ANNALY CAPITAL MANAGEMENT INC
10-Ks and 10-Qs
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SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
(MARK
ONE)
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR
THE FISCAL YEAR ENDED: DECEMBER 31, 2009
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR
THE TRANSITION PERIOD
FROM TO
COMMISSION
FILE NUMBER: 1-13447
ANNALY
CAPITAL MANAGEMENT, INC.
(Exact
Name of Registrant as Specified in its Charter)
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MARYLAND
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22-3479661
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(State or other jurisdiction of
incorporation
of
organization)
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(I.R.S.
Employer Identification
Number)
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1211
Avenue of the Americas, Suite 2902
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New
York, New York
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10036
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(Address
of Principal Executive Offices)
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(Zip
Code)
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(212)
696-0100
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
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Title
of Each Class
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Name
of Each Exchange on Which Registered
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Common
Stock, par value $.01 per share
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New
York Stock Exchange
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7.875% Series A Cumulative
Redeemable Preferred Stock
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New
York Stock
Exchange
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Securities
registered pursuant to Section 12(g) of the Act:
None.
Indicate
by check mark whether the Registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act. Yes
x
No
o
Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act. Yes
o
No
x
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 (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
Yes
x
No
o
Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days:
Yes
x
No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of 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, or a non-accelerated filer or a smaller reporting
company. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act. (Check one):
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Large
accelerated filer
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x |
Non-accelerated
filer
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o |
Accelerated
filer
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o |
Smaller
reporting company
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o |
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes
o
No
x
.
At
June 30, 2009, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $8,193,939,370.
The
number of shares of the Registrant’s Common Stock outstanding on February 24,
2010 was 553,156,865.
Documents
Incorporated by Reference
The
registrant intends to file a definitive proxy statement pursuant to Regulation
14A within 120 days of the end of the fiscal year ended December 31,
2009. Portions of such proxy statement are incorporated by reference
into Part III of this Form 10-K.
ANNALY
CAPITAL MANAGEMENT, INC.
2009
FORM 10-K ANNUAL REPORT
TABLE
OF CONTENTS
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PART
I
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PAGE
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PART
II
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41 | ||||
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65 | ||||
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PART
III
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66 | ||||
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66 | ||||
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PART
IV
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| F-1 | |||||
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II-1
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SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain
statements contained in this annual report, and certain statements contained in
our future filings with the Securities and Exchange Commission (the “SEC” or the
“Commission”), in our press releases or in our other public or shareholder
communications may not be based on historical facts and are “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements, which are based on various
assumptions (some of which are beyond our control), may be identified by
reference to a future period or periods or by the use of forward-looking
terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,”
“continue,” or similar terms or variations on those terms or the negative of
those terms. Actual results could differ materially from those set
forth in forward-looking statements due to a variety of factors, including, but
not limited to:
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·
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changes
in interest rates,
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·
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changes
in the yield curve,
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·
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changes
in prepayment rates,
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·
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the
availability of mortgage-backed securities and other securities for
purchase,
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·
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the
availability of financing and, if available, the terms of any
financing,
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·
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changes
in the market value of our assets,
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·
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changes
in business conditions and the general
economy,
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·
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our
ability to consummate any contemplated investment
opportunities,
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·
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risks
associated with the investment advisory business of our wholly owned
subsidiaries, including:
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o
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the
removal by clients of assets
managed,
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o
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their
regulatory requirements, and
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o
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competition
in the investment advisory
business,
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·
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risks
associated with the broker-dealer business of our
subsidiary,
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·
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changes
in government regulations affecting our business,
and
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·
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our
ability to maintain our qualification as a REIT for federal income tax
purposes
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No
forward-looking statements can be guaranteed and actual future results may vary
materially and we caution you not to place undue reliance on these
forward-looking statements. For a discussion of the risks and
uncertainties which could cause actual results to differ from those contained in
the forward-looking statements, please see the information under the caption
“Risk Factors” described in this Form 10-K. We do not undertake, and
specifically disclaim any obligation, to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
PART
I
ITEM
1.
BUSINESS
THE
COMPANY
Background
We own,
manage, and finance a portfolio of real estate related investment securities,
including mortgage pass-through certificates, collateralized mortgage
obligations (or CMOs), agency callable debentures, and other securities
representing interests in or obligations backed by pools of mortgage
loans. Our principal business objective is to generate net income for
distribution to our stockholders from the spread between the interest income on
our investment securities and the cost of borrowings to finance our acquisition
of investment securities and from dividends we receive from our
subsidiaries. Our wholly-owned subsidiaries offer diversified real
estate, asset management and other financial services. We are a
Maryland corporation that commenced operations on February 18,
1997. We are self-advised and self-managed.
We acquired Fixed
Income Discount Advisory Company (or FIDAC) on June 4, 2004 and Merganser
Capital Management, Inc. (or Merganser) on October 31, 2008. FIDAC
and Merganser manage a number of investment vehicles and separate accounts for
which they earn fee income. Our subsidiary, RCap Securities Inc. (or
RCap), operates as a broker-dealer, and was granted membership in the Financial
Industry Regulatory Authority (or FINRA) in January 2009.
We have
elected and believe that we are organized and have operated in a manner that
qualifies us to be taxed as a real estate investment trust (or REIT) under the
Internal Revenue Code of 1986, as amended (or the Code). If we
qualify for taxation as a REIT, we generally will not be subject to federal
income tax on our taxable income that is distributed to our
stockholders. Therefore, substantially all of our assets, other than
FIDAC, Merganser and RCap, which are our taxable REIT subsidiaries, consist of
qualified REIT real estate assets (of the type described in Section 856(c)(5)(B)
of the Code). We have financed our purchases of investment securities
with the net proceeds of equity offerings and borrowings under repurchase
agreements whose interest rates adjust based on changes in short-term market
interest rates.
As used
herein, “Annaly,” the “Company,” “we,” “our” and similar terms refer to Annaly
Capital Management, Inc., unless the context indicates otherwise.
Assets
Under our
capital investment policy, at least 75% of our total assets must be comprised of
high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are
rated within one of the two highest rating categories by at least one of the
nationally recognized rating agencies, (2) are unrated but are guaranteed by the
United States government or an agency of the United States government, or (3)
are unrated but we determine them to be of comparable quality to rated
high-quality mortgage-backed securities.
The
remainder of our assets, comprising not more than 25% of our total assets, may
consist of other qualified REIT real estate assets which are unrated or rated
less than high quality, but which are at least “investment grade” (rated “BBB”
or better by Standard & Poor’s Corporation (or S&P) or the equivalent by
another nationally recognized rating agency) or, if not rated, we determine them
to be of comparable credit quality to an investment which is rated “BBB” or
better. In addition, we may directly or indirectly invest part of
this remaining 25% of our assets in other types of securities, including but
without limitation, unrated debt, equity or derivative securities, to the extent
consistent with our REIT qualification requirements. The derivative
securities in which we invest may include securities representing the right to
receive interest only or a disproportionately large amount of interest, as well
as inverse floaters, which may have imbedded leverage as part of their
structural characteristics.
We may
acquire mortgage-backed securities backed by single-family residential mortgage
loans as well as securities backed by loans on multi-family, commercial or other
real estate related properties. To date, substantially all of the
mortgage-backed securities that we have acquired have been backed by
single-family residential mortgage loans.
To date,
substantially all of the mortgage-backed securities that we have acquired have
been agency mortgage-backed securities which, although not rated, carry an
implied “AAA” rating. Agency mortgage-backed securities are
mortgage-backed securities for which a government agency or federally chartered
corporation, such as the Federal Home Loan Mortgage Corporation (FHLMC or
Freddie Mac), the Federal National Mortgage Association (FNMA or Fannie Mae), or
the Government National Mortgage Association (GNMA or Ginnie Mae), guarantees
payments of principal or interest on the securities. Agency
mortgage-backed securities consist of agency pass-through certificates and CMOs
issued or guaranteed by an agency. Pass-through certificates provide
for a pass-through of the monthly interest and principal payments made by the
borrowers on the underlying mortgage loans. CMOs divide a pool of
mortgage loans into multiple tranches with different principal and interest
payment characteristics.
