DYNEX CAPITAL INC
10-Ks and 10-Qs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
fiscal year ended December 31, 2009
or
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period from _______________ to _______________
Commission
file number 1-9819
DYNEX
CAPITAL, INC.
(Exact
name of registrant as specified in its charter)
|
Virginia
|
52-1549373
|
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
|
incorporation
or organization)
|
Identification
No.)
|
|
4991
Lake Brook Drive, Suite 100, Glen Allen, Virginia
|
23060
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
|
(804)
217-5800
(Registrant’s
telephone number, including area code)
|
|
|
Securities
registered pursuant to Section 12(b) of the Act:
|
|
|
Title of each class
|
Name of each exchange on which
registered
|
|
Common
Stock, $.01 par value
|
New
York Stock Exchange
|
|
Series
D 9.50% Cumulative Convertible
Preferred
Stock, $.01 par value
|
New
York Stock Exchange
|
|
Securities
registered pursuant to Section 12(g) of the Act:
None
|
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes
o
No
þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.
Yes
o
No
þ
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
þ
No
o
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
Yes
o
No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of 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.
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
|
Large
accelerated filer
|
o
|
Accelerated
filer
|
þ
|
|
Non-accelerated
filer
|
o
(Do
not check if a smaller reporting company)
|
Smaller reporting
company
|
o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
Yes
o
No
þ
As of
June 30, 2009, the aggregate market value of the voting stock held by
non-affiliates of the registrant was approximately $90,065,635 based on the
closing sales price on the New York Stock Exchange of $8.20.
Common
stock outstanding as of March 1, 2010 was 14,182,912 shares.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the Definitive Proxy Statement for the registrant’s 2010 annual meeting of
shareholders, expected to be filed pursuant to Regulation 14A within 120 days
from December 31, 2009, are incorporated by reference into Part
III.
TABLE
OF CONTENTS
|
Page
Number
|
|||
|
PART
I.
|
|||
|
Item
1.
|
Business
|
1
|
|
|
Item
1A.
|
Risk
Factors
|
7
|
|
|
Item
1B.
|
Unresolved
Staff Comments
|
23
|
|
|
Item
2.
|
Properties
|
23
|
|
|
Item
3.
|
Legal
Proceedings
|
23
|
|
|
Item
4.
|
Reserved
|
24
|
|
|
PART
II.
|
|||
|
Item
5.
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
25
|
|
|
Item
6.
|
Selected
Financial Data
|
27
|
|
|
Item
7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
27
|
|
|
Item
7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
54
|
|
|
Item
8.
|
Financial
Statements and Supplementary Data
|
61
|
|
|
Item
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
61
|
|
|
Item
9A.
|
Controls
and Procedures
|
61
|
|
|
Item
9B.
|
Other
Information
|
62
|
|
|
PART
III.
|
Item
10.
|
Directors,
Executive Officers and Corporate Governance
|
63
|
|
Item
11.
|
Executive
Compensation
|
63
|
|
|
Item
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
63
|
|
|
Item
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
63
|
|
|
Item
14.
|
Principal
Accountant Fees and Services
|
64
|
|
|
PART
IV.
|
Item
15.
|
Exhibits,
Financial Statement Schedules
|
65
|
|
SIGNATURES
|
68
|
||
i
CAUTIONARY
STATEMENT – This Annual Report on Form 10-K may contain “forward-looking”
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended (or “1933 Act”), and Section 21E of the Securities Exchange Act of 1934,
as amended. We caution that any such forward-looking statements
made by us are not guarantees of future performance, and actual results may
differ materially from those in such forward-looking statements. Some
of the factors that could cause actual results to differ materially from
estimates contained in our forward-looking statements are set forth in this
Annual Report on Form 10-K for the year ended December 31, 2009. See
Item 1A, “Risk Factors” as well as “Forward-Looking Statements” set forth in
Item 7, “Management’s Discussion and Analysis of Financial Condition and Results
of Operations” of this Annual Report on Form 10-K.
In
this Annual Report on Form 10-K, we refer to Dynex Capital, Inc. and its
subsidiaries as “we,” “us,” or “our,” unless we specifically state otherwise or
the context indicates otherwise. The following defines certain
commonly used terms in this Annual Report on Form 10-K: MBS refers to
mortgage-backed securities; CMBS refers to commercial mortgage-backed
securities; RMBS refers to residential mortgage-backed securities; Agency MBS
refers to our MBS that are issued or guaranteed by a federally chartered
corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S.
government, such as Ginnie Mae; Hybrid ARMs refers to ARMs that have interest
rates that are fixed for a specified period of time and, thereafter, adjust
generally annually to an increment over a specified interest rate index; ARMs
refers to adjustable-rate mortgage loans which typically have interest rates
that adjust annually to an increment over a specified interest rate index,
and includes Hybrid ARMs that are within twelve months of their
initial reset date; and ARM MBS refers to MBS that are secured by ARMs. The date
that the interest rate on an ARM adjusts based on the terms of that respective
security is known as the reset date.
|
ITEM
1.
|
BUSINESS
|
We are a
real estate investment trust, or REIT, which invests in mortgage securities and
loans on a leveraged basis. We were incorporated in Virginia on
December 18, 1987 and commenced operations in February
1988.
We invest
in mortgage-backed securities (“MBS”) issued or guaranteed by a federally
chartered corporation, such as Federal National Mortgage Corporation (“Fannie
Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency
of the U.S. government, such as Government National Mortgage Association
(“Ginnie Mae”). MBS issued or guaranteed by Fannie Mae, Freddie Mac
and Ginnie Mae are commonly referred to as “Agency MBS”. We initiated
our Agency MBS strategy during the first quarter of 2008, and it has remained
our primary investment strategy throughout 2009.
We also
invest in commercial mortgage-backed securities (“CMBS”) and non-Agency
residential mortgage-backed securities, (collectively, “non-Agency securities”)
as well as securitized residential and commercial mortgage
loans. Substantially all of these securities and loans consist of, or
are secured by, first lien mortgages which were originated by us from 1992 to
1998. We are no longer originating loans.
We have
generally financed our investments through a combination of repurchase
agreements, securitization financing, and equity capital. We employ
leverage in order to increase the overall yield on our invested
capital. Our primary source of income is net interest income, which
is the excess of the interest income earned on our investments over the cost of
financing these investments. Although our intention is generally to
hold our investments on a long-term basis, we may occasionally sell investments
prior to their maturity.
As a
REIT, we are required to distribute to our shareholders as dividends on our
preferred and common stock at least 90% of our taxable income, which is our
income as calculated for income tax purposes after consideration of our tax net
operating loss carryforwards (“NOLs”). We had an NOL carryforward of
approximately $156.7 million as of December 31, 2008. We anticipate
utilizing approximately $7.5 million of the NOL carryforward to offset our 2009
taxable income, but this amount is subject to change as we complete our 2009 tax
return. These NOLs do not begin to meaningfully expire
until
1
2019. Provided
that we do not experience an ownership shift as defined under Section 382 of the
Internal Revenue Code (“Code”), we may utilize the NOLs to offset portions of
our distribution requirements for our REIT taxable income with certain
limitations. If we do incur an ownership shift under Section 382 of
the Code, then the use of the NOLs to offset REIT distribution requirements may
be limited. We also have a taxable REIT subsidiary which has a NOL
carryforward of approximately $4.2 million as of December 31,
2008. For further discussion, see “Federal Income Tax
Considerations.”
Investment
Strategy
Our
investment strategy contemplates the allocation of our capital in investments
that in our view have attractive risk-adjusted return
profiles. Because we use leverage to enhance the returns on our
invested capital, we must evaluate the attractiveness and risk of any investment
based on the actual amount of the investment and the amount of equity capital
(i.e., investment less leverage) allocated to each
investment. Our strategy for the last several years has
included the investment in short-duration, high-grade Agency MBS with less
exposure to credit risk, interest rate risk, and liquidity risk (i.e., the risk
that the security cannot be leveraged). In 2009, we also began
investing in CMBS rated ‘AAA’ by at least one of the nationally recognized
rating services. During 2009, we increased our portfolio of Agency
MBS by $282.5 million and our portfolio of non-Agency securities by $102.9
million primarily related to our acquisition of ‘AAA’ rated CMBS with a fair
value of $99.1 million as of December 31, 2009.
We have
invested our capital primarily in Agency MBS because of the attractive
risk-adjusted return profile of that strategy. We expect to continue
primarily investing in shorter-duration, high grade securities such as Agency
MBS and ‘AAA’-rated CMBS and RMBS for the foreseeable future depending on the
nature and risks of the investment, its expected return, and future economic and
market conditions.
With
respect to our investment in Agency MBS, we invest in Hybrid Agency ARMs and
Agency ARMs and, to a lesser extent, fixed-rate Agency MBS. Hybrid
Agency ARMs are MBS collateralized by hybrid adjustable mortgage loans, which
have a fixed-rate of interest for a specified period (typically three to ten
years) and which then reset their interest rates at least annually to an
increment over a specified interest rate index. Hybrid Agency ARMs
that are within twelve months of the end of their fixed-rate periods may be
classified within Agency ARMs. Agency ARMs are MBS collateralized by
adjustable rate mortgage loans which have interest rates that generally will
adjust at least annually to an increment over a specified interest rate
index. As of December 31, 2009, our Agency MBS were collateralized by
approximately $295.7 million in Hybrid Agency ARMs, $298.3 million in Agency
ARMs, and $0.1 million in fixed rate MBS.
Interest
rates on the ARM loans collateralizing the Hybrid Agency ARMs and Agency ARMs
are based on specific index rates, such as the one-year constant maturity
treasury (“CMT”) rate, the London Interbank Offered Rate (“LIBOR”), the Federal
Reserve U.S. 12-month cumulative average one-year CMT (“MTA”), or the 11th
District Cost of Funds Index (“COFI”). These mortgage loans will
typically have interim and lifetime caps on interest rate adjustments, or
interest rate caps, limiting the amount that the rates on these loans may reset
in any given period.
With
respect to our remaining investments, we currently have $109.1 million in
non-Agency securities, $150.4 million in securitized commercial mortgage loans,
$62.1 million in securitized single-family residential mortgage loans, and $2.1
million in unsecuritized mortgage loans. Of the non-Agency
securities, $103.2 million are CMBS and $99.1 million of those are rated
‘AAA’. The commercial mortgage loans and non-Agency securities
generally carry a fixed rate of interest. The single-family mortgage
loans are predominantly variable rate based primarily on a spread to six month
LIBOR.
Financing
Strategy
As noted above, we use leverage to
enhance the returns of our investments. Currently, we use a
combination of repurchase agreements and securitizations to finance our
investments. In addition, we have recently received approval to
participate in the Term Asset-Backed Securities Loan Facility (“TALF”) program
offered by the Federal Reserve Bank of New York. This program is
discussed further in the “Non-Agency securities” section below. We
may occasionally hedge our borrowing costs by entering into derivative
instruments such as interest rate caps and interest rate swaps. Below
is a discussion of our financing strategy for our different
investments.
2
Agency
MBS
We finance our Agency MBS by borrowing
against a substantial portion of the market value of these assets utilizing
repurchase agreements. Repurchase agreements are financings under
which we pledge our Agency MBS as collateral to secure loans made by the
repurchase agreement counterparty (i.e., the lender). The amount
borrowed under a repurchase agreement is usually limited by the lender to a
percentage of the estimated market value of the pledged collateral, which is
normally up to 95% for Agency MBS. The difference between the market
value of the pledged Agency MBS collateral and the amount of the repurchase
agreement is the amount of equity we have in the position and is intended to
provide the lender some protection against fluctuations of value in the
collateral and/or the failure by us to repay the borrowing.
Under
repurchase agreement arrangements, a lender may require that we pledge
additional assets by initiating a margin call if the fair value of our pledged
collateral declines below a required margin amount specified within the terms of
the particular repurchase agreement. Our pledged collateral
fluctuates in value primarily due to principal payments and changes in market
interest rates and spreads, prevailing market yields, actual or anticipated
prepayment speeds and other market conditions. Lenders may also
initiate margin calls during periods of market stress. If we fail to
meet any margin call, our lenders have the right to terminate the repurchase
agreement and sell the collateral pledged. We will set aside
securities and/or cash in order to lower our overall debt to equity ratio and to
maintain financial flexibility to meet margin calls from our
lenders.
With
respect to financing our Agency MBS, we expect to maintain an effective debt to
equity capital ratio of between five and nine times our equity capital invested
in Agency MBS, although the ratio may vary from time to time depending upon
market conditions and other factors.
Non-Agency
Securities
We generally finance our ‘AAA’-rated
non-Agency securities by borrowing against a portion of the market value of
these assets utilizing repurchase agreements. We are not
currently borrowing against non-Agency securities that are rated below
‘AAA’.
Like
Agency MBS, the amount borrowed under a repurchase agreement for non-Agency
securities is limited by the lender to a certain percentage of the estimated
market value of the pledged collateral, which is normally up to 85% for
non-Agency securities. Similar to Agency MBS, we are subject to
margin calls by lenders, and if we fail to meet any margin call, our lenders
have the right to terminate the repurchase agreement and sell the collateral
pledged. We will set aside securities and/or cash in order to lower
our overall debt to equity ratio and to maintain financial flexibility to meet
margin calls from our lenders. With respect to financing our
non-Agency securities, we expect to maintain an effective debt to equity capital
ratio of between two and five times our equity capital invested in non-Agency
securities, although the ratio may vary from time to time depending upon market
conditions and other factors.
Repurchase
agreement borrowings generally will have a term of between one and three months
and carry a rate of interest based on a spread to an index, such as LIBOR.
In prior years, repurchase agreement terms for certain collateral could be as
long as one year, though such terms are less common in the marketplace
today. Repurchase agreement financing is provided principally by
major financial institutions and major broker-dealers. A significant
source of liquidity for the repurchase agreement market is money market funds
which provide collateral-based lending to the financial institutions and
broker-dealer community that, in turn, is provided to the repurchase agreement
market. In order to reduce our exposure to counterparty related risk,
we generally seek to diversify our exposure by entering into repurchase
agreements with multiple lenders. Together with Agency MBS, our
maximum net exposure, which is defined as the difference between the amount
loaned to us plus accrued interest payable and the value of the securities
pledged by us as collateral plus accrued interest receivable, to any single
repurchase agreement lender was $18.0 million as of December 31,
2009.
In June
2009, the New York Federal Reserve began accepting certain ‘AAA’ rated CMBS as
eligible collateral for financing under its TALF program. The
financing is on a non-recourse basis for periods ranging from three to five
years. This program will only be offered for a limited time as the
financing of existing CMBS under TALF is set to expire in March 2010 and the
financing of newly issued CMBS under TALF is set to expire in June
2010. As of February 28, 2010, we have purchased $15.0 million in
non-Agency CMBS of which $12.8 million is being financed under the TALF
program. We anticipate using additional financing under the TALF
program for certain of our future CMBS investments.
3
In the
future, we may use other sources of funding in addition to repurchase agreements
and TALF borrowings to finance our Agency MBS and non-Agency portfolios
including, but not limited to, other types of collateralized borrowings such as
loan agreements, lines of credit, commercial paper, or the issuance of equity or
debt securities.
Securitized
Mortgage Loans
We have
financed our securitized mortgage loans with securitization financing issued by
us to third parties. Through limited-purpose finance subsidiaries the
Company has issued non-recourse bonds pursuant to indentures which are
collateralized by the mortgage loans. Each series of securitization
financing may consist of various classes of bonds at either fixed or variable
rates of interest and having varying repayment terms. Payments
received on securitized mortgage loans and reinvestment income earned thereon is
used to make payments on the securitization financing bonds. As of
December 31, 2009, we had approximately $119.7 million of securitization
financing which carried a fixed-rate of interest and approximately $23.4 million
which carried a variable-rate of interest which resets monthly based on a spread
to LIBOR.
The
obligations under securitization financing are payable solely from the cash
flows generated by the securitized mortgage loans collateralizing the financing
and are otherwise non-recourse to the Company. The stated maturity
date for each class of bonds is generally calculated based on the final
scheduled payment date of the underlying collateral. The actual
maturity of each class will be directly affected by the rate of principal
prepayments on the related collateral. Generally we will have the
right to redeem the securitization financing at its outstanding principal
balance plus accrued interest after a certain date or once the securitization
financing is paid down to a certain percentage of its original principal
balance. As a result, the actual maturity of any class of a series of
securitization financing may occur earlier than its stated
maturity.
Hedging
Activities
We have
and will continue to use derivative instruments to hedge our exposure to changes
in interest rates. For example, during a period of rising interest
rates, we may be exposed to reductions in our net interest income because
interest rates on our investments may not reset as frequently as the interest
rates on our repurchase agreement and securitization financing borrowings, or if
we have financed fixed rate assets with floating rate borrowings. In
an effort to protect our net interest income during a period of rising interest
rates, we may enter into certain hedging transactions including entering into
interest rate swap agreements and interest rate cap agreements.
An
interest rate swap agreement allows us to fix the borrowing cost on a portion of
our repurchase agreement or securitization financing for a specified period of
time. Typically in an interest rate swap transaction, we will pay an
agreed upon fixed rate of interest determined at the time of entering into the
agreement for a period typically between two and five years while receiving
interest based on a floating rate such as LIBOR. An interest rate cap
agreement is a contract whereby we, as the purchaser, pay a fee in exchange for
the right to receive payments equal to the principal (i.e., notional amount)
times the difference between a specified interest rate and a future interest
rate (typically LIBOR) during a defined “active” period of
time. During the fourth quarter of 2009, we entered into three
interest rate swap agreements which are discussed further in Item 7,
“Management’s Discussion and Analysis of Financial Condition” and in Note 11 to
the consolidated financial statements. As of December 31, 2009,
we had $105 million in interest rate swaps with a weighted average fixed rate of
interest of 1.67%. We have not entered into any interest rate cap
agreements as of December 31, 2009.
In
addition, in a period of rising rates we may experience a decline in the
carrying value of our Agency MBS and non-Agency securities, which will impact
our shareholders’ equity and common book value per share. As a
result, we may also utilize derivative financial instruments such as interest
rate swap and interest rate cap agreements in an effort to protect our book
value.
Competition
The
financial services industry is a highly competitive market in which we compete
with a number of institutions with greater financial resources. In
purchasing portfolio investments, we compete with other mortgage REITs,
investment banking firms, savings and loan associations, commercial banks, hedge
funds, mortgage bankers, insurance companies, federal agencies and other
entities, many of which have much greater financial resources and a lower cost
of capital than we do. Increased competition in the market may drive
prices of investments to unacceptable levels for the Company and could adversely
impact our ability to borrow under repurchase agreements.
4
Government
Policy
The
volatility experienced in the credit markets over the last several years
resulted in extraordinary and often coordinated measures by global central banks
and governments to restore liquidity to the credit markets. Some of
these activities included participation in markets by central banks and
governments in which they would not normally participate. For example, among
other programs, the U.S. Treasury Department (“Treasury”) and the Federal
Reserve initiated programs to purchase Agency MBS in the open market pursuant to
a congressional authority. These programs expire as of December 31,
2009 and in March 2010, respectively. Through February 16, 2010, the
Treasury and Federal Reserve have purchased a combined total of $1.4 trillion in
Agency MBS, which is comprised mostly of 30-year and 15-year fixed rate
mortgages. The Treasury and Federal Reserve purchases of Agency MBS
have resulted in increased prices of all Agency MBS, including Hybrid ARMs and
ARMs, which has resulted in an increased market value of our portfolio of Agency
MBS. In addition, the New York Federal Reserve has initiated the TALF
financing program for certain types of securities as discussed
above. Active participation by governmental entities in the private
markets has resulted in generally more liquid and less volatile markets, while
causing asset prices to increase and yields to decrease
correspondingly.
Over time
as the credit markets function more normally, the Treasury and the Federal
Reserve will likely withdraw from participating in or providing liquidity to the
private markets. However, until that time, government participation
in private markets will continue to impact supply, values, and the liquidity of
these markets. The impact on the markets of the withdrawal of
governmental entities is uncertain and market reactions to such withdrawal could
be severe.
FEDERAL
INCOME TAX CONSIDERATIONS
As a
REIT, we are required to abide by certain requirements for qualification as a
REIT under the Code. The REIT rules generally require that a REIT
invest primarily in real estate-related assets, that our activities be passive
rather than active and that we distribute annually to our shareholders
substantially all of our taxable income, after certain deductions, including
deductions for NOL carryforwards. We could be subject to income tax
if we failed to satisfy those requirements. We use the calendar year
for both tax and financial reporting purposes.
There may
be differences between taxable income and income computed in accordance with
U.S. generally accepted accounting principles (“GAAP”). These
differences primarily arise from timing differences in the recognition of
revenue and expense for tax and GAAP purposes. We had NOL
carryforwards of approximately $156.7 million as of December 31, 2008, which
expire principally between 2019 and 2020. We anticipate utilizing
$7.5 million of the NOL carryforward to offset our 2009 taxable income, but this
amount is subject to change as we complete our 2009 tax return.
Failure
to satisfy certain Code requirements could cause us to lose our status as a
REIT. If we failed to qualify as a REIT for any taxable year, we may
be subject to federal income tax (including any applicable alternative minimum
tax) at regular corporate rates and would not receive deductions for dividends
paid to shareholders. We could, however, utilize our NOL
carryforwards to offset any taxable income. In addition, given the
size of our NOL carryforwards, we could pursue a business plan in the future in
which we would voluntarily forego our REIT status. If we lost or
otherwise surrendered our status as a REIT, we could not elect REIT status again
for five years. Several of our investments in securitized mortgage
loans have ownership restrictions limiting their ownership to
REITs. Therefore, if we chose to forego our REIT status, we would
have to sell these investments or otherwise provide for REIT ownership of these
investments. In addition, many of our repurchase agreement lenders
require us to maintain our REIT status. If we lost our
REIT status these lenders have the right to terminate any repurchase agreement
borrowings at that time.
We also
have a taxable REIT subsidiary (“TRS”), which had a NOL carryforward of
approximately $4.2 million as of December 31, 2008. As we have not yet completed
our 2009 tax return, we do not know the balance of this NOL carryforward as of
December 31, 2009. The TRS has limited operations, and, accordingly,
we have established a full valuation allowance for the related deferred tax
asset.
Qualification as a
REIT
Qualification
as a REIT requires that we satisfy a variety of tests relating to our income,
assets, distributions and ownership. The significant tests are
summarized below.
5
Sources of
Income
. To continue qualifying as a REIT, we must satisfy two
distinct tests with respect to the sources of our income: the “75% income test”
and the “95% income test.” The 75% income test requires that we
derive at least 75% of our gross income (excluding gross income from prohibited
transactions) from certain real estate-related sources. In order to
satisfy the 95% income test, 95% of our gross income for the taxable year must
consist of either income that qualifies under the 75% income test or certain
other types of passive income.
If we
fail to meet either the 75% income test or the 95% income test, or both, in a
taxable year, we might nonetheless continue to qualify as a REIT, if our failure
was due to reasonable cause and not willful neglect and the nature and amounts
of our items of gross income were properly disclosed to the Internal Revenue
Service. However, in such a case we would be required to pay a tax
equal to 100% of any excess non-qualifying income.
Nature and Diversification of
Assets
. At the end of each calendar quarter, we must meet
multiple asset tests. Under the “75% asset test”, at least 75% of the
value of our total assets must represent cash or cash items (including
receivables), government securities or real estate assets. Under the
“10% asset test,” we may not own more than 10% of the outstanding voting power
or value of securities of any single non-governmental issuer, provided such
securities do not qualify under the 75% asset test or relate to taxable REIT
subsidiaries. Under the “5% asset test,” ownership of any stocks or
securities that do not qualify under the 75% asset test must be limited, in
respect of any single non-governmental issuer, to an amount not greater than 5%
of the value of our total assets (excluding ownership of any taxable REIT
subsidiaries).
If we
inadvertently fail to satisfy one or more of the asset tests at the end of a
calendar quarter, such failure would not cause us to lose our REIT status,
provided that (i) we satisfied all of the asset tests at the close of the
preceding calendar quarter and (ii) the discrepancy between the values of
our assets and the standards imposed by the asset tests either did not exist
immediately after the acquisition of any particular asset or was not wholly or
partially caused by such an acquisition. If the condition described
in clause (ii) of the preceding sentence was not satisfied, we still could
avoid disqualification by eliminating any discrepancy within 30 days after the
close of the calendar quarter in which it arose.
Ownership
. In
order to maintain our REIT status, we must not be deemed to be closely held and
must have more than 100 shareholders. The closely held prohibition
requires that not more than 50% of the value of our outstanding shares be owned
by five or fewer persons at anytime during the last half of our taxable
year. The more than 100 shareholders rule requires that we have at
least 100 shareholders for 335 days of a twelve-month taxable
year. In the event that we failed to satisfy the ownership
requirements we would be subject to fines and be required to take curative
action to meet the ownership requirements in order to maintain our REIT
status.
EMPLOYEES
As of
December 31, 2009, we had 13 employees and one corporate office in Glen Allen,
Virginia. We believe our relationship with our employees is
good. None of our employees are covered by any collective bargaining
agreements, and we are not aware of any union organizing activity relating to
our employees.
Executive Officers of the
Registrant
|
Name
(Age)
|
Current
Title
|
Business
Experience
|
|
Thomas
B. Akin (58)
|
Chairman
of the Board and Chief Executive Officer
|
Chief
Executive Officer since February 2008; Chairman of the Board since 2003;
managing general partner of Talkot Capital, LLC since 1995.
|
|
Stephen
J. Benedetti (47)
|
Executive
Vice President, Chief Operating Officer and Chief Financial
Officer
|
Executive
Vice President and Chief Operating Officer since November 2005; Executive
Vice President and Chief Financial Officer from September 2001 to November
2005 and beginning again in February 2008.
|
|
Byron
L. Boston (51)
|
Chief
Investment Officer
|
Chief
Investment Officer since April 2008; President of Boston Consulting Group
from November 2006 to April 2008; Vice Chairman and Executive Vice
President of Sunset Financial Resources, Inc. from January 2004 to October
2006.
|
6
AVAILABLE
INFORMATION
We are
subject to the reporting requirements of the Securities Act of 1934 (“Exchange
Act”), as amended, and its rules and regulations. The Exchange Act requires us
to file reports, proxy statements, and other information with the SEC. Copies of
these reports, proxy statements, and other information can be read and copied
at:
SEC
Public Reference Room
100 F
Street, N.E.
Washington,
D.C. 20549
Information
on the operation of the Public Reference Room may be obtained by calling the SEC
at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy
statements, and other information regarding issuers that file electronically
with the SEC. These materials may be obtained electronically by accessing the
SEC’s home page at
http://www.sec.gov
.
Our
website can be found at
www.dynexcapital.com
. Our
annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current
reports on Form 8-K, and amendments to those reports, filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act, are made available free
of charge through our website as soon as reasonably practicable after such
material is electronically filed with or furnished to the Securities and
Exchange Commission (“SEC”).
We have
adopted a Code of Business Conduct and Ethics (“Code of Conduct”) that applies
to all of our employees, officers and directors. Our Code of Conduct
is also available free of charge on our website, along with our Audit Committee
Charter, our Nominating and Corporate Governance Committee Charter, and our
Compensation Committee Charter. We will post on our website
amendments to the Code of Conduct or waivers from its provisions, if any, which
are applicable to any of our directors or executive officers in accordance with
SEC or NYSE requirements.
|
ITEM
1A.
|
RISK
FACTORS
|
Our
business is subject to various risks, including those described
below. Our business, operating results, and financial condition could
be materially and adversely affected by any of these risks. Please
note that additional risks not presently known to us or that we currently deem
immaterial could also impair our business, operating results, and financial
condition.
|
Page
Number
|
|
|
Risks
Related to Access to Credit Markets
|
7
|
|
Risks
Related to Our Business
|
8
|
|
Risks
Related to Regulatory and Legal Requirements
|
19
|
|
Risks
Related to Owning Our Stock
|
21
|
Risks
Related to Access to Credit Markets
The
success of our business is predicated on our access to the credit
markets. Failure to access credit markets on reasonable terms, or at
all, could adversely affect our profitability and may, in turn, negatively
affect the market price of shares of our common stock.
The
credit markets have in recent years experienced extreme volatility, resulting in
diminished financing capacity for mortgage investments. We depend
upon the availability of adequate funding for our operations. Our
access to capital depends upon a number of factors, over which we have little or
no control, including:
|
-
|
General
market and economic conditions;
|
|
-
|
The
actual or perceived financial condition of credit market participants
including banks, broker-dealers, hedge funds, and money-market funds,
among others;
|
7
|
-
|
The
impact of governmental policies and/or regulations on institutions with
respect to activities in the credit
markets;
|
|
-
|
Market
perception of asset quality and liquidity of securities in which we
invest; and
|
|
-
|
Market
perception of our financial strength, our growth potential and the quality
of our assets.
|
The recent volatility in the credit
markets has demonstrated that general market conditions and the perceived effect
on market participants can severely restrict the flow of capital to the credit
markets. In recent years, volatility in the credit markets
significantly impacted many participants in these markets resulting in a
meaningful reduction in the amount of liquidity available for
participants. When such an event occurs, lenders may be unwilling or
unable to provide financing for our investments or may be willing to provide
financing only at much higher rates. This may impact our
profitability by increasing our borrowing costs or by forcing us to sell
assets.
In
addition, the impairment of other financial institutions could negatively affect
us. If one or more major market participants fails or otherwise experience a
major liquidity crisis, as was the case for Lehman Brothers Holdings Inc. in
September 2008, it could adversely affect the marketability of all fixed income
securities and this could negatively impact the value of the securities we
acquire, thus reducing our shareholders’ equity and book
value. Furthermore, if any of our potential lenders or any of our
lenders are unwilling or unable to provide us with financing, we could be forced
to sell our securities at time when prices are depressed or when we are under
duress.
In
addition, there is uncertainty as to governmental policies and/or regulations
with respect to participants in the credit markets. Much of the
liquidity for the credit markets comes from money funds whose size and liquidity
have been impacted by the recent low interest rate environment. The
Treasury has terminated its purchases of Agency MBS, which totaled approximately
$220 billion as of December 31, 2009. As of February 16, 2010, the
Federal Reserve has purchased approximately $1.2 trillion in Agency MBS and will
continue its purchases through March 2010. The Federal Reserve has
also indicated that at some point in the future it will conduct reverse
repurchase operations in order to remove excess liquidity from the
markets. While the Federal Reserve is unlikely to conduct such
operations until the markets have fully stabilized, such an event could
constrain credit markets in the future.
Risks
Related to Our Business
We
invest in securities where the timely receipt of principal and interest is
guaranteed by Fannie Mae and Freddie Mac. Both Fannie Mae and Freddie
Mac are currently under federal conservatorship and the Treasury has committed
to purchasing preferred stock from each of these entities in order to ensure
their adequate capitalization. Efforts made to stabilize Fannie Mae
and Freddie Mac may prove unsuccessful, which may impact their ability to
perform under the guaranty. If Fannie Mae and Freddie Mac are unable
to perform on their guaranty, we are likely to incur losses on our investments
in Agency MBS.
The
payments we receive on the Agency MBS in which we invest depend upon payments on
the mortgages underlying the MBS which are guaranteed by Fannie Mae and Freddie
Mac. Fannie Mae and Freddie Mac are U.S. Government-sponsored
entities, but their guarantees are not explicitly backed by the full faith and
credit of the United States. Fannie Mae and Freddie Mac have reported
substantial losses in recent years and a need for substantial amounts of
additional capital. Such losses are due to these entities’ business model being
tied extensively to the U.S. housing market which is in a severe
contraction. In response to the deteriorating financial condition of
Fannie Mae and Freddie Mac, Congress and the Treasury have undertaken a series
of actions to stabilize these entities including the creation of the Federal
Housing Finance Agency, or FHFA, to enhance regulatory oversight over Fannie Mae
and Freddie Mac. FHFA has placed Fannie Mae and Freddie Mac into
federal conservatorship.
In order
to provide additional capital and to support the debt obligations issued by
Fannie Mae and Freddie Mac, the Treasury and FHFA have entered into preferred
stock purchase agreements between the Treasury and Fannie Mae and Freddie Mac,
pursuant to which the Treasury will ensure that each of Fannie Mae and Freddie
Mac maintains a positive net worth. Under this initiative, the
Treasury has purchased or has committed to purchasing an unlimited amount of
preferred stock of both Fannie Mae and Freddie Mac in order to ensure their
solvency. The Treasury also has established a new secured lending
credit facility available to Fannie Mae and Freddie Mac until December 2010
which is intended to serve as a liquidity backstop.
8
Although
the federal government has committed capital to Fannie Mae and Freddie Mac,
there is no explicit guaranty of the obligations of these entities by the
federal government, and there can be no assurance that these credit facilities
and other capital infusions will be adequate for their needs or that the
Treasury will not alter its support in the future. If the financial support is
inadequate, these companies could continue to suffer losses and could fail to
honor their guarantees of payment on Agency MBS in which we
invest. In such a case we are likely to experience losses on
our Agency MBS.
The
federal conservatorship of Fannie Mae and Freddie Mac may lead to structural
changes in Agency MBS and/or Fannie Mae and Freddie Mac which may adversely
affect our business.
As noted
above, Fannie Mae and Freddie Mac are both under conservatorship and the
Treasury has committed to purchasing preferred stock of each of these entities
to support their capitalization. The poor financial condition of
these entities and their reliance on the Treasury for capital could alter or
limit their future participation in the mortgage markets. The outcome
of the conservatorship of Fannie Mae and Freddie Mac is uncertain and could
result in their liquidation, the combining of the two entities into one, or the
consolidation of these entities with a government entity such as Ginnie
Mae. Any of these events could result in a meaningful change in the
nature of their guarantees and the Agency MBS market. The supply of
new issue Agency MBS could be reduced or eliminated which would substantially
impact a major component of our business model. While existing Agency MBS may
not be impacted, it is uncertain whether such actions with respect to Fannie Mae
and Freddie Mac will cause volatility in the pricing of Agency MBS. A
reduction in the supply of Agency MBS could also increase the pricing of Agency
securities we seek to acquire, thereby reducing the spread between the interest
we earn on our investments and our cost of financing those
investments.
Attempts
to stabilize the housing and mortgage market have resulted in the Treasury and
Federal Reserve buying fixed-rate Agency MBS in an effort to lower overall
mortgage rates. During 2009, the Treasury and Federal Reserve
purchased approximately $1.3 trillion in Agency MBS, or 81%, of the estimated
$1.6 trillion of Agency MBS issued during 2009. When the Treasury and
Federal Reserve discontinue their purchases of Agency MBS, this may result in an
increase in mortgage rates and substantial volatility in Agency MBS
prices.
In an
effort to support the U.S. housing market, the Treasury and Federal Reserve have
become substantial buyers of Agency MBS. While they have not
purchased Hybrid Agency ARMs or Agency ARMs, their purchases of fixed rate
Agency MBS have caused all Agency MBS to increase in price. The
Treasury announced it has discontinued its purchases of Agency MBS as of
December 31, 2009 while the Federal Reserve has announced it will discontinue
its purchases of Agency MBS in March 2010. While the ultimate impact
is unknown, the withdrawal of the Treasury and Federal Reserve from purchasing
Agency MBS may cause prices of all Agency MBS to decline which would cause our
shareholders’ equity to decline and may result in margin calls by our lenders
for Agency MBS that are pledged as collateral for repurchase
agreements. If declines in prices are substantial, this may force us
to sell assets at a loss or at an otherwise inopportune time in order to meet
margin calls or repay lenders.
Mortgage loan modification programs
and future legislative action may adversely affect the value of and the return
on the single-family loans and securities in which we
invest
.
The U.S.
Government, through the Federal Housing Authority and the Federal Deposit
Insurance Corporation, has implemented programs designed to provide homeowners
who are delinquent on their mortgage loans with alternatives to a
lender-initiated foreclosure on their home. These programs may
involve, among other things, the modification of mortgage loans to reduce the
principal amount of the loans or the rate of interest payable on the loan or to
extend the payment terms of the loans. In addition, the U.S. Congress
has indicated support for additional legislative relief for homeowners at the
expense of lender’s rights, including an amendment of the bankruptcy laws to
permit the modification of mortgage loans in bankruptcy proceedings. Loan
modifications such as these may cause the fair value of some of our investments
to decline. A decrease in the fair value of our investments that are
pledged as collateral for repurchase agreements may result in margin calls by
our lenders, which will negatively impact our liquidity. We may be
forced to sell assets at a loss or at a lower than expected return in order to
meet margin calls or repay lenders.
Changes
in prepayment rates on the mortgage loans underlying our investments may
adversely affect our profitability and subject us to reinvestment
risk.
9
Our
investments subject us to prepayment risk to the extent that we own these
investments at premiums or discounts to their par value. Prepayments
by borrowers of principal on the loans underlying our investments impact the
amortization of premiums and discounts under the effective yield method of
accounting in accordance with GAAP. Under the effective yield method
of accounting, we recognize yields on our assets based on assumptions regarding
future cash flows. Variations in actual cash flows from those assumed
as a result of prepayments and subsequent changes in future cash flow
expectations will cause adjustments in yields on assets which could contribute
to volatility in our future results. For example, if we own our
investments at premiums to their par value, such as our Agency MBS and CMBS,
actual prepayments experienced in excess of forecasts as well as increased
future prepayments, will cause us to amortize these premiums on an accelerated
basis which may adversely affect our profitability. We use a
third-party prepayment modeling servicer to help us estimate future prepayments
on our investments.
Prepayments
occur on both a voluntary or involuntary basis. Voluntary prepayments
tend to increase when interest rates are declining or, in the case of Hybrid
ARMs or ARMs, based on the shape of the yield curve as discussed further
below. However, the actual level of prepayments will be impacted by
economic and market conditions, including loan-to-value and income documentation
requirements. Involuntary prepayments tend to increase when the yield
curve is steep, evidencing economic stress and increasing delinquencies on the
underlying loans.
If we
receive increased prepayments of our principal in a declining interest rate
environment, we may earn a lower return on our new investments as compared to
the MBS that prepay given the declining interest rate environment. If
we reinvest our capital in lower yielding investments, we will likely have lower
net interest income and reduced profitability unless the cost of financing these
investments declines faster than the rate at which we may reinvest.
Fannie
Mae and Freddie Mac have recently announced a change in their policy of
purchasing delinquent loans included in Agency MBS pools, which could increase
prepayment rates on Agency MBS we currently own.
Under current policies, Fannie Mae and
Freddie Mac are obligated to buy out seriously delinquent loans from an Agency
MBS pool if the loan has been seriously delinquent for 24 months, if the loan
has been permanently modified, or if a foreclosure or short sale has occurred on
the property. Otherwise, Fannie Mae and Freddie Mac have the right,
but not the obligation, to buy out delinquent loans in Agency MBS pools before
the 24 month period. Fannie Mae and Freddie Mac have an obligation to
advance principal and interest on delinquent loans to the holders of the Agency
MBS if such loans have not been bought out of the Agency MBS pool. In
the past, despite the requirement to continue to advance principal and interest,
Fannie Mae and Freddie Mac have not exercised their right to actively buy out
delinquent loans from Agency MBS pools because such buy-outs required an
immediate write-down in the balance of the loans in their GAAP financial
statements (and therefore a capital charge). However, recent changes
in GAAP which become effective as of January 1, 2010 will result in Fannie Mae
and Freddie Mac having to consolidate all loans guaranteed by them in their
financial statements and provide loss reserves on delinquent loans versus
writing them down to liquidation value.
