6/15/04 230 Park Avenue Office $ - $10,000 $ - $9,938 -% 7.7% L 9.2% 8.8%
New York, NY
11/20/01 12/11/07 Landmark Building Office - 11,953 - 9,889 - 10.0 F 19.0 16.6
San Francisco, CA
12/17/01 4/9/04 Greensboro Center Office - 10,000 - 8,759 - 9.0 L 27.3 19.5
Tyson's Corner, VA
5/17/02 12/11/05 Alliance I/O (1) Residential 10,070 11,278 67 138 2.6 3.8 L - -
10/16/02 11/1/07 311 S. Wacker Dr. Office 31,418 31,710 31,128 31,181 8.00 9.3 L 11.5 9.8
Mez. Chicago, IL
(3)(22)
11/1/02 11/9/05 Westin St. Francis Hotel 35,000 35,000 34,973 34,964 11.9 10.7 L 11.9 10.7
Mez. San Francisco,
CA (3)(4)
2/10/03 3/11/08 Pennmark (3)(5)(22) Mixed-use 35,000 35,000 34,739 34,388 8.8 8.8 L 8.9 9.8
New York, NY
5/7/03 11/1/04 The Edge Condominium Residential - 12,000 - 11,912 - 22.0 F 22.1 22.4
Chicago, IL (6)
5/9/03 1/09/06 Alliance FQ B Note Residential 7,850 8,450 7,701 8,130 7.5 7.5 L 10 9.6
Texas
(2)(3)(7)(22)
5/9/03 1/09/06 Alliance FQ Residential 6,000 6,000 5,879 5,755 15.1 17.9 L 17.9 17.7
Mezzanine
Texas
(2)(3)(7)(22)
8/19/03 1/14/04 880 Mandalay Residential - 6,885 - 6,853 - 7.8 L 19.7 8.1
Clearwater Beach,
FL
9/16/03 3/09/06 Ocean's Resort Hotel 24,421 26,375 23,276 24,890 10.7 10.7 L 12.6 12.8
Portfolio
Daytona Beach, FL
(2)(3)(8)(22)
11/10/03 4/2/04 Pointe @ Park Center Residential - 9,546 - 9,546 - 7.6 L 34.5 7.5
Alexandria, VA
11/25/03 11/24/05 Mary Brickell Village Retail 13,640 13,640 13,511 13,442 18.0 18.0 F 18.1 18.4
Miami, FL(9)
12/15/03 12/1/06 Independent Office 13,836 14,000 13,752 13,864 10.2 10.0 L 10.5 10.5
Square(3)(22)
Jacksonville, FL
2/6/04 2/9/06 Hyatt Regency Hotel 15,000 - 15,000 - 9.7 - L 8.7 -
Mezzanine
Washington,
D.C.(3)(10)
3/10/04 2/28/06 Highpointe Condo Residential 14,500 - 14,500 - 20.0 - F 20.7 -
Hunt Valley, MD
(11)
3/18/04 1/9/06 Prime Retail 26,000 - 25,985 - 13.1 - L 13.1 -
Outlets(3)(12)(22)
4/26/04 2/9/06 Town Mall Retail 10,000 - 9,906 - 7.7 - L 8.1 -
(3)(10)(13)(22)
Westminster, MD
4/30/04 4/30/07 Leasco(2)(14) Storage 10,171 - 10,171 - 16.0 - F 16.0 -
5/19/04 4/30/07 Park Crest at Residential 3,990 - 3,990 - 8.8 - L 14.6 -
Innisbrook II
Palm Harbor,
FL(15)
5/21/04 5/9/06 River East - Retail 14,000 - 13,964 - 16.5 - L 18.1 -
Mez(3)(16)
Chicago, IL
5/21/04 5/9/06 River East - Retail 17,800 - 17,800 - 7.4 - L 7.4 -
Loan(3)(16)
Chicago, IL
5/28/04 11/12/06 Parkway Office 12,838 - 12,796 - 7.9 - L 8.0 -
Center(2)(17)(22)
Roseville, CA
6/25/04 6/17/07 Island Club Residential 7,224 - 7,224 - 8.8 - L 15.4 -
Apartments
Miami, FL(18)
7/01/04 6/17/07 Marquis at Vienna Residential 4,343 - 4,343 - 8.8 - L 18.4 -
(19)
Vienna, VA
6/30/04 7/9/07 Market Tower #1 Office 7,500 - 7,432 - 11.0 - F 11.0 -
(2)(20)
Indianapolis, IN
6/30/04 7/9/07 Market Tower #2 Office 7,500 - 7,500 - 11.0 - F 11.0 -
(2)(20)
Indianapolis, IN
8/20/04 8/9/06 Penncomm(10)(21) Office 8,914 - 8,914 - 11.1 - L 11.1 -
New York, NY
12/29/04 12/31/09 10/Ten Post Office Office 17,000 - 16,980 - 8.1 - L 8.1 -
(23)
Boston, MA
11/24/04 8/1/05 Westbrook Office 23,285 - 23,285 - 8.1 - L 8.1 -
Portfolio(24)(25)
12/07/04 1/9/05 L Enfant Plaza Office 13,700 - 13,700 - 7.7 - L 7.7 -
(2)(26)
Washington D.C.
11/23/04 10/9/06 Fifteen Group Mezz Residential 24,692 - 24,692 - 7.6 - L 7.6 -
(3)(27)
12/20/04 11/9/06 Alliance Eaton Residential 52,500 - 52,500 - 8.1 - L 8.1 -
Vance Portfolio,
(10) (28)
11/4/04 10/4/06 Desert Passage Jr. Retail 20,000 - 20,000 - 17.0 - L 17.0 -
Mezz
Las Vegas, NV
(3)(29)(30)
10/13/04 8/10/07 Oceanview Residential 26,400 - 26,400 - 8.2 - L 8.2 -
Sunny Isles
Beach, FL(31)
11/18/04 11/1/07 Palazzo at Park Residential 16,800 - 16,800 - 8.2 - L 8.2 -
Center
Alexandria,
VA(32)
----------------------------------------------------------------------------------
Totals $531,392 $241,837 $436,194 $223,649
F - Fixed Rate; L - LIBOR based floating rate
(1) The Concordia Portfolio was secured by the partnership interests in
three super regional malls. In conjunction with the purchase of the
Portfolio, the Company purchased a 1.46% interest only strip (the
"Alliance I/O") off of a B Note secured by a portfolio of apartments
(5,389 units) located in Dallas/Fort Worth and Phoenix. Payments
received are the greater of 1.5% or 9.5% less LIBOR+450, based upon a
notional par.
(2) May be extended at the borrower's option for two additional
twelve-month periods, subject to certain performance hurdles and an
extension fee.
(3) The entire principal balance of the Company's investment is pledged to
secure line of credit borrowing agreements.
(4) Represents a $35,000 mezzanine loan, secured by the borrower's
interest in a full service hotel. May be extended at the borrower's
option for two additional twelve-month periods for a 0.125% extension
fee. On March 20, 2003, the Company sold at par, a $30,000 subordinate
interest in a $160,000 note secured by the same hotel property.
(5) Represents a $35,000 mezzanine loan secured by 100% of the ownership
interests in the entity, which owns the Pennmark, a 24-story apartment
and retail development. This property is encumbered with an $111,000
first mortgage.
(6) Represents a $12,000 mezzanine construction loan, secured by a second
mortgage and 100% pledge of partnership interests. Borrower paid a
current interest rate of 12% with the remaining 10% paid at maturity.
The Company's remaining commitment of $545 was paid on July 18, 2003.
(7) Represents a subordinate interest in a $43,000 note secured by three
apartment properties located in Corpus Christi and Houston, Texas and
a $6,000 mezzanine loan, secured by the borrower's interest in the
same properties.