1
At
December 31, 2009, approximately 21% of our investment securities were
adjustable-rate pass-through certificates, approximately 74% of our investment
securities were fixed-rate pass-through certificates or CMOs, and approximately
5% of our investment securities were CMO floaters. Our
adjustable-rate pass-through certificates are backed by adjustable-rate mortgage
loans and have coupon rates which adjust over time, subject to interest rate
caps and lag periods, in conjunction with changes in short-term interest
rates. Our fixed-rate pass-through certificates are backed by
fixed-rate mortgage loans and have coupon rates which do not adjust over
time. CMO floaters are tranches of mortgage-backed securities where
the interest rate adjusts in conjunction with changes in short-term interest
rates. CMO floaters may be backed by fixed-rate mortgage loans or,
less often, by adjustable-rate mortgage loans. In this Form 10-K,
except where the context indicates otherwise, we use the term “adjustable-rate
securities” or “adjustable-rate investment securities” to refer to
adjustable-rate pass-through certificates, CMO floaters, and Agency
debentures. At December 31, 2009, the weighted average yield on our
portfolio of earning assets was 4.51% and the weighted average term to next
rate adjustment on adjustable rate securities was 33 months.
We may
also invest in Federal Home Loan Bank (FHLB), FHLMC, and FNMA debentures. We
refer to the mortgage-backed securities and agency debentures collectively as
“Investment Securities.” We intend to continue to invest in
adjustable rate pass-through certificates, fixed-rate mortgage-backed
securities, CMO floaters, and Agency debentures. We may also invest
on a limited basis in derivative securities which include securities
representing the right to receive interest only or a disproportionately large
amount of interest as well as inverse floaters, which may have imbedded leverage
as part of their structural characteristics. We have not and will not
invest in real estate mortgage investment conduit (REMIC) residuals and other
CMO residuals.
Borrowings
We
attempt to structure our collateralized borrowings to have interest rate
adjustment indices and interest rate adjustment periods that, on an aggregate
basis, correspond generally to the interest rate adjustment indices and periods
of our adjustable-rate investment securities. However, periodic rate
adjustments on our collateralized borrowings are generally more frequent than
rate adjustments on our investment securities. At December 31, 2009,
the weighted average cost of funds for all of our collateralized borrowings was
2.11%, with the effect of swaps, the weighted average original term to maturity
was
217 days, and
the weighted average term to next rate adjustment of these collateralized
borrowings was 170 days.
We
generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1,
although the ratio may vary from time to time depending upon market conditions
and other factors that our management deems relevant. For purposes of
calculating this ratio, our equity is equal to the value of our investment
portfolio on a mark-to-market basis, less the book value of our obligations
under repurchase agreements and other collateralized borrowings. At
December 31, 2009, our ratio of debt-to-equity was 5.7:1.
On
February 9, 2010, we issued $500.0 million in aggregate principal amount
of our 4% convertible senior notes due 2015 (Convertible Senior Notes) for
net proceeds following underwriting expenses of approximately $484.8
million. Interest on the notes will be paid semi-annually at a rate
of 4% per year and the notes will mature on February 15, 2015 unless earlier
repurchased or converted. The notes will be convertible into shares
of common stock at an initial conversion rate of 46.6070 shares of common stock
per $1,000 principal amount of notes, which is equivalent to an initial
conversion price of approximately $21.456 per share of common stock, subject to
adjustment in certain circumstances.
2
Hedging
To the
extent consistent with our election to qualify as a REIT, we enter into hedging
transactions to attempt to protect our investment securities and related
borrowings against the effects of major interest rate changes. This
hedging would be used to mitigate declines in the market value of our investment
securities during periods of increasing or decreasing interest rates and to
limit or cap the interest rates on our borrowings. These transactions
would be entered into solely for the purpose of hedging interest rate or
prepayment risk and not for speculative purposes. In connection with
our interest rate risk management strategy, we hedge a portion of our interest
rate risk by entering into derivative financial instrument
contracts. As of December 31, 2009, we had $21.5 billion in interest
rate swaps, which in effect modify the cash flows on repurchase
agreements.
Our
Subsidiaries
FIDAC, an
investment advisor registered with the Securities and Exchange Commission, is a
fixed-income investment management company specializing in managing fixed income
investments in residential mortgage-backed securities, commercial
mortgage-backed securities and collateralized debt obligations for various
investment vehicles and separate accounts. FIDAC also has experience
in managing and structuring debt financing associated with various asset classes
and serves as a liquidation agent of collateralized debt
obligations. FIDAC commenced active investment management operations
in 1994. At September 30, 2009, FIDAC was the adviser or sub-adviser
for investment vehicles and separate accounts. The team managing Annaly
plays the same roles at FIDAC.
Merganser, an
investment advisor registered with the Securities and Exchange Commission,
has expertise in a variety of fixed income strategies and focuses on managing
each portfolio based on each client’s specific investment
principles. Merganser serves a diverse group of clients in a variety
of disciplines nationwide including pension, public, operating, Taft-Hartley and
endowment funds as well as defined contribution plans. Merganser’s investment
team maintains a careful balance of risk management and performance by employing
fundamental security analysis and by trading in an environment supported by
state-of-the-art technology, infrastructure and operations.
RCap
operates as a broker-dealer and was granted membership in the Financial
Industry Regulatory Authority (or FINRA) in January 2009.
Compliance
with REIT and Investment Company Requirements
We
constantly monitor our investment securities and the income from these
securities and, to the extent we enter into hedging transactions, we monitor
income from our hedging transactions as well, so as to ensure at all times that
we maintain our qualification as a REIT and our exemption from registration
under the Investment Company Act of 1940, as amended.
Executive
Officers of the Company
The
following table sets forth certain information as of February 25, 2010
concerning our executive officers:
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Name
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Age
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Position held with the
Company
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Michael
A.J. Farrell
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58 |
Chairman
of the Board, Chief Executive Officer and President
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Wellington
J. Denahan-Norris
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46 |
Vice
Chairman of the Board, Chief Investment Officer and Chief Operating
Officer
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Kathryn
F. Fagan
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43 |
Chief
Financial Officer and Treasurer
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R.
Nicholas Singh
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50 |
Executive
Vice President, General Counsel, Secretary and Chief Compliance
Officer
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James
P. Fortescue
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36 |
Managing Director
and Head of
Liabilities
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Kristopher
Konrad
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35 |
Managing Director and Co-Head Portfolio
Management
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Rose-Marie
Lyght
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36 |
Managing Director
and Co-Head
Portfolio Management
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Jeremy
Diamond
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46 |
Managing Director
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Ronald
Kazel
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42 |
Managing
Director
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3
Mr.
Farrell and Ms. Denahan-Norris have an average of 25 years experience in the
investment banking and investment management industries where, in various
capacities, they have each managed portfolios of mortgage-backed securities,
arranged collateralized borrowings and utilized hedging techniques to mitigate
interest rate and other risk within fixed-income portfolios. Ms.
Fagan is a certified public accountant and, prior to becoming our Chief
Financial Officer and Treasurer, served as Chief Financial Officer and
Controller of a publicly owned savings and loan
association. Mr. Singh joined Annaly in February
2005. Prior to that, he was a partner in the law firm of McKee Nelson
LLP. Mr. Fortescue joined Annaly in 1997. Mr. Konrad
joined Annaly in 1997. Ms. Lyght joined Annaly in April
1999. Mr. Diamond joined Annaly in March 2002. Mr. Kazel
joined Annaly in December 2001. We and our subsidiaries had 87
full-time employees at December 31, 2009.