On
February 10, 2010, primarily as a result of the change in GAAP, Fannie Mae and
Freddie Mac announced their intentions to buy out delinquent loans that are
currently past due 120 days or more from Agency MBS pools. Freddie
Mac is expected to complete its buy-outs in February 2010 and Fannie Mae is
expected to have completed its buy-outs over a three month period beginning in
March 2010. Neither Freddie Mac nor Fannie Mae has provided
sufficient information to determine the ultimate impact of the buy-outs on our
Agency MBS. We believe, however, that some of our Agency MBS will be
affected and that we will see an increase in prepayments in those pools over the
next several months. Given the dollar price at which we own the
Agency MBS and since we record premium amortization under GAAP based on actual
and anticipated prepayment activity, we expect to see some increase in premium
amortization for the first half of 2010 relative to the last two quarters of
2009 where our premium amortization has averaged approximately $0.9 million per
quarter. Any increase in premium amortization could adversely affect
our results of operations. We expect Fannie Mae and Freddie Mac will
continue buying out any additional loans that become 120 days or more delinquent
from Agency MBS pools for the foreseeable future; however, we do not anticipate
that subsequent buy-outs will have as significant of an impact on our
prepayments because the population of delinquent loans 120 days or more past due
will not be as large as the initial population.
10
A flat or inverted yield curve may
adversely affect prepayment rates and supply of Hybrid ARMs and
ARMs
.
When the differential between
short-term and long-term benchmark interest rates narrows, the yield curve is
said to be “flattening.” When short-term interest rates increase and
exceed long-term interest rates, the yield curve is said to be
“inverted”. When this flattening or inversion occurs, borrowers have
an incentive to refinance into fixed rate mortgages, or Hybrid ARMs with longer
initial fixed-rate periods, which could cause our investments to experience
faster levels of prepayments than expected. As noted above, increases
in prepayments on our investments would cause our premium amortization to
accelerate, lowering the yield on such assets and decreasing our net interest
income. In addition, a decrease in the supply of Hybrid ARMS and ARMs
will decrease the supply of securities collateralized by these types of loans,
which could force us to change our investment strategy.
A
decrease or lack of liquidity in our investments may adversely affect our
business, including our ability to value and sell our assets.
We invest
in securities that are not publicly traded in liquid markets. Though
Agency MBS are generally deemed to be a very liquid security turbulent market
conditions in the past have at times significantly and negatively impacted the
liquidity of these assets. Generally this has resulted in
reduced pricing for the Agency MBS (with disparities in pricing depending upon
the source) and lower advance rates (or conversely higher equity requirements)
from our repurchase agreement lenders. In some extreme cases,
financing might not be available for certain Agency MBS. Generally
our lenders will value Agency MBS based on liquidation value in periods of
significant market volatility.
With
respect to non-Agency securities, such securities typically experience greater
price volatility than Agency MBS as there is no guaranty of payment, and they
generally can be more difficult to value. In addition, third-party
pricing for non-Agency securities and CMBS may be more subjective than for
Agency MBS. As such, non-Agency securities and CMBS are typically
less liquid than Agency MBS and are subject to greater risk of repurchase
agreement financing not being available, market value reductions, and/or lower
advance rates and higher costs from lenders.
The
illiquidity of our investment securities may make it difficult for us to sell
any such investments if the need or desire arises. In addition, if we are
required to liquidate all or a portion of our portfolio quickly, we may realize
significantly less than the value at which we have previously recorded certain
of our investment securities. As a result, our ability to vary our portfolio in
response to changes in economic and other conditions may be relatively limited,
which could adversely affect our results of operations and financial
condition.
Changes
to the availability and terms of leverage used to finance our business may
adversely affect our profitability and result in losses and/or reduced cash
available for distribution to our shareholders.
We use
leverage in part to finance the acquisition of investments in order to enhance
the overall returns on our invested capital. As long as we earn a
positive spread between interest and other income we earn on our assets and our
borrowing costs, we can generally increase our profitability by using greater
amounts of leverage. While the use of leverage enhances the returns
on our capital, it also exposes us to certain risks, particularly if such
leverage is uncommitted, short-term in nature or has terms which are
significantly different from the terms of the related investment being
financed.
Repurchase
agreements are generally uncommitted financings from lenders with an average
term of ninety days or less. We use repurchase agreements to finance
Hybrid ARM Agency MBS, Arm Agency MBS, non-Agency securities, and
CMBS. Changes in the availability and cost of repurchase agreement
borrowings could negatively impact our results. As discussed above,
changes in the availability of repurchase agreement financing may occur as a
result of volatility in the credit markets from volatility in asset prices,
financial stress at the Company or the financial stress at one or more of our
lenders. Our return on our assets and cash available for distribution
to our shareholders may be reduced due to changes in market conditions which may
prevent us from leveraging our investments efficiently, or at all, or may cause
the cost of our financing to increase relative to the income that can be derived
from the leveraged assets.
11
In
addition to changes in the availability of repurchase agreement financing and
rising costs, if the value of the collateral pledged to support the repurchase
agreement borrowing should fall below the level required by the lender, the
lender could initiate a margin call. This would require that we
either pledge additional collateral acceptable to the lender (typically cash or
a highly liquid security such as Agency MBS) or repay a portion of the debt in
order to meet the margin requirement. Should we be unable to meet a
margin call, we may have to liquidate the collateral or other assets
quickly. Because a margin call and quick sale could result in a lower
than otherwise expected and attainable sale price, we may incur a loss on the
sale of the collateral.
Since
we expect to rely primarily on borrowings under repurchase agreements to finance
certain of our investments, our ability to achieve our investment objectives
depends on our ability to borrow money in sufficient amounts and on favorable
terms and on our ability to renew or replace maturing borrowings on a continuous
basis. Our ability to enter into repurchase agreements in the future
will depend on the market value of our investments pledged to secure the
specific borrowings, the availability of adequate financing and other conditions
existing in the lending market at that time. If we are not able to
renew or replace maturing borrowings, we could be forced to sell some of our
assets, potentially under adverse circumstances, which would adversely affect
our profitability.
In
addition, in response to certain market, interest rate and investment
environments, we could implement a strategy of reducing our leverage by selling
assets or not replacing MBS as they amortize and/or prepay, thereby decreasing
the outstanding amount of our related borrowings. Such an action
would likely reduce interest income, interest expense and net income, the extent
of which would depend on the level of reduction in assets and liabilities as
well as the sale prices for which the assets were sold.
If
a lender to us in a repurchase transaction defaults on its obligation to resell
the underlying security back to us at the end of the transaction term, or if we
default on our obligations under a repurchase agreement, we will incur
losses.
Repurchase
agreement transactions are legally structured as the sale of a security to a
lender in return for cash from the lender. These transactions are
accounted for as financing agreements since the lenders are obligated to resell
the same securities back to us at the end of the transaction
term. Because the cash we receive from the lender when we initially
sell the securities to the lender is less than the value of those securities, if
the lender defaults on its obligation to resell the same securities back to us,
we would incur a loss on the transaction equal to the difference between the
value of the securities sold and the amount borrowed from the
lender. Further, if we default on one of our obligations under a
repurchase agreement, the lender can terminate the transaction, sell the
underlying collateral and cease entering into any other repurchase transactions
with us. Any losses we incur on our repurchase transactions could
adversely affect our earnings and reduce our ability to pay dividends to our
shareholders.
A
decline in the market value of our assets may cause our book value to decline
and may result in margin calls that may force us to sell assets under adverse
market conditions.
The
market value of our assets generally moves inversely to changes in interest
rates and, as a result, may be negatively impacted by increases in interest
rates. Our investments are generally valued based on a spread to the
Treasury curve or the LIBOR swap curve. The movement of the Treasury
and LIBOR swap curves can result from a variety of factors, including factors
such as Federal Reserve policy, market inflation expectations, and market
perceptions of risk. In periods of high volatility, spreads to the
respective curve may increase causing reductions in value on these
investments. In addition, in a rising interest rate environment, the
value of our assets may decline. As most of our investments are
considered available for sale under GAAP, the decline in value will cause our
shareholders’ equity to correspondingly decline.
In
addition, since we utilize recourse collateralized financing such as repurchase
agreements, a decline in the market value of our investments may limit our
ability to borrow against these assets or result in our lenders initiating
margin calls and requiring a pledge of additional collateral or
cash. Posting additional collateral or cash to support our borrowings
will reduce our liquidity and limit our ability to leverage our assets, which
could adversely affect our business. As a result, we could be forced
to sell some of our assets in order to maintain liquidity. Forced
sales typically result in lower sales prices than do market sales made in the
normal course of business. If our investments were liquidated at
prices below the amortized cost basis of such investments, we would incur
losses, which could result in a rapid deterioration of our financial
condition.
12
Adverse developments involving major
financial institutions or one of our lenders could also result in a rapid
reduction in our ability to borrow and adversely affect our business and
profitability.
Recent
turmoil in the financial markets relating to major financial institutions has
raised concerns that a material adverse development involving one or more major
financial institutions could result in our lenders reducing our access to funds
available under our repurchase agreements. All of our repurchase
agreements are uncommitted, and such a disruption could cause our lenders to
reduce or terminate our access to future borrowings. In such a
scenario, we may be forced to sell investments under adverse market
conditions. We may also be unable to purchase additional investments
without access to additional financing. Either of these events could
adversely affect our business and profitability.
Our
ownership of securitized mortgage loans subjects us to credit risk and, although
we provide for an allowance for loan losses on these loans as required under
GAAP, the loss reserves are based on estimates. As a result, actual
losses incurred may be larger than our reserves, requiring us to provide
additional reserves, which will impact our financial position and results of
operations.
We are subject to credit risk as a
result of our ownership of securitized mortgage loans. Credit risk is
the risk of loss to us from the failure by a borrower (or the proceeds from the
liquidation of the underlying collateral) to fully repay the principal balance
and interest due on a mortgage loan. A borrower’s ability to repay
the loan and the value of the underlying collateral could be negatively impacted
by economic and market conditions. These conditions could be global,
national, regional or local in nature.
We
attempt to mitigate this risk by pledging loans to a securitization trust and
issuing non-recourse securitization financing bonds (referred to as a
“securitization”), and by obtaining certain insurance policies or other loss
reimbursement agreements when available. Upon securitization of a
pool of mortgage loans, the credit risk retained by us from an economic point of
view is generally limited to the overcollateralization tranche of the
securitization trust, inclusive of any subordinated bonds of the trust that we
may own. The overcollateralization tranche is generally the excess
value of the mortgage loans pledged over the securitization financing bonds
issued. However, GAAP does not recognize the transfer of credit risk
through the securitization process. Instead, GAAP requires that we
provide reserves for estimated losses on the entire pool of loans regardless of
the securitization process.
We
provide reserves for losses on securitized mortgage loans based on the current
performance of the respective pool or on an individual loan basis. If
losses are experienced more rapidly due to declining property performance,
market conditions or other factors, than we have provided for in our reserves,
we may be required to provide additional reserves for these
losses. In addition, our allowance for loan losses is based on
estimates and to the extent that proceeds from the liquidation of the underlying
collateral are less than our estimates, we will record a reduction in our
profitability for that period equal to the shortfall.
Our
efforts to manage credit risk may not be successful in limiting delinquencies
and defaults in underlying loans or losses on our investments. If we experience
higher than anticipated delinquencies and defaults, our earnings and our cash
flow may be negatively impacted.
There are
many aspects of credit performance for our investments that we cannot
control. Third party servicers provide for the primary and special
servicing of our single-family and commercial mortgage loans and non-Agency
securities and CMBS. In that capacity these service providers control
all aspects of loan collection, loss mitigation, default management and ultimate
resolution of a defaulted loan. We have a risk management function
which oversees the performance of these servicers and provides limited asset
management services. Loan servicing companies may not cooperate with
our risk management efforts, or such efforts may be ineffective. We
have no contractual rights with respect to these servicers and our risk
management operations may not be successful in limiting future delinquencies,
defaults, and losses.
The
securitizations in which we have invested may not receive funds that we believe
are due from mortgage insurance companies and other
counter-parties. Service providers to securitizations, such as
trustees, bond insurance providers, guarantors and custodians, may not perform
in a manner that promotes our interests or may default on their obligation to
the securitization trust. The value of the properties collateralizing
the loans may decline causing higher losses
13
than
anticipated on the liquidation of the property. The frequency of
default and the loss severity on loans that do default may be greater than we
anticipated. If loans become “real estate owned” (“REO”), servicing
companies will have to manage these properties and may not be able to sell
them. Changes in consumer behavior, bankruptcy laws, tax laws, and
other laws may exacerbate loan losses. In some states and
circumstances, the securitizations in which we invest have recourse, as the
owner of the loan, against the borrower’s other assets and income in the event
of loan default; however, in most cases, the value of the underlying property
will be the sole source of funds for any recoveries.
We
invest in commercial mortgage loans and CMBS collateralized by commercial
mortgage loans which are secured by income producing properties. Such
loans are typically made to single-asset entities and the repayment of the loan
is dependent principally on the performance and value of the underlying
property. The volatility of certain mortgaged property values may
adversely affect our CMBS.
Our CMBS
which are secured by multifamily and commercial property are subject to risks of
delinquency, foreclosure, and loss that are greater than similar risks
associated with loans secured by single-family residential property. The ability
of a borrower to repay a loan secured by an income-producing property typically
is dependent upon the successful operation of the property rather than upon the
existence of independent income or assets of the borrower. If the net operating
income of the property is reduced, the borrower's ability to repay the loan may
be impaired. Net operating income of an income-producing property can be
affected by, among other things: tenant mix, success of tenant businesses,
property management decisions, property location and condition, competition from
comparable types of properties, changes in laws that increase operating expenses
or limit rents that may be charged, any need to address environmental
contamination at the property, changes in national, regional or local economic
conditions and/or specific industry segments, declines in regional or local real
estate values and declines in regional or local rental or occupancy rates,
increases in interest rates, real estate tax rates and other operating expenses,
changes in governmental rules, regulations and fiscal policies, including
environmental legislation, and acts of God, terrorism, social unrest and civil
disturbances.
Commercial
and multifamily property values and net operating income derived from them are
subject to volatility and may be affected adversely by a number of factors,
including, but not limited to, national, regional and local economic conditions
(which may be adversely affected by plant closings, industry slowdowns and other
factors); local real estate conditions (such as an oversupply of housing,
retail, industrial, office or other commercial space); changes or continued
weakness in specific industry segments; perceptions by prospective tenants,
retailers and shoppers of the safety, convenience, services and attractiveness
of the property; the willingness and ability of the property's owner to provide
capable management and adequate maintenance; construction quality, age and
design; demographic factors; retroactive changes to building or similar codes;
and increases in operating expenses (such as energy costs).
Certain
investments employ internal structural leverage as a result of the
securitization process and are in the most subordinate position in the capital
structure, which magnifies the potential impact of adverse events on our cash
flows.
As
discussed above, securitized mortgage loans have been pledged to securitization
trusts which have issued securitization financing bonds collateralized by the
loans pledged. By their design, securitization trusts employ a high
degree of internal structural leverage (i.e., the securitization financing bonds
issued), which results in concentrated credit, interest rate, prepayment, or
other risks to our investment in the trust. Generally in a
securitization, we will receive the excess of the interest income and principal
received on the loans pledged over the interest expense and principal paid on
the securitization financing bonds according to the terms of the respective
indenture. Our cash flow received is generally subordinate to
payments due on the securitization bonds. As a result, our net
interest income and related cash flows will vary based on the performance of the
assets pledged to the securitization trust. In particular, should
assets significantly underperform as to defaults and credit losses, it is
possible that net interest income and cash flows which may have otherwise been
paid to us as a result of our ownership of the securitization trust may be
retained within the trust and payments of principal amounts on our ownership
position in the trust may be delayed or permanently reduced. To date,
none of our existing trusts have reached or are near the levels of
underperformance that would trigger delays or reductions in income or cash
flows, but such levels could be reached in the future.
Guarantors
may fail to perform on their obligations to our securitization trusts, which
could result in additional losses to our Company.
14
In
certain instances we have guaranty of payment on commercial and single family
mortgage loans pledged to securitization trusts (See Item 7A. “Quantitative and
Qualitative Disclosures About Market Risk”). These guarantors have
reported substantial losses since 2007, eroding their respective capital base
and potentially impacting their ability to make payments where
required. Generally the guarantors will only make payment in the
event of the default and liquidation of the collateral supporting the
loan. If these guarantors fail to make payment, we may experience
losses on the loans that we otherwise would not have.
We
may be subject to the risks associated with inadequate or untimely services from
third-party service providers, which may harm our results of operations. We also
rely on corporate trustees to act on behalf of us and other holders of
securities in enforcing our rights.
Our loans
and loans underlying securities we own are serviced by third-party service
providers. Should a servicer experience financial difficulties, it may not be
able to perform these obligations. Servicers who have sought bankruptcy
protection may, due to application of provisions of bankruptcy law, not be
required to make advance payments to us of amounts due from loan obligors. Even
if a servicer were able to advance amounts in respect of delinquent loans, its
obligation to make the advances may be limited to the extent that is does not
expect to recover the advances due to the deteriorating credit of the delinquent
loans. In addition, as with any external service provider, we are subject to the
risks associated with inadequate or untimely services for other reasons.
Servicers may not advance funds to us that would ordinarily be due because of
errors, miscalculations, or other reasons. Many borrowers require notices and
reminders to keep their loans current and to prevent delinquencies and
foreclosures, which our servicers may fail to provide. In the current economic
environment, many servicers are experiencing higher volumes of delinquent loans
than they have in the past and, as a result, there is a risk that their
operational infrastructures cannot properly process this increased volume. A
substantial increase in our delinquency rate that results from improper
servicing or loan performance in general may result in credit
losses.
We also
rely on corporate trustees to act on behalf of us and other holders of
securities in enforcing our rights. Under the terms of most securities we hold
we do not have the right to directly enforce remedies against the issuer of the
security, but instead must rely on a trustee to act on behalf of us and other
security holders. Should a trustee not be required to take action under the
terms of the securities, or fail to take action, we could experience
losses.
Credit
ratings assigned to debt securities by the credit rating agencies may not
accurately reflect the risks associated with those
securities. Changes in credit ratings for securities we own or
for similar securities might negatively impact the market value of these
securities.
Rating
agencies rate securities based upon their assessment of the safety of the
receipt of principal and interest payments. Rating agencies do not consider the
risks of fluctuations in fair value or other factors that may influence the
value of securities and, therefore, the assigned credit rating may not fully
reflect the true risks of an investment in securities. Also, rating agencies may
fail to make timely adjustments to credit ratings based on available data or
changes in economic outlook or may otherwise fail to make changes in credit
ratings in response to subsequent events, so that our investments may be better
or worse than the ratings indicate. We try to reduce the impact of the risk that
a credit rating may not accurately reflect the risks associated with a
particular debt security by not relying solely on credit ratings as the
indicator of the quality of an investment. We make our acquisition decisions
after factoring in other information. However, our assessment of the quality of
an investment may also prove to be inaccurate and we may incur credit losses in
excess of our initial expectations.
Credit
rating agencies may change their methods of evaluating credit risk and
determining ratings on securities backed by real estate loans and securities.
These changes may occur quickly and often. The market’s ability to understand
and absorb these changes, and the impact to the securitization market in
general, are difficult to predict. Such changes may have a negative
impact on the value of securities that we own.
Fluctuations
in interest rates may have various negative effects on us and could lead to
reduced profitability and a lower book value.
15
Fluctuations
in interest rates impact us in a number of ways. For example, as more
fully explained below, in a period of rising rates, we may experience a decline
in our profitability from borrowing rates increasing faster than our assets
reset or from our investments adjusting less frequently or relative to a
different index (e.g., one-year LIBOR) from our borrowings. We may
also experience a reduction in the market value of our Hybrid ARM securities and
CMBS as a result of higher yield requirements for these types of securities by
the market. In a period of declining interest rates, we may
experience increasing prepayments resulting in reduced profitability and returns
of our capital in lower yielding investments as discussed
elsewhere.
Many of our investments are financed
with borrowings which have shorter maturity or interest-reset terms than the
associated investment. In addition, our CMBS are fixed-rate and a
significant portion of our Agency MBS will have a fixed-rate of interest for a
certain period of time and which have an interest rate which resets
semi-annually or annually, based on an index such as the one-year CMT or the
one-year LIBOR. Agency MBS are financed with repurchase agreements
which bear interest based predominantly on one-month LIBOR, and generally have
initial maturities between 30 and 90 days. In a period of rising
rates our borrowings will typically increase in rate faster than our assets may
reset resulting in a reduction in our net interest income. The
severity of any such decline would depend on our asset/liability composition at
the time as well as the magnitude and period over which interest rates
increase.
Additionally, increases in interest
rates may negatively affect the market value of our securities. In
rare instances increases in short-term rates are rapid enough that short-term
rates equal or exceed medium/long-term rates resulting in a flat or inverted
yield curve. Any fixed-rate or Hybrid ARM investments will generally be more
negatively affected by these increases than securities whose interest-rate
periodically adjusts. For those securities that we carry at estimated market
value in our financial statements, we are required to reduce our stockholders’
equity, or book value, by the amount of any decrease in the market value of
these securities.
Interest
rate caps on the adjustable rate mortgage loans collateralizing our investments
may adversely affect our profitability if interest rates increase.
The coupons earned on Hybrid ARMs
adjust over time as interest rates change after a fixed-rate
period. The level of adjustment on the interest rates on ARMs is
limited by contract and is based on the limitations of the underlying adjustable
rate mortgage loans. Such loans typically have interim and lifetime
interest rate caps which limit the amount by which the interest rates on such
assets can adjust. Interim interest rate caps limit the amount
interest rates can adjust during any given period. Lifetime interest
rate caps limit the amount interest rates can increase from inception through
maturity of a particular loan. The financial markets primarily determine the
interest rates that we pay on the repurchase transactions used to finance the
acquisition of our ARMs. These repurchase transactions are not
subject to interim and lifetime interest rate caps. Accordingly, in a
sustained period of rising interest rates or a period in which interest rates
rise rapidly, we could experience a decrease in net income or a net loss because
the interest rates paid by us on our borrowings could increase without
limitation (as new repurchase transactions are entered into upon the maturity of
existing repurchase transactions) while increases in the interest rates earned
on the adjustable rate mortgage loans collateralizing our ARMs could be limited
due to interim or lifetime interest rate caps.
Our
use of hedging strategies to mitigate our interest rate exposure may not be
effective, may adversely affect our income, may expose us to counterparty risks,
and may increase our contingent liabilities.
We may
pursue various types of hedging strategies, including interest rate swap
agreements, interest rate caps and other derivative transactions (collectively,
“hedging instruments”). We expect hedging to assist us in mitigating
and reducing our exposure to higher interest expenses, and to a lesser extent,
losses in book value, from adverse changes in interest rates. Our
hedging activity will vary in scope based on the level and volatility of
interest rates, the type of assets in our investment portfolio and financing
sources used. No hedging strategy, however, can completely insulate
us from the interest rate risks to which we are exposed, and there is no
assurance that the implementation of any hedging strategy will have the desired
impact on our results of operations or financial condition. Certain
of the U.S. federal income tax requirements that we must satisfy in order to
qualify as a REIT may limit our ability to hedge against such
risks. In addition, these hedging strategies may adversely affect us
because hedging activities involve an expense that we will incur regardless of
the effectiveness of the hedging activity.
16
Interest
rate hedging may fail to protect or could adversely affect us because, among
other things:
|
·
|
interest
rate hedging can be expensive, particularly during periods of rising and
volatile interest rates;
|
|
·
|
available
interest rate hedges may not correspond directly with the interest rate
risk for which we seek protection;
|
|
·
|
the
duration of the hedge may not match the duration of the related
liability;
|
|
·
|
the
amount of income that a REIT may earn from hedging transactions (other
than through taxable REIT subsidiaries) to offset interest rate losses may
be limited by U.S. federal income tax provisions governing
REITs;
|
|
·
|
the
credit quality of the party owing money on the hedge may be downgraded to
such an extent that it impairs our ability to sell or assign our side of
the hedging transaction;
|
|
·
|
the
party owing money in the hedging transaction may default on its obligation
to pay;
|
|
·
|
the
value of derivatives used for hedging may be adjusted from time to time in
accordance with GAAP to reflect changes in fair value. Downward
adjustments, or “mark-to-market losses,” would reduce our shareholders’
equity and book value; and
|
|
·
|
hedge
accounting under GAAP is extremely complex and any ineffectiveness of our
hedges under GAAP will impact our statement of
operations.
|
We expect
to primarily use interest rate swap agreements to hedge against anticipated
future increases in interest rates on our repurchase
agreements. Should an interest rate swap agreement counterparty be
unable to make required payments pursuant to the agreement, the hedged liability
would cease to be hedged for the remaining term of the interest rate swap
agreement. In addition, we may be at risk for any collateral held by
a hedging counterparty to an interest rate swap agreement, should the
counterparty become insolvent or file for bankruptcy. Our hedging
transactions, which are intended to limit losses, may actually adversely affect
our earnings, which could reduce our ability to pay dividends to our
shareholders.
Hedging
instruments involve risk since they often are not traded on regulated exchanges,
guaranteed by an exchange or its clearing house, or regulated by any U.S. or
foreign governmental authorities. Consequently, there are no
requirements with respect to record keeping, financial responsibility or
segregation of customer funds and positions. Furthermore, the
enforceability of hedging instruments may depend on compliance with applicable
statutory, commodity and other regulatory requirements and, depending on the
identity of the counterparty, applicable international
requirements. The business failure of a hedging counterparty with
whom we enter into a hedging transaction will most likely result in its
default. Default by a party with whom we enter into a hedging
transaction may result in the loss of unrealized profits and force us to cover
our commitments, if any, at the then current market price. Although
generally we will seek to reserve the right to terminate our hedging positions,
it may not always be possible to dispose of or close out a hedging position
without the consent of the hedging counterparty, and we may not be able to enter
into an offsetting contract in order to cover our risk. In certain
circumstances a liquid secondary market may not exist for hedging instruments
purchased or sold, and we may be required to maintain a position until exercise
or expiration, which could result in losses.
Hedging
instruments could also require us to fund cash payments in certain circumstances
(such as the early termination of a hedging instrument caused by an event of
default or other voluntary or involuntary termination event or the decision by a
hedging counterparty to request the posting of collateral it is contractually
owed under the terms of the hedging instrument). With respect to the
termination of an existing interest rate swap agreement, the amount due would
generally be equal to the unrealized loss of the open interest rate swap
agreement position with the hedging counterparty and could also include other
fees and charges. These economic losses would be reflected in our
results of operations, and our ability to fund these obligations will depend on
the liquidity of our assets and access to capital at the time. Any
losses we incur on our hedging instruments could adversely affect our earnings
and reduce our ability to pay dividends to our shareholders.
17
We
may change our investment strategy, operating policies, dividend policy and/or
asset allocations without shareholder consent.
We may
change our investment strategy, operating policies, dividend policy and/or asset
allocation with respect to investments, acquisitions, leverage, growth,
operations, indebtedness, capitalization and distributions at any time without
the consent of our shareholders. A change in our investment strategy
may increase our exposure to interest rate and/or credit risk, default risk and
real estate market fluctuations. Furthermore, a change in our asset
allocation could result in our making investments in asset categories different
from our historical investments. These changes could adversely affect
our financial condition, results of operations, the market price of our common
stock or our ability to pay dividends to our shareholders.
In 2008,
we began paying a dividend to our common shareholders for the first time since
1998. During 2009 we paid $0.92 per common share in dividends to our
common shareholders, or $0.23 per quarter. Given our ability to
offset most of our taxable income with our NOL carryforward, we may not be
required to distribute any of our taxable income to common shareholders in order
to maintain our REIT status. Our Board of Directors reviews the
status of our common dividend on a quarterly basis. We may change our
dividend strategy in the future and elect to retain all or a greater portion of
our earnings by using our NOL carryforward.
Competition
may prevent us from acquiring new investments at favorable yields, and we may
not be able to achieve our investment objectives which may potentially have a
negative impact on our profitability.
Our net
income will largely depend on our ability to acquire mortgage-related assets at
favorable spreads over our borrowing costs. The availability of
mortgage-related assets meeting our investment criteria depends upon, among
other things, the level of activity in the real estate market and the quality of
and demand for securities in the mortgage securitization and secondary markets.
The size and level of activity in the residential real estate lending market
depends on various factors, including the level of interest rates, regional and
national economic conditions and real estate values. In acquiring
investments, we may compete with other purchasers of these types of investments,
including but not limited to other mortgage REITs, broker-dealers, hedge funds,
banks, savings and loans, insurance companies, mutual funds, and other entities
that purchase assets similar to ours, many of which have greater financial
resources than we do. As a result of all of these factors, we may not
be able to acquire sufficient assets at acceptable spreads to our borrowing
costs, which would adversely affect our profitability.
New
assets we acquire may not generate yields as attractive as yields on our current
assets, resulting in a decline in our earnings per share over time.
We
believe the assets we acquire have the potential to generate attractive economic
returns and GAAP yields, but acquiring new assets poses risks. Potential cash
flow and mark-to-market returns from new asset acquisitions could be negative,
including both new assets that are backed by newly-originated loans, as well as
new acquisitions that are backed by more seasoned assets that may experience
higher than expected levels of delinquency and default.
In order
to maintain our portfolio size and our earnings, we must reinvest in new assets
a portion of the cash flows we receive from principal, interest, calls, and
sales. We receive monthly payments from many of our assets, consisting of
principal and interest. In addition, occasionally some of our residential
securities are called (effectively sold). Principal payments and calls reduce
the size of our current portfolio and generate cash for us. We may also sell
assets from time to time as part of our portfolio management and capital
recycling strategies.
If the
assets we acquire in the future earn lower GAAP yields than the assets we
currently own, our reported earnings per share will likely decline over time as
the older assets pay down, are called, or are sold.
Loss
of key management could result in material adverse effects on our
business.
We are
dependent to a significant extent on the continued services of our executive
management team. Our executive officers consist of Thomas Akin, our
Chief Executive Officer, Byron Boston, our Chief Investment Officer, and Stephen
Benedetti, our Chief Operating Officer and Chief Financial
Officer. The loss of one or more of Messrs. Akin, Boston or Benedetti
could have an adverse effect on our business, financial condition, liquidity,
and results of operations regardless of the existence of any current or future
key man insurance policies.
18
Our
Chairman and Chief Executive Officer devotes a portion of his time to another
company in a capacity that could create conflicts of interest that may harm our
investment opportunities; this lack of a full-time commitment could also harm
our operating results.
Our
Chairman, Thomas Akin, is the managing general partner of Talkot Capital, LLC,
where he devotes a portion of his time. Talkot Capital invests in both private
and public companies, including investments in common and preferred stocks of
other public mortgage REITs. Mr. Akin’s activities with respect to
Talkot Capital results in his spending only a portion of his time and effort on
managing our activities, as he is under no contractual obligation which mandates
that he devote a minimum amount of time to our company. Since he is
not fully focused on us at all times, this may harm our overall management and
operating results. In addition, though the investment strategy and
activities of Talkot Capital are not directly related to us, Mr. Akin’s
activities with respect to Talkot Capital may create conflicts. Our
corporate governance policies include formal notification policies with respect
to potential issues of conflict of interest for competing business
opportunities. Compliance by Mr. Akin, and all employees, is closely
monitored by our Chief Financial Officer and Board of
Directors. Nonetheless, Mr. Akin’s activities with respect to Talkot
could create conflicts of interest.
Risks
Related to Regulatory and Legal Requirements
Risks Specific to Our REIT
Status
Qualifying
as a REIT involves highly technical and complex provisions of the Code, and a
technical or inadvertent violation could jeopardize our REIT
qualification. Maintaining our REIT status may reduce our flexibility
to manage our operations.
Qualification
as a REIT involves the application of highly technical and complex Code
provisions for which only limited judicial and administrative authorities
exist. Even a technical or inadvertent violation could jeopardize our
REIT qualification. Our qualification as a REIT will depend on our
satisfaction of certain asset, income, organizational, distribution, stockholder
ownership and other requirements on a continuing basis. Our
operations and use of leverage also subjects us to interpretations of the Code,
and technical or inadvertent violations of the Code could cause us to lose our
REIT status or to pay significant penalties and interest. In
addition, our ability to satisfy the requirements to qualify as a REIT depends
in part on the actions of third parties over which we have no control or only
limited influence, including in cases where we own an equity interest in an
entity that is classified as a partnership for U.S. federal income tax
purposes.
Maintaining
our REIT status may limit flexibility in managing our operations. For
instance:
|
·
|
If
we make frequent asset sales from our REIT entities to persons deemed
customers, we could be viewed as a “dealer,” and thus subject to 100%
prohibited transaction taxes or other entity level taxes on income from
such transactions.
|
|
·
|
Compliance
with the REIT income and asset rules may limit the type or extent of
hedging that we can undertake.
|
|
·
|
Our
ability to own non-real estate related assets and earn non-real estate
related income is limited. Our ability to own equity interests
in other entities is limited. If we fail to comply with these
limits, we may be forced to liquidate attractive assets on short notice on
unfavorable terms in order to maintain our REIT
status.
|
|
·
|
Our
ability to invest in taxable subsidiaries is limited under the REIT
rules. Maintaining compliance with this limitation could
require us to constrain the growth of future taxable REIT
affiliates.
|
|
·
|
Notwithstanding
our NOL carryforwards, meeting minimum REIT dividend distribution
requirements could reduce our liquidity. Earning non-cash REIT
taxable income could necessitate our selling assets, incurring debt, or
raising new equity in order to fund dividend
distributions.
|
|
·
|
Stock
ownership tests may limit our ability to raise significant amounts of
equity capital from one source.
|
19
If
we do not qualify as a REIT or fail to remain qualified as a REIT, we may be
subject to tax as a regular corporation and could face a tax liability, which
would reduce the amount of cash available for distribution to our
stockholders.
We intend
to operate in a manner that will allow us to qualify as a REIT for federal
income tax purposes. Our qualification as a REIT will depend on our
satisfaction of certain asset, income, organizational, distribution, stockholder
ownership and other requirements on a continuing basis. Our ability
to satisfy the asset tests depends upon our analysis of the characterization and
fair market values of our assets, some of which are not susceptible to a precise
determination, and for which we will not obtain independent appraisals. Our
compliance with the REIT income and quarterly asset requirements also depends
upon our ability to successfully manage the composition of our income and assets
on an ongoing basis.
If we
were to fail to qualify as a REIT in any taxable year, we would be subject to
federal income tax, after consideration of our NOL carryforwards but not
considering any dividends paid to our stockholders during the respective tax
year. If we could not otherwise offset this taxable income with our
NOL carryforwards, the resulting corporate tax liability could be material to
our results and would reduce the amount of cash available for distribution to
our stockholders, which in turn could have an adverse impact on the value of our
common stock. Unless we were entitled to relief under certain Code
provisions, we also would be disqualified from taxation as a REIT for the four
taxable years following the year in which we failed to qualify as a
REIT.
The
failure of investments subject to repurchase agreements to qualify as real
estate assets could adversely affect our ability to qualify as a
REIT.
Repurchase
agreement financing arrangements are structured as a sale and repurchase whereby
we sell certain of our investments to a counterparty and simultaneously enter
into an agreement to repurchase these securities at a later date in exchange for
a purchase price. Economically, these agreements are financings which
are secured by the investments sold pursuant thereto. We believe that
we would be treated for REIT asset and income test purposes as the owner of the
agency MBS that are the subject of any such sale and repurchase agreement,
notwithstanding that such agreements may legally transfer record ownership of
the securities to the counterparty during the term of the
agreement. It is possible, however, that the IRS could assert that we
did not own the securities during the term of the sale and repurchase agreement,
in which case we could fail to qualify as a REIT.
Even
if we remain qualified as a REIT, we may face other tax liabilities that reduce
our cash flow and our profitability.
Even if
we remain qualified for taxation as a REIT, we may be subject to certain
federal, state and local taxes on our income and assets, including taxes on any
undistributed income, tax on income from some activities conducted as a result
of a foreclosure or considered prohibited transactions under the Code, and state
or local income taxes. Any of these taxes would decrease cash
available for distribution to our stockholders. In addition, in order
to meet the REIT qualification requirements, or to avert the imposition of a
100% tax that applies to certain gains derived by a REIT from prohibited
transactions (i.e., dealer property or inventory), we may hold some of our
assets through a taxable REIT subsidiary (“TRS”) or other subsidiary
corporations that will be subject to corporate-level income tax at regular rates
to the extent that such TRS does not have an NOL carryforward. Any of
these taxes would decrease cash available for distribution to our
stockholders.
If
we fail to maintain our REIT status, our ability to utilize repurchase
agreements as a source of financing may be impacted.
Most of
our repurchase agreements require that we maintain our REIT status as a
condition to engaging in a repurchase transaction with us. Even
though repurchase agreements are not committed facilities with our lenders, if
we failed to maintain our REIT status our ability to enter into new repurchase
agreement transactions or renew existing, maturing repurchase agreements will
likely be limited. As such, we may be required to sell investments,
potentially under adverse circumstances, that were previously financed with
repurchase agreements.
Certain
of our securitization trusts, which qualify as “taxable mortgage pools,” require
us to maintain equity interests in the securitization trusts. If we
do not, our profitability and cash flow may be reduced
20
Certain
of our commercial mortgage and single-family mortgage securitization trusts are
considered taxable mortgage pools for federal income tax
purposes. These securitization trusts are exempt from taxes so long
as we, or another REIT, own 100% of the equity interests in the
trusts. If we fail to maintain sufficient equity interest in these
securitization trusts or if we fail to maintain our REIT status, then the trusts
may be considered separate taxable entities. If the trusts are
considered separate taxable entities, they will be required to compute taxable
income and pay tax on such income. Our profitability and cash flow
will be impacted by the amount of taxes paid. Moreover, we may be
precluded from selling equity interests, including debt securities issued in
connection with these trusts that might be considered to be equity interests for
tax purposes, to certain outside investors.
Risks Related to Accounting
and Reporting Requirements
Our
reported income depends on GAAP and conventions in applying GAAP which are
subject to change in the future and which may not have a favorable impact on our
reported income.
Accounting
rules for our assets and for the various aspects of our current and future
business change from time to time. Changes in GAAP, or the accepted
interpretation of these accounting principles, can affect our reported income
and shareholders’ equity.
Estimates
are inherent in the process of applying GAAP, and management may not always be
able to make estimates which accurately reflect actual results, which may lead
to adverse changes in our reported GAAP results.
Interest
income on our assets and interest expense on our liabilities may be partially
based on estimates of future events. These estimates can change in a
manner that negatively impacts our results or can demonstrate, in retrospect,
that revenue recognition in prior periods was too high or too
low. For example, we use the effective yield method of accounting for
many of our investments which involves calculating projected cash flows for each
of our assets. Calculating projected cash flows involves making
assumptions about the amount and timing of credit losses, loan prepayment rates,
and other factors. The yield we recognize for GAAP purposes generally
equals the discount rate that produces a net present value for actual and
projected cash flows that equals our GAAP basis in that asset. We
update the yield recognized on these assets based on actual performance and as
we change our estimates of future cash flows. The assumptions that
underlie our projected cash flows and effective yield analysis may prove to be
overly optimistic, or conversely, overly conservative. In these
cases, our GAAP yield on the asset or cost of the liability may change, leading
to changes in our reported GAAP results.