(8) Interest payments on the loan are based upon a spread to 30-day LIBOR,
subject to a floor of 2.5% on the first $20,250 of original par.
(9) Represents a $13,640 mezzanine construction loan, secured by a 100%
pledge of partnership interests. The loan may be extended at the
borrower's option for one additional twelve-month period for a fee of
1%. Borrower pays a current interest rate of 12% with the remaining 6%
plus $354 payable at maturity.
(10) May be extended at the borrower's option for three additional
twelve-month periods, subject to certain compliance hurdles.
(11) Represents a $14,500 mezzanine loan for the acquisition and
condominium conversion of a 389-unit rental apartment community in
suburban Baltimore, secured by a 100% pledge of partnership interests
in the property. The loan may be extended at the borrower's option for
one additional twelve-month period and one additional six-month period
for a fee of .50%. Borrower pays a current interest rate of 12% with
the remaining 8% payable at maturity.
(12) Prime Outlets is a $26,000 junior participation in a $336,000 first
mortgage, secured by nine retail outlet properties with 3.1 million
square feet, located in seven states. The loan may be extended at the
borrower's option for three additional twelve-month periods. An
extension fee of .125% is due for the second and third extensions.
(13) Represents a $10,000 B-Note secured by a subordinate interest in a
first mortgage on a 629,000 square foot regional mall located in
suburban Baltimore.
(14) Represents a $10,171 mezzanine loan for borrower's acquisition of a
14-property self-storage portfolio located in California (10
properties), Phoenix (3 properties), and Las Vegas (1 property).
Borrower pays a current interest of 12% with the remaining 4% payable
at maturity. The Borrower invested 10% of project costs and has
arranged first mortgage and mezzanine loans totaling 90% of total
acquisition cost.
(15) Represents a subordinate participation in a $40,450 first mortgage
loan, secured by a 396-unit condominium conversion project located in
Palm Harbor, Florida. In addition to interest, borrower is required to
pay a release fee of approximately $1 per unit. Release fees are
included in interest income.
(16) Represents a $17,800 subordinate interest in a first mortgage note
secured by retail and parking components of River East Center, a large
mixed-use development in downtown Chicago and a $14,000 mezzanine
loan, secured by the borrower's interest in the same property. May be
extended at the borrower's option for three additional twelve-month
periods, subject to certain performance hurdles, and an extension fee
on second and third extension of the mezzanine loan.
(17) Represents a subordinate interest in a $45,000 note, secured by a
first mortgage on the 286,775 square foot office complex in
Roseville, California.
(18) Represents a subordinate participation in a $57,300 first mortgage
loan, secured by a 300-unit condominium conversion project located in
Miami, Florida. In addition to interest, borrower is required to pay a
release fee of approximately $3 per unit. If the loan is prepaid prior
to the sale of all of the units or if the property is not converted,
borrower is required to pay an exit fee of $476. Release fees are
included in interest income.
(19) Represents a subordinate participation in a $74,000 note, secured by a
327-unit rental apartment community in Vienna, Virginia. In addition
to interest, borrower is required to pay a release fee of $6 at the
time of sale of each unit until 2.75% of the first mortgage has been
paid. The total release fee will be adjusted until it equals 2.25% of
the first mortgage if the Loan is repaid 20 months prior to the
Maturity and reduced to 2.50% if the Loan is repaid 1 year prior to
the Maturity.
(20) Represents a $15,000 mezzanine loan, secured by the borrower's
interest in a 30-story office tower in Indianapolis, Indiana.
(21) Represents a junior participation interest in an $82,000 first
mortgage, secured by a 17-story class B office building in the Penn
Plaza/Garment district of New York, NY.
(22) The LIBOR floor component of these loans has been bifurcated from the
loans, classified as prepaid and other assets on the balance sheet,
with subsequent changes in fair value included in the statement of
operations. The bifurcation causes an additional discount on the loan,
which is then amortized over the loan's expected maturity using the
effective interest method. The loss on LIBOR floors for all the
Company's loans was $1,892 for the year ended December 31, 2004.
(23) Represents a mezzanine loan secured by a 100% pledge of partnership
interests in the entity that owns 10/Ten Post Office Square, a 437
square foot, multi-tenant office building, located in the Boston
financial district.
(24) The Westbrook Portfolio represents a senior mezzanine loan secured by
a pledge of partnership interests in the entity that owns a portfolio
of 18 office properties primarily concentrated in and around Kansas
City, Orlando and Denver.
(25) May be extended at the borrower's option for two additional
twelve-month periods, subject to certain performance hurdles.
(26) Represents a subordinate interest in a $43,500 first mortgage note,
secured by a 264 square foot office building leased primarily to the
General Services Administration (GSA).
(27) Represents mezzanine loans secured by 100% pledge of partnership
interests in the entity that owns a portfolio of ten apartment
complexes located primarily in Los Angeles, California, Birmingham,
Alabama, and Dallas, Texas. May be extended at the borrower's option
for two additional twelve-month periods and one additional
eleven-month term, subject to certain performance hurdles and fees for
the second and third extensions.
(28) Represents a junior participation in an $802,500 first mortgage note
secured by an 80-property, 24,165-unit apartment portfolio located
primarily in the Southeastern and Southwestern United States.
(29) Represents a junior participation interest in a 75.000 mezzanine loan
secured by a pledge of equity interests in the owner of the Desert
Passage, a themed retail and entertainment complex and parking garage,
adjacent to the Aladdin Hotel and Casino on Las Vegas Boulevard ("The
Strip") in Las Vegas, Nevada.
(30) May be extended for three additional twelve-month periods, subject to
certain performance hurdles and a fee for each extension.
(31) Represents a subordinate interest in a $146,200 note secured by a
1,198-unit apartment property expected to be converted to
condominiums. In addition to interest, the borrower is required to pay
a release fee of approximately $2 per unit. If the conversion does not
occur, an additional 3% fee will be due at maturity.
(32) Represents a subordinate interest in a $79,200 note secured by a
392-unit apartment complex expected to be converted to condominiums.
In addition to interest, the borrower is required to pay an exit fee
to be paid at the earlier of maturity or $3 per unit upon sale.
Combined summarized financial information of the unconsolidated equity
investments and real estate joint ventures of the Company is as follows:
December 31,
-------------------------------------------
2004 2003
------------------ ---------------------
Combined Balance Sheets:
Real estate property $31,163 $46,547
Commercial mortgage loans, net 518,908 225,636
Other assets 21,235 18,709
------------------ ---------------------
Total Assets $571,306 $290,892
================== =====================
Mortgage debt $15,977 $30,536
Other liabilities 259,313 102,438
Partners', members' and stockholders' equity 296,016 157,918
------------------ ---------------------
Total liabilities, partners', members', and
stockholders' equity $571,306 $290,892
================== =====================
Anthracite Capital, Inc.'s share of equity $61,843 $36,316
================== =====================
For the years ended December 31,
-------------------------------------------
2004 2003 2002
----------- ------------ ------------
Combined Statements of Operations:
Revenues $49,107 $30,767 $19,901
----------- ------------ ------------
Expenses
Interest expense 7,731 7,043 4,877
Depreciation and amortization 1,274 1,824 2,203
Operating expenses 6,752 5,711 5,611
----------- ------------ ------------
Total expenses 15,757 14,578 12,691
----------- ------------ ------------
Net Income $33,350 $16,189 7,210
=========== ============ ============
The Company's share of net income $8,157 $4,322 $2,246
=========== ============ ============
Note 8 FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS
No. 107"), requires the disclosure of the estimated fair value of financial
instruments. The following table presents the notional amount, carrying value
and estimated fair value of financial instruments as of December 31, 2004 and
2003:
2004 2003
---------------------------------------------- ---------------------------------------------
Notional Carrying Estimated Notional Carrying Estimated
Amount Value Fair Value Amount Value Fair Value
---------------------------------------------- ---------------------------------------------
Securities available-for-sale $ - $1,763,093 $1,763,093 $ - $1,806,000 $1,806,000
Securities held-for-trading - 232,918 232,918 - 313,727 313,727
Commercial mortgage loans - 268,086 268,086 - 61,668 61,668
Secured borrowings - 804,351 804,351 - 1,138,571 1,138,571
CDO borrowings - 1,067,967 1,079,243 - 684,970 696,195
Commercial mortgage loan pool
borrowings - 1,294,058 1,294,058 - - -
Currency forward contracts - (25,807) (25,807) - - -
Interest rate swap agreements 1,410,165 (10,869) (10,869) 1,545,623 (26,352) (26,352)
Futures - - - 103 (11,436) (11,436)
Notional amounts are a unit of measure specified in a derivative instrument.
