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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, 2001
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) 409-3333
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act: Not Applicable
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE (NYSE)
(Title of each class) (Name of each exchange on
which registered)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
As of March 25, 2002, the aggregate market value of the registrant's Common
Stock, $.001 par value, held by nonaffiliates of the registrant, computed by
reference to the closing price of $11.74 as reported on the New York Stock
Exchange as of the close of business on March 25, 2002: $537,114,112 (for
purposes of this calculation affiliates include only directors and executive
officers of the Company).
The number of shares of the registrant's Common Stock, $.001 par value,
outstanding as of March 25, 2002 was 45,924,297 shares.
ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business............................................................................................4
Item 2. Properties .......................................................................................20
Item 3. Legal Proceedings .................................................................................20
Item 4. Submission of Matters to a Vote of
Security Holders ..................................................................................20
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters ...................................................................21
Item 6. Selected Financial Data ...........................................................................21
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations .....................................................23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ........................................44
Item 8. Financial Statements and Supplementary Data .......................................................48
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ............................................................84
PART III
Item 10. Directors and Executive Officers of the Registrant ................................................85
Item 11. Executive Compensation ............................................................................85
Item 12. Security Ownership of Certain Beneficial Owners and Management ....................................85
Item 13. Certain Relationships and Related Transactions ....................................................85
PART IV
Item 14. Exhibits ..........................................................................................85
Signatures ........................................................................................85
Cautionary Statement Regarding Forward-Looking Statements
Certain statements contained herein are not, and certain statements
contained in future filings by Anthracite Capital, Inc. (the "Company") with
the SEC, in the Company's press releases or in the Company's other public or
stockholder communications may not be based on historical facts and are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements which are based on
various assumptions (some of which are beyond the Company's control) may be
identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or
the negative of those terms. Actual results could differ materially from
those set forth in forward-looking statements due to a variety of factors,
including, but not limited to, those related to the economic environment,
particularly in the market areas in which the Company operates, competitive
products and pricing, fiscal and monetary policies of the U.S. government,
changes in prevailing interest rates, acquisitions and the integration of
acquired businesses, credit risk management, asset/liability management, the
financial and securities markets and the availability of and costs
associated with sources of liquidity. The Company does not undertake, and
specifically disclaims any obligation, to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
PART I
ITEM 1. BUSINESS
All dollar figures expressed herein are expressed in thousands, except share
amounts or per share amounts.
General
Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real
estate finance company that generates income based on the spread between the
interest income on its mortgage loans and securities investments and the
interest expense from borrowings used to finance its investments. The
Company seeks to earn high returns on a risk-adjusted basis to support a
consistent quarterly dividend. The Company has elected to be taxed as a Real
Estate Investment Trust, therefore, its income is largely exempt from
corporate taxation. This allows the Company to generate a higher level of
earnings than otherwise attainable by a taxable finance company making
similar investments. The Company commenced operations on March 24, 1998.
In the past five years the real estate finance markets have evolved
significantly as the capital markets play a larger role along with the
traditional commercial banking sources of capital. This has created
opportunities for companies that have expertise in both areas. The Company's
external manager, BlackRock Financial Management, Inc. (the "Manager" or
"BlackRock"), provides significant experience in traditional real estate
loan origination and servicing along with capital markets, investing and
risk management expertise.
The Company's business focuses on (i) investing in below investment grade
Commercial Mortgage Backed Securities (CMBS) where the Company has the right
to control the foreclosure/workout process on the underlying loans; (ii)
originating high yield commercial real estate loans, which includes senior
interests in partnerships that own real property and are reported as real
estate or joint venture investments; and (iii) acquiring investment grade
real estate related securities, including Government guaranteed residential
mortgage backed securities to act as a liquidity support for the other two
operations.
The Company's management believes that this represents an integrated
strategy where each asset class supports the others and creates additional
value for shareholders over and above operating each in isolation. The CMBS
portfolio provides diversification and high loss adjusted returns over a
weighted average life of approximately 10 years, the commercial real estate
loans provide high risk adjusted returns for shorter periods of time, and
the investment grade securities is an actively managed portfolio that
supports the liquidity needs of the Company while earning attractive
returns.
These strategies are pursued within an aggregate risk management framework
that seeks to limit the exposure of the Company's equity and earnings to
changes in interest rates and other exogenous factors beyond the Company's
control.
The day-to-day operations of the Company are managed by BlackRock, subject
to the direction and oversight of the Company's board of directors (the
"Board of Directors"). The Manager is a wholly owned subsidiary of
BlackRock, Inc., which is listed for trading on the New York Stock Exchange
("NYSE") under the symbol "BLK". BlackRock, Inc. is 70% owned by PNC Bank,
National Association ("PNC Bank"), which is itself a wholly owned subsidiary
of PNC Bank Corp (NYSE: PNC). Established in 1988, the Manager is a
registered investment adviser under the Investment Advisers Act of 1940, as
amended (the "Investment Advisers Act"), and is one of the largest
investment management firms in the United States. The Manager, in its
discretion, subject to the supervision of the Board of Directors, evaluates
and monitors the Company's assets and how long such assets should be held in
the Company's portfolio. The Manager is permitted to actively manage the
Company's assets, and such assets may or may not be held to maturity.
Although the Company intends to manage its assets actively, it does not
intend to acquire, hold or sell assets in such a manner that such assets
would be characterized as dealer property for Federal income tax purposes.
Commercial Real Estate Loans
High yield commercial real estate loan originations represent the Company's
efforts to take advantage of opportunities in the real estate finance
markets on a targeted basis. The traditional first lien real estate lender
has shifted its focus to originating loans that can be sold into a
securitization in the capital markets. To achieve the best execution for
this strategy first lien lenders will generally reduce their loan to value
ratios. Borrowers continue to require the same leverage to achieve their
required equity returns, so alternative sources of capital are needed to
fill the financing gap between the first lien lender and the borrower's
equity. The Company's high yield commercial real estate loan originations,
also known as mezzanine loans, fill this gap on a secured basis at very
attractive prices and terms. An effective mezzanine-lending program can
achieve superior risk adjusted returns versus alternative investments.
The type of investments in this class include loans secured by second
mortgages, subordinated participations in first mortgages, loans secured by
partnership interests and preferred equity interests in real estate limited
partnerships. The weighted average life of these investments is generally
two to three years and average leverage is 1:1 debt to equity generally
funded with the debt coterminous with the investment. These investments have
fixed or floating rate coupons, and some provide additional earnings through
an IRR look back or profit participation.
The Company performs significant due diligence before making investments to
evaluate risks and opportunities in this sector. The Company generally
focuses on strong sponsorship, attractive real estate fundamentals, and
pricing and structural characteristics that provide significant control over
the underlying asset.
At December 31, 2001 the Company owned eight separate mezzanine investments
with an average investment of approximately $16,600 and is focused on
adding to this on a strategic basis. The real estate underlying each of the
Company's mezzanine investments is performing in accordance with
underwritten expectations. The typical current returns on Company's equity
range from 11% - 24% with additional earning potential from profit
participations and IRR look back features. This asset class earns a high
yield and allows the Company to maintain flexibility to move quickly in
search of the highest risk adjusted returns.
Commercial Mortgage Backed Securities
The Company owns below investment grade classes of ten different CMBS and
has been an active bidder for this asset class. These CMBS investments are
fixed rate securities backed by pools of first mortgage loans on commercial
real estate assets located across the country. Owning commercial real estate
loans in this form allows the Company to earn attractive loss adjusted
returns while achieving significant diversification across geographic areas
and property types. The total par amount of these investments is $733,830,
the total fair market value at year-end was $360,159 representing an average
dollar price of 49.08. The unlevered yield on this portfolio is
approximately 10.9% before adjusting for expected losses and 10.1% on a
loss-adjusted basis. The Company anticipates receiving approximately
two-thirds of its stated par amount with the remainder representing assumed
credit losses. Income is reported to shareholders after taking into account
assumed credit losses.
The Company uses a sophisticated Intranet-based performance monitoring
system to track the credit experience of the loans in the CMBS pools. The
Company receives remittance reports monthly and can closely monitor any
delinquent loans or other issues that may affect the performance of the
loans. The Company also reviews its credit assumptions on a quarterly basis
using updated debt service coverage information on each loan in the pools
and reviewing economic trends on both a national and regional level.
Investment Grade Real Estate Related Securities
A key element in managing the risk of owning a portfolio of mezzanine loans
and below investment grade CMBS is to maintain sufficient liquid assets to
support these investments during periods of reduced liquidity in the
financial markets. The Company's portfolio of liquid assets is generally
comprised of government guaranteed residential fixed rate and adjustable
rate mortgages, and BBB or higher rated commercial mortgage backed
securities. At year-end, the portfolio represented approximately 75% of the
Company's total assets or 30% of the Company's equity (net of financing)
and provides a ready source of cash that can be used to support the
Company's other investment operations, if needed. This allows the Company
to earn attractive returns on equity while still maintaining significant
liquidity. This portfolio is leveraged more than the mezzanine and CMBS
portfolios but significantly lower than a typical investment grade
portfolio.
At December 31, 2001, the Company's assets were allocated among these three
categories as follows:
Percent of
Invested Debt to
Assets Liabilities Net Capital Equity Ratio
------ ----------- --- ------- ------------
Cash and liquidity portfolio $1,730,323 (1) $1,598,614 $131,709 31.8% 12.14
Below investment grade CMBS 360,159 178,631 181,528 43.8% 0.98
Mezzanine loans, Joint Ventures
and Equity Investment 159,738 58,693 101,045 24.4% 0.58
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Total Invested Assets 2,250,220 1,835,938 414,282 100.0% 4.43
========= ========= ======= ====== ====
(1) The Cash and liquidity portfolio consists of cash and cash equivalents, restricted cash, investment grade
securities and securities held for trading.
The Company's anticipated yields to maturity on its investments are based
upon a number of assumptions that are subject to certain business and
economic uncertainties and contingencies. Examples of such contingencies
include, among other things, expectation of credit losses, the rate and
timing of principal payments (including prepayments, repurchases, defaults
and liquidations), the pass-through or coupon rate, and interest rate
fluctuations. Additional factors that may affect the Company's anticipated
yields to maturity on its subordinated CMBS include interest payment
shortfalls due to delinquencies on the underlying mortgage loans and the
timing and magnitude of credit losses on the mortgage loans underlying the
subordinated CMBS that are a result of the general condition of the real
estate market (including competition for tenants and their related credit
quality) and changes in market rental rates. As these uncertainties and
contingencies are difficult to predict and are subject to future events,
which may alter these assumptions, no assurance can be given that the
Company's anticipated yields to maturity will be achieved.
The following is a summary of the types of assets, among others, that the
Company may invest in from time to time;
Mortgage Backed Securities (MBS). The Company acquires both investment grade
and non-investment grade classes of MBS from various sources. MBS typically
are divided into two or more interests, sometimes called "tranches" or
"classes." The senior classes are often securities which, if rated, would
have ratings ranging from low investment grade "BBB" to higher investment
grades "A," "AA" or "AAA." The junior, subordinated classes typically would
include one or more non-investment grade classes, which, if rated, would
have ratings below investment grade "BBB." Such subordinated classes also
typically include an unrated higher-yielding, credit support class (which
generally is required to absorb the first losses on the underlying mortgage
loans).
MBS are generally issued either as "CMOs" or "Pass-Through Certificates."
CMOs are debt obligations of special purpose corporations, owner trusts or
other special purpose entities secured by commercial mortgage loans or MBS.
Pass-Through Certificates evidence interests in trusts, the primary assets
of which are mortgage loans. CMO Bonds and Pass-Through Certificates may be
issued or sponsored by agencies or instrumentalities of the United States
Government or private originators of, or investors in, mortgage loans,
including savings and loan associations, mortgage bankers, commercial banks,
investment banks and other entities. MBS may not be guaranteed by an entity
having the credit status of a governmental agency or instrumentality and in
this instance are generally structured with one or more of the types of
credit enhancements described below. In addition, MBS may be illiquid.
The Company acquires both CMBS and Residential Mortgage Backed Securities
(RMBS). The mortgage collateral supporting CMBS may be pools of whole loans
or other MBS, or both. Unlike RMBS, which typically are collateralized by
thousands of single-family mortgage loans, CMBS are collateralized generally
by a more limited number of commercial or multifamily mortgage loans with
larger principal balances than those of single-family mortgage loans. As a
result, a loss on a single mortgage loan underlying a CMBS will have a
greater negative effect on the yield of such CMBS, especially the
subordinated MBS in such CMBS.
Mortgage Loans. The Company acquires or originates fixed and adjustable-rate
mortgage loans secured by senior, mezzanine or subordinate liens on
multifamily residential, commercial, single-family (one-to-four unit)
residential or other real property as a significant part of its investment
strategy ("Mortgage Loans").
Mortgage loans may be originated by or purchased from various suppliers of
mortgage assets throughout the United States and abroad, such as savings and
loan associations, banks, mortgage bankers, home builders, insurance
companies and other mortgage lenders. The Company acquires mortgage loans
directly from originators and from entities holding mortgage loans
originated by others. The Company also originates its own mortgage loans,
particularly on mezzanine financing of mortgage loans and real property
portfolios.
The Company may invest in or provide loans used to finance construction,
loans secured by real property and used as interim financing, and loans
secured by junior liens on real property. The Company may invest in
multifamily and commercial mortgage loans that are in default, or for which
default is likely or imminent, or for which the borrower is making monthly
payments in accordance with a forbearance plan.
The Company may provide mezzanine financing on commercial property that is
subject to first lien mortgage debt. The Company's mezzanine financing takes
the form of subordinated loans, commonly known as second mortgages, or in
the case of loans originated for securitization, partnership loans (also
known as pledge loans) or preferred equity investments. For example, on a
commercial property subject to a first lien mortgage loan with a principal
balance equal to 65% of the value of the property, the Company could lend
the owner of the property (typically a partnership) an additional 15% to 20%
of the value of the property.
Typically in a mezzanine mortgage loan, as security for its loan, the
property owner would pledge to the Company either the property subject to
the first lien (giving the Company a second lien position typically subject
to an inter-creditor agreement), or the limited partnership and/or general
partnership interest in the property owner. If the property owner's general
partnership interest is pledged, then the Company would be in a position to
take over the operation of the property in the event of a default by the
property owner. By borrowing against the additional value in their
properties, the property owners obtain additional cash to apply to
property improvements, the purchase price of the property, or alternative
uses. Mezzanine mortgage loans generally provide the Company with the right
to receive a stated interest rate on the loan plus various commitment
and/or exit fees. In certain instances, subject to the REIT Provisions of
the Internal Revenue Code of 1986 (the "Code"), the Company may negotiate
to receive a percentage of net operating income or gross revenues from the
property, payable to the Company on an ongoing basis, and a percentage of
any increase in value of the property, payable upon maturity or refinancing
of the loan, or the Company will otherwise seek terms to allow the Company
to charge an interest rate that would provide an attractive risk-adjusted
return. Alternatively, the mezzanine mortgage loans can take the form of a
non-voting preferred equity investment in a single purpose entity borrower
with substantially similar economic terms.
The Company may acquire or originate mortgage loans secured by real property
located outside the United States or acquire such real property. The Company
has no limitations on the geographic scope of its investments in foreign
real properties and such investments may be made in a single foreign country
or among several foreign countries as the Board of Directors may deem
appropriate. Investing in real estate related assets located in foreign
countries creates risks associated with the uncertainty of foreign laws and
markets and risks related to currency conversion. The Company may be subject
to foreign income tax with respect to its investments in foreign real estate
related assets. Any foreign tax credit that otherwise would be available to
the Company for Federal income tax purposes will not flow through to the
Company's stockholders.
Multifamily and Commercial Real Properties. The Company believes that under
appropriate circumstances the acquisition of multifamily and commercial real
properties may offer significant opportunities to the Company. The Company's
policy is to conduct an investigation and evaluation of the real properties
in a portfolio of real properties before purchasing such a portfolio. Prior
to purchasing real estate related assets, the Manager generally will
identify and contact real estate brokers and/or appraisers in the relevant
market areas to obtain rent and sale comparables for the assets in the
portfolio contemplated to be acquired. This information is used to
supplement due diligence performed by the Manager's employees.
The Company may acquire real properties with known material environmental
problems and Mortgage Loans secured by such real properties subsequent to an
environmental assessment that would reasonably indicate that the present
value of the cost of clean-up or remediation would not exceed the
realizable value from the disposition of the mortgage property.
The Company may invest in net leased real estate on a leveraged basis. Net
leased real estate is generally defined as real estate that is net leased to
tenants who are customarily responsible for paying all costs of owning,
operating, and maintaining the leased property during the term of the lease,
in addition to paying a monthly net rent to the landlord for the use and
occupancy of the premises ("Net Leased Real Estate"). The Company will
consider investing in Net Leased Real Estate that is either leased to
creditworthy tenants or is underlied by real estate that can be leased to
other tenants in the event of a default of the initial tenant.
Other Real Estate Related Assets. The Company may invest in a variety of
other real estate related investments, the principal features of which are
summarized below.
Pass-Through Certificates. The Company's investments in residential mortgage
assets are currently and expected to be concentrated in Pass-Through
Certificates. The Pass-Through Certificates to be acquired by the Company
will consist primarily of pass-through certificates issued by Federal
National Mortgage Associates (FNMA), Federal Home Loan Mortgage Corporation
(FHLMC) and Government National Mortgage Associates (GNMA), as well as
privately issued adjustable-rate and fixed-rate mortgage pass-through
certificates. The Pass-Through Certificates to be acquired by the Company
will represent interests in mortgages that will be secured by liens on
single-family (one-to-four units) residential properties, multifamily
residential properties, and commercial properties. Pass-Through Certificates
backed by adjustable-rate Mortgage Loans are subject to lifetime interest
rate caps and to periodic interest rate caps that limit the amount an
interest rate can change during any given period. The Company's borrowings
are generally not subject to similar restrictions. In a period of increasing
interest rates, the Company could experience a decrease in net income or
incur losses because the interest rates on its borrowings could exceed the
interest rates on adjustable-rate Pass-Through Certificates owned by the
Company. The impact on net income of such interest rate changes will depend
on the adjustment features of the mortgage assets owned by the Company, the
maturity schedules of the Company's borrowings and related hedging.
Privately Issued Pass-Through Certificates. Privately Issued Pass-Through
Certificates are structured similar to the FNMA, FHLMC and GNMA pass-through
certificates discussed below and are issued by originators of and investors
in Mortgage Loans, including savings and loan associations, savings banks,
commercial banks, mortgage banks, investment banks and special purpose
subsidiaries of such institutions. Privately Issued Pass-Through
Certificates are usually backed by a pool of conventional Mortgage Loans and
are generally structured with credit enhancement such as pool insurance or
subordination. However, Privately Issued Pass-Through Certificates are
typically not guaranteed by an entity having the credit status of FNMA,
FHLMC or GNMA guaranteed obligations.
FNMA Certificates. FNMA is a federally chartered and privately owned
corporation. FNMA provides funds to the mortgage market primarily by
purchasing Mortgage Loans on homes from local lenders, thereby replenishing
their funds for additional lending.
FNMA Certificates may be backed by pools of Mortgage Loans secured by
single-family or multi-family residential properties. The original terms to
maturity of the Mortgage Loans generally do not exceed 40 years. FNMA
Certificates may pay interest at a fixed rate or adjustable rate. Each
series of FNMA adjustable-rate certificates bears an initial interest rate
and margin tied to an index based on all loans in the related pool, less a
fixed percentage representing servicing compensation and FNMA's guarantee
fee. The specified index used in each such series has included the Treasury
Index, the 11th District Cost of Funds Index, LIBOR and other indices.
Interest rates paid on fully-indexed FNMA adjustable-rate certificates equal
the applicable index rate plus a specified number of basis points ranging
typically from 125 to 250 basis points. In addition, the majority of FNMA
adjustable-rate certificates issued to date have evidenced pools of Mortgage
Loans with monthly, semi-annual or annual interest rate adjustments.
Adjustments in the interest rates paid are generally limited to an annual
increase or decrease of either 100 or 200 basis points and to a lifetime cap
of 500 or 600 basis points over the initial interest rate. Certain FNMA
programs include Mortgage Loans, which allow the borrower to convert the
adjustable mortgage interest rate of its adjustable-rate Mortgage Loan to a
fixed rate. Adjustable-rate Mortgage Loans which are converted into fixed
rate Mortgage Loans are repurchased by FNMA, or by the seller of such loans
to FNMA, at the unpaid principal balance thereof plus accrued interest to
the due date of the last adjustable rate interest payment.
FNMA guarantees to the registered holder of a FNMA Certificate that it will
distribute amounts representing scheduled principal and interest (at the
rate provided by the FNMA Certificate) on the Mortgage Loans in the pool
underlying the FNMA Certificate, whether or not received, and the full
principal amount of any such Mortgage Loan foreclosed or otherwise finally
liquidated, whether or not the principal amount is actually received. The
obligations of FNMA under its guarantees are solely those of FNMA and are
not backed by the full faith and credit of the United States. If FNMA were
unable to satisfy such obligations, distributions to holders of FNMA
Certificates would consist solely of payments and other recoveries on the
underlying Mortgage Loans and, accordingly, monthly distributions to holders
of FNMA Certificates would be affected by delinquent payments and defaults
on such Mortgage Loans.
FHLMC Certificates. FHLMC is a privately owned corporate instrumentality of
the United States created pursuant to an Act of Congress. The principal
activity of FHLMC currently consists of the purchase of conforming Mortgage
Loans or participation interests therein and the resale of the loans and
participations so purchased in the form of guaranteed MBS.
Each FHLMC Certificate issued to date has been issued in the form of a
Pass-Through Certificate representing an undivided interest in a pool of
Mortgage Loans purchased by FHLMC. The Mortgage Loans included in each pool
are fully amortizing, conventional Mortgage Loans with original terms to
maturity of up to 40 years secured by first liens on one-to-four unit family
residential properties or multi-family properties.
FHLMC guarantees to each holder of its certificates the timely payment of
interest at the applicable pass-through rate and ultimate collection of all
principal on the holder's pro rata share of the unpaid principal balance of
the related Mortgage Loans, but does not guarantee the timely payment of
scheduled principal of the underlying Mortgage Loans. The obligations of
FHLMC under its guarantees are solely those of FHLMC and are not backed by
the full faith and credit of the United States. If FHLMC were unable to
satisfy such obligations, distributions to holders of FHLMC Certificates
would consist solely of payments and other recoveries on the underlying
Mortgage Loans and, accordingly, monthly distributions to holders of FHLMC
Certificates would be affected by delinquent payments and defaults on such
Mortgage Loans.
GNMA Certificates. GNMA is a wholly owned corporate instrumentality of the
United States within HUD. GNMA guarantees the timely payment of the
principal of and interest on certificates that represent an interest in a
pool of Mortgage Loans insured by the FHA and other loans eligible for
inclusion in mortgage pools underlying GNMA Certificates. GNMA Certificates
constitute general obligations of the United States backed by its full faith
and credit.
Collateralized Mortgage Obligations (CMOs). The Company invests, from time
to time, in adjustable rate and fixed rate CMOs issued by private issuers or
FHLMC, FNMA or GNMA. CMOs are a series of bonds or certificates ordinarily
issued in multiple classes, each of which consists of several classes with
different maturities and often complex priorities of payment, secured by a
single pool of Mortgage Loans, Pass-Through Certificates, other CMOs or
other mortgage assets. Principal prepayments on collateral underlying a CMO
may cause it to be retired substantially earlier than the stated maturities
or final distribution dates. Interest is paid or accrues on all interest
bearing classes of a CMO on a monthly, quarterly or semi-annual basis. The
principal and interest on underlying Mortgages Loans may be allocated among
the several classes of a series of a CMO in many ways, including pursuant to
complex internal leverage formulas that may make the CMO class especially
sensitive to interest rate or prepayment risk.
CMOs may be subject to certain rights of issuers thereof to redeem such CMOs
prior to their stated maturity dates, which may have the effect of
diminishing the Company's anticipated return on its investment.
Privately-issued single-family, multi-family and commercial CMOs are
supported by private credit enhancements similar to those used for
Privately-Issued Certificates and are often issued as senior-subordinated
mortgage securities. In general, the Company intends to only acquire CMOs or
multi-class Pass-Through certificates that represent beneficial ownership in
grantor trusts holding Mortgage Loans, or regular interests and residual
interests in REMICs, or that otherwise constitute REIT Real Estate Assets.