Other Regulatory
Risks
In
the event of bankruptcy either by ourselves or one or more of our third party
lenders, assets pledged as collateral under repurchase agreements may not be
recoverable by us. We may incur losses equal to the excess of the
collateral pledged over the amount of the associated repurchase agreement
borrowing.
Borrowings
made under repurchase agreements may qualify for special treatment under the
U.S. Bankruptcy Code. In the event that a lender under our repurchase
agreements files for bankruptcy, it may be difficult for us to recover our
assets pledged as collateral to such lender. In addition, if we ever
file for bankruptcy, lenders under our repurchase agreements may be able to
avoid the automatic stay provisions of the U.S. Bankruptcy Code and take
possession of and liquidate our collateral under our repurchase agreements
without delay. In the event of a bankruptcy, we may incur losses
equal to the excess of our collateral pledged over the amount of repurchase
agreement borrowing due to the lender.
If
we fail to properly conduct our operations we could become subject to regulation
under the Investment Company Act of 1940. Conducting our business in a manner so
that we are exempt from registration under and compliance with the Investment
Company Act of 1940 may reduce our flexibility and could limit our ability to
pursue certain opportunities.
We seek
to conduct our operations so as to avoid falling under the definition of an
investment company pursuant to the Investment Company Act of 1940 (the “1940
Act”). Specifically, we currently seek to conduct our operations under one
of the exemptions afforded under the 1940 Act. We primarily expect to
use the exemption provided under Section 3(c)(5)(C) of the 1940 Act, a provision
available to companies primarily engaged in the business of purchasing and
otherwise acquiring
21
mortgages
and other liens on and interests in real estate. According to SEC
no-action letters, companies relying on this exemption must ensure that at least
55% of their assets are mortgage loans and other qualifying assets, and at least
80% of their assets are real estate-related. The 1940 Act requires
that we and each of our subsidiaries evaluate our qualification for exemption
under the Act. Our subsidiaries will rely either on Section
3(c)(5)(C) or other sections that provide exemptions from registering under
the 1940 Act, including Sections 3(a)(1)(C) and 3(c)(7).
Under the
1940 Act, an investment company is required to register with the SEC and is
subject to extensive restrictive and potentially adverse regulations relating
to, among other things, operating methods, management, capital structure,
dividends, and transactions with affiliates. If we were determined to
be an investment company, our ability to use leverage and conduct
business as we do today would be impaired.
Risks
Related to Owning Our Stock
The
stock ownership limit imposed by the Code for REITs and our Articles of
Incorporation may restrict our business combination opportunities. The stock
ownership limitation may also result in reduced liquidity in our stock and may
result in losses to an acquiring shareholder.
To
qualify as a REIT under the Code, not more than 50% in value of our outstanding
stock may be owned, directly or indirectly, by five or fewer individuals (as
defined in the Code to include certain entities) at any time during the last
half of each taxable year after our first year in which we qualify as a
REIT. Our Articles of Incorporation, with certain exceptions,
authorizes our Board of Directors to take the actions that are necessary and
desirable to qualify as a REIT. Pursuant to our Articles of
Incorporation, no person may beneficially or constructively own more than 9.8%
of our common or capital stock. Our Board of Directors may grant an
exemption from this 9.8% stock ownership limitation, in its sole discretion,
subject to such conditions, representations and undertakings as it may determine
are reasonably necessary. Our Board of Directors has waived this
ownership limitation with respect to Talkot Capital, LLC, of which Mr. Thomas B.
Akin, our Chairman and Chief Executive Officer, is managing general
partner. Per the terms of the waiver, Talkot Capital may own up to
15% of our outstanding common stock on a fully diluted basis, provided, however,
that no single beneficial owner has a greater than two-thirds ownership stake in
Talkot Capital.
The
ownership limits imposed by the tax law are based upon direct or indirect
ownership by “individuals,” but only during the last half of a tax
year. The ownership limits contained in our Articles of Incorporation
apply to the ownership at any time by any “person,” which includes entities, and
are intended to assist us in complying with the tax law requirements and to
minimize administrative burdens. However, these ownership limits
might also delay or prevent a transaction or a change in our control that might
involve a premium price for our common stock or otherwise be in the best
interest of our stockholders.
Whether
we would waive ownership limitation for any other shareholder will be determined
by our Board of Directors on a case by case basis. Our Articles of
Incorporation’s constructive ownership rules are complex and may cause the
outstanding stock owned by a group of related individuals or entities to be
deemed to be constructively owned by one individual or entity. As a
result, the acquisition of less than these percentages of the outstanding stock
by an individual or entity could cause that individual or entity to own
constructively in excess of these percentages of the outstanding stock and thus
be subject to the ownership limit. Any attempt to own or transfer
shares of our common or preferred stock (if and when issued) in excess of the
ownership limit without the consent of the Board of Directors will result in the
shares being automatically transferred to a charitable trust or, if the transfer
to a charitable trust would not be effective, such transfer being void ab
initio.
Dividends
payable by REITs do not qualify for the reduced tax rates available for some
dividends.
The
maximum tax rate applicable to income from “qualified dividends” payable to
domestic stockholders that are individuals, trusts and estates has been reduced
by legislation to 15% through the end of 2010. Dividends payable by
REITs, however, generally are not eligible for the reduced
rates. Although this legislation does not adversely affect the
taxation of REITs or dividends payable by REITs, the more favorable rates
applicable to regular corporate qualified dividends could cause investors who
are individuals, trusts and estates to perceive investments in REITs to be
relatively less attractive than investments in the stocks of non-REIT
corporations that pay dividends, which could adversely affect the value of the
stock of REITs, including our common stock.
22
Recognition
of excess inclusion income by us could have adverse consequences to us or our
shareholders.
Certain
of our securities have historically generated excess inclusion income and may
continue to do so in the future. Certain categories of stockholders, such as
foreign stockholders eligible for treaty or other benefits, stockholders with
net operating losses, and certain tax-exempt stockholders that are subject to
unrelated business income tax, could be subject to increased taxes on a portion
of their dividend income from us that is attributable to excess inclusion
income. In addition, to the extent that our stock is owned by
tax-exempt “disqualified organizations,” such as certain government-related
entities and charitable remainder trusts that are not subject to tax on
unrelated business income, we may incur a corporate level tax on a portion of
our income. In that case, we may reduce the amount of our
distributions to any disqualified organization whose stock ownership gave rise
to the tax.
|
ITEM
1B.
|
UNRESOLVED
STAFF COMMENTS
|
There are no unresolved comments from
the SEC Staff.
|
ITEM
2.
|
PROPERTIES
|
We lease
one facility located at 4991 Lake Brook Drive, Suite 100, Glen Allen, Virginia
23060 which provides office space for our executive officers and administrative
staff. As of December 31, 2009, we leased 7,068 square
feet. The term of the lease runs to December 2013, but may be renewed
at our option for one additional five-year period at a rental rate 3% greater
than the rate in effect during the preceding 12-month period. We
believe that our property is maintained in good operating condition and is
suitable and adequate for our purposes.
|
ITEM
3.
|
LEGAL
PROCEEDINGS
|
We and
our subsidiaries may be involved in certain litigation matters arising in the
ordinary course of business. Although the ultimate outcome of these
matters cannot be ascertained at this time, and the results of legal proceedings
cannot be predicted with certainty, we believe, based on current knowledge, that
the resolution of any such matters arising in the ordinary course of business
will not have a material adverse effect on our financial position but could
materially affect our consolidated results of operations in a given
period. Information on litigation arising out of the ordinary course
of business is described below.
One of
our subsidiaries, GLS Capital, Inc. (“GLS”), and the County of Allegheny,
Pennsylvania are defendants in a class action lawsuit (“Pentlong”) filed in 1997
in the Court of Common Pleas of Allegheny County, Pennsylvania (the "Court of
Common Pleas"). Between 1995 and 1997, GLS purchased delinquent
county property tax receivables for properties located in Allegheny
County. The Pentlong Plaintiffs allege that GLS did not enjoy the
same rights as its assignor, Allegheny County, to recover from delinquent
taxpayers certain attorney fees, costs and expenses and interest in the
collection of the tax receivables. Class action status has been
certified in this matter, but a motion to reconsider is pending. The
Pentlong litigation had been stayed pending the outcome of similar litigation
before the Pennsylvania Supreme Court in a case in which GLS was not a
defendant. The plaintiff in that case had disputed the application of
curative legislation enacted in 2003 but retroactive to 1996 which specifically
set forth the right of owners of delinquent property tax receivables such as GLS
to collect reasonable attorney fees, costs, and interest which were properly
taxable as part of the tax debt owed. The Pennsylvania Supreme Court
has issued an opinion in favor of the defendants in that matter, which we
believe favorably impacts the Pentlong litigation by substantially reducing
Pentlong Plaintiffs’ universe of actionable claims against GLS in connection
with the collection of the tax receivables. Based on the opinion
issued by the Pennsylvania Supreme Court, the Court of Common Pleas requested
GLS file a motion for summary judgment and heard arguments on such motion in
November 2009. As of March 1, 2010, the court has not yet rendered a
decision with respect to such motion. Pentlong Plaintiffs have not
enumerated their damages in this matter.
23
We and
Dynex Commercial, Inc. (“DCI”), a former affiliate of the Company and now known
as DCI Commercial, Inc., were appellees (or respondents) in the Supreme Court of
Texas related to the matter of Basic Capital Management, Inc. et
al. (collectively, “BCM” or the “Plaintiffs”) versus DCI et
al. The appeal seeks to overturn the trial court’s judgment, and the
subsequent affirmation of the trial court by the Fifth Court of Appeals at
Dallas, in our and DCI’s favor which denied any recovery to Plaintiffs in this
matter. Specifically, Plaintiffs are seeking reversal of the trial
court’s judgment and sought rendition of judgment against us for alleged breach
of loan agreements for tenant improvements in the amount of $0.3
million. They also seek reversal of the trial court’s judgment and
rendition of judgment against DCI in favor of BCM under two mutually exclusive
damage models, for $2.2 million and $25.6 million, respectively, related to the
alleged breach by DCI of a $160.0 million “master” loan
commitment. Plaintiffs also seek reversal and rendition of a judgment
in their favor for attorneys’ fees in the amount of $2.1
million. Alternatively, Plaintiffs seek a new trial. The
original litigation was filed in 1999, and the trial was held in January
2004. Even if Plaintiffs were to be successful on appeal, DCI is a
former affiliate of ours, and we believe that we would have no obligation for
amounts, if any, awarded to the Plaintiffs as a result of the actions of
DCI.
We and
MERIT Securities Corporation, a subsidiary (“MERIT”), as well as the former
president and current Chief Operating Officer and Chief Financial Officer of
Dynex Capital, Inc., (together, “Defendants”) are defendants in a putative class
action alleging violations of the federal securities laws in the United States
District Court for the Southern District of New York (“District Court”) by the
Teamsters Local 445 Freight Division Pension Fund (“Teamsters”). The
complaint was filed on February 7, 2005, and purports to be a class action on
behalf of purchasers between February 2000 and May 2004 of MERIT Series 12 and
MERIT Series 13 securitization financing bonds (“Bonds”), which are
collateralized by manufactured housing loans. After a series of rulings by
the District Court and an appeal by us and MERIT, on February 22, 2008 the
United States Court of Appeals for the Second Circuit dismissed the litigation
against us and MERIT. Teamsters filed an amended complaint on August
6, 2008 with the District Court which essentially restated the same allegations
as the original complaint and added our former president and our current Chief
Operating Officer as defendants. Teamsters seeks unspecified damages
and alleges, among other things, fraud and misrepresentations in connection with
the issuance of and subsequent reporting related to the Bonds On October
19, 2009, the District Court substantially denied the Defendants’ motion to
dismiss the Teamsters’ second amended complaint. On December 11, 2009, the
Defendants’ filed an answer to the second amended complaint. The Company
has evaluated the allegations made in the complaint and believes them to be
without merit and intends to vigorously defend itself against them.
|
ITEM
4.
|
RESERVED
|
24
|
ITEM
5.
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
Our
common stock is traded on the New York Stock Exchange under the trading symbol
“DX”. The common stock was held by approximately 5,138 holders of
record as of March 1, 2010. On that date, the closing price of our
common stock on the New York Stock Exchange was $8.96 per
share. During the last two years, the high and low stock prices and
cash dividends declared on common stock were as follows:
|
High
|
Low
|
Dividends
Declared
|
||||||||||
|
2009:
|
||||||||||||
|
First
quarter
|
$ | 7.47 | $ | 6.30 | $ | 0.23 | ||||||
|
Second
quarter
|
$ | 8.70 | $ | 6.75 | $ | 0.23 | ||||||
|
Third
quarter
|
$ | 8.92 | $ | 7.82 | $ | 0.23 | ||||||
|
Fourth
quarter
|
$ | 9.33 | $ | 7.80 | $ | 0.23 | ||||||
|
2008:
|
||||||||||||
|
First
quarter
|
$ | 9.90 | $ | 8.23 | $ | 0.10 | ||||||
|
Second
quarter
|
$ | 9.99 | $ | 8.50 | $ | 0.15 | ||||||
|
Third
quarter
|
$ | 9.23 | $ | 6.52 | $ | 0.23 | ||||||
|
Fourth
quarter
|
$ | 8.00 | $ | 5.79 | $ | 0.23 | ||||||
During
the year ended December 31, 2009, the Company paid common dividends totaling
$0.92 per share. Any dividends declared by the Board of Directors have generally
been for the purpose of maintaining our REIT status and maintaining compliance
with dividend requirements of the Series D Preferred Stock. The
stated quarterly dividend on Series D Preferred Stock is $0.2375 per
share. In accordance with the terms of the Series D Preferred Shares,
if we fail to pay two consecutive quarterly preferred dividends or if we fail to
maintain consolidated shareholders’ equity of at least 200% of the aggregate
issue price of the Series D Preferred Stock, then these shares automatically
convert into a new series of 9.50% senior unsecured notes. Dividends
for the preferred stock must be fully paid before dividends can be paid on
common stock.
The
following graph is a five year comparison of cumulative total returns for the
shares of our common stock, the Standard & Poor’s 500 Stock Index (“S&P
500”), and the Bloomberg Mortgage REIT Index. The table below assumes
$100 was invested at the close of trading on December 31, 2004 in each of
our common stock, the S&P 500, and the Bloomberg Mortgage REIT
Index.
25
Comparative
Five-Year Total Returns
(1)
Dynex
Capital, Inc., S&P 500, and Bloomberg Mortgage REIT Index
(Performance
Results through December 31, 2009)
|
Cumulative
Total Stockholder Returns as of December 31,
|
||||||||||||||||||||||||
|
Index
|
2004
|
2005
|
2006
|
2007
|
2008
|
2009
|
||||||||||||||||||
|
Dynex
Capital, Inc.
|
$ | 100.00 | $ | 88.24 | $ | 90.67 | $ | 113.43 | $ | 91.43 | $ | 136.37 | ||||||||||||
|
S&P
500
(1)
|
$ | 100.00 | $ | 104.21 | $ | 121.48 | $ | 128.14 | $ | 80.73 | $ | 102.10 | ||||||||||||
|
Bloomberg
Mortgage REIT Index
(1)
|
$ | 100.00 | $ | 83.56 | $ | 100.36 | $ | 54.42 | $ | 31.97 | $ | 40.63 | ||||||||||||
|
(1)
|
Cumulative
total return assumes reinvestment of dividends. The source of
this information is Bloomberg and Standard & Poor’s, which management
believes to be reliable sources.
|
26
|
ITEM
6.
|
SELECTED
FINANCIAL DATA
|
The
following selected financial information should be read in conjunction with the
audited consolidated financial statements of the Company and notes thereto
contained in Item 8 of this Annual Report on Form 10-K.
|
Years
ended December 31,
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
|
(amounts
in thousands except share and per share data)
|
||||||||||||||||||||
|
Net
interest income
|
$ | 24,565 | $ | 10,547 | $ | 10,683 | $ | 11,087 | $ | 11,889 | ||||||||||
|
Net
interest income after (provision for) recapture of loan
losses
|
23,783 | 9,556 | 11,964 | 11,102 | 6,109 | |||||||||||||||
|
Equity
in income (loss) of joint venture
|
2,400 | (5,733 | ) | 709 | (852 | ) | – | |||||||||||||
|
Loss
on capitalization of joint venture
|
– | – | – | (1,194 | ) | – | ||||||||||||||
|
Gain
(loss) on sale of investments
|
171 | 2,316 | 755 | (183 | ) | 9,609 | ||||||||||||||
|
Impairment
charges
|
– | – | – | – | (2,474 | ) | ||||||||||||||
|
Fair
value adjustments, net
|
205 | 7,147 | – | – | – | |||||||||||||||
|
Other
(expense) income
|
(2,262 | ) | 7,467 | (533 | ) | 557 | 2,022 | |||||||||||||
|
General
and administrative expenses
|
(6,716 | ) | (5,632 | ) | (3,996 | ) | (4,521 | ) | (5,681 | ) | ||||||||||
|
Net
income
|
$ | 17,581 | $ | 15,121 | $ | 8,899 | $ | 4,909 | $ | 9,585 | ||||||||||
|
Net
income to common shareholders
|
$ | 13,571 | $ | 11,111 | $ | 4,889 | $ | 865 | $ | 4,238 | ||||||||||
|
Net
income per common share:
|
||||||||||||||||||||
|
Basic
|
$ | 1.04 | $ | 0.91 | $ | 0.40 | $ | 0.07 | $ | 0.35 | ||||||||||
|
Diluted
|
$ | 1.02 | $ | 0.91 | $ | 0.40 | $ | 0.07 | $ | 0.35 | ||||||||||
|
Dividends
declared per share:
|
||||||||||||||||||||
|
Common
|
$ | 0.92 | $ | 0.71 | $ | – | $ | – | $ | – | ||||||||||
|
Series D
Preferred
|
$ | 0.95 | $ | 0.95 | $ | 0.95 | $ | 0.95 | $ | 0.95 | ||||||||||
|
As
of December 31,
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
|
Investments
|
$ | 917,981 | $ | 572,255 | $ | 331,795 | $ | 401,186 | $ | 751,294 | ||||||||||
|
Total
assets
|
958,062 | 607,191 | 374,758 | 466,557 | 805,976 | |||||||||||||||
|
Repurchase
agreements
|
638,329 | 274,217 | 4,612 | 95,978 | 133,315 | |||||||||||||||
|
Securitization
financing
|
143,081 | 177,157 | 203,199 | 210,135 | 513,140 | |||||||||||||||
|
Total
liabilities
|
789,309 | 466,782 | 232,822 | 330,019 | 656,642 | |||||||||||||||
|
Shareholders’
equity
|
168,753 | 140,409 | 141,936 | 136,538 | 149,334 | |||||||||||||||
|
Common
shares outstanding
|
13,931,512 | 12,169,762 | 12,136,262 | 12,131,262 | 12,163,391 | |||||||||||||||
|
Book
value per common share
|
$ | 9.08 | $ | 8.07 | $ | 8.22 | $ | 7.78 | $ | 7.65 | ||||||||||
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
The
following discussion and analysis of the consolidated financial condition and
results of operations should be read together with the audited consolidated
financial statements of the Company and notes thereto contained in Item 8 of
this Annual Report on Form 10-K.
27
EXECUTIVE
SUMMARY
For most
of 2009, our principal investment strategy for 2009 was acquiring Hybrid Agency
ARMs. Toward the latter part of 2009, as Hybrid Agency ARM prices
increased and correspondingly yields decreased, we expanded our investment
activities and sought to acquire non-Agency securities with more attractive
risk-adjusted returns. As discussed below, in the fourth quarter of
2009, we acquired ‘AAA’ rated non-Agency CMBS backed by loans originated by us
in 1998. These securities have characteristics that complement the
risk and return profile of the Agency MBS.
For 2010,
we expect to continue to purchase Agency MBS and ‘AAA’ rated non-Agency
securities Generally we are targeting to invest half of our
investment capital in Agency MBS and the other half in non-Agency
securities. To the extent that we raise capital in 2010 through our
controlled equity offering program or otherwise, we expect to continue to
maintain that ratio. Our continued investment in Agency MBS and ‘AAA’
rated non-Agency securities, however, is dependent on market conditions and the
risk-adjusted returns on these securities compared to other investment
opportunities.
As of
December 31, 2009, we had total investments of $918.0 million. Our
investments consisted substantially of $594.1 million of Agency MBS, $109.1
million in non-Agency securities consisting of $103.2 million in CMBS and $5.9
million in RMBS, $62.1 million of securitized single-family mortgage loans and
$150.4 million of securitized commercial mortgage loans.
We
generally finance our acquisition of securities by borrowing against a
substantial portion of the market value of these assets utilizing repurchase
agreements. Repurchase agreements are financings under which we will
pledge our securities as collateral to secure loans made by repurchase agreement
counterparties. During 2009, we had $364.1 million of net additional
borrowings under our repurchase agreement facilities, which were used to finance
our acquisition of Agency MBS and non-Agency securities during the year, and
ended 2009 with $638.3 million in repurchase agreement borrowings. We
may also opportunistically use other types of financing such as TALF for our
assets. As of February 28, 2010, we have purchased $15.1 million of
non-Agency CMBS using $12.8 million in TALF financing.
The
results of our operations are affected by a number of factors, many of which are
beyond our control, and primarily depend on, among other things, the level of
our net interest income, the market value of our assets, the supply of and
demand for MBS in the marketplace, and the cost and availability of
financing. Our net interest income varies primarily as a result of
changes in interest rates, the slope of the yield curve (i.e. the differential
between long-term and short-term interest rates), the credit performance of our
securitized commercial and single-family mortgage loans, borrowing costs (i.e.,
our interest expense) and prepayment speeds on our MBS portfolio, the behavior
of which involves various risks and uncertainties. Interest rates and
prepayment speeds, as measured by the constant prepayment rate (“CPR”), vary
according to the type of investment, conditions in the financial markets,
competition and other factors, none of which can be predicted with any
certainty.
In
general, with respect to our business operations, increases in interest rates
over time may cause: (i) the interest expense associated with our borrowings to
increase: (ii) the value of our securities to decline; (iii) coupons on our
variable-rate investments to reset, although on a delayed basis, to higher
interest rates; and (iv) prepayments on our investments to slow, thereby slowing
the amortization of our MBS purchase premiums. Conversely, decreases
in interest rates, in general, may over time cause: (i) prepayments
on our investments to increase, thereby accelerating the amortization of
premiums; (ii) the interest expense associated with our borrowings to decrease;
(iii) the value of our securities to increase, and (iv) coupons on our
variable-rate investments to reset, although on a delayed basis, to lower
interest rates.
For
further discussion of risks inherent in our investment strategy see Item 7A.
“Quantitative and Qualitative Disclosures About Market Risk”.
MARKET
CONDITIONS
The well
publicized disruptions in the financial markets that began in 2007 and escalated
in 2008 have led to various initiatives by the U.S. federal government to
address credit and liquidity issues as discussed above in Item 1. Business and
as discussed further in Item 1A. Risk Factors. In addition, in
December 2008, in response to severe disruptions in the credit markets, the
Federal Reserve lowered the targeted Federal Funds rate to a range of 0.0% to
0.25%. Despite recent improvements in the credit markets, the Federal
Reserve has continued to maintain this targeted federal funds rate into
2010
28
as
a result of current economic conditions. These initiatives impact our
business in several ways. First, Fannie Mae and Freddie Mac, which
guarantee the timely payment of principal and interest on our Agency MBS, are
under federal conservatorship and have liquidity and preferred capital
commitments from the government. Without such intervention, it is
unlikely that government sponsored entities could perform under their guaranty
of payment on the Agency MBS. Second, as of February 16, 2010 the
Treasury and Federal Reserve have purchased approximately $1.4 trillion in 15
and 30-year fixed-rate Agency MBS which has reduced overall mortgage rates while
driving up prices on all Agency MBS, including Hybrid Agency ARMs and Agency
ARMs. Third, our repurchase agreement borrowing costs have benefitted
by the lowered Federal Funds rate, increasing our net interest income and as a
result our profitability. Over time, the government and Federal
Reserve will change the above policies (and other policies not discussed above)
with respect to the credit markets. For instance, the Treasury
discontinued its purchases of Agency MBS as of December 31, 2009, and the
Federal Reserve is expected to discontinue its purchases in March
2010. When these policies change or reverse, our profitability, the
market value of our investments, and our investment opportunities will likely
all be impacted. While liquidity returned to many markets in
2009, we believe the stability of the global credit markets remains fragile,
particularly given global economic fundamentals. The long-term
success of our business model is generally predicated on the stability of the
capital markets.
On
February 10, 2010, Fannie Mae and Freddie Mac announced their intentions to buy
out delinquent loans that are past due 120 or more days from Agency MBS
pools. Freddie Mac announced that it would buy all such loans in February
2010 and Fannie Mae indicated that it would purchase loans over a period of a
few months subject to certain conditions. The purchase of delinquent
loans will likely impact certain of our Agency MBS investments, resulting in an
increase in prepayments on our Agency MBS for those periods. Neither of
the government-sponsored entities has published sufficient information to
precisely predict the ultimate impact on the Company’s investment portfolio from
these actions. However, based on published information, the Company
believes that Agency MBS with coupons greater than 5.00% and originated between
2005 and 2008 are likely to have the most seriously delinquent loans and are at
the greatest risk for buy-outs. As of January 31, 2010, approximately
$216.6 million, or 40%, of the Company’s investment in Agency MBS have these
characteristics. Overall, the Company expects that its concentration
in lower coupon MBS should reduce the overall impact of the
buy-outs. Additional information on the potential impact of these
buyouts is discussed within the “Liquidity and Capital Resources” section of
Item 7. “Management’s Discussion and Analysis of Financial Condition and Results
of Operations”.
CRITICAL
ACCOUNTING POLICIES
The
discussion and analysis of our financial condition and results of operations are
based in large part upon our consolidated financial statements, which have been
prepared in accordance with GAAP. The preparation of the financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenue and expenses during the reported period. Actual results
may differ from the estimated amounts we have recorded.
Critical
accounting policies are defined as those that are reflective of significant
judgments or uncertainties, and which may result in materially different results
under different assumptions and conditions, or the application of which may have
a material impact on our financial statements.
Consolidation of
Subsidiaries.
The consolidated financial statements represent
our accounts after the elimination of all inter-company
transactions. We consolidate entities in which we own more than 50%
of the voting equity and control does not rest with others and variable interest
entities in which we are determined to be the primary beneficiary in accordance
with Accounting Standards Codification (“ASC” or “Codification”) Topic
810. We follow the equity method of accounting for investments with
greater than 20% and less than a 50% interest in partnerships and corporate
joint ventures or when we are able to influence the financial and operating
policies of the investee but own less than 50% of the voting
equity.
Securitization.
We
have securitized mortgage loans in a securitization transaction by transferring
financial assets to a wholly owned trust, and the trust issues non-recourse
securitization financing bonds pursuant to an indenture. Generally,
we retain some form of control over the transferred assets, and/or the trust is
not deemed to be a qualified special purpose entity. In instances
where the trust is deemed not to be a qualified special purpose entity, the
trust is included in our consolidated financial statements. For
accounting and tax purposes, the loans and securities financed through the
issuance of bonds in a securitization financing transaction are treated as our
assets (presented as securitized mortgage loans), and the
29
associated
bonds issued are treated as our debt as securitization financing. We
may retain certain of the bonds issued by the trust, and we have generally
transferred collateral in excess of the bonds issued. This excess is
typically referred to as over-collateralization. Each securitization
trust generally provides us the right to redeem, at our option, the remaining
outstanding bonds prior to their maturity date.
Other-than-Temporary
Impairments.
We evaluate all securities in our investment
portfolio for other-than-temporary impairments. A security is
generally defined to be other-than-temporarily impaired if the carrying value of
such security exceeds its estimated fair value. Under the provisions
of ASC Topic 320, a security is considered to be other-than-temporarily impaired
if the present value of cash flows expected to be collected is less than the
security’s amortized cost basis (the difference being defined as the credit
loss) or if the fair value of the security is less than the security’s amortized
cost basis and the investor intends, or more-likely-than-not will be required,
to sell the security before recovery of the security’s amortized cost
basis. The charge to earnings is limited to the amount of credit loss
if the investor does not intend, and it is more-likely-than-not that it will not
be required, to sell the security before recovery of the security’s amortized
cost basis. Any remaining difference between fair value and amortized cost is
recognized in other comprehensive income, net of applicable taxes. Otherwise,
the entire difference between fair value and amortized cost is charged to
earnings. In certain instances, as a result of the
other-than-temporary impairment analysis, the recognition or accrual of interest
will be discontinued and the security will be placed on non-accrual
status. Securities normally are not placed on non-accrual status if
the servicer continues to advance on the impaired mortgage loans in the
security.
Allowance for Loan
Losses.
An allowance for loan losses has been estimated and
established for currently existing and probable losses for mortgage loans that
are considered impaired. Provisions made to increase the allowance
are charged as a current period expense. Commercial mortgage loans
are secured by income-producing real estate and are evaluated individually for
impairment when the debt service coverage ratio on the mortgage loan is less
than 1:1 or when the mortgage loan is delinquent. An allowance may be
established for a particular impaired commercial mortgage
loan. Commercial mortgage loans not evaluated for individual
impairment or not deemed impaired are evaluated for a general
allowance. Certain of the commercial mortgage loans are covered by
mortgage loan guarantees that limit the Company’s exposure on these mortgage
loans. Single family mortgage loans are considered homogeneous and
according are evaluated on a pool basis for a general allowance.
We
consider various factors in determining our specific and general allowance
requirements. Such factors include whether a loan is delinquent, our
historical experience with similar types of loans, historical cure rates of
delinquent loans, and historical and anticipated loss severity of the mortgage
loans as they are liquidated. The factors may differ by mortgage loan
type (e.g., single-family versus commercial) and collateral type (e.g.,
multifamily versus office property). The allowance for loan losses is
evaluated and adjusted periodically by management based on the actual and
estimated timing and amount of probable credit losses as well as industry loss
experience.
In
reviewing both general and specific allowance requirements for commercial
mortgage loans, for loans secured by low-income housing tax credit (“LIHTC”)
properties, the Company considers the remaining life of the tax compliance
period in its analysis. Because defaults on mortgage loan financings
for these properties can result in the recapture of previously received tax
credits for the borrower, the potential cost of this recapture provides an
incentive to support the property during the compliance period, which has
historically decreased the likelihood of defaults.
Derivatives.
As
required by ASC Topic 815, we record all derivatives on our balance sheet at
fair value. The accounting for changes in the fair value of each
derivative depends on whether we designate the derivative as a trading position
or as a hedging position for a financial instrument or forecasted
transaction. If we designate a derivative as a trading position,
changes in its fair value are immediately recognized in the current period’s
consolidated statement of income as trading income or loss. If we
designate a derivative as a hedging position and we satisfy certain criteria
established within ASC Topic 815, then we may apply hedge accounting to record
changes in the derivative’s fair value. Hedge accounting involves
evaluating the effectiveness of the hedge against the financial instrument or
transaction being hedged. The ineffective portion of the hedge
relationship is immediately recognized in the current period’s statement of
income as a portion of other income (expense) while the effective portion of the
hedge relationship is reported in accumulated other comprehensive income
(“AOCI”) and later reclassified into the statement of income as a portion of
interest expense in the same period during which the hedged financial instrument
or transaction affects earnings. If our management decides to
terminate any or all derivatives designated as hedging positions or if our
management decides to sell or terminate the underlying financial instruments
being hedged, any changes in fair value of the associated derivatives recorded
in other comprehensive income at the time of termination will be recognized in
that period’s statement of income. In addition, our
30
interest
rate agreements contain covenants which require us to maintain a minimum level
of equity and earnings as well as maintain our REIT status. If we
breach any of these covenants, our counterparties will be allowed to immediately
terminate any interest rate agreement they have with us. At the time
of this termination, any changes in fair value of the derivatives recorded in
other comprehensive income will be recognized in that period’s statement of
income.
F
air Value
. As
defined in ASC Topic 820, the fair value of a financial instrument is the
exchange price in an orderly transaction, that is not a forced liquidation or
distressed sale, between market participants to sell an asset or transfer a
liability in the market in which the reporting entity would transact for the
asset or liability, that is, the principal or most advantageous market for the
asset/liability. The transaction to sell the asset or transfer the
liability is a hypothetical transaction at the measurement date, considered from
the perspective of a market participant that holds the
asset/liability. ASC Topic 820 provides a consistent definition of
fair value which focuses on exit price and prioritizes, within a measurement of
fair value, the use of market-based inputs over entity-specific
inputs. In addition, ASC Topic 820 provides a framework for measuring
fair value and establishes a three-level hierarchy for fair value measurements
based upon the transparency of inputs to the valuation of an asset or liability
as of the measurement date.
The three
levels of valuation hierarchy established by ASC Topic 820 are as
follows:
|
·
|
Level
1 — Inputs are unadjusted, quoted prices in active markets for identical
assets or liabilities at the measurement date. Our investments
included in Level 1 fair value generally are equity securities listed in
active markets.
|
|
·
|
Level
2 — Inputs (other than quoted prices included in Level 1) are either
directly or indirectly observable for the asset or liability through
correlation with market data at the measurement date and for the duration
of the instrument’s anticipated life. Fair valued assets and
liabilities that are generally included in this category are Agency MBS,
which are valued based on the average of multiple dealer quotes that are
active in the Agency MBS market, and interest rate swaps, which are valued
using a third-party pricing service, and the valuations are tested with
internally developed models that apply readily observable market
variables.
|
|
·
|
Level
3 — Inputs reflect management’s best estimate of what market participants
would use in pricing the asset or liability at the measurement
date. Consideration is given to the risk inherent in the
valuation technique and the risk inherent in the inputs to the
model. Generally, assets and liabilities carried at fair value
and included in this category are non-Agency mortgage-backed securities,
delinquent property tax receivables and the obligation under payment
agreement liability.
|
Estimates
of fair value for financial instruments are based primarily on management’s
judgment. Since the fair value of our financial instruments is based
on estimates, actual fair values recognized may differ from those estimates
recorded in the consolidated financial statements. Please see Note 12
of the Notes to Consolidated Financial Statements for additional information
regarding ASC Topic 820 with respect to specific assets.
We
account for our Agency MBS and non-Agency securities in accordance with ASC
Topic 320, which requires that investments in debt and equity securities be
designated as either “held-to-maturity,” “available-for-sale” or “trading” at
the time of acquisition. All of our securities are designated as
available-for-sale and are carried at their fair value with unrealized gains and
losses excluded from earnings and reported in other comprehensive (loss)/income
as a component of shareholders’ equity. We determine the fair value
of our non-Agency securities by discounting the estimated future cash flows
derived from pricing models that utilize information such as the security’s
coupon rate, estimated prepayment speeds, expected weighted average life,
collateral composition, estimated future interest rates, expected losses, and
credit enhancement as well as certain other relevant
information. The fair value of our other investment securities
is based upon prices obtained from a third-party pricing service and broker
quotes.
Although
we generally intend to hold our investment securities until maturity, we may,
from time to time, sell any of our securities as part of the overall management
of our business. The available-for-sale designation provides us with
the flexibility to sell any of our investment securities. Upon the
sale of an investment security, any unrealized gain or loss is reclassified out
of AOCI to earnings as a realized gain or loss using the specific identification
method.
31
RECENT
ACCOUNTING PRONOUNCEMENTS
The
following section discusses recent accounting pronouncements issued prior to the
filing of this Annual Report on Form 10-K which will likely have a material
impact our future financial condition or results of operations.
In
December 2009, FASB issued Accounting Standards Update (“ASU” or “Update”) No.
2009-16 and ASU No. 2009-17 which amends ASC Topic 860 and ASC Topic 810,
respectively. The purpose of the amendment to ASC Topic 860 is to
eliminate the concept of a “qualifying special-purpose entity” (“QSPE”) and to
require more information about transfers of financial assets, including
securitization transactions as well as a company’s continuing exposure to the
risks related to transferred financial assets. The purpose of the
amendment to ASC Topic 810 is to change how a reporting entity determines when
to consolidate another entity that is insufficiently capitalized or is not
controlled by voting rights. Instead of focusing on quantitative
determinants, consolidation is to be determined based on, among other things,
qualitative factors such as the other entity’s purpose and design as well as the
reporting entity’s ability to direct the activities of the other entity that
most significantly impact its performance. The reporting entity is
also required to add significant disclosures regarding its involvement with
variable interest entities and any changes in risk exposure due to this
involvement. Both of these amendments to the ASC are effective for
transactions and events occurring after the beginning of a reporting entity’s
first fiscal year that begins after November 15, 2009. Early
adoption is prohibited, and the application will be prospective. We
have one QSPE that we will consolidate as a result of the adoption of these
standards on January 1, 2010. As a result, our investments will
increase by approximately $15 million as a result of the consolidation of this
QSPE with a corresponding $15 million increase in its securitization
financing. We do not anticipate that the adoption of this standard
will have a material impact on our results of operations.
Subsequently,
FASB issued Update No. 2010-10 which allowed certain reporting entities to defer
the consolidation requirements amended in ASC Topic 810 by Update No.
2009-17. Our company is not eligible for this deferral.
In January 2010, FASB issued Update No.
2010-06 which amends ASC Topic 820 to require additional disclosures and to
clarify existing disclosures. Specifically, entities will be required
to disclose reasons for and amounts of transfers in and out of levels 1 and 2 as
well as a reconciliation of level 3 measurements to include separate information
about purchases, sales, issuances, and
settlements. Additionally, this amendment clarifies that a
“class” of assets or liabilities is often a subset of assets or liabilities
within a line item on the entity’s balance sheet, and that a reporting entity
should provide fair value measurement disclosures for each
class. This amendment also clarifies that disclosures about valuation
techniques and inputs used to measure fair value for both recurring and
nonrecurring fair value measurements is required for those measurements that
fall in either level 2 or 3. The effective date for the new
disclosure requirements relating to the rollforward of activity in level 3 fair
value measurements is for fiscal years beginning after December 15, 2010, and
for interim periods within those fiscal years. All other new
disclosures and clarifications of existing disclosures issued in this Update are
effective for interim and annual reporting periods beginning after December 15,
2009. Management will comply with these new disclosure requirements
in the future applicable periods. Because these amendments to ASC
Topic 820 relate only to disclosures and do not alter GAAP, they will not impact
our financial condition or results of operations.
FINANCIAL
CONDITION
The
following discussion includes our balance sheet items that had significant
activity during the past fiscal year and should be read in conjunction with the
Notes to the Financial Statements contained within Item 8 of this Annual Report
on Form 10-K.