Distributions
To maintain our
qualification as a REIT, we must distribute substantially all of our taxable
income to our stockholders each year. We have done this in the past
and intend to continue to do so in the future. We also have declared
and paid regular quarterly dividends in the past and intend to do so in the
future. We have adopted a dividend reinvestment plan to enable
holders of common stock to reinvest dividends automatically in additional shares
of common stock.
4
BUSINESS
STRATEGY
General
Our
principal business objective is to generate income for distribution to our
stockholders, primarily from the net cash flows on our investment
securities. Our net cash flows result primarily from the difference
between the interest income on our investment securities and borrowing costs of
our repurchase agreements and from dividends we receive from our
subsidiaries. To achieve our business objective and generate dividend
yields, our strategy is:
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§
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to
acquire mortgage-backed securities that we
believe:
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-
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we
have the necessary expertise to evaluate and
manage;
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- we
can readily finance;
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-
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are
consistent with our balance sheet guidelines and risk management
objectives; and
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- provide
attractive investment returns in a range of scenarios;
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§
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to
finance purchases of mortgage-backed securities with the proceeds of
equity offerings and, to the extent permitted by our capital investment
policy, to utilize leverage to increase potential returns to stockholders
through borrowings;
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§
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to
attempt to structure our borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
generally correspond to the interest rate adjustment indices and interest
rate adjustment periods of our adjustable-rate mortgage-backed
securities;
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§
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to
seek to minimize prepayment risk by structuring a diversified portfolio
with a variety of prepayment characteristics and through other means;
and
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§
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to
issue new equity or debt and increase the size of our balance sheet when
opportunities in the market for mortgage-backed securities are likely to
allow growth in earnings per share.
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We believe we are able to obtain cost
efficiencies through our facilities-sharing arrangement with FIDAC and RCap and
by virtue of our management’s experience in managing portfolios of
mortgage-backed securities and arranging collateralized
borrowings. We will strive to become even more cost-efficient over
time by:
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§
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seeking
to raise additional capital from time to time in order to increase our
ability to invest in mortgage-backed
securities;
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§
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striving
to lower our effective borrowing costs by seeking direct funding with
collateralized lenders, rather than using financial intermediaries, and
investigating the possibility of using commercial paper and medium term
note programs;
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§
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improving
the efficiency of our balance sheet structure by investigating the
issuance of uncollateralized subordinated debt, preferred stock and other
forms of capital; and
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§
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utilizing
information technology in our business, including improving our ability to
monitor the performance of our investment securities and to lower our
operating costs.
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5
Mortgage-Backed
Securities
General
To date, substantially all of the
mortgage-backed securities that we have acquired have been agency
mortgage-backed securities which, although not rated, carry an implied “AAA”
rating. Agency mortgage-backed securities are mortgage-backed
securities where a government agency or federally chartered corporation, such as
FHLMC, FNMA or GNMA, guarantees payments of principal or interest on the
securities. Agency mortgage-backed securities consist of agency
pass-through certificates and CMOs issued or guaranteed by an
agency.
Even though to date we have only
acquired mortgage backed securities with an implied “AAA” rating, under our
capital investment policy, we have the ability to acquire securities of lower
quality. Under our policy, at least 75% of our total assets must be
high quality mortgage-backed securities and short-term
investments. High quality securities are securities (1) that are
rated within one of the two highest rating categories by at least one of the
nationally recognized rating agencies, (2) that are unrated but are
guaranteed by the United States government or an agency of the United States
government, or (3) that are unrated or whose ratings have not been updated but
that our management determines are of comparable quality to rated high quality
mortgage-backed securities.
Under our capital investment policy,
the remainder of our assets, comprising not more than 25% of total assets, may
consist of mortgage-backed securities and other qualified REIT real estate
assets which are unrated or rated less than high quality, but which are at least
“investment grade” (rated “BBB” or better by S&P or the equivalent by
another nationally recognized rating organization) or, if not rated, we
determine them to be of comparable credit quality to an investment which is
rated “BBB” or better. In addition, we may directly or indirectly
invest part of this remaining 25% of our assets in other types of securities,
including without limitation, unrated debt, equity or derivative securities, to
the extent consistent with our REIT qualification requirements. The
derivative securities in which we invest may include securities representing the
right to receive interest only or a disproportionately large amount of interest,
as well as inverse floaters, which may have imbedded leverage as part of their
structural characteristics. We intend to structure our portfolio to maintain a
minimum weighted average rating (including our deemed comparable ratings for
unrated mortgage-backed securities) of our mortgage-backed securities of at
least single “A” under the S&P rating system and at the comparable level
under the other rating systems.
Our allocation of investments among the
permitted investment types may vary from time-to-time based on the evaluation by
our board of directors of economic and market trends and our perception of the
relative values available from these types of investments, except that in no
event will our investments that are not high quality exceed 25% of our total
assets.
We intend to acquire only those
mortgage-backed securities that we believe we have the necessary expertise to
evaluate and manage, that are consistent with our balance sheet guidelines and
risk management objectives and that we believe we can readily
finance. Since we generally hold the mortgage-backed securities we
acquire until maturity, we generally do not seek to acquire assets whose
investment returns are attractive in only a limited range of
scenarios. We believe that future interest rates and mortgage
prepayment rates are very difficult to predict. Therefore, we seek to acquire
mortgage-backed securities which we believe will provide acceptable returns over
a broad range of interest rate and prepayment scenarios.
At December 31, 2009, our
mortgage-backed securities consisted of pass-through certificates and
collateralized mortgage obligations issued or guaranteed by FHLMC, FNMA or
GNMA. We have not, and will not, invest in REMIC residuals and other
CMO residuals.
6
Description of Mortgage-Backed
Securities
The mortgage-backed securities that we
acquire provide funds for mortgage loans made primarily to residential
homeowners. Our securities generally represent interests in pools of
mortgage loans made by savings and loan institutions, mortgage bankers,
commercial banks and other mortgage lenders. These pools of mortgage
loans are assembled for sale to investors (like us) by various government,
government-related and private organizations.
Mortgage-backed securities differ from
other forms of traditional debt securities, which normally provide for periodic
payments of interest in fixed amounts with principal payments at maturity or on
specified call dates. Instead, mortgage-backed securities provide for
a monthly payment, which consists of both interest and principal. In
effect, these payments are a “pass-through” of the monthly interest and
principal payments made by the individual borrower on the mortgage loans, net of
any fees paid to the issuer or guarantor of the
securities. Additional payments result from prepayments of principal
upon the sale, refinancing or foreclosure of the underlying residential
property, net of fees or costs which may be incurred. Some
mortgage-backed securities, such as securities issued by GNMA, are described as
“modified pass-through”. These securities entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
certain fees, regardless of whether the mortgagors actually make mortgage
payments when due.
The investment characteristics of
pass-through mortgage-backed securities differ from those of traditional
fixed-income securities. The major differences include the payment of
interest and principal on the mortgage-backed securities on a more frequent
schedule, as described above, and the possibility that principal may be prepaid
at any time due to prepayments on the underlying mortgage loans or other
assets. These differences can result in significantly greater price
and yield volatility than is the case with traditional fixed-income
securities.
Various factors affect the rate at
which mortgage prepayments occur, including changes in interest rates, general
economic conditions, the age of the mortgage loan, the location of the property
and other social and demographic conditions. Generally prepayments on
mortgage-backed securities increase during periods of falling mortgage interest
rates and decrease during periods of rising mortgage interest
rates. We may reinvest prepayments at a yield that is higher or lower
than the yield on the prepaid investment, thus affecting the weighted average
yield of our investments.
To the extent mortgage-backed
securities are purchased at a premium, faster than expected prepayments result
in a faster than expected amortization of the premium
paid. Conversely, if these securities were purchased at a discount,
faster than expected prepayments accelerate our recognition of
income.