The fair values of the Company's securities available-for-sale, securities
held-for-trading, currency forward contracts and interest rate swap agreements
are based on market prices provided by certain dealers who make markets in
these financial instruments. The fair values reported reflect estimates and may
not necessarily be indicative of the amounts the Company could realize in a
current market exchange. Commercial mortgage loans and secured borrowings are
floating rate instruments, and based on these terms their carrying value
approximates fair value.
Note 9 IMPAIRMENTS - CMBS
In 2001, the Company adopted the rules contained in EITF 99-20, These rules
require the Company to update its estimated cash flows for its non-investment
grade securities and compare the net present value of these cash flows to the
adjusted purchase price. The Company complies with EITF 99-20 by comparing the
yields resulting from the updated cash flows to the current accrual yields. An
impairment charge is required under EITF 99-20 if the updated yield is lower
than the current accrual yield and the security has a market value less than
its adjusted purchase price. The Company carries all these securities at their
market value on its consolidated statement of financial condition.
The Company's portfolio has six 1998 vintage CMBS securities in four separate
CMBS transactions that required impairment charges at December 31, 2004
following the application of EITF 99-20. As a result, the Company recorded a
loss on impairment of assets of $26,018 in the fourth quarter of 2004. A
variety of factors influence updated yields for these securities including
magnitude of credit loss, timing of credit loss, prepayments and servicer
advances. The Company completed a re-evaluation of credit assumptions of its
1998 vintage CMBS portfolio in the fourth quarter of 2004. The magnitude of
credit losses did not significantly change as a result of this process, as
total loss expectations on the underlying loans moved from 2.06% to 2.04%.
Changes in the timing of credit losses and prepayments caused updated yields on
these securities to decline by a weighted average of 66 basis points. Market
dislocations in 1998 caused disproportionate unrealized losses in market value
on these securities based on price quotes received from third parties. The
Company had recorded these unrealized losses as other comprehensive loss on its
consolidated statement of financial condition since that time.
Based on current economic conditions and updated credit assumptions, the
Company believes these 1998 vintage CMBS securities will be repaid in full and
that the impairment charge of $25,355 with respect to five of the six
securities will be reflected in income over the remaining life of the bonds. In
addition, the Company increased underlying loan loss expectations on one
non-rated security resulting in an impairment charge of $663.
During 2003, the Company performed an analysis of its current underlying loan
loss expectations and credit performance of its 1998 vintage Controlling Class
CMBS. The Company increased underlying loan loss expectations on four
securities from three 1998 vintage CMBS transactions. As a result of the
increase in loss expectations, the Company recorded an impairment charge of
$27,014 during the second quarter of 2003, to reduce the amortized cost of
these securities to their fair value. The $27,014 impairment charge is
comprised of $19,217 related to the non-rated and CCC rated classes of CMAC
98-C2, $5,573 related to LBCMT 98-C1, and $2,224 related to GMAC 98-C1. Three
of the four impaired securities are not rated and the fourth security is rated
CCC by Fitch Ratings. Securities that are not rated are highly sensitive to
changes in the timing of losses recognized on the underlying loans.
Based on the delinquencies and defaults in the underlying pools, and missed
payments during the fourth quarter of 2002, the Company revised its estimated
future cash flows from its investment in FMACT 1998-BA class B security.
Accordingly, as of December 31, 2002, the Company determined that its
investment was impaired and wrote down the adjusted purchase price of this
security by $10,273 to its estimated fair value and increased the security's
yield from 7.69% to a market yield for a security of this credit quality,
estimated to be 20%. These figures incorporate the assumption that the
underlying loan pools and an estimate of another 1.0% of losses per year will
experience an additional $31,203 of losses over the remaining life of the
trust. This security was part of the CORE Cap acquisition in May of 2000 and
was rated AA at that time. The most recent rating of this security was CC by
Fitch Ratings was in December 2002.
During the third quarter of 2003, the Company determined it is unlikely that
further payments will be received from the FMACT 1998-BA class B security and
wrote this security down to zero, despite the servicer reporting a par balance
of $16,366 as of September 30, 2003. As a result, the Company recorded an
impairment charge during the quarter of $5,412.
Note 10 COMMON STOCK
For the year ended December 31, 2004, the Company issued 1,084,619 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $12,691. For the year ended December 31, 2003, the Company
issued 1,955,919 shares of Common Stock under its Dividend Reinvestment Plan.
Net proceeds to the Company were approximately $21,134. For the year ended
December 31, 2002, the Company issued 1,455,725 shares of Common Stock under
its Dividend Reinvestment Plan. Net proceeds to the Company were approximately
$15,920.
During the year ended December 31, 2004, the Company declared dividends to
stockholders totaling $58,208 or $1.12 per share, of which $43,287 was paid
during the year and $14,921 was paid on February 1, 2005. During the year ended
December 31, 2003, the Company declared dividends to stockholders totaling
$61,088 or $1.26 per share, of which $47,238 was paid during the year and
$13,850 was paid on February 2, 2004. During the year ended December 31, 2002,
the Company declared dividends to stockholders totaling $65,366 or $1.40 per
share, of which $48,777 was paid during the year and $16,589 was paid on
January 31, 2003.
For the year ended December 31, 2004 and 2003, respectively, the Company issued
294,400 and 45,000 shares of Common Stock under a sale agency agreement with
Brinson Patrick Securities Corporation. Net proceeds to the Company were
approximately $3,210 and $497, respectively. For the year ended December 31,
2003, the Company issued 45,000 shares of Common Stock under a sale agency
agreement with Brinson Patrick Securities Corporation. Net proceeds to the
Company were approximately $497.
All Common Stock dividends paid by the Company during 2004 are 100% ordinary
income. The following chart details the estimated tax characterization of the
Company's Common Stock dividends with March 31, 2003, June 30, 2003, and
September 30, 2003 record dates.
Cash Taxable Non-taxable
Record Payable Distribution Ordinary Return of
Date Date Per Share Dividend Capital
--------------------------------------------------------------------------
3/31/03 4/30/03 $0.3500 $0.3344 $0.0156
6/30/03 7/31/03 $0.3500 $0.3344 $0.0156
9/30/03 10/31/03 $0.2800 $0.2675 $0.0125
------------------------------------------------
Total $0.9800 $0.9363 $0.0437
During the first quarter of 2004, the Company suspended its Dividend
Reinvestment Plan for all investments after March 26, 2004, and for all future
investment dates. During the second quarter of 2004, the dividend reinvestment
portion of the Dividend Reinvestment Plan was reinstated for all dividend
payments made after August 2, 2004, and for all future dividend payment dates
with a discount of 2%. The optional cash purchase portion of the Dividend
Reinvestment Plan remains suspended; however, it may be resumed at any time.
On June 30, 2004, the Company completed a follow-on offering of 2,100,000
shares of its Common Stock in an underwritten public offering. The net proceeds
to the Company (after deducting underwriting fees and expenses) were
approximately $23,184. The Company had granted the underwriters an option,
exercisable for 30 days, to purchase up to 315,000 additional shares of Common
Stock to cover over-allotments. This option was exercised on July 6, 2004 and
resulted in net proceeds to the Company of approximately $3,478.