Agency
MBS
Our
Agency MBS investments, which are classified as available-for-sale and carried
at fair value, are comprised as follows:
32
|
(amounts
in thousands)
|
December
31, 2009
|
December
31, 2008
|
||||||
|
Agency
MBS:
|
||||||||
|
Hybrid ARMs
|
$ | 293,428 | $ | 217,800 | ||||
|
ARMs
|
297,002 | 92,626 | ||||||
| 590,430 | 310,426 | |||||||
|
Fixed-rate
|
131 | 194 | ||||||
| 590,561 | 310,620 | |||||||
|
Principal
receivable
|
3,559 | 956 | ||||||
| $ | 594,120 | $ | 311,576 | |||||
Agency
MBS increased $282.5 million to $594.1 million as of December 31, 2009 from
$311.6 million as of December 31, 2008 primarily as a result of our purchase of
approximately $389.2 million of Agency MBS. In addition, the weighted
average price on our Agency MBS increased to 104.2 from 101.3 as of December 31,
2009 and 2008, respectively. Partially offsetting these increases was
the receipt of $116.7 million of principal on the securities during the
twelve-month period ended December 31, 2009. Approximately $575.4
million of the Agency MBS are pledged to counterparties as security for
repurchase agreement financing.
As of
December 31, 2009, our portfolio of Agency MBS included net unamortized premiums
of $12.9 million, or 2.3% of the par value of the securities, compared to net
unamortized premiums of $3.5 million, or 1.1% of the par value of the
securities, as of December 31, 2008. The average constant prepayment
rate (“CPR”) realized on our Agency MBS portfolio was 17.0% for the years ended
December 31, 2009 and 2008.
Securitized Mortgage Loans,
Net
Securitized
mortgage loans are comprised of loans secured by first deeds of trust on
single-family residential and commercial properties. Our net basis in
these loans at amortized cost, which includes discounts, premiums, deferred
costs, and allowance for loan losses, is presented in the following table by the
type of property collateralizing the loan.
|
(amounts
in thousands)
|
December
31, 2009
|
December
31, 2008
|
||||||
|
Securitized
mortgage loans, net:
|
||||||||
|
Commercial
|
$ | 150,371 | $ | 170,806 | ||||
|
Single-family
|
62,100 | 71,483 | ||||||
| $ | 212,471 | $ | 242,289 | |||||
Our
securitized commercial mortgage loans are pledged to two securitization trusts,
which were issued in 1993 and 1997, and have outstanding principal balances,
including defeased loans, of $13.1 million and $142.0 million, respectively, as
of December 31, 2009 compared to $22.9 million and $152.2 million, respectively,
as of December 31, 2008. The decrease in the balance of these
mortgage loans from December 31, 2008 to December 31, 2009 was primarily related
principal payments, net of amounts received on loans entering defeasance, of
$20.3 million. We provided approximately $0.3 million for estimated
losses on these commercial mortgage loans as a result of an increase in
estimated losses on the commercial loan portfolio.
Our
securitized single-family mortgage loans are pledged to a securitization trust
issued in 2002 using loans that were principally originated between 1992 and
1997. The decrease in the balance of these mortgage loans is
primarily related to principal payments on the loans of $9.1 million, $5.8
million of which was unscheduled, and the provision of approximately $0.3
million for estimated loan losses during the 2009 fiscal year. These
loans are comprised of approximately 87% ARMs, 62% of which are based on
six-month LIBOR, and the remaining 13% being fixed rate loans. These
loans have a loan to original appraised value of approximately 49.6%, based on
the unpaid principal balance as of December 31, 2009. In addition,
approximately 32.7% of the loans are covered by pool
insurance. Although the portfolio experienced an increase in the
percentage of single-family mortgage loans more than 60 days delinquent from
4.45% as of
33
December
31, 2008 to 6.77% as of December 31, 2009, the loans continue to perform well
with realized losses of only $0.2 million for the year ended December 31, 2009
and no realized losses for the year ended December 31, 2008. Due to
the seasoning of these loans, pool insurance, and other credit support, we
provided approximately $0.3 million estimated losses on the single-family
mortgage loans during the year.
Non-Agency
securities
Non-Agency
securities increased $102.8 million to $109.1 million as of December 31, 2009
from $6.3 million as of December 31, 2008. In November of 2009, we
acquired all of the interests in our previous joint venture and now consolidate
the assets of the former joint venture. One of the assets we acquired
was a subordinate CMBS with a fair value of approximately $4.1 million, which is
included in non-Agency securities. We also acquired the redemption
rights for $182.5 million CMBS issued in 1998 when we purchased the controlling
interest in the joint venture.
We
exercised certain of the redemption rights and redeemed $111.3 million of ‘AAA’
rated CMBS. We refinanced these CMBS through a securitization
transaction in December 2009 and sold $15.0 million of the securitization bonds
as part of the transaction on which we recognized a loss of less than $0.1
million. As of December 31, 2009, we held $99.1 million of the
securitization bonds in our investment portfolio.
Other
Investments
In 2009,
we sold all of our remaining investment in equity securities of $3.4 million,
which generated net proceeds of approximately $3.6 million and a gain of $0.2
million.
Other
loans and investments declined approximately $0.6 million primarily due to the
receipt of principal on the mortgage loans. The balance as of
December 31, 2009 is comprised of $2.1 million of seasoned residential and
commercial mortgage loans and $0.1 million related to an investment in
delinquent property tax receivables.
Repurchase
Agreements
Repurchase
agreements increased to $638.3 million as of December 31, 2009 from $274.2
million as of December 31, 2008. The increase is primarily related to
our use of repurchase agreements to finance our acquisition of Agency MBS and
non-Agency securities, net of repayments during the year. The
following table presents our repurchase agreement borrowings and the fair value
of the investments collateralizing those borrowing by collateral type as of
December 31, 2009 and 2008.
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
(amounts
in thousands)
|
Repurchase
agreement
|
Estimated
fair value of collateral
|
Repurchase
agreement
|
Estimated
fair value of collateral
|
||||||||||||
|
Collateral
type:
|
||||||||||||||||
|
Agency MBS
|
$ | 540,586 | $ | 575,386 | $ | 274,217 | $ | 300,277 | ||||||||
|
Non-Agency securities -
CMBS
|
73,338 | 82,770 |
─
|
─
|
||||||||||||
|
Securitization financing bonds
(1)
|
24,405 | 34,431 |
─
|
─
|
||||||||||||
| $ | 638,329 | $ | 692,587 | $ | 274,217 | $ | 300,277 | |||||||||
|
(1)
|
The
securities collateralizing these repurchase agreements are two
securitization financing bonds, which were issued by trusts that we
consolidate and which were redeemed by us. Although these securities
remain outstanding, which enables us to finance them with repurchase
agreements, because we consolidate the trusts that issued these bonds,
they are eliminated in our consolidated financial
statements.
|
Our
repurchase agreements generally have original maturities of thirty to sixty days
and bear interest at a spread to LIBOR. As of December 31, 2009 and
2008, our repurchase agreements had the following weighted average maturities
and interest rates:
34
|
December
31, 2009
|
December
31, 2008
|
|||
|
(amounts
in thousands)
|
Weighted
average original maturity
(in
days)
|
Interest
rate
|
Weighted
average original maturity
(in
days)
|
Interest
rate
|
|
Collateral
type:
|
||||
|
Agency MBS
|
64
|
0.60%
|
41
|
2.70%
|
|
Non-Agency securities -
CMBS
|
33
|
1.73%
|
─
|
─
|
|
Securitization financing
bonds
|
33
|
1.59%
|
─
|
─
|
Securitization
Financing
Securitization
financing consists of fixed and variable rate bonds. The balances in
the table below include unpaid principal, premiums, discounts, and deferred
costs.
|
(amounts
in thousands)
|
December
31, 2009
|
December
31, 2008
|
||||||
|
Securitization
financing bonds:
|
||||||||
|
Fixed, secured by commercial
mortgage loans
|
$ | 119,713 | $ | 149,584 | ||||
|
Variable, secured by single-family
mortgage loans
|
23,368 | 27,573 | ||||||
| $ | 143,081 | $ | 177,157 | |||||
The
fixed-rate bonds were issued pursuant to two separate indentures (via two
securitization trusts) and finance our securitized commercial mortgage loans,
which are also fixed-rate. The fixed-rate bonds have a range of rates
from 6.7% to 7.2% and a weighted average rate of 6.9% as of December 31,
2009. Approximately $15.5 million of the decrease in fixed-rate
securitization financing was related to the Company’s redemption of a senior
bond issued by one of the securitization trusts. The bond was
redeemed at its par value and was partially financed with a repurchase agreement
with a balance of $6.1 million as of December 31, 2009, which is referred to in
the repurchase agreement discussion above. The remainder of the
decrease in fixed-rate bonds is primarily related to principal payments on the
bonds of $12.9 million and bond premium and deferred cost amortization of
approximately $1.5 million during the year ended December 31, 2009.
Our
securitized single-family mortgage loans are financed by a variable-rate
securitization financing bond issued pursuant to a single
indenture. As of December 31, 2009, the interest rate for this
variable-rate bond was 0.5%. The balance decreased $4.2 million to
$23.4 million as of December 31, 2009 from $27.6 million as of December 31, 2008
and is primarily related to principal payments on the bonds of $4.3 million
partially offset by $0.1 million of bond discount amortization.
Shareholders’
Equity
Shareholders’
equity increased $28.3 million to $168.8 million as of December 31,
2009. The increase was primarily related to net income of $17.6
million, an increase in AOCI of $14.0 million primarily related to an increase
in the average price of our Agency MBS portfolio to 104.2 as of December 31,
2009 from 101.3 as of December 31, 2008, and a $12.9 million increase for the
issuance of 1,751,750 shares of our common stock at an average price of $7.59
(net of issuance costs). These increases were partially offset by
dividends declared on our common and preferred stock dividends of $16.1
million.
Supplemental
Discussion of Investments
The
tables below summarize our investment portfolio by major category as of December
31, 2009 and December 31, 2008, and provide our investment basis, associated
financing, net invested capital (which is the difference between our investment
basis and the associated financing as reported in our audited consolidated
financial statements), and the estimated fair value of the net invested capital
as of December 31, 2009. Net invested capital in the table below
represents the approximate allocation of our shareholders’ capital by major
investment category. Because our business model employs the use of
leverage, our investment portfolio presented on a gross basis may not reflect
the true commitment of our shareholders’
35
equity
capital to a particular investment category, and it may not indicate to our
shareholders where our capital is at risk. We believe this analysis
is particularly important when we use financing which is recourse to us such as
repurchase agreements. Our capital allocation decisions are in large
part determined based on risk adjusted returns for our capital available in the
marketplace. Such risk-adjusted returns are based on the leveraged
return on investment (i.e., return on equity or, alternatively, return on
invested capital). We present the information in the table below to
show where our capital is allocated by investment category. We
believe that our shareholders view our actual capital allocations as important
in their understanding of the risks in our business and the earnings potential
of our business model.
For
investments carried at fair value in our consolidated financial statements, the
estimated fair value of net invested capital (presented in the last column of
the following table) is equal to the basis as presented in the consolidated
financial statements less the financing amount associated with that
investment. For investments carried at an amortized cost basis
(principally securitized mortgage loans), the estimated fair value of net
invested capital is based on the present value of the projected cash flow from
the investment, adjusted for the impact and assumed level of future prepayments
and credit losses, less the projected principal and interest due on the
associated financing. In general, because of the uniqueness and age
of these investments, an active secondary market does not currently exist so
management makes assumptions as to market expectations of prepayment speeds,
losses and discount rates. Therefore, if we actually were to have
attempted to sell these investments as of December 31, 2009 or as of December
31, 2008, there can be no assurance that the amounts set forth in the tables
below could have been realized. In all cases, we believe that these
valuation techniques are consistent with the methodologies used in our fair
value disclosures included in Note 12 in the Notes to the Consolidated Financial
Statements.
Estimated Fair Value of Net
Invested Capital
|
December
31, 2009
(amounts
in thousands)
|
||||||||||||||||
|
Investment
|
Investment
basis
|
Financing
(1)
|
Net invested
capital
|
Estimated
fair value of net invested capital
|
||||||||||||
|
Agency
MBS
(2)
|
$ | 594,120 | $ | 540,586 | $ | 53,534 | $ | 53,534 | ||||||||
|
Securitized
mortgage loans:
(3)
|
||||||||||||||||
|
Single-family
mortgage loans – 2002 Trust
|
62,100 | 41,716 | 20,384 | 13,911 | ||||||||||||
|
Commercial
mortgage loans – 1993 Trust
|
11,574 | 6,057 | 5,517 | 5,762 | ||||||||||||
|
Commercial
mortgage loans – 1997 Trust
|
138,797 | 119,713 | 19,084 | 10,235 | ||||||||||||
| 212,471 | 167,486 | 44,985 | 29,908 | |||||||||||||
|
Non-Agency
securities
(4)
|
||||||||||||||||
|
CMBS
|
103,203 | 73,338 | 29,865 | 29,865 | ||||||||||||
|
RMBS
|
5,907 |
─
|
5,907 | 5,907 | ||||||||||||
| 109,110 | 73,338 | 35,772 | 35,772 | |||||||||||||
|
Other
investments
|
2,280 |
─
|
2,280 | 2,079 | ||||||||||||
|
Total
|
$ | 917,981 | $ | 781,410 | $ | 136,571 | $ | 121,293 | ||||||||
|
(1)
|
Financing
includes repurchase agreements and securitization financing issued to
third parties.
|
|
(2)
|
Estimated
fair values are based on a third-party pricing service and dealer
quotes. Net invested capital excludes cash maintained to
support investment in Agency MBS financed with repurchase agreement
borrowings.
|
|
(3)
|
Estimated
fair values are based on discounted cash flows using assumptions set forth
in the table below, inclusive of amounts invested in unredeemed
securitization financing bonds.
|
|
(4)
|
Estimated
fair values are calculated as the net present value of expected future
cash flows.
|
The
following table summarizes management’s assumptions used in our calculation of
estimated fair value of net invested capital as of December 31, 2009 for the
securitized mortgage loan and non-Agency CMBS portions of our investment
portfolio.
36
|
Fair
Value Assumptions
|
||||
|
Investment
type
|
Approximate
year of investment origination or issuance
|
Weighted-average
prepayment speeds
(1)
|
Projected
annual losses
(2)
|
Weighted-average
discount
rate
(3)
|
|
Single-family
mortgage loans – 2002 Trust
|
1994
|
15%
CPR
|
0.2%
|
11%
|
|
Commercial
mortgage loans – 1993 Trust
|
1993
|
0%
CPR
|
0.8%
|
11%
|
|
Commercial
mortgage loans – 1997 Trust
|
1997
|
20%
CPY
(4)
|
1.5%
|
21%
|
|
Non-Agency
CMBS
|
1998
|
20%
CPY
(4)
|
0.0%
|
6%
|
|
(1)
|
Assumed
CPR speeds generally are governed by underlying pool
characteristics. Loans currently delinquent in excess of 30
days are assumed to be liquidated in six months at a loss amount that is
calculated for each loan based on its specific
facts.
|
|
(2)
|
Management’s
estimate of losses that would be used by a third party in valuing these or
similar assets.
|
|
(3
)
|
Represents
management’s estimate of the market discount rate that would be used by a
third party in valuing these or similar
assets.
|
|
(4)
|
CPR
with yield maintenance provision. 20% CPY assumes a CPR of 20%
per annum on the pool upon expiration of the prepayment lock-out
period.
|
|
December
31, 2008
(amounts
in thousands)
|
||||||||||||||||
|
Investment
|
Investment
basis
|
Financing
(1)
|
Net
invested capital
|
Estimated
fair value of net invested capital
|
||||||||||||
|
Agency
MBS
(2)
|
$ | 311,576 | $ | 274,217 | $ | 37,359 | $ | 37,359 | ||||||||
|
Securitized
mortgage loans:
(3)
|
||||||||||||||||
|
Single-family
mortgage loans – 2002 Trust
|
71,483 | 27,573 | 43,910 | 35,594 | ||||||||||||
|
Commercial
mortgage loans – 1993 Trust
|
21,314 | 18,218 | 3,096 | 3,307 | ||||||||||||
|
Commercial
mortgage loans – 1997 Trust
|
149,492 | 139,900 | 9,592 |
─
|
||||||||||||
| 242,289 | 185,691 | 56,598 | 38,901 | |||||||||||||
|
Non-Agency
securities
(4)
|
||||||||||||||||
|
CMBS
|
─
|
─
|
─
|
─
|
||||||||||||
|
RMBS
|
6,259 |
─
|
6,259 | 6,259 | ||||||||||||
| 6,259 |
─
|
6,259 | 6,259 | |||||||||||||
|
Investment
in joint venture
(5)
|
5,655 |
─
|
5,655 | 5,595 | ||||||||||||
|
Other
investments
|
6,476 |
─
|
6,476 | 6,099 | ||||||||||||
|
Total
|
$ | 572,255 | $ | 459,908 | $ | 112,347 | $ | 94,213 | ||||||||
|
(1)
|
Financing
includes repurchase agreements and securitization financing issued to
third parties. Financing for the 1997 Trust also includes our
obligation under payment agreement, which at December 31, 2008 had a
balance of $8,534.
|
|
(2)
|
Estimated
fair values are based on a third-party pricing service and dealer
quotes.
|
|
(3)
|
Estimated
fair values are based on discounted cash flows and are inclusive of
amounts invested in unredeemed securitization financing
bonds.
|
|
(4)
|
Estimated
fair values are calculated as the net present value of expected future
cash flows.
|
|
(5)
|
Estimated
fair values for investment in joint venture represents our share of the
estimated fair value of the joint venture’s
assets.
|
37
The
following table presents the information from the “Net Invested Capital” column
included in the “Estimated Fair Value of Net Invested Capital” tables by rating
classification as of December 31, 2009 and 2008. These ratings are
derived based on the rating of the asset in which such capital is
invested. Investments in the unrated and non-investment grade
classification primarily include other loans that are not rated but are
substantially seasoned and performing loans. Securitization
overcollateralization generally includes the excess of the securitized mortgage
loan collateral pledged over the outstanding bonds issued by the securitization
trust.
|
(amounts
in thousands)
|
December
31, 2009
|
December
31, 2008
|
||||||
|
Investments
by rating classification:
|
||||||||
|
Agency
MBS
|
$ | 53,534 | $ | 37,359 | ||||
|
AAA
rated non-Agency securities
|
42,793 | 40,622 | ||||||
|
AA
and A rated non-Agency securities
|
355 | 337 | ||||||
|
Securitization
overcollateralization
|
33,116 | 21,457 | ||||||
|
Unrated
and non-investment grade
|
6,773 | 6,917 | ||||||
|
Investment
in joint venture
|
─
|
5,655 | ||||||
|
Net
invested capital
|
$ | 136,571 | $ | 112,347 | ||||
The following table reconciles net
invested capital to shareholders’ equity as presented on the Company’s
consolidated balance sheets as of December 31, 2009 and 2008:
|
(amounts
in thousands)
|
December
31, 2009
|
December
31, 2008
|
||||||
|
Net
invested capital
|
$ | 136,571 | $ | 112,347 | ||||
|
Cash
and cash equivalents
|
30,173 | 27,309 | ||||||
|
Derivative
assets
|
1,008 |
─
|
||||||
|
Accrued
interest, net
|
3,375 | 1,559 | ||||||
|
Other
assets and liabilities, net
|
(2,374 | ) | (806 | ) | ||||
|
Shareholders’
equity
|
$ | 168,753 | $ | 140,409 | ||||
The
following discussion for our consolidated results of operation should be read in
conjunction with the Notes to the Financial Statements contained within Item 8
of this Annual Report on Form 10-K.
Year Ended December 31, 2009
Compared to Year Ended December 31, 2008
Interest
Income
Interest
income includes interest earned on our investment portfolio and also reflects
the amortization of any related discounts, premiums and deferred
costs. The following tables present the significant components of our
interest income.
|
Year
Ended December 31,
|
||||||||
|
(amounts
in thousands)
|
2009
|
2008
|
||||||
|
Interest
income - Investments:
|
||||||||
|
Agency MBS
|
$ | 20,962 | $ | 6,731 | ||||
|
Securitized mortgage
loans
|
17,169 | 20,886 | ||||||
|
Non-Agency
securities
|
863 | 709 | ||||||
|
Other
investments
|
226 | 642 | ||||||
|
Cash and cash
equivalents
|
16 | 685 | ||||||
| $ | 39,236 | $ | 29,653 | |||||
38
Interest Income – Agency
MBS
The
increase of $14.2 million in interest income on Agency MBS is related to the
increase in Agency MBS investments from net purchases of approximately $389.2
million of Agency MBS during 2009, which increased the average balance from
$149.2 million for the year ended December 31, 2008 to $492.9 million for the
year ended December 31, 2009. This increase is offset by a 26 basis
point decrease in the average yield on Agency MBS from 4.51% for 2008 to 4.25%
for 2009 as well as an increase of $2.4 million in net premium amortization to
$3.0 million for the year ended December 31, 2009 compared to $0.6 million for
the year ended December 31, 2008.
Interest Income –
Securitized Mortgage Loans
The
following table summarizes the detail of the interest income earned on
securitized mortgage loans.
|
Year
Ended December 31,
|
||||||||||||||||||||||||
|
2009
|
2008
|
|||||||||||||||||||||||
|
(amounts
in thousands)
|
Interest
Income
|
Net
Amortization
|
Total
Interest Income
|
Interest
Income
|
Net
Amortization
|
Total
Interest Income
|
||||||||||||||||||
|
Securitized
mortgage loans:
|
||||||||||||||||||||||||
|
Commercial
|
$ | 13,506 | $ | (32 | ) | $ | 13,474 | $ | 15,282 | $ | 409 | $ | 15,691 | |||||||||||
|
Single-family
|
3,710 | (15 | ) | 3,695 | 5,474 | (279 | ) | 5,195 | ||||||||||||||||
| $ | 17,216 | $ | (47 | ) | $ | 17,169 | $ | 20,756 | $ | 130 | $ | 20,886 | ||||||||||||
The
majority of the decrease of $2.2 million in interest income on securitized
commercial mortgage loans is related to the lower average balance of the
commercial mortgage loans outstanding for the year ended December 31, 2009,
which decreased approximately $17.6 million, or 10%, compared to the average
balance for the year ended December 31, 2008. The decrease in the
average balance is primarily related to principal payments received of $20.3
million, which includes both scheduled and unscheduled payments net of amounts
received on loans entering defeasance, during 2009. In addition, net
amortization of premiums on commercial mortgage loans changed from an
amortization benefit of $0.4 million for the year ended December 31, 2008 to an
amortization expense of less than $0.1 million for the same period in
2009. Current and expected market conditions are expected to make it
more difficult for commercial borrowers to refinance, which should slow
unscheduled payments.
The
decline of $1.5 million in interest income on securitized single-family mortgage
loans was related to the decrease in the average balance of the loans
outstanding to $67.1 million for the year ended December 31, 2009 from $78.9
million for the year ended December 31, 2008. Interest income on
single-family mortgage loans also declined as a result of an approximately 108
basis point decrease in the average yield on our single-family mortgage loan
portfolio to 5.47% for the year ended December 31, 2009 from 6.56% for the year
ended December 31, 2008. For a discussion of the reasons for the
decrease in average yields, see the section “Average Balances and Effective
Interest Rates” below.
Interest Income – Cash and
Cash Equivalents
The
decrease of $0.7 million in interest income on cash and cash equivalents is
primarily the result of a $6.1 million decrease in the average balance of cash
and cash equivalents for the year ended December 31, 2009 compared to the year
ended December 31, 2008 and a decrease in short-term interest rates during
2009. The average balance of cash and cash equivalents declined
during 2009 as we continued to deploy our cash in investments. The
average yield on cash and cash equivalents decreased from 1.90% for the year
ended December 31, 2008 to 0.05% for the year ended December 31,
2009.
39
Interest
Expense
The
following table presents the significant components of our interest
expense.
|
Year
Ended December 31,
|
||||||||
|
(amounts
in thousands)
|
2009
|
2008
|
||||||
|
Interest
expense:
|
||||||||
|
Securitization
financing
|
$ | 9,801 | $ | 13,416 | ||||
|
Repurchase
agreements
|
3,288 | 4,079 | ||||||
|
Obligation under payment
agreement
|
1,589 | 1,608 | ||||||
|
Other
|
(7 | ) | 3 | |||||
| $ | 14,671 | $ | 19,106 | |||||
Interest Expense –
Securitization Financing
The
following table summarizes the detail of the interest expense recorded on
securitization financing bonds.
|
Year
Ended December 31,
|
||||||||||||||||||||||||
|
2009
|
2008
|
|||||||||||||||||||||||
|
(amounts
in thousands)
|
Interest
Expense
|
Net
Amortization
|
Total
Interest Expense
|
Interest
Expense
|
Net
Amortization
|
Total
Interest Expense
|
||||||||||||||||||
|
Securitization
financing:
|
||||||||||||||||||||||||
|
Commercial
|
$ | 10,797 | $ | (1,472 | ) | $ | 9,325 | $ | 12,903 | $ | (995 | ) | $ | 11,908 | ||||||||||
|
Single-family
|
171 | 128 | 299 | 995 | 155 | 1,150 | ||||||||||||||||||
|
Other bond related
costs
|
177 | – | 177 | 358 | – | 358 | ||||||||||||||||||
| $ | 11,145 | $ | (1,344 | ) | $ | 9,801 | $ | 14,256 | $ | (840 | ) | $ | 13,416 | |||||||||||
The
decrease of $2.6 million in interest expense on securitization financing secured
by commercial mortgage loans is primarily related to the $28.2 million, or
approximately 18%, decrease in the average balance of securitization financing
to $131.5 million for the year ended December 31, 2009 from $159.7 million for
the year ended December 31, 2008. The decrease in average balance of
securitization financing is due to principal payments of $12.9 million on the
mortgage loans collateralizing these bonds. We also redeemed a
securitization financing bond with a balance of $15.5 million during the period,
which is discussed previously in more detail in the “Financial Condition”
section above. In addition, securitization financing secured by
commercial mortgage loans is fixed-rate and had a weighted average cost, net of
amortization, of 7.09% and 7.46% for the years ended December 31, 2009 and 2008,
respectively.
The
decrease of $0.9 million in interest expense on securitization financing secured
by single-family mortgage loans is related to the $5.1 million, or approximately
17%, decrease in the average balance of securitization financing to $25.4
million for the year ended December 31, 2009 from $30.6 million for the year
ended December 31, 2008. This decrease in average balance of
securitization financing is related to the prepayments on the mortgage loans
collateralizing these bonds. In addition, the cost of financing
decreased to 1.18% for the year ended December 31, 2009 from 3.76% for the year
ended December 31, 2008. The financing is variable-rate based on
one-month LIBOR which declined during the 2009 period.
Interest Expense –
Repurchase Agreements
The
following table summarizes the components of interest expense by the type of
securities collateralizing the repurchase agreements.
40
|
Year
Ended December 31,
|
||||||||
|
(amounts
in thousands)
|
2009
|
2008
|
||||||
|
Interest
expense:
|
||||||||
|
Repurchase agreements
collateralized by Agency MBS
|
$ | 2,847 | $ | 3,978 | ||||
|
Repurchase agreements
collateralized by securitization financing bonds
|
409 | 101 | ||||||
|
Repurchase agreements
collateralized by CMBS
|
32 | – | ||||||
| $ | 3,288 | $ | 4,079 | |||||
The
decrease of $1.2 million in interest expense on repurchase agreements
collateralized by Agency MBS is primarily related to a 235 basis point decrease
in the average rate on the repurchase agreements to 0.63% for the year ended
December 31, 2009 from 2.96% for the year ended December 31,
2008. The benefit from the decrease in the average rate of borrowing
costs was offset in part by a $314.0 million increase in the average balance of
repurchase agreements outstanding for the year ended December 31, 2009 to $448.3
million from $134.3 million for the year ended December 31, 2008.
Interest
expense on repurchase agreements collateralized by securitization bonds
increased $0.3 million due to a $17.7 million increase in the average balance
outstanding to $20.9 million for the year ended December 31, 2009 from $3.2
million for the year ended December 31, 2008. The increase in balance
was primarily related to financing the securitization bond that was redeemed
during 2009 with a repurchase agreement. The effect of the increased
balance on interest expense was partially offset by a 119 basis point decrease
in the average rate on the repurchase agreements to 1.96% for the year ended
December 31, 2009 from 3.15% for the year ended December 31, 2008.
Provision
for Loan Losses
During
the year ended December 31, 2009, we added approximately $0.8 million of
reserves for estimated losses on our securitized mortgage loan
portfolio. We provided $0.4 million for estimated losses on our
commercial mortgage loans, which include $15.3 million of loans delinquent for
30 or more days at December 31, 2009. We also provided approximately
$0.3 million for estimated losses on our portfolio of securitized single-family
mortgage loans.
Gain
on Sale of Investments, Net
The gain
on sale of investments for the year ended December 31, 2009 is primarily related
to the sale of our remaining investment in the equity securities of publicly
traded companies during the year which generated proceeds of approximately $3.6
million on equity securities in which we had a cost basis of approximately $3.4
million resulting in a gain of approximately $0.2 million. The gain
of $2.3 million for the year ended December 31, 2008 is primarily related to the
sale of approximately $14.2 million of equity securities during that
period.
Fair
Value Adjustments, Net
Fair
value adjustments, net for the year ended December 31, 2009 was primarily
comprised of an unfavorable fair value adjustment of $2.0 million related to the
obligation under payment agreement offset by a favorable fair value adjustment
of $1.9 million related to certain bond redemption rights. Prior to
our acquisition of the remaining interests of the joint venture, market discount
rates declined which resulted in an increase in the fair value of the obligation
under payment agreement and the recognition of the unfavorable fair value
adjustment of $2.0 million. When we acquired the remaining interests
of the joint venture and consolidated its assets into our balance sheet, we
recognized $2.7 million in redemption rights for CMBS which subsequently
increased in fair value by $1.9 million.
Other
(Expense) Income
Other
expense of $2.3 million for the year ended December 31, 2009 was primarily
related to a $2.5 million charge recognized in relation to our acquisition in
November 2009 of the remaining 50.125% interest in the joint venture, Copperhead
Ventures, LLC, in which we previously owned 49.875%.
41
Other
income of $7.5 million for the year ended December 31, 2008 includes the
recognition of $2.7 million of income related to the redemption of a commercial
securitization bond. Of that amount approximately $1.4 million
relates to the unamortized premium on the redeemed bond on the redemption date
and $1.3 million relates to the release of a contingency reserve at the time of
redemption. In addition, we recognized a $3.4 million benefit related
to our release from an obligation to fund certain mortgage servicing
payments. Other income also includes $1.2 million in dividend income
we earned during 2008 on our investment in equity securities.
General
and Administrative Expenses
Compensation and
Benefits
Compensation
and benefits expense increased $1.3 million to $3.6 million for the year ended
December 31, 2009 from $2.3 million for the year ended December 31,
2008. Our stock-based compensation expense increased $0.8 million
primarily due to an increase in the closing price of our common stock from $6.54
at December 31, 2008 to $8.73 at December 31, 2009. The remaining
increase in compensation and benefits is primarily related to the salary, bonus
and benefits associated with hiring two additional executive officers during the
second half of 2008.
Other General and
Administrative
The
decrease of $0.2 million in other general and administrative expenses is
primarily related to consulting and related expenses associated with expanding
our investment platform and the related infrastructure that were incurred in
2008.
Year Ended December 31, 2008
Compared to Year Ended December 31, 2007
Interest
Income
Interest
income includes interest earned on our investment portfolio and also reflects
the amortization of any related discounts, premiums and deferred
costs. The following tables present the significant components of
interest income.
|
Year
Ended December 31,
|
||||||||
|
(amounts
in thousands)
|
2008
|
2007
|
||||||
|
Interest
income - Investments:
|
||||||||
|
Agency MBS
|
$ | 6,731 | $ | 110 | ||||
|
Securitized mortgage
loans
|
20,886 | 26,424 | ||||||
|
Other
investments
|
1,351 | 1,633 | ||||||
|
Cash and cash
equivalents
|
685 | 2,611 | ||||||
| $ | 29,653 | $ | 30,778 | |||||
Interest Income – Agency
MBS
Interest
income on Agency MBS increased to $6.7 million for the year ended December 31,
2008 from $0.1 million for the same period in 2007. The increase is
related to the net purchase of approximately $335.6 million of Agency MBS during
the year ended December 31, 2008, which increased the average balance from $1.2
million for the year ended December 31, 2007 to $149.2 million for the same
period in 2008. The average balance increased less than the gross
purchases during 2008 because the Agency MBS purchases occurred throughout
2008.
Interest
income on Agency MBS for 2008 of $6.7 million was reduced by approximately $0.6
million of net premium amortization during the year.
Interest Income –
Securitized Mortgage Loans
The
following table summarizes the detail of the interest income earned on
securitized mortgage loans.
42
|
Year
Ended December 31,
|
||||||||||||||||||||||||
|
2008
|
2007
|
|||||||||||||||||||||||
|
(amounts
in thousands)
|
Interest
Income
|
Net
Amortization
|
Total
Interest Income
|
Interest
Income
|
Net
Amortization
|
Total
Interest Income
|
||||||||||||||||||
|
Securitized
mortgage loans:
|
||||||||||||||||||||||||
|
Commercial
|
$ | 15,282 | $ | 409 | $ | 15,691 | $ | 18,114 | $ | 485 | $ | 18,599 | ||||||||||||
|
Single-family
|
5,474 | (279 | ) | 5,195 | 7,887 | (62 | ) | 7,825 | ||||||||||||||||
| $ | 20,756 | $ | 130 | $ | 20,886 | $ | 26,001 | $ | 423 | $ | 26,424 | |||||||||||||
The
majority of the decrease of $2.9 million in interest income on securitized
commercial mortgage loans is primarily related to the decline in the average
balance of the commercial mortgage loans outstanding during 2008, which
decreased approximately $31.6 million (15%) from the balance for the same period
in 2007. The decrease in the average balance between the periods is
primarily related to payments on the commercial mortgage loans of $22.3 million,
which includes both scheduled and unscheduled payments, during
2008.
Interest
income on securitized single-family mortgage loans declined $2.6 million to $5.2
million for the year ended December 31, 2008. The decline in interest
income on single-family mortgage loans was primarily related to the decrease in
the average balance of the loans outstanding, which declined approximately $21.8
million, or approximately 22%, to $78.9 million for the year ended December 31,
2008 compared to the same period in 2007. Approximately $12.3 million
of unscheduled payments were received on our single-family mortgage loans during
2008, which represented approximately 14% of outstanding unpaid principal
balance as of December 31, 2007. Interest income on our single-family
mortgage loans also declined as a result of a decrease in the average yield on
our single-family mortgage loan portfolio, which declined from 7.7% to 6.6% for
the years ended December 31, 2007 and 2008,
respectively. Approximately 87% of our single-family mortgage loans
were variable rate as of December 31, 2008.
Interest Income – Cash and
Cash Equivalents
Interest
income on cash and cash equivalents decreased $1.9 million to $0.7 million for
the year ended December 31, 2008 from $2.6 million for the same period in
2007. This decrease is primarily the result of a $16.8 million
decrease in the average balance of cash and cash equivalents for 2008 compared
to 2007 and a decrease in short-term interest rates during 2008. The
average balance of cash and cash equivalents declined during 2008 as we deployed
our cash in investments. The yield on cash decreased from 5.0% for
the year ended December 31, 2007 to 1.9% for the same period in
2008.
Interest
Expense
The
following table presents the significant components of interest
expense.
|
Year
Ended December 31,
|
||||||||
|
(amounts
in thousands)
|
2008
|
2007
|
||||||
|
Interest
expense:
|
||||||||
|
Securitization
financing
|
$ | 13,416 | $ | 14,999 | ||||
|
Repurchase
agreements
|
4,079 | 3,546 | ||||||
|
Obligation under payment
agreement
|
1,608 | 1,525 | ||||||
|
Other
|
3 | 25 | ||||||
| $ | 19,106 | $ | 20,095 | |||||
43
Interest Expense –
Securitization Financing
The
following table summarizes the detail of the interest expense recorded on
securitization financing bonds.
|
Year
Ended December 31,
|
||||||||||||||||||||||||
|
2008
|
2007
|
|||||||||||||||||||||||
|
(amounts
in thousands)
|
Interest
Expense
|
Net
Amortization
|
Total
Interest Expense
|
Interest
Expense
|
Net
Amortization
|
Total
Interest Expense
|
||||||||||||||||||
|
Securitization
financing:
|
||||||||||||||||||||||||
|
Commercial
|
$ | 12,903 | $ | (995 | ) | $ | 11,908 | $ | 15,856 | $ | (1,831 | ) | $ | 14,025 | ||||||||||
|
Single-family
|
995 | 155 | 1,150 | 387 | 62 | 449 | ||||||||||||||||||
|
Other bond related
costs
|
358 | – | 358 | 525 | – | 525 | ||||||||||||||||||
| $ | 14,256 | $ | (840 | ) | $ | 13,416 | $ | 16,768 | $ | (1,769 | ) | $ | 14,999 | |||||||||||
Interest
expense on commercial securitization financing decreased from $14.0 million for
the year ended December 31, 2007 to $11.9 million for the same period in
2008. The majority of this $2.1 million decrease is related to the
$34.2 million (18%) decrease in the weighted average balance of securitization
financing, from $193.9 million for the year ended December 31, 2007 to $159.7
million for the same period in 2008 related to principal payments on the
mortgage loans collateralizing these bonds.
The
interest expense on single-family securitization financing is related to a
securitization bond that we redeemed in 2005 and reissued in the fourth quarter
of 2007. The net amortization of $0.2 million during the year ended
December 31, 2008 is attributable to the discount at which the bond was
reissued.
Interest Expense –
Repurchase Agreements
The
increase of $0.5 million of interest expense to $4.1 million on the repurchase
agreements in 2008 is primarily the result of an increase of the average balance
of repurchase agreements from $64.2 million for the year ended December 31, 2007
to $134.3 million for the same period in 2008. The increase in the
balance of repurchase agreements was related to our purchase of additional
Agency MBS, which we financed with repurchase agreements. The
increase in expense related to the increase in the average balance was partially
offset by a decrease in the yield on the repurchase agreements from 5.5% to 3.0%
for the years ended December 31, 2007 and 2008, respectively.
(Provision
for) Recapture of Provision for Loan Losses
During
the year ended December 31, 2008, we added approximately $1.0 million of
reserves for estimated losses on our securitized mortgage loan
portfolio. The majority of this amount was provided for estimated
losses on our commercial mortgage loans, with less than $0.1 million provided
for estimated losses on our portfolio of single–family mortgage
loans.
Equity
in (Loss) Income of Joint Venture
Our
interest in the operations of the joint venture, in which we held a 49.875%
interest, decreased from income of $0.7 million to a loss of $5.7 million for
the year ended December 31, 2007 and 2008, respectively. The joint
venture had interest income of approximately $4.0 million for the year ended
December 31, 2008. The joint venture’s results for the year ended
December 31, 2008 were reduced by an other-than-temporary impairment charge of
$7.3 million that it recognized on its interests in a subordinate CMBS and a
$7.4 million decrease in the estimated fair value of certain interests in a
subordinate CMBS, for which it elected the fair value option under SFAS
159. Our proportionate share of these items was a $5.7 million
loss.
44
Fair
Value Adjustments, Net
The $7.1
million fair value adjustment is primarily related to a decline in the fair
value of our obligation under a payment agreement to the joint venture, with
respect to which we elected to apply fair value accounting under SFAS 159, which
we adopted on January 1, 2008. The decline in fair value of the
obligation resulted from an increase in the rate used to discount estimated
future cash flows to 36.50% from 14.75% as spreads to interest rate indices
widened during the year. In addition, the estimated prepayments on
the loans covered by the obligation under payment agreement were slowed due to
economic conditions which make refinancing commercial loans
difficult. The reduced prepayments resulted in estimated cash flows
occurring later than was previously forecast, which, along with the increase in
the discount rate, reduced the carrying value of the obligation during the
year.