Mortgage Derivatives. The Company invests in Mortgage Derivatives, including
Interest-Only securities (IOs), Inverse IOs, Sub IOs and floating rate
derivatives, as market conditions warrant. Mortgage Derivatives provide for
the holder to receive interest only, principal only, or interest and
principal in amounts that are disproportionate to those payable on the
underlying Mortgage Loans. Payments on Mortgage Derivatives are highly
sensitive to the rate of prepayments on the underlying Mortgage Loans. In
the event that prepayments on such Mortgage Loans occur more frequently than
anticipated, the rates of return on Mortgage Derivatives representing the
right to receive interest only or a disproportionately large amount of
interest, i.e., IOs, would be likely to decline. Conversely, the rates of
return on Mortgage Derivatives representing the right to receive principal
only or a disproportional amount of principal, i.e., POs, would be likely to
increase in the event of rapid prepayments.
Some IOs in which the Company may invest, such as Inverse IOs, bear interest
at a floating rate that varies inversely with (and often at a multiple of)
changes in a specific index. The yield to maturity of an Inverse IO is
extremely sensitive to changes in the related index. The Company also may
invest in inverse floating rate Mortgage Derivatives, which are similar in
structure and risk to Inverse IOs, except they generally are issued with a
greater stated principal amount than Inverse IOs.
Other IOs in which the Company may invest, such as Sub IOs, have the
characteristics of a Subordinated Interest. A Sub IO is entitled to no
payments of principal; moreover, interest on a Sub IO often is withheld in a
reserve fund or spread account to fund required payments of principal and
interest on more senior tranches of mortgage securities. Once the balance in
the spread account reaches a certain level, excess funds are paid to the
holders of the Sub IO. These Sub IOs provide credit support to the senior
classes and thus bear substantial credit risks. In addition, because a Sub
IO receives only interest payments, its yield is extremely sensitive to the
rate of prepayments (including prepayments as a result of defaults) on the
underlying Mortgage Loans.
IOs can be effective hedging devices because they generally increase in
value as fixed-rate mortgage securities decrease in value. The Company also
may invest in other types of derivatives currently available in the market
and other Mortgage Derivatives that may be developed in the future if the
Manager determines that such investments would be advantageous to the
Company.
FHA and GNMA Project Loans. The Company may invest in loan participations
and pools of loans insured under a variety of programs administered by the
Department of Housing and Urban Development ("HUD"). These loans will be
insured under the National Housing Act and will provide financing for the
purchase, construction or substantial rehabilitation of multifamily housing,
nursing homes and intermediate care facilities, elderly and handicapped
housing, and hospitals.
Similar to CMBS, investments in FHA and GNMA Project Loans will be
collateralized by a more limited number of loans, with larger average
principal balances, than RMBS, and will therefore be subject to greater
performance variability. Loan participations are most often backed by a
single FHA-insured loan. Pools of insured loans, while more diverse, still
provide much less diversification than pools of single-family loans.
FHA insured loans will be reviewed on a case by case basis to identify and
analyze risk factors, which may materially impact investment performance.
Property-specific data such as debt service coverage ratios, loan-to-value
ratios, HUD inspection reports, HUD financial statements and rental
subsidies will be analyzed in determining the appropriateness of a loan for
investment purposes. The Manager will also rely on the FHA insurance
contracts and their anticipated impact on investment performance in
evaluating and managing the investment risks. FHA insurance covers 99% of
the principal balance of the underlying project loans. Additional GNMA
credit enhancement may cover 100% of the principal balance.
Other. The Company may invest in fixed-income securities that are not
mortgage assets, including securities issued by corporations or issued or
guaranteed by U.S. or sovereign foreign entities, loan participations,
emerging market debt, high yield debt and collateralized bond obligations.
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, Mortgage Derivatives and other hedging instruments. These
instruments may be used to hedge as much of the interest rate risk as the
Manager determines is in the best interest of the Company's stockholders,
given the cost of such hedges and the need to maintain the Company's status
as a REIT. The Manager may elect to have the Company bear a level of
interest rate risk that could otherwise be hedged when the Manager believes,
based on all relevant facts, that bearing such risk is advisable. The
Manager has extensive experience in hedging mortgages, 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. Consequently, there may be no requirements with
respect to record keeping, financial responsibility or segregation of
customer funds and positions. The Company will enter into these transactions
only with counterparties with long-term debt rated "A" or better by at least
one nationally recognized statistical rating organization. The business
failure of a counterparty with which the Company has entered into a hedging
transaction will most likely result in a default, which may result in the
loss of unrealized profits and force the Company to cover its resale
commitments, if any, at the then current market price. Although generally
the Company will seek to reserve for itself the right to terminate its
hedging positions, it may not always be possible to dispose of or close out
a hedging position without the consent of the counterparty, and the Company
may not be able to enter into an offsetting contract in order to cover its
risk. There can be no assurance that a liquid secondary market will exist
for hedging instruments purchased or sold, and the Company may be required
to maintain a position until exercise or expiration, which could result in
losses.
The Company's hedging activities are intended to address both income and
capital preservation. Income preservation refers to maintaining a stable
spread between yields from mortgage assets and the Company's borrowing costs
across a reasonable range of adverse interest rate environments. Capital
preservation refers to maintaining a relatively steady level in the market
value of the Company's capital across a reasonable range of adverse interest
rate scenarios. However, no strategy can insulate the Company completely
from changes in interest rates.
The Company's hedging policy with regard to its sterling denominated London
Loan, a (pound)21,459 Sterling denominated loan funded in August 1998, is to
minimize its exposure to fluctuations in the sterling exchange rate. As of
December 31, 2001, the Company had forward contracts outstanding which are
intended to hedge currency risk in connection with the Company's investment
in the London Loan.
From time to time the Company may reduce its exposure to market interest
rates by entering into various financial instruments that adjust portfolio
duration. These financial instruments are intended to mitigate the effect of
interest rates on the value of certain assets in the Company's portfolio. At
December 31, 2001, the Company had outstanding short positions of 80
thirty-year U.S. Treasury Bond future contracts, 500 ten-year U.S. Treasury
Note future contracts and a short call swaption with a notional amount of
$400,000. At December 31, 2000, the Company did not have U.S. Treasury
future contracts or swaptions.
Interest rate swap agreements as of December 31, 2001 and 2000 consisted of
the following:
2001 2000
----------------------------------------------------------------- -------------------------------------------------------------
Estimated Average Estimated Unamortized Average
Notional Value Fair Value Unamortized Cost Remaining Term Notional Value Fair Value Cost Remaining Term
--------------- ------------ ------------------- ---------------- --------------- ------------ ---------------- ---------------
$792,000 $(9,380) $4,764 8.12 years $226,000 $(12,505) $9,471 19.3 years
As of December 31, 2001, the Company had designated $682,000 of the interest
rate swap agreements as cash flow hedges of borrowings under reverse
repurchase agreements.
Financing and Leverage
The Company has financed its assets with the net proceeds of its initial
public, secondary offering, follow-on offerings, the issuance of preferred
stock, short-term borrowings under repurchase agreements, and the lines of
credit discussed below. In the future, operations may be financed by future
offerings of equity securities, and unsecured and secured borrowings. The
Company expects that, in general, it will employ leverage consistent with
the type of assets acquired and the desired level of risk in various
investment environments. The Company's governing documents do not explicitly
limit the amount of leverage that the Company may employ. Instead, the Board
of Directors has adopted an indebtedness policy for the Company that limits
total leverage to a maximum 6.0:1 debt to equity. At December 31, 2001 and
2000, the Company's debt-to-equity ratio was approximately 4.8 to 1 and 3.2
to 1, respectively. The Company anticipates that it will maintain
debt-to-equity ratios between 2.5 to 1 and 5.0 to 1 in the foreseeable
future, although this ratio may be higher or lower from time to time. The
Company's indebtedness policy may be changed by the Board of Directors in
the future.
On July 19, 1999, the Company entered into an $185,000 committed credit
facility with Deutsche Bank, AG (the "Deutsche Bank Facility"). The Deutsche
Bank Facility has a two-year term and provides for a one-year extension at
the Company's option. The Deutsche Bank Facility was extended for a one-year
term thru July 19, 2002, and is currently under negotiation to be extended.
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, 2001 and December 31, 2000, the
outstanding borrowings under this facility were $43,409 and $53,810,
respectively. Outstanding borrowings under the Deutsche Bank Facility bear
interest at a LIBOR based variable rate
The Company has an agreement with Merrill Lynch which permits the Company to
borrow up to $200,000. As of December 31, 2001 and December 31, 2000, the
outstanding borrowings under this line of credit were $57,113, and $63,453
respectively. The agreement requires assets to be pledged as collateral,
which may consist of rated CMBS, rated RMBS, residential and commercial
mortgage loans, and certain other assets. Outstanding borrowings under this
line of credit bear interest at a LIBOR based variable rate. On January 15,
2002, the facility was renewed for a twelve-month period.
In September 2000, the Company closed a $200,000, one-year term facility
with Merrill Lynch Mortgage Capital Inc. ("Merrill Lynch"), which was used
to finance the Company's residential loan pools. As of December 31, 2001
there were no outstanding borrowings under this facility. As of December 31,
2000 outstanding borrowings were $37,253. Outstanding borrowings under this
facility bear interest at a LIBOR based variable rate. This facility expired
pursuant to its terms in September 2001.
On March 14, 2001 the Company entered into a one-year term facility with PNC
Funding, Inc. which permits the Company to borrow up to $50,000. As of
December 31, 2001, the outstanding borrowing under this facility was
$13,885. The agreement requires assets to be pledged as collateral. The
outstanding borrowings were repaid prior to the expiration on March 13,
2002.
In June 1999, the Company closed a $17,500, three-year term financing
secured by the Company's $35,000 Santa Monica Loan. As of December 31, 2000,
the Company had drawn $17,500; the financing was paid off in March 2001 when
the Santa Monica Loan was paid off.
At the time of the CORE Cap acquisition, CORE Cap was a party to commercial
paper facility agreements with ABN Amro which was used to finance
residential and commercial loans, which are used to collateralize borrowings
under the facility. Following the CORE Cap acquisition, the Company renewed
the facility with ABN Amro, in the amount of $200,000. As of December 31,
2000, outstanding borrowing under the facility was $30,115; this facility
was paid off in 2001.
The Company is subject to various covenants in its lines of credit,
including maintaining a minimum GAAP net worth of $140,000, a debt-to-equity
ratio not to exceed 5.0 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. Additionally, the Company's GAAP net
worth cannot decline by more than 37% during the course of any two
consecutive fiscal quarters. As of December 31, 2001, the Company was in
compliance with all such covenants.
On December 2, 1999 the Company authorized and issued 1,200,000 shares of
Series A Preferred Stock for aggregate proceeds of $30,000. The Preferred
Stock carries a 10.5% coupon and is convertible into Common Stock at a price
of $7.35 per share. The Series A Preferred Stock has a seven-year maturity
at which time, at the option of the holders, the shares may be converted
into common shares or liquidated for $28.50 per share. On December 21, 2001,
the only Series A Preferred shareholder converted 1,190,000 shares of the
Series A Preferred Stock into 4,096,854 shares of Company Common Stock at a
price of $7.26 per share pursuant to the terms of such preferred stock,
which was $0.09 lower than the original conversion price due to the effects
of anti-dilution provisions in the Series A Preferred Stock. The remaining
10,000 shares of Series A Preferred Stock were converted into 34,427 shares
of the Company's Common Stock in March 2002.
On February 14, 2001 the Company completed a secondary offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $33,300. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on March
13, 2001 and resulted in net proceeds to the Company of approximately
$5,000.
On May 11, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $37,800. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on June
6, 2001 and resulted in net proceeds to the Company of approximately $5,675.
On November 7, 2001 the Company completed a follow-on offering of 4,400,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting estimated expenses) were
approximately $39.4 million. On November 13, 2001, the underwriters
exercised an option to purchase an additional 90,000 shares of Common Stock
available through an over-allotment granted to the underwriters and resulted
in net proceeds to the Company of approximately $810.
For the year ended December 31, 2001, the Company issued 2,228,566 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the
Company were approximately $22,945. No shares were issued for the year ended
December 31, 2000 under the Dividend Reinvestment Plan.
The Company has entered into reverse repurchase agreements to finance most
of its securities available for sale which are not financed under its lines
of credit. The reverse repurchase agreements are collateralized by most of
the Company's securities available for sale and bear interest at rates that
have historically moved in close relationship to LIBOR.
Certain information with respect to the Company's collateralized borrowings
at December 31, 2001 is summarized as follows:
Lines of Credit and Reverse Repurchase Total
Term Loans Agreements Collateralized Borrowings
--------------------- ----------------------- --------------------------
Outstanding borrowings $115,747 $1,720,191 $1,835,938
Weighted average borrowing rate 3.62% 1.94% 2.04%
Weighted average remaining maturity 186 Days 18 Days 29 Days
Estimated fair value of assets pledged $173,139 $1,825,971 $1,999,110
At December 31, 2001, $20,356 of borrowings outstanding under the line of
credit was denominated in pounds sterling, and interest payable is based on
sterling LIBOR.
At December 31, 2001, the Company's collateralized borrowings had the following remaining maturities:
Lines of Credit and Reverse Repurchase Total
Term Loan Agreements Collateralized Borrowings
-------------------- ------------------ ---------------------------
Within 30 days $58,453 $1,700,420 $1,758,873
31 to 59 days - 19,771 19,771
Over 60 days 57,294 - 57,294
-------------------- ------------------ ---------------------------
$115,747 $1,720,191 $1,835,938
==================== ================== ===========================
As of December 31, 2001, $141,591 of the Company's $185,000 committed credit
facility with Deutsche Bank, AG was available for future borrowings, and
$142,887 was available under the Company's $200,000 term facility with
Merrill Lynch.
Under the line of credit and the reverse repurchase agreements, the lender
retains the right to mark the underlying collateral to estimated market
value. A reduction in the value of its pledged assets will require the
Company to provide additional collateral or fund cash margin calls. From
time to time, the Company expects that it will be required to provide such
additional collateral or fund margin calls. The Company maintains adequate
liquidity to meet such calls.
Operating Policies
The Company has adopted compliance guidelines, including restrictions on
acquiring, holding and selling assets, to ensure that the Company meets the
requirements for qualification as a REIT and is excluded from regulation as
an investment company. Before acquiring any asset, the Manager determines
whether such asset would constitute a Real Estate Asset under the REIT
Provisions of the Code. The Company regularly monitors purchases of mortgage
assets and the income generated from such assets, including income from its
hedging activities, in an effort to ensure that at all times the Company's
assets and income meet the requirements for qualification as a REIT and
exclusion under the Investment Company Act of 1940.
The Company's unaffiliated directors review all transactions of the Company
on a quarterly basis to ensure compliance with the operating policies and to
ratify all transactions with PNC Bank and its affiliates, except that the
purchase of securities from PNC 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.
In order to maintain the Company's REIT status, the Company generally
intends to distribute to stockholders aggregate dividends equaling at least
95% of its taxable income each year and 90% for years ending after 2000. The
code permits the Company to fulfill this distribution requirement by the end
of the year following the year the taxable income was earned.
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. Pursuant to
such SEC staff interpretations, certain of the Company's interests in agency
pass-through and mortgage-backed securities and agency insured project loans
are Qualifying Interests. In general, the Company will acquire subordinated
CMBS only when such mortgage securities are collateralized by pools of first
mortgage loans, when the Company can monitor the performance of the
underlying mortgage loans through loan management and servicing rights, and
when the Company has appropriate workout/foreclosure rights with respect to
the underlying mortgage loans. When such arrangements exist, the Company
believes that the related subordinated CMBS constitute Qualifying Interests
for purposes of the Investment Company Act. Therefore, the Company believes
that it should not be required to register as an "investment company" under
the Investment Company Act as long as it continues to invest primarily in
such subordinated CMBS and/or in other Qualifying Interests. However, if the
SEC or its staff were to take a different position with respect to whether
the Company's subordinated CMBS constitute Qualifying Interests, the Company
could be required to modify its business plan so that either (i) it would
not be required to register as an investment company or (ii) it would comply
with the Investment Company Act and be able to register as an investment
company. In such event, (i) modification of the Company's business plan so
that it would not be required to register as an investment company would
likely entail a disposition of a significant portion of the Company's
subordinated CMBS or the acquisition of significant additional assets, such
as agency pass-through and mortgage-backed securities, which are Qualifying
Interests or (ii) modification of the Company's business plan to register as
an investment company would result in significantly increased operating
expenses and would likely entail significantly reducing the Company's
indebtedness (including the possible prepayment of the Company's short-term
borrowings), which could also require it to sell a significant portion of
its assets. No assurances can be given that any such dispositions or
acquisitions of assets, or deleveraging, could be accomplished on favorable
terms. Consequently, any such modification of the Company's business plan
could have a material adverse effect on the Company. Further, if it were
established that the Company were an unregistered investment company, there
would be a risk that the Company would be subject to monetary penalties and
injunctive relief in an action brought by the SEC, that the Company would be
unable to enforce contracts with third parties and that third parties could
seek to obtain recission of transactions undertaken during the period it was
established that the Company was an unregistered investment company. Any
such results would be likely to have a material adverse effect on the
Company.
Competition
The Company's net income depends, in large part, on the Company's ability to
acquire mortgage assets at favorable spreads over the Company's borrowing
costs. In acquiring mortgage assets, the Company competes with other
mortgage REITs, specialty finance companies, savings and loan associations,
banks, mortgage bankers, insurance companies, mutual funds, institutional
investors, investment banking firms, other lenders, governmental bodies and
other entities. In addition, there are numerous mortgage REITs with asset
acquisition objectives similar to the Company, and others may be organized
in the future. The effect of the existence of additional REITs may be to
increase competition for the available supply of mortgage assets suitable
for purchase by the Company. Many of the Company's anticipated competitors
are significantly larger than the Company, have access to greater capital
and other resources and may have other advantages over the Company. In
addition to existing companies, other companies may be organized for
purposes similar to that of the Company, including companies organized as
REITs focused on purchasing mortgage assets. A proliferation of such
companies may increase the competition for equity capital and thereby
adversely affect the market price of the Company's Common Stock.
Employees
The Company does not have any employees other than officers, each of whom
are full-time employees of the Manager, whose duties include performing
administrative activities for the Company.
Management Agreement
The Company is managed pursuant to a management agreement, dated March 27,
1998, between the Company and the Manager (the "Management Agreement"),
pursuant to which the Manager is responsible for the day-to-day operations
of the Company and performs such services and activities relating to the
assets and operations of the Company as may be appropriate. The initial two
year term of the Management Agreement was to expire on March 27, 2000; on
March 16, 2000, the Management Agreement was extended for an additional two
years, with the unanimous approval of the unaffiliated directors, on terms
similar to the prior agreement. On March 25, 2002, the Management Agreement
was extended for one year through March 27, 2003, with the unanimous
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. The Board was advised
by Houlihan Lokey Howard & Zukin Financial Advisors, Inc. ("Houlihan Lokey")
in the renewal process. Houlihan Lokey is a national investment banking and
financial advisory firm. The Manager primarily engages in three activities
on behalf of the Company: (i) acquiring and originating mortgage loans and
other real estate related assets; (ii) asset/liability and risk management,
hedging of floating rate liabilities, and financing, management and
disposition of assets, including credit and prepayment risk management; and
(iii) capital management, structuring, analysis, capital raising and
investor relations activities. In conducting these activities, the Manager
formulates operating strategies for the Company, arranges for the
acquisition of assets by the Company, arranges for various types of
financing and hedging strategies for the Company, monitors the performance
of the Company's assets and provides certain administrative and managerial
services in connection with the operation of the Company. At all times, the
Manager is subject to the direction and oversight of the Company's Board of
Directors.
The Company may terminate, or decline to renew the term of, the Management
Agreement without cause at any time after the first two years upon 60 days
written notice by a majority vote of the unaffiliated directors. Although no
termination fee is payable in connection with a termination for cause, in
connection with a termination without cause, the Company must pay the
Manager a termination fee, which could be substantial. The amount of the
termination fee will be determined by independent appraisal of the value of
the Management Agreement. Such appraisal is to be conducted by a
nationally-recognized appraisal firm mutually agreed upon by the Company and
the Manager. Additionally, at the time of the Core-Cap merger, the Manager
agreed to pay GMAC Mortgage Asset Management, Inc. (GMAC) $12,500 over a
ten-year period (Installment Payment). The Company agreed that should it
terminate the Manager without 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, 2001, the installment payment would
be $11,000 payable over nine 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.
In order to coincide with the increased scale of the Company, effective July
1, 2001, the Manager reduced the base management fee, payable under the
Mangement Agreement to 0.20% of average invested assets rated above BB+ from
0.35%. Additionally, effective July 1, 2001, the Manager revised the hurdle
rate applicable to the incentive fee from 3.5% over the ten-year U.S.
Treasury Rate, to the greater of 3.5% over the ten-year U.S. Treasury Rate
or 9.5% on the adjusted issue price of the Common Stock. This revision
resulted in $1,689 in savings to the Company during 2001.
Taxation of the Company
The Company has elected to be taxed as a REIT under the Code, commencing
with its taxable year ended December 31, 1998, and the Company intends to
continue to operate in a manner consistent with the REIT Provisions of the
Code. The Company's qualification as a REIT depends on its ability to meet
the various requirements imposed by the Code, through actual operating
results, asset holdings, distribution levels, and diversity of stock
ownership.
Provided the Company qualifies for taxation as a REIT, it generally will not
be subject to Federal corporate income tax on its net income that is
currently distributed to stockholders. This treatment substantially
eliminates the "double taxation" (at the corporate and stockholder levels)
that generally results from an investment in a corporation. If the Company
fails to qualify as a REIT in any taxable year, its taxable income would be
subject to Federal income tax at regular corporate rates (including any
applicable alternative minimum tax). Even if the Company qualifies as a
REIT, it will be subject to Federal income and excise taxes on its
undistributed income.
If in any taxable year the Company fails to qualify as a REIT and, as a
result, incurs additional tax liability, the Company may need to borrow
funds or liquidate certain investments in order to pay the applicable tax,
and the Company would not be compelled to make distributions under the Code.
Unless entitled to relief under certain statutory provisions, the Company
would also be disqualified from treatment as a REIT for the four taxable
years following the year during which qualification is lost. Although the
Company currently intends to operate in a manner designated to qualify as a
REIT, it is possible that future economic, market, legal, tax or other
considerations may cause the Company to fail to qualify as a REIT or may
cause the Board of Directors to revoke the Company's REIT election.
The Company and its stockholders may be subject to foreign, state and local
taxation in various foreign, state and local jurisdictions, including those
in which it or they transact business or reside. The state and local tax
treatment of the Company and its stockholders may not conform to the
Company's Federal income tax treatment.
ITEM 2. PROPERTIES
The Company does not maintain an office and owns no real property. It
utilizes the offices of the Manager, located at 40 East 52nd Street, New
York, New York 10022.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 2001, through the solicitation of proxies or
otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been listed and is traded on the New York
Stock Exchange under the symbol "AHR" since the initial public offering in
March 1998. The following table sets forth, for the periods indicated, the
high, low and last sale prices in dollars on the New York Stock Exchange for
the Company's Common Stock and the distributions declared by the Company
with respect to the periods indicated as were traded during these respective
time periods.
Last Dividends
1999 High Low Sale Declared
---- ------- -------- --------- ---------
First Quarter............................ $7.938 $6.380 $7.500 .29
Second Quarter........................... 7.689 6.500 6.563 .29
Third Quarter............................ 7.125 6.500 6.875 .29
Fourth Quarter........................... 6.938 6.000 6.375 .29
2000
----
First Quarter............................ 7.500 6.250 7.125 .29
Second Quarter........................... 7.625 6.625 7.125 .29
Third Quarter............................ 8.625 6.813 8.125 .29
Fourth Quarter........................... 8.188 7.125 7.750 .30
2001
----
First Quarter........................... 9.850 7.563 9.650 .30
Second Quarter.......................... 11.080 9.290 11.050 .32
Third Quarter........................... 11.690 10.050 10.400 .32
Fourth Quarter.......................... 11.210 9.500 10.990 .35
2002
----
First Quarter through March 25, 2002... 11.86 10.80 11.74 .35
On March 25, 2002, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $11.74. As of March 25, 2002,
there were approximately 544 record holders of the Common Stock and 34
record holders of the Preferred Stock. This figure does not reflect
beneficial ownership of shares held in nominee name.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended
December 31, 2001, 2000 and 1999, and the period March 24, 1998
(commencement of operations) through December 31, 1998 has been derived from
the Company's audited financial statements. This information should be read
in conjunction with "Item 1. Business" and "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations", as well as
the audited financial statements and notes thereto included in "Item 8.
Financial Statements and Supplementary Data".