Note 11 PREFERRED STOCK
At the end of the first quarter of 2004, the Board of Directors approved the
Company's decision to redeem its Series B Preferred Stock, $0.001 par value per
share ("Series B Preferred Stock"). The second quarter of 2004 earnings
includes a charge of $0.21 per share for the redemption of the Company's Series
B Preferred Stock. The Series B Preferred Stock was redeemed on May 6, 2004.
On May 29, 2003, the Company authorized and issued 2,300,000 shares of Series C
Preferred Stock, including 300,000 shares of Series C Preferred Stock issued
pursuant to an option granted to the underwriters to cover over-allotments. The
Series C Preferred Stock is perpetual, carries a 9.375% coupon and has a
preference in liquidation of $57,500. The aggregate net proceeds to the Company
(after deducting underwriting fees and expenses) were approximately $55,435.
As part of the CORE Cap merger, the Company authorized and issued 2,261,000
shares of Series B Preferred Stock, $0.001 par value per share, to CORE Cap
stockholders. The Series B Preferred Stock was perpetual, carries a 10% coupon,
has a preference in liquidation as of December 31, 2003 of $43,942, and is
convertible into the Company's Common Stock at a price of $17.09 per share,
subject to adjustment. If converted, the Series B Preferred Stock would convert
into approximately 2,571,423 shares of the Company's Common Stock. On May 29,
2003, the Company redeemed 155,000 shares at its liquidation value of $25 per
share. In 2002, 300,000 shares of 10% Series B Preferred Stock with a
liquidation preference of $7,500 were converted at the stockholder's option
into 438,885 shares of the Company's Common stock.
As of December 31, 2004, the Company has authorized and un-issued 94,394,003
shares of preferred stock.
All Series B Preferred Stock dividends paid by the Company during 2004 are 100%
ordinary income. The following chart details the estimated tax characterization
of the Company's Series B Preferred Stock dividends with March 15, 2003, June
15, 2003, September 15, 2003, and December 15, 2003 record dates.
Cash Taxable Non-taxable
Record Payable Distribution Ordinary Return of
Date Date Per Share Dividend Capital
--------------------------------------------------------------------------
3/15/03 3/31/03 $0.6250 $0.5963 $0.0287
6/15/03 6/30/03 0.6250 0.5963 0.0287
9/15/03 9/30/03 0.6250 0.5963 0.0287
12/15/03 12/31/03 0.6250 0.5963 0.0287
-------------------------------------------------
Total $2.5000 $2.3853 $0.1147
The following chart details the estimated tax characterization of the
Company's Series C Preferred Stock dividends with July 15, 2003 and October
10, 2003 record dates. All other Series C Preferred Stock dividends that have
been paid by the Company are 100% ordinary income.
Cash Taxable Non-taxable
Record Payable Distribution Ordinary Return of
Date Date Per Share Dividend Capital
--------------------------------------------------------------------------
7/15/03 7/31/03 $0.4100 $0.3556 $0.0544
10/10/03 10/31/03 0.5860 0.5083 0.0777
-------------------------------------------------
Total $0.9960 $0.8639 $0.1321
Note 12 TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement with the Manager, a majority owned
indirect subsidiary of The PNC Financial Services Group, Inc. and the employer
of certain directors and officers of the Company, under which the Manager
manages the Company's day-to-day operations, subject to the direction and
oversight of the Company's Board of Directors. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with
the approval of the unaffiliated directors, on terms similar to the prior
agreement with the following changes: (i) the incentive fee calculation would
be based on GAAP earnings instead of funds from operations, (ii) the removal
of the four-year period to value the Management Agreement in the event of
termination and (iii) subsequent renewal periods of the Management Agreement
would be for one year instead of two years. Houlihan Lokey Howard & Zukin
Financial Advisors, Inc., a national investment banking and financial advisory
firm, advised the Board in the 2002 renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year
through March 31, 2004. The terms of the renewed agreement were similar to the
prior agreement except for the incentive fee calculation that would provide
for a rolling four-quarter high watermark rather than a quarterly calculation.
In determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee, as defined, were greater than what was paid to
the Manager in the prior three quarters cumulatively. The Company phased in
the rolling four-quarter high watermark commencing with the second quarter of
2003. Calculation of the incentive fee was based on GAAP earnings and adjusted
to exclude special one-time events pursuant to changes in GAAP accounting
pronouncements after discussion between the Manager and the unaffiliated
directors. The incentive fee threshold did not change. The high watermark
provided for the Manager to be paid 25% of the amount of earnings (calculated
in accordance with GAAP) per share that exceeds the product of the adjusted
issue price of the Company's Common Stock per share and the greater of 9.5% or
350 basis points over the ten-year Treasury note.
The Management Agreement was further extended for one year from March 31, 2004
through March 31, 2005. The base management fee was revised to equal 2% of the
quarterly average total stockholders' equity for the applicable quarter. The
incentive fee was revised to be 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's Common Stock per share ($11.37 as of December 31, 2004)
and the greater of 8.5% or 400 basis points over the ten-year Treasury note.
On March 10, 2004, the members of the Company's Board of Directors who are not
affiliated with the Manager approved an extension of the Company's management
agreement with the Manager for one additional year through March 31, 2006. The
terms of the extended agreement did not change.
During the third quarter of 2003, the Manager agreed to reduce its management
fees by 20% from its calculated amount for the third and fourth quarter of
2003 and the first quarter of 2004. This revision resulted in $1,046 in
savings to the Company during 2003 and $532 during 2004, respectively.
The Company incurred $8,956, $9,411, and $9,332 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2004, 2003 and 2002, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements to
the Manager of $120, $66, and $14 for certain expenses incurred on behalf of
the Company during 2004, 2003 and 2002, respectively.
The Company has an administration agreement with the Manager. Under the terms
of the administration agreement, the Manager provides financial reporting,
audit coordination and accounting oversight services to the Company. Either
party can cancel the agreement upon 60-day written notice. The Company pays
the Manager a monthly administrative fee at an annual rate of 0.06% of the
first $125,000 of average net assets, 0.04% of the next $125,000 of average
net assets and 0.03% of average net assets in excess of $250,000 subject to a
minimum annual fee of $120. For the years ended December 31, 2004, 2003 and
2002, the Company paid administration fees of $174, $173, and $168,
respectively.
The special servicer on 11 of the Company's 16 Controlling Class trusts is
Midland Loan Services, Inc. ("Midland"), a wholly owned indirect subsidiary of
PNC Bank. The Company's fees for Midland's services are at market rates.
In March 2001, the Company purchased twelve certificates each representing a
1% interest in different classes of Owner Trust NS I Trust ("Owner Trusts")
for an aggregate investment of $37,868. These certificates were purchased from
PNC Bank. The assets of the Owner Trusts consist of commercial mortgage loans
originated or acquired by an affiliate of PNC Bank. The Company entered into a
$50,000 committed line of credit from PNC Funding Corp. to borrow up to 95% of
the fair market value of the Company's interest in the Owner Trusts.
Outstanding borrowings against this line of credit bear interest at a LIBOR
based variable rate. As of December 31, 2001, there was $13,885 borrowed under
this line of credit. The Company earned $1,468 from the Owner Trusts and paid
interest of approximately $849 to PNC Funding Corp. as interest on borrowings
under a related line of credit for year ended December 31, 2001. During 2001,
the Company sold four Owner Trusts. The gain on the sale of those Owner Trusts
was $35. The outstanding borrowings were repaid prior to the expiration on
March 13, 2002, at which time the remaining Owner Trusts were sold at a gain
of $90.