Gain
on Sale of Investments, Net
The $2.3
million gain on sale of investments for the year ended December 31, 2008 is
primarily related to a $2.6 million net gain recognized on the sale of
approximately $14.2 million of equity securities during the
period. That gain was partially offset by a $0.2 million loss on the
sale of a senior convertible debt security with a par value of $5.0
million.
Other
Income (Expense)
Other
income of $7.5 million for the year ended December 31, 2008 includes the
recognition of $2.7 million of income related to the redemption of a commercial
securitization bond. Of that amount approximately $1.4 million
relates to the unamortized premium on the redeemed bond on the redemption date
and $1.3 million relates to the release of a contingency reserve at the time of
redemption. In addition, we recognized a $3.4 million benefit related
to our release from an obligation to fund certain mortgage servicing
payments. The obligation was related to payments we had been required
to make to a former affiliate that was the servicer of manufactured housing
loans that were originated by one of our subsidiaries in 1998 and
1999. The servicer resigned effective July 1, 2008, which resulted in
our release from the obligation to make further payments. Other
income also includes $1.2 million in dividend income we earned during 2008 on
our investment in equity securities.
General
and Administrative Expenses
Compensation and
Benefits
Compensation
and benefits expense increased $0.4 million from $1.9 million to $2.3 million
for the years ended December 31, 2007 and 2008, respectively. This
increase is primarily due to an increase in salaries and bonuses of
approximately $1.0 million, the majority of which is related to the hiring of
two additional executive officers during the year. This increase in
salaries and bonuses was partially offset by a $0.5 million decrease in stock
based compensation expense related to outstanding stock appreciation rights,
which decreased from an expense of $0.2 million to a benefit of $0.3 million as
a result of decreases in our common stock price and the stock price
volatility.
Other General and
Administrative
Other
general and administrative expenses increased by $1.2 million to $3.3 million
for the year ended December 31, 2008. This increase was primarily
related to additional costs associated with expanding our investment platform
and evaluating potential investment opportunities of approximately $0.9 million
and $0.2 million for certain consulting services.
Average
Balances and Effective Interest Rates
The
following table summarizes the average balances of interest-earning investment
assets and their average effective yields, along with the average
interest-bearing liabilities and the related average effective interest rates,
for each of the periods presented. Cash and cash equivalents and
assets that are on non-accrual status are excluded from the table below for each
period presented.
45
|
Year
ended December 31,
|
||||||||||||||||||||||||
|
(amounts
in thousands)
|
2009
|
2008
|
2007
|
|||||||||||||||||||||
|
Average
Balance
(1)(2)
|
Effective
Rate
(3)
|
Average
Balance
(1)(2)
|
Effective
Rate
(3)
|
Average
Balance
(1)(2)
|
Effective
Rate
(3)
|
|||||||||||||||||||
|
Agency MBS
|
||||||||||||||||||||||||
|
Agency MBS
|
$ | 492,900 | 4.25 | % | $ | 149,229 | 4.51 | % | $ | 1,214 | 9.03 | % | ||||||||||||
|
Repurchase
agreements
|
448,279 | 0.63 | % | 134,252 | 2.96 | % | – | – | % | |||||||||||||||
|
Net interest
spread
|
3.62 | % | 1.55 | % | 9.03 | % | ||||||||||||||||||
|
Securitized Mortgage Loans
|
||||||||||||||||||||||||
|
Securitized mortgage
loans
|
$ | 233,120 | 7.36 | % | $ | 262,482 | 7.95 | % | $ | 315,962 | 8.35 | % | ||||||||||||
|
Securitization financing
(4)
|
156,891 | 6.13 | % | 190,234 | 6.86 | % | 201,148 | 7.19 | % | |||||||||||||||
|
Repurchase
agreements
|
20,869 | 1.96 | % | 3,201 | 3.15 | % | 64,231 | 5.45 | % | |||||||||||||||
|
Net interest
spread
|
1.71 | % | 1.15 | % | 1.56 | % | ||||||||||||||||||
|
Non-Agency Securities and Other Investments,
Net
|
||||||||||||||||||||||||
|
All other investments
(5)
|
$ | 14,620 | 7.45 | % | $ | 12,203 | 11.07 | % | $ | 15,908 | 10.26 | % | ||||||||||||
|
Repurchase
agreements
|
1,808 | 1.75 | % |
–
|
─%
|
─
|
─%
|
|||||||||||||||||
|
Net interest
spread
|
5.70 | % | 11.07 | % | 10.26 | % | ||||||||||||||||||
|
Total
|
||||||||||||||||||||||||
|
Interest-earning
assets
|
$ | 740,640 | 5.29 | % | $ | 423,914 | 6.83 | % | $ | 333,084 | 8.45 | % | ||||||||||||
|
Interest-bearing
liabilities
|
627,848 | 2.05 | % | 327,687 | 5.23 | % | 265,379 | 6.77 | % | |||||||||||||||
|
Net interest
spread
|
3.24 | % | 1.60 | % | 1.68 | % | ||||||||||||||||||
|
(1)
|
Average
balances are calculated as a simple average of the daily balances and
exclude unrealized gains and losses on available-for-sale
securities.
|
|
(2)
|
Average
balances exclude funds held by trustees except defeased funds held by
trustees.
|
|
(3)
|
Certain
income and expense items of a one-time nature are not annualized for the
calculation of effective rates. Examples of such one-time items
include retrospective adjustments of discount and premium amortization
arising from adjustments of effective interest
rates.
|
|
(4)
|
Effective
rates are calculated excluding non-interest related securitization
financing expenses.
|
|
(5)
|
Because
the majority of non-Agency securities outstanding as of December 31, 2009
were not acquired until December 2009, average balances are combined with
“Other investments, net”.
|
Year Ended December 31, 2009
compared to Year Ended December 31, 2008
The overall yield on interest-earning
assets, which excludes cash and cash equivalents, decreased to 5.29% for the
year ended December 31, 2009 from 6.83% for the year ended December 31,
2008. The overall cost of financing decreased to 2.05% for the year
ended December 31, 2009 from 5.23% for the year ended December 31,
2008. This resulted in an overall increase in net interest spread of
164 basis points. The reasons for the changes from 2008 to 2009 are
discussed below by investment type.
Agency
MBS
The yield
on Agency MBS decreased by 26 basis points to 4.25% for the year ended December
31, 2009 from 4.51% for the year ended December 31, 2008. This
decrease is primarily the result of lower yields on our purchases of Agency MBS
during 2009 as well as a decrease in the yield on some of our securities that
had loans which reset lower during the year.
46
We used
repurchase agreements to finance the acquisition of Agency MBS during
2009. Repurchase agreement borrowing costs decreased to 0.63% for the
year ended December 31, 2009 compared to 2.96% for the same period in
2008. As the financial markets returned to normal after the turmoil
in 2008, repurchase agreement financing became more readily accessible at lower
financing rates.
Securitized Mortgage
Loans
The net
interest spread for the year ended December 31, 2009 for securitized mortgage
loans was 1.71% versus 1.15% for the same period in 2008. The
increase in spread was due to reduced financing costs partially offset by
reduced yield on securitized mortgage loans.
The yield
on securitized mortgage loans decreased from 7.95% for the year ended December
31, 2008 to 7.36% for the corresponding period in 2009 primarily as a result of
a 109 basis point decrease in the average yield on our securitized single-family
mortgage loans to 5.47% for the year ended December 31, 2009. The
majority of our single-family mortgage loans (87% as of December 31, 2009) are
variable rate and continued to reset at lower rates during
2009. Yields on our commercial mortgage loans decreased from 8.55% to
8.12% for the years ended December 31, 2008 and 2009,
respectively. This decrease can be attributed largely to six loans
for which interest income accrual was stopped during 2009 due to the impairment
of the loans.
The cost
of securitization financing decreased to 6.13% for the year ended December 31,
2009 from 6.86% for the same period in 2008. The yield on a
LIBOR-based variable rate bond collateralized by single-family mortgage loans
decreased by 258 basis points from 3.76% for the year ended December 31, 2008 to
1.18% for the same period in 2009. Average one-month LIBOR decreased
to 0.33% for the year of 2009 from 2.68% for the year ended
2008. Cost of bond financing for the commercial mortgage loan
portfolio decreased 37 basis points primarily due to the redemption of the
higher yielding fixed rate commercial securitization financing during the second
quarter of 2009 which was replaced with lower yielding, variable rate repurchase
agreement financing.
The
average rate on our repurchase agreements that finance our securitized mortgage
loans declined along with LIBOR during the period. However, the
average outstanding balance of these repurchase agreements increased
significantly during the year due to the refinancing of the commercial loan
portfolio discussed above.
Non-Agency Securities and
Other Investments, Net
The yield
on non-Agency securities and other investments, net decreased 362 basis points
to 7.45% for the year ended December 31, 2009 compared to the same period in
2008. The decrease in the yield on these investments was primarily
related to the sale of a $2.7 million debt security in 2008 that had a yield of
approximately 13.0%. In addition, two loans with a total unpaid
principal balance of approximately $1.1 million were placed on non-accrual
during 2009 as they became more than 60 days past due.
Year Ended December 31, 2008
compared to Year Ended December 31, 2007
The
overall yield on interest-earning assets, which excludes cash and cash
equivalents, decreased to 6.83% for the year ended December 31, 2008 from 8.45%
for the same period in 2007. The overall cost of financing decreased
from 6.77% for the year ended December 31, 2007 to 5.23% for the same period in
2008. The above table is discussed in detail below by investment
type. The decrease in the average yield on our interest-earning
assets and financing cost is primarily related to the increase in our investment
in Agency MBS, which are financed with short-term repurchase
agreements. Agency MBS and repurchase agreements had lower yields on
average than our existing legacy investments.
Agency
MBS
The yield
on Agency MBS decreased for the year ended December 31, 2008 compared to the
same period in 2007 primarily as a result of a significant increase in our
investment in Hybrid Agency MBS during 2008, which had a lower average yield
than the small amount of fixed rate Agency MBS we held as of December 31,
2007. We used repurchase agreements to finance the acquisition of
Agency MBS during 2008, which resulted in the increase in the average balance of
repurchase agreements. The increase in the balance of financed Hybrid
Agency MBS resulted in the decline in the net interest spread on Agency MBS of
748 basis points to 1.55% for the year ended December 31, 2008.
47
In 2008,
the Agency MBS had a gross yield of 4.90%, which was reduced by 39 basis points
for net premium amortization, resulting in the net yield on Agency MBS of 4.51%
for the year ended December 31, 2008.
Securitized Mortgage
Loans
The net
interest spread for the year ended December 31, 2008 for securitized mortgage
loans was 1.15% versus 1.56% for the same period in 2007. The yield
on securitized mortgage loans decreased from 8.35% for the year ended December
31, 2007 to 7.95% for the corresponding period in 2008 primarily as a result of
a 118 basis point decrease in the average yield on our securitized single-family
mortgage loans to 6.56% for the year ended December 31, 2008. The
majority of our single-family mortgage loans (87% as of December 31, 2008) are
variable rate and were resetting at lower rates during 2008.
The cost
of securitization financing decreased to 6.86% for the year ended December 31,
2008 from 7.19% for the same period in 2007. This decrease resulted
from the reissuance in the second half of 2007 of a LIBOR-based variable rate
bond collateralized by single-family mortgage loans and a $31.6 million
reduction in the average balance of the higher yielding fixed rate commercial
securitization financing, as a result of principal payments during the year
ended December 31, 2008.
The
average rate on our repurchase agreements that finance our securitized mortgage
loans declined along with LIBOR during the period. In addition, the
average outstanding balance of these repurchase agreements declined
significantly during the year.
Other
Investments
The yield
on other investments increased 81 basis points to 11.07% for the year ended
December 31, 2008 compared to the same period in 2007. This increase
in yield was primarily due to the purchase of a corporate debt security, which
had a higher yield than the average of other investments, during the third
quarter of 2007.
LIQUIDITY
AND CAPITAL RESOURCES
We
finance our investment activities and operations from a variety of sources,
including a mix of collateral-based short-term financing sources such as
repurchase agreements, collateral-based long-term financing sources such as
securitization financing, equity capital, and net earnings.
As a
REIT, we are required to distribute to our shareholders amounts equal to at
least 90% of our REIT taxable income for each taxable year. We
generally fund our dividend distributions through our cash flows from
operations. If we make dividend distributions in excess of our
operating cash flows during the period, whether for purposes of meeting our REIT
distribution requirements or other strategic reasons, those distributions would
generally be funded either through our existing cash balances or through the
return of principal from our investments (either through repayment or
sale). Alternatively, we have the ability to utilize our NOL
carryforwards to offset taxable income and therefore reduce our REIT
distribution requirements. This would allow us to retain capital and
increase our book value per common share and also increase our liquidity by
reducing or eliminating our dividend payout to common
shareholders. For the year ended December 31, 2009, we expect our
taxable income to exceed our dividend, and we intend to utilize our NOL to
offset the REIT distribution requirement.
During
2009, we acquired approximately $500.9 million of investments using repurchase
agreements and equity capital to finance the acquisitions. During
2009, we received principal payments and sale proceeds on investments of $155
million. We generally intend to hold our MBS as long-term
investments, but we will occasionally sell these securities when market
conditions warrant or to manage our interest-rate risks or liquidity
needs.
48
We
initiated a controlled equity offering program (“CEOP”) on March 16, 2009
by filing a prospectus supplement under our shelf registration. The
CEOP allows us to offer and sell through our agent up to 3,000,000 shares of our
common stock in negotiated transactions or transactions that are deemed to be
“at the market offerings”, as defined in Rule 415 under the 1933 Act, including
sales made directly on the New York Stock Exchange or sales made to or through a
market maker other than on an exchange. We intend to use any net
proceeds from the CEOP to acquire additional investments consistent with our
investment policy and for general corporate purposes which may include, among
other things, repayment of maturing obligations, capital expenditures, and
working capital. During the year ended December 31, 2009, we sold
1,749,250 shares of our common stock at a weighted average price of $7.59 per
share. For the quarter ended December 31, 2009, we sold 357,000
shares of our common stock under the CEOP, for which we received proceeds of
$3.0 million, net of $0.1 million commissions paid to our sales
agent. As of December 31, 2009, there are 1,250,750 shares of our
common stock remaining for offer and sale under the CEOP.
In
deploying any new capital raised, we are likely to utilize repurchase agreement
financing which will subject us to liquidity risk driven by fluctuations in
market values of the collateral pledged to support the repurchase
agreement. We will attempt to mitigate this risk by limiting the
investments that we purchase to higher-credit quality investments, and by
managing certain aspects of the investments such as potential market value
changes from changes in interest rates, as much as possible. We will
also seek to manage the ratio of our debt-to-equity in order to give us
financial flexibility and allow us to better manage through, and possibly take
advantage of, periods of market volatility. Our operating policies
provide that repurchase agreements used to finance Agency MBS will be in the
range of five to nine times to our invested equity capital and non-Agency
securities will be in the range of one to four times our invested equity
capital. Our current debt-to-equity ratio for Agency MBS as of
December 31, 2009 was approximately 7 times our invested equity
capital. Our current debt-to-equity capital for non-Agency securities
was 3 times our invested equity capital as of December 31, 2009. Our
operating policies also limit our overall debt-to-equity ratio to no more than 6
times our equity capital. As of December 31, 2009, our overall
debt-to-equity ratio including securitization financing was approximately 4.6
times our invested equity capital.
Repurchase
agreement financing is recourse to both the assets pledged and to
us. We are required to post margin to the lender (i.e., collateral
deposits in excess of the repurchase agreement financing) in order to support
the amount of the financing and to give the lender a cushion against the value
of the collateral pledged. The repurchase agreement lender can
request that we post additional margin (or “margin calls”) if the value of the
pledged collateral declines, and in certain circumstances can request that we
repay all financing balances. If we fail to meet a margin call, the
lender can terminate the repurchase agreement and immediately sell the
collateral. All of the Company’s repurchase agreements are based on
the September 1996 version of the Bond Market Association Master Repurchase
Agreement, which provides that the lender is responsible for obtaining
collateral valuations from a generally recognized source agreed to by both the
Company and the lender, or the most recent closing quotation of such
source. Repurchase agreement borrowings generally will have a term of
between one and three months and carry a rate of interest based on a spread to
an index such as LIBOR. Our repurchase agreements are renewable at
the discretion of our lenders and, as such, do not contain guaranteed roll-over
terms. If we fail to repay the lender at maturity, the lender has the
right to immediately sell the collateral and pursue us for any shortfall if the
sales proceeds are inadequate to cover the repurchase agreement
financing.
While
repurchase agreement funding currently remains available to us at attractive
rates, we are cautious as to the use of repurchase agreements given the state of
the global banking system and the overall health of financial
institutions. Our repurchase agreement counterparties are both
foreign and domestic institutions and we believe substantially all of these
institutions have received some form of assistance from their respective federal
government or central bank. To protect against unforeseen reductions
in our borrowing capabilities, we maintain unused capacity under our existing
repurchase agreement credit lines with multiple counterparties and an asset
“cushion,” comprised of cash and cash equivalents, unpledged Agency MBS and
collateral in excess of margin requirements held by our counterparties, to meet
potential margin calls. As of December 31, 2009, we had cash and
unpledged Agency MBS of $48.9 million. In addition to these measures,
we manage our debt to equity ratio as discussed above.
As
previously noted, securitization financing represents bonds issued that are
recourse only to the assets pledged as collateral to support the financing and
are not otherwise recourse to us. As of December 31, 2009, we had
$143.1 million of non-recourse securitization financing outstanding, most of
which carries a fixed rate of interest. The maturity of each class of
securitization financing is directly affected by the rate of principal
prepayments on the related collateral and is not subject to margin call
risk. Each series is also subject to redemption according to specific
terms of the respective indentures, generally on the earlier of a specified date
or when the remaining balance of the bond equals 35% or less of the original
principal balance of the bonds.
49
We
believe that we have adequate financial resources to meet our obligations,
including margin calls, to fund dividends that we declare, and to fund our
operations. Should the global credit markets become as destabilized
as they were in 2008 and early 2009, causing market volatility in prices of
investments that we own, particularly Agency MBS, or cause continued weakness in
financial institutions, we may be subject to margin calls from fluctuating
values of assets pledged to support repurchase agreement financing, or financial
institutions may be unable or unwilling to renew such financing depending on the
severity of the market volatility. In such an instance, we may be
forced to liquidate investments in potentially unfavorable market
conditions.
As
previously noted, Fannie Mae and Freddie Mac announced on February 10, 2010 that
they intend to buy out delinquent loans that are past due 120 days or more from
the pool of Agency MBS issued and guaranteed by them. This announcement
most likely will result in a spike in prepayments on our Agency MBS for the
periods affected. Agency MBS have a payment delay feature whereby Fannie
Mae and Freddie Mac announce principal payments on Agency MBS but do not
remit the actual principal payments and interest for 20 days in the case of
Fannie Mae and 40 days in the case of Freddie Mac. Since Agency MBS are
financed with repurchase agreements, the repurchase agreement lender will
generally make a margin call for an amount equal to the product of their
advance rate on the repurchase agreement and the announced principal payments on
the Agency MBS. This will cause a temporary use of our resources
to meet the margin call until we receive the principal payments and interest 20
to 40 days later. Because of the unique nature of this announcement
whereby Fannie Mae and Freddie Mac are announcing a significant shift in
their delinquent loan repurchase activity, the amount of margin calls received
by the Company for the period of March through June 2010 are likely to be
atypically large. The Company believes that it has the resources to meets
these margin calls but its investment activity may be constrained during this
period until the principal and interest payments have been
received.
CONTRACTUAL
OBLIGATIONS AND COMMITMENTS
The following table summarizes our
contractual obligations under our financing arrangements by payment due date as
of December 31, 2009:
|
(amounts
in thousands)
|
Payments
due by period
|
|||||||||||||||||||
|
Contractual Obligations:
(1)
|
Total
|
<
1 year
|
1-3
years
|
3-5
years
|
>
5 years
|
|||||||||||||||
|
Securitization
financing
(2)
(3)
|
$ | 180,729 | $ | 30,669 | $ | 81,989 | $ | 62,038 | $ | 6,033 | ||||||||||
|
Repurchase
agreements
(2)
|
638,329 | 638,329 | – | – | – | |||||||||||||||
|
Operating
lease obligations
|
625 | 150 | 475 | – | – | |||||||||||||||
|
Total
|
$ | 819,683 | $ | 669,148 | $ | 82,464 | $ | 62,038 | $ | 6,033 | ||||||||||
|
(1)
|
As
the master servicer for certain of the series of non-recourse
securitization financing securities which we have issued, and certain
loans which have been securitized but for which we are not the master
servicer, we have an obligation to advance scheduled principal and
interest on delinquent loans in accordance with the underlying servicing
agreements should the primary servicer of the loan fail to make such
advance. Such advance amounts are generally repaid in the same
month as they are made or shortly thereafter, and so the contractual
obligation with respect to these advances is excluded from the above
table. During 2009, our average monthly servicing advance was
$0.3 million compared to $0.2 million for
2008.
|
|
(2)
|
Amounts
presented include estimated principal and interest on the related
obligations.
|
|
(3)
|
Securitization
financing is non-recourse to us as the bonds are payable solely from loans
and securities pledged as securitized mortgage loans. Payments
due by period were estimated based on the principal repayments forecast
for the underlying loans, substantially all of which is used to repay the
associated securitization financing
outstanding.
|
OFF-BALANCE
SHEET ARRANGEMENTS
We do not
believe that any off-balance sheet arrangements exist that are reasonably likely
to have a material current or future effect on our financial condition, results
of operations, liquidity or capital resources.
50
FORWARD-LOOKING
STATEMENTS
Certain
written statements in this Annual Report on Form
10-K
that are not historical
fact constitute “forward-looking statements” within the meaning of Section 27A
of the 1933 Act, and Section 21E of the Exchange Act. All statements
contained in this annual report addressing the results of operations, our
operating performance, events, or developments that we expect or anticipate will
occur in the future, including statements relating to investment strategies, net
interest income growth, earnings or earnings per share growth, and market share,
as well as statements expressing optimism or pessimism about future operating
results, are forward-looking statements. The forward-looking
statements are based upon management’s views and assumptions as of the date of
this report, regarding future events and operating performance and are
applicable only as of the dates of such statements. Such
forward-looking statements may involve factors that could cause our actual
results to differ materially from historical results or from any results
expressed or implied by such forward-looking statements. We caution
readers not to place undue reliance on forward-looking statements, which may be
based on assumptions and anticipated events that do not
materialize.
Factors
that may cause actual results to differ from historical results or from any
results expressed or implied by forward-looking statements include the
following:
R
einvestment.
Yields
on assets in which we invest may be lower than yields on existing assets that we
may sell or which may be prepaid, due to lower overall interest rates and more
competition for these assets. In order to maintain our investment
portfolio size and our earnings, we need to reinvest a portion of the cash flows
we receive into new interest-earning assets. If we are unable to find
suitable reinvestment opportunities, the net interest income on our investment
portfolio and investment cash flows could be negatively impacted.
Economic
Conditions
. We are affected by general economic
conditions. We may experience an increase in defaults on our loans as
a result of an economic slowdown or recession. This could result in
our potentially having to provide for additional allowance for loan losses or
may lead to higher prepayments on our higher grade investments. In
addition, economic conditions can result in increased market volatility, as we
experienced in 2008 and 2009. As a result of our investments being
pledged as collateral for short-term borrowings, high levels of market
volatility can result in margin calls and involuntary investments sales as well
as volatility in our earnings and cash flows.
Investment
Portfolio Cash
Flow
. Cash flows from the investment portfolio fund our
operations, dividends, and repayments of outstanding debt, and are subject to
fluctuation due to changes in interest rates, prepayment rates and default rates
and related losses. In addition, we have securitized loans, which may
have been pledged as collateral to support securitization financing
bonds. Based on the performance of the underlying assets within the
securitization structure, cash flows which may have otherwise been paid to us as
a result of our ownership interest may be retained within the structure to make
payments on the securitization financing bonds.
Defaults.
Defaults
by borrowers on loans we securitized may have an adverse impact on our financial
performance, if actual credit losses differ materially from our estimates or
exceed reserves for losses recorded in the financial statements. The
allowance for loan losses is calculated on the basis of historical experience
and management’s best estimates. Actual default rates or loss
severity may differ from our estimate as a result of economic
conditions. Actual defaults on adjustable rate mortgage loans may
increase during a rising interest rate environment or for other reasons, such as
rising unemployment. In addition, commercial mortgage loans are
generally large dollar balance loans, and a significant loan default may have an
adverse impact on our financial results. Such impact may include
higher provisions for loan losses and reduced interest income if the loan is
placed on non-accrual.
I
nterest Rate
Fluctuations.
Our income and cash flow depends on our ability
to earn greater interest on our investments than the interest cost to finance
those investments. For example, some of our investments have interest
rates with delayed reset dates and interim interest rate caps while our related
borrowings used to finance those investments do not. In a rapidly
rising short-term interest rate environment, our interest income earned on some
investments may not increase in a manner timely enough to offset the increase in
our interest expense on the related borrowings used to finance the purchase of
those investments.
51
P
repayments.
Prepayments
on our securitized mortgage loans or on mortgage loans underlying our investment
portfolio may have an adverse impact on our financial
performance. Prepayments are expected to increase during a declining
interest rate or flat yield curve environment. Prepayments also occur
in periods of economic stress. When borrowers default on their loans,
we are likely to experience increased liquidations on loans underlying our
non-Agency securities and increased buyouts by Fannie Mae and Freddie Mac of
loans underlying our Agency MBS, which results in faster
prepayments. Our exposure to rapid prepayments is primarily (i) the
faster amortization of premium on our investments and, to the extent applicable,
amortization of bond discount, and (ii) the replacement of investments in our
portfolio with lower yielding investments.
T
hird-party
Servicers.
Our loans and loans underlying securities are
serviced by third-party service providers. As with any external
service provider, we are subject to the risks associated with inadequate or
untimely services. Many borrowers require notices and reminders to
keep their loans current and to prevent delinquencies and
foreclosures. A substantial increase in our delinquency rate that
results from improper servicing or loan performance in general may have an
adverse effect on our earnings.
Competition.
The
financial services industry is a highly competitive market in which we compete
with a number of institutions with greater financial resources. In
purchasing portfolio investments, we compete with other mortgage REITs,
investment banking firms, savings and loan associations, commercial banks,
mortgage bankers, insurance companies, federal agencies and other entities, many
of which have greater financial resources and a lower cost of capital than we
do. Increased competition in the market and our competitors greater
financial resources have adversely affected us and may continue to do
so. Competition may also continue to keep pressure on spreads
resulting in us being unable to reinvest our capital on an acceptable
risk-adjusted basis.
Re
gulatory
Changes.
Our businesses as of and for the year ended December
31, 2009 were not subject to any material federal or state regulation or
licensing requirements. However, changes in existing laws and
regulations or in the interpretation thereof, or the introduction of new laws
and regulations, could adversely affect us and the performance of our
securitized loan pools or our ability to collect on our delinquent property tax
receivables. We are a REIT and are required to meet certain tests in
order to maintain our REIT status as described in the earlier discussion of
“Federal Income Tax Considerations” in Item 1, Business. If we should
fail to maintain our REIT status, we would not be able to hold certain
investments and would be subject to income taxes.
S
ection 404 of the Sarbanes-Oxley Act
of 2002
. We are required to comply with the provisions of
Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations
promulgated by the SEC and the New York Stock Exchange. Failure to
comply may result in doubt in the capital markets about the quality and adequacy
of our internal controls and corporate governance. This could result
in our having difficulty in, or being unable to, raise additional capital in
these markets in order to finance our operations and future
investments.
Other.
The
following risks, which are discussed in more detail in Item 1A, Risk Factors
above, could also affect our results of operations, financial condition and cash
flows:
|
·
|
The
success of our business is predicated on our access to the credit
markets. Failure to access credit markets on reasonable terms,
or at all, could adversely affect our profitability and may, in turn,
negatively affect the market price of shares of our common
stock.
|
|
·
|
We
invest in securities where the timely receipt of principal and interest is
guaranteed by Fannie Mae and Freddie Mac. Both Fannie Mae and
Freddie Mac are currently under federal conservatorship, and the Treasury
has committed to purchasing preferred stock from each of these entities in
order to ensure their adequate capitalization. Efforts made to
stabilize Fannie Mae and Freddie Mac may prove unsuccessful, which may
impact their ability to perform under the guaranty. If Fannie
Mae and Freddie Mac are unable to perform on their guaranty, we are likely
to incur losses on our investments in Agency
MBS.
|
|
·
|
The
federal conservatorship of Fannie Mae and Freddie Mac may lead to
structural changes in Agency MBS and/or Fannie Mae and Freddie Mac which
may adversely affect our business.
|
|
·
|
Attempts
to stabilize the housing and mortgage market have resulted in the Treasury
and Federal Reserve buying fixed-rate Agency MBS in an effort to lower
overall mortgage rates. During 2009, the Treasury and the
Federal Reserve purchased approximately $1.3 trillion in Agency MBS, or
81%, of the estimated $1.6 trillion of Agency MBS issued during
2009. When the Treasury and the Federal Reserve discontinue
their purchases of Agency MBS, this may result in an increase in mortgage
rates and substantial volatility in Agency MBS
prices.
|
52
|
·
|
Mortgage
loan modification programs and future legislative action may adversely
affect the value of and the return on the single-family loans and
securities in which we invest.
|
|
·
|
Changes
in prepayment rates on the mortgage loans underlying our investments may
adversely affect our profitability and subject us to reinvestment
risk.
|
|
·
|
Fannie
Mae and Freddie Mac have recently announced a change in their policy of
purchasing delinquent loans included in Agency MBS pools, which could
increase prepayment rates on Agency MBS we currently
own.
|
|
·
|
A
flat or inverted yield curve may adversely affect prepayment rates and
supply of Hybrid ARMs and ARMs.
|
|
·
|
A
decrease or lack of liquidity in our investments may adversely affect our
business, including our ability to value and sell our
assets.
|
|
·
|
Changes
to the availability and terms of leverage used to finance our business may
adversely affect our profitability and result in losses and/or reduced
cash available for distribution to our
shareholders.
|
|
·
|
If
a lender to us in a repurchase transaction defaults on its obligation to
resell the underlying security back to us at the end of the transaction
term, or if we default on our obligations under a repurchase agreement, we
will incur losses.
|
|
·
|
A
decline in the market value of our assets may cause our book value to
decline and may result in margin calls that may force us to sell assets
under adverse market conditions.
|
|
·
|
Adverse
developments involving major financial institutions or one of our lenders
could also result in a rapid reduction in our ability to borrow and
adversely affect our business and
profitability.
|
|
·
|
Our
ownership of securitized mortgage loans subjects us to credit risk and,
although we provide for an allowance for loan losses on these loans as
required under GAAP, the loss reserves are based on
estimates. As a result, actual losses incurred may be larger
than our reserves, requiring us to provide additional reserves, which will
impact our financial position and results of
operations.
|
|
·
|
Our
efforts to manage credit risk may not be successful in limiting
delinquencies and defaults in underlying loans or losses on our
investments. If we experience higher than anticipated delinquencies and
defaults, our earnings and our cash flow may be negatively
impacted.
|
|
·
|
We
invest in commercial mortgage loans and CMBS collateralized by commercial
mortgage loans which are secured by income producing
properties. Such loans are typically made to single-asset
entities and the repayment of the loan is dependent principally on the
performance and value of the underlying property. The
volatility of certain mortgaged property values may adversely affect our
CMBS.
|
|
·
|
Certain
investments employ internal structural leverage as a result of the
securitization process and are in the most subordinate position in the
capital structure, which magnifies the potential impact of adverse events
on our cash flows.
|
|
·
|
Guarantors
may fail to perform on their obligations to our securitization trusts,
which could result in additional losses to our
Company.
|
|
·
|
We
may be subject to the risks associated with inadequate or untimely
services from third-party service providers, which may harm our results of
operations. We also rely on corporate trustees to act on behalf of us and
other holders of securities in enforcing our
rights.
|
|
·
|
Credit
ratings assigned to debt securities by the credit rating agencies may not
accurately reflect the risks associated with those
securities. Changes in credit ratings for securities we
own or for similar securities might negatively impact the market value of
these securities.
|
|
·
|
Fluctuations
in interest rates may have various negative effects on us and could lead
to reduced profitability and a lower book
value.
|
|
·
|
Interest
rate caps on the adjustable rate mortgage loans collateralizing our
investments may adversely affect our profitability if interest rates
increase.
|
|
·
|
Our
use of hedging strategies to mitigate our interest rate exposure may not
be effective, may adversely affect our income, may expose us to
counterparty risks, and may increase our contingent
liabilities.
|
|
·
|
We
may change our investment strategy, operating policies, dividend policy
and/or asset allocations without shareholder
consent.
|
|
·
|
Competition
may prevent us from acquiring new investments at favorable yields, and we
may not be able to achieve our investment objectives which may potentially
have a negative impact on our
profitability.
|
|
·
|
New
assets we acquire may not generate yields as attractive as yields on our
current assets, resulting in a decline in our earnings per share over
time.
|
|
·
|
Loss
of key management could result in material adverse effects on our
business.
|
53
|
·
|
Our
Chairman and Chief Executive Officer devotes a portion of his time to
another company in a capacity that could create conflicts of interest that
may harm our investment opportunities; this lack of a full-time commitment
could also harm our operating
results.
|
|
·
|
Qualifying
as a REIT involves highly technical and complex provisions of the Code,
and a technical or inadvertent violation could jeopardize our REIT
qualification. Maintaining our REIT status may reduce our
flexibility to manage our
operations.
|
|
·
|
If
we do not qualify as a REIT or fail to remain qualified as a REIT, we may
be subject to tax as a regular corporation and could face a tax liability,
which would reduce the amount of cash available for distribution to our
stockholders.
|
|
·
|
The
failure of investments subject to repurchase agreements to qualify as real
estate assets could adversely affect our ability to qualify as a
REIT.
|
|
·
|
Even
if we remain qualified as a REIT, we may face other tax liabilities that
reduce our cash flow and our
profitability.
|
|
·
|
If
we fail to maintain our REIT status, our ability to utilize repurchase
agreements as a source of financing may be
impacted.
|
|
·
|
Certain
of our securitization trusts, which qualify as “taxable mortgage pools,”
require us to maintain equity interests in the securitization
trusts. If we do not, our profitability and cash flow may be
reduced.
|
|
·
|
Our
reported income depends on GAAP and conventions in applying GAAP which are
subject to change in the future and which may not have a favorable impact
on our reported income.
|
|
·
|
Estimates
are inherent in the process of applying GAAP, and management may not
always be able to make estimates which accurately reflect actual results,
which may lead to adverse changes in our reported GAAP
results.
|
|
·
|
In
the event of bankruptcy either by ourselves or one or more of our third
party lenders, assets pledged as collateral under repurchase agreements
may not be recoverable by us. We may incur losses equal to the
excess of the collateral pledged over the amount of the associated
repurchase agreement borrowing.
|
|
·
|
If
we fail to properly conduct our operations we could become subject to
regulation under the Investment Company Act of 1940. Conducting our
business in a manner so that we are exempt from registration under and
compliance with the Investment Company Act of 1940 may reduce our
flexibility and could limit our ability to pursue certain
opportunities.
|
|
·
|
The
stock ownership limit imposed by the Code for REITs and our Articles of
Incorporation may restrict our business combination opportunities. The
stock ownership limitation may also result in reduced liquidity in our
stock and may result in losses to an acquiring
shareholder.
|
|
·
|
Dividends
payable by REITs do not qualify for the reduced tax rates available for
some dividends.
|
|
·
|
Recognition
of excess inclusion income by us could have adverse consequences to us or
our shareholders.
|
|
ITEM
7A.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
We seek
to manage risks related to our investment strategy, including prepayment,
reinvestment, market value, liquidity, credit and interest rate
risks. We do not seek to avoid risk completely, but rather, we
attempt to manage these risks while earning an acceptable risk-adjusted return
for our shareholders. Below is a discussion of the current risks in
our business model and investment strategy.
Prepayment
and Reinvestment Risk
We are
subject to prepayment risk from premiums paid on our investments and for
discounts accepted on the issuance of securitization financing. In
general, purchase premiums on our investments and discounts on securitization
financing are amortized as a reduction in interest income or an increase in
interest expense using the effective yield method under GAAP, adjusted for the
actual and anticipated prepayment activity of the investment and/or
securitization financing. An increase in the actual or expected rate
of prepayment will typically accelerate the amortization of purchase premiums or
issuance discounts, thereby reducing the yield/interest income earned on such
assets or increasing the cost of such financing.
54
We are
also subject to reinvestment risk as a result of the prepayment, repayment or
sale of our investments. Yields on assets in which we invest now are
generally lower than yields on existing assets that we may sell or which may be
repaid, due to lower overall interest rates and more competition for these as
investment assets. In some cases such as Agency MBS, yields are near
historic lows. As a result, our interest income may decline in the
future, thereby reducing earnings per share. In order to maintain our
investment portfolio size and our earnings, we need to reinvest our capital into
new interest-earning assets. If we are unable to find suitable
reinvestment opportunities, interest income on our investment portfolio and
investment cash flows could be negatively impacted.
Market
Value Risk
Market value risk generally represents
the risk of loss from the change in the value of a financial instrument due to
fluctuations in interest rates and changes in the perceived risk in owning such
financial instrument. Regardless of whether an investment is carried
at fair value or at historical cost in our financial statements, we will monitor
the change in its market value. In particular, we will monitor
changes in the value of investments which collateralize a repurchase agreement
for liquidity management and other purposes. We attempt to manage
this risk by managing our exposure to factors that can impact the market value
of our investments such as changes in interest rates. For example,
the types of derivative instruments we are currently using to hedge the interest
rates on our debt tend to increase in value when our investment portfolio
decreases in value. See the analysis in “Tabular Presentation” below,
which presents the estimated change in our portfolio given changes in market
interest rates.
Liquidity
Risk
We have
liquidity risk principally from the use of recourse repurchase agreements to
finance our ownership of securities. Our repurchase agreements
provide a source of uncommitted short-term financing which finances a
longer-term asset, thereby creating a mismatch between the maturity of the asset
and of the associated financing. Repurchase agreements are recourse
to both the assets pledged and to us. Generally such agreements will
have an original term to maturity of between 30 and 90 days and carry a rate of
interest based on a spread to an index such as LIBOR. Our repurchase
agreements are renewable at the discretion of our lenders and, as such, do not
contain guaranteed roll-over terms. If we fail to repay the lender at
maturity, the lender has the right to immediately sell the collateral and pursue
us for any shortfall if the sales proceeds are inadequate to cover the
repurchase agreement financing. At the inception of the repurchase
agreement, we post margin to the lender (i.e., collateral deposits in excess of
the repurchase agreement financing) in order to support the amount of the
financing and to give the lender a cushion against fluctuations in the value of
the collateral pledged. The repurchase agreement lender may also
request that we post additional margin (“margin calls”) in the event of a
decline in value of the collateral pledged including the payment delay feature
on Agency MBS as discussed in “Liquidity and Capital Resources” in Item 7.