For the Year For the Year For the Year Ended March 24, 1998
(In thousands, except per share data) Ended December Ended December December through December
31, 2001 31, 2000 31, 1999 31, 1998
------------------------------------------------- --------------- --------------- ------------------ -----------------
Operating Data:
--------------
Total income $131,220 $97,642 $57,511 $46,055
Expenses 72,136 60,839 33,280 29,004
Other gains (losses) (910) 2,523 2,442 (18,440)
Cumulative transition adjustment (1,903) - - -
Net income (loss) 56,271 39,326 26,673 (1,389)
Net income (loss) available to common shareholders 47,307 32,261 26,389 (1,389)
Per Share Data:
--------------
Net income (loss):
Basic 1.41 1.37 1.27 (0.07)
Diluted 1.35 1.28 1.26 (0.07)
Dividends declared per common share 1.29 1.17 1.16 .92
Balance sheet Data:
------------------
Total assets 2,613,276 1,033,651 679,662 956,395
Total liabilities 2,229,903 760,993 481,379 774,666
Total stockholders' equity 383,115 242,254 168,261 181,729
Redeemable convertible preferred stock 258 30,404 30,022 -
The net loss in 1998 reflects realized losses of $18,262 resulting from the
sale of a substantial portion of the Company's available for sales
securities and termination of an interest rate swap agreement.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Dollars in thousands, except per share amounts)
General
The Company's primary long-term objective is to distribute consistent
dividends supported by operating earnings. The Company considers its
operating earnings to be net income available to common shareholders as
determined under GAAP before realized gains (losses) and FAS 133 hedging
adjustments.
Strong GAAP operating earnings are primarily maintained by consistent credit
performance on the Company's investments and stability of the Company's
liability structure. To achieve its objective the Company is focused on
increasing its size and capital base. This should lead to increased
diversification of credit exposures and improved diversification of
financing sources creating a more stable earnings platform. Where increased
size can be achieved without diluting common shareholders equity the Company
will pursue it aggressively.
The Company's business focuses on (i) investing in below investment grade
CMBS where the Company has the right to control the foreclosure or workout
process on the underlying loans; (ii) originating high yield commercial real
estate loans, which includes senior interests in partnerships that own real
property and are reported as real estate or joint venture investments; and
(iii) acquiring investment grade real estate related securities, including
Government guaranteed residential mortgage backed securities to act as a
liquidity support for the other two operations.
The Company's management believes that this represents an integrated
strategy where each asset class supports the others and creates additional
value for shareholders over and above operating each in isolation. The CMBS
portfolio provides diversification and high loss adjusted returns over a
weighted average life of approximately 10 years, the commercial real estate
loans provide high risk adjusted returns for shorter periods of time, and
the investment grade securities is an actively managed portfolio that
supports the liquidity needs of the Company while earning attractive
returns.
These strategies are pursued within an aggregate risk management framework
that seeks to limit the exposure of the Company's equity and earnings to
changes in interest rates, capital availability and other factors beyond the
Company's control.
In 2001 the Company continued to focus on maintaining liquidity, increasing
capital base and reducing risk where feasible. During 2001, the Company
issued 15,918,565 shares of Common Stock for cash at levels that were
accretive to shareholder book value. In addition $65,600 of commercial
assets were paid off in the first half of the year. The Company deployed
most of its new capital and maturity proceeds into Government guaranteed
residential mortgages. This strategy was highly effective in an environment
in which the U.S. economy was slowing. The steep yield curve created by the
Federal Reserve Board's aggressive reduction of short-term rates resulted in
significant income opportunities for investments in this sector. This
further served to allow the Company to maintain its cautious approach to the
commercial real estate sector, yet still increase earnings per share. This
in turn put upward pressure on the dividends resulting in an increase in
annualized dividends of $0.20 per share, a 17% increase.
Invested equity in the investment grade portfolio reached a peak of 47.4% at
the end of the third quarter 2001 and fell to 31.8% by the end of the fourth
quarter of 2001. The Company records these assets on its balance sheet in
the categories Securities available for sale - Investment grade securities
and Securities held for trading. Generally, the Company has maintained 25%
of its invested equity in this sector to act as a liquidity reserve in
support of commercial assets.
During the fourth quarter of 2001, signs of improving economic activity in
the United States began to appear, according to some sources and
indications. In reaction to this, the Company began to hedge short-term
rates more actively and shifted its investment focus back to commercial real
estate assets. Management saw the trend of tightening first mortgage
underwriting and wider spreads was creating more favorable risk adjusted
returns in the CMBS markets. Additionally, the feasibility of issuing term
debt secured by these assets was improving through an increasingly active
collateralized debt obligation ("CDO") market. During the fourth quarter of
2001 the Company closed on approximately $108,000 par value of CMBS. The
focus of these acquisitions has generally been towards office and retail
properties throughout the United States with less emphasis on lodging
properties. The Company is also aggressively pursuing a matched funding
strategy for its CMBS assets as greater liquidity in the capital markets
increases the probability of executing a term financing transaction in the
CDO market.
Reportable earnings also benefited from economies of scale as the Company
has grown. Effective July 1, 2001 the Manager reduced the base management
fee payable to the Manager under the Management Agreement by over 42% on
investment grade assets. Quarterly base management fees on a per share basis
were $0.047 per share for the quarter ended December 31, 2001, as compared
to $0.059 per share for the quarter ended December 31, 2000. Additionally,
the Manager reduced the incentive fee, payable to the Manager under the
Management Agreement, by raising the threshold of its participation in
income of the Company from 350 basis points over the 10 year Treasury (8.23%
for the quarter ended December 31, 2001) to the greater of that amount or
9.50%. This threshold is based on the adjusted issue price of the Common
Stock. At December 31, 2001, the adjusted issue price of the Common Stock
was $11.75 compared to the GAAP book value of $7.53. The increase to a 9.50%
threshold on adjusted issue price increased the earnings threshold from
$0.97 to $1.12 per share and from 12.9% to 14.9% return on equity based upon
December 31, 2001 GAAP book value. In aggregate, the fee reductions adopted
by the Manager increased return on equity by 122 basis points, and increased
GAAP book value by $0.02 per share, for the quarter ended December 31, 2001.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of
operations is based on the amounts reported in the Company's consolidated
financial statements. These financial statements are prepared in accordance
with accounting principles generally accepted in the United States of
America. 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 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 its 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 their values must be estimated by
management. 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
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 which is other than temporary, and, accordingly, write
the impaired security down to its fair value, through earnings. Significant
judgment is required in this analysis.
Income on these securities is recognized based upon a number of assumptions
that are subject to uncertainties and contingencies. Examples of these
include, among other things, the rate and timing of principal payments
(including prepayments, repurchases, defaults and liquidations), the
pass-through or coupon rate and interest rate fluctuations. Additional
factors that may affect the Company's reported interest income on its
mortgage securities 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 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 which may alter the assumptions.
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, but
changes in fair value are 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 an investment in a private
opportunity fund which invests in commercial mortgage loans, and is managed
by the same entity that manages the Company. Management must periodically
evaluate each of these loans 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 is determined to be impaired, the Company would establish a reserve for
possible 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 is required in determining impairment and
the resulting loss allowance. To date, the Company has determined that no
loss allowances have been necessary on the loans in its portfolio or held by
the opportunity fund.
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 is
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, Company management must decide whether to designate
these derivatives as hedging borrowings, securities available for sale,
trading securities, or foreign currency exposure. This designation decision
affects the manner in which the changes in the fair value of the derivatives
are reported.
Market Conditions and Their Effect on Company Performance
The principal performance risks that the Company faces are (i) credit risk
on the CMBS and commercial real estate loans it underwrites; (ii) interest
rate risk, which affects the market value of the Company's assets and the
cost of funds needed to finance these assets and (iii) liquidity risk, which
affects the Company's ability to finance itself over the long term.
Credit Risk and Company Performance: The Company's primary risk is
commercial real estate credit risk. These investments take two forms: (1)
below investment grade CMBS 2) commercial real estate loans.
CMBS are debt instruments with a stated par amount and a fixed or floating
rate coupon. The cash flow used to pay the CMBS comes from a pool of
commercial real estate secured by first mortgages. The credit losses that
occur on the underlying mortgages are charged first to the CMBS with the
lowest credit rating. These CMBS are commonly referred to as the "first
loss" securities.
Commercial real estate loans are loans made directly to a borrower that are
secured by some form of commercial real estate. These loans may be secured
by a subordinated interest in a first mortgage, a second mortgage, or
interests in a partnership that owns commercial real estate. Additionally,
the Company has made preferred equity investments in partnerships that own
commercial real estate.
CMBS: The Company considers delinquency information from the Lehman Brothers
Conduit Guide for 1998 vintage transactions to be the most relevant measure
of credit performance market conditions applicable to its below investment
grade CMBS holdings. The broader measure of all transactions tracked in the
Conduit Guide since 1994 also provides relevant comparable information. The
delinquency statistics are shown in the table below:
--------------------------------------------------------------------------------------------------------------------------------
| | Lehman Brothers Conduit Guide For 1998 Vintage | Lehman Brothers Conduit Guide For All Transactions |
| | Transactions | |
|---------------|------------------------------------------------------|---------------------------------------------------------|
| Date | Number of | Collateral | % | Number of | Collateral | % |
| | Securitizations | Balance | Delinquent | Securitizations | Balance | Delinquent |
|---------------|-------------------|------------------|---------------|-------------------|------------------|------------------|
| 12/31/01 | 39 | $51,321,238 | 1.51% | 210 | $185,756,237 | 1.51% |
|---------------|-------------------|------------------|---------------|-------------------|------------------|------------------|
| 12/31/00 | 41 | 52,890,768 | 0.77 | 180 | 158,597,044 | 0.77 |
|---------------|-------------------|------------------|---------------|-------------------|------------------|------------------|
| 12/31/99 | 41 | 54,338,032 | 0.47 | 147 | 131,892,534 | 0.51 |
|---------------|-------------------|------------------|---------------|-------------------|------------------|------------------|
| 12/31/98 | 38 | 53,256,049 | 0.17 | 106 | 94,839,000 | 0.34 |
--------------- ------------------------------------------------------ ---------------------------------------------------------
Morgan Stanley Dean Witter (MSDW) also tracks CMBS loan delinquencies using
a slightly smaller universe. The MSDW index tracks all CMBS transactions
with more than $200,000 of collateral that have been seasoned for at least
one year. This will generally adjust for the lower delinquencies that occur
in newly originated collateral. As of December 31, 2000 the MSDW index
indicated that delinquencies on 144 securitizations was 1.01%. As of
December 31, 2001 this same index tracked 174 securitizations with
delinquencies of 1.85%. See the section titled "Quantitative and Qualitative
Disclosures About Market Risks" for a detailed discussion of how
delinquencies and loan losses affect the Company.
The Company's below investment grade CMBS portfolio has a total par amount
of $733,830. Of this amount, $134,433 is the par of the securities that
represent the first loss on the underlying mortgages, and $560,596 is the
par of the securities that represent the remaining tranches owned by the
Company when the Company owns the first loss security. There are 1,911
underlying loans supporting the Company's first loss CMBS with an aggregate
principal balance of over $9.9 billion as of December 31, 2001. The total
below investment grade CMBS portfolio represents 43.8% of invested equity at
year end.
The Company manages its credit risk through conservative underwriting,
diversification, active monitoring of loan performance and exercise of its
right to control the workout process as early as possible. All of these
processes are based on the extensive intranet-based analytic systems
developed by BlackRock.
In underwriting loans, the Company performs site inspections and/or desktop
reviews of all loans in the pools. This process includes detailed analysis
of regional economic factors, industry outlooks, project viability and
documentation. Unacceptable risks are removed from the pool prior to closing
the transaction. An assumption of expected losses is developed and the
securities are priced accordingly. Earnings are reported net of the
assumption that credit losses will occur.
The Company maintains diversification of credit exposures through its
underwriting process and can shift its focus in future investments by
adjusting the mix of loans in subsequent acquisitions. During 2001 the
Company added $13,938 of par of first loss CMBS. The collateral profile of
the new investment was specifically underwritten to reduce the Company's
exposure to the lodging sector. The comparative profiles of the loans
underlying the Company's CMBS by property type are:
---------------------------------------------------------------------------------------
| 12/31/01 | 12/31/00 |
| Exposure | Exposure |
|------------------------------------------------------|--------------------------------|
|Property Type Loan Balance % of Total | Loan Balance % of Total |
|------------------------------------------------------|--------------------------------|
|Multifamily $3,432,708 34.6% | $3,176,333 34.8% |
|Retail 2,763,045 27.9 | 2,429,959 26.6 |
|Office 1,866,338 18.8 | 1,724,130 18.9 |
|Lodging 853,935 8.6 | 861,094 9.4 |
|Industrial 604,852 6.1 | 547,037 6.0 |
|Healthcare 353,697 3.6 | 367,989 4.0 |
|Parking 35,225 0.4 | 30,608 0.3 |
|------------------------------------------------------|--------------------------------|
|Total $9,909,800 100% | $9,137,150 100% |
---------------------------------------------------------------------------------------
Active monitoring of loan performance is a critical function that is
performed via electronic uploads of information gathered from the loan
servicers, PNC Bank and external data providers. This Internet-based system
allows the Company to monitor payments, debt service coverage ratios,
regional economic statistics, general real estate market trends and other
relevant factors.
The Company also uses the Internet-based system to monitor delinquencies.
The Company updates this information monthly allowing for more detailed
analysis of loans before problems develop.
The following table shows a comparison of these delinquencies:
------------------------------------------------------------------------------------------------------------------------------
| | 2001 | 2000 |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
| | | Number of | % of | | Number of | % of |
| | Principal | Loans | Collateral | Principal | Loans | Collateral |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
|Past due 30 days to 60 days | $15,401 | 5 | 0.15% | $6,319 | 3 | 0.07% |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
|Past due 60 days to 90 days | 9,865 | 4 | 0.10 | 7,963 | 2 | 0.09 |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
|Past due 90 days or more | 112,017 | 18 | 1.13 | 28,526 | 5 | 0.31 |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
|Real Estate owned | 8,805 | 1 | 0.09 | 10,145 | 2 | 0.11 |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
|Total Delinquent | $146,088 | 28 | 1.47% | $52,953 | 12 | 0.58% |
|--------------------------------|---------------|-------------|---------------|-----------------|-------------|---------------|
|Total Loan Portfolio | $9,909,800 | 1,911 | | $9,137,150 | 1,756 | |
-------------------------------------------------------------------------------------------------------------------------------
Of the 28 delinquent loans as of December 31, 2001, two were delinquent due
to technical reasons, one was REO and being marketed for sale, five were in
foreclosure, and the remaining 20 loans were in some form of workout
negotiations. Aggregate realized losses of $3,455 were taken in 2001. This
brings aggregate losses to $5,056. This is in line with the Company's loss
expectations as realized losses are expected to increase on the 1998 vintage
loans as they age.
The subordinated CMBS owned by the Company has a delinquency experience of
1.47%, which is slightly better than 1.51% for directly comparable
collateral pursuant to the Lehman Brothers Conduit Guide for 1998
vintage transactions. The Company expects delinquencies to continue to rise
throughout 2002 in line with expectations.
During 2001 the Company also experienced early payoffs of $53,722, which
represents 0.54% of the year-end pool balance. These loans were paid-off at
par with no loss. The anticipated losses attributable to these loans will
be reallocated to the loans remaining in the pools.
Subsequent to December 31, 2001, two of the 28 delinquent loans were brought
current and 12 loans became delinquent. Additionally, two other loans with a
total balance of $16,829 were paid off at par with no loss to the Company.
The unrealized loss on the Company's holdings of CMBS at December 31, 2001
was $96,956. This decline in the value of the investment portfolio
represents market valuation changes and is not due to credit experience or
credit expectations. The adjusted purchase price of the Company's CMBS
portfolio as of December 31, 2001 represents approximately 62% of its par
amount. The market value of the Company's CMBS portfolio as of December 31,
2001 represents approximately 49% of its par amount. As the portfolio
matures the Company expects to recoup the unrealized loss, provided that the
credit losses experienced are not greater than the credit losses assumed in
the purchase analysis. The Company performs a detailed review of its loss
assumptions on a quarterly basis and will adjust them when it believes that
credit experience or expectations justify such an adjustment. As of December
31, 2001 the Company concluded that real estate credit fundamentals remain
solid, and the Company believes there has been no material change in the
credit quality of its portfolio. As the portfolio matures and expected
losses occur subordination levels of the lower rated classes of a CMBS
investment will be reduced. This may cause the lower rated classes to be
downgraded. This would negatively affect the market value and liquidity of
the portfolio.
Commercial Real Estate Markets: There is typically a lagged impact of
economic conditions on commercial real estate. The most obvious fundamental
impacts have been the precipitous drop in office demand and hence asking
rents, a reduction in business travel and hence RevPar in the lodging
sector, a substantial increase in rent concessions by apartment operators
and an increase in tenant bankruptcies, particularly in retail. These
effects will continue to be seen even as the public equity markets reflect
economic recovery.
The often-noted counterbalance to these negative demand factors is the
better-managed supply pipeline. The far greater information availability and
transparency of the real estate markets as compared to the 1980's has
clearly had a positive effect in aggregate on lender discipline. Aggregate
construction starts were down across all property types in 2001 with the
biggest year over year percentage declines in office and industrial. The
biggest decline by far over the past two years has been in hotel room
additions; down 30%. Despite the greater aggregate health of the markets, it
is important to note that in "New Economy" submarkets the Company finds
conditions as bad or worse than they were in the early 1990's. Just as
euphoria gripped sectors of the public equity markets, it similarly affected
certain sectors of commercial real estate.
With cap rates trending up on softening fundamentals, the bid/ask spread
between buyers and sellers of property widened in 2001 and aggregate
transaction volume declined by 13% according to data from Granite Partners.
The biggest declines were in office (22%) and multifamily (12%). Despite
negative flows from foreign property funds the Company believes there
remains substantial liquidity available for U.S. real estate equity
investments with unspent allocations from pension funds likely representing
the largest single source, and with equity REITs prepared to invest as they
see accretive opportunities.
Commercial Real Estate Loans: The Company also owns seven loans and two
preferred equity interests in partnerships that own office buildings. The
Company's commercial loan portfolio generally emphasizes larger transactions
located in metropolitan markets as compared to the loans in the CMBS
portfolio. Exposures based on geography and asset type follows:
Principal Property
Location Balance % Type LTV DSCR
----------------------------------- -----------------------------------------------------------------------
Los Angeles $22,500 14.9% Office 78.0% 1.14
Tyson's Corner 22,000 14.6 Office 74.0 1.90
San Francisco 20,876 13.8 Office 76.0 1.13
San Francisco 17,892 11.9 Hotel 69.0 1.20
London* 31,199 20.7 Hotel 65.0 1.15
New York City 13,170 8.7 Office 66.0 1.25
Chicago 15,000 9.9 Multifamily 90.0 1.10
Suburban Philadelphia 3,159 2.1 Office 90.0 1.21
Tallahassee 5,158 3.4 Office 75.0 1.20
------------------------- -------------------
Total $150,954 100% 74.0% 1.27
------------------------- -------------------
Diversification by Asset Type
-----------------------------
Office 57.6%
Full Service Lodging 32.5%
Multifamily 9.9%
* The London Loan is translated into US dollars using the December 31, 2001
sterling exchange rate of (pound)0.687852.
The Los Angeles Loan, a $22,500 subordinate class of a $60,850 loan, is
secured by the borrower's interest in a 54-story office tower in downtown
Los Angeles, California. The loan matures in December 2002, which may be
extended at the borrower's option for two additional one-year periods.
The Tyson's Corner Loan is a $22,000 subordinate interest in a $92,000 first
mortgage secured by two ten-story office buildings located in Tyson's
Corner, Virginia. The loan matures in April 2004, which may be extended at
the borrower's option for two additional one-year periods.
The San Francisco Loan consists of two subordinate interests in a $125,000
note secured by an 11-story 394,457 square foot office building located in
the financial district of San Francisco, California. These two subordinated
interests total $20,876 and have a weighted average rating of BB+. The loan
matures in December 2007.
The San Francisco Hotel Loan is a $17,892 mezzanine loan secured by a lien
on the borrower's interest in a full service hotel located in San Francisco,
California. The loan matures in May 2003.
The London Loan is a (pound)21,459 Sterling denominated loan that was funded
in August of 1998. It is secured by five luxury hotel properties in and
around London. As of December 31, 2001 the London Loan was valued at 90.0%
of par, a decrease from 97.0% of par as of December 31, 2000.
At the beginning of the fourth quarter 2001, the occupancy of both hotel
assets declined significantly in the wake of the September 11th tragedy.
Occupancy for both assets has subsequently improved and is within the
Company's underwritten range of expectations.
The New York City Loan is a $13,170 subordinate interest in a $57,750 first
mortgage secured by a commercial office building located in midtown New York
City. The building is currently 100% leased. The loan matures in January
2004. The Company also owns the $6,080 BBB- rated CMBS security which is
senior to the Company's $13,170 interest.
The Chicago Loan was a $30,000 mezzanine loan originated in August of 2000.
The loan is secured by a second mortgage on a condominium conversion project
in Chicago, Illinois, and a first mortgage on an adjacent land parcel, as
well as the borrower's partnership interest in the property. The Company
originated this loan in September of 2000, for a 24-month term. Condominium
unit sales at the project currently exceed expectations. Due to this strong
demand the borrower paid off $15,000 of this loan with prepayment penalties
in December of 2000.
None of the loans have experienced any delinquency to-date. All loans are
performing at or above underwritten expectations, and all loans are expected
to pay off in full at or before their stated maturities.
The suburban Philadelphia investment is a $3,159 preferred equity interest
in a partnership that owns two office buildings totaling approximately
190,000 square feet. One property is in the western suburb of Paoli while
the other is in the northern suburb of Newtown. The Paoli property is 100%
occupied and the Newtown property is 80% occupied. The expected life of the
investment is three years.
The Tallahassee investment is a $5,158 preferred equity interest in a
partnership that owns a 500,000 square foot mixed-use office/retail
building. The Company's preferred equity interest represents 36.4% of the
partnership. The building is 99% occupied. Primary office tenants include
various Florida state government agencies on long-term leases. The expected
life of the investment is four years.
Interest Rate Risk and Company Performance: The Company generally makes
investments at long-term rates and borrows money to fund those investments
at short-term rates. The level of short-term rates and their relationship to
long-term rates directly affects the net investment income of the Company.
The value of the Company's assets is generally based on market rates for
ten-year U.S. Treasury notes and credit spreads. The Company generally
pledges its assets when it borrows funds. The value of the assets pledged
affects the amount of money the Company can borrow at a given time.
During 2001 the yield on the ten-year U.S. Treasury Note dropped by 7 basis
points from 5.11% to 5.04%. During 2001 the yield on the ten-year note was
as low as 4.20% and as high as 5.52%. Short-term rates decreased steadily
throughout the year as one month LIBOR decreased by 469 basis points from
6.56% to 1.87 %. See below the section titled, "Quantitative and Qualitative
Disclosures About Market Risk" for a detailed discussion of how interest
rates and spreads affect the Company.
Credit spreads represent the premium above the treasury rates required by
the market to take credit risk. CMBS credit spreads remain at historically
wide levels despite continued strength in the commercial real estate credit
markets. The chart below compares the credit spreads for high yield CMBS to
high yield corporate bonds.
Average Credit Spreads (in basis points)*
BB CMBS BB Corporate Difference
------- ------------ ----------
As of December 31, 2001 590 496 94
As of December 31, 2000 558 523 35
B CMBS B Corporate Difference
------ ----------- ----------
As of December 31, 2001 1051 709 342
As of December 31, 2000 987 978 9
* Source - Lehman Brothers CMBS High Yield Index & Lehman Brothers High
Yield Index
All of the Company's borrowings bear interest at rates that are determined
with reference to LIBOR. To the extent that interest rates on the Company's
borrowings increase without an offsetting increase in the interest rates
earned on the Company's investments and hedges, the Company's earnings could
be negatively affected. The chart below compares the rate for ten-year U.S.
Treasury securities to the one-month LIBOR rate.
Ten Year One month
U.S Treasury Securities LIBOR Difference
----------------------- ----- ----------
December 31, 2001 5.04% 1.87% 3.17%
December 31, 2000 5.12 6.56 1.44
The decrease in LIBOR from December 31, 2000 to December 31, 2001 had a
positive impact on the Company's financing costs.
The Company actively hedges its exposure to both short-term and long-term
rates. The degree of hedging and the choice of hedging instruments depends
on market conditions. This information is reviewed on a daily basis and
changes are made accordingly. The Company uses a combination of interest
rate futures contracts and interest rate swap agreements to hedge these
exposures.
Liquidity Risk: The Company acquires its investments using its capital and
borrowed funds. The availability of funds is a key component of the
Company's operations. During times of market uncertainty the availability of
this type of financing can be very limited. The Company funds itself mainly
through short-term secured lending arrangements with various counterparties.
These arrangements are generally for 30 day terms and are rolled over for 30
day periods at the end of each term. The Company also has a committed
borrowing facility from Deutsche Bank in the amount of $185 million. This
facility matures in July of 2002 and is currently under negotiation to be
extended.