During 2001, the Company entered into a $50,000 commitment to acquire shares
in Carbon I, a private commercial real estate income opportunity fund managed
by the Manager. The Carbon I investment period ended on July 12, 2004 and the
Company's investment in Carbon I as of December 31, 2004 was $39,563. The
Company does not incur any additional management or incentive fees to the
Manager as a result of its investment in Carbon I. On December 31, 2004, the
Company owned approximately 20% of the outstanding shares in Carbon I.
On October 13, 2004, the Company entered into a commitment of up to $30,000 to
acquire shares in Carbon II, a private commercial real estate income
opportunity fund managed by the Manager. On November 19, 2004 the Company
entered into an additional $32,067 commitment to acquire shares in Carbon II.
During 2004, the Company received capital call notices of $16,953. As of
December 31, 2004, the Company's investment in Carbon II was $17,249 and the
Company's remaining commitment to Carbon II is $45,114. The Company may commit
up to the lower of 20% of the total of Carbon II's capital commitments or
$100,000. The Company may commit up to the lower of 20% of the total of Carbon
II's capital commitments or $100,000. The Company does not incur any
additional management or incentive fees to the Manager as a result of its
investment in Carbon II. The Company's unaffiliated directors approved this
transaction in September of 2004.
During 2000, the Company completed the acquisition of CORE Cap, Inc. The
merger was a stock for stock acquisition where the Company issued 4,180,552
shares of its common stock and 2,261,000 shares of its Series B preferred
stock. At the time of the CORE Cap acquisition, the Manager agreed to pay GMAC
(CORE Cap, Inc.'s external advisor) $12,500 over a ten-year period
("Installment Payment") to purchase the right to manage the assets under the
existing management contract ("GMAC Contract"). The GMAC Contract had to be
terminated in order to allow for the Company to complete the merger, as the
Company's management agreement with the Manager did not provide for multiple
managers. As a result the Manager offered to buy-out the GMAC Contract as the
Manager estimated it would receive incremental fees above and beyond the
Installment Payment, and thus was willing to pay for, and separately
negotiate, the termination of the GMAC Contract. Accordingly, the value of the
Installment Payment was not considered in the Company's allocation of its
purchase price to the net assets acquired in the acquisition of CORE Cap, Inc.
The Company agreed that should the Management Agreement with its Manager be
terminated, not renewed or not extended for any reason other than for cause,
the Company would pay to the Manager an amount equal to the Installment
Payment less the sum of all payments made by the Manager to GMAC. As of
December 31, 2004, the Installment Payment would be $6,500 payable over six
years. The Company does not accrue for this contingent liability.
Note 13 STOCK OPTIONS
The Company has adopted a stock option plan (the "1998 Stock Option Plan")
that provides for the grant of both qualified incentive stock options that
meet the requirements of Section 422 of the Code and non-qualified stock
options, stock appreciation rights and dividend equivalent rights. Stock
options may be granted to the Manager, directors, officers and any key
employees of the Company, directors, officers and key employees of the Manager
and to any other individual or entity performing services for the Company.
The exercise price for any stock option granted under the 1998 Stock Option
Plan may not be less than 100% of the fair market value of the shares of
Common Stock at the time the option is granted. Each option must terminate no
more than ten years from the date it is granted and have vested over either a
two or three-year period. Subject to anti-dilution provisions for stock
splits, stock dividends and similar events, the 1998 Stock Option Plan
authorizes the grant of options to purchase up to an aggregate of 2,470,453
shares of Common Stock.
On May 25, 2004, the Company granted stock options to each of its unaffiliated
directors with an exercise price equal to the closing price of the Common
Stock on the New York Stock Exchange on such date (or $11.81). The options
vested immediately upon grant. The fair value of the options granted is
estimated on the date of grant using the Black-Scholes option-pricing model
with the following assumptions.
May 25, 2004
------------------
Estimated volatility 22.6%
Expected life 7 years
Risk-free interest rate 1.2%
Expected dividend yield 9.5%
The fair value of the options granted on May 25, 2004 was negligible. There
were no options granted in 2003.
The following table summarizes information about options outstanding under the
1998 Stock Option Plan:
2004 2003 2002
------------------------ ------------------------- ---------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ----------- ------------ ------------ -------------- ------------
Outstanding at January 1 1,468,351 $ 14.75 1,560,542 $ 14.49 1,766,341 $ 11.87
Granted 5,000 11.81 - - - -
Exercised (30,000) 8.44 (65,400) 8.45 (182,700) 8.33
Cancelled (25,500) 15.00 (26,791) 15.00 (23,099) 15.63
Outstanding at December 31 1,417,851 $ 14.87 1,468,351 $ 14.75 1,560,542 $ 14.49
============ ============ ==============
Options exercisable at December 31 1,417,851 $ 14.87 1,468,351 $ 14.75 1,560,542 $ 14.49
============ ============ ==============
The following table summarizes information about options outstanding under the
1998 Stock Option Plan at December 31, 2004:
Options Remaining Options
Outstanding at Contractual Life Exercisable at
Exercise Price December 31, 2004 (Years) December 31, 2004
-------------------------------------------------------------------------------
$ 7.82 3,850 5.1 3,850
8.44 25,000 4.2 25,000
9.11 3,850 4.2 3,850
11.81 5,000 9.4 5,000
15.00 1,310,851 3.2 1,310,851
15.58 57,750 2.7 57,750
15.83 11,550 3.2 11,550
-------------------------------------------------------------------------------
$7.82-$15.83 1,417,851 3.3 1,417,851
===============================================================================
Shares of Common Stock available for future grant under the 1998 Stock Option
Plan at December 31, 2004 were 774,502.
Note 14 BORROWINGS
The Company's borrowings consist of lines of credit, CDOs, commercial mortgage
loan pools and reverse repurchase borrowings.
The Company has a $200,000 committed credit facility with Deutsche Bank, AG
(the "Deutsche Bank Facility") that matures December 20, 2007. The Deutsche
Bank Facility can be used to replace existing reverse repurchase agreement
borrowings and to finance the acquisition of mortgage-backed securities, loan
investments and investments in real estate joint ventures. As of December 31,
2004 and 2003, the outstanding borrowings under this facility were $126,349
and $82,406, respectively. Outstanding borrowings under the Deutsche Bank
Facility bear interest at a LIBOR based variable rate.
On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. The facility provides the Company with the
ability to borrow only through July 17, 2004 with the repayment of principal
not due until July 7, 2005. Outstanding borrowings under this credit facility
bear interest at a LIBOR based variable rate. As of December 31, 2004,
outstanding borrowings under this facility were $24,527. As of December 31,
2003, outstanding borrowings under this facility were $7,530.
At December 31, 2004, the Company had outstanding borrowings of $12,800 under
a $13,000 committed credit facility with Morgan Stanley Mortgage Capital, Inc.
The Morgan Stanley Mortgage Capital, Inc. facility matures May 11, 2006.
The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth measured on GAAP of $305,000, a debt-to-equity
ratio not to exceed 5.5 to 1, a recourse debt-to-equity of 3.0 to 1, a minimum
cash requirement based upon certain debt-to-equity ratios, a minimum debt
service coverage ratio of 1.5 and a minimum liquidity reserve of $10,000. The
Company received authorization from its lenders to permit debt to equity
ratios in excess of existing covenants and a debt service coverage ratio less
than 1.5. As of December 31, 2004 and 2003, the Company was in compliance with
all other covenants.
On May 29, 2002, the Company issued ten tranches of secured debt through CDO
I. In this transaction, a wholly owned subsidiary of the Company issued
secured debt in the par amount of $419,185 secured by the subsidiary's assets.