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations.” Such margin calls could adversely change our liquidity
position. If we fail to meet this margin call, the lender has the right to
terminate the repurchase agreement and immediately sell the
collateral. If the proceeds from the sale of the collateral are
insufficient to repay the entire amount of the repurchase agreement outstanding,
we would be required to repay any shortfall. All of our repurchase agreements
provide that the lender is responsible for obtaining collateral valuations,
which must be from a generally recognized source agreed to by both us and the
lender, or the most recent closing quotation of such source. Given
the uncommitted nature of repurchase agreement financing and the varying
collateral requirements, we cannot assume that we will always be able to roll
over our repurchase agreements as they mature.
In order
to attempt to mitigate liquidity risk, we typically pledge only Agency MBS and
‘AAA’-rated non-Agency securities to secure our outstanding repurchase
agreements. We attempt to maintain an appropriate amount of cash and
unpledged investments in order to meet margin calls on our repurchase agreements
and to fund our on-going operations. See also “Liquidity and Capital
Resources” in Item 7. “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” for further discussion.
Credit
Risk
Credit
risk is the risk that we will not receive all contractual amounts due on
investments that we have purchased or funded due to default by the borrower or
due to a deficiency in proceeds from the liquidation of the collateral securing
the obligation. To mitigate credit risk, certain of our investments,
such as Agency MBS and portions of our securitized mortgage loan portfolio,
contain a guaranty of payment from third parties. For example, our
Agency MBS have credit risk to the extent that Fannie Mae or Freddie Mac fails
to remit payments on these MBS for which they have issued a guaranty of
payment. In
55
addition,
certain of our securitized mortgage loans have “pool” guarantees by which
certain parties provide guarantees of repayment on pools of loans up to a
limited amount. The following tables present information as of
December 31, 2009 and December 31, 2008 with respect to our investments and the
amounts guaranteed, if applicable.
|
December
31, 2009
|
|||||||||||||
|
Investment
(amounts
in thousands)
|
Amortized
Cost Basis
|
Amount
of Guaranty
|
Guarantor
|
Average
Credit Rating of Guarantor
(1)
|
|||||||||
|
With
Guaranty of Payment
|
|||||||||||||
|
Agency MBS
|
$ | 594,120 | $ | 566,656 |
Fannie
Mae/Freddie Mac
|
AAA
|
|||||||
|
Securitized mortgage
loans:
|
|||||||||||||
|
Commercial
|
59,684 | 6,359 |
American
International Group
|
A3 | |||||||||
|
Single-family
|
20,369 | 20,029 |
PMI/GEMICO
|
Caa2
|
|||||||||
|
Defeased loans
|
17,492 | 17,588 |
Fully
secured with cash
|
||||||||||
|
Without
Guaranty of Payment
|
|||||||||||||
|
Securitized mortgage
loans:
|
|||||||||||||
|
Commercial
|
77,130 | – | |||||||||||
|
Single-family
|
42,008 | – | |||||||||||
|
Non-Agency
securities
|
109,110 | – | |||||||||||
|
Other
investments
|
2,376 | – | |||||||||||
| 922,289 | 610,632 | ||||||||||||
|
Allowance
for loan losses
|
(4,308 | ) | – | ||||||||||
|
Total
investments
|
$ | 917,981 | $ | 610,632 | |||||||||
|
December
31, 2008
|
|||||||||||||
|
Investment
(amounts
in thousands)
|
Amortized
Cost Basis
|
Amount
of Guaranty
|
Guarantor
|
Average
Credit Rating of Guarantor
(1)
|
|||||||||
|
With
Guaranty of Payment
|
|||||||||||||
|
Agency MBS
|
$ | 311,576 | $ | 306,592 |
Fannie
Mae/Freddie Mac
|
AAA
|
|||||||
|
Securitized mortgage
loans:
|
|||||||||||||
|
Commercial
|
65,067 | 6,935 |
American
International Group
|
A3 | |||||||||
|
Single-family
|
22,959 | 22,621 |
PMI/GEMICO
|
B3/Baa1
|
|||||||||
|
Defeased loans
|
11,072 | 11,118 |
Fully
secured with cash
|
||||||||||
|
Without
Guaranty of Payment
|
|||||||||||||
|
Securitized mortgage
loans:
|
|||||||||||||
|
Commercial
|
98,194 | – | |||||||||||
|
Single-family
|
48,704 | – | |||||||||||
|
Investment in joint
venture
|
5,655 | – | |||||||||||
|
Non-Agency
securities
|
6,259 | – | |||||||||||
|
Other
investments
|
6,476 | – | |||||||||||
| 575,962 | 347,266 | ||||||||||||
|
Allowance
for loan losses
|
(3,707 | ) | – | ||||||||||
|
Total
investments
|
$ | 572,255 | $ | 347,266 | |||||||||
|
(1)
|
Reflects
lowest rating of the three nationally-recognized ratings agencies for the
senior unsecured debt of the
guarantor.
|
56
For our
securitized mortgage loans, we also limit our credit risk through the
securitization process and the issuance of securitization
financing. The securitization process limits our credit risk from an
economic point of view as the securitization financing is recourse only to the
assets pledged. Therefore, our risk is limited to the difference
between the amount of securitized mortgage loans pledged in excess of the amount
of securitization financing outstanding. This difference is referred
to as “overcollateralization.” For further information see
“Supplemental Discussion of Investments” in Item 7. “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” The
following tables present information for securitized mortgage loans as of
December 31, 2009 and December 31, 2008.
|
As
of December 31, 2009
|
||||||||||||||||||||
|
Investment
(amounts
in thousands)
|
Amortized
Cost Basis of loans
|
Average
Seasoning
(in
years)
|
Current
Loan-to-Value based on Original Appraised Value
|
Amortized
Cost Basis of Delinquent Loans
(1)
|
Delinquency
%
|
|||||||||||||||
|
Commercial
mortgage loans
|
$ | 150,017 | 13 | 47 | % | $ | 15,165 | 9.77 | % | |||||||||||
|
Single-family
mortgage loans
|
62,100 | 15 | 50 | % | 6,284 | (2) | 9.96 | % | ||||||||||||
|
As
of December 31, 2008
|
||||||||||||||||||||
|
Investment
(amounts
in thousands)
|
Amortized
Cost Basis of loans
|
Average
Seasoning
(in
years)
|
Current
Loan-to-Value based on Original Appraised Value
|
Amortized
Cost Basis of Delinquent Loans
(1)
|
Delinquency
%
|
|||||||||||||||
|
Commercial
mortgage loans
|
$ | 174,185 | 13 | 50 | % | $ | 3,080 | 1.77 | % | |||||||||||
|
Single-family
mortgage loans
|
71,663 | 15 | 53 | % | 6,068 | (2) | 8.47 | % | ||||||||||||
|
(1)
|
Loans
contractually delinquent by 30 or more days, which included loans on
non-accrual status.
|
|
(2)
|
As
of December 31, 2009, approximately $1.9 million of the delinquent
single-family loans are pool insured and, of the remaining $4.4 million,
$1.9 million of the loans made a payment within the 90 days prior to
December 31, 2009. As of December 31, 2008, approximately $1.9 million of
the delinquent single-family loans were pool insured and, of the remaining
$4.2 million, $3.6 million of the loans made a payment within the 90 days
prior to December 31, 2008.
|
Additionally,
the mortgage loans collateralizing our securitized portfolio are typically
well-seasoned, thereby lowering our average loan-to-value (“LTV”) ratio and
decreasing our risk of loss.
Aside
from guaranty of payment and the securitization process, we also attempt to
minimize our credit risk by investing in mortgage loans collateralized by
multi-family low-income housing tax credit (“LIHTC”) properties, which by nature
have a lower risk of default. Mortgage loans secured by these
properties account for 85% of our securitized commercial loan
portfolio. LIHTC properties are properties eligible for tax credits
under Section 42 of the Code, as amended. .Section 42 of the Code provides tax
credits to investors in projects to construct or substantially rehabilitate
properties that provide housing for qualifying low-income families for as much
as 90% of the eligible cost basis of the property. Failure by the
borrower to comply with certain income and rental restrictions required by
Section 42 or, more importantly, a default on a mortgage loan financing a
Section 42 property during the Section 42 prescribed tax compliance period
(generally 15 years from the date the property is placed in service) can result
in the recapture of previously used tax credits from the
borrower. The potential cost of tax credit recapture has historically
provided an incentive to the property owner to support the property during the
compliance period, including making debt service payments on the loan if
necessary to keep the loan current. As of December 31, 2009, there
were 10 delinquent LIHTC commercial mortgage loans with a total unpaid principal
balance of $15.3 million compared to 2 delinquent LIHTC commercial mortgage
loans with a total unpaid principal balance of $3.1 million as of December 31,
2008. The following table shows the weighted average remaining
compliance period of our portfolio of LIHTC commercial loans as a percent of the
total LIHTC commercial loan portfolio as of December 31, 2009 and December 31,
2008.
57
|
Months
remaining to end of compliance period
|
December
31, 2009
|
December
31, 2008
|
||||||
|
Compliance
period already exceeded
|
38.5 | % | 25.9 | % | ||||
|
Up
to one year remaining
|
37.1 | 21.2 | ||||||
|
Between
one and three years remaining
|
24.4 | 52.0 | ||||||
|
Between
four and six years remaining
|
0.0 | 0.9 | ||||||
|
Total
|
100.0 | % | 100.0 | % | ||||
Other
efforts to mitigate credit risk include maintaining a risk management function
which monitors and oversees the performance of the servicers of the mortgage
loans, as well as providing an allowance for loan loss as required by
GAAP.
Interest
Rate Risk
Our strategy of investing in
interest-rate sensitive investments on a leveraged basis subjects us to interest
rate risk. This risk arises from the difference in the timing of
resets of interest rates on our investments versus the associated borrowings or
differences in the indices on which the investments reset versus the
borrowings. At any given time, our investments may consist of Hybrid
Agency ARMs which have a fixed-rate of interest for an initial period, Agency
ARMs or adjustable-rate mortgage loans which generally have interest rates which
reset annually based on a spread to an index such as LIBOR and which are subject
to interim and lifetime interest rate caps, and fixed-rate mortgage
loans. Of our Agency ARMs and adjustable-rate loans, approximately
13% of these loans reset based upon the level of six month LIBOR, 75% reset
based on the level of one-year LIBOR and 10% reset based on the level of
one-year CMT. Periodic or lifetime interest rate caps could limit the
amount that the interest rate may reset. Generally the borrowings
used to finance these assets will have interest rates resetting every 30 to 90
days and they will not have periodic or lifetime interest rate
caps. Periodic caps on our investments range from 1-2% annually, and
lifetime caps are generally 5%. In addition, certain of our
securitized mortgage loans have a fixed-rate of interest and are financed with
borrowings with interest rates that adjust monthly.
During a
period of rising short-term interest rates, the rates on our borrowings will
reset higher on a more frequent basis than the interest rates on our
investments, decreasing our net interest income earned and the corresponding
cash flow on our investments. Conversely, net interest income may
increase following a fall in short-term interest rates. This increase
may be temporary as the yields on the adjustable-rate loans adjust to the new
market conditions after a lag period. The net interest income may
also be increased or decreased by the proceeds or costs of interest rate swap or
cap agreements to the extent that we have entered into such
agreements.
In an
effort to mitigate the interest-rate risk associated with the mismatch in the
timing of the interest rate resets in our investments versus our borrowings, we
may enter into derivative transactions in the form of forward purchase
commitments and interest rate swaps, which are intended to serve as a hedge
against future interest rate increases on our repurchase agreements, which rates
are typically LIBOR based. Swaps generally result in interest savings in a
rising interest rate environment, while a declining interest rate environment
generally results in our paying the stated fixed rate on the notional amount for
each of the swap transactions, which could be higher than the market
rate.
As of
December 31, 2009, the interest-rates on our investments and the associated
borrowings on these investments will prospectively reset based on the following
time frames (not considering the impact of prepayments and including
interest-rate swaps):
58
|
Investments
|
Borrowings
|
|||||||||||||||
|
(amounts
in thousands)
|
Amounts
(1)
|
Percent
|
Amounts
|
Percent
|
||||||||||||
|
Fixed-Rate
Investments/Obligations
|
$ | 273,921 | 29.7 | % | $ | 119,713 | 15.3 | % | ||||||||
|
Adjustable-Rate
Investments/Obligations:
|
||||||||||||||||
|
Less than 3
months
|
58,581 | 6.3 | 556,697 | 71.2 | ||||||||||||
|
Greater than 3 months and less
than 1 year
|
294,056 | 31.9 | – | – | ||||||||||||
|
Greater than 1 year and less
than 2 years
|
66,726 | 7.2 | 25,000 | 3.2 | ||||||||||||
|
Greater than 2 years and less
than 3 years
|
149,099 | 16.2 | 50,000 | 6.4 | ||||||||||||
|
Greater than 3 years and less
than 5 years
|
79,906 | 8.7 | 30,000 | 3.9 | ||||||||||||
|
Total
|
$ | 922,289 | 100.0 | % | $ | 781,410 | 100.0 | % | ||||||||
|
(1)
|
The
investment amount represents the fair value of the related securities and
amortized cost basis of the related loans, excluding any related allowance
for loan losses.
|
As of
December 31, 2008, the interest-rates on our investments and the associated
borrowings, if any, on these investments would have prospectively reset based on
the following time frames (not considering the impact of
prepayments):
|
Investments
|
Borrowings
|
|||||||||||||||
|
(amounts
in thousands)
|
Amounts
(1)
|
Percent
|
Amounts
|
Percent
|
||||||||||||
|
Fixed-Rate
Investments/Obligations
|
$ | 184,877 | 33.0 | % | $ | 159,121 | 34.5 | % | ||||||||
|
Adjustable-Rate
Investments/Obligations:
|
||||||||||||||||
|
Less than 3
months
|
– | – | 301,795 | 65.5 | ||||||||||||
|
Greater than 3 months and less
than 1 year
|
156,279 | 28.0 | – | – | ||||||||||||
|
Greater than 1 year and less
than 2 years
|
116,304 | 20.8 | – | – | ||||||||||||
|
Greater than 2 years and less
than 3 years
|
68,246 | 12.2 | – | – | ||||||||||||
|
Greater than 3 years and less
than 5 years
|
33,404 | 6.0 | – | – | ||||||||||||
|
Total
|
$ | 559,110 | 100.0 | % | $ | 460,916 | 100.0 | % | ||||||||
|
(1)
|
The
investment amount represents the fair value of the related securities and
amortized cost basis of the related loans, excluding any related allowance
for loan losses.
|
Adjustable
rate mortgage loans collateralize our Hybrid Agency and Agency ARM MBS
portfolio. The interest rates on the adjustable rate mortgage loans
are typically fixed for a predetermined period and then adjust annually to an
increment over a specified interest rate index. Interest rate caps
impact a security’s yield and its time to reset to market rates.
The
following table presents information about the lifetime and interim interest
rate caps on our Hybrid Agency MBS portfolio as of December 31,
2009:
|
Lifetime
Interest Rate Caps on ARM MBS
|
Interim
Interest Rate Caps on ARM MBS
|
|||
|
%
of Total
|
%
of Total
|
|||
|
9.0%
to 10.0%
|
37.54%
|
1.0%
|
1.23%
|
|
|
>10.0%
to 11.0%
|
48.55%
|
2.0%
|
33.17%
|
|
|
>11.0%
to 12.0%
|
13.91%
|
5.0%
|
65.60%
|
|
|
100.00%
|
100.00%
|
|||
59
TABULAR
PRESENTATION
We
monitor the aggregate cash flow, projected net interest income and estimated
market value of our investment portfolio under various interest rate and
prepayment assumptions. While certain investments may perform poorly
in an increasing or decreasing interest rate environment, other investments may
perform well, and others may not be impacted at all.
The table
below presents immediate changes of 100 and 200 basis points to the interest
rate environment as it existed as of December 31, 2009 and assumes
instantaneous, parallel shifts in interest rates relative to the forward LIBOR
curve. As of December 31, 2009, one-month LIBOR was 0.23% and
six-month LIBOR was 0.43%. The interest rate environment as of
December 31, 2009 reflected historically low short-term LIBOR
rates. Modeled LIBOR rates used to determine the 0 basis point change
in interest rates ranged from a low of 0.21% to a high of 4.69% during the
modeled period. No changes in the shape, or slope, of the interest
rate curves were assumed for this analysis.
The
information presented in the table below projects the impact of sudden changes
in interest rates on our annual projected net interest income and projected
portfolio value, as more fully discussed below, based on our investments as of
December 31, 2009, and includes all of our interest rate-sensitive assets and
liabilities.
“Percentage
change in projected net interest income” equals the change that would occur in
the calculated net interest income for the next twenty-four months relative to
the 0% change scenario if interest rates were to instantaneously parallel shift
to and remain at the stated level for the next twenty-four months.
“Percentage
change in projected market value” equals the change in value of our assets at
the end of the twenty-fourth month that we carry at fair value rather than at
historical amortized cost and any change in the value of any derivative
instruments or hedges, such as interest rate swap agreements, in the event of an
interest rate shift as described above.
The
analysis below is heavily dependent upon the assumptions used in the
model. The effect of changes in future interest rates beyond the
forward LIBOR curve, the shape of the yield curve or the mix of our assets and
liabilities may cause actual results to differ significantly from the modeled
results. In addition, certain investments which we own provide a
degree of “optionality.” The most significant option affecting the portfolio is
the borrowers’ option to prepay the loans. The model applies
prepayment rate assumptions representing management’s estimate of prepayment
activity on a projected basis for each collateral pool in the investment
portfolio. The model applies the same prepayment rate assumptions for
all five cases indicated below for all investments owned by us except for Agency
MBS. For Agency MBS, prepayment rates are adjusted based on modeled
and management estimates for each of the rate scenarios set forth
below. The extent to which borrowers utilize the ability to exercise
their option may cause actual results to significantly differ from the
analysis. Furthermore, the projected results assume no additions or
subtractions to our portfolio, and no change to our liability
structure. Historically, there have been significant changes in our
investment portfolio and the liabilities incurred by us in response to interest
rate movement, as such changes are a tool by which we can mitigate interest rate
risk in response to changed conditions. As a result of anticipated
prepayments on assets in the investment portfolio, there are likely to be such
changes in the future.
|
Basis
Point Change in
Interest
Rates
|
Percentage
change in projected net interest income
|
Percentage
change in projected market value
|
|||
|
+200
|
(16.1)%
|
(1.8)%
|
|||
|
+100
|
(6.4)%
|
(0.8)%
|
|||
|
0
|
–
|
–
|
|||
|
-100
|
(3.3)%
|
0.5%
|
|||
|
-200
|
(15.8)%
|
0.7%
|
60
Many
assumptions are made to present the information in the above table and, as such,
there can be no assurance that assumed events will occur, or that other events
will not occur, that would affect the outcomes; therefore, the above tables and
all related disclosures constitute forward-looking statements. The
analyses presented utilize assumptions and estimates based on management’s
judgment and experience. Furthermore, future sales or acquisitions of
investments, prepayments of investments, or a restructuring of our investment
portfolio could materially change the interest rate risk profile for
us. The tables quantify the potential changes in net interest income
and net asset value over a twenty-four month period should interest rates change
by the amounts indicated in the table on an instantaneous, parallel
basis. The results of interest rate shocks of plus and minus 100 and
200 basis points are presented. The cash flows associated with our
investment portfolio for each rate shock are calculated based on a variety of
assumptions including prepayment speeds, time until coupon reset, slope of the
yield curve, and size of the portfolio. Assumptions made on interest
rate-sensitive liabilities include anticipated interest rates (no negative rates
are utilized), collateral requirements as a percent of the borrowing and amount
of borrowing. Assumptions made in calculating the impact on net asset
value of interest rate shocks include interest rates, prepayment rates and the
yield spread of mortgage-related assets relative to prevailing interest
rates.
|
ITEM
8.
|
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
|
Our
consolidated financial statements and the related notes, together with the
Reports of the Independent Registered Public Accounting Firm thereon, are set
forth on pages F-1 through F-32 of this Annual Report on Form 10-K.
|
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
|
Not
applicable.
|
ITEM
9A.
|
CONTROLS
AND PROCEDURES
|
Evaluation of Disclosure
Controls and Procedures
Our
management evaluated, with the participation of our principal executive officer
and principal financial officer, the effectiveness of our disclosure controls
and procedures, as defined in Rule 13a-15(e) under the Exchange Act, as of the
end of the period covered by this report (the “Evaluation
Date”). Based on this evaluation, our principal executive officer and
principal financial officer concluded that our disclosure controls and
procedures were effective as of the Evaluation Date.
Changes in Internal Control
over Financial Reporting
There
were no changes in our internal control over financial reporting during the
fourth quarter of 2009 that materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Management’s Report on
Internal Control over Financial Reporting
Our management is responsible for
establishing and maintaining adequate internal control over financial reporting
as defined in Rule 13a-15(f) of the Exchange Act. Because of inherent
limitations, a system of internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate due to change in conditions, or that the degree of compliance
with policies or procedures may deteriorate.
Our
management evaluated, with the participation of our principal executive officer
and principal financial officer, the effectiveness of our internal control over
financial reporting using the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”) in “Internal
Control-Integrated Framework.” Based on that evaluation, our
principal executive officer and principal financial officer concluded that our
internal control over financial reporting was effective as of the end of the
period covered by this report.
61
The
Company’s internal control over financial reporting as of December 31, 2009 has
been audited by BDO Seidman, LLP, the independent registered public accounting
firm that also audited the Company’s consolidated financial statements included
in this Annual Report on Form 10-K. BDO Seidman, LLP’s attestation
report on the effectiveness of the Company’s internal control over financial
reporting appears on page F-4 herein.
|
ITEM
9B.
|
OTHER
INFORMATION
|
None.
62
|
ITEM
10.
|
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
|
The
information about our executive officers required by this item is included in
Part I, Item I of this Annual Report on Form 10-K under the caption “Executive
Officers of the Registrant”. The remaining information required by
Item 10 will be included in our definitive proxy statement for use in connection
with our 2010 Annual Meeting of Shareholders (“2010 Proxy Statement”) under the
captions “Election of Directors,” “Committees of the Board,” “Code of Ethics”
and “Section 16(a) Beneficial Ownership Reporting Compliance,” and is
incorporated herein by reference.
|
ITEM
11.
|
EXECUTIVE
COMPENSATION
|
The
information required by Item 11 is included in the 2010 Proxy Statement under
the captions “Executive Compensation” and “Directors’ Compensation,” and is
incorporated herein by reference.
|
ITEM
12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
The
following table sets forth information as of December 31, 2009, with respect to
the Company’s equity compensation plans, under which shares of our common stock
are authorized for issuance.
|
Plan
Category
|
Number
of Securities to Be Issued upon Exercise of Outstanding Options, Warrants
and Rights
(1)
|
Weighted-Average
Exercise
Price of Outstanding Options, Warrants and Rights
|
Number
of Securities Remaining Available for Future Issuance Under Equity
Compensation Plans
(2)
|
|||||||||
|
Equity
Compensation Plans Approved by Shareholders:
|
||||||||||||
|
2004
Stock Incentive Plan
|
95,000 | $ | 8.59 | – | ||||||||
|
2009
Stock and Incentive Plan
|
– | – | 2,490,000 | |||||||||
|
Equity
Compensation Plans Not Approved by Shareholders
(3)
|
– | – | – | |||||||||
|
Total
|
95,000 | $ | 8.59 | 2,490,000 | ||||||||
|
(1)
|
Amount
includes all outstanding stock option awards, but excludes all outstanding
stock appreciation rights, which can only be settled for
cash.
|
|
(2)
|
Reflects
shares available to be granted under the 2009 Stock and Incentive Plan in
the form of stock options, stock appreciation rights, stock awards,
dividend equivalent rights, performance share awards, stock units and
incentive awards. No new awards may be issued under the 2004 Stock
Incentive Plan on or after May 13,
2009.
|
|
(3)
|
The
Company does not have any equity compensation plans that have not been
approved by shareholders.
|
The
remaining information required by Item 12 is included in the 2010 Proxy
Statement under the caption “Ownership of Stock” and is incorporated herein by
reference.
|
ITEM
13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
The
information required by Item 13 is included in the 2010 Proxy Statement under
the captions “Related Person Transactions” and “Director Independence,” and is
incorporated herein by reference.
63
|
ITEM
14.
|
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|
The
information required by Item 14 is included in the 2010 Proxy Statement under
the caption “Audit Information,” and is incorporated herein by
reference.
64
|
ITEM
15.
|
EXHIBITS,
FINANCIAL STATEMENT SCHEDULES
|
(a)
Documents filed as part of
this report
:
|
1.
and 2.
|
Financial
Statements and Schedules
The
information required by this section of Item 15 is set forth in the
Consolidated Financial Statements and Reports of Independent Registered
Public Accounting Firm beginning at page F-1 of this Annual Report on Form
10-K. The index to the Financial Statements is set forth at
page F-2 of this
Annual
Report on Form 10-K.
|
|
3.
|
Exhibits
|
|
Number
|
Exhibit
|
|
3.1
|
Restated
Articles of Incorporation, effective July 9, 2008 (incorporated herein by
reference to Exhibit 3.1 to Dynex’s Current Report on Form 8-K filed July
11, 2008).
|
|
3.2
|
Amended
and Restated Bylaws, effective March 26, 2008 (incorporated herein by
reference to Exhibit 3.2 to Dynex’s Current Report on Form 8-K filed April
1, 2008).
|
|
8.1
|
Opinion
of Troutman Sanders, LLP (incorporated herein by reference to Exhibit 8.1
to Dynex’s Annual Report on Form 10-K for the year ended December 31,
2008).
|
|
10.1*
|
Dynex
Capital, Inc. 2004 Stock Incentive Plan (incorporated herein by reference
to Exhibit 10.1 to Dynex’s Annual Report on Form 10-K for the year ended
December 31, 2004).
|
|
10.1.1*
|
409A
Amendment to Dynex Capital, Inc. 2004 Stock Incentive Plan, dated December
31, 2008 (incorporated herein by reference to Exhibit 10.1.1 to Dynex’s
Annual Report on Form 10-K for the year ended December 31,
2008).
|
|
10.2*
|
Form
of Stock Option Agreement for Non-Employee Directors under the Dynex
Capital, Inc. 2004 Stock Incentive Plan (incorporated herein by reference
to Exhibit 10.2 to Dynex’s Quarterly Report on Form 10-Q for the quarter
ended June 30, 2005).
|
|
10.3*
|
Form
of Stock Appreciation Rights Agreement for Senior Executives under the
Dynex Capital, Inc. 2004 Stock Incentive Plan (incorporated herein by
reference to Exhibit 10.3 to Dynex’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2005).
|
65
|
Number
|
Exhibit
|
|
10.5*
|
Severance
Agreement between Dynex Capital, Inc. and Stephen J. Benedetti dated June
11, 2004 (incorporated herein by reference to Exhibit 10.5 to Dynex’s
Annual Report on Form 10-K for the year ended December 31,
2007).
|
|
10.5.1*
|
409A
Amendment to Severance Agreement between Dynex Capital, Inc. and Stephen
J. Benedetti, dated December 31, 2008 (incorporated herein by reference to
Exhibit 10.1.1 to Dynex’s Annual Report on form 10-K for the year ended
December 31, 2008).
|
|
10.6*
|
Employment
Agreement, dated as of July 31, 2009, between Dynex Capital, Inc. and
Thomas B. Akin (incorporated herein by reference to Exhibit 10.6 to
Dynex’s Quarterly Report on 10-Q for the quarter ended September 30,
2009).
|
|
10.7*
|
Dynex
Capital, Inc. 401(k) Overflow Plan, effective July 1, 1997 (incorporated
herein by reference to Exhibit 10.7 to Dynex’s Quarterly Report on Form
10-Q for the quarter ended March 31, 2008).
|
|
10.8
|
Sales
Agreement, dated as of March 16, 2009, between Dynex Capital, Inc. and
Cantor Fitzgerald & Co. (incorporated herein by reference to Exhibit
10.8 to Dynex’s Annual Report on Form 10-K for the year ended December 31,
2008).
|
|
10.9*
|
Dynex
Capital, Inc. ROAE Bonus Program, as amended October 8, 2009 (incorporated
herein by reference to Exhibit 10.9 to Dynex’s Quarterly Report on Form
10-Q for the quarter ended September 30, 2009).
|
|
10.10*
|
Dynex
Capital, Inc. 2009 Capital Bonus Pool (incorporated herein by reference to
Exhibit 10.10 to Dynex’s Quarterly Report on Form 10-Q for the quarter
ended March 31, 2009).
|
|
10.11*
|
Dynex
Capital, Inc. 2009 Stock and Incentive Plan, effective as of May 13, 2009
(incorporated herein by reference to Appendix A to Dynex’s Proxy Statement
filed April 3, 2009).
|
|
10.12*
|
Employment
Agreement, dated as of July 31, 2009, between Dynex Capital, Inc. and
Byron L. Boston (incorporated herein by reference to Exhibit 10.12 to
Dynex’s Quarterly Report on Form 10-Q for the quarter ended September 30,
2009).
|
|
10.13
|
Assignment
and Transfer of Interest in Copperhead Ventures, LLC, dated as of November
20, 2009, between DBAH Capital, LLC, and Issued Holdings Capital
Corporation (incorporated herein by reference to Exhibit 10.13 to Dynex’s
Current Report on Form 8-K filed November 24, 2009).
|
|
21.1
|
List
of consolidated entities of Dynex (filed herewith).
|
|
23.1
|
Consent
of BDO Seidman, LLP (filed herewith).
|
|
31.1
|
Certification
of principal executive officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (filed herewith).
|
|
31.2
|
Certification
of principal financial officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (filed herewith).
|
66
|
Number
|
Exhibit
|
|
32.1
|
Certification
of principal executive officer and principal financial officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
|
|
99.1
|
Financial
Statements of Copperhead Ventures, LLC (filed herewith).
|
________________________________________
* Denotes management
contract.
(b)
Exhibits:
See
Item 15(a)(3) above.
(c)
Financial Statement
Schedules:
None.
67
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
|
DYNEX CAPITAL, INC.
|
||
|
(Registrant)
|
||
|
March
8, 2010
|
/s/
Stephen J. Benedetti
|
|
|
Stephen
J. Benedetti, Executive Vice President, Chief Operating Officer and Chief
Financial Officer
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
|
Signature
|
Title
|
Date
|
|
/s/
Thomas B. Akin
|
Chairman and Chief Executive Officer
|
March
8, 2010
|
|
Thomas
B. Akin
|
and Director
|
|
|
(Principal Executive Officer)
|
||
|
/s/
Stephen J. Benedetti
|
Executive Vice President, Chief
|
March
8, 2010
|
|
Stephen
J. Benedetti
|
Operating Officer and Chief Financial Officer
|
|
|
(Principal Financial Officer)
|
||
|
/s/
Jeffrey L. Childress
|
Vice President and Controller
|
March
8, 2010
|
|
Jeffrey
L. Childress
|
(Principal Accounting Officer)
|
|
|
/s/
Leon A. Felman
|
Director
|
March
8, 2010
|
|
Leon
A. Felman
|
||
|
/s/
Barry Igdaloff
|
Director
|
March
8, 2010
|
|
Barry
Igdaloff
|
||
|
/s/
Daniel K. Osborne
|
Director
|
March
8, 2010
|
|
Daniel
K. Osborne
|
||
|
/s/
James C. Wheat, III
|
Director
|
March
8, 2010
|
|
James
C. Wheat, III
|
||
68
DYNEX
CAPITAL, INC.
CONSOLIDATED
FINANCIAL STATEMENTS AND
REPORTS
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
For
Inclusion in Form 10-K
Annual
Report Filed with
Securities
and Exchange Commission
December
31, 2009
F-1
DYNEX
CAPITAL, INC.
INDEX
TO FINANCIAL STATEMENTS
|
Page
|
||
|
Reports
of Independent Registered Public Accounting Firm
|
F-3
|
|
|
Consolidated
Balance Sheets – As of December 31, 2009 and 2008
|
F-5
|
|
|
Consolidated
Statements of Income – Years ended December 31, 2009, 2008 and
2007
|
F-6
|
|
|
Consolidated
Statements of Shareholders’ Equity – Years ended December 31, 2009, 2008
and 2007
|
F-7
|
|
|
Consolidated
Statements of Cash Flows – Years ended December 31, 2009, 2008 and
2007
|
F-8
|
|
|
Notes
to Consolidated Financial Statements
|
F-9
|
F-2
Report
of Independent Registered Public Accounting Firm
Board of
Directors and Stockholders
Dynex
Capital, Inc.
Glen
Allen, Virginia
We have
audited the accompanying consolidated balance sheets of Dynex Capital, Inc.
(Dynex) as of December 31, 2009 and 2008 and the related consolidated statements
of income, stockholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2009. These financial statements are
the responsibility of Dynex’s management. Our responsibility is to
express an opinion on these financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, 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, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Dynex at December 31, 2009
and 2008, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2009
,
in conformity with
accounting principles generally accepted in the United States of
America.
As
discussed in Note 7 to the consolidated financial statements, Dynex adopted FASB
Statement of Financial Accounting Standards No. 159 “The Fair Value
Option for Financial Assets and Financial Liabilities”, (included in FASB ASC
Topic 825 Financial Instruments), as of January 1, 2008.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Dynex's internal control over financial
reporting as of December 31, 2009, based on criteria established in
Internal Control – Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) and our report dated March 8, 2010 expressed an
unqualified opinion thereon.
BDO
Seidman, LLP
Richmond,
Virginia
March 8,
2010
F-3
Report
of Independent Registered Public Accounting Firm
Board of
Directors and Stockholders
Dynex
Capital, Inc.
Glen
Allen, Virginia
We have
audited Dynex Capital, Inc.’s (Dynex) internal control over financial reporting
as of December 31, 2009, based on criteria established in
Internal Control – Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). Dynex’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal Control Over
Financial Reporting. Our responsibility is to express an opinion on Dynex’s
internal control over financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, Dynex maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2009, based on the COSO
criteria
.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Dynex
Capital, Inc. as of December 31, 2009 and 2008, and the related consolidated
statements of income, stockholders’ equity, and cash flows for each of the three
years in the period ended December 31, 2009 and our report dated March 8, 2010
expressed an unqualified opinion thereon.
BDO
Seidman, LLP
Richmond,
Virginia
March 8,
2010
F-4
CONSOLIDATED
BALANCE SHEETS
DYNEX
CAPITAL, INC.
(amounts in thousands except share
data)
|
December
31, 2009
|
December
31, 2008
|
|||||||
|
ASSETS
|
||||||||
|
Agency
MBS (including pledged Agency MBS of $575,386 and $300,277 at December 31,
2009 and 2008, respectively)
|
$ | 594,120 | $ | 311,576 | ||||
|
Securitized
mortgage loans, net
|
212,471 | 242,289 | ||||||
|
Non-Agency
securities (including pledged non-Agency securities of $82,770 and none at
December 31, 2009 and 2008, respectively)
|
109,110 | 6,259 | ||||||
|
Other
investments, net
|
2,280 | 6,476 | ||||||
|
Investment
in joint venture
|
– | 5,655 | ||||||
| 917,981 | 572,255 | |||||||
|
Cash
and cash equivalents
|
30,173 | 24,335 | ||||||
|
Restricted
cash
|
– | 2,974 | ||||||
|
Derivative
assets
|
1,008 | – | ||||||
|
Accrued
interest receivable
|
4,583 | 3,215 | ||||||
|
Other
assets, net
|
4,317 | 4,412 | ||||||
| $ | 958,062 | $ | 607,191 | |||||
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
||||||||
|
Liabilities:
|
||||||||
|
Repurchase
agreements
|
$ | 638,329 | $ | 274,217 | ||||
|
Securitization
financing
|
143,081 | 177,157 | ||||||
|
Obligation
under payment agreement
|
– | 8,534 | ||||||
|
Accrued
interest payable
|
1,208 | 1,656 | ||||||
|
Other
liabilities
|
6,691 | 5,218 | ||||||
| 789,309 | 466,782 | |||||||
|
Commitments
and Contingencies (Note 16)
|
||||||||
|
Shareholders’
equity:
|
||||||||
|
Preferred
stock, par value $.01 per share, 50,000,000 shares
|
||||||||
|
authorized;
9.5% Cumulative Convertible Series D, 4,221,539 shares
|
||||||||
|
issued
and outstanding ($43,218 aggregate liquidation preference)
|
41,749 | 41,749 | ||||||
|
Common
stock, par value $.01 per share, 100,000,000 shares
authorized;
13,931,512 and 12,169,762 shares issued and
outstanding, respectively
|
139 | 122 | ||||||
|
Additional
paid-in capital
|
379,717 | 366,817 | ||||||
|
Accumulated
other comprehensive income (loss)
|
10,061 | (3,949 | ) | |||||
|
Accumulated
deficit
|
(262,913 | ) | (264,330 | ) | ||||
| 168,753 | 140,409 | |||||||
|
|
$ | 958,062 | $ | 607,191 | ||||
See
notes to consolidated financial statements.
F-5
CONSOLIDATED
STATEMENTS OF INCOME
DYNEX
CAPITAL, INC.
(amounts in thousands except per
share data)
|
Year
Ended December 31,
|
||||||||||||
|
2009
|
2008
|
2007
|
||||||||||
|
Interest
income:
|
||||||||||||
|
Agency
MBS
|
$ | 20,962 | $ | 6,731 | $ | 110 | ||||||
|
Securitized
mortgage loans
|
17,169 | 20,886 | 26,424 | |||||||||
|
Non-Agency
securities
|
863 | 709 | 945 | |||||||||
|
Other
investments
|
226 | 642 | 688 | |||||||||
|
Cash
and cash equivalents
|
16 | 685 | 2,611 | |||||||||
| 39,236 | 29,653 | 30,778 | ||||||||||
|
Interest
expense:
|
||||||||||||
|
Securitization
financing
|
9,801 | 13,416 | 14,999 | |||||||||
|
Repurchase
agreements
|
3,288 | 4,079 | 3,546 | |||||||||
|
Obligation
under payment agreement
|
1,589 | 1,608 | 1,525 | |||||||||
|
Other
interest (income) expense
|
(7 | ) | 3 | 25 | ||||||||
| 14,671 | 19,106 | 20,095 | ||||||||||
|
Net
interest income
|
24,565 | 10,547 | 10,683 | |||||||||
|
(Provision
for) recapture of loan losses
|
(782 | ) | (991 | ) | 1,281 | |||||||
|
Net
interest income after (provision for) recapture of loan
losses
|
23,783 | 9,556 | 11,964 | |||||||||
|
Equity
in income (loss) of joint venture, net
|
2,400 | (5,733 | ) | 709 | ||||||||
|
Gain
on sale of investments, net
|
171 | 2,316 | 755 | |||||||||
|
Fair
value adjustments, net
|
205 | 7,147 | – | |||||||||
|
Other
(expense) income
|
(2,262 | ) | 7,467 | (533 | ) | |||||||
|
General
and administrative expenses:
|
||||||||||||
|
Compensation
and benefits
|
(3,626 | ) | (2,341 | ) | (1,921 | ) | ||||||
|
Other
general and administrative expenses
|
(3,090 | ) | (3,291 | ) | (2,075 | ) | ||||||
|
Net
income
|
17,581 | 15,121 | 8,899 | |||||||||
|
Preferred
stock dividends
|
(4,010 | ) | (4,010 | ) | (4,010 | ) | ||||||
|
Net
income to common shareholders
|
$ | 13,571 | $ | 11,111 | $ | 4,889 | ||||||
|
Weighted
average common shares:
|
||||||||||||
|
Basic
|
13,088 | 12,167 | 12,135 | |||||||||
|
Diluted
|
17,311 | 12,170 | 12,138 | |||||||||
|
Net
income per common share:
|
||||||||||||
|
Basic
|
$ | 1.04 | $ | 0.91 | $ | 0.40 | ||||||
|
Diluted
|
$ | 1.02 | $ | 0.91 | $ | 0.40 | ||||||
|
Dividends
declared per common share
|
$ | 0.92 | $ | 0.71 | $ | – | ||||||
See
notes to consolidated financial statements.