The Company's debt to equity ratio has been approximately 4:1 throughout
2001. The three investment operations of the Company are all financed on a
secured basis at levels that takes into account the specific risks of that
asset class. As of December 31, 2001 the Company's CMBS portfolio is
financed at a debt to equity ratio of .98:1, commercial lending at .58:1,
and while the high credit quality of the RMBS portfolio allows for financing
levels of up to 20:1, the Company operates this portfolio at much more
conservative levels of 12:1. Generally the Company maintains debt to equity
ratios of 1.5:1 on CMBS, 1:1 on commercial lending and 9:1 on RMBS.
The Company manages this risk by maintaining diverse counterparties, keeping
at least 25% of invested equity in liquid assets and seeking matched funding
opportunities in secured lending markets such as a CDO.
The Investment Grade assets portfolio acts as the store of liquidity and
would be used to support the financing of the credit sensitive assets at
times of impaired liquidity. These assets can be sold quickly to raise cash
in support of the Company's main investment operations.
Yields on residential mortgage-backed securities fell steadily during the
third quarter 2001 as evidence of a weaker economy, exacerbated by the
terrorist attacks of September 11, continued to accumulate. Typically,
yields of mortgage-backed securities lag declines in other interest rates
due to rising prepayment expectations. This was generally the case during
the quarter as yield spreads widened against both Treasuries and interest
rate swaps, particularly along the shorter end of the yield curve. However,
during the second half of September 2001, the significant incremental yield
of mortgage-backed securities over other short and intermediate duration
assets attracted sizable demand from financial institutions. Therefore,
despite poor prepayment fundamentals and rising supply, demand indicators
were exceptionally strong.
This trend reversed dramatically in the fourth quarter as yields were
exceptionally volatile. Investors reduced interest rate exposure in
anticipation of a reversal in Federal Reserve Board policy. The sell-off was
exacerbated by the lengthening durations of mortgage securities, which
thereby increased the amount of securities that needed to be sold. The
combination of increased realized volatility and duration uncertainty hurt
the sector during the quarter. While rising interest rates should ultimately
improve fundamentals and technicals for the sector, the violent nature of
the sell-off led to poor relative performance for mortgage-backed securities
during November and December.
During 2001 the Company increased the size of the Investment Grade portfolio
significantly. The capital markets were favorable for issuing stock and the
Company took advantage of that opportunity. The proceeds raised were
invested immediately into the investment grade portfolio. Investments were
generally made in fixed rate 15 year Government guaranteed residential
mortgage backed securities issued by FNMA or FHLMC. The portfolio is
comprised mainly of low coupon mortgages that were acquired at a slight
discount to par. This would serve to protect the Company during periods of
high pre-payment. The prepayment characteristics of RMBS generally cause the
value of these securities to increase less in falling interest rate
environments and decrease at a greater rate in rising interest rate
environments. The equity duration of this portfolio is generally hedged to
five years using interest rate swaps and futures.
Recent Events
In March 2002 the remaining 10,000 shares of the Series A Preferred Stock
were converted into 34,427 shares of Company Common Stock at a price of
$7.26 per share pursuant to its terms.
In February 2002, the Company sold the FMACT Class C bond, resulting in a
realized loss of $3,610.
On March 25, 2002, the Management Agreement was extended for one year
through March 27, 2003, with the unanimous 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 FFO, (ii) removal of the four year period to value the investment
agreement in case of termination, and (iii) subsequent renewal periods of
the Management Agreement would be for one year instead of two years.
Funds From Operations (FFO)
Most industry analysts, including the Company, consider FFO an appropriate
supplementary measure of operating performance of a REIT. In general, FFO
adjusts net income for non-cash charges such as depreciation, certain
amortization expenses and gains or losses from debt restructuring and sales
of property. However, FFO does not represent cash provided by operating
activities in accordance with GAAP and should not be considered an
alternative to net income as an indication of the results of the Company's
performance or to cash flows as a measure of liquidity.
The Company computes FFO in accordance with the definition recommended by
the National Association of Real Estate Investment Trusts. The Company
believes that the exclusion from FFO of gains or losses from sales of
property was not intended to address gains or losses from sales of
securities as it applies to the Company. Accordingly, the Company includes
gains or losses from sales of securities in its calculation of FFO.
The Company's FFO for the year ended December 31, 2001 and 2000 was $56,271,
and $39,326, respectively, which was the same as its reported GAAP net
income for the periods. The Company reported cash flows (used in)/provided
by operating activities of $(375,715) and $115,734, cash flows (used
in)/provided by investing activities of $(832,525) and of $883,913 and cash
flows provided by/(used in) financing activities of $1,213,482 and
$(984,083) in its statement of cash flows for the year ended December 31,
2001 and 2000, respectively.
Results of Operations
Net income for the year ended December 31, 2001 was $56,271 or $1.41 per
share ($1.35 diluted). Net income for the year ended December 31, 2000 was
$39,326 or $1.37 per share ($1.28 diluted). Net income for the year ended
December 31, 1999 was $26,673, or $1.27 per share ($1.26 diluted). The
increase in income in 2001 from 2000 is primarily due to the reduction in
short-term rates and accretive reinvestment of new capital. The increase in
income in 2000 from 1999 is primarily due to the fact that the Company
raised additional capital and was able to invest at high-risk adjusted
yields.
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, 2001
------------------------------------------------------------------
Interest Average Annualized
Income Balance Yield
---------------------- --------------------- ---------------------
CMBS $ 39,882 $ 388,800 10.26%
Other securities available for sale 45,255 736,752 6.14
Commercial mortgage loans 15,499 123,802 12.52
Mortgage loan pools 1,575 20,778 7.58
Cash and cash equivalents 2,581 91,630 2.82
---------------------- --------------------- ---------------------
Total $ 104,792 $ 1,361,762 7.70
====================== ===================== =====================
For the Year Ended December 31, 2000
------------------------------------------------------------------
Interest Average Annualized
Income Balance Yield
---------------------- --------------------- ---------------------
CMBS $37,619 $372,465 10.10%
Other securities available for sale 37,497 468,177 8.01
Commercial mortgage loans 14,359 110,287 13.01
Mortgage loan pools 6,481 85,501 7.58
Cash and cash equivalents 1,313 22,189 5.92
---------------------- --------------------- ---------------------
Total $97,269 $1,058,619 9.19%
====================== ===================== =====================
For the Year Ended December 31, 1999
---------------------- --------------------- ---------------------
Interest Average Annualized
Income Balance Yield
---------------------- --------------------- ---------------------
CMBS $33,788 $354,713 9.53%
Other securities available for sale 14,318 223,410 6.41
Commercial mortgage loan 5,549 51,787 10.71
Cash and cash equivalents 670 11,473 5.84
---------------------- --------------------- ---------------------
Total $54,325 $641,383 8.47%
====================== ===================== =====================
In addition to the foregoing, the Company earned $24,681, $25, and $3,186 in
interest income from securities held for trading during the years ended
December 31, 2001, 2000, and 1999, respectively, $1,667 and $348 in earnings
from real estate joint ventures during the years ended December 31, 2001 and
2000, respectively, and $80 in earnings from an equity investment in 2001.
Interest Expense: The following table sets forth information regarding the
total amount of interest expense from certain of the Company's
collateralized borrowings. Information is based on daily average balances
during the period.
For the Year Ended December 31, 2001
----------------------------------------------------------------
Interest Average Annualized
Expense Balance Rate
---------------- ------------------ ------------------
Reverse repurchase agreements $ 45,126 $ 1,180,115 3.82%
Lines of credit and term loan 8,204 140,468 5.84%
---------------- ------------------ ------------------
Total $ 53,330 $ 1,320,583 4.04%
================ ================== ==================
For the Year Ended December 31, 2000
------------------------------------------------------------------
Interest Average Annualized
Expense Balance Rate
---------------- ------------------ ------------------
Reverse repurchase agreements $34,263 $505,893 6.77%
Lines of credit and term loan 16,849 229,863 7.35
---------------- ------------------ ------------------
Total $51,112 $735,756 6.94%
================ ================== ==================
For the Year Ended December 31, 1999
----------------------------------------------------------------
Interest Average Annualized
Expense Balance Rate
---------------- ------------------ ------------------
Reverse repurchase agreements $16,454 $283,322 5.81%
Lines of credit and term loan 5,314 82,540 6.44
---------------- ------------------ ------------------
Total $21,768 $365,862 5.95%
================ ================== ==================
The foregoing interest expense amounts for the year ended December 31, 2001
does not include $428 of hedge ineffectiveness, as well as $5,643 of
interest expense related to swaps. See Note 12, Derivative Instruments, for
further description of the Company's hedge ineffectiveness.
Net Interest Margin and Net Interest Spread from the Portfolio: The Company
considers its portfolio to consist of its securities available for sale,
mortgage loan pools, commercial mortgage loans, and cash and cash
equivalents because these assets relate to its core strategy of acquiring
and originating high yield loans and securities backed by commercial real
estate, while at the same time maintaining a portfolio of liquid investment
grade securities to enhance the Company's liquidity.
Net interest margin from the portfolio is annualized net interest income
from the portfolio divided by the average market value of interest-earning
assets in the portfolio. Net interest income from the portfolio is total
interest income from the portfolio less interest expense relating to
collateralized borrowings. Net interest spread from the portfolio equals the
yield on average assets for the period less the average cost of funds for
the period. The yield on average assets is interest income from the
portfolio divided by average amortized cost of interest earning assets in
the portfolio. The average cost of funds is interest expense from the
portfolio divided by average outstanding collateralized borrowings.
The following chart describes the interest income, interest expense, net
interest margin, and net interest spread for the Company's portfolio. The
following interest income and expense amounts exclude income and expense
related to real estate joint ventures and hedge ineffectiveness.
For the Year For the Year For the Year
Ended Ended Ended
December 31, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- -----------------
Interest Income 129,553 $97,294 $54,325
Interest Expense 57,196 $51,112 $21,768
Net Interest Margin 4.38% 5.55% 6.02%
Net Interest Spread 3.60% 3.78% 2.59%
Other Expenses: Expenses other than interest expense consist primarily of
management fees and general and administrative expenses. Management fees,
paid to the Manager of $11,018 for the year ended December 31, 2001 were
comprised of base management fees of $7,780 and incentive fees of $3,238.
Management fees paid to the Manager of $7,450 for the year ended December
31, 2000 were comprised of base management fees of $6,483 and incentive fees
of $967. Management fees paid to the Manager of $4,565 for the year ended
December 31, 1999, were comprised solely of the base management fee paid to
the Manager (as provided pursuant to the management agreement between the
Manager and the Company), as the Manager earned no incentive fee. Other
expenses/income-net of $1,717 for the year ended December 31, 2001, and
$2,277 for the year ended December 31, 2000, and $2,839 for the year ended
December 31, 1999, respectively, were comprised of accounting agent fees,
custodial agent fees, directors' fees, fees for professional services,
insurance premiums, broken deal expenses, and due diligence costs. Other
expenses/income-net in the year 2001 and 2000 also includes the amortization
of negative goodwill.
Other Gains (Losses): During the year ended December 31, 2001, the Company
sold a portion of its securities available for sale for total proceeds of
$1,452,577, resulting in a realized gain of $7,401. During the year ended
December 31, 2000, the Company sold a portion of its securities available
for sale for total proceeds of $3,176,357, resulting in a realized gain of
$3,212. During the year ended December 31, 1999 the Company sold a portion
of its securities available for sale for total proceeds of $47,843,
resulting in a realized loss of $516. The (loss) gain on securities held for
trading of $(2,604), $(647), and $2,992 for the years ended December 31,
2001, 2000 and 1999, respectively, consisted primarily of realized and
unrealized gains and losses on U.S. Treasury and agency securities, forward
commitments to purchase or sell Agency RMBS, and financial futures
contracts. The foreign currency loss of $5, $42, and $34 for the years ended
December 31, 2001, 2000, and 1999, respectively, relates to the Company's
net investment in a commercial mortgage loan denominated in pounds sterling
and associated hedging.
Dividends Declared: During the year ended December 31, 2001, the Company
declared dividends to shareholders totaling $47,458 or $1.29 per share, of
which $31,607 was paid during the year and $15,850 was paid on January 31,
2002. On March 14, 2002, the Company declared distributions to its
shareholders of $0.35 per share, payable on April 30, 2002 to shareholders
of record on April 4, 2002. During the year ended December 31, 2000, the
Company declared dividends to shareholders totaling $27,591 or $1.17 per
share. During the year ended December 31, 1999, the Company declared
dividends to shareholders totaling $24,348 or $1.16 per share. For U.S.
Federal income tax purposes, the dividends are ordinary income to the
Company's stockholders.
Tax Basis Net Income and GAAP Net Income: Net income as calculated for tax
purposes (tax basis net income) was estimated at $52,918 or $1.31 ($1.26
diluted) per share, for the year ended December 31, 2001, compared to a net
income as calculated in accordance with GAAP of $56,271, or $1.41 ($1.35
diluted) per share.
Tax basis income was $37,594, or $1.29 ($1.22 diluted) per share, for the
year ended December 31, 2000, compared to a net income as calculated in
accordance with GAAP of $39,326, or $1.37 ($1.28 diluted) per share. Tax
basis income was $28,347, or $1.36 ($1.34 diluted) per share, for the year
ended December 31, 1999, compared to a net income as calculated in
accordance with GAAP of $26,673 or $1.27 ($1.26 diluted) per share.
Differences between tax basis net income and GAAP net income arise for
various reasons. For example, in computing income from its subordinated CMBS
for GAAP purposes, the Company takes into account estimated credit losses on
the underlying loans whereas for tax basis income purposes, only actual
credit losses are taken into account. Additionally, in 2000, payments made
to GMAC Mortgage Asset Management, Inc. to terminate its management contract
with Core Cap, Inc. were deducted for tax purposes. Certain general and
administrative expenses may differ due to differing treatment of the
deductibility of such expenses for tax basis income. Also, differences could
arise in the treatment of premium and discount amortization on the Company's
securities available for sale.
Changes in Financial Condition
Securities Available for Sale: At December 31, 2001 and 2000, respectively,
an aggregate of $104,768 and $102,871 in unrealized losses on securities
available for sale was included as a component of accumulated other
comprehensive income (loss) in shareholders' equity.
The Company's securities available for sale, which are carried at estimated
fair value, included the following at December 31, 2001 and 2000:
December 31, 2001 December 31,
Estimated 2000 Estimated
Fair Fair
Security Description Value Percentage Value Percentage
-----------------------------------------------------------------------------------------------------------------------------------
Commercial mortgage-backed securities:
CMBS IO's $ 79,204 5.5% $ 68,844 10.2%
Investment grade CMBS 14,590 1.0 54,905 8.1
Non-investment grade rated subordinated securities 328,532 22.7 261,489 38.5
Non-rated subordinated securities 31,627 2.2 27,197 4.0
---------------- --------------- ----------------- ----------------
453,953 31.4 412,435 60.8
---------------- --------------- ----------------- ----------------
Single-family residential mortgage-backed securities:
Agency adjustable rate securities 75,035 5.2 160,928 23.7
Agency fixed rate securities 804,759 55.7 104,759 15.5
Residential CMO's 33,522 2.3 - -
Home equity loans 27,299 1.9 - -
Hybrid arms 51,386 3.5 - -
---------------- --------------- ----------------- ----------------
992,001 68.6 265,687 39.2
---------------- --------------- ----------------- ----------------
Total securities available for sale $ 1,445,954 100.0% $ 678,122 100.0%
================ =============== ================= ================
Short-Term Borrowings: To date, the Company's debt has consisted of
preferred stock and line-of-credit borrowings, term loans and reverse
repurchase agreements, which have been collateralized by a pledge of most of
the Company's securities available for sale, securities held for trading and
its commercial mortgage loans. The Company's financial flexibility is
affected by its ability to renew or replace on a continuous basis its
maturing short-term borrowings. To date, the Company has obtained short-term
financing in amounts and at interest rates consistent with the Company's
financing objectives.
Under the lines of credit, term loans, and the reverse repurchase
agreements, the lender retains the right to mark the underlying collateral
to market value. A reduction in the value of its pledged assets will require
the Company to provide additional collateral or fund margin calls. From time
to time, the Company expects that it will be required to provide such
additional collateral or fund margin calls.
The following tables set forth information regarding the Company's
collateralized borrowings.
For the Year Ended
December 31, 2001
-----------------------------------------------------------------
December 31, 2001 Maximum Range of
Balance Balance Maturities
------------------- ----------------- -------------------
Reverse repurchase agreements $1,717,326 $1,771,596 7 to 35 days
Line of credit and term loan borrowings 118,612 206,278 15 to 830 days
=================== ================= ===================
For the Year Ended
December 31, 2000
-----------------------------------------------------------------
December 31, 2000 Maximum Range of
Balance Balance Maturities
------------------- ----------------- -------------------
Reverse repurchase agreements $517,212 $1,202,696 3 to 55 days
Line of credit and term loan borrowings 202,130 453,841 15 to 261 days
=================== ================= ===================
Hedging Instruments: The Company's hedging policy with regard to its
sterling denominated London Loan is to minimize its exposure to fluctuations
in the sterling exchange rate. As of December 31, 2001 the Company had
forward contracts outstanding which are intended to hedge currency risk in
connection with the Company's investment in the London Loan.
From time to time the Company may reduce its exposure to market interest
rates by entering into various financial instruments that adjust portfolio
duration. These financial instruments are intended to mitigate the effect of
interest rates on the value of certain assets in the Company's portfolio. At
December 31, 2001, the Company had outstanding short positions of 80
thirty-year U.S. Treasury Bond future contracts, 500 ten-year U.S. Treasury
Note future contracts and a short call swaption with a notional amount of
$400,000. At December 31, 2000, the Company did not have any U.S. Treasury
future contracts or swaptions.
Interest rate swap agreements as of December 31, 2001 and 2000 consisted of
the following:
2001 2000
---- ----
Estimated Estimated Unamortized Remaining
Notional Value Fair Value Unamortized Cost Remaining Term Notional Value Fair Value Cost Term
---------------------------------------------------------------- ------------------------------------------------------------
$792,000 $(9,380) $4,764 8.12 years $226,000 $(12,505) $9,471 19.3 years
As of December 31, 2001, the Company had designated $682,000 of the interest
rate swap agreements as cash flow hedges of borrowings under reverse
repurchase agreements.
Capital Resources and Liquidity
Liquidity is a measurement of the Company's ability to meet potential cash
requirements, including ongoing commitments to repay borrowings, fund
investments, loan acquisition and lending activities and for other general
business purposes. The primary sources of funds for liquidity consist of
collateralized borrowings, principal and interest payments on and maturities
of securities available for sale, securities held for trading and commercial
mortgage loans, and proceeds from sales thereof.
To the extent that the Company may become unable to maintain its borrowings
at their current level due to changes in the financing markets for the
Company's assets, the Company may be required to sell assets in order to
achieve lower borrowing levels. In this event, the Company's level of net
earnings would decline. The Company's principal strategies for mitigating
this risk are to maintain portfolio leverage at levels it believes are
sustainable and to diversify the sources and types of available borrowing
and capital. The Company has utilized committed bank facilities, preferred
stock, and will consider resecuritization or other achievable term funding
of existing assets.
On July 11, 2001, the Company filed a registration statement to register
with the SEC an additional 10,000,000 shares of Common Stock to be issued
under its Dividend Reinvestment and Stock Purchase Plan (the "Plan"). The
Plan allows investors the opportunity to purchase additional shares of the
Company's Common Stock through the reinvestment of the Company's dividends,
optional cash payments and initial cash investments.
On September 21, 2001, the Company filed a registration statement to
register an additional $300,000 of securities with the SEC. The shelf
registration statement permits the Company to issue a variety of debt and
equity securities in the public markets. There can be no certainty, however,
that the Company will be able to issue, on terms favorable to the Company,
or at all, any of the securities so registered.
On December 2, 1999 the Company authorized and issued 1,200,000 shares of
Series A Preferred Stock for aggregate proceeds of $30,000. The Series A
Preferred Stock carries a 10.5% coupon and is convertible into Common Stock
at a price of $7.35 per share. The Series A Preferred Stock has a seven-year
maturity at which time, at the option of the holders, the shares may be
converted into common shares or liquidated for $28.50 per share. On December
21, 2001, the only Series A Preferred shareholder converted 1,190,000 shares
of the Series A Preferred Stock into 4,096,854 shares of Company Common
Stock at a price of $7.26 per share pursuant to the terms of such preferred
stock, which is $0.09 lower than the original conversion price due to the
effects of anti-dilution provisions in the Series A Preferred Stock. The
remaining 10,000 shares of Series A Preferred Stock were converted into
34,427 shares of the Company's Common Stock in March 2002.
On February 14, 2001 the Company completed a secondary offering of 4,000,000
shares of Company Common Stock in an underwritten public offering. The
aggregate net proceeds to the Company (after deducting underwriting fees and
expensed) were approximately $33,300. The Company had granted the
underwriters an option, exercisable for 30 days, to purchase up to 600,000
additional shares of Common Stock to cover over-allotments. This option was
exercised on March 13, 2001 and resulted in net proceeds to the Company of
approximately $5,000.
On May 11, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $37,800. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on June
6, 2001 and resulted in net proceeds to the Company of approximately $5,675.
On November 7, 2001 the Company completed a follow-on offering of 4,400,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting estimated expenses) were
approximately $39,400. On November 13, 2001, the underwriters exercised an
option to purchase an additional 90,000 shares of Common Stock available
through an over-allotment granted to the underwriters and resulted in net
proceeds to the Company of approximately $810.
For the year ended December 31, 2001, the Company issued 2,228,566 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the
Company were approximately $22,945. No shares were issued for the year ended
December 31, 2000 under the Dividend Reinvestment Plan.
As of December 31, 2001 $141,591 of the Company's $185,000 committed credit
facility with Deutsche Bank, AG was available for future borrowings and
$142,887 was available under the Company's $200,000 term facility with
Merrill Lynch.
The Company's operating activities (used) provided cash flows of $(375,715)
and $115,734 during the years ended December 31, 2001 and 2000,
respectively, primarily through net income and purchases of trading
securities in excess of sales in 2001.
The Company's investing activities (used) provided cash flows totaling
$(832,525) and $883,913, during the years ended December 31, 2001 and 2000,
respectively, primarily to purchase securities available for sale and to
fund commercial mortgage loans, offset by significant sales of securities
during 2001 and 2000.
The Company's financing activities provided (used) $1,213,482 and $(984,083)
during the years ended December 31, 2001 and 2000, respectively, primarily
from secondary and follow on offerings in 2001 and reductions of the level
of short-term borrowings related to the Company's trading portfolio.
Although the Company's portfolio of securities available for sale was
acquired at a net discount to the face amount of such securities, the
Company has received to date and expects to continue to have sufficient cash
flows from its portfolio to fund distributions to stockholders.
The Company is subject to various covenants in its lines of credit,
including maintaining: a minimum GAAP net worth of $140,000, a
debt-to-equity ratio not to exceed 5.0 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. Additionally, the
Company's GAAP net worth cannot decline by more than 37% during the course
of any two consecutive fiscal quarters. As of December 31, 2001, the Company
was in compliance with all such covenants.
The Company's ability to execute its business strategy depends to a
significant degree on its ability to obtain additional capital. Factors
which could affect the Company's access to the capital markets, or the costs
of such capital, include changes in interest rates, general economic
conditions and perception in the capital markets of the Company's business,
covenants under the Company's current and future credit facilities, results
of operations, leverage, financial conditions and business prospects.
Current conditions in the capital markets for REITS such as the Company have
made permanent financing transactions difficult and more expensive than at
the time of the Company's initial public offering. Consequently, there can
be no assurance that the Company will be able to effectively fund future
growth. Except as discussed herein, management is not aware of any other
trends, events, commitments or uncertainties that may have a significant
effect on liquidity.
Contingent Liability
At the time of the Core-Cap merger, the Manager agreed to pay GMAC Mortgage
Asset Management, Inc. (GMAC) $12,500 over a ten-year period (Installment
Payment). The Company agreed that should it terminate the Manager without
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, 2001, the installment payment would be $11,000
payable over nine 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 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. The initial two
year term of the Management Agreement was to expire on March 27, 2000; on
March 16, 2000, the Management Agreement was extended for an additional two
years, with the unanimous approval of the unaffiliated directors, on terms
similar to the prior agreement. On March 25, 2002, the Management Agreement
was extended for one year through March 27, 2003, with the unanimous
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 FFO, (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. The Board was advised by Houlihan Lokey
Howard & Zukin Financial Advisors, Inc. ("Houlihan Lokey") in the renewal
process. Houlihan Lokey is a national investment banking and financial
advisory firm. The Company pays the Manager an annual base management fee
equal to a percentage of the average invested assets of the Company as
defined in the Management Agreement. The base management fee is equal to 1%
per annum of the average invested assets rated less than BB- or not rated,
0.75% of average invested assets rated BB- to BB+, and 0.20% of average
invested assets rated above BB+. In order to coincide with the increased
scale of the Company, effective July 1, 2001, the Manager reduced the base
management fee from 0.35% of average invested assets rated above BB+. This
revision resulted in $1,059 in savings to the Company during 2001.