CMOs may allow for shifting of
prepayment risk from slower-paying tranches to faster-paying
tranches. This is in contrast to mortgage pass-through certificates
where all investors share equally in all payments, including all prepayments, on
the underlying mortgages.
FHLMC
Certificates
FHLMC is a privately-owned
government-sponsored enterprise created pursuant to an Act of Congress on July
24, 1970. The principal activity of FHLMC currently consists of the
purchase of mortgage loans or participation interests in mortgage loans and the
resale of the loans and participations in the form of guaranteed mortgage-backed
securities. FHLMC guarantees to each holder of FHLMC certificates the
timely payment of interest at the applicable pass-through rate and ultimate
collection of all principal on the holder’s pro rata share of the unpaid
principal balance of the related mortgage loans, but does not guarantee the
timely payment of scheduled principal of the underlying mortgage
loans. The obligations of FHLMC under its guarantees are solely those
of FHLMC and are not backed by the full faith and credit of the United
States. If FHLMC were unable to satisfy these obligations,
distributions to holders of FHLMC certificates would consist solely of payments
and other recoveries on the underlying mortgage loans and, accordingly, defaults
and delinquencies on the underlying mortgage loans would adversely affect
monthly distributions to holders of FHLMC certificates.
FHLMC certificates may be backed by
pools of single-family mortgage loans or multi-family mortgage
loans. These underlying mortgage loans may have original terms to
maturity of up to 40 years. FHLMC certificates may be issued under
cash programs (composed of mortgage loans purchased from a number of sellers) or
guarantor programs (composed of mortgage loans acquired from one seller in
exchange for certificates representing interests in the mortgage loans
purchased).
7
FHLMC
certificates may pay interest at a fixed rate or an adjustable
rate. The interest rate paid on adjustable-rate FHLMC certificates
(FHLMC ARMs) adjusts periodically within 60 days prior to the month in which the
interest rates on the underlying mortgage loans adjust. The interest
rates paid on certificates issued under FHLMC’s standard ARM programs adjust in
relation to the Treasury index. Other specified indices used in FHLMC
ARM programs include the 11th District Cost of Funds Index published by the
Federal Home Loan Bank of San Francisco, LIBOR and other
indices. Interest rates paid on fully-indexed FHLMC ARM certificates
equal the applicable index rate plus a specified number of basis
points. The majority of series of FHLMC ARM certificates issued to
date have evidenced pools of mortgage loans with monthly, semi-annual or annual
interest adjustments. Adjustments in the interest rates paid are
generally limited to an annual increase or decrease of either 100 or 200 basis
points and to a lifetime cap of 500 or 600 basis points over the initial
interest rate. Certain FHLMC programs include mortgage loans which
allow the borrower to convert the adjustable mortgage interest rate to a fixed
rate. Adjustable-rate mortgages which are converted into fixed-rate
mortgage loans are repurchased by FHLMC or by the seller of the loan to FHLMC at
the unpaid principal balance of the loan plus accrued interest to the due date
of the last adjustable rate interest payment.
FNMA
Certificates
FNMA is a privately-owned,
federally-chartered corporation organized and existing under the Federal
National Mortgage Association Charter Act. FNMA provides funds to the
mortgage market primarily by purchasing home mortgage loans from local lenders,
thereby replenishing their funds for additional lending. FNMA
guarantees to the registered holder of a FNMA certificate that it will
distribute amounts representing scheduled principal and interest on the mortgage
loans in the pool underlying the FNMA certificate, whether or not received, and
the full principal amount of any such mortgage loan foreclosed or otherwise
finally liquidated, whether or not the principal amount is actually
received. The obligations of FNMA under its guarantees are solely
those of FNMA and are not backed by the full faith and credit of the United
States. If FNMA were unable to satisfy its obligations, distributions
to holders of FNMA certificates would consist solely of payments and other
recoveries on the underlying mortgage loans and, accordingly, defaults and
delinquencies on the underlying mortgage loans would adversely affect monthly
distributions to holders of FNMA.
FNMA certificates may be backed by
pools of single-family or multi-family mortgage loans. The original
term to maturity of any such mortgage loan generally does not exceed 40
years. FNMA certificates may pay interest at a fixed rate or an
adjustable rate. Each series of FNMA ARM certificates bears an
initial interest rate and margin tied to an index based on all loans in the
related pool, less a fixed percentage representing servicing compensation and
FNMA’s guarantee fee. The specified index used in different series
has included the Treasury Index, the 11th District Cost of Funds Index published
by the Federal Home Loan Bank of San Francisco, LIBOR and other
indices. Interest rates paid on fully-indexed FNMA ARM certificates
equal the applicable index rate plus a specified number of basis
points. The majority of series of FNMA ARM certificates issued to
date have evidenced pools of mortgage loans with monthly, semi-annual or annual
interest rate adjustments. Adjustments in the interest rates paid are
generally limited to an annual increase or decrease of either 100 or 200 basis
points and to a lifetime cap of 500 or 600 basis points over the initial
interest rate. Certain FNMA programs include mortgage loans which
allow the borrower to convert the adjustable mortgage interest rate of the ARM
to a fixed rate. Adjustable-rate mortgages which are converted into
fixed-rate mortgage loans are repurchased by FNMA or by the seller of the loans
to FNMA at the unpaid principal of the loan plus accrued interest to the due
date of the last adjustable rate interest payment. Adjustments to the
interest rates on FNMA ARM certificates are typically subject to lifetime caps
and periodic rate or payment caps.
GNMA
Certificates
GNMA is a wholly owned corporate
instrumentality of the United States within the Department of Housing and Urban
Development (HUD). The National Housing Act of 1934 authorizes GNMA
to guarantee the timely payment of the principal of and interest on certificates
which represent an interest in a pool of mortgages insured by the Federal
Housing Administration (FHA) or partially guaranteed by the Department of
Veterans Affairs and other loans eligible for inclusion in mortgage pools
underlying GNMA certificates. Section 306(g) of the Housing Act
provides that the full faith and credit of the United States is pledged to the
payment of all amounts which may be required to be paid under any guaranty by
GNMA.
8
At present, most GNMA certificates are
backed by single-family mortgage loans. The interest rate paid on
GNMA certificates may be a fixed rate or an adjustable rate. The
interest rate on GNMA certificates issued under GNMA’s standard ARM program
adjusts annually in relation to the Treasury index. Adjustments in
the interest rate are generally limited to an annual increase or decrease of 100
basis points and to a lifetime cap of 500 basis points over the initial coupon
rate.
Single-Family and Multi-Family
Privately-Issued Certificates
Single-family and multi-family
privately-issued certificates are pass-through certificates that are not issued
by one of the agencies and that are backed by a pool of conventional
single-family or multi-family mortgage loans. These certificates are
issued by originators of, investors in, and other owners of mortgage loans,
including savings and loan associations, savings banks, commercial banks,
mortgage banks, investment banks and special purpose “conduit” subsidiaries of
these institutions.
While agency pass-through certificates
are backed by the express obligation or guarantee of one of the agencies, as
described above, privately-issued certificates are generally covered by one or
more forms of private (i.e., non-governmental) credit
enhancements. These credit enhancements provide an extra layer of
loss coverage in the event that losses are incurred upon foreclosure sales or
other liquidations of underlying mortgaged properties in amounts that exceed the
equity holder’s equity interest in the property. Forms of credit
enhancements include limited issuer guarantees, reserve funds, private mortgage
guaranty pool insurance, over-collateralization and subordination.