F-6
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY
DYNEX
CAPITAL, INC.
(amounts in
thousands)
|
Preferred
Stock
|
Common
Stock
|
Additional
Paid-in
Capital
|
Accumulated
Other
Comprehensive
(Loss)
Income
|
Accumulated
Deficit
|
Total
|
|||||||||||||||||||
|
Balance
as of January 1, 2007
|
$ | 41,749 | $ | 121 | $ | 366,637 | $ | 663 | $ | (272,632 | ) | $ | 136,538 | |||||||||||
|
Dividends
on preferred stock
|
– | – | – | – | (4,010 | ) | (4,010 | ) | ||||||||||||||||
|
Stock
option exercise
|
– | – | 37 | – | – | 37 | ||||||||||||||||||
|
Stock
option issuance
|
– | – | 42 | – | – | 42 | ||||||||||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||||||
|
Net
income
|
– | – | – | – | 8,899 | 8,899 | ||||||||||||||||||
|
Other
comprehensive income:
|
||||||||||||||||||||||||
|
Change
in market value of available-for-sale securities
|
– | – | – | 1,256 | – | 1,256 | ||||||||||||||||||
|
Reclassification
adjustment for net gain on sale of investments
|
– | – | – | (826 | ) | – | (826 | ) | ||||||||||||||||
|
Total
comprehensive income:
|
9,329 | |||||||||||||||||||||||
|
Balance
as of December 31, 2007
|
41,749 | 121 | 366,716 | 1,093 | (267,743 | ) | 141,936 | |||||||||||||||||
|
Dividends
on preferred stock
|
– | – | – | – | (4,010 | ) | (4,010 | ) | ||||||||||||||||
|
Dividends
on common stock
|
– | – | – | – | (8,641 | ) | (8,641 | ) | ||||||||||||||||
|
Stock
option issuance
|
– | – | 13 | – | – | 13 | ||||||||||||||||||
|
Vesting
of restricted stock
|
– | 1 | 88 | – | – | 89 | ||||||||||||||||||
|
Cumulative
effect of adoption of SFAS 159
|
– | – | – | – | 943 | 943 | ||||||||||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||||||
|
Net
income
|
– | – | – | – | 15,121 | 15,121 | ||||||||||||||||||
|
Other
comprehensive income:
|
||||||||||||||||||||||||
|
Change
in market value of available-for-sale securities
|
– | – | – | (2,725 | ) | – | (2,725 | ) | ||||||||||||||||
|
Reclassification
adjustment for net gain on sale of investments
|
– | – | – | (2,317 | ) | – | (2,317 | ) | ||||||||||||||||
|
Total
comprehensive income:
|
10,079 | |||||||||||||||||||||||
|
Balance
as of December 31, 2008
|
41,749 | 122 | 366,817 | (3,949 | ) | (264,330 | ) | 140,409 | ||||||||||||||||
|
Dividends
on preferred stock
|
– | – | – | – | (4,010 | ) | (4,010 | ) | ||||||||||||||||
|
Dividends
on common stock
|
– | – | – | – | (12,154 | ) | (12,154 | ) | ||||||||||||||||
|
Common
stock issuance
|
– | 17 | 12,782 | – | – | 12,799 | ||||||||||||||||||
|
Grant
and vesting of restricted stock
|
– | – | 118 | – | – | 118 | ||||||||||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||||||
|
Net
income
|
– | – | – | – | 17,581 | 17,581 | ||||||||||||||||||
|
Other
comprehensive income:
|
||||||||||||||||||||||||
|
Net
unrealized gain on cash flow hedge assets
|
– | – | – | 1,008 | – | 1,008 | ||||||||||||||||||
|
Available-for-sale
securities:
|
||||||||||||||||||||||||
|
Change in market
value
|
– | – | – | 9,976 | – | 9,976 | ||||||||||||||||||
|
Reclassification adjustment for
net gain on sale of investments
|
– | – | – | (171 | ) | – | (171 | ) | ||||||||||||||||
|
Reclassification adjustment for
loss on acquisition of joint venture
|
2,490 | 2,490 | ||||||||||||||||||||||
|
Reclassification adjustment for
joint venture’s other-than-temporary impairment
|
– | – | – | 707 | – | 707 | ||||||||||||||||||
|
Total
comprehensive income:
|
31,591 | |||||||||||||||||||||||
|
Balance
as of December 31, 2009
|
$ | 41,749 | $ | 139 | $ | 379,717 | $ | 10,061 | $ | (262,913 | ) | $ | 168,753 | |||||||||||
See
notes to consolidated financial statements.
F-7
CONSOLIDATED
STATEMENTS OF CASH FLOWS
DYNEX
CAPITAL, INC.
(amounts in
thousands)
See
notes to consolidated financial statements.
F-8
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEX
CAPITAL, INC.
(amounts
in thousands except share and per share data)
Dynex
Capital, Inc., together with its subsidiaries (the “Company”), was incorporated
in the Commonwealth of Virginia in 1987 and is currently based in Glen Allen,
Virginia. The Company has elected to be treated as a real estate
investment trust (“REIT”) for federal income tax purposes.
Basis
of Presentation and Principles of Consolidation
The
accompanying consolidated financial statements have been prepared in accordance
with the generally accepted accounting principles in the United States (“GAAP”)
and the instructions to the Annual Report on Form 10-K. The
consolidated financial statements include the accounts of the Company, its
qualified REIT subsidiaries and its taxable REIT subsidiary. All
intercompany balances and transactions have been eliminated in
consolidation.
Certain
items in the prior year’s consolidated balance sheets have been reclassified to
conform to the current year’s presentation. The Company’s
consolidated balance sheets now present separately its investment in non-Agency
securities which was previously included in its other investments
balance. The Company’s consolidated balance sheets also now present
separately its accrued interest receivable which was previously included in
securitized mortgage loans, net and other assets, net. The Company’s
consolidated balance sheets also now present separately its accrued interest
payable which was previously included in securitization financing and other
liabilities. These respective amounts on the consolidated balance
sheet as of December 31, 2008 presented herein have been reclassified to conform
to the current year presentation and have no effect on reported total assets or
total liabilities.
The
consolidated financial statements represent the Company’s accounts after the
elimination of inter-company transactions. The Company consolidates
entities in which it owns more than 50% of the voting equity and control does
not rest with others and variable interest entities in which it is determined to
be the primary beneficiary in accordance with ASC Topic 810. The
Company follows the equity method of accounting for investments with greater
than 20% and less than a 50% interest in partnerships and corporate joint
ventures or when it is able to influence the financial and operating policies of
the investee but owns less than 50% of the voting equity.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reported period. Actual results could differ from those
estimates. The most significant estimates used by management include
but are not limited to fair value measurements of its investments, allowance for
loan losses, other-than-temporary impairments, commitments and contingencies,
and amortization of premiums and discounts. These items are discussed further
below within this note of the consolidated financial statements.
Federal
Income Taxes
The
Company believes it has complied with the requirements for qualification as a
REIT under the Internal Revenue Code (the “Code”). As such, the
Company believes that it qualifies as a REIT for federal income tax purposes,
and it generally will not be subject to federal income tax on the amount of its
income or gain that is distributed as dividends to shareholders. The
Company uses the calendar year for both tax and financial reporting
purposes. There may be differences between taxable income and income
computed in accordance with GAAP.
F-9
Investments
The
Company’s investments include Agency mortgage backed securities (“MBS”),
securitized mortgage loans, non-Agency securities, and other
investments.
Agency MBS.
Agency MBS are
MBS issued or guaranteed by a federally chartered corporation, such as Federal
National Mortgage Corporation, or Fannie Mae, or Federal Home Loan Mortgage
Corporation, or Freddie Mac, or an agency of the U.S. government, such as
Government National Mortgage Association, or Ginnie Mae. MBS issued
or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are commonly referred to
as “Agency MBS”. The Company’s Agency MBS are comprised primarily of
Hybrid Agency ARMs and Agency ARMs and, to a lesser extent, fixed-rate Agency
MBS. Hybrid Agency ARMs are MBS collateralized by hybrid adjustable
mortgage loans. Hybrid adjustable rate mortgage loans are loans which
have a fixed rate of interest for a specified period (typically three to ten
years) and which then adjust their interest rate at least annually to an
increment over a specified interest rate index as further discussed
below. Agency ARMs are MBS collateralized by adjustable rate mortgage
loans which have interest rates that generally will adjust at least annually to
an increment over a specified interest rate index. Agency ARMs also
include Hybrid Agency ARMs that are past their fixed rate periods.
Interest
rates on the adjustable rate loans collateralizing the Hybrid Agency ARMs or
Agency ARMs are based on specific index rates, such as the one-year constant
maturity treasury, or CMT rate, the London Interbank Offered Rate, or LIBOR, the
Federal Reserve U.S. 12-month cumulative average one-year CMT, or MTA, or the
11th District Cost of Funds Index, or COFI. These loans will
typically have interim and lifetime caps on interest rate adjustments, or
interest rate caps, limiting the amount that the rates on these loans may reset
in any given period.
The
Company accounts for its Agency MBS in accordance with ASC Topic 320, which
requires that investments in debt and equity securities be designated as either
“held-to-maturity,” “available-for-sale” or “trading” at the time of
acquisition. All of the Company’s securities are designated as
available-for-sale with changes in their fair value reported in other
comprehensive income until the security is collected, disposed of, or determined
to be other than temporarily impaired. The Company determines the
fair value of its investment securities based upon prices obtained from a
third-party pricing service and broker quotes. Although the
Company generally intends to hold its investment securities until maturity, it
may, from time to time, sell any of its securities as part of the overall
management of its business. The available-for-sale designation
provides the Company with the flexibility to sell any of its investment
securities. Upon the sale of an investment security, any unrealized
gain or loss is reclassified out of AOCI to earnings as a realized gain or loss
using the specific identification method.
Substantially
all of the Company’s Agency MBS are pledged as collateral against repurchase
agreements.
Securitized Mortgage Loans.
Securitized mortgage loans consist of loans pledged to support the
repayment of securitization financing bonds issued by the
Company. Securitized mortgage loans are reported at amortized
cost. An allowance has been established for currently existing
estimated losses on such loans. Securitized mortgage loans can only
be sold subject to the lien of the respective securitization financing
indenture.
Non-Agency
securities.
The Company’s non-Agency securities are primarily
comprised of CMBS and RMBS, the majority of which are investment grade
rated. The Company accounts for its non-Agency securities in
accordance with ASC Topic 320, which requires that investments in debt and
equity securities be designated as either “held-to-maturity,”
“available-for-sale” or “trading” at the time of acquisition. All of
the Company’s non-Agency securities are designated as available-for-sale and are
carried at their fair value with unrealized gains and losses excluded from
earnings and reported in AOCI as a component of shareholders’
equity.
F-10
The
Company determines the fair value of its non-Agency securities by discounting
the estimated future cash flows derived from pricing models that utilize
information such as the security’s coupon rate, estimated prepayment speeds,
expected weighted average life, collateral composition, estimated future
interest rates, expected losses, credit enhancement, as well as certain other
relevant information. Although the Company generally intends to hold
its investment securities until maturity, it may, from time to time, sell any of
its securities as part of the overall management of its business. The
available-for-sale designation provides the Company with the flexibility to sell
any of its investment securities. Upon the sale of an investment
security, any unrealized gain or loss is reclassified out of AOCI to earnings as
a realized gain or loss using the specific identification method.
Other
Investments.
Other investments include equity securities and
unsecuritized single-family and commercial mortgage loans. The
unsecuritized mortgage loans are carried at amortized cost. Equity
securities are considered available-for-sale and are reported at fair value with
unrealized gains and losses excluded from earnings and reported in
AOCI.
Allowance
for Loan Losses
An
allowance for loan losses has been estimated and established for currently
existing and probable losses for mortgage loans that are considered
impaired. Provisions made to increase the allowance are charged as a
current period expense. Commercial mortgage loans are secured by
income-producing real estate and are evaluated individually for impairment when
the debt service coverage ratio on the mortgage loan is less than 1:1 or when
the mortgage loan is delinquent. An allowance may be established for
a particular impaired commercial mortgage loan. Commercial mortgage
loans not evaluated for individual impairment or not deemed impaired are
evaluated for a general allowance. Certain of the commercial mortgage
loans are covered by mortgage loan guarantees that limit the Company’s exposure
on these mortgage loans. Single family mortgage loans are considered
homogeneous and according are evaluated on a pool basis for a general
allowance.
The
Company considers various factors in determining its specific and general
allowance requirements. Such factors considered include whether a
loan is delinquent, the Company’s historical experience with similar types of
loans, historical cure rates of delinquent loans, and historical and anticipated
loss severity of the mortgage loans as they are liquidated. The
factors may differ by mortgage loan type (e.g., single-family versus commercial)
and collateral type (e.g., multifamily versus office property). The
allowance for loan losses is evaluated and adjusted periodically by management
based on the actual and estimated timing and amount of probable credit losses,
using the above factors, as well as industry loss experience.
In
reviewing both general and specific allowance requirements for commercial
mortgage loans, for loans secured by low-income housing tax credit (“LIHTC”)
properties, the Company considers the remaining life of the tax compliance
period in its analysis. Because defaults on mortgage loan financings
for these properties can result in the recapture of previously received tax
credits for the borrower, the potential cost of this recapture provides an
incentive to support the property during the compliance period, which has
historically decreased the likelihood of defaults for these types of
loans.
Other-than-Temporary
Impairments
The
Company evaluates all debt securities in its investment portfolio for
other-than-temporary impairments by applying the guidance prescribed in ASC
Topic 320 in determining whether an other-than-temporary impairment has
occurred. A debt security is considered to be other-than-temporarily
impaired if the present value of cash flows expected to be collected is less
than the security’s amortized cost basis (the difference being defined as the
credit loss) or if the fair value of the security is less than the security’s
amortized cost basis and the Company intends, or is required, to sell the
security before recovery of the security’s amortized cost
basis. Declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are deemed to be
other-than-temporary are reflected in earnings as realized losses to the extent
the impairment is related to credit losses. Any remaining difference
between fair value and amortized cost is recognized in other comprehensive
income. In certain instances, as a result of the other-than-temporary impairment
analysis, the recognition or accrual of interest will be discontinued and the
security will be placed on non-accrual status. Securities normally
are not placed on non-accrual status if the servicer continues to advance on the
delinquent mortgage loans in the security.
F-11
Repurchase
Agreements
The
Company uses repurchase agreements to finance certain of its
investments. Under these repurchase agreements, the Company sells the
securities to a lender and agrees to repurchase the same securities in the
future for a price that is higher than the original sales price. The
difference between the sales price that the Company receives and the repurchase
price that the Company pays represents interest paid to the
lender. Although structured as a sale and repurchase obligation, a
repurchase agreement operates as a financing in accordance with the provision of
ASC Topic 860 under which the Company pledges its securities as collateral to
secure a loan, which is equal in value to a specified percentage of the
estimated fair value of the pledged collateral. The Company retains
beneficial ownership of the pledged collateral. At the maturity of a
repurchase agreement, the Company is required to repay the loan and concurrently
receives back its pledged collateral from the lender or, with the consent of the
lender, the Company may renew the agreement at the then prevailing financing
rate. A repurchase agreement lender may require the Company to pledge
additional collateral in the event the estimated fair value of the existing
pledged collateral declines. Repurchase agreement financing is
recourse to the Company and the assets pledged. All of the Company’s
repurchase agreements are based on the September 1996 version of the Bond Market
Association Master Repurchase Agreement, which provides that the lender is
responsible for obtaining collateral valuations from a generally recognized
source agreed to by both the Company and the lender, or the most recent closing
quotation of such source.
Securitization
Transactions
The
Company has securitized mortgage loans in a securitization transaction by
transferring financial assets to a wholly owned trust, and the trust issues
non-recourse securitization financing bonds pursuant to an
indenture. Generally, the Company retains some form of control over
the transferred assets, and/or the trust is not deemed to be a qualified special
purpose entity. In instances where the trust is deemed not to be a
qualified special purpose entity, the trust is included in the consolidated
financial statements of the Company. For accounting and tax purposes,
the loans and securities financed through the issuance of bonds in a
securitization financing transaction are treated as assets of the Company
(presented as securitized mortgage loans), and the associated bonds issued are
treated as debt of the Company as securitization financing. The
Company may retain certain of the bonds issued by the trust, and the Company has
generally transferred collateral in excess of the bonds issued. This
excess is typically referred to as over-collateralization. Each
securitization trust generally provides the Company the right to redeem, at its
option, the remaining outstanding bonds prior to their maturity
date.
In
December 2009, the Company re-securitized a portion of its CMBS and sold $15,000
of bonds to a qualified special purpose entity which is not included in the
consolidated financial statements of the Company as of or for the year ended
December 31, 2009. Please refer to the “Recent Accounting
Pronouncements” section contained within this note for information related to
the subsequent accounting treatment for these bonds.
Derivative
Instruments
The
Company may enter into interest rate swap agreements, interest rate cap
agreements, interest rate floor agreements, financial forwards, financial
futures and options on financial futures (“interest rate agreements”) to manage
its sensitivity to changes in interest rates. These interest rate
agreements are intended to provide income and cash flow to offset potentially
reduced net interest income and cash flow under certain interest rate
environments. The Company accounts for its interest rate agreements
under ASC Topic 815, designating each as either hedge positions or trading
positions using criteria established therein. In order to qualify as
a cash flow hedge, ASC Topic 815 requires formal documentation to be prepared at
the inception of the interest rate agreement. This formal
documentation must describe the risk being hedged, identify the hedging
instrument and the means to be used for assessing the effectiveness of the
hedge, and demonstrate that the hedging instrument will be highly effective at
hedging the risk exposure. If these conditions are not met, an
interest rate agreement will be classified as a trading position.
For
interest rate agreements designated as cash flow hedges, the Company evaluates
the effectiveness of these hedges against the financial instrument being
hedged. The effective portion of the hedge relationship on an
interest rate agreement designated as a cash flow hedge is reported in AOCI and
is later reclassified into the
F-12
statement
of income in the same period during which the hedged transaction affects
earnings. The ineffective portion of such hedge is immediately
reported in the current period’s statement of income. These
derivative instruments are carried at fair value on the Company’s balance sheet
in accordance with ASC Topic 815. Amounts receivable from
counterparties, if any, are included on the consolidated balance sheets in other
assets.
The
Company may be required periodically to terminate hedging
instruments. Any basis adjustments or changes in the fair value of
hedges recorded in other comprehensive income are recognized into income or
expense in conjunction with the original hedge or hedged exposure.
If the
underlying asset, liability or commitment is sold or matures, the hedge is
deemed partially or wholly ineffective, or if the criterion that was executed at
the time the hedging instrument was entered into no longer exists, the interest
rate agreement no longer qualifies as a designated hedge. Under these
circumstances, such changes in the market value of the interest rate agreement
are recognized in current period’s statement of income.
For
interest rate agreements designated as trading positions, realized and
unrealized changes in fair value of these instruments are recognized in the
statement of income as trading income or loss in the period in which the changes
occur or when such trade instruments are settled. As of December 31,
2009, the Company does not have any derivative instruments designated as trading
positions.
Cash
Equivalents
Cash and
cash equivalents include cash on hand and highly liquid investments with
original maturities of three months or less.
Interest
Income
Interest
income on securities and loans that are rated “AAA” is recognized over the
contractual life of the investment using the effective interest
method. Interest income on non-Agency securities which are rated “AA”
or lower is recognized over the expected life as adjusted for estimated
prepayments and credit losses of the securities in accordance with ASC Topic
325.
For
loans, the accrual of interest is discontinued when, in the opinion of
management, the interest is not collectible in the normal course of business,
when the loan is significantly past due or when the primary servicer of the loan
fails to advance the interest and/or principal due on the loan. Loans
are considered past due when the borrower fails to make a timely payment in
accordance with the underlying loan agreement. For securities and
other investments, the accrual of interest is discontinued when, in the opinion
of management, it is probable that all amounts contractually due will not be
collected. All interest accrued but not collected for investments
that are placed on a non-accrual status or are charged-off is reversed against
interest income. Interest on these investments is accounted for on
the cash-basis or cost-recovery method, until qualifying for return to accrual
status. Investments are returned to accrual status when all the
principal and interest amounts contractually due are brought current and future
payments are reasonably assured.
Amortization
of Premiums, Discounts, and Deferred Issuance Costs
Premiums
and discounts on investments and obligations, as well as debt issuance costs and
hedging basis adjustments, are amortized into interest income or expense,
respectively, over the contractual life of the related investment or obligation
using the effective interest method in accordance with ASC Topic 310 and ASC
Topic 470. For securities representing beneficial interests in
securitizations that are not highly rated, unamortized premiums and discounts
are recognized over the expected life, as adjusted for estimated prepayments and
credit losses of the securities, in accordance with ASC Topic
325. Actual prepayment and credit loss experience are reviewed, and
effective yields are recalculated when originally anticipated prepayments and
credit losses differ from amounts actually received plus anticipated future
prepayments.
F-13
Net
Income per Common Share
Net
income per common share is presented on both a basic net income per common share
and diluted net income per common share basis. Diluted net income per
common share assumes the conversion of the convertible preferred stock into
common stock, using the two-class method, and stock options, using the treasury
stock method, but only if these items are dilutive. Each share of
preferred stock is convertible into one share of common stock.
Contingencies
In the
normal course of business, there are various lawsuits, claims, and contingencies
pending against the Company. In accordance with ASC Topic 450, we
evaluate whether to establish provisions for estimated losses from pending
claims, investigations and proceedings. Although the ultimate outcome
of the various matters cannot be ascertained at this point, it is the opinion of
management, after consultation with counsel, that the resolution of the
foregoing matters will not have a material adverse effect on the financial
condition of the Company, taken as a whole. Such resolution may,
however, have a material effect on the results of operations or cash flows in
any future period, depending on the level of income for such
period.
Recent
Accounting Pronouncements
In 2009,
the Financial Accounting Standards Board (“FASB”) announced the release of a new
topically-based structure for all authoritative U.S. GAAP known as the
Accounting Standards Codification
(“ASC”
or
“Codification”)
.
This
restructuring is the result of efforts by the FASB to culminate all
authoritative standards into a single resource in order to ensure accuracy and
completeness of content, reduce redundancy, eliminate conflicting guidance, and
simplify user research. Management has updated all references to
previous standards for GAAP in this Annual Report on Form 10-K to reflect the
appropriate topic in the Codification.
In June
2009, ASU No. 2009-01,
Topic
105-Generally Accepted Accounting Principles amendments based on Statement of
Financial Accounting Standards No. 168-The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles,
was issued as an amendment to the Codification, and made the Codification
effective for all financial statements issued with interim or annual reporting
periods ending after September 15, 2009. This Update establishes the
ASC as the authoritative source for GAAP recognized by the FASB to be applied by
nongovernmental entities. This Update also recognizes the rules and
interpretative releases of the SEC as an additional authoritative source for
GAAP as issued under the authority of federal securities laws. The
Codification supersedes all previously issued non-SEC accounting and reporting
standards. The Codification did not materially change GAAP, and
therefore did not have a material effect the Company’s financial position or
results of operations.
In August 2009, ASU No. 2009-05,
Fair Value Measurements and
Disclosures (Topic 820)-Measuring Liabilities at Fair Value,
amended the
Codification to clarify the techniques to be used in measuring the fair value
for liabilities in which a quoted price in an active market (i.e., a level 1
measurement ) for an identical liability is not available or does not
exist. This amendment became effective immediately upon
issuance. As of December 31, 2009, the Company did not have any
liabilities measured at fair value on the Company’s balance sheet. As
such, this amendment to the Codification did not currently have a material
effect on the Company’s financial position or results of
operations.
In May 2009, prior to the issuance of
ASU No. 2009-01, the FASB issued Statement of Financial Accounting Standard
No. 165 (“SFAS No. 165”),
Subsequent Events,
which has subsequently been codified in ASC Topic
855
.
It
establishes general standards of accounting for and disclosure of material
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. These subsequent events are
identified as either “recognized” or “nonrecognized”. Recognized
subsequent events are events or transactions that provide additional evidence
about conditions or circumstances of a company that existed as of the balance
sheet date. Nonrecognized subsequent events are events or
transactions that provide additional evidence about conditions
F-14
or
circumstances of a company that did
not
exist as of the balance
sheet date. Recognized subsequent events require adjustments to the
financial statements for the period presented; nonrecognized subsequent events
do
not
require
adjustments. Both types of subsequent events require disclosure in
the notes to the financial statements if considered material. The
effective date of this amendment is for interim or annual periods ending after
June 15, 2009 with prospective application. The Company applied ASC
Topic 855 in the second quarter of 2009, and this application did not have a
material effect on its financial condition or results of
operations.
In
December 2009, ASU No. 2009-16,
Transfers and Servicing (Topic
860)-Accounting for Transfers of Financial Assets
and ASU No. 2009-17,
Consolidations (Topic
810)-Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities
were issued as amendments to the ASC. The
purpose of the amendment to ASC Topic 860 is to eliminate the concept of a
“qualifying special-purpose entity” (“QSPE”) and to require more information
about transfers of financial assets, including securitization transactions as
well as a company’s continuing exposure to the risks related to transferred
financial assets. The purpose of the amendment to ASC Topic 810 is to
change how a reporting entity determines when to consolidate another entity that
is insufficiently capitalized or is not controlled by voting
rights. Instead of focusing on quantitative determinants,
consolidation is to be determined based on, among other things, qualitative
factors such as the other entity’s purpose and design as well as the reporting
entity’s ability to direct the activities of the other entity that most
significantly impact its performance. The reporting entity is also
required to add significant disclosures regarding its involvement with variable
interest entities and any changes in risk exposure due to this
involvement. Both of these amendments to the Codification are
effective for transactions and events occurring after the beginning of a
reporting entity’s first fiscal year that begins after November 15,
2009. Early adoption is prohibited, and the application will be
prospective. The Company has one QSPE that it will consolidate as a
result of the adoption of these standards on January 1, 2010. The
Company’s investments will increase by approximately $15,000 as a result of the
consolidation of this QSPE with a corresponding $15,000 increase in its
securitization financing. The Company does not anticipate that the
adoption of this standard will have a material impact on its results of
operations.
Subsequently,
FASB issued ASU No. 2010-10 which allowed certain reporting entities to defer
the consolidation requirements amended in ASC Topic 810 by ASU No.
2009-17. The Company is not eligible for this deferral.
The
following table presents the components of the Company’s investment in Agency
MBS as of December 31, 2009 and December 31, 2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||
|
Principal/par
value
|
$ | 570,215 | $ | 307,548 | ||||
|
Purchase
premiums
|
12,991 | 3,585 | ||||||
|
Purchase
discounts
|
(44 | ) | (59 | ) | ||||
|
Amortized cost
|
583,162 | 311,074 | ||||||
|
Gross
unrealized gains
|
11,261 | 1,355 | ||||||
|
Gross
unrealized losses
|
(303 | ) | (853 | ) | ||||
|
Fair value
|
$ | 594,120 | $ | 311,576 | ||||
|
Weighted
average coupon
|
4.76 | % | 5.06 | % | ||||
|
Weighted
average months to reset
|
20
months
|
21
months
|
||||||
Principal/par
value includes principal payments receivable on Agency MBS of $3,559 and $956 as
of December 31, 2009 and 2008, respectively. As of December 31, 2009,
the Company did not have any securities pending settlement. The
Company’s investment in Agency MBS as of December 31, 2009 is comprised of
$295,730 of Hybrid Agency ARMs, $298,259 of Agency ARMs, and $131 of fixed-rate
Agency MBS. The Company received principal payments of $116,704 on its portfolio
of Agency MBS and purchased approximately $389,220 of Agency MBS during the year
ended December 31, 2009.
F-15
The
following table summarizes the components of securitized mortgage loans as of
December 31, 2009 and December 31, 2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||
|
Securitized
mortgage loans:
|
||||||||
|
Commercial
|
$ | 137,567 | $ | 164,032 | ||||
|
Single-family
|
61,336 | 70,607 | ||||||
| 198,903 | 234,639 | |||||||
|
Funds
held by trustees, including funds held for defeasance
|
17,737 | 11,267 | ||||||
|
Unamortized
discounts and premiums, net
|
43 | 90 | ||||||
|
Loans,
at amortized cost
|
216,683 | 245,996 | ||||||
|
Allowance
for loan losses
|
(4,212 | ) | (3,707 | ) | ||||
| $ | 212,471 | $ | 242,289 | |||||
All of
the securitized mortgage loans are encumbered by securitization financing bonds
(see Note 10).
Commercial
mortgage loans were originated principally in 1996 and 1997 and are
collateralized by first deeds of trust on income producing
properties. Approximately 85% of commercial mortgage loans are
secured by multifamily properties and approximately 15% by office, health-care,
hospital, retail, warehouse, industrial and mixed-used properties.
Single-family
mortgage loans are secured by first deeds of trust on residential real estate
and were originated principally from 1992 to 1997. Single-family
mortgage loans includes $1,512 of loans in foreclosure and $1,877 of loans more
than 90 days delinquent on which the Company continues to accrue
interest.
The
Company identified $20,491 of securitized commercial mortgage loans and $4,065
of securitized single-family mortgage loans as being impaired as of December 31,
2009. The Company recognized $1,423 of interest income on impaired
securitized commercial mortgage loans and $319 on impaired single-family
mortgage loans for the year ended December 31, 2009.
Funds
held by trustees include $17,588 of cash and cash equivalents held by the trust
for defeased loans. These defeased funds represent replacement
collateral for the defeased mortgage loan, which replicates the contractual cash
flows of the defeased mortgage loan and will be used to service the debt for
which the underlying mortgage on the property has been released.
The
following table summarizes the aggregate activity for the allowance for loan
losses for the years ended December 31, 2009, 2008 and 2007:
|
December
31, 2009
|
December
31, 2008
|
December
31, 2007
|
||||||||||
|
Allowance
at beginning of year
|
$ | 3,707 | $ | 2,721 | $ | 4,495 | ||||||
|
Provision
for (recapture of) loan losses
|
782 | 991 | (1,281 | ) | ||||||||
|
Credit
losses, net of recoveries
|
(181 | ) | (5 | ) | (493 | ) | ||||||
|
Allowance
at end of year
|
$ | 4,308 | $ | 3,707 | $ | 2,721 | ||||||
F-16
The
following table presents the components of the allowance for loan losses as of
December 31, 2009 and December 31, 2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||
|
Securitized
commercial mortgage loans
|
$ | 3,935 | $ | 3,527 | ||||
|
Securitized
single-family mortgage loans
|
277 | 180 | ||||||
| 4,212 | 3,707 | |||||||
|
Other
investments
|
96 |
─
|
||||||
| $ | 4,308 | $ | 3,707 | |||||
The
following table presents certain information on impaired single-family and
commercial securitized mortgage loans as of December 31, 2009 and
2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Commercial
|
Single-family
|
Commercial
|
Single-family
|
|||||||||||||
|
Investment
in impaired loans
|
$ | 20,465 | $ | 4,152 | $ | 17,253 | $ | 3,501 | ||||||||
|
Allowance
for loan losses
|
3,935 | 277 | 3,527 | 180 | ||||||||||||
|
Investment
in excess of allowance
|
$ | 16,530 | $ | 3,875 | $ | 13,726 | $ | 3,321 | ||||||||
The
following table presents the components of the Company’s non-Agency securities
as of December 31, 2009 and December 31, 2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Carrying
Value
|
Weighted
Average Yield
|
Carrying
Value
|
Weighted
Average Yield
|
|||||||||||||
|
CMBS
|
$ | 104,553 | 4.23 | % |
$ ─
|
─
|
||||||||||
|
RMBS
|
6,462 | 7.93 | % | 6,959 | 8.02 | % | ||||||||||
| 111,015 | 6,959 | |||||||||||||||
|
Gross
unrealized gains
|
3,211 | 593 | ||||||||||||||
|
Gross
unrealized losses
|
(5,116 | ) | (1,293 | ) | ||||||||||||
| $ | 109,110 | $ | 6,259 | |||||||||||||
Non-Agency
securities consist primarily of fixed-rate CMBS and RMBS. The
Company’s CMBS have a fair value of $103,203 at December 31, 2009 and are
comprised primarily of ‘AAA’ rated securities with a fair value of
$99,092. Of these ‘AAA’ rated CMBS, CMBS with a par value of $86,280
and a fair value of approximately $82,770 have been pledged as collateral
against repurchase agreements with a par value of $73,338.
The
Company exercised certain of its redemption rights and redeemed at par CMBS with
a principal balance of $111,280. The redeemed CMBS were refinanced
through a securitization transaction in December 2009, and the Company sold
$15,000 of the securitization bonds as part of the transaction on which it
recognized a loss of $47. This loss will result in a cumulative
adjustment to retained earnings in subsequent reporting periods as a result of
the amendments to ASC Topic 860 discussed previously in the “Recent Accounting
Pronouncements” section of Note 2.
The
Company’s RMBS are largely made up of RMBS issued by a single trust in 1994 and
have a fair value of $5,907 as of December 31, 2009.
F-17
On
November 20, 2009, the Company acquired the remaining 50.125% interest in
Copperhead Ventures, LLC (“Copperhead”) at a cash purchase price of
$9,547. The acquiree primarily held investments in CMBS, including
certain rights to redeem CMBS not owned by Copperhead, and cash. The
Company acquired the controlling interest in Copperhead primarily to enable the
Company to maximize the value of the assets held by the
venture. Prior to the acquisition date, the Company owned a 49.875%
interest in the acquiree. Because all assets and liabilities on
Copperhead’s balance sheet were already carried at fair value, the Company’s
equity interest in Copperhead as of the acquisition date equaled the carrying
value on the Company’s balance sheet of $9,547.
Prior to
the Company’s acquisition of its controlling interest in Copperhead, the Company
had recognized $2,490 in AOCI as part of shareholders’ equity, which reflected
the Company’s portion of the changes in fair value of available-for-sale
subordinate CMBS held by Copperhead. In connection with the
acquisition, this amount has been classified to other expense.
The
following table presents the condensed results of operations for the joint
venture for the period January 1, 2009 through November 20, 2009 and the year
ended December 31, 2008 and the financial condition as of December 31,
2008:
|
Condensed
Statement of Operations
|
2009
|
2008
|
||||||
|
Interest
income
|
$ | 2,359 | $ | 3,956 | ||||
|
Impairment
|
(1,417 | ) | (7,278 | ) | ||||
|
Fair
value adjustments, net
|
4,017 | (7,391 | ) | |||||
|
General
and administrative expense
|
(25 | ) | (59 | ) | ||||
|
Net
income (loss)
|
$ | 4,934 | $ | (10,772 | ) | |||
|
Condensed
Balance Sheet
|
2008
|
|||
|
Total
assets
|
$ | 11,240 | ||
|
Total
liabilities
|
21 | |||
|
Total
equity
|
$ | 11,219 | ||
The
impairment of $1,417 and $7,278 in 2009 and 2008, respectively, resulted from an
other-than-temporary impairment on CMBS owned by the joint
venture. The net negative fair value adjustments of $7,391 resulted
from adjustments to the payment agreement discussed below. The
instrument is accounted for under SFAS 159, “The Fair Value Option for Financial
Assets and Financial Liabilities,” and accordingly, changes in value of this
instrument are recorded in the statement of operations.
Copperhead
held a payment agreement receivable prior to the acquisition, which was written
by a subsidiary of Dynex. This agreement required that Dynex make
monthly payments to Copperhead equal to the amount Dynex received on certain
outstanding securitized commercial mortgage loans and defeased commercial
mortgage loans. Dynex reported its liability under this agreement in
its consolidated balance sheets as obligation under payment
agreement. Dynex made payments to Copperhead of $1,589 and $1,608 for
the period ended November 20, 2009 (the acquisition date) and the year ended
December 31, 2008, respectively, which Dynex recorded as interest expense and
Copperhead recorded as interest income. As of December 31, 2009, the
obligation under payment agreement is eliminated in Dynex’s consolidated balance
sheets.
Dynex
adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities” (“SFAS 159”), which was codified into ASC
Topic 825 and which permits entities to choose to measure financial instruments
at fair value, on January 1, 2008. The Company adopted SFAS 159 to
enhance the transparency of its financial condition. The effect of
the adoption of SFAS 159 was to decrease beginning accumulated deficit in 2008
by $1,323.
F-18
The
following table summarizes the estimated fair value of assets acquired and
liabilities assumed in the purchase of Copperhead:
|
At
acquisition:
|
||||
|
Consideration
paid:
|
$ | 9,548 | ||
|
Fair
value of Company’s equity interest prior to acquisition:
|
9,500 | |||
| $ | 19,048 | |||
|
Assets
acquired:
|
||||
|
CMBS
|
$ | 4,082 | ||
|
Payment
agreement
|
10,557 | |||
|
Cash
and other assets
|
4,430 | |||
|
Liabilities
assumed:
|
||||
|
Other
liabilities
|
(21 | ) | ||
|
Net
assets acquired:
|
$ | 19,048 | ||
The
Company’s other investments is comprised principally of unsecuritized mortgage
loans. Of the approximately 26 mortgage loans that make up the
balance, two loans with a combined unpaid principal balance of $806 were more
than 60 days delinquent as of December 31, 2009. An allowance for
loan loss of $96 has been recorded for these loans.
The Company also sold
approximately $3,441 of equity securities, on which it recognized a gain of $220
during the year ended December 31, 2009.