The adjusted issue price of the CDO I debt, as of December 31, 2004, is
$405,377. Five tranches were issued at a fixed rate coupon and five tranches
were issued at a floating rate coupon with a combined weighted average
remaining maturity of 7.29 years as of December 31, 2004. All floating rate
coupons were swapped to fixed rate coupons resulting in a total fixed rate
cost of funds for CDO I of approximately 7.21%. The Company incurred $9,890 of
issuance costs that will be amortized over the weighted average life of the
CDO. The CDO was structured to match fund the cash flows from a significant
portion of the Company's CMBS and unsecured real estate investment trust debt
portfolio (REIT debt). The par amount as of December 31, 2004 of the
collateral securing CDO I consists of 78% CMBS rated B or higher and 22% REIT
debt rated BBB or higher. As of December 31, 2004, the collateral securing CDO
I has a fair value of $475,157.
On December 10, 2002, the Company issued seven tranches of secured debt
through CDO II. In this transaction, a wholly owned subsidiary of the Company
issued secured debt in the par amount of $280,783 secured by the subsidiary's
assets. In July 2004, the Company issued a bond with a par of $12,850 from its
CDO II. Before issuing this security, the Company amended the indenture to
reduce the coupon from 9.0% to 7.6%. The adjusted issue price of the CDO II
debt as of December 31, 2004 is $293,167. Five tranches were issued at a fixed
rate coupon and three tranches were issued at a floating rate coupon with a
combined weighted average remaining maturity of 7.72 years as of December 31,
2004. All floating rate coupons were swapped to fixed rate coupons resulting
in a total fixed rate cost of funds for CDO II of approximately 5.79%. The
Company incurred $6,004 of issuance costs that will be amortized over the
weighted average life of the CDO. The CDO was structured to match fund the
cash flows from a significant portion of the Company's CMBS and unsecured real
estate investment trust debt portfolio (REIT debt). The par amount as of
December 31, 2004 of the collateral securing CDO II consists of 84% CMBS rated
B or higher and 16% REIT debt rated BBB or higher. As of December 31, 2004,
the collateral securing CDO II has a fair value of $340,686.
On March 30, 2004 the Company issued its third collateralized debt obligation
("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold
was $372,456. The adjusted issue price of the CDO III debt, as of December 31,
2004, is $369,422. Five tranches were issued at a fixed rate coupon and six
tranches were issued at a floating rate coupon with a combined weighted
average remaining maturity of 8.39 years as of December 31, 2004. All floating
rate coupons were swapped to fixed rate coupons resulting in a total fixed
rate cost of funds for CDO I of approximately 5.03%. The Company incurred
$2,006 of issuance costs that will be amortized over the weighted average life
of the CDO. The CDO was structured to match fund the cash flows from a
significant portion of the Company's CMBS and unsecured real estate investment
trust debt portfolio (REIT debt). The par amount as of December 31, 2004 of
the collateral securing CDO III consists of 88% CMBS rated B or higher and 12%
REIT debt rated BBB or higher. As of December 31, 2004, the collateral
securing CDO II has a fair value of $386,916.
Proceeds from the CDOs were used to pay off all of the financing of the
Company's CMBS below investment grade portfolio, BBB portfolio and its REIT
debt. Prior to the CDOs, these portfolios were financed with thirty-day
repurchase agreements with various counterparties that marked the assets to
market on a daily basis at interest rates based on 30-day LIBOR. For
accounting purposes, these transactions were treated as a secured financing,
and the debt is non-recourse to the Company.
The Company has entered into reverse repurchase agreements to finance most of
its securities available-for-sale that are not financed under its lines of
credit or from the issuance of its collateralized debt obligations. The
reverse repurchase agreements are collateralized by most of the Company's
securities available-for-sale and bear interest at a LIBOR based variable
rate.
Certain information with respect to the Company's collateralized borrowings as
of December 31, 2004 is summarized as follows:
Lines of Reverse Commercial Collateralized Total
Credit and Repurchase Mortgage Loan Debt Collateralized
Term Loans Agreements Pools Obligations Borrowings
------------------------------------------------------------------------------------------
Outstanding borrowings $163,676 $640,675 $1,294,058 $1,067,967 $3,166,376
Weighted average
borrowing rate 3.52% 2.47% 3.76% 6.07% 4.27%
Weighted average
remaining maturity 218 days 26 days 2,587 days 2,936 days 2,064 days
Estimated fair value of
assets pledged $222,122 $701,913 $1,312,045 $1,202,760 $3,438,839
As of December 31, 2004, the Company's collateralized borrowings had the
following remaining maturities:
Reverse Commercial Collateralized Total
Lines of Repurchase Mortgage Debt Collateralized
Credit Agreements Loan Pools Obligations* Borrowings
--------------------------------------------------------------------------------------
Within 30 days $- $605,944 $- $- $605,944
31 to 59 days - 7,925 - - 7,925
60 days to less than 1 year 150,876 26,806 - - 177,682
1 year to 3 years 12,800 - - - 12,800
3 years to 5 years - - - - -
Over 5 years - - 1,294,058 1,067,967 2,362,025
--------------------------------------------------------------------------------------
$163,676 $640,675 $1,294,058 $1,067,967 $3,166,376
======================================================================================
* Comprised of $405,377 of CDO debt with a weighted average remaining maturity
of 7.29 years as of December 31, 2004 and $293,167 of CDO debt with a weighted
average remaining maturity of 7.72 years as of December 31, 2004, and $369,422
of CDO debt with a weighted average remaining maturity of 8.39 years as of
December 31, 2004.
Certain information with respect to the Company's collateralized borrowings as
of December 31, 2003 is summarized as follows:
Lines of Reverse Collateralized Total
Credit and Repurchase Debt Collateralized
Term Loans Agreements Obligations Borrowings
-----------------------------------------------------------------------------
Outstanding borrowings $89,936 $1,048,635 $684,970 $1,823,541
Weighted average borrowing
rate 2.40% 1.24% 6.60% 3.31%
Weighted average remaining
maturity 484 days 21 days 3,033 days 1,175 days
Estimated fair value of
assets pledged $146,608 $1,137,539 $770,575 $2,054,722
As of December 31, 2003, the Company's collateralized borrowings had the
following remaining maturities:
Total
Lines of Reverse Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
-----------------------------------------------------------------------------
Within 30 days $ - $1,048,635 $ - $1,048,635
31 to 59 days - - - -
60 days to less than 1 year 15,180 - - 15,180
1 year to 2 years 74,756 - - 74,756
3 years to 5 years - - - -
Over 5 years - - 684,970* 684,970
-----------------------------------------------------------------------------
$89,936 $1,048,635 $684,970 $1,823,541
=============================================================================
* Comprised of $404,637 of CDO debt with a weighted average remaining maturity
of 8.29 years as of December 31, 2003 and $280,333 of CDO debt with a weighted
average remaining maturity of 8.34 years as of December 31, 2003.
Under the lines of credit and the reverse repurchase agreements, the respective
lender retains the right to mark the underlying collateral to estimated market
value. A reduction in the value of pledged assets would require the Company to
provide additional collateral or fund margin calls. From time to time, the
Company may be required to provide additional collateral or fund margin calls.
Note 15 DERIVATIVE INSTRUMENTS
Effective January 1, 2001, the Company adopted SFAS No. 133, as amended and
interpreted, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. All derivatives, whether designated
in hedging relationships or not, are required to be recorded on the balance
sheet at fair value. If the derivative is designated as a fair value hedge, the
changes in the fair value of the derivative and of the hedged item attributable
to the hedged risk are recognized in earnings. If the derivative is designated
as a cash flow hedge, the effective portions of change in the fair value of the
derivative are recorded in other comprehensive income ("OCI") and are
recognized in the income statement when the hedged item affects earnings.
Ineffective portions of changes in the fair value of cash flow hedges are
recognized in earnings. For those swaps designated as cash flow hedges, the
Company will maintain variable rate debt equal to or greater than the notional
of the outstanding cash flow hedges. Ineffective portions of charges in the
fair value of cash flow hedges are recognized in earnings.