The Company incurred $7,780, $6,483 and $4,565 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2001, 2000, and 1999, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements
to the Manager of $216, $120, and $333 for certain expenses incurred on
behalf of the Company during 2001, 2000, and 1999, respectively.
The Company has also paid the Manager on a quarterly basis, as incentive
compensation, an amount equal to 25% of the funds from operations of the
Company (as defined) plus gains (minus losses) from debt restructuring and
sales of property, before incentive compensation in excess of a threshold
rate. The threshold rate for 1999, 2000 and the six months ended June 30,
2001 was based upon an annualized return on equity equal to 3.5% over the
ten-year U.S. Treasury Rate on the adjusted issue price of the Common Stock.
Effective July 1, 2001, the Manager revised the threshold rate to be the
greater of 3.5% over the ten-year U.S. Treasury Rate or 9.5%. This revision
resulted in $630 in savings to the Company during 2001.
Pursuant to the March 25, 2002 one-year Management Agreement extension, such
incentive fee would be based on 25% of earnings (calculated in accordance
with GAAP) of the Company. For purposes of the incentive compensation
calculation, equity is generally defined as proceeds from issuance of Common
Stock before underwriting discounts and commissions and other costs of
issuance. The Company incurred $3,238 and $967 in incentive compensation for
the years ended December 31, 2001 and 2000, respectively. The Company did
not pay incentive compensation during 1999.
On March 17, 1999, the Company's Board of Directors approved an
administration agreement with the Manager and the termination of a previous
agreement with an unaffiliated third party. Under the terms of the
administration agreement, the Manager provides financial reporting, audit
coordination and accounting oversight services. The Company pays the Manager
a monthly administrative fee at an annual rate of 0.06% of the first $125
million of average net assets, 0.04% of the next $125 million of average net
assets and 0.03% of average net assets in excess of $250 million subject to
a minimum annual fee of $120. The terms of the administrative agreement are
substantially similar to the terms of the previous third-party agreement.
For the years ended December 31, 2001, 2000 and 1999, the administration fee
was $144, $120 and $120, respectively.
During the year ended December 31, 2000, the Company purchased certificates
representing a 1% interest in Midland Commercial Mortgage Owner Trust IV,
Midland Commercial Mortgage Owner Trust V, Midland Commercial Mortgage Owner
Trust VI, Commercial Mortgage Owner Trust VII, PNC Loan Trust VII, and PNC
Loan Trust VIII for an aggregate investment of $7,021. These Midland Trusts
were purchased from Midland Loan Services, Inc. and the PNC trusts were
purchased from PNC Bank. Midland is a wholly owned indirect subsidiary of
PNC Bank and the depositor to the Trusts. The assets of the Trusts consist
of commercial mortgage loans originated or acquired by Midland and PNC Bank.
In connection with these transactions, the Company entered into a $4,500
committed line of credit from PNC Funding Corp., a wholly owned indirect
subsidiary of PNC Bank, to borrow up to 90% of the fair market value of the
Company's interest in the Trusts. Outstanding borrowings against this line
of credit bear interest at a LIBOR based variable rate. As of December 31,
2001 and 2000 there were no outstanding borrowings under this line of
credit. The Company earned $163 and $33 from the Trusts and paid interest of
approximately $138 and $20 to PNC Funding Corp. during years ended December
31, 2000 and 1999, respectively. These Midland Trusts were all sold prior to
December 31, 2000. The gain on sale of these investments was not
significant.
During 1999, the Company purchased certificates representing 1% interests in
Midland Commercial Mortgage Owner Trust I, Midland Commercial Mortgage Owner
Trust II, and Midland Commercial Mortgage Owner Trust III (the "Trusts")
from Midland for an aggregate investment of $5,346. During 1999 the
Company's interests in the Midland Commercial Mortgage Owner Trust I and II
were sold for $3,876 resulting in a realized gain of $87. In connection with
these transactions, the Company utilized a $4,500 committed line of credit
from PNC Funding Corp. to borrow up to 90% of the fair market value of the
Company's interest in the Trusts. Outstanding borrowings against this line
of credit bear interest at a LIBOR based variable rate. The Company paid
interest of approximately $20 to PNC Funding Corp. during the year ended
December 31, 1999.
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. 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 trusts were sold at a gain of $90.
On July 20, 2001, the Company entered into a $50 million commitment to
acquire shares in Carbon Capital, Inc. ("Carbon"), a private commercial real
estate income opportunity fund managed by BlackRock Financial Management,
Inc., who is also the manager of the Company. The Company does not pay
BlackRock management or incentive fees through Carbon. On November 7, 2001
the Company received a capital call notice to fund a portion of its Carbon
investment. The total amount of the capital call was $8,784, which was paid
on November 19, 2001. The proceeds were used by Carbon to acquire three
commercial loans all of which are secured by office buildings. The Company's
remaining commitment is $41,216. On December 31, 2001, the Company owned
32.5% of the outstanding shares in Carbon, and BlackRock, its affiliates,
officers, directors and employees collectively own 5%. In March 2002, Carbon
obtained additional commitments from unaffiliated institutional investors,
while the Company's commitment remeained unchanged. Accordingly, the
Company's ownership was reduced from 32.5% to 18.8%.
REIT Status
The Company has elected to be taxed as a REIT and to comply with the
provisions of the Code, with respect thereto. Accordingly, the Company
generally will not be subject to Federal income tax to the extent of its
distributions to stockholders and as long as certain asset, income and stock
ownership tests are met. The Company may, however, be subject to tax at
corporate rates or at excise tax rates on net income or capital gains not
distributed.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk: Market risk is the exposure to loss resulting from changes in
interest rates, credit curve spreads, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks to which the
Company is exposed are interest rate risk and credit curve risk. Interest
rate risk is highly sensitive to many factors, including governmental,
monetary and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Credit
risk is highly sensitive to dynamics of the markets for commercial mortgage
securities and other loans and securities held by the Company. Excessive
supply of these assets combined with reduced demand will cause the market to
require a higher yield. This demand for higher yield will cause the market
to use a higher spread over the U.S. Treasury securities yield curve, or
other benchmark interest rates, to value these assets. Changes in the
general level of the U.S. Treasury yield curve can have significant effects
on the market value of the Company's portfolio.
The majority of the Company's assets are fixed rate securities valued based
on a market credit spread to U.S. Treasuries. As U.S. Treasury securities
are priced to a higher yield and/or the spread to U.S. Treasuries used to
price the Company's assets is increased, the market value of the Company's
portfolio may decline. Conversely, as U.S. Treasury securities are priced to
a lower yield and/or the spread to U.S. Treasuries used to price the
Company's assets is decreased, the market value of the Company's portfolio
may increase. Changes in the market value of the Company's portfolio may
affect the Company's net income or cash flow directly through their impact
on unrealized gains or losses on securities held for trading or indirectly
through their impact on the Company's ability to borrow. Changes in the
level of the U.S. Treasury yield curve can also affect, among other things,
the prepayment assumptions used to value certain of the Company's securities
and the Company's ability to realize gains from the sale of such assets. In
addition, changes in the general level of the LIBOR money market rates can
affect the Company's net interest income. The majority of the Company's
liabilities are floating rate based on a market spread to U.S. LIBOR. As the
level of LIBOR increases or decreases, the Company's interest expense will
move in the same direction.
The Company may utilize a variety of financial instruments, including
interest rate swaps, caps, floors and other interest rate exchange
contracts, in order to limit the effects of fluctuations in interest rates
on its operations. The use of these types of derivatives to hedge
interest-earning assets and/or interest-bearing liabilities carries certain
risks, including the risk that losses on a hedge position will reduce the
funds available for payments to holders of securities and, indeed, that such
losses may exceed the amount invested in such instruments. A hedge may not
perform its intended purpose of offsetting losses or increased costs.
Moreover, with respect to certain of the instruments used as hedges, the
Company is exposed to the risk that the counterparties with which the
Company trades may cease making markets and quoting prices in such
instruments, which may render the Company unable to enter into an offsetting
transaction with respect to an open position. If the Company anticipates
that the income from any such hedging transaction will not be qualifying
income for REIT income test purposes, the Company may conduct part or all of
its hedging activities through a to-be-formed corporate subsidiary that is
fully subject to federal corporate income taxation. The profitability of the
Company may be adversely affected during any period as a result of changing
interest rates.
The following tables quantify the potential changes in the Company's net
portfolio value and net interest income under various interest rates and
credit-spread scenarios. Net portfolio value is defined as the value of
interest-earning assets net of the value of interest-bearing liabilities. It
is evaluated using an assumption that interest rates, as defined by the U.S.
Treasury yield curve, increase or decrease and the assumption that the yield
curves of the rate shocks will be parallel to each other.
Net interest income is defined as interest income earned from
interest-earning assets net of the interest expense incurred by the interest
bearing liabilities. It is evaluated using the assumptions that interest
rates, as defined by the U.S. LIBOR curve, increase or decrease and the
assumption 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.
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, 2001
and 2000. Actual results could differ significantly from these estimates.
Projected Percentage Change In Portfolio Net Market Value
Given U.S. Treasury Yield Curve Movements
2001 2000
Projected Change in Change in Projected Change in
Portfolio Treasury Yield Curve, Portfolio
Net Market Value +/- Basis Points Net Market Value
------------------------------------------------------------------------------
4.0% -200 4.1%
3.9% -100 2.8%
Base Case
(7.8)% +100 (4.3)%
(19.5)% +200 (10.1)%
Projected Percentage Change In Portfolio Net Market Value
Given Credit Spread Movements
2001 2000
Projected Change in Change in Projected Change in
Portfolio Credit Spreads, Portfolio
Net Market Value +/- Basis Points Net Market Value
------------------------------------------------------------------------------
19.1% -200 25.5%
11.5% -100 12.3%
Base Case
(15.4)% +100 (11.3)%
(34.6)% +200 (21.5)%
Projected Percentage Change In Portfolio Net Interest Income
Given LIBOR Movements
2001 2000
Projected Change in Projected Change Projected Change in Projected Change
Portfolio in Net Income Change in LIBOR, Portfolio in Net Income per
Net Interest Income per Share +/- Basis Points Net Interest Income Share
---------------------------------------------------------------------------------------------------------------------
13.4% $0.32 -200 12.2% $0.23
6.7% $0.16 -100 6.2% $0.11
3.3% $0.08 -50 3.1% $0.06
Base Case
(3.3)% ($0.08) +50 (3.1)% ($0.06)
(6.7)% ($0.16) +100 (6.2)% ($0.11)
(13.4)% ($0.32) +200 (12.2)% ($0.23)
Credit Risk: Credit risk is the exposure to loss from loan defaults. Default
rates are subject to a wide variety of factors, including, but not limited
to, property performance, property management, supply/demand factors,
construction trends, consumer behavior, regional economics, interest rates,
the strength of the American economy, and other factors beyond the control
of the Company.
All loans are subject to a certain probability of default. The nature of the
CMBS assets owned are such that all losses experienced by a pool of
mortgages will be borne by the Company. Changes in the expected default
rates of the underlying mortgages will significantly affect the value of the
Company, the income it accrues and the cash flow it receives. An increase in
default rates will reduce the book value of the Company's assets and the
Company earnings and cash flow available to fund operations and pay
dividends.
The Company manages credit risk through the underwriting process,
establishing loss assumptions, and careful monitoring of loan performance.
Before acquiring a security that represents a pool of loans, the Company
will perform a rigorous analysis of the quality of substantially all of the
loans proposed for that security. As a result of this analysis, loans with
unacceptable risk profiles will be removed from the proposed security.
Information from this review is then used to establish loss assumptions. The
Company will assume that a certain portion of the loans will default and
calculate an expected, or loss adjusted yield based on that assumption.
After the securities have been acquired the Company monitors the performance
of the loans, as well as external factors that may affect their value.
Factors that indicate a higher loss severity or timing experience is likely
to cause a reduction in the expected yield and therefore reduce the earnings
of the Company, and may require a significant write down of assets.
For purposes of illustration, a doubling of the losses in the Company's
credit sensitive portfolio, without a significant acceleration of those
losses would reduce the expected yield on adjusted purchase price from 10.1%
to approximately 8.77%. This would reduce GAAP income going forward by
approximately $0.16 per common share per annum and cause a significant write
down in assets at the time the loss assumption is changed to recapture
income previously accrued above the revised loss assumption.
Asset and Liability Management: Asset and liability management is concerned
with the timing and magnitude of the repricing and/or maturing of assets and
liabilities. It is the objective of the Company to attempt to control risks
associated with interest rate movements. In general, management's strategy
is to match the term of the Company's liabilities as closely as possible
with the expected holding period of the Company's assets. This is less
important for those assets in the Company's portfolio considered liquid as
there is a very stable market for the financing of these securities.
The Company uses interest rate duration as its primary measure of interest
rate risk. This metric, expressed when considering any existing leverage,
allows the Company's management to approximate changes in the net market
value of the Company's portfolio given potential changes in the U.S.
Treasury yield curve. Interest rate duration considers both assets and
liabilities. As of December 31, 2001, and 2000 the Company's duration on
equity was approximately 5.9 and 4.2 years, respectively. This implies that
a parallel shift of the U.S. Treasury yield curve of 100 basis points would
cause the Company's net asset value to increase or decrease by approximately
5.9% and 4.2%, respectively. The difference in the value change when rates
rise versus fall is attributable to the prepayment characteristics of the
Company's RMBS portfolio. Because the Company's assets, and their markets,
have other, more complex sensitivities to interest rates, the Company's
management believes that this metric represents a good approximation of the
change in portfolio net market value in response to changes in interest
rates, though actual performance may vary due to changes in prepayments,
credit spreads and increased market volatility.
Other methods for evaluating interest rate risk, such as interest rate
sensitivity "gap" (defined as the difference between interest-earning assets
and interest-bearing liabilities maturing or repricing within a given time
period), are used but are considered of lesser significance in the daily
management of the Company's portfolio. The majority of the Company's assets
pay a fixed coupon and the income from such assets are relatively unaffected
by interest rate changes. The majority of the Company's liabilities are
borrowings under its line of credit or reverse repurchase agreements that
bear interest at variable rates that reset monthly. Given this relationship
between assets and liabilities, the Company's interest rate sensitivity gap
is highly negative. This implies that a period of falling short-term
interest rates will tend to increase the Company's net interest income while
a period of rising short-term interest rates will tend to reduce the
Company's net interest income. Management considers this relationship when
reviewing the Company's hedging strategies. Because different types of
assets and liabilities with the same or similar maturities react differently
to changes in overall market rates or conditions, changes in interest rates
may affect the Company's net interest income positively or negatively even
if the Company were to be perfectly matched in each maturity category.
The Company currently has positions in forward currency exchange contracts
to hedge currency exposure in connection with its commercial mortgage loan
denominated in pounds sterling. The purpose of the Company's foreign
currency-hedging activities is to protect the Company from the risk that the
eventual U.S. dollar net cash inflows from the commercial mortgage loan will
be adversely affected by changes in exchange rates. The Company's current
strategy is to roll these contracts from time to time to hedge the expected
cash flows from the loan. Fluctuations in foreign exchange rates are not
expected to have a material impact on the Company's net portfolio value or
net interest income.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
Independent Auditors'Report...................................................................................49
Financial Statements:
Consolidated Statements of Financial Condition at December 31, 2001 and 2000..................................50
Consolidated Statements of Operations
For the Years Ended December 31, 2001, 2000 and 1999..........................................................51
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2001, 2000 and 1999.........................................................52
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2001, 2000 and 1999..........................................................54
Notes to Financial Statements.................................................................................56
All schedules have been omitted because either the required information is
not applicable or the information is shown in the financial statements or
notes thereto.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Anthracite Capital, Inc.
We have audited the accompanying consolidated statements of financial
condition of Anthracite Capital, Inc. and subsidiaries (the "Company") at
December 31, 2001 and 2000, and the related statements of operations,
changes in stockholders' equity and cash flows for each of the years in the
three year period ended December 31, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Anthracite Capital, Inc. and
subsidiaries at December 31, 2001 and 2000 and the results of their
operations and their cash flows for each of the years in the three year
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
New York, New York
March 22, 2002
Anthracite Capital, Inc.
Consolidated Statements of Financial Condition
(in thousands, except per share data)
-----------------------------------------------------------------------------------------------------------------------------------
December 31, 2001 December 31, 2000
----------------- -----------------
ASSETS
Cash and cash equivalents $ 43,071 $ 37,829
Restricted cash equivalents 37,376 9,484
Securities available for sale, at fair value
Subordinated commercial mortgage-backed securities (CMBS) $360,159 $288,686
Investment grade securities 1,085,795 389,436
--------- -------
Total securities available for sale 1,445,954 678,122
Securities held for trading, at fair value 564,081 54,043
Mortgage loan pools available for sale, at fair value - 71,535
Commercial mortgage loans, net 142,637 153,187
Investments in real estate joint ventures 8,317 10,354
Equity investment in Carbon Capital, Inc. 8,784 -
Receivable for investments sold 344,789 -
Other assets 18,267 19,097
------------- ------------
Total Assets $ 2,613,276 $ 1,033,651
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings:
Secured by pledge of subordinated CMBS $178,631 $161,608
Secured by pledge of other securities available for sale
and cash equivalents 1,039,469 356,491
Secured by mortgage loan pools - 67,367
Secured by pledge of securities held for trading 559,145 55,212
Secured by pledge of investments in real estate joint ventures 1,337 3,385
Secured by pledge of commercial mortgage loans 57,356 75,279
------------ ----------
Total borrowings $ 1,835,938 $ 719,342
Payable for investments purchased 346,913 -
Distributions payable 17,245 9,741
Other liabilities 29,807 31,910
------------- -----------
Total Liabilities 2,229,903 760,993
------------ -----------
10.5% Series A Preferred Stock, redeemable convertible,
liquidation preference $258 in 2001 and $34,200 in 2000 258 30,404
------------ -----------
Commitments and Contingencies
Stockholders' Equity:
Common Stock, par value $0.001 per share; 400,000 shares
authorized;
45,286 shares issued and outstanding in 2001;
25,136 shares issued and outstanding in 2000 45 25
10% Series B Preferred Stock, liquidation preference $55,317
in 2001, $56,525 in 2000 42,086 43,004
Additional paid-in capital 492,531 315,533
Distributions in excess of earnings (13,588) (13,437)
Accumulated other comprehensive loss (137,959) (102,871)
------------ ------------
Total Stockholders' Equity 383,115 242,254
------------ ------------
Total Liabilities and Stockholders' Equity $ 2,613,276 $ 1,033,651
============ ============
The accompanying notes are an integral part of these 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, 2001 December 31, 2000 December 31, 1999
----------------- ----------------- -----------------
Income:
Securities available for sale $ 85,137 $ 75,116 $ 48,106
Commercial mortgage loans 15,499 14,359 5,549
Mortgage loan pools 1,575 6,481 -
Trading securities 24,681 25 3,186
Earnings from real estate joint ventures 1,667 348 -
Earnings from equity investment 80 - -
Cash and cash equivalents 2,581 1,313 670
-------- -------- --------
Total income 131,220 97,642 57,511
-------- -------- --------
Expenses:
Interest 44,425 51,112 21,768
Interest-trading securities 14,976 - 4,108
Management and incentive fee 11,018 7,450 4,565
Other expenses / income - net 1,717 2,277 2,839
-------- -------- --------
Total expenses 72,136 60,839 33,280
-------- -------- --------
Other gains (losses):
Gain (loss) on sale of securities available for sale 7,401 3,212 (516)
Gain (loss) on securities held for trading (2,604) (647) 2,992
Foreign currency loss (5) (42) (34)
Loss on impairment of asset (5,702) - -
-------- -------- --------
Total other gain (loss) (910) 2,523 2,442
-------- -------- --------
Income before cumulative transition adjustment 58,174 39,326 26,673
Cumulative transition adjustment-SFAS 133 (1,903) - -
-------- -------- --------
Net Income 56,271 39,326 26,673
-------- -------- --------
Dividends and accretion on Preferred Stock 8,964 7,065 284
-------- -------- --------
Net Income Available to Common Shareholders $47,307 $32,261 $26,389
======== ======== ========
Net income per common share, basic:
Income before cumulative transition adjustment $1.47 $1.37 $1.27
Cumulative transition adjustment - SFAS 133 (0.06) - -
-------- -------- --------
Net income $1.41 $1.37 $1.27
======== ======== ========
Net income per common share, diluted:
Income before cumulative transition adjustment $1.40 $1.28 $1.26
Cumulative transition adjustment - SFAS 133 (0.05) - -
-------- -------- --------
Net income $1.35 $1.28 $1.26
======== ======== ========
Weighted average number of shares outstanding:
Basic 33,568 23,587 20,814
Diluted 37,616 27,668 21,150
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc.
Consolidated Statements of Changes in Stockholders' Equity for the Years
Ended December 31, 2001 and 2000 and 1999 (in thousands)
Series Accumulated
Common B Additional Distributions Other Total
Stock, Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders'
Par Value Stock Capital Of Earnings Loss Income Equity
-----------------------------------------------------------------------------------------
Balance at December 31, 1998 $20 $ - $280,994 $(20,148) $(79,137) $ - $181,729
Net income 26,673 $26,673 26,673
Change in net unrealized (loss) on
securities available for sale, net
of reclassification adjustment (22,002) (22,002) (22,002)
-------
Other Comprehensive loss (22,002)
Comprehensive Income $4,671
Dividends declared-Common Stock (24,348) ======= (24,348)
Dividends and accretion on
preferred stock (284) (284)
Purchase of Common Stock (234) (234)
Shares issued under Dividend
Reinvestment and Stock
Purchase Plan 1 6,726 6,727
-----------------------------------------------------------------------------------------
Balance at December 31, 1999 21 287,486 (18,107) (101,139) 168,261
Purchase of common shares (39) (39)
Net income 39,326 $39,326 39,326
Change in net unrealized (loss)
on securities available for sale,
net of reclassification adjustment (1,732) (1,732) (1,732)
-------
Other Comprehensive loss (1,732)
Comprehensive Income $37,594
=======
Dividends declared-Common Stock (27,591) (27,591)
Dividends and accretion on
preferred stock (7,065) (7,065)
Issuance of Common Stock 4 28,086 28,090
Issuance of Series B preferred stock $43,004 $43,004
-----------------------------------------------------------------------------------------
Balance at December 31, 2000 $25 $43,004 $315,533 ($13,437) ($102,871) $242,254
Net income 56,271 56,271 56,271
Cumulative transition adjustment
- SFAS 133 1,903 1,903 1,903
Unrealized loss on cash flow hedges (11,941) (11,941) (11,941)
Reclassification adjustments from cash
flow hedges included in net income 994 994 994
Change in net unrealized (loss) on
securities available for sale, net
of reclassification adjustment (26,044) (26,044) (26,044)
--------
Other Comprehensive loss (35,088)
Comprehensive Income 21,183
========
Dividends declared-Common Stock (47,458) (47,458)
Dividends and accretion on preferred (8,964) (8,964)
stock
Issuance of Common Stock 15 145,438 145,453
Conversion of Series B preferred
stock to Common Stock 1 (918) 917 -
Conversion of Series A preferred
stock to Common Stock 4 30,492 30,496
Compensation cost - stock options 151 151
-----------------------------------------------------------------------------------------
Balance at December 31, 2001 $45 $42,086 $492,531 ($13,588) ($137,959) $383,115
=========================================================================================
Disclosure of reclassification adjustment:
Years ended December 31, 2001 2000 1999
---- ---- ----
Unrealized holding loss $ (33,445) $(4,944) $(21,486)
Less: reclassification for realized
gains previously recorded as unrealized 7,401 3,212 (516)
----------------------------------------------
(26,044) (1,732) (22,002)
Cumulative transition adjustment - SFAS 133 1,903 - -
Unrealized loss on cash flow hedges (11,941) - -
Reclassification adjustments from cash
flow hedges included in net income 994 - -
----------------------------------------------
Net unrealized loss on securities $(35,088) $(1,732) $(22,002)
==============================================
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc.