The
Company uses repurchase agreements, which are recourse to the Company, to
finance certain of its investments. The following tables present the
components of the Company’s repurchase agreements as of December 31, 2009 and
December 31, 2008 by the type of securities collateralizing the repurchase
agreement:
|
December
31, 2009
|
||||||||||||
|
Collateral
Type
|
Balance
|
Weighted
Average Rate
|
Fair
Value of Collateral
|
|||||||||
|
Agency
MBS
|
$ | 540,586 | 0.60 | % | $ | 575,386 | ||||||
|
Non-Agency
securities
|
73,338 | 1.73 | % | 82,770 | ||||||||
|
Securitization
financing bonds (see Note 10)
|
24,405 | 1.59 | % | 34,431 | ||||||||
| $ | 638,329 | 0.76 | % | $ | 692,587 | |||||||
|
December
31, 2008
|
||||||||||||
|
Collateral
Type
|
Balance
|
Weighted
Average Rate
|
Fair
Value of Collateral
|
|||||||||
|
Agency
MBS
|
$ | 274,217 | 2.70 | % | $ | 300,277 | ||||||
|
Non-Agency
securities
|
– | – | – | |||||||||
|
Securitization
financing bonds (see Note 10)
|
– | – | – | |||||||||
| $ | 274,217 | 2.70 | % | $ | 300,277 | |||||||
F-19
As of
December 31, 2009 and December 31, 2008, the repurchase agreements had the
following original maturities:
|
Original
Maturity
|
December
31, 2009
|
December
31, 2008
|
||||||
|
30
days or less
|
$ | 69,576 | $ | 38,617 | ||||
|
31
to 60 days
|
300,413 | 187,960 | ||||||
|
61
to 90 days
|
180,643 | 47,640 | ||||||
|
Greater
than 90 days
|
87,697 | – | ||||||
| $ | 638,329 | $ | 274,217 | |||||
The
following table presents our borrowings by repurchase agreement counterparty as
of December 31, 2009:
|
Counterparty
|
Repurchase
agreements
|
Fair
Value of Collateral
|
Equity
at Risk
|
Weighted
Average Original Maturity
|
|||||||||
|
Bank
of America Securities, LLC
|
$ | 178,522 | $ | 195,820 | $ | 17,298 |
91
days
|
||||||
|
All
other
|
459,807 | 496,767 | 36,960 |
47
days
|
|||||||||
| $ | 638,329 | $ | 692,587 | $ | 54,258 |
59
days
|
|||||||
There
were no counterparties with which we had equity at risk of more than 10% as of
December 31, 2008.
The
Company has two series of securitization financing bonds remaining outstanding
which were issued pursuant to two separate indentures. One of the
series has two classes of bonds outstanding, one of which is owned by third
parties and the other which has been retained by the Company. The
class owned by third parties has a principal amount of $23,852 as of December
31, 2009 and is collateralized by single-family mortgage loans with unpaid
principal balances of $24,563. This class shares additional
collateralization of $6,555 with the other class within the same series that the
Company retained.
The
second series of bonds is fixed-rate with a principal amount of $121,168 as of
December 31, 2009, and is collateralized by commercial mortgage loans with
unpaid principal balances of $124,451.
In May
2009, the Company redeemed a securitization financing bond which it had issued
in 1993. This bond was collateralized by commercial mortgage loans at
its then par value of $15,493. The redemption was financed with an
$11,039 repurchase agreement. As of December 31, 2009, the par value
of this bond is $8,501 and the balance of the repurchase agreement is
$6,057. The bond is rated “AAA” and has a guaranty of payment by
Fannie Mae. The bond is eliminated in the consolidated financial
statements but remains legally outstanding. The Company also has one
additional redeemed securitization bond which has a par value of $30,217 as of
December 31, 2009 and is rated “AAA.” The bond, which is
collateralized by single-family mortgage loans, was issued by the Company in
2002 and was redeemed in 2004. This bond is pledged as collateral to
support repurchase agreement borrowings of $18,348 as of December 31,
2009.
The
components of securitization financing along with certain other information as
of December 31, 2009 and December 31, 2008 are summarized as
follows:
F-20
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Bonds
Outstanding
|
Range
of
Interest
Rates
|
Bonds
Outstanding
|
Range
of
Interest
Rates
|
|||||||||||||
|
Fixed
rate classes
|
$ | 121,168 | 6.7% - 7.1 | % | $ | 149,598 | 6.6% - 8.8 | % | ||||||||
|
Variable
rate class
|
23,852 | 0.5 | % | 28,186 | 1.7 | % | ||||||||||
|
Unamortized
net bond premium and deferred costs
|
(1,939 | ) | (627 | ) | ||||||||||||
| $ | 143,081 | $ | 177,157 | |||||||||||||
|
Range
of stated maturities
|
2024-2027 | 2024-2027 | ||||||||||||||
|
Estimated
weighted average life
|
3.0
years
|
2.6
years
|
||||||||||||||
|
Number
of series
|
2 | 3 | ||||||||||||||
The
estimated weighted average life of the bonds increased as a result of a decrease
in the expected prepayment speed of the commercial mortgage loans
collateralizing the bonds, which are the source of funds that are used to pay
down the bonds. The extension of the estimated cash flows of the bond
resulted in an adjustment to the amortization of the net bond premium and
deferred costs of approximately $789 during the year ended December 31,
2009. As of December 31, 2009, the weighted-average coupon on the
bonds outstanding was 6.9% which is the same as of December 31,
2008. The average effective rate on the bonds was 6.2%, 6.1%, and
7.2% for the years ended December 31, 2009, 2008, and 2007,
respectively. The variable rate bonds pay interest based on one-month
LIBOR plus .30%.
Please
see Note 2 for additional information related to the Company’s accounting
policies for derivative instruments.
The
following table summarizes information regarding the Company’s outstanding
interest rate swap agreements as of December 31, 2009:
|
Effective
Date
|
Maturity
Date
|
Notional
Amount
|
Fixed
Rate Swapped
|
||||||
|
November
24, 2009
|
November
24, 2011
|
$ | 25,000 | 0.96 | % | ||||
|
November
24, 2009
|
November
24, 2012
|
$ | 50,000 | 1.53 | % | ||||
|
December
24, 2009
|
December
24, 2014
|
$ | 30,000 | 2.50 | % | ||||
These
interest rate swaps have been designated as cash flow hedging positions and are
classified on the Company’s consolidated balance sheet as derivative assets with
a gross fair value of $1,008 as of December 31, 2009. The Company did
not have derivative instruments designated as trading positions as of December
31, 2009. The Company did not hold derivative instruments of any kind
as of or for the years ended December 31, 2008 or 2007. As of
December 31, 2009, the Company had margin requirements for these interest rate
swaps totaling $275 for which Agency MBS with a fair value of $322 have been
posted as collateral.
The
Company’s objective for using interest rate swaps is to minimize its exposure to
the risk of increased interest expense resulting from its existing and
forecasted short-term, fixed-rate borrowings. The Company
continuously borrows funds via sequential fixed-rate, short-term repurchase
agreement borrowings. As each fixed-rate repurchase agreement
matures, it is replaced with new fixed-rate agreements based on the market
interest rate in effect at the time of such replacement. This
sequential rollover borrowing program creates a variable interest expense
pattern. The changes in the cash flows of the interest rate swaps
listed above are expected to be highly effective at offsetting changes in the
interest portion of the cash flows expected to be paid at maturity of each
borrowing.
F-21
The
Company recorded an unrealized gain of $1,008 in accumulated other comprehensive
income as of December 31, 2009 for the fair value of the Company’s interest rate
swaps. Amounts reported in other comprehensive income related to cash
flow hedging instruments are reclassified to the statement of income as interest
payments are made on the Company’s variable rate debt. For the year
ended December 31, 2009, the amount of this reclassification for the Company is
$103 and is recorded as a portion of interest expense. During the
year ending December 31, 2010, the Company estimates that an additional $1,170
will be reclassified to earnings from AOCI as an increase to interest
expense.
The
Company records any income or expense resulting from the ineffective portions of
its interest rate swaps in other expense. For the year ended December
31, 2009, the Company recorded $0 of hedge ineffectiveness in
earnings.
The interest rate agreements the
Company has with its derivative counterparties contain various covenants related
to the Company’s credit risk. Specifically, if the Company defaults
on any of its indebtedness, including those circumstances whereby repayment of
the indebtedness has not been accelerated by the lender, then the Company could
also be declared in default of its derivative
obligations. Additionally, the agreements outstanding with one of the
derivative counterparties allows that counterparty to require settlement of its
outstanding derivative transactions if the Company fails to earn GAAP net income
greater than $1 as measured on a rolling two quarter basis. These
interest rate agreements also contain provisions whereby, if the Company fails
to maintain a minimum net amount of shareholders’ equity, then the Company may
be declared in default on its derivative obligations. As of December
31, 2009, the Company had no derivatives in a net liability
position.
The
Company utilizes fair value measurements at various levels within the hierarchy
established by ASC Topic 820 for certain of its assets and
liabilities. The three levels of valuation hierarchy established by
ASC Topic 820 are as follows:
|
·
|
Level
1 — Inputs are unadjusted, quoted prices in active markets for identical
assets or liabilities at the measurement date. The Company’s
investments included in Level 1 fair value generally are equity securities
listed in active markets.
|
|
·
|
Level
2 — Inputs (other than quoted prices included in Level 1) are either
directly or indirectly observable for the asset or liability through
correlation with market data at the measurement date and for the duration
of the instrument’s anticipated life. The Company’s fair valued
assets and liabilities that are generally included in this category are
Agency MBS, which are valued based on the average of multiple dealer
quotes that are active in the Agency MBS market, and its
derivatives.
|
|
·
|
Level
3 — Inputs reflect management’s best estimate of what market participants
would use in pricing the asset or liability at the measurement
date. Consideration is given to the risk inherent in the
valuation technique and the risk inherent in the inputs to the
model. Generally, the Company’s assets and liabilities carried
at fair value and included in this category are non-Agency securities and
delinquent property tax
receivables.
|
F-22
The
following table presents the fair value of the Company’s assets and liabilities
as of December 31, 2009, segregated by the hierarchy level of the fair value
estimate:
|
Fair
Value Measurements
|
||||||||||||||||
|
Fair
Value
|
Level
1
|
Level
2
|
Level
3
|
|||||||||||||
|
Assets:
|
||||||||||||||||
|
Agency MBS
|
$ | 594,120 | $ | – | $ | 594,120 | $ | – | ||||||||
|
Non-Agency
securities
|
109,110 | – | – | 109,110 | ||||||||||||
|
Derivative assets
|
1,008 | – | 1,008 | – | ||||||||||||
|
Other
|
131 | – | – | 131 | ||||||||||||
|
Total assets carried at fair
value
|
$ | 704,369 | $ | – | $ | 595,128 | $ | 109,241 | ||||||||
Non-Agency
securities are comprised primarily of CMBS and RMBS for which substantially
similar securities do not trade frequently. As such, the Company
determines the fair value of its non-Agency securities by discounting the
estimated future cash flows derived from pricing models using assumptions that
are confirmed to the extent possible by third party dealers or other pricing
indicators. Significant inputs into the pricing models are Level 3 in
nature due to the lack of readily available market quotes and utilize
information such as the security’s coupon rate, estimated prepayment speeds,
expected weighted average life, collateral composition, estimated future
interest rates, expected losses, credit enhancement, as well as certain other
relevant information. The following tables present the beginning and
ending balances of the Level 3 fair value estimates for the years ended December
31, 2009, and 2008:
|
Level
3 Fair Values
|
||||||||||||||||||||
|
Non-Agency
securities
|
Corporate
debt securities
|
Other
|
Total
assets
|
Obligation
under payment agreement
|
||||||||||||||||
|
Balance
as of January 1, 2008
|
$ | 7,726 | $ | 4,347 | $ | 2,127 | $ | 14,200 | $ | (15,473 | ) | |||||||||
|
Total
realized and unrealized gains (losses)
|
||||||||||||||||||||
|
Included
in the statement of operations
|
– | (187 | ) | (9 | ) | (196 | ) | 6,939 | ||||||||||||
|
Included
in other comprehensive income (loss)
|
(742 | ) | 375 | 15 | (352 | ) | – | |||||||||||||
|
Purchases,
sales, issuances and other settlements, net
|
(725 | ) | (4,535 | ) | (1,922 | ) | (7,182 | ) | – | |||||||||||
|
Transfers
in and/or out of Level 3
|
– | – | – | – | – | |||||||||||||||
|
Balance
at December 31, 2008
|
$ | 6,259 | $ | – | $ | 211 | $ | 6,470 | $ | (8,534 | ) | |||||||||
|
Total
realized and unrealized gains (losses)
|
||||||||||||||||||||
|
Included
in statement of operations
|
(47 | ) | – | (2 | ) | (49 | ) | (2,023 | ) | |||||||||||
|
Included
in other comprehensive income (loss)
|
(1,206 | ) | – | (16 | ) | (1,222 | ) | – | ||||||||||||
|
Purchases,
sales, issuances and other
settlements,
net
|
104,104 | – | (62 | ) | 104,042 | 10,557 | ||||||||||||||
|
Transfers
in and/or out of Level 3
|
– | – | – | – | – | |||||||||||||||
|
Balance
as of December 31, 2009
|
$ | 109,110 | $ | – | $ | 131 | $ | 109,241 | $ | – | ||||||||||
There
were no assets or liabilities which were measured at fair value on a
non-recurring basis as of December 31, 2009 or December 31, 2008.
F-23
The
following table presents the recorded basis and estimated fair values of the
Company’s financial instruments as of December 31, 2009 and December 31,
2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Recorded
Basis
|
Fair
Value
|
Recorded
Basis
|
Fair
Value
|
|||||||||||||
|
Assets:
|
||||||||||||||||
|
Agency MBS
|
$ | 594,120 | $ | 594,120 | $ | 311,576 | $ | 311,576 | ||||||||
|
Non-Agency securities and
CMBS
|
109,110 | 109,110 | 6,259 | 6,259 | ||||||||||||
|
Securitized mortgage loans,
net
|
212,471 | 186,547 | 242,289 | 200,699 | ||||||||||||
|
Investment in joint
venture
|
– | – | 5,655 | 5,595 | ||||||||||||
|
Other
investments
|
2,280 | 2,079 | 6,476 | 6,099 | ||||||||||||
|
Liabilities:
|
||||||||||||||||
|
Repurchase
agreements
|
638,329 | 638,329 | 274,217 | 274,217 | ||||||||||||
|
Securitization
financing
|
143,081 | 132,234 | 177,157 | 153,264 | ||||||||||||
|
Obligation under payment
agreement
|
– | – | 8,534 | 8,534 | ||||||||||||
The
following table presents certain information for Agency MBS and Non-Agency
securities that were in an unrealized loss position as of December 31, 2009 and
December 31, 2008:
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Fair
Value
|
Unrealized
Loss
|
Fair
Value
|
Unrealized
Loss
|
|||||||||||||
|
Unrealized
loss position for:
|
||||||||||||||||
|
Less than one
year:
|
||||||||||||||||
|
Agency MBS
|
$ | 73,288 | $ | 302 | $ | 98,171 | $ | 853 | ||||||||
|
Non-Agency
securities
|
92,438 | 4,145 | 3,719 | 937 | ||||||||||||
|
One year or
more:
|
||||||||||||||||
|
Non-Agency
securities
|
4,087 | 971 | 598 | 355 | ||||||||||||
| $ | 169,813 | $ | 5,418 | $ | 102,488 | $ | 2,145 | |||||||||
The
Company reviews the estimated future cash flows for its non-Agency securities to
determine whether there have been adverse changes in the cash flows which
necessitate recognition of other-than-temporary impairment
amounts. Approximately, $96,424 of the non-Agency securities in an
unrealized loss position as of December 31, 2009 are investment grade MBS
collateralized by mortgage loans which were originated during or prior to
1999. Based on the credit rating of these MBS and the seasoning of
the mortgage loans collateralizing these securities, the impairment of these MBS
is not determined to be other-than-temporary as of December 31,
2009.
The
estimated cash flows of the remaining $12,686 of non-Agency securities were
reviewed based on the performance of the underlying mortgage loans
collateralizing the MBS as well as projected loss and prepayment
rates. Based on that review, management did not determine any adverse
changes in the timing or amount of estimated cash flows which necessitate
recognition of other-than temporary impairment amounts as of December 31,
2009.
Net
income per common share is presented on both a basic and diluted
basis. Diluted net income per common share assumes the conversion of
the convertible preferred stock into common stock using the two-class method,
and stock options using the treasury stock method, but only if these items are
dilutive. Each share of Series D preferred stock is convertible into
one share of common stock. The following tables reconcile the
numerator and denominator for both basic and diluted net income per common
share:
F-24
|
Year
ended December 31,
|
||||||||||||||||||||||||
|
2009
|
2008
|
2007
|
||||||||||||||||||||||
|
Income
|
Weighted
Average Common Shares
|
Income
|
Weighted
Average Common Shares
|
Income
|
Weighted
Average Common Shares
|
|||||||||||||||||||
|
Net
income
|
$ | 17,581 | $ | 15,121 | $ | 8,899 | ||||||||||||||||||
|
Preferred
stock dividends
|
(4,010 | ) | (4,010 | ) | (4,010 | ) | ||||||||||||||||||
|
Net
income to common shareholders
|
13,571 | 13,088,154 | 11,111 | 12,166,558 | 4,889 | 12,135,495 | ||||||||||||||||||
|
Effect
of dilutive items
|
4,010 | 4,222,826 | – | 3,053 | – | 2,593 | ||||||||||||||||||
|
Diluted
income
|
$ | 17,581 | 17,310,980 | $ | 11,111 | 12,169,611 | $ | 4,889 | 12,138,088 | |||||||||||||||
|
Net
income per common share:
|
||||||||||||||||||||||||
|
Basic
|
$ | 1.04 | $ | 0.91 | $ | 0.40 | ||||||||||||||||||
|
Diluted
|
$ | 1.02 | $ | 0.91 | $ | 0.40 | ||||||||||||||||||
|
Components
of dilutive items:
|
||||||||||||||||||||||||
|
Convertible preferred
stock
|
4,010 | 4,221,539 | – | – | – | – | ||||||||||||||||||
|
Stock options
|
– | 1,287 | – | 3,053 | – | 2,593 | ||||||||||||||||||
| $ | 4,010 | 4,222,826 | $ | 11,111 | 3,053 | $ | 4,889 | 2,593 | ||||||||||||||||
The
following securities were excluded from the calculation of diluted net income
per common shares, as their inclusion would have been
anti-dilutive:
|
Year
ended December 31,
|
||||||||||||
|
2009
|
2008
|
2007
|
||||||||||
|
Shares
issuable under stock option awards
|
70,000 | 118,053 | 92,407 | |||||||||
|
Convertible
preferred shares
|
– | 4,221,539 | 4,221,539 | |||||||||
The
Company is authorized to issue up to 50,000,000 shares of preferred
stock. For all series issued, dividends are cumulative from the date
of issue and are payable quarterly in arrears. The dividends per
share are equal to the greater of (i) the per quarter base rate of $0.2375
for Series D, or (ii) the quarterly dividend declared on the Company’s
common stock. One share of Series D preferred stock is convertible at
any time at the option of the holder into one share of common
stock. The series is redeemable by the Company at any time, in whole
or in part, (i) at a rate of one share of preferred stock for one share of
common stock plus accrued and unpaid dividends, provided that the closing price
of the common stock equals or exceeds the issue price of the preferred stock for
20 trading days within any period of 30 consecutive trading days, or
(ii) for cash at the issue price plus any accrued and unpaid
dividends.
In the
event of liquidation, the holders of this series of preferred stock will be
entitled to receive out of the Company’s assets, prior to any such distribution
to the common shareholders, the issue price per share in cash plus any accrued
and unpaid dividends. If the Company fails to pay dividends for two
consecutive quarters or if the Company fails to maintain consolidated
shareholders’ equity of at least 200% of the aggregate issue price of the Series
D preferred stock, then these shares automatically convert into a new series of
9.50% senior notes. The Company paid dividends of $0.95 per share of
Series D Preferred Stock for each of the years ended December 31, 2009, 2008 and
2007.
F-25
The
Company initiated a controlled equity offering program (“CEOP”) on
March 16, 2009 by filing a prospectus supplement under its shelf
registration statement filed in 2008. The CEOP allows the Company to
offer and sell through Cantor Fitzgerald & Co., as its agent, up to
3,000,000 shares of its common stock in negotiated transactions or transactions
that are deemed to be “at the market offerings”, as defined in Rule 415 under
the 1933 Act, including sales made directly on the New York Stock Exchange or
sales made to or through a market maker other than on an
exchange. During the year ended December 31, 2009, the Company sold
1,749,250 shares of its common stock through the CEOP at an average price of
$7.59 per share for which it received proceeds of $12,923, net of broker sales
commissions. As of December 31, 2009, there are 1,250,750 shares of
the Company’s common stock available for offer and sale under the
CEOP.
The
following table presents a summary of the changes in the number of preferred and
common shares outstanding from January 1, 2007 through December 31,
2009:
|
Preferred
Stock Series D
|
Common
Stock
|
|||||||
|
January
1, 2007
|
4,221,539 | 12,131,262 | ||||||
|
Stock
options exercised
|
- | 5,000 | ||||||
|
December
31, 2007
|
4,221,539 | 12,136,262 | ||||||
|
Restricted
shares granted
|
- | 33,500 | ||||||
|
December
31, 2008
|
4,221,539 | 12,169,762 | ||||||
|
Common
stock issued (1,749,250 under CEOP)
|
- | 1,751,750 | ||||||
|
Restricted
shares granted
|
- | 10,000 | ||||||
|
December
31, 2009
|
4,221,539 | 13,931,512 | ||||||
The
following table presents the preferred and common dividends declared during the
year ended December 31, 2009:
|
Dividend
per Share
|
||||||||||
|
Declaration
Date
|
Record
Date
|
Payment
Date
|
Common
|
Preferred
|
||||||
|
March
20, 2009
|
March
31, 2009
|
April
30, 2009
|
$ | 0.2300 | $ | 0.2375 | ||||
|
June
16, 2009
|
June
30, 2009
|
July
31, 2009
|
0.2300 | 0.2375 | ||||||
|
September
15, 2009
|
September
30, 2009
|
October
30, 2009
|
0.2300 | 0.2375 | ||||||
|
December
9, 2009
|
December
31, 2009
|
February
1, 2010
|
0.2300 | 0.2375 | ||||||
Stock
Incentive Plan
Pursuant
to the Company’s 2009 Stock and Incentive Plan, as approved by the shareholders
at the Company’s 2009 annual shareholders’ meeting (the “2009 Stock and
Incentive Plan”), the Company may grant to eligible employees, directors or
consultants or advisors to the Company stock based compensation, including stock
options, stock appreciation rights (“SARs”), stock awards, dividend equivalent
rights, performance shares, and stock units. A total of 2,500,000
shares of common stock is available for issuance pursuant to the 2009 Stock and
Incentive Plan.
The
Company also has a 2004 Stock Incentive Plan, as approved by the Company’s
shareholders at its 2005 annual shareholders’ meeting (the “2004 Stock Incentive
Plan”) under which it made awards to its employees and directors prior to May
13, 2009. The 2004 Stock Incentive Plan covers only those awards made
prior to May 13, 2009, and no new awards will be made under this
plan.
F-26
As
required by ASC Topic 718, stock options which may be settled only in shares of
common stock have been treated as equity awards with their fair value measured
at the grant date, and SARs which may be settled only in cash have been treated
as liability awards with their fair value measured at the grant date and
remeasured at the end of each reporting period. The fair value of
SARs was estimated as of December 31, 2009 and December 31, 2008 using the
Black-Scholes option valuation model based upon the assumptions in the table
below.
|
As
of December 31,
|
||||||||
|
2009
|
2008
|
|||||||
|
Expected
volatility
|
25.4%-30.9 | % | 21.3%-26.6 | % | ||||
|
Weighted-average
volatility
|
29.4 | % | 24.4 | % | ||||
|
Expected
dividends
|
10.4 | % | 14.1 | % | ||||
|
Expected
term (in months)
|
18 | 22 | ||||||
|
Weighted-average
risk-free rate
|
1.87 | % | 1.89 | % | ||||
|
Range
of risk-free rates
|
1.44%-2.42 | % | 1.73%-2.08 | % | ||||
The
following table presents a rollforward of the SARs activity for the years ended
December 31, 2009, 2008, and 2007:
|
Number
of Shares
|
Weighted-
Average
Exercise
Price
|
|||||||
|
SARs
outstanding as of January 1, 2007
|
203,297 | $ | 7.36 | |||||
|
SARs
granted
|
82,500 | 7.06 | ||||||
|
SARs
forfeited or redeemed
|
(7,651 | ) | 7.25 | |||||
|
SARs
exercised
|
– | – | ||||||
|
SARs
outstanding as of December 31, 2007
|
278,146 | $ | 7.27 | |||||
|
SARs
granted
|
– | – | ||||||
|
SARs
forfeited, redeemed, or exercised
|
– | – | ||||||
|
SARs
outstanding as of December 31, 2008
|
278,146 | $ | 7.27 | |||||
|
SARs
granted
|
– | – | ||||||
|
SARs
forfeited, redeemed, or exercised
|
– | – | ||||||
|
SARs
outstanding as of December 31, 2009
|
278,146 | $ | 7.27 | |||||
|
SARs
vested and exercisable as of December 31, 2009
|
219,396 | $ | 7.37 | |||||
The
weighted average remaining contractual term on the SARs outstanding and
exercisable as of December 31, 2009 is 34 months.
The
following table presents a rollforward of the stock option activity for the
years ended December 31, 2009, 2008, and 2007:
F-27
|
Number
of Shares
|
Weighted-
Average
Exercise
Price
|
|||||||
|
Options
outstanding as of January 1, 2007
|
75,000 | $ | 7.98 | |||||
|
Options
granted
|
25,000 | 9.02 | ||||||
|
Options
forfeited
|
(5,000 | ) | 8.46 | |||||
|
Options
exercised
|
(5,000 | ) | 7.43 | |||||
|
Options
outstanding as of December 31, 2007 (all vested and
exercisable)
|
90,000 | $ | 8.27 | |||||
|
Options
granted
|
25,000 | 9.81 | ||||||
|
Options
forfeited
|
(5,000 | ) | 9.81 | |||||
|
Options
exercised
|
– | – | ||||||
|
Options
outstanding as of December 31, 2008 (all vested and
exercisable)
|
110,000 | $ | 8.61 | |||||
|
Options
granted
|
– | – | ||||||
|
Options
forfeited
|
(15,000 | ) | 8.30 | |||||
|
Options
exercised
|
– | – | ||||||
|
Options
outstanding as of December 31, 2009 (all vested and
exercisable)
|
95,000 | $ | 8.59 | |||||
There
were no restricted stock grants during the year ended December 31,
2007. The following table presents a rollforward of the activity for
the restricted stock issued by the Company for the years ended December 31,
2009, and 2008:
|
Number
of Shares of Restricted Stock
|
||||
|
Restricted
stock as of January 1, 2008
|
– | |||
|
Restricted
stock granted
|
33,500 | |||
|
Restricted
stock forfeited
|
– | |||
|
Restricted
stock vested
|
(3,500 | ) | ||
|
Restricted
stock outstanding as of December 31, 2008
|
30,000 | |||
|
Restricted
stock granted
|
10,000 | |||
|
Restricted
stock forfeited
|
– | |||
|
Restricted
stock vested
|
(7,500 | ) | ||
|
Restricted
stock outstanding as of December 31, 2009
|
32,500 | |||
The
Company recognized stock based compensation expense (benefit) of $526, $(271),
and $306 for the years ended December 31, 2009, 2008, and 2007,
respectively. The total remaining compensation cost related to
non-vested awards was $49 as of December 31, 2009 and will be recognized as the
awards vest.
Employee
Savings Plan
The
Company provides an Employee Savings Plan under Section 401(k) of the
Code. The Employee Savings Plan allows eligible employees to defer up
to 25% of their income on a pretax basis. The Company matches the
employees’ contribution, up to 6% of the employees’ eligible
compensation. The Company may also make discretionary contributions
based on the profitability of the Company. The total expense related
to the Company’s matching and discretionary contributions in 2009, 2008, and
2007 was $77, $64, and $65, respectively. The Company does not
provide post-employment or post-retirement benefits to its
employees.
F-28
As of
December 31, 2009, the Company is obligated under non-cancelable operating
leases with expiration dates through December 2013. Required rental
payments are as follows:
|
2010
|
$ | 149 | ||
|
2011
|
154 | |||
|
2012
|
159 | |||
|
2013
|
163 | |||
| $ | 625 |
Rent
and lease expense under leases which expired in previous years was $147, $181,
and $143, respectively in 2009, 2008, and 2007.
Litigation
Matters
The
Company and its subsidiaries may be involved in certain litigation matters
arising in the ordinary course of business. Although the ultimate
outcome of these matters cannot be ascertained at this time, and the results of
legal proceedings cannot be predicted with certainty, the Company believes,
based on current knowledge, that the resolution of these matters arising in the
ordinary course of business will not have a material adverse effect on the
Company’s financial position or results of operations. Information on
litigation arising out of the ordinary course of business is described
below.
One of
the Company’s subsidiaries, GLS Capital, Inc. (“GLS”), and the County of
Allegheny, Pennsylvania are defendants in a class action lawsuit (“Pentlong”)
filed in 1997 in the Court of Common Pleas of Allegheny County, Pennsylvania
(the "Court of Common Pleas"). Between 1995 and 1997, GLS purchased
delinquent county property tax receivables for properties located in Allegheny
County. The Pentlong Plaintiffs allege that GLS did not enjoy the
same rights as its assignor, Allegheny County, to recover from delinquent
taxpayers certain attorney fees, costs and expenses and interest in the
collection of the tax receivables. Class action status has been
certified in this matter, but a motion to reconsider is pending. The
Pentlong litigation had been stayed pending the outcome of similar litigation
before the Pennsylvania Supreme Court in a case in which GLS was not a
defendant. The plaintiff in that case had disputed the application of
curative legislation enacted in 2003 but retroactive to 1996 which specifically
set forth the right of owners of delinquent property tax receivables such as GLS
to collect reasonable attorney fees, costs, and interest which were properly
taxable as part of the tax debt owed. The Pennsylvania Supreme Court
has issued an opinion in favor of the defendants in that matter, which we
believe favorably impacts the Pentlong litigation by substantially reducing
Pentlong Plaintiffs’ universe of actionable claims against GLS in connection
with the collection of the tax receivables. Based on the opinion
issued by the Pennsylvania Supreme Court such opinion, the Court of Common Pleas
requested GLS file a motion for summary judgment and heard arguments on such
motion in November 2009. As of March 1, 2010, the court has not yet
rendered a decision with respect to such motion. Pentlong Plaintiffs
have not enumerated their damages in this matter.
Dynex
Capital, Inc. and Dynex Commercial, Inc. (“DCI”), a former affiliate of the
Company and now known as DCI Commercial, Inc., are appellees (or respondents) in
the Supreme Court of Texas related to the matter of Basic Capital Management,
Inc. et al. (collectively, “BCM” or the “Plaintiffs”) versus DCI et
al. The appeal seeks to overturn the trial court’s judgment, and
subsequent affirmation by the Fifth Court of Appeals at Dallas, in our and DCI’s
favor which denied recovery to Plaintiffs. Specifically, Plaintiffs
are seeking reversal of the trial court’s judgment and sought rendition of
judgment against us for alleged breach of loan agreements for tenant
improvements in the amount of $253,000. They also seek reversal of
the trial court’s judgment and rendition of judgment against DCI in favor of BCM
under two mutually exclusive damage models, for $2,200 and $25,600,
respectively, related to the alleged breach by DCI of a $160,000 “master” loan
commitment. Plaintiffs also seek reversal and rendition of a judgment
in their favor for attorneys’ fees in the amount of
$2,100. Alternatively, Plaintiffs seek a new trial. Even
if Plaintiffs were to be successful on appeal, DCI is a former affiliate of
ours, and we believe that we would have no obligation for amounts, if any,
awarded to the Plaintiffs as a result of the actions of DCI.
F-29
Dynex
Capital, Inc., MERIT Securities Corporation, a subsidiary (“MERIT”), and the
former president and current Chief Operating Officer and Chief Financial Officer
of Dynex Capital, Inc., (together, “Defendants”) are defendants in a putative
class action alleging violations of the federal securities laws in the United
States District Court for the Southern District of New York (“District Court”)
by the Teamsters Local 445 Freight Division Pension Fund
(“Teamsters”). The complaint was filed on February 7, 2005, and
purports to be a class action on behalf of purchasers between February 2000 and
May 2004 of MERIT Series 12 and MERIT Series 13 securitization financing bonds
(“Bonds”), which are collateralized by manufactured housing loans. After a
series of rulings by the District Court and an appeal by us and MERIT, on
February 22, 2008 the United States Court of Appeals for the Second Circuit
dismissed the litigation against us and MERIT. Teamsters filed an
amended complaint on August 6, 2008 with the District Court which essentially
restated the same allegations as the original complaint and added our former
president and our current Chief Operating Officer as
defendants. Teamsters seeks unspecified damages and alleges, among
other things, fraud and misrepresentations in connection with the issuance of
and subsequent reporting related to the Bonds. On October 19, 2009, the
District Court substantially denied the Defendants’ motion to dismiss the
Teamsters’ second amended complaint. On December 11, 2009, the Defendants’
filed an answer to the second amended complaint. The Company has evaluated
the allegations made in the complaint and believes them to be without merit and
intends to vigorously defend itself against them.
Although
no assurance can be given with respect to the ultimate outcome of the above
litigation, the Company believes the resolution of these lawsuits will not have
a material effect on its consolidated balance sheet but could materially affect
its consolidated results of operations in a given period.
|
Year
ended December 31,
|
||||||||||||
|
2009
|
2008
|
2007
|
||||||||||
|
Supplemental
disclosure of cash activities:
|
||||||||||||
|
Cash paid for
interest
|
$ | 36,710 | $ | 19,817 | $ | 20,082 | ||||||
|
Supplemental
disclosure of non-cash investing and financing activities:
|
||||||||||||
|
Common dividends declared but not
paid
|
$ | 3,204 | $ | 2,799 | $ | – | ||||||
|
Preferred dividends declared but
not paid
|
$ | 1,003 | $ | 1,003 | $ | 1,003 | ||||||
The
following table discloses the ending balances for each item in accumulated other
comprehensive income (loss) as of December 31, 2009 and December 31,
2008:
|
Available
for sale securities
|
Cash
flow hedging
|
Total
AOCI
|
||||||||||
|
Balance
as of December 31, 2008
|
$ | (3,949 | ) | $ | – | $ | (3,949 | ) | ||||
|
Current
period change
|
13,002 | 1,008 | 14,010 | |||||||||
|
Ending
balance as of December 31, 2009
|
$ | 9,053 | $ | 1,008 | $ | 10,061 | ||||||
Due to the Company’s REIT status, the
items comprising other comprehensive income do not have related tax
effects.
As
discussed in Note 16, the Company and DCI have been jointly named in litigation
regarding the activities of DCI while it was an operating subsidiary of an
affiliate of the Company. The Company and DCI entered into a
Litigation Cost Sharing Agreement whereby the parties set forth how the costs of
defending against
F-30
litigation
would be shared, and whereby the Company agreed to fund all costs of such
litigation, including DCI’s portion. DCI’s cumulative portion of
costs associated with litigation and funded by the Company is $3,375 and is
secured by the proceeds of any counterclaims that DCI may receive in the
litigation. DCI costs funded by the Company are loans and bear simple
interest at the rate of Prime plus 8.0% per annum. As of December 31,
2009, the total amount due the Company under the Litigation Cost Sharing
Agreement, including interest, was $6,551, which has been fully reserved by the
Company. DCI is currently wholly owned by ICD Holding,
Inc. An executive of the Company is the sole shareholder of ICD
Holding.
The
Company holds a 1% limited partnership interest in a partnership that owns a
low-income housing tax credit multifamily housing property located in
Texas. The Company has loaned the partnership $986, $55 of which was
advanced to the partnership during 2009. These advances and the
accrued interest thereon are due on demand. The Company, through a
subsidiary, has made a first mortgage loan to the partnership secured by the
property, with a current unpaid principal balance of $1,363. Because
the Company does not have control or exercise significant influence over the
operations of this partnership, its investment in the partnership is accounted
for using the cost method as per ASC Topic 325.
The
following tables present the Company’s unaudited selected quarterly results for
2009 and 2008:
|
Year
Ended December 31, 2009
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
||||||||||||
|
Operating
results:
|
||||||||||||||||
|
Net
interest income
|
$ | 5,044 | $ | 5,881 | $ | 6,597 | $ | 7,043 | ||||||||
|
Net
interest income after (provision for) recapture of loan
losses
|
4,865 | 5,742 | 6,349 | 6,827 | ||||||||||||
|
Net
income
|
3,134 | 4,370 | 6,002 | 4,075 | ||||||||||||
|
Basic
net income per common share
|
0.18 | 0.26 | 0.37 | 0.23 | ||||||||||||
|
Diluted
net income per common share
|
0.18 | 0.25 | 0.34 | 0.23 | ||||||||||||
|
Cash
dividends declared per common share
|
0.23 | 0.23 | 0.23 | 0.23 | ||||||||||||
|
Year
Ended December 31, 2008
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
||||||||||||
|
Operating
results:
|
||||||||||||||||
|
Net
interest income
|
$ | 2,421 | $ | 2,501 | $ | 2,787 | $ | 2,838 | ||||||||
|
Net
interest income after (provision for) recapture of
loan losses
|
2,395 | 2,180 | 2,338 | 2,643 | ||||||||||||
|
Net
income
(1)
|
5,319 | 4,296 | 3,045 | 2,461 | ||||||||||||
|
Basic
net income per common share
|
0.36 | 0.27 | 0.17 | 0.12 | ||||||||||||
|
Diluted
net income per common share
|
0.32 | 0.26 | 0.17 | 0.12 | ||||||||||||
|
Cash
dividends declared per common share
|
0.10 | 0.15 | 0.23 | 0.23 | ||||||||||||
Management
has evaluated events and circumstances occurring as of and through the date this
Annual Report on Form 10-K was filed with the SEC and made available to the
public, and has determined that there have been no significant events or
circumstances that provide additional evidence about conditions of the Company
that existed as of December 31, 2009, or that qualify as “recognized subsequent
events” as defined by ASC Topic 855.
Management
has determined that the following events, which occurred subsequent to December
31, 2009 and before the filing of this Annual Report on Form 10-K, qualify as
“nonrecognized subsequent events” as defined by ASC Topic 855:
F-31
The
Company has issued 260,100 additional shares under its CEOP since December 31,
2009, resulting in proceeds of $2,292 net of commissions.
Since
December 31, 2009, the Company has borrowed $12,750 under the Federal Reserve’s
Term Asset-Backed Securities Loan Facility program. This borrowing
was collateralized by a non-Agency CMBS with a par value of
$15,000.
F-32
TABLE OF CONTENTS
Part IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. ReservedPart IIItem 5. Market For Registrant S Common Equity, Related Stockholder Matters and Issuer Purchases Of Equity SecuritiesItem 6. Selected Financial DataItem 7. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPart IIIItem 10. Directors, Executive Officers and Corporate GovernanceItem 11. Executive CompensationItem 12. Security Ownership Of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13. Certain Relationships and Related Transactions, and Director IndependenceItem 14. Principal Accountant Fees and ServicesPart IVItem 15. Exhibits, Financial Statement SchedulesNote 1 OrganizationNote 2 Summary Of Significant Accounting PoliciesNote 3 Agency Mortgage Backed SecuritiesNote 4 Securitized Mortgage Loans, NetNote 5 Allowance For Loan LossesNote 6 Non-agency SecuritiesNote 7 Copperhead Ventures, LlcNote 8 Other InvestmentsNote 9 Repurchase AgreementsNote 10 Securitization FinancingNote 11 Derivative InstrumentsNote 12 Fair Value Of Financial InstrumentsNote 13 Net Income Per Common ShareNote 14 Preferred and Common StockNote 15 Employee BenefitsNote 16 Commitments and ContingenciesNote 17 Supplemental Consolidated Statements Of Cash Flows InformationNote 18 Accumulated Other Comprehensive Income (loss)Note 19 Related Party TransactionsNote 20 Non-consolidated AffiliatesNote 21 Summary Of Quarterly Results (unaudited)Note 22 Subsequent Events