The Company uses interest rate swaps to manage exposure to variable cash flows
on portions of its borrowings under reverse repurchase agreements and as
trading derivatives intended to offset changes in fair value related to
securities held as trading assets. On the date in which the derivative
contract is entered, the Company designates the derivative as either a cash
flow hedge or a trading derivative.
The reverse repurchase agreements bear interest at a LIBOR based variable
rate. Increases in the LIBOR rate could negatively impact earnings. The
interest rate swap agreements allow the Company to receive a variable rate
cash flow based on LIBOR and pay a fixed rate cash flow, mitigating the impact
of this exposure.
Interest rate swap agreements contain an element of risk in the event that the
counterparties to the agreements do not perform their obligations under the
agreements. The Company minimizes its risk exposure by entering into
agreements with parties rated at least A or better by Standard & Poor's Rating
Services. Furthermore, the Company has interest rate swap agreements
established with several different counterparties in order to reduce the risk
of credit exposure to any one counterparty. Management does not expect any
counterparty to default on their obligations. As of December 31, 2004, the
counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch
Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special
Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-,
respectively. The Company continually monitors the rating and overall credit
quality of its swap counterparties.
On July 6, 2004, interest rate swaps with a notional of $264,000 classified as
trading derivatives were re-designated as cash flow hedges of borrowings under
reverse repurchase agreements. The reclassification was based on the Company's
intent with respect to these derivatives with the principle objective of
generating returns from other than short-term pricing differences.
As of December 31, 2004, the Company had interest rate swaps that were
designated as cash flow hedges of borrowings under reverse repurchase
agreements. Cash flow hedges with a fair value of $10,252 are included in
other assets on the consolidated statement of financial condition and cash
flow hedges with a fair value of $(21,261) are included in other liabilities
on the consolidated statement of financial condition. This liability was
collateralized with the restricted cash equivalents recorded on the Company's
consolidated statement of financial condition. For the year ended December 31,
2004, the fair value of the interest rate swaps decreased by $2,793 of which
$1,015 was deemed ineffective and is included as an addition of interest
expense, $1,078 was recorded as an increase of OCI and $2,856 was included as
an addition to loss on trading securities due to a period of ineffectiveness.
The Company expects that $1,038 currently recorded as a component of OCI will
be recognized in earnings in the next twelve months as the hedged forecasted
transactions occur. As of December 31, 2004, the $1,170,720 notional of swaps
that were designated as cash flow hedges had a weighted average remaining term
of 7.32 years.
During the year ended December 31, 2004, the Company terminated fifteen of its
interest rate swaps with a notional amount of $623,000 that were designated as
cash flow hedges of borrowings under reverse repurchase agreements. The
Company will reclassify from OCI as an increase to interest expense the
$18,978 loss in value incurred, over 5.54 years, which was the weighted
average remaining term of the swaps at the time they were closed out. For the
year ended December 31, 2004, $2,016 was reclassified as an increase to
interest expense and $2,471 will be reclassified as an increase to interest
expense for the next 12 months.
As of December 31, 2004, the Company had interest rate swaps with notional
amounts aggregating $239,445 designated as trading derivatives. Trading
derivatives with a fair value of $145 are included in other assets on the
consolidated statement of financial condition and trading derivatives with a
fair value of $(5) are included in other liabilities on the consolidated
statement of financial condition. For the year ended December 31, 2004, the
change in fair value for these trading derivatives was $(54) and is included
as an addition to loss on securities held-for-trading in the consolidated
statement of operations. As of December 31, 2004, the $239,445 notional of
swaps, which were designated as trading derivatives, had a weighted average
remaining term of 7.67 years.
As of December 31, 2003, the Company had interest rate swaps that were
designated as cash flow hedges of borrowings under reverse repurchase
agreements. Cash flow hedges with a fair value of $2,759 are included in other
assets on the consolidated statement of financial condition and cash flow
hedges with a fair value of $(30,653) are included in other liabilities on the
consolidated statement of financial condition. This liability was
collateralized with the restricted cash equivalents recorded on the Company's
consolidated statement of financial condition. For the year ended December 31,
2003, the fair value of the interest rate swaps increased by $13,180 of which
$706 was deemed ineffective and is included as a reduction of interest
expense. The remaining increase in fair value of $12,474 was recorded as a
decrease to other comprehensive loss. As of December 31, 2003, the $1,066,078
notional of swaps, which were designated as cash flow hedges, had a weighted
average remaining term of 7.4 years.
During the year ended December 31, 2003, the Company terminated one of its
interest rate swaps with a notional amount of $200,000 that was designated as
a cash flow hedge of borrowings under reverse repurchase agreements. The
Company will reclassify from OCI as an increase to interest expense the $1,593
loss in value incurred, over 1.9 years, which was the remaining term of the
swap at the time it was closed out. For the year ended December 31, 2003, $476
was reclassified as an increase to interest expense and $212 was reclassified
as an increase to interest expense each quarter for the next 12 months.
As of December 31, 2003, the Company had interest rate swaps with notional
amounts aggregating $479,545 designated as trading derivatives. Trading
derivatives with a fair value of $1,591 are included in other assets on the
consolidated statement of financial condition and trading derivatives with a
fair value of $(49) are included in other liabilities on the consolidated
statement of financial condition. For the year ended December 31, 2003, the
change in fair value for these trading derivatives was $(714) and is included
as an addition to loss on securities held-for-trading in the consolidated
statement of operations. As of December 31, 2003, the $479,545 notional of
swaps, which were designated as trading derivatives, had a weighted average
remaining term of 5.2 years.
The Company formally documents all relationships between hedging instruments
and hedged items, as well as its risk-management objectives and strategies for
undertaking various hedge transactions. The Company assesses, both at the
inception of the hedge and on an on-going basis, whether the derivatives that
are used in hedging transactions are highly effective in offsetting changes in
fair values or cash flows of hedged items. When it is determined that a
derivative is not highly effective as a hedge, the Company discontinues hedge
accounting prospectively.
Occasionally, counterparties will require the Company or the Company will
require counterparties to provide collateral for the interest rate swap
agreements in the form of margin deposits. Net deposits are recorded as a
component of other assets or other liabilities. Should the counterparty fail
to return deposits paid, the Company would be at risk for the fair market
value of that asset. At December 31, 2004 and 2003, the balance of such net
margin deposits owed to counterparties as collateral under these agreements
totaled $4,680 and $10,445, respectively.
The implementation of SFAS No. 133 did not change the manner in which the
Company accounts for its forward currency exchange contracts. Hedge accounting
is not applied for these contracts and they are carried at fair value, with
changes in fair value included as a component of net foreign currency gain or
loss in the consolidated statement of operations.
The Company's foreign currency exchange contracts were intended to
economically hedge currency risk in connection with the Company's investment
in the London Loan, which was denominated in pounds sterling. The estimated
fair value of the forward currency exchange contracts was a liability of $365
at December 31, 2002, which change was recognized as a reduction of foreign
currency losses. As of December 31, 2003, the Company did not have economic
exposure to its forward currency exchange contract.
The contracts identified in the remaining portion of this footnote have been
entered into to limit the Company's mark to market exposure to long-term
interest rates.
The Company had a forward LIBOR cap with a notional amount of $85,000 and a
fair value at December 31, 2004 of $694 that is included in other assets.
At December 31, 2003, the Company had outstanding short positions of 30
five-year and 73 ten-year U.S. Treasury Note future contracts, which
represented $3,000 and $7,300 in face amounts of U.S. Treasury Notes,
respectively. The estimated fair value of the contracts was approximately
$(11,436), and the change in fair value related to these contracts is included
as a component of loss on securities held-for-trading. Additionally, the
Company had a forward LIBOR cap with a notional amount of $85,000 and a fair
value at December 31, 2003 of $1,114 that is included in other assets.