Subordination is a form of credit
enhancement frequently used and involves the issuance of classes of senior and
subordinated mortgage-backed securities. These classes are structured
into a hierarchy to allocate losses on the underlying mortgage loans and also
for defining priority of rights to payment of principal and
interest. Typically, one or more classes of senior securities are
created which are rated in one of the two highest rating levels by one or more
nationally recognized rating agencies and which are supported by one or more
classes of mezzanine securities and subordinated securities that bear losses on
the underlying loans prior to the classes of senior securities. Mezzanine
securities, as used in this Form 10-K, refers to classes that are rated below
the two highest levels, but no lower than a single “B” rating under the S&P
rating system (or comparable level under other rating systems) and are supported
by one or more classes of subordinated securities which bear realized losses
prior to the classes of mezzanine securities. Subordinated securities, as used
in this Form 10-K, refers to any class that bears the “first loss” from losses
from underlying mortgage loans or that is rated below a single “B” level (or, if
unrated, we deem it to be below that level). In some cases, only
classes of senior securities and subordinated securities are
issued. By adjusting the priority of interest and principal payments
on each class of a given series of senior-subordinated mortgage-backed
securities, issuers are able to create classes of mortgage-backed securities
with varying degrees of credit exposure, prepayment exposure and potential total
return, tailored to meet the needs of sophisticated institutional
investors.
Collateralized
Mortgage Obligations and Multi-Class Pass-Through Securities
We may also invest in CMOs and
multi-class pass-through securities. CMOs are debt obligations issued
by special purpose entities that are secured by mortgage loans or
mortgage-backed certificates, including, in many cases, certificates issued by
government and government-related guarantors, including, GNMA, FNMA and FHLMC,
together with certain funds and other collateral. Multi-class
pass-through securities are equity interests in a trust composed of mortgage
loans or other mortgage-backed securities. Payments of principal and
interest on underlying collateral provide the funds to pay debt service on the
CMO or make scheduled distributions on the multi-class pass-through
securities. CMOs and multi-class pass-through securities may be
issued by agencies or instrumentalities of the U.S. Government or by private
organizations. The discussion of CMOs in the following paragraphs is
similarly applicable to multi-class pass-through securities.
9
In a CMO, a series of bonds or
certificates is issued in multiple classes. Each class of CMOs, often
referred to as a “tranche,” is issued at a specific coupon rate (which, as
discussed below, may be an adjustable rate subject to a cap) and has a stated
maturity or final distribution date. Principal prepayments on
collateral underlying a CMO may cause it to be retired substantially earlier
than the stated maturity or final distribution date. Interest is paid
or accrues on all classes of a CMO on a monthly, quarterly or semi-annual
basis. The principal and interest on underlying mortgages may be
allocated among the several classes of a series of a CMO in many
ways. In a common structure, payments of principal, including any
principal prepayments, on the underlying mortgages are applied to the classes of
the series of a CMO in the order of their respective stated maturities or final
distribution dates, so that no payment of principal will be made on any class of
a CMO until all other classes having an earlier stated maturity or final
distribution date have been paid in full.
Other types of CMO issues include
classes such as parallel pay CMOs, some of which, such as planned amortization
class CMOs (“PAC bonds”), provide protection against prepayment
uncertainty. Parallel pay CMOs are structured to provide payments of
principal on certain payment dates to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC bonds generally require payment
of a specified amount of principal on each payment date so long as prepayment
speeds on the underlying collateral fall within a specified range.
Other types of CMO issues include
targeted amortization class CMOs (or TAC bonds), which are similar to PAC
bonds. While PAC bonds maintain their amortization schedule within a
specified range of prepayment speeds, TAC bonds are generally targeted to a
narrow range of prepayment speeds or a specified prepayment
speed. TAC bonds can provide protection against prepayment
uncertainty since cash flows generated from higher prepayments of the underlying
mortgage-related assets are applied to the various other pass-through tranches
so as to allow the TAC bonds to maintain their amortization
schedule.
A CMO may be subject to the issuer’s
right to redeem the CMO prior to its stated maturity date, which may diminish
the anticipated return on our investment. Privately-issued CMOs are
supported by private credit enhancements similar to those used for
privately-issued certificates and are often issued as senior-subordinated
mortgage-backed securities. We will only acquire CMOs or multi-class
pass-through certificates that constitute debt obligations or beneficial
ownership in grantor trusts holding mortgage loans, or regular interests in
REMICs, or that otherwise constitute qualified REIT real estate assets under the
Internal Revenue Code (provided that we have obtained a favorable opinion of our
tax advisor or a ruling from the IRS to that effect).
Adjustable-Rate
Mortgage Pass-Through Certificates and Floating Rate Mortgage-Backed
Securities
Some of the mortgage pass-through
certificates we acquire are adjustable-rate mortgage pass-through
certificates. This means that their interest rates may vary over time
based upon changes in an objective index, such as:
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LIBOR or the London Interbank
Offered Rate.
The interest rate that banks in London
offer for deposits in London of U.S.
dollars.
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Treasury
Index
.
A monthly
or weekly average yield of benchmark U.S. Treasury securities, as
published by the Federal Reserve
Board.
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CD Rate.
The
weekly average of secondary market interest rates on six-month negotiable
certificates of deposit, as published by the Federal Reserve
Board.
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These
indices generally reflect short-term interest rates. The underlying
mortgages for adjustable-rate mortgage pass-through certificates are
adjustable-rate mortgage loans (“ARMs”).
We also
acquire CMO floaters. One or more tranches of a CMO may have coupon
rates that reset periodically at a specified increment over an index such as
LIBOR. These adjustable-rate tranches are sometimes known as CMO
floaters and may be backed by fixed or adjustable-rate mortgages.
10
There are
two main categories of indices for adjustable-rate mortgage pass-through
certificates and floaters: (1) those based on U.S. Treasury
securities, and (2) those derived from calculated measures such as a cost
of funds index or a moving average of mortgage rates. Commonly
utilized indices include the one-year Treasury note rate, the three-month
Treasury bill rate, the six-month Treasury bill rate, rates on long-term
Treasury securities, the 11th District Federal Home Loan Bank Costs of Funds
Index, the National Median Cost of Funds Index, one-month or three-month LIBOR,
the prime rate of a specific bank, or commercial paper rates. Some
indices, such as the one-year Treasury rate, closely mirror changes in market
interest rate levels. Others, such as the 11th District Home Loan
Bank Cost of Funds Index, tend to lag changes in market interest rate
levels. We seek to diversify our investments in adjustable-rate
mortgage pass-through certificates and floaters among a variety of indices and
reset periods so that we are not at any one time unduly exposed to the risk of
interest rate fluctuations. In selecting adjustable-rate mortgage
pass-through certificates and floaters for investment, we will also consider the
liquidity of the market for the different mortgage-backed
securities.
We
believe that adjustable-rate mortgage pass-through certificates and floaters are
particularly well-suited to our investment objective of high current income,
consistent with modest volatility of net asset value, because the value of
adjustable-rate mortgage pass-through certificates and floaters generally
remains relatively stable as compared to traditional fixed-rate debt securities
paying comparable rates of interest. While the value of
adjustable-rate mortgage pass-through certificates and floaters, like other debt
securities, generally varies inversely with changes in market interest rates
(increasing in value during periods of declining interest rates and decreasing
in value during periods of increasing interest rates), the value of
adjustable-rate mortgage pass-through certificates and floaters should generally
be more resistant to price swings than other debt securities because the
interest rates on these securities move with market interest rates.
Accordingly,
as interest rates change, the value of our shares should be more stable than the
value of funds which invest primarily in securities backed by fixed-rate
mortgages or in other non-mortgage-backed debt securities, which do not provide
for adjustment in the interest rates in response to changes in market interest
rates.
Adjustable-rate
mortgage pass-through certificates and floaters typically have caps, which limit
the maximum amount by which the interest rate may be increased or decreased at
periodic intervals or over the life of the security. To the extent
that interest rates rise faster than the allowable caps on the adjustable-rate
mortgage pass-through certificates and floaters, these securities will behave
more like fixed-rate securities. Consequently, interest rate
increases in excess of caps can be expected to cause these securities to behave
more like traditional debt securities than adjustable-rate securities and,
accordingly, to decline in value to a greater extent than would be the case in
the absence of these caps.