Consolidated Statements of Cash Flow (in thousands)
----------------------------------------------------------------------------
Years Ended December 31 2001 2000 1999
---- ---- ----
Cash flows from operating activities:
Net income $ 56,271 $ 39,326 $ 26,673
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Net (purchase) sale of trading securities (454,960) 52,751 168,367
Amortization of negative goodwill (1,942) (1,062) -
Cumulative transition adjustment - SFAS 133 1,903 - -
Premium amortization (discount accretion), net 6,376 5,420 (274)
Compensation cost - stock options 151 - -
Loss on impairment of asset 5,702 - -
Noncash portion of net foreign currency loss 5 42 34
Net (loss) gain on sale of securities (4,797) (1,732) 516
Distributions from joint ventures in excess of earnings 116 (84) -
Decrease (increase) in other assets 12,803 8,316 (2,627)
Increase (decrease) in other liabilities 2,657 12,757 (3,954)
--------------------------------------
Net cash (used in) provided by operating activities (375,715) 115,734 188,735
--------------------------------------
Cash flows from investing activities:
Purchase of securities available for sale (2,383,483) (991,191) (265,174)
Principal payments received on securities available for sale 123,578 102,950 78,719
Funding of commercial mortgage loans (56,070) (101,100) (35,000)
Repayments received from commercial mortgage loans 66,620 17,524 970
(Increase) decrease in restricted cash equivalents (27,892) (9,484) 3,242
Investment in real estate joint ventures, net 1,921 (10,270) -
Investment in Carbon Capital, Inc. (8,784) - -
Principal payment received on mortgage loan pools 10,981 20,274 -
Proceeds from sale of securities available for sale
and mortgage loan pools 1,452,577 1,822,107 47,843
Net cash acquired in merger - 33,379 -
Acquisition costs - 4,129 -
Net payments under hedging securities (11,973) (4,405) 3,947
--------------------------------------
Net cash (used in) provided by investing activities (832,525) 883,913 (165,453)
--------------------------------------
Cash flows from financing activities:
Net increase (decrease) in borrowings 1,116,596 (962,396) (14,531)
Proceeds from issuance of Common Stock, net of offering costs 145,803 - 6,727
Proceeds from issuance of redeemable convertible preferred stock - - 30,000
Distributions on Common Stock (40,038) (26,130) (24,066)
Distributions on preferred stock (8,879) 4,482 -
Purchase of common shares - (39) (234)
--------------------------------------
Net cash provided by (used in) financing activities 1,213,482 (984,083) (2,104)
--------------------------------------
Net increase in cash and cash equivalents 5,242 15,564 21,178
Cash and cash equivalents, beginning of period 37,829 22,265 1,087
--------------------------------------
Cash and cash equivalents, end of period $ 43,071 $ 37,829 $ 22,265
======================================
Supplemental disclosure of cash flow information:
Interest paid $ 54,852 $ 47,504 $ 24,309
======================================
Investments purchased not settled $ 346,913 $ - $ -
======================================
Investments sold not settled $ 344,789 $ - $ -
======================================
Supplemental schedule of non-cash investing and financing activities: The
Company purchased all of the assets of CORE Cap., Inc during the Year end
December 31, 2000 primarily through issuance of the Company's common and
preferred stock, as follows:
Fair value of assets acquired $ 1,281,070
Cash included in acquired assets 33,379
Liabilities assumed 1,215,534
Common Stock issued in connection with acquisition 28,090
Preferred stock issued in connection with the acquisition 43,004
The accompanying notes are an integral part of these 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
Anthracite Capital, Inc. (the "Company") was incorporated in Maryland in
November, 1997 and commenced operations on March 24, 1998. The Company's
principal business activity is to invest in a diversified portfolio of
multifamily, commercial and residential mortgage loans, mortgage-backed
securities and other real estate related assets in the U.S. and non-U.S.
markets. The Company is organized and managed as a single business segment.
In preparing the financial statements in accordance with accounting
principles generally accepted in the United States of America (GAAP),
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the dates of the statements of financial condition
and revenues and expenses for the periods covered. Actual results could
differ from those estimates and assumptions. Significant estimates in the
financial statements include the valuation of the Company's mortgage-backed
securities and certain other investments.
A summary of the Company's significant accounting policies follows:
Principles of Consolidation
The consolidated financial statements include the financial statements of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
All highly liquid investments with original maturities of three months or
less are considered to be cash equivalents.
Securities Available for Sale
The Company has designated its investments in mortgage-backed securities,
mortgage-related securities and certain other securities as assets available
for sale because the Company may dispose of them prior to maturity.
Securities available for sale are carried at estimated fair value with the
net unrealized gains or losses reported as a component of accumulated other
comprehensive income (loss) in stockholders' equity. Unrealized losses on
securities that reflect a decline in value which is judged by management to
be other than temporary, if any, are charged to earnings. At disposition the
realized net gain or loss is included in income on a specific identification
basis. The amortization of premiums and accretion of discounts are computed
using the effective yield method after considering actual and estimated
prepayment rates, if applicable, and credit losses. Actual prepayment and
credit loss experience is reviewed quarterly and effective yields are
recalculated when differences arise between prepayments and credit losses
originally anticipated and amounts actually received plus anticipated future
prepayments and credit losses.
The Company may, in the future, acquire similar securities that it intends
to hold to maturity, or change its intent with respect to certain securities
currently in its portfolio, and designate such securities as "held to
maturity." Securities so designated would be carried at amortized cost,
subject to an impairment test.
Securities Held for Trading
The Company has designated certain securities as assets held for trading
because the Company intends to hold them for short periods of time.
Securities held for trading are carried at estimated fair value with net
unrealized gains or losses included in income.
Mortgage Loans
The Company purchases and originates certain commercial mortgage loans to be
held as long-term investments. Loans held for long-term investment are
recorded at cost at the date of purchase. Premiums and discounts related to
these loans are amortized over their estimated lives using the effective
interest method. Any origination fee income, application fee income and
direct costs associated with originating or purchasing commercial mortgage
loans are deferred and the net amount is included in the basis of the loans
on the statement of financial condition. The 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.
The Company acquired certain residential mortgage loan pools in the CORE Cap
merger (Note 13). Residential loan pools are treated as available-for-sale
debt securities and are carried at estimated fair value with net unrealized
gains or losses reported as a component of accumulated other comprehensive
income (loss) in stockholders' equity. Unrealized losses that reflect a
decline in value, which is judged by management to be other than temporary,
if any, are charged to earnings.
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 is determined to
exist.
Short Sales
As part of its short-term trading strategies (see Note 3), the Company may
sell securities that it does not own ("short sales"). To complete a short
sale, the Company may arrange through a broker to borrow the securities to
be delivered to the buyer. The proceeds received by the Company from the
short sale are retained by the broker until the Company replaces the
borrowed securities, generally within a period of less than one month. In
borrowing the securities to be delivered to the buyer, the Company becomes
obligated to replace the securities borrowed at their market price at the
time of the replacement, whatever that price may be. A gain, limited to the
price at which the Company sold the security short, or a loss, unlimited as
to dollar amount, will be recognized upon the termination of a short sale if
the market price is less than or greater than the proceeds originally
received. The Company's liability under the short sales is recorded at fair
value, with unrealized gains or losses included in net gain or loss on
securities held for trading in the statement of operations.
The Company is exposed to credit loss in the event of nonperformance by any
broker that holds a deposit as collateral for securities borrowed. However,
the Company does not anticipate nonperformance by any broker.
Forward Commitments - Trading
As part of its short-term trading strategies (see Note 3), the Company may
enter into forward commitments to purchase or sell U.S. Treasury or agency
securities, which obligate the Company to purchase or sell such securities
at a specified date at a specified price. When the Company enters into such
a forward commitment, it will, generally within sixty days or less, enter
into a matching forward commitment with the same or a different counterparty
which entitles the Company to sell (in instances where the original
transaction was a commitment to purchase) or purchase (in instances where
the original transaction was a commitment to sell) the same or similar
securities on or about the same specified date as the original forward
commitment. Any difference between the specified price of the original and
matching forward commitments will result in a gain or loss to the Company.
Changes in the fair value of open commitments are recognized on the
statement of financial condition and included among assets (if there is an
unrealized gain) or among liabilities (if there is an unrealized loss). A
corresponding amount is included as a component of net gain or loss on
securities held for trading in the statement of operations.
The Company is exposed to interest rate risk on these commitments, as well
as to credit loss in the event of nonperformance by any other party to the
Company's forward commitments. However, the Company does not anticipate
nonperformance by any counterparty.
Financial Futures Contracts - Trading
As part of its short-term trading strategies (see Note 3), 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 management activities, the Company may enter
into interest rate swap agreements, forward currency exchange contracts and
other financial instruments in order to hedge interest rate and foreign
currency exposures or to modify the interest rate or foreign currency
characteristics of related items in its statement of financial condition.
Income and expenses from interest rate swap agreements that are, for
accounting purposes, designated as hedging borrowings under reverse
repurchase agreements are recognized as a net adjustment to the interest
expense of the hedged item. During the term of the interest rate swap
agreement, changes in fair value are recognized on the statement of
financial condition and included among assets (if there is an unrealized
gain) or among liabilities (if there is an unrealized loss). A corresponding
amount is included as a component of accumulated other comprehensive income
(loss) in stockholders' equity. The Company accounts for revenues and
expenses from the interest rate swap agreements under the accrual basis over
the period to which the payment relates. Amounts paid to acquire these
instruments are capitalized and amortized over the life of the instrument.
Amortization of capitalized fees paid as well as payments received under
these agreements are recorded as an adjustment to interest income. If the
underlying hedged securities are sold, the amount of unrealized gain or loss
in accumulated other comprehensive income (loss) relating to the
corresponding interest rate swap agreement is included in the determination
of gain or loss on the sale of the securities. If interest rate swap
agreements are terminated, the associated gain or loss is deferred over the
shorter of the remaining term of the swap agreement, or the underlying
hedged item, provided that the underlying hedged item has not been sold.
Revenues and expenses from forward currency exchange contracts are
recognized as a net adjustment to foreign currency gain or loss. During the
term of the forward currency exchange contracts, changes in fair value are
recognized on the statement of financial condition and included among assets
(if there is an unrealized gain) or among liabilities (if there is an
unrealized loss). A corresponding amount is included as a component of net
foreign currency gain or loss in the statement of operations.
Financial futures contracts that are, for accounting purposes, designated as
hedging securities available for sale, are carried at fair value, with
changes in fair value included in other comprehensive income (loss).
Realized gains and losses on closed contracts are deferred and recognized in
the basis of the hedged available for sale security, and amortized as a
yield adjustment over the security's remaining term.
The Company monitors its hedging instruments throughout their terms to
ensure that they remain effective at their intended purpose. The Company is
exposed to interest rate and/or currency risk on these hedging instruments,
as well as to credit loss in the event of nonperformance by any other party
to the Company's hedging instruments. However, the Company does not
anticipate nonperformance by any counterparty.
Negative Goodwill
Negative goodwill reflects the excess of the estimated fair value of the net
assets acquired in the CORE Cap Inc. merger (See Note 13) over the purchase
price for such assets. Negative goodwill was being amortized using the
straight-line method from the date of acquisition over approximately 5.7
years, the weighted average lives of the assets acquired in the merger that
the Company intended to retain. In March 2001, the Company sold
approximately $60,211 of the assets acquired in the CORE Cap merger.
Effective in April 2001 the Company began amortizing the remaining balance
of negative goodwill over 4.5 years, which represents the weighted average
life of the remaining assets. This amortization is included in other
expenses/income - net. Negative goodwill, net, was $6,327 at December 31,
2001, and is included in other liabilities. Pursuant to SFAS 142 (See Recent
Accounting Pronouncements), the Company will recognize the unamortized
negative goodwill balance in income during the first quarter of 2002.
Income Taxes
The Company has elected to be taxed as a Real Estate Investment Trust
("REIT") and to comply with the provisions of the Internal Revenue Code of
1986, as amended, with respect thereto. Accordingly, the Company generally
will not be subject to Federal income tax to the extent of its distributions
to stockholders and as long as certain asset, income and stock ownership
tests are met. As of December 31, 2001, the Company had a capital loss
carryover of $4,348 available to offset future capital gains.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, "Business Combinations" (SFAS 141) and Statement No. 142, "Goodwill and
Other Intangible Assets" (SFAS 142). These statements establish new
standards for accounting and reporting for business combinations and for
goodwill and intangible assets resulting from business combinations. SFAS
141 applies to all business combinations initiated after June 30, 2001; the
Company is required to implement SFAS 142 on January 1, 2002. For the
Company, this will result in the unamortized balance of negative goodwill
being recognized in income during the first quarter of 2002 as the
cumulative effect of implementing the new accounting standard. The gain
recognized upon implementation will be $6,327.
In July of 2000, the FASB's Emerging Issues Task Force reached a consensus
on Issue 99-20, "Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interests in Securitized Financial Interests." This
issue provides guidance on the appropriate methodology to be used in
recognizing changes in the estimated yield on asset-backed securities, and
in determining whether impairment exists. This consensus was applied by the
Company beginning in the second quarter of 2001, and did not have an impact
on the Company's financial statements, but it may require earlier
recognition of impairment of CMBS investments than under previous guidance,
should the Company experience credit losses on the loans underlying a CMBS
investment in amounts greater than anticipated at acquisition.
In August of 2001, the FASB issued SFAS No, 143, "Accounting for Asset
Retirement Obligations" (effective January 1, 2003) and SFAS No. 144,
"Accounting for the Impariment or Disposal of Long Lived Assets" (effective
January 1, 2002). SFAS No. 143 requires the recording of the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. SFAS No. 144 supercedes existing accounting literature dealing
with impariment and disposal of long-lived assets, including discontinued
operations. It addresses financial accounting and reporting for the
impariment of long-lived assets and for long-lived assets to be disposed of,
and expands current reporting for discontinued operations to include
disposals of a "component" of an entity that has been disposed of or is
classified as held for sale. The Company is in the process of evaluating the
financial statement impact of the adoption of these two standards.
Reclassifications
Certain amounts from 2000 and 1999 have been reclassified to conform to the
2001 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, 2001 are summarized as follows:
Gross Estimated
Amortized Gross Unrealized Fair
Security Description Cost Unrealized Gain Loss Value
------------------------------------------------------------------------------------------------------------------------------
Commercial mortgage-backed securities ("CMBS"):
CMBS IO's $ 77,470 $ 2,322 $ (588) $79,204
Investment grade CMBS 20,318 - (5,728) 14,590
Non-investment grade rated subordinated securities 416,171 3,461 (91,100) 328,532
Non-rated subordinated securities 40,944 1,173 (10,490) 31,627
------------------------------------------------------------------
Total CMBS 554,903 6,956 (107,906) 453,953
------------------------------------------------------------------
Single-family residential mortgage-backed securities ("RMBS"):
Agency adjustable rate securities 74,185 850 - 75,035
Agency fixed rate securities 810,691 3,740 (9,672) 804,759
Residential CMO's 33,319 203 - 33,522
Home Equity Loans 26,302 997 - 27,299
Hybrid Arms 51,322 64 - 51,386
------------------------------------------------------------------
Total RMBS 995,819 5,854 (9,672) 992,001
------------------------------------------------------------------
Total securities available for sale $ 1,550,722 $ 12,810 $(117,578) $1,445,954
==================================================================
As of December 31, 2001, an aggregate of $1,336,622 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, 2000 are summarized as follows:
Gross Estimated
Amortized Gross Unrealized Fair
Security Description Cost Unrealized Gain Loss Value
------------------------------------------------------------------------------------------------------------------------------
Commercial mortgage-backed securities ("CMBS"):
CMBS IO's $ 66,711 $ 2,133 $ - $68,844
Investment grade CMBS 52,071 2,834 - 54,905
Non-investment grade rated subordinated securities 341,445 754 (80,710) 261,489
Non-rated subordinated securities 35,140 436 (8,379) 27,197
------------------------------------------------------------------
Total CMBS 495,367 6,157 (89,089) 412,435
------------------------------------------------------------------
Single-family residential mortgage-backed securities ("RMBS"):
Agency adjustable rate securities 159,673 1,269 (14) 160,928
Agency fixed rate securities 104,665 408 (314) 104,759
Total RMBS 264,338 1,677 (328) 265,687
------------------------------------------------------------------
Total securities available for sale $759,705 $ 7,834 $ (89,417) $678,122
==================================================================
As of December 31, 2000, an aggregate of $620,067 in estimated fair value
of the Company's securities available for sale was pledged to secure its
collateralized borrowings.
As of December 31, 2001 and 2000 there were 1,911 and 1,765 loans
underlying the subordinated CMBS held by the Company, with a principal
balance of $9,909,800 and $9,137,150, respectively.
As of December 31, 2001, and 2000, the aggregate estimated fair value by
underlying credit rating of the Company's securities available for sale
are as follows:
December 31, 2001 December 31, 2000
Estimated Estimated
Security Rating Fair Value Percentage Fair Value Percentage
-------------------------------------------------------------------------------------------------------------
Agency and agency insured securities $875,039 60.5% $203,073 30.0%
AAA 160,249 11.1 68,844 10.2
AA 35,917 2.5 62,613 9.2
A - - 7,743 1.1
BBB 14,590 1.0 47,163 7.0
BB+ 74,610 5.2 25,870 3.8
BB 34,246 2.4 26,876 4.0
BB- 56,935 4.0 48,581 7.1
B+ 19,274 1.3 15,487 2.3
B 93,946 6.5 87,763 12.9
B- 37,954 2.6 38,351 5.7
CCC 17,637 1.2 18,561 2.7
Not rated 25,557 1.7 27,197 4.0
----------------- ---------------- ----------------- ---------------
Total securities available for sale $1,445,954 100.0% $678,122 100.0%
================= ================ ================= ===============
As of December 31, 2001 and 2000, the mortgage loans underlying the CMBS
held by the Company were secured by properties of the types and at the
locations identified below:
Percentage (1) Percentage (1)
-----------------------------------------------------------------------------------------------------------
Property Type 2001 2000 Geographic 2001 2000
Location
-----------------------------------------------------------------------------------------------------------
Multifamily 34.6% 34.8% California 12.8% 13.4%
Retail 27.9 26.6 Texas 10.7 10.3
Office 18.8 18.9 New York 9.1 9.6
Lodging 8.6 9.4 Florida 7.0 7.0
Other 10.1 10.3 Illinois 4.5 5.1
-----------------------------
Total 100.0% 100.0% Other (2) 55.9 54.6
============================= ------------------------------
Total 100.0% 100.0%
==============================
(1) Based on a percentage of the total unpaid principal balance of the underlying loans.
(2) No other individual state comprises more than 5% of the total.
The following table sets forth certain information relating to the aggregate
principal balance and payment status of delinquent mortgage loans underlying
the subordinated CMBS held by the Company as of December 31:
--------------------------------------------------------------------------------------------------------------------------------
2001 2000
--------------------------------------------------------------------------------------------------------------------------------
Number of % of Number of % of
Principal Loans Collateral Principal Loans Collateral
--------------------------------------------------------------------------------------------------------------------------------
Past due 30 days to 60 days $15,401 5 0.15% $6,319 3 0.07%
--------------------------------------------------------------------------------------------------------------------------------
Past due 60 days to 90 days 9,865 4 0.10 7,963 2 0.09
--------------------------------------------------------------------------------------------------------------------------------
Past due 90 days or more 112,017 18 1.13 28,526 5 0.31
--------------------------------------------------------------------------------------------------------------------------------
Resolved loans - - - - - -
--------------------------------------------------------------------------------------------------------------------------------
Real Estate owned 8,805 1 0.09 10,145 2 0.11
--------------------------------------------------------------------------------------------------------------------------------
Total Delinquent $146,088 28 1.47% $52,953 12 0.58%
--------------------------------------------------------------------------------------------------------------------------------
Total Principal Balance $9,909,800 1,911 $9,137,150 1,756
--------------------------------------------------------------------------------------------------------------------------------
Of the 28 delinquent loans as of December 31, 2001, two were delinquent due
to technical reasons, one was REO and being marketed for sale, five were in
foreclosure, and the remaining 20 loans were in some form of workout
negotiations. One of the loans in foreclosure is the subject of litigation
with the loan seller. The matter involves a significant breach of
representations and warranties made when the loan was contributed to the
securitization transaction. The Company caused the loan trust to file a
claim against the seller for representing that a loan secured by a limited
service hotel in Phoenix, AZ was a flagged hotel when, in fact, it was not.
The Company believes strongly in the merits of the breach claim and has
caused the special servicer to institute legal action against the loan
seller.
The subordinate CMBS owned by the Company has a delinquency experience of
1.47%, which is slightly better than the 1.51% for directly comparable
collateral pursuant to the Lehman Brothers CMBS 1998 vintage
collateral delinquency index.
During 2001 the Company also experienced early payoffs of $53,722, which
represents 0.54% of the year-end pool balance. These loans were paid-off at
par with no loss. The anticipated losses attributable to these loans will
be reallocated to the loans remaining in the pools.
To the extent that realized losses, if any, or such resolutions differ
significantly from the Company's original loss estimates, it may be
necessary to reduce the projected GAAP yield on the applicable CMBS
investment to better reflect such investment's expected earnings net of
expected losses, from the date of purchase. While realized losses on
individual assets may be higher or lower than original estimates, the
Company currently believes its aggregate loss estimates and GAAP yields are
appropriate.
The CMBS held by the Company consist of subordinated securities
collateralized by adjustable and fixed rate commercial and multifamily
mortgage loans. The RMBS held by the Company consist of adjustable rate and
fixed rate residential pass-through or mortgage-backed securities
collateralized by adjustable and fixed rate single-family residential
mortgage loans. Agency RMBS were issued by Federal Home Loan Mortgage
Corporation (FHLMC), Federal National Mortgage Association (FNMA) or
Government National Mortgage Association (GNMA). Privately issued RMBS were
issued by entities other than FHLMC, FNMA or GNMA. The agency insured
project loan held by the Company consists of a participation interest in a
mortgage loan guaranteed by the Federal Housing Administration (FHA). The
Company's securities available for sale are subject to credit, interest rate
and/or prepayment risks.
The CMBS owned by the Company provide credit support to the more senior
classes of the related commercial securitization. Cash flow from the
mortgages underlying the CMBS generally is allocated first to the senior
classes, with the most senior class having a priority entitlement to cash
flow. Then, any remaining cash flow is allocated generally among the other
CMBS classes in order of their relative seniority. To the extent there are
defaults and unrecoverable losses on the underlying mortgages, resulting in
reduced cash flows, the most subordinated CMBS class will bear this loss
first. To the extent there are losses in excess of the most subordinated
class' stated entitlement to principal and interest, then the remaining CMBS
classes will bear such losses in order of their relative subordination.
As of December 31, 2001 and 2000, the anticipated weighted average
unleveraged yield to maturity based upon adjusted cost of the Company's
subordinated CMBS was 10.1% and 9.78% per annum, respectively, and of the
Company's other securities available for sale was 6.04% and 7.46% per annum,
respectively. The Company's anticipated yields to maturity on its
subordinated CMBS and other securities available for sale are based upon a
number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of these include, among other
things, the rate and timing of principal payments (including prepayments,
repurchases, defaults and liquidations), the pass-through or coupon rate and
interest rate fluctuations. Additional factors that may affect the Company's
anticipated yields to maturity on its subordinated CMBS include interest
payment shortfalls due to delinquencies on the underlying mortgage loans,
and the timing and magnitude of credit losses on the mortgage loans
underlying the subordinated CMBS that are a result of the general condition
of the real estate market (including competition for tenants and their
related credit quality) and changes in market rental rates. As these
uncertainties and contingencies are difficult to predict and are subject to
future events which may alter these assumptions, no assurance can be given
that the anticipated yields to maturity, discussed above and elsewhere, will
be achieved.
The agency adjustable rate RMBS held by the Company are subject to periodic
and lifetime caps that limit the amount the interest rates of such
securities can change during any given period and over the life of the loan.
The Company's mortgage loan pools as of December 31, 2000, consist of 191
loans secured by first mortgages on single-family homes. The amortized cost
of these pools is $70,698, the balance owed is $70,787, the weighted average
maturity is 27.68 years, the weighted average coupon is 7.36%, the minimum
interest payable is 5.125%, and the maximum interest payable is 9.375%. The
top five largest geographical concentrations are Michigan, California,
Colorado, Florida and Illinois, representing 60% of the balance owed for the
mortgage loan pools. In April 2001, the Company sold all of the mortgage
loan pools at a slight gain to the Company. The estimated fair value of the
mortgage loan pools at December 31, 2000 was $71,535, resulting in an
unrealized gain of $837.
As of December 31, 2001, the unamortized net discount on all securities
available for sale was $1,786,400, which represented 53.53% of the then
remaining face amount of such securities. During 2001, the Company sold
securities available for sale and mortage loan pools for total proceeds of
$1,452,577, resulting in a realized gain of $7,401. During 2000, the Company
sold securities available for sale for total proceeds of $1,568,805
resulting in a realized gain of $3,212.