Note 16 NET INCOME PER SHARE
Net income per share is computed in accordance with SFAS No. 128, "Earnings
Per Share" ("SFAS No. 128"). Basic income per share is calculated by dividing
net income available to common stockholders by the weighted average number of
shares of Common Stock outstanding during the period. Diluted income per share
is calculated using the weighted average number of shares of Common stock
outstanding during the period plus the additional dilutive effect of common
stock equivalents. The dilutive effect of outstanding stock options is
calculated using the treasury stock method, and the dilutive effect of
preferred stock is calculated using the "if converted" method.
For the year ended December 31,
2004 2003 2002
-----------------------------------------------
Numerator:
Net income (loss) available to common stockholders before
cumulative transition adjustment $25,768 $(16,386) $48,466
Cumulative transition adjustment - SFAS No. 142 - - 6,327
Numerator for basic and diluted earnings (loss) per share $25,768 $(16,386) $54,793
Denominator:
Denominator for basic earnings per share--weighted average
common shares outstanding 51,766,877 48,245,927 46,411,324
Effect of 10.5% Series A senior cumulative redeemable preferred stock - - 7,283
Dilutive effect of stock options 8,903 - 33,663
----------- ----------- -----------
Denominator for diluted earnings per share--weighted average
common shares outstanding and common stock equivalents
outstanding 51,775,780 48,245,927 46,452,270
=========== =========== ===========
Basic net income (loss) per weighted average common share:
Income (loss) before cumulative transition adjustment $0.50 $(0.34) $1.04
Cumulative transition adjustment - SFAS No. 142 - - 0.14
-----------------------------------------------
Net income (loss) $0.50 $(0.34) $1.18
===============================================
Diluted net income (loss) per weighted average common stock and common
stock equivalents:
Income (loss) before cumulative transition adjustment $0.50 $(0.34) $1.04
Cumulative transition adjustment - SFAS No. 142 - - 0.14
-----------------------------------------------
Net income (loss) $0.50 $(0.34) $1.18
===============================================
Total anti-dilutive stock options and warrants excluded from the calculation
of net income (loss) per share were 1,385,151, 1,468,351 and 1,432,442 for the
years ended December 31, 2004, 2003, and 2002, respectively.
Note 17 SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of quarterly results of operations:
Quarters Ending
March 31 June 30 September 30 December 31
2004 2003 2004 2003 2004 2003 2004 2003
---------------------------------------------------------------------------------------------------
Interest Income $ 39,064 $ 42,823 $ 52,146 $ 42,410 $ 56,094 $ 40,329 $ 56,560 $38,216
---------------------------------------------------------------------------------------------------
Expenses:
Interest 20,873 19,705 33,150 21,737 37,359 21,614 36,784 20,193
Management fee and
Other 2,732 3,159 2,796 3,240 3,098 2,666 3,757 2,642
---------------------------------------------------------------------------------------------------
Total Expenses 23,605 22,864 35,946 24,977 40,457 24,280 40,541 22,835
---------------------------------------------------------------------------------------------------
Gain (loss) on sale of
securities available-for-sale 2,813 142 (4,036) 3,294 2,081 (4,704) 16,687 (5,564)
Gain (loss) on securities
held-for-trading (5,983) (10,404) (4,046) (4,716) (1,103) (28,154) (331) 5,068
Foreign currency (loss) - - (12) - (114) - (61) -
Loss on impairment of assets - - - (27,014) - (5,412) (26,018) -
---------------------------------------------------------------------------------------------------
Net income (loss) $ 12,289 $ 9,697 $ 8,106 $(11,003) $ 16,501 $(22,221) $ 6,295 $14,885
---------------------------------------------------------------------------------------------------
Cost to retire preferred stock
in excess of carrying value - - 10,508 - - - - -
Dividends and accretion on
redeemable convertible preferred
stock 2,446 $ 1,195 1,775 1,611 1,348 2,491 1,348 2,446
---------------------------------------------------------------------------------------------------
Net income (loss) available
to common stockholders $ 9,843 $ 8,502 $ (4,177) $ (12,614) $ 15,153 $ (24,712) $ 4,948 $12,439
===================================================================================================
Net income (loss) per share,
basic: $ 0.20 $ 0.18 $ (0.08) $ (0.26) $ 0.28 $ (0.51) $ 0.09 $ 0.25
===================================================================================================
Net income (loss) per share,
diluted: $ 0.20 $ 0.18 $ (0.08) $ (0.26) $ 0.28 $ (0.51) $ 0.09 $ $0.25
===================================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Under the direction of the Company's Chief Executive Officer
and Chief Financial Officer, the Company evaluated its
disclosure controls and procedures and concluded that its
disclosure controls and procedures were effective as of
December 31, 2004.
No change in internal control over financial reporting occurred
during the quarter ended December 31, 2004 that has materially
affected, or is reasonably likely to materially affect, such
internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
(a) None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2005 Annual Meeting of Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2005 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2005 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2005 Annual Meeting of Stockholders.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Incorporated by reference to the Company's Definitive Proxy Statement
for the 2005 Annual Meeting of Stockholders.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)(1) Financial statements
See index to Financial statements at item 8 of this report.
(a)(3) Exhibit Index
*3.1 Articles of Amendment and Restatement of the Registrant
*3.2 Bylaws of the Registrant
*3.3 Form of Articles Supplementary of the Registrant establishing
10% Cumulative Convertible Series B Preferred Stock.
*3.4 Articles Supplementary of the Registrant establishing 9.375%
Series C Cumulative Redeemable Preferred Stock.
*10.1 Investment Advisory Agreement between the Registrant and
BlackRock Financial Management, Inc.
*10.2 Amendment No. 1 to the Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
*10.3 Amendment No. 2 to the Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
*10.4 Amendment No. 3 to the Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
10.5 Amended and Restated Investment Advisory Agreement between
the Registrant and BlackRock Financial Management, Inc.
*10.6 Form of 1998 Stock Option Incentive Plan
10.7 Annex I to Master Repurchase Agreement between Anthracite
Funding LLC and Deutsche Bank AG, Cayman Islands
21.1 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
24.1 Power of Attorney (included on signature page hereto)
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer and
Chief Financial Officer
-------------------------------------------------------------------------------
* Previously filed.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
ANTHRACITE CAPITAL, INC.
Date: March 16, 2005 By: /s/ Christopher A. Milner
--------------------------------
Christopher A. Milner
Chief Executive Officer
(duly authorized representative)
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below constitutes and appoints Richard M. Shea his true and lawful
attorney-in-fact and agents with full power of substitution and
re-substitution, for his name, place and stead, in any and all capacities, to
sign any and all amendments (including post-effective amendments) to this Form
10-K and to file the same with all exhibits thereto, and all documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof. This power of attorney may be
executed in counterparties.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
Date: March 16, 2005 By: /s/ Christopher A. Milner
--------------------------------
Christopher A. Milner
Chief Executive Officer
Date: March 16, 2005 By: /s/ James J. Lillis
---------------------------------
James J. Lillis
Chief Financial Officer
Date: March 16, 2005 By: /s/ Laurence D. Fink
---------------------------------
Laurence D. Fink
Chairman of the Board of Directors
Date: March 16, 2005 By: /s/ Hugh R. Frater
---------------------------------
Hugh R. Frater
Director
Date: March 16, 2005 By: /s/ Donald G. Drapkin
---------------------------------
Donald G. Drapkin
Director
Date: March 16, 2005 By: /s/ Carl F. Geuther
---------------------------------
Carl F. Geuther
Director
Date: March 16, 2005 By: /s/ Jeffrey C. Keil
---------------------------------
Jeffrey C. Keil
Director
Date: March 16, 2005 By: /s/ Ralph L. Schlosstein
---------------------------------
Ralph L. Schlosstein
Director
Date: March 16, 2005 By: /s/ Leon T. Kendall
---------------------------------
Leon T. Kendall
Director
Date: March 16, 2005 By: /s/ Clay G. Lebhar
---------------------------------
Clay G. Lebhar
Director