Adjustable-rate
mortgage pass-through certificates and floaters, like other mortgage-backed
securities, differ from conventional bonds in that principal is to be paid back
over the life of the security rather than at maturity. As a result,
we receive monthly scheduled payments of principal and interest on these
securities and may receive unscheduled principal payments representing
prepayments on the underlying mortgages. When we reinvest the
payments and any unscheduled prepayments we receive, we may receive a rate of
interest on the reinvestment which is lower than the rate on the existing
security. For this reason, adjustable-rate mortgage pass-through
certificates and floaters are less effective than longer-term debt securities as
a means of “locking in” longer-term interest rates. Accordingly,
adjustable-rate mortgage pass-through certificates and floaters, while generally
having less risk of price decline during periods of rapidly rising interest
rates than fixed-rate mortgage-backed securities of comparable maturities, have
less potential for capital appreciation than fixed-rate securities during
periods of declining interest rates.
As in the
case of fixed-rate mortgage-backed securities, to the extent these securities
are purchased at a premium, faster than expected prepayments would accelerate
our amortization of the premium. Conversely, if these securities were
purchased at a discount, faster than expected prepayments would accelerate our
recognition of income.
As in the
case of fixed-rate CMOs, floating-rate CMOs may allow for shifting of prepayment
risk from slower-paying tranches to faster-paying tranches. This is
in contrast to mortgage pass-through certificates where all investors share
equally in all payments, including all prepayments, on the underlying
mortgages.
11
Other Floating
Rate Instruments
We may
also invest in structured floating-rate notes issued or guaranteed by government
agencies, such as FNMA and FHLMC. These instruments are typically
structured to reflect an interest rate arbitrage (i.e., the difference between
the agency’s cost of funds and the income stream from specified assets of the
agency) and their reset formulas may provide more attractive returns than other
floating rate instruments. The indices used to determine resets are the same as
those described above.
Mortgage
Loans
As of December 31, 2009, we have not
invested directly in mortgage loans, but we may from time-to-time invest a small
percentage of our assets directly in single-family, multi-family or commercial
mortgage loans. We expect that the majority of these mortgage loans
would be ARM pass-through certificates. The interest rate on an ARM
pass-through certificate is typically tied to an index (such as LIBOR or the
interest rate on Treasury bills), and is adjustable periodically at specified
intervals. These mortgage loans are typically subject to lifetime
interest rate caps and periodic interest rate or payment caps. The
acquisition of mortgage loans generally involves credit risk. We may
obtain credit enhancement to mitigate this risk; however, there can be no
assurances that we will be able to obtain credit enhancement or that credit
enhancement would mitigate the credit risk of the underlying mortgage
loans.
Capital Investment
Policy
Asset Acquisitions
Our capital investment policy provides
that at least 75% of our total assets will be comprised of high quality
mortgage-backed securities and short-term investments. The remainder
of our assets (comprising not more than 25% of total assets), may consist of
mortgage-backed securities and other qualified REIT real estate assets which are
unrated or rated less than high quality but which are at least “investment
grade” (rated “BBB” or better) or, if not rated, are determined by us to be of
comparable credit quality to an investment which is rated “BBB” or
better. In addition, we may directly or indirectly invest part of
this remaining 25% of our assets in other types of securities, including without
limitation, unrated debt, equity or derivative securities, to the extent
consistent with our REIT qualification requirements. The derivative
securities in which we invest may include securities representing the right to
receive interest only or a disproportionately large amount of interest, as well
as inverse floaters, which may have imbedded leverage as part of their
structural characteristics.
Our capital investment policy requires
that we structure our portfolio to maintain a minimum weighted average rating
(including our deemed comparable ratings for unrated mortgage-backed securities)
of our mortgage-backed securities of at least single “A” under the S&P
rating system and at the comparable level under the other rating
systems. To date, substantially all of the mortgage-backed securities
we have acquired have been pass-through certificates or CMOs issued or
guaranteed by FHLMC, FNMA or GNMA which, although not rated, have an implied
“AAA” rating.
We intend to acquire only those
mortgage-backed securities that we believe we have the necessary expertise to
evaluate and manage, that we can readily finance and that are consistent with
our balance sheet guidelines and risk management objectives. Since we
expect to hold our mortgage-backed securities until maturity, we generally do
not seek to acquire assets whose investment returns are only attractive in a
limited range of scenarios. We believe that future interest rates and
mortgage prepayment rates are very difficult to predict and, as a result, we
seek to acquire mortgage-backed securities which we believe provide acceptable
returns over a broad range of interest rate and prepayment
scenarios.
Among the asset choices available to
us, our policy is to acquire those mortgage-backed securities which we believe
generate the highest returns on capital invested, after consideration of the
following:
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the
amount and nature of anticipated cash flows from the
asset;
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our
ability to pledge the asset to secure collateralized
borrowings;
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the
increase in our capital requirement determined by our capital investment
policy resulting from the purchase and financing of the asset;
and
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the
costs of financing, hedging and managing the
asset.
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Prior to
acquisition, we assess potential returns on capital employed over the life of
the asset and in a variety of interest rate, yield spread, financing cost,
credit loss and prepayment scenarios.
We also give consideration to balance
sheet management and risk diversification issues. We deem a specific
asset which we are evaluating for potential acquisition as more or less valuable
to the extent it serves to increase or decrease certain interest rate or
prepayment risks which may exist in the balance sheet, to diversify or
concentrate credit risk, and to meet the cash flow and liquidity objectives our
management may establish for our balance sheet from
time-to-time. Accordingly, an important part of the asset evaluation
process is a simulation, using risk management models, of the addition of a
potential asset and our associated borrowings and hedges to the balance sheet
and an assessment of the impact this potential asset acquisition would have on
the risks in and returns generated by our balance sheet as a whole over a
variety of scenarios.
We
believe that adjustable-rate mortgage pass-through certificates and floaters are
particularly well-suited to our investment objective of high current income,
consistent with modest volatility of net asset value, because the value
of adjustable-rate mortgage pass-through certificates and floaters
generally remains relatively stable as compared to traditional fixed-rate debt
securities paying comparable rates of interest. We have, however,
purchased a significant amount of fixed-rate mortgage-backed securities and may
continue to do so in the future if, in our view, the potential returns on
capital invested, after hedging and all other costs, would exceed the returns
available from other assets or if the purchase of these assets would serve to
reduce or diversify the risks of our balance sheet.
We may purchase the stock of mortgage
REITs or similar companies when we believe that these purchases would yield
attractive returns on capital employed. When the stock market
valuations of these companies are low in relation to the market value of their
assets, these stock purchases can be a way for us to acquire an interest in a
pool of mortgage-backed securities at an attractive price. We do not,
however, presently intend to invest in the securities of other issuers for the
purpose of exercising control or to underwrite securities of other
issuers.
We may acquire newly issued
mortgage-backed securities, and also may seek to expand our capital base in
order to further increase our ability to acquire new assets, when the potential
returns from new investments appears attractive relative to the return
expectations of stockholders. We may in the future acquire
mortgage-backed securities by offering our debt or equity securities in exchange
for the mortgage-backed securities.
We generally intend to hold
mortgage-backed securities for extended periods. In addition, the
REIT provisions of the Internal Revenue Code limit in certain respects our
ability to sell mortgage-backed securities. We may decide however to
sell assets from time to time, for a number of reasons, including our desire to
dispose of an asset as to which credit risk concerns have arisen, to reduce
interest rate risk, to substitute one type of mortgage-backed security for
another, to improve yield or to maintain compliance with the 55% requirement
under the Investment Company Act, or generally to re-structure the balance sheet
when we deem advisable. Our board of directors has not adopted any
policy that would restrict management’s authority to determine the timing of
sales or the selection of mortgage-backed securities to be sold.
We do not invest in REMIC residuals or
other CMO residuals.