As part of the acquisition of CORE Cap, Inc. in May 2000 (see Note 13) the
Company acquired securities backed by franchise loans originated by
Franchise Mortgage Acceptance Corporation ("FMAC 1998-BA trust"). The trust
is collateralized by loans on 365 properties to 75 borrowers. The properties
are largely franchise restaurants and gas station convenience stores.
Collateral performance has been poor. In March of 2001 the class B
securities were downgraded to BBB and the class C securities were downgraded
to BB. In July 2001 the class B was downgraded to BBB- and class C was
downgraded to B. The Company concluded that due to poor collateral
performance, future cash flows on the class C bond were not likely to be
received as originally provided and, accordingly, the bond was deemed to be
impaired. During the second quarter of 2001, the Company took a charge to
income of $5,702 on the class C bond, to write this bond down to its
estimated fair value. At December 31, 2001, the Company owned $16,366 of
class B principal and $10,829 of class C principal. In February 2002, the
class C bond was sold for a loss of $3,610.
Note 3 SECURITIES HELD FOR TRADING
Securities held for trading reflect short-term trading strategies, which the
Company employs from time to time, designed to generate economic and taxable
gains. As part of its trading strategies, the Company may acquire long or
short positions in U.S. Treasury or agency securities, forward commitments
to purchase such securities, financial futures contracts and other fixed
income or fixed income derivative securities. Any taxable gains from such
strategies will be applied as an offset against the tax basis capital loss
carry forward that the Company incurred during 1998 as a result of the sale
of a substantial portion of its securities available for sale.
The Company's securities held for trading are carried at estimated fair
value. At December 31, 2001, the Company's securities held for trading
consisted of FNMA and Federal Home Loan Corp. mortgage pools with an
estimated fair value of $578,008 and short positions of 80 thirty-year U.S.
Treasury Bond future contracts and 500 ten-year U.S. Treasury Note future
contracts expiring in March 2002, which represented $50,000 and $8,000 in
face amount of U.S. Treasury Bonds and Notes respectively. The estimated
fair value of these contracts was approximately $(61,235) at December 31,
2001. Also, the Company had outstanding a short position of 140 Eurodollar
futures of which 35 expire in each of June, September, and December 2003,
and 35 in March 2004, and an outstanding a short call swaption with a
notional amount of $400,000, which expires in December 2004. The estimated
fair value of these Eurodollar futures contracts was approximately $(32,987)
and the estimated fair value of the swaption contract was approximately
$(10,500) as of December 31, 2001. In February 2002, the Company closed the
swaption position. At December 31, 2000, the Company's securities held for
trading consisted of U.S. Treasury securities with an estimated fair value
of $54,179 and a long position of 13 ten-year U.S. Treasury Note future
contracts expiring March 30, 2001, which represented $1,300 in face amount
of U.S. Treasury notes. The estimated value at December 31, 2000 of the
future contracts was $(136).
The Company'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 4 COMMERCIAL MORTGAGE LOANS
The following table summarizes the Company's loan investments at December 31, 2001 and 2000:
Date of Scheduled Amount Outstanding Interest Rate
Initial Maturity/Date of Property
Investment Repayment or Sale Location Type 2001 2000 2001 2000
-------------------------------------------------------------------------------------------------------------------------------
3/28/00 6/20/01 New York, NY Office $ - $30,600 -% 12.5%
2/12/99 3/27/01 Santa Monica, CA Office - 35,000 - 13.3%
8/15/00 5/1/03 San Francisco, CA(2) Hotel 17,892 18,000 8.4 13.2
8/26/98 6/30/03 London, England (1) Hotel 31,199 32,087 8.1 9.9
12/20/00 12/19/02 Los Angeles, CA Office 22,500 22,500 12.7 16.9
12/17/01 4/9/04 Tyson's Corner, VA(2) Office 22,000 - 8.9 -
9/22/00 9/21/02 Chicago, IL(3) Multifamily 15,000 15,000 20.0 20.0
11/7/01 11/11/07 San Francisco, CA (4) Office 10,987 - 7.2 -
11/7/01 11/11/07 San Francisco, CA(4) Office 9,889 - 6.7 -
6/25/01 1/11/06 New York, NY (5) Office 13,170 - 5.8 -
-----------------------
$142,637 $153,187
=======================
(1) The exchange rate for the British pound at December 31, 2001 was
(pound)0.687852 to US $1.00; at December 31, 2000 the exchange rate
was (pound)0.668762 to US $1.00. The entire principal balance of
the Company's investment in the London Loan is pledged to secure
line of credit borrowings.
(2) The entire principal balance of the Company's investment is pledged to
secure line of credit borrowings.
(3) Payments are interest only based at 12%. Additional interest of 8% is
due upon pay-off.
(4) Two subordinate interests in a $125,000 note secured by one 11-story
office building.
(5) The entire principal balance of the Company's investment is pledged to
secure reverse repurchase agreements.
Reconciliation of commercial mortgage loans: 2001 2000
----------------------------
Balance at beginning of period $153,187 $69,611
Discount accretion - -
Advances made during the period 56,070 101,100
Proceeds from repayment of mortgage loans (66,620) (17,524)
-----------------------------
Balance at end of period $142,637 $153,187
=============================
Note 5 EQUITY INVESTMENT 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 99 thousand square foot
office building and a 120 thousand square foot office building, both of
which are located in suburban Philadelphia. The Company's ownership interest
is 64.81% in each partnership. The Company receives a preferred return of
12% compounded, on its unreturned capital, payable monthly and a share of
the proceeds from a sale or refinancing. In July 2001, the Company received
a return of capital distribution from the partnerships in the amount of
$1,921.
On December 14, 2000, the Company made an investment aggregating
approximately $5,149 in a limited liability company, a 36.4% interest, for
the purpose of acquiring a 500 thousand square foot office and retail
complex in Tallahassee, Florida. The Company receives a preferred return of
13.25% and a return of capital of $3, payable monthly.
On July 20, 2001, the Company entered into a $50 million commitment to
acquire shares in Carbon Capital, Inc. ("Carbon"), a private commercial real
estate income opportunity fund managed by BlackRock Financial Management,
Inc., who is also the manager of the Company (Note 9). On November 7, 2001
the Company received a capital call notice to fund a portion of its Carbon
investment. The total amount of the capital call was $8,784, which was paid
on November 19, 2001. The proceeds were used by Carbon to acquire three
commercial loans all of which are secured by office buildings. The Company's
remaining commitment is $41,216. On December 31, 2001, the Company owned
32.5% of the outstanding shares in Carbon. In March 2002, Carbon obtained
additional commitments from unaffiliated institutional investors while the
Company's commitment remained unchanged. Accordingly, the Company's
ownership was reduced from 32.5% to 18.8%.
Combined summarized financial information of the unconsolidated equity
investment and real estate joint ventures is as follows:
December 31,
-----------------------------------------
2001 2000
------------------ -------------------
Balance Sheets:
Real estate, net $58,078 $58,534
Commercial mortgage loans, net 26,469 -
Other assets 8,687 5,643
------------------ -------------------
Total Assets $93,234 $64,177
================== ===================
Mortgage debt $45,603 $42,930
Other liabilities 2,201 502
Partners' and shareholders' equity 45,430 20,745
------------------ -------------------
Total liabilities and shareholders' equity $93,234 $64,177
================== ===================
Anthracite Capital, Inc.'s share of equity $16,865 $10,058
================== ===================
Carrying value of unconsolidated equity investments
and real estate joint ventures $17,101 $10,354
================== ===================
For the years ended December 31,
-----------------------------------------
2001 2000 1999
------------ ---------- -----------
Statements of Operations:
Revenues $11,119 $1,723 $ -
------------ ---------- -----------
Expenses
Interest expense 3,796 901 -
Depreciation and amortization 1,840 317 -
Operating expenses 3,560 559 -
------------ ---------- -----------
Total expenses 9,196 1,777 -
------------ ---------- -----------
Net Income $1,923 $(54) $ -
============ ========== ===========
Anthracite Capital, Inc.'s share of net income $1,747 $348 $ -
============ ========== ===========
The following table summarizes the loan investments held by Carbon Capital,
Inc. at December 31, 2001 and 2000:
Scheduled Amount
Date of Initial Maturity/Date of Property Outstanding Interest Rate
Investment Repayment or Sale Location Type 2001 2000 2001 2000
----------------- --------------------- ------------------------------ ------------ --------------------- ----------------
11/19/01 9/11/04 New York, NY(1) Office $10,000 $ - 8.45% -
11/20/01 12/11/07 San Francisco, CA(2) Office 12,144 - 10.00 -
12/17/01 4/9/04 Tyson's Corner, VA(3) Office 10,000 - 9.70 -
------------------
$32,144 $ -
==================
(1) The loan was issued at a discount, which will amortize to its par
value on a straight-line basis. The carrying value of the loan at
December 31, 2001 was $9,760 and the yield was 9.6%.
(2) The loan matures in December 2030, but due to the hyper
amortization structure, is expected to be repaid by December 2007,
as the interest rate increases by 2% and the borrower is required
to use all cash flow after interest expense to reduce the loan
balance. The loan was issued at a discount, which will amortize to
its par value at a yield to maturity of 16.6%. The carrying value
of the loan at December 31, 2001 was $9,343. Anthracite Capital,
Inc. owns two subordinate interests, which are senior to the
interest owned in its unconsolidated equity investment.
(3) The loan was issued at a discount, which will amortize to its par
value on a straight-line basis. The carrying value of the loan at
December 31, 2001 was $7,366, and the yield was 19.6%. Anthracite
Capital, Inc. owns a subordinate interest, secured by the same
collateral, which is to the interest owned in its unconsolidated
equity investment.
Reconciliation of commercial mortgage loans: Par Book Value
--------------- --------------
Investments in commercial mortgage loans $32,152 $26,390
Proceeds from principal repayments (8) (8)
Accretion of loan discount - 87
--------------- --------------
Total $32,144 $ 26,469
=============== ==============
Note 6 FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard No. 107, Disclosures about Fair
Value of Financial Instruments requires the disclosure of the estimated fair
value of financial instruments. The following table presents the carrying
value and estimated fair value of financial instruments as of December 31,
2001 and 2000:
2001 2000
----------------------------------------------------------------------------------------
Notional Carrying Estimated Notional Carrying Estimated
Amount Value Fair Value Amount Value Fair Value
----------------------------------------------------------------------------------------
Securities available for sale $ - $ 1,445,954 $ 1,445,954 $ - $ 678,122 $ 678,122
Securities held for trading - 564,081 564,081 - 54,043 54,043
Mortgage loan pools - - - - 71,535 71,535
Commercial mortgage loans - 142,637 146,635 - 153,187 152,225
Secured borrowings - (1,835,938) (1,835,938) - (719,342) (719,342)
Currency forward contracts 12,350 (489) (489) 12,137 749 749
Interest rate swap agreements 792,000 (9,380) (9,380) 226,000 (12,505) (12,505)
Futures 930,000 (94,221) (94,221) - - -
Notional amounts are a unit of measure specified in a derivative instrument.
The fair values of the Company's securities available for sale, securities
held for trading, mortgage loan pools, currency forward contracts, and
interest rate swap agreements are based on market prices provided by certain
dealers who make markets in these financial instruments. The fair values
reported reflect estimates and may not necessarily be indicative of the
amounts the Company could realize in a current market exchange. Commercial
mortgage loans and secured borrowings are floating rate instruments.
Therefore their carrying value is approximate fair value.
Note 7 COMMON STOCK
On January 5, 2000, the Company repurchased 6,100 shares of its Common Stock
for $39 in open market transactions. This purchase was made at a price of
$6.42 per share (including commissions). The remaining number of shares
authorized for repurchase is 2,713,519. During 1999, the Company repurchased
36,800 shares of its Common Stock for $234 in open market transactions;
these purchases were made at an average price of $6.35 per share. In
accordance with Maryland corporate regulations, all repurchased shares are
retired.
As part of the CORE Cap merger (see Note 13), the Company issued 4,180,552
shares of its Common Stock to CORE Cap shareholders on May 15, 2000.
On July 11, 2001, the Company filed a registration statement to register
with the SEC an additional 10,000,000 shares of Common Stock to be issued
under its Dividend Reinvestment and Stock Purchase Plan (the "Plan"). The
Plan allows investors the opportunity to purchase additional shares of the
Company's Common Stock through the reinvestment of the Company's dividends,
optional cash payments and initial cash investments.
On September 21, 2001, the Company filed a registration statement to
register an additional $300,000 of securities with the SEC. The shelf
registration statement permits the Company to issue a variety of debt and
equity securities in the public markets. There can be no certainty, however,
that the Company will be able to issue, on terms favorable to the Company,
or at all, any of the securities so registered.
On February 14, 2001 the Company completed a secondary offering of 4,000,000
shares of its common stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $33,300. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on March
13, 2001 and resulted in net proceeds to the Company of approximately
$5,000.
On May 11, 2001, the Company completed a follow-on offering of 4,000,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $37,800. The Company had granted the underwriters an
option, exercisable for 30 days, to purchase up to 600,000 additional shares
of Common Stock to cover over-allotments. This option was exercised on June
6, 2001 and resulted in net proceeds to the Company of approximately $5,675.
On November 7, 2001 the Company completed a follow-on offering of 4,400,000
shares of its Common Stock in an underwritten public offering. The aggregate
net proceeds to the Company (after deducting estimated expenses) were
approximately $39,400. On November 13, 2001, the underwriters exercised an
option to purchase an additional 90,000 shares of Company Common Stock
available through an over-allotment granted to the underwriters and resulted
in net proceeds to the Company of approximately $810.
For the year ended December 31, 2001, the Company issued 2,228,566 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the
Company were approximately $22,945. No shares were issued for the year ended
December 31, 2000 under the Dividend Reinvestment Plan.
During the year ended December 31, 2001, the Company declared dividends to
shareholders totaling $47,458 or $1.29 per share, of which $31,607 was paid
during the year and $15,850 was paid on January 31, 2002. On March 14, 2002,
the Company declared distributions to its shareholders of $.35 per share,
payable on April 30, 2002 to stockholders of record on April 4, 2002. For
U.S. Federal income tax purposes, the dividends are ordinary income to the
Company's stockholders.
During the year ended December 31, 2000, the Company declared dividends
to shareholders totaling $27,591 or $1.17 per share, of which $20,005 was
paid during the year and $7,541 was paid on January 31, 2001. On March 14,
2001, the Company declared distributions to its shareholders of $.30 per
share, payable on April 30, 2001 to stockholders of record on March 30,
2001. For U.S. Federal income tax purposes, the dividends are ordinary
income to the Company's stockholders.
During the year ended December 31, 1999, the Company declared dividends to
shareholders totaling $24,348 or $1.16 per share, of which $18,270 was paid
during the year and $6,078 was paid on January 17, 2000. For U.S. Federal
income tax purposes, the dividends are ordinary income to the Company
stockholders.
Note 8 PREFERRED STOCK
On December 2, 1999 the Company authorized and issued 1,200,000 shares of
10.5% Series A Senior Cumulative Redeemable Preferred Stock ("Series A
Preferred Stock"), $0.001 par value per share, for aggregate proceeds of
$30,000. The Series A Preferred Stock carries a 10.5% coupon and is
convertible into the Company's Common Stock at a price of $7.35. The Series
A Preferred Stock has a seven-year maturity at which time, at the option of
the holders, the shares may be converted into common shares or liquidated
("Liquidation Preference") for $28.50 per share. On December 21, 2001, the
only Series A Preferred shareholder converted 1,190,000 shares of the Series
A Preferred Stock into 4,096,854 shares of Company Common Stock at a price
of $7.26 per share pursuant to its terms, which is $0.09 lower than the
original conversion price due to the effects of anti-dilution provisions in
the Series A Preferred Stock. The remaining 10,000 shares of Series A
Preferred Stock were converted into 34,427 shares of the Company's Common
Stock in March 2002.
The Series A Preferred Stock was privately sold by the Company, and there
was no underwriting discount paid. At the closing of the CORE Cap merger
(see Note 13), the Liquidation Preference of the Series A Preferred Stock
was increased from $27.75 to $28.50 per share.
As part of the CORE Cap merger, the Company authorized and issued 2,261,000
shares of 10% Series B Cumulative Redeemable Convertible Preferred Stock
("Series B Preferred Stock"), $0.001 par value per share to CORE Cap
shareholders. The Series B Preferred Stock is perpetual, carries a 10%
coupon, has a preference in liquidation as of December 31, 2001 of $55,317,
and is convertible into the Company's Common Stock at a price of $17.09 per
share, subject to adjustment. If converted, the Series B Preferred Stock
would convert into approximately 3,237,065 shares of the Company's Common
Stock. In 2001, 48,300 shares of 10% Series B Preferred Stock with a
liquidation preference of $1,207 were converted at the shareholder's option
into 70,660 shares of the Company's Common Stock.
As of December 31, 2001, the Company has authorized and un-issued preferred
stock of 96,539,000 shares.
Note 9 TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement with the "Manager", a majority owned
indirect subsidiary of 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. The initial two
year term of the Management Agreement was to expire on March 27, 2000; on
March 16, 2000, the Management Agreement was extended for an additional two
years, with the unanimous approval of the unaffiliated directors, on terms
similar to the prior agreement. On March 25, 2002, the Management Agreement
was extended for one year through March 27, 2003, with the unanimous
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 FFO, (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. The Board was advised by Houlihan Lokey
Howard & Zukin Financial Advisors, Inc. ("Houlihan Lokey") in the renewal
process. Houlihan Lokey is a national investment banking and financial
advisory firm. The Company pays the Manager an annual base management fee
equal to a percentage of the average invested assets of the Company as
defined in the Management Agreement. The base management fee is equal to 1%
per annum of the average invested assets rated less than BB- or not rated,
0.75% of average invested assets rated BB- to BB+, and 0.20% of average
invested assets rated above BB+. In order to coincide with the increased
scale of the Company, effective July 1, 2001, the Manager reduced the base
management fee from 0.35% of average invested assets rated above BB+. This
revision resulted in $1,059 in savings to the Company during 2001.
The Company incurred $7,780, $6,483 and $4,565 in base management fees in
accordance with the terms of the Management Agreement for the years ended
December 31, 2001, 2000, and 1999, respectively. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements
to the Manager of $216, $120, and $333 for certain expenses incurred on
behalf of the Company during 2001, 2000, and 1999, respectively.
The Company has also paid the Manager on a quarterly basis, as incentive
compensation, an amount equal to 25% of the funds from operations of the
Company (as defined) plus gains (minus losses) from debt restructuring and
sales of property, before incentive compensation in excess of a threshold
rate. The threshold rate for 1999, 2000, and the six months ended June 30,
2001 was based upon an annualized return on equity equal to 3.5% over the
ten year U.S. Treasury Rate on the adjusted issue price of the Common Stock.
Effect July 1, 2001, the Manager revised the threshold rate to be the
greater of 3.5% over the ten-year U.S. Treasury Rate or 9.5%. This revision
resulted in $630 in savings to the Company during 2001.
Pursuant to the March 25, 2002 one-year Management Agreement extension, such
incentive fee will be based on 25% of earnings (calculated in accordance
with GAAP) of the Company. For purposes of the incentive compensation
calculation, equity is generally defined as proceeds from issuance of Common
Stock before underwriting discounts and commissions and other costs of
issuance. The Company incurred $3,238 and $967 in incentive compensation for
the years ended December 31, 2001 and 2000, respectively. The Company did
not pay incentive compensation during 1999.
On March 17, 1999, the Company's Board of Directors approved an
administration agreement with the Manager and the termination of a previous
agreement with an unaffiliated third party. Under the terms of the
administration agreement, the Manager provides financial reporting, audit
coordination and accounting oversight services. The Company pays the Manager
a monthly administrative fee at an annual rate of 0.06% of the first $125
million of average net assets, 0.04% of the next $125 million of average net
assets and 0.03% of average net assets in excess of $250 million subject to
a minimum annual fee of $120. The terms of the administrative agreement are
substantially similar to the terms of the previous third-party agreement.
For the years ended December 31, 2001, 2000 and 1999, the administration fee
was $144, $120 and $120, respectively.
During the year ended December 31, 2000, the Company purchased certificates
representing a 1% interest in Midland Commercial Mortgage Owner Trust IV,
Midland Commercial Mortgage Owner Trust V, Midland Commercial Mortgage Owner
Trust VI, Commercial Mortgage Owner Trust VII, PNC Loan Trust VII, and PNC
Loan Trust VIII for an aggregate investment of $7,021. These Midland Trusts
were purchased from Midland Loan Services, Inc. and the PNC trusts were
purchased from PNC Bank. Midland is a wholly owned indirect subsidiary of
PNC Bank and the depositor to the Trusts. The assets of the Trusts consist
of commercial mortgage loans originated or acquired by Midland and PNC Bank.
In connection with these transactions, the Company entered into a $4,500
committed line of credit from PNC Funding Corp., a wholly owned indirect
subsidiary of PNC Bank, to borrow up to 90% of the fair market value of the
Company's interest in the Trusts. Outstanding borrowings against this line
of credit bear interest at a LIBOR based variable rate. As of December 31,
2001 and 2000 there were no outstanding borrowings under this line of
credit. The Company earned $163 and $33 from the Trusts and paid interest of
approximately $138 and $20 to PNC Funding Corp. during years ended December
31, 2000 and 1999, respectively. These Midland Trusts were all sold prior to
December 31, 2000. The gain on sale of these investments was not
significant.
During 1999, the Company purchased certificates representing 1% interests in
Midland Commercial Mortgage Owner Trust I, Midland Commercial Mortgage Owner
Trust II, and Midland Commercial Mortgage Owner Trust III (the "Trusts")
from Midland for an aggregate investment of $5,346. During 1999 the
Company's interests in the Midland Commercial Mortgage Owner Trust I and II
were sold for $3,876 resulting in a realized gain of $87. In connection with
these transactions, the Company utilized a $4,500 committed line of credit
from PNC Funding Corp. to borrow up to 90% of the fair market value of the
Company's interest in the Trusts. Outstanding borrowings against this line
of credit bear interest at a LIBOR based variable rate. The Company paid
interest of approximately $20 to PNC Funding Corp. during the year ended
December 31, 1999.
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. 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 trusts were sold at a gain of $90.
On July 20, 2001, the Company entered into a $50 million commitment to
acquire shares in Carbon Capital, Inc. ("Carbon"), a private commercial real
estate income opportunity fund managed by BlackRock Financial Management,
Inc., who is also the manager of the Company. The Company does not pay
BlackRock management or incentive fees through Carbon and has received a
reduced fee for this investment on its own management contract with
BlackRock. On November 7, 2001 the Company received a capital call notice to
fund a portion of its Carbon Capital, Inc. investment. The total amount of
the capital call was $8,784, which was paid on November 19, 2001. The
proceeds were used by Carbon to acquire three commercial loans all of which
are secured by office buildings. The Company's remaining commitment is
$41,216. On December 31, 2001, the Company owned 32.5% of the outstanding
shares in Carbon, and BlackRock Financial Management, Inc., its affiliates,
officers, directors and employees collectively own 5%. In March 2002, Carbon
obtained additional commitments from unaffiliated institutional investors
while the Company's commitment remained unchanged. Accordingly, the
Company's ownership was reduced from 32.5% to 18.8%.
At the time of the Core-Cap merger, the Manager agreed to pay GMAC Mortgage
Asset Management, Inc. (GMAC) $12,500 over a ten-year period (Installment
Payment). The Company agreed that should it terminate the Manager without
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, 2001, the installment payment would be $11,000
payable over nine years. The Company does not accrue for this contingent
liability.
Note 10 STOCK OPTIONS
The Company has adopted a stock option plan (the "1998 Stock Option Plan")
that provides for the grant of both qualified incentive stock options that
meet the requirements of Section 422 of the Code, and non-qualified stock
options, stock appreciation rights and dividend equivalent rights. Stock
options may be granted to the Manager, directors, officers and any key
employees of the Company, directors, officers and key employees of the
Manager and to any other individual or entity performing services for the
Company.
The exercise price for any stock option granted under the 1998 Stock Option
Plan may not be less than 100% of the fair market value of the shares of
Common Stock at the time the option is granted. Each option must terminate
no more than ten years from the date it is granted. Subject to anti-dilution
provisions for stock splits, stock dividends and similar events, the 1998
Stock Option Plan authorizes the grant of options to purchase an aggregate
of up to 2,470,453 shares of Common Stock.
For option grants prior to December 15, 1998, the Company considered its
officers and directors to be employees for the purposes of stock option
accounting. In accordance with the FASB's Interpretation No. 44, Accounting
for Certain Transactions Involving Stock Compensation, the Company's
officers and directors are not considered to be employees for grants made
subsequent to that date.