As a requirement for maintaining REIT
status, we will distribute to stockholders aggregate dividends equaling at least
90% of our REIT taxable income (determined without regard to the deduction for
dividends paid and by excluding any net capital gain) for each taxable
year. We will make additional distributions of capital when the
return expectations of the stockholders appear to exceed returns potentially
available to us through making new investments in mortgage-backed
securities. Subject to the limitations of applicable securities and
state corporation laws, we can distribute capital by making purchases of our own
capital stock or through paying down or repurchasing any outstanding
uncollateralized debt obligations.
Our asset acquisition strategy may
change over time as market conditions change and as we evolve.
13
Credit
Risk Management
Although
we do not expect to encounter credit risk in our Investment Securities, we face
credit risk on the portions of our portfolio which are not Investment
Securities. In addition, our use of repurchase agreements and
interest rate swaps creates exposure to credit risk relating to potential losses
that could be recognized if the counterparties to these instruments fail to
perform their obligations under the contracts. In the event of a
default by the counterparty, we could have difficulty obtaining our MBS pledged
as collateral for swaps. We review credit risk and other risk of loss
associated with each investment and determine the appropriate allocation of
capital to apply to the investment under our capital investment
policy. Our management will monitor the overall portfolio risk and
determine appropriate levels of provision for loss.
Capital and Leverage
We expect generally to maintain a
debt-to-equity ratio of between 8:1 and 12:1, although the ratio may vary from
time-to-time depending upon market conditions and other factors our management
deems relevant, including the composition of our balance sheet, haircut levels
required by lenders, the market value of the mortgage-backed securities in our
portfolio and “excess capital cushion” percentages (as described below) set by
our board of directors from time to time. For purposes of calculating
this ratio, our equity (or capital base) is equal to the value of our investment
portfolio on a mark-to-market basis less the book value of our obligations under
repurchase agreements and other collateralized borrowings. For the
calculation of this ratio, equity includes the Series B Cumulative Convertible
Preferred Stock, which is not included in equity under Generally
Accepted Accounting Principles.
Our goal is to strike a balance between
the under-utilization of leverage, which reduces potential returns to
stockholders, and the over-utilization of leverage, which could reduce our
ability to meet our obligations during adverse market conditions. Our
capital investment policy limits our ability to acquire additional assets during
times when our debt-to-equity ratio exceeds 12:1. At December 31,
2009, our ratio of debt-to-equity was 5.7:1. Our capital base
represents the approximate liquidation value of our investments and approximates
the market value of assets that we can pledge or sell to meet
over-collateralization requirements for our borrowings. The unpledged
portion of our capital base is available for us to pledge or sell as necessary
to maintain over-collateralization levels for our borrowings.
We are prohibited from acquiring
additional assets during periods when our capital base is less than the minimum
amount required under our capital investment policy, except as may be necessary
to maintain REIT status or our exemption from the Investment Company Act of
1940, as amended (the “Investment Company Act”). In addition, when
our capital base falls below our risk-managed capital requirement, our
management is required to submit to our board of directors a plan for bringing
our capital base into compliance with our capital investment policy
guidelines. We anticipate that in most circumstances we can achieve
this goal without overt management action through the natural process of
mortgage principal repayments. We anticipate that our capital base is
likely to exceed our risk-managed capital requirement during periods following
new equity offerings and during periods of falling interest rates and that our
capital base could fall below the risk-managed capital requirement during
periods of rising interest rates.
The first component of our capital
requirements is the current aggregate over-collateralization amount or “haircut”
the lenders require us to hold as capital. The haircut for each
mortgage-backed security is determined by our lenders based on the risk
characteristics and liquidity of the asset. Should the market value
of our pledged assets decline, we will be required to deliver additional
collateral to our lenders to maintain a constant over-collateralization level on
our borrowings.
The second component of our capital
requirement is the “excess capital cushion.” This is an amount of
capital in excess of the haircuts required by our lenders. We
maintain the excess capital cushion to meet the demands of our lenders for
additional collateral should the market value of our mortgage-backed securities
decline. The aggregate excess capital cushion equals the sum of
liquidity cushion amounts assigned under our capital investment policy to each
of our mortgage-backed securities. We assign excess capital cushions
to each mortgage-backed security based on our assessment of the mortgage-backed
security’s market price volatility, credit risk, liquidity and attractiveness
for use as collateral by lenders. The process of assigning excess
capital cushions relies on our management’s ability to identify and weigh the
relative importance of these and other factors. In assigning excess
capital cushions, we also give consideration to hedges associated with the
mortgage-backed security and any effect such hedges may have on reducing net
market price volatility, concentration or diversification of credit and other
risks in the balance sheet as a whole and the net cash flows that we can expect
from the interaction of the various components of our balance
sheet.
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Our capital investment policy
stipulates that at least 25% of the capital base maintained to satisfy the
excess capital cushion must be invested in AAA-rated adjustable-rate
mortgage-backed securities or assets with similar or better liquidity
characteristics.
A substantial portion of our borrowings
are short-term or variable-rate borrowings. Our borrowings are
implemented primarily through repurchase agreements, but in the future may also
be obtained through loan agreements, lines of credit, dollar-roll agreements (an
agreement to sell a security for delivery on a specified future date and a
simultaneous agreement to repurchase the same or a substantially similar
security on a specified future date) and other credit facilities with
institutional lenders and issuance of debt securities such as commercial paper,
medium-term notes, CMOs and senior or subordinated notes. We enter
into financing transactions only with institutions that we believe are sound
credit risks and follow other internal policies designed to limit our credit and
other exposure to financing institutions.
We expect to continue to use repurchase
agreements as our principal financing device to leverage our mortgage-backed
securities portfolio. We anticipate that, upon repayment of each
borrowing under a repurchase agreement, we will use the collateral immediately
for borrowing under a new repurchase agreement. We have not at the
present time entered into any commitment agreements under which the lender would
be required to enter into new repurchase agreements during a specified period of
time, nor do we presently plan to have liquidity facilities with commercial
banks. We may, however, enter into such commitment agreements in the
future. We enter into repurchase agreements primarily with national
broker-dealers, commercial banks and other lenders which typically offer this
type of financing. We enter into collateralized borrowings only with
financial institutions meeting credit standards approved by our board of
directors, and we monitor the financial condition of these institutions on a
regular basis.
A repurchase agreement, although
structured as a sale and repurchase obligation, acts as a financing under which
we effectively pledge our mortgage-backed securities as collateral to secure a
short-term loan. Generally, the other party to the agreement makes
the loan in an amount equal to a percentage of the market value of the pledged
collateral. At the maturity of the repurchase agreement, we are
required to repay the loan and correspondingly receive back our
collateral. While used as collateral, the mortgage-backed securities
continue to pay principal and interest which are for our benefit. In
the event of our insolvency or bankruptcy, certain repurchase agreements may
qualify for special treatment under the Bankruptcy Code, the effect of which,
among other things, would be to allow the creditor under the agreement to avoid
the automatic stay provisions of the Bankruptcy Code and to foreclose on the
collateral without delay. In the event of the insolvency or
bankruptcy of a lender during the term of a repurchase agreement, the lender may
be permitted, under applicable insolvency laws, to repudiate the contract, and
our claim against the lender for damages may be treated simply as an unsecured
creditor. In addition, if the lender is a broker or dealer subject to
the Securities Investor Protection Act of 1970, or an insured depository
institution subject to the Federal Deposit Insurance Act, our ability to
exercise our rights to recover our securities under a repurchase agreement or to
be compensated for any damages resulting from the lender’s insolvency may be
further limited by those statutes. These claims would be subject to
significant delay and, if and when received, may be substantially less than the
damages we actually incur.