Of the options issued under the 1998 Stock Option Plan, options covering
979,426 shares of the Company's Common Stock were granted prior to December
15, 1998 to individuals deemed to be employees. The Company adopted the
disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, for such options. Accordingly, no compensation cost for these
options has been recorded in the statement of operations. Had compensation
cost for these options been determined based on the fair value of the
options at the grant date consistent with the provisions of SFAS No. 123,
the Company's net income (loss) and net income (loss) per share would have
changed to the pro forma amounts indicated below:
2001 2000 1999
------------------------------------------------
Net income (loss) - as reported $56,271 $39,326 $26,673
Net income (loss) - pro forma 56,218 39,158 26,348
Basic income (loss) per share - as reported 1.41 1.37 1.27
Basic income (loss) per share - pro forma 1.41 1.36 1.25
Diluted income (loss) per share - as reported 1.35 1.28 1.26
Diluted income (loss) per share - pro forma 1.35 1.28 1.25
For the Company's pro forma net loss, the compensation cost is amortized
over the vesting period of the options.
For the options to purchase 786,915 shares of the Company's Common Stock
granted to non employees under the 1998 Stock Option Plan, compensation cost
is accrued based on the estimated fair value of the options issued, and
amortized over the vesting period. Because vesting of the options is
contingent upon the recipient continuing to provide services to the Company
to the vesting date, the Company estimates the fair value of the
non-employee options at each period end, up to the vesting date, and adjusts
expensed amounts accordingly. The value of these non-employee options at
each period end was negligible.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the periods ending December 31, 2000, and
1999. There were no options granted in 2001.
December 31
-----------------------------------
2000 1999
--------- --------
Estimated volatility 25% 25%
Expected life 7 years 8 years
Risk-free interest rate 6.0% 5.82%
Expected dividend yield 11.35% 15.91%
On May 15, 2000 pursuant to the acquisition of CORE Cap, the Company granted
stock options on the Company's stock to the directors of CORE Cap similar in
term and vesting to the stock options the directors held immediately prior
to the date of acquisition. The strike price was adjusted for the effect of
the acquisition. The options granted are as follows:
Number of Options Exercise %
Granted Price Vested
------------------------------------------------------------
76,998 $15.58 100%
15,400 15.84 100%
15,400 9.11 100%
15,400 7.82 100%
The fair value of the CORE Cap option grants at the grant date was estimated
by the Company using the Black-Scholes option-pricing model; the resulting
valuation was negligible.
The following table summarizes information about options outstanding under
the Plan:
2001 2000 1999
------------------------ ------------------------ ------------------------
Weighted- Weighted- Weighted-
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------------------ ------------------------ ------------------------
Outstanding at January 1 1,766,341 $13.87 1,718,143 $14.03 1,488,143 $15.00
Granted 0 193,198 11.73 270,000 8.44
Exercised 0 0 0
Cancelled 0 (145,000) 12.91 (40,000) 12.54
---------- ---------- ----------
Outstanding at December 31 1,766,341 $13.87 1,766,341 $13.87 1,718,143 $14.03
========== ========= ==========
Options exercisable at December 31 1,400,554 $13.70 919,770 $14.02 365,786 $15.00
========== ========= ==========
Weighted-average fair value of
options granted during the
year ended December 31
(per option) $0.12 $0.12 $0.06
======= ======= ======
The following table summarizes information about options outstanding
under the Plan at December 31, 2001:
Exercise Options Outstanding Remaining Options Exercisable at December 31,
Price at December 31,2001 Contractual Life 2001
-------------- ------------------- ---------------- -----------------------------------
7.82 15,400 8.1 Years 15,400
8.02 50,000 8.2 Years 25,000
8.44 230,000 7.2 Years 230,000
9.11 15,400 7.2 Years 15,400
15.00 1,363,143 6.2 Years 1,022,356
15.58 76,998 5.7 Years 76,998
15.83 15,400 6.2 Years 15,400
============== =================== ===================================
7.82-$15.83 1,766,341 6.43 Years 1,400,554
============== =================== ===================================
Shares available for future grant under the plan at December 31, 2001 were
704,122.
Note 11 BORROWINGS
The Company's borrowings consist of lines of credit borrowings and reverse
repurchase agreements.
In September of 2000, the Company closed a $200,000, one-year term facility
with Merrill Lynch Mortgage Capital Inc. ("Merrill Lynch"), which will be
used to finance the Company's residential mortgage loan pools. As of
December 31, 2001, there were no outstanding borrowings under this facility.
As of December 31, 2000, outstanding borrowings under this facility were
$37,253. Outstanding borrowings under this facility bear interest at a LIBOR
based variable rate. This facility expired pursuant to its terms.
The Company has another agreement with Merrill Lynch, which permits the
Company to borrow up to $200,000. As of December 31, 2001 and December 31,
2000, the outstanding borrowings under this line of credit were $57,113 and
$63,453, respectively. The agreement requires assets to be pledged as
collateral, which may consist of rated CMBS, rated RMBS, residential and
commercial mortgage loans, and certain other assets. Outstanding borrowings
under this line of credit bear interest at a LIBOR based variable rate. On
January 15, 2002, the facility was renewed for a twelve-month period.
In June 1999, the Company closed a $17,500, three year term financing
secured by the Company's $35,000 Santa Monica Loan. As of December 31, 2000,
the Company had drawn $17,500 under this loan. The loan was paid off in
March 2001 when the Santa Monica Loan was paid off.
On July 19, 1999, the Company entered into an $185,000 committed credit
facility with Deutsche Bank, AG (the "Deutsche Bank Facility"). The Deutsche
Bank Facility has a two-year term and provides for a one-year extension at
the Company's option. The Deutsche Bank Facility was extended for a one-year
term thru July 19, 2002, and is currently under negotiation to be extended.
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, 2001 and December 31, 2000, the
outstanding borrowings under this facility were $43,409 and $53,810,
respectively. Outstanding borrowings under the Deutsche Bank Facility bear
interest at a LIBOR based variable rate.
At the time of the CORE Cap acquisition, CORE Cap was a party to commercial
paper facility agreements with each of ABN Amro which was used to finance
residential and commercial loans, which are used to collateralize borrowings
under the facility. Following the CORE Cap acquisition, the Company renewed
the facility with ABN Amro, which facility is in the amount of $200,000, and
matured on June 18, 2001. As of December 31, 2000, outstanding borrowing
under the ABN Amro facility was $30,115; this facility was paid off in 2001.
The Company is subject to various covenants in its lines of credit,
including maintaining a minimum GAAP net worth of $140,000, a debt-to-equity
ratio not to exceed 5.0 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. Additionally, the Company's GAAP net
worth cannot decline by more than 37% during the course of any two
consecutive fiscal quarters. As of December 31, 2001 and 2000, the Company
was in compliance with all such covenants.
The Company has entered into reverse repurchase agreements to finance most
of its securities available for sale that are not financed under its lines
of credit. The reverse repurchase agreements are collateralized by most of
the Company's securities available for sale and bear interest at a LIBOR
based variable rate.
Certain information with respect to the Company's collateralized borrowings
at December 31, 2001 is summarized as follows:
Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loans Agreements Borrowings
--------------------- --------------------- ------------------------
Outstanding borrowings $ 115,747 $1,720,191 $1,835,938
Weighted average borrowing rate 3.62% 1.94% 2.04%
Weighted average remaining maturity 186 days 18 days 29 days
Estimated fair value of assets pledged $173,139 $1,825,971 $1,999,110
At December 31, 2001, $20,356 of borrowings outstanding under the line of
credit was denominated in pounds sterling, and interest payable is based on
sterling LIBOR.
As of December 31, 2001, the Company's collateralized borrowings had the following remaining maturities:
Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loan Agreements Borrowings
----------------------- ----------------------- ---------------------------
Within 30 days $58,453 $1,700,420 $1,758,873
31 to 59 days - 19,771 19,771
Over 60 days 57,294 - 57,294
----------------------- ----------------------- ---------------------------
$115,747 $1,720,191 $1,835,938
======================= ======================= ===========================
Certain information with respect to the Company's collateralized borrowings
as of December 31, 2000 is summarized as follows:
Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loans Agreements Borrowings
--------------------- ----------------------- ----------------------
Outstanding borrowings $ 202,130 $517,212 $719,342
Weighted average borrowing rate 7.71% 7.06% 7.24%
Weighted average remaining maturity 152 days 22 days 57 days
Estimated fair value of assets pledged $354,108 $588,657 $942,765
As of December 31, 2000, $23,129 of borrowings outstanding under the line of
credit were denominated in pounds sterling and interest payable based on
sterling LIBOR.
As of December 31, 2000, the Company's collateralized borrowings had the following remaining maturities:
Lines of Reverse Total
Credit and Term Loans Repurchase Collateralized
Agreements Borrowings
----------------------- ----------------------- ---------------------------
Within 30 days $63,453 $376,588 $440,041
31 to 59 days - 140,624 140,624
Over 60 days 138,677 - 138,677
======================= ======================= ===========================
$202,130 $517,212 $719,342
======================= ======================= ===========================
Under the lines of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
estimated market value. A reduction in the value of its pledged assets will
require the Company to provide additional collateral or fund margin calls.
From time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.
Note 12 DERIVATIVE INSTRUMENTS
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", as amended, 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.
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+ 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.
On January 1, 2001 the Company reclassified certain of its adjustable rate
agency debt securities, with an amortized cost of $64,432 from
available-for-sale to trading. An interest rate swap agreement with a
$25,000 notional amount that had been designated as hedging these debt
securities was similarly reclassified. The unrealized gain of $895 related
to the adjustable rate agency debt securities and the unrealized loss of
$2,798 related to the interest rate swap as of January 1, 2001 were
reclassified from OCI and recorded as the cumulative transition adjustment
to earnings upon adoption of SFAS 133. The net cumulative effect of adopting
SFAS 133 was ($1,903) and is reflected as "Cumulative Transition Adjustment
- SFAS 133" on the consolidated statement of operations.
In addition, on January 1, 2001, the Company re-designated interest rate
swap agreements with notional amounts aggregating $98,000 that had been
hedging available-for-sale debt securities as cash flow hedges of its
variable rate borrowings under reverse repurchase agreements. The fair value
of these swap agreements on January 1, 2001, an unrealized loss of ($9,853),
remained in OCI at the date of adoption of FAS 133, and therefore, did not
result in a transition adjustment.
Because of the de-designation and re-designation of the $98,000 interest
rate swaps, the Company is required to reclassify the related $9,853
recorded in OCI. Reclassification is on a straight-line basis over the
shorter of the life of the swap or the previously hedged assets and is
recognized as a reduction of interest income. For the year ended December
31, 2001, $994 was reclassified as a reduction of interest income and $248
will be reclassified as a reduction of interest income each quarter for the
next 12 months.
In addition, on January 1, 2001 the Company re-designated interest rate swap
agreements with notional amounts aggregating $57,744 that had been hedging
available-for-sale debt securities to hedges of trading securities. These
interest rate swap agreements were sold in January 2001; the loss of $795 is
included in loss on securities held for trading. As of December 31, 2000 the
accumulated loss for these interest rate swaps was $3,226. This accumulated
loss is being reclassified from OCI as a reduction of income from securities
available for sale over the weighted average life of the securities these
interest rate swaps were hedging on December 31, 2000. For the year ended
December 31, 2001, $257 was reclassified as a reduction of interest income.
As of December 31, 2001, the Company had interest rate swaps with notional
amounts aggregating $682,000 that were designated as cash flow hedges of
borrowings under reverse repurchase agreements. Their aggregate fair value
was a $9,343 liability included in other liabilities on the statement of
financial condition. This liability was collateralized with cash listed as
restricted cash on the Company's statement of financial condition. For the
year ended December 31, 2001, the net change in the fair value of the
interest rate swaps was ($12,369) of which $428 was deemed ineffective and
is included as additional interest expense and $11,941 was recorded as a
reduction of OCI. As of December 31, 2001, the $682,000 notional of swaps
which were designated as cash flow hedges had a weighted average remaining
term of 4.6 years.
During the year ended December 31, 2001, the Company terminated two of its
interest rate swaps with notional amounts aggregating $105,000 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 $7,291 loss in value incurred during 2001 thru the sale date,
over 8.8 years, which was the weighted average remaining term of the swaps
at the time they were closed out. For the year ended December 31, 2001, $118
was reclassified as an increase to interest expense and $203 will be
reclassified as an increase to interest expense each quarter for the next 12
months.
As of December 31, 2001, the Company had interest rate swaps with notional
amounts aggregating $110,000 designated as trading derivatives. Their
aggregate fair value at December 31, 2001 of ($37) is included in trading
securities. For the year ended December 31, 2001, the change in fair value
for these trading derivatives was $2,320 and is included as a reduction of
loss on securities held for trading in the consolidated statement of
operations. As of December 31, 2001, the $110,000 notional of swaps which
were designated as trading derivatives had a weighted average remaining term
of 29.9 years.
As of December 31, 2000, the Company had interest rate swaps with notional
amounts aggregating $226,000 designated as hedges of available for sale
securities. Their aggregate fair value at December 31, 2000 was a liability
of $12,505 and is included in other liabilities in the consolidated
statement of financial condition, the amortized cost was $9,471, and the
weighted average remaining term was 19.3 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.
In July 2000 the Company redesignated two interest rate agreements from
hedging certain of the Company's available-for-sale securities to securities
held for trading. These interest rate agreements were redesignated in
September 2000 back to hedging certain of the Company's available-for-sale
securities. The loss in value of these interest rate agreements during the
period they were designated as trading securities was $612 and is included
in gain on securities held for trading in the statement of operations.
Occasionally, counterparties will require the Company or the Company will
require counterparties to provide collateral for the interest rate swap
agreements in the form of margin deposits. Net deposits are recorded as a
component of accounts receivable or other liabilities. Should the
counterparty fail to return deposits paid, the Company would be at risk for
the fair market value of that asset. At December 31, 2001 and 2000, the
balance of such net margin deposits owed to counterparties as collateral
under these agreements totaled $1,311 and $81, respectively.
The implementation of SFAS 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. These
contracts are intended to manage currency risk in connection with the
Company's investment in the London Loan, which is denominated in pounds
sterling.
As of December 31, 2001 the Company agreed to exchange (pound)8,831 (pounds
sterling) for $12,350 (U.S. dollars) on January 22, 2002. On January 22,
2002 the Company agreed to exchange (pound)8,831 (pounds sterling) for
$12,679 on July 22, 2002. As of December 31, 2000 the Company agreed to
exchange (pound)8,000 (pounds sterling) for $12,137 (U.S. dollars) on
January 18, 2001. These contracts are intended to economically hedge
currency risk in connection with the Company's investment in the London
Loan, which is denominated in pounds sterling. The estimated fair value of
the forward currency exchange contracts was a liability of $489 and an asset
of $749 at December 31, 2001 and 2000, respectively, which was recognized as
a (reduction) addition of foreign currency losses. In certain circumstances,
the Company may be required to provide collateral to secure its obligations
under the forward currency exchange contracts, or may be entitled to receive
collateral from the counter party to the forward currency exchange
contracts. At December 31, 2001 and 2000 no collateral was required under
the forward currency exchange contracts.
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.
At December 31, 2001, the Company had outstanding short positions of 80
thirty-year U.S. Treasury Bond future contracts and 500 ten-year U.S.
Treasury Note future contracts expiring in March 2002, which represented
$8,000 and $50,000 in face amount of U.S. Treasury Bonds and Notes
respectively. The estimated fair value of these contracts was approximately
$(61,235) at December 31, 2001, and the change in fair value related to
these contracts in included as a component of loss on securities held for
trading. At December 31, 2000 the Company did not have U.S. Treasury future
contracts.
At December 31, 2001, the Company had outstanding a short position of 140
Eurodollar futures which expire 35 in each of June, September and December
2003, and 35 in March 2004. The estimated fair value of these contracts was
approximately $(32,987) at December 31, 2001, and the change in fair value
related to these contracts in included as a component of loss on securities
held for trading. At December 31, 2000 the Company did not have Eurodollar
future contracts.
In addition in December 2001 the Company wrote a call option on a 5-year
interest rate swap agreement with a notional amount of $400,000. The option
has an expiration date of December 2004. Proceeds received from the sale
were $13,180. This transaction was entered into to provide additional
short-term rate protection in a rising interest rate environment. The
Company wrote the option to accomplish this and take advantage of the high
market value of option prices at that time. The estimated fair value of this
contract was a liability of $10,500 as of December 31, 2001, and is included
in securities held for trading at a gain of $2,680. The Company closed this
position in February 2002. At December 31, 2000, the Company did not own any
call swaptions.
Note 13 Acquisition of CORE Cap, Inc.
On May 15, 2000, the Company acquired all of the outstanding capital stock
of CORE Cap, Inc. ("CORE Cap"), a private real estate investment trust
investing in mortgage loans and mortgage-backed securities, in exchange for
4,180,552 of the Company's common shares and 2,261,000 Series B preferred
shares. The common and preferred shares issued by the Company were valued at
approximately $71,094 on May 15, 2000. The acquisition was accounted for
under the purchase method. Application of purchase accounting resulted in an
excess of the value of the acquired net assets over the value of the
Company's common and preferred shares issued in the acquisition, plus
transaction costs. This deferred credit totaled $9,687 and is being
amortized as described in "Negative Goodwill" above. The operations of CORE
Cap are included in the Company's financial statements from May 15, 2000.
Pursuant to SFAS 142 (See Recent Accounting Pronouncements), the Company
will recognize the December 31, 2001 unamortized negative goodwill balance
of $6,327 in income during the first quarter of 2002.
The following unaudited consolidated proforma results of operations for the
years ended December 31, 2000 and 1999 assume the CORE Cap acquisition
occurred as of the beginning of each period presented:
2000 1999
------------------------------- --------------------------------
Total income $131,482 $174,441
Net income 44,427 48,693
Net income available to 35,242 41,587
common shareholders
Earnings per share:
Basic 1.49 1.66
Diluted 1.39 1.70
Note 14 NET INCOME (LOSS) PER SHARE
Net income per share is computed in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 128, Earnings Per Share. Basic income
(loss) per share is calculated by dividing net income (loss) available to
common shareholders by the weighted average number of common shares
outstanding during the period. Diluted income (loss) per share is calculated
using the weighted average number of common shares outstanding during the
period plus the additional dilutive effect of Common Stock equivalents. The
dilutive effect of outstanding stock options is calculated using the
treasury stock method, and the dilutive effect of preferred stock is
calculated using the "if converted" method.
For the year ended December 31,
2001 2000 1999
-------------------------------------------
Numerator:
Net Income available to common shareholders before
cumulative transition adjustment $ 49,210 $ 32,261 $ 26,389
Cumulative transition adjustment - SFAS 133 (1,903) - -
----------- --------- ----------
Numerator for basic earnings per share 47,307 32,261 26,389
Effect of 10.5% series A senior cumulative redeemable preferred stock 3,420 3,232 284
----------- --------- ----------
Numerator for diluted earnings per share $50,727 35,493 26,673
=========== ========= ==========
Denominator:
Denominator for basic earnings per share--weighted average
common shares outstanding 33,568 23,587 20,814
Effect of 10.5% series A senior cumulative redeemable preferred stock 3,993 4,082 336
Dilutive effect of stock options 55 - -
----------- --------- ----------
Denominator for diluted earnings per share--weighted average common shares
outstanding and common share equivalents outstanding 37,616 27,669 21,150
=========== ========= ==========
Basic net income per weighted average common share:
Income before cumulative transition adjustment $1.47 $1.37 $1.27
Cumulative transition adjustment - SFAS 133 (0.06) - -
----------- --------- ----------
Net income $1.41 $1.37 $1.27
=========== ========= ==========
Diluted net income per weighted average common share and common share
equivalents:
Income before cumulative transition adjustment $1.40 $1.28 $1.26
Cumulative transition adjustment - SFAS 133 (0.05) - -
----------- --------- ----------
$1.35 $1.28 $1.26
=========== ========= ==========
The Company's stock options were antidilutive in 2001 and the Series B
Preferred Stock was were antidilutive for all periods presented.
Note 15 SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of quarterly results of operations.
Quarters Ending
March 31 June 30 September 30 December 31
2001 2000 2001 2000 2001 2000 2001 2000
----------- ---------- ----------- ---------- ----------- ------------ ----------- -----------
Interest Income $26,340 $16,622 $28,405 $26,003 $36,246 $26,968 $40,229 $28,049
----------- ---------- ----------- ---------- ----------- ------------ ----------- -----------
Expenses:
Interest 12,272 7,467 11,665 15,096 18,341 14,765 17,123 13,784
Management fee and other 3,135 2,177 2,951 2,248 3,381 2,040 3,268 3,262
---------- ----------- ---------- ----------- ------------ ----------- ----------- -----------
Total Expenses 15,407 9,644 14,616 17,344 21,722 16,805 20,391 17,046
---------- ----------- ---------- ----------- ------------ ----------- ----------- -----------
Gain (loss) on sale of
securities available for sale 1,947 24 5,134 682 175 994 145 1,512
Gain (loss) on securities held
for trading 692 328 (124) - 1,875 191 (5,047) (1,166)
Foreign currency (loss) gain 104 (4) 5 (7) (91) 29 (23) (60)
Loss on impairment of asset - - (5,702) - - - - -
---------- ----------- ---------- ----------- ------------ ----------- ----------- -----------
Net income before cumulative
transition adjustment $13,676 $7,326 $13,102 $9,334 $16,483 $11,377 $14,913 $11,289
----------- ---------- ----------- ---------- ----------- ------------ ----------- -----------
Cumulative transition
adjustment - SFAS 133 (1,903) - - - - - - -
Net Income $11,773 $7,326 $13,102 $9,334 $16,483 $11,377 $14,913 $11,289
Dividends and accretion on
redeemable convertible preferred
stock 2,289 866 2,287 1,575 2,290 2,307 2,098 2,317
---------- ----------- ---------- ----------- ------------ ----------- ----------- -----------
Net income available to common
shareholders $9,484 $6,460 $10,815 $7,759 $14,193 $9,070 $12,815 $8,972
=========== ========== =========== ========== =========== ============ =========== ===========
Net income per share:
Basic $0.35 $0.31 $0.33 $0.34 $0.40 $0.36 $0.33 $0.36
Diluted $0.33 $0.29 $0.32 $0.32 $0.38 $0.34 $0.31 $0.34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT
Incorporated by reference to the Company's annual report
to security holders for the year ended December 31, 2001
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to the Company's annual report
to security holders for the year ended December 31, 2001
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference to the Company's annual report
to security holders for the year ended December 31, 2001
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference to the Company's annual report
to security holders for the year ended December 31, 2001
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a)(3) Exhibit Index
**3.1 Articles of Amendment and Restatement of the Registrant
**3.2 Bylaws of the Registrant
**10.1 Investment Advisory Agreement between the Registrant and
BlackRock Financial Management, Inc.
**10.2 Form of 1998 Stock Option Incentive Plan
10.3 Amendment No.3 to the Investment Advisory Agreement between
the Registrant and Black Rock Financial Mangement, Inc. dated
March 25, 2002
**21.1 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche
24.1 Power of Attorney (included on signature page hereto)
------------------------------------------------------------------------------
** Previously filed.
1. Reports on Form 8-K.
o Current Report on Form 8-K filed on December 21, 2001.
o Current Report on Form 8-K filed on November 14, 2001.
o Current Report on Form 8-K filed on October 29, 2001.
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 28, 2002 By: /s/ Hugh R. Frater
------------------
Hugh R. Frater
President and Chief Executive Officer
and Director
(duly authorized representative)
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below constitutes and appoints Richard M. Shea his true and lawful
attorney-in-fact and agents with full power of substitution and
resubstitution, for his name, place and stead, in any and all capacities, to
sign any and all amendments (including post-effective amendments) to this
Form 10-K and to file the same with all exhibits thereto, and all documents
in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full
power and authority to do and perform each and every act and thing requisite
and necessary to be done, as fully to all intents and purposes as he might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof. This
power of attorney may be executed in counterparties.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
Date: March 28, 2002 By: /s/ Hugh R. Frater
--------------------------------------
Hugh R. Frater
President and Chief Executive Officer
and Director
Date: March 28, 2002 By: /s/ Laurence D. Fink
--------------------------------------
Laurence D. Fink
Chairman of the Board of Directors
Date: March 28, 2002 By: /s/ Donald G. Drapkin
--------------------------------------
Donald G. Drapkin
Director
Date: March 28, 2002 By: /s/ Carl F. Guether
--------------------------------------
Carl F. Guether
Director
Date: March 28, 2002 By: /s/ Jeffrey C. Keil
--------------------------------------
Jeffrey C. Keil
Director
Date: March 28, 2002 By: /s/ Kendrick R. Wilson, III
--------------------------------------
Kendrick R. Wilson, III
Director
Date: March 28, 2002 By: /s/ David M. Applegate
--------------------------------------
David M. Applegate
Director
Date: March 28, 2002 By: /s/ Leon T. Kendall
--------------------------------------
Leon T. Kendall
Director