Substantially all of our collateralized
borrowing agreements require us to deposit additional collateral in the event
the market value of existing collateral declines, which may require us to sell
assets to reduce our borrowings. We have designed our liquidity
management policy to maintain a cushion of equity sufficient to provide required
liquidity to respond to the effects under our borrowing arrangements of interest
rate movements and changes in market value of our mortgage-backed securities, as
described above. However, a major disruption of the repurchase or
other market that we rely on for short-term borrowings would have a material
adverse effect on us unless we were able to arrange alternative sources of
financing on comparable terms.
Our articles of incorporation and
bylaws do not limit our ability to incur borrowings, whether secured or
unsecured.
15
Interest Rate Risk
Management
To the extent consistent with our
election to qualify as a REIT, we follow an interest rate risk management
program intended to protect our portfolio of mortgage-backed securities and
related debt against the effects of major interest rate
changes. Specifically, our interest rate risk management program is
formulated with the intent to offset the potential adverse effects resulting
from rate adjustment limitations on our mortgage-backed securities and the
differences between interest rate adjustment indices and interest rate
adjustment periods of our adjustable-rate mortgage-backed securities and related
borrowings.
Our
interest rate risk management program encompasses a number of procedures,
including the following:
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§
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we
attempt to structure our borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
generally correspond to the interest rate adjustment indices and interest
rate adjustment periods of our adjustable-rate mortgage-backed securities;
and
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§
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we
attempt to structure our borrowing agreements relating to adjustable-rate
mortgage-backed securities to have a range of different maturities and
interest rate adjustment periods (although substantially all will be less
than one year).
|
We adjust the average maturity
adjustment periods of our borrowings on an ongoing basis by changing the mix of
maturities and interest rate adjustment periods as borrowings come due and are
renewed. Through use of these procedures, we attempt to minimize the
differences between the interest rate adjustment periods of our mortgage-backed
securities and related borrowings that may occur.
We purchase from time-to-time
interest rate swaps. We may enter into interest rate collars,
interest rate caps or floors, and purchase interest-only mortgage-backed
securities and similar instruments to attempt to mitigate the risk of the cost
of our variable rate liabilities increasing at a faster rate than the earnings
on our assets during a period of rising interest rates or to mitigate prepayment
risk. We may hedge as much of the interest rate risk as our
management determines is in our best interests, given the cost of the hedging
transactions and the need to maintain our status as a REIT. This
determination may result in our electing to bear a level of interest rate or
prepayment risk that could otherwise be hedged when management believes, based
on all relevant facts, that bearing the risk is advisable.
We seek to build a balance sheet and
undertake an interest rate risk management program which is likely to generate
positive earnings and maintain an equity liquidation value sufficient to
maintain operations given a variety of potentially adverse
circumstances. Accordingly, our interest rate risk management program
addresses both income preservation, as discussed above, and capital preservation
concerns. For capital preservation, we monitor our
“duration.” This is the expected percentage change in market value of
our assets that would be caused by a 1% change in short and long-term interest
rates. To monitor weighted average duration and the related risks of
fluctuations in the liquidation value of our equity, we model the impact of
various economic scenarios on the market value of our mortgage-backed securities
and liabilities. At December 31, 2009, we estimate that the duration
of our assets was 2.04 years and giving effect to the swap transactions, our
weighted average duration was 0.83 years. We believe that our
interest rate risk management program will allow us to maintain operations
throughout a wide variety of potentially adverse
circumstances. Nevertheless, in order to further preserve our capital
base (and lower our duration) during periods when we believe a trend of rapidly
rising interest rates has been established, we may decide to increase hedging
activities or to sell assets. Each of these actions may lower our
earnings and dividends in the short term to further our objective of maintaining
attractive levels of earnings and dividends over the long term.
We may elect to conduct a portion of
our hedging operations through one or more subsidiary corporations, each of
which we would elect to treat as a “taxable REIT subsidiary.” To
comply with the asset tests applicable to us as a REIT, we could own 100% of the
voting stock of such subsidiary, provided that the value of the stock that we
own in all such taxable REIT subsidiaries does not exceed 25% of the value of
our total assets at the close of any calendar quarter. A taxable
subsidiary, such as FIDAC, Merganser, and RCap, would not elect REIT status and
would distribute any net profit after taxes to us. Any dividend
income we receive from the taxable subsidiaries (combined with all other income
generated from our assets, other than qualified REIT real estate assets) must
not exceed 25% of our gross income.
16
We believe that we have developed a
cost-effective asset/liability management program to provide a level of
protection against interest rate and prepayment risks. However, no
strategy can completely insulate us from interest rate changes and prepayment
risks. Further, as noted above, the federal income tax requirements
that we must satisfy to qualify as a REIT limit our ability to hedge our
interest rate and prepayment risks. We monitor carefully, and may
have to limit, our asset/liability management program to assure that we do not
realize excessive hedging income, or hold hedging assets having excess value in
relation to total assets, which could result in our disqualification as a REIT,
the payment of a penalty tax for failure to satisfy certain REIT tests under the
Internal Revenue Code, provided the failure was for reasonable
cause. In addition, asset/liability management involves transaction
costs which increase dramatically as the period covered by the hedging
protection increases. Therefore, we may be unable to hedge
effectively our interest rate and prepayment risks.
Prepayment
Risk Management
We seek to minimize the effects of
faster or slower than anticipated prepayment rates through structuring a
diversified portfolio with a variety of prepayment characteristics, investing in
mortgage-backed securities with prepayment prohibitions and penalties, investing
in certain mortgage-backed security structures which have prepayment
protections, and balancing assets purchased at a premium with assets purchased
at a discount. We monitor prepayment risk through periodic review of
the impact of a variety of prepayment scenarios on our revenues, net earnings,
dividends, cash flow and net balance sheet market value.
Future Revisions in Policies and
Strategies
Our board of directors has established
the investment policies and operating policies and strategies set forth in this
Form 10-K. The board of directors has the power to modify or waive
these policies and strategies without the consent of the stockholders to the
extent that the board of directors determines that the modification or waiver is
in the best interests of our stockholders. Among other factors,
developments in the market which affect our policies and strategies or which
change our assessment of the market may cause our board of directors to revise
our policies and strategies.
Potential Acquisitions, Strategic
Alliances and Other Investments
From
time-to-time we have explored possible transactions to enhance our operations
and growth, including entering into new businesses, acquisitions of other
businesses or assets, investments in other entities, joint venture arrangements,
or strategic alliances. We entered into the broker-dealer business during
the first quarter of January 2009, through our subsidiary RCap, which was
granted membership in FINRA in January 2009. On October 31, 2008 we
consummated our acquisition of Merganser which is a registered investment
advisor. We own approximately 45.0 million shares of common stock of
Chimera Investment Corporation, or Chimera. Chimera is a publicly
traded, specialty finance company that acquires, manages, and finances, directly
or through its subsidiaries, residential mortgage loans, residential
mortgage-backed securities, real estate related securities and various other
asset classes. Chimera is externally managed by FIDAC and has elected
and qualify to be taxed as a REIT for federal income tax purposes. We
own approximately 4.5 million shares of common stock of CreXus
Investment Corp., or CreXus. CreXus is a publicly traded, specialty
finance company that acquires, manages, and finances, directly or through its
subsidiaries, commercial mortgage loans and other commercial real estate debt,
commercial mortgage-backed securities, or CMBS, and other commercial real
estate-related assets. CreXus is externally managed by FIDAC and
intends to elect and qualify to be taxed as a REIT for federal income tax
purposes. We also own an investment fund.
We may,
from time-to-time, continue to explore possible new businesses, acquisitions,
investments, joint venture arrangements and strategic alliances which may
enhance our operations and assist our and our subsidiaries’
growth.
Dividend
Reinvestment and Share Purchase Plan
We have adopted a dividend reinvestment
and share purchase plan. Under the dividend reinvestment feature of
the plan, existing shareholders can reinvest their dividends in additional
shares of our common stock. Under the share purchase feature of the
plan, new and existing shareholders can purchase shares of our common
stock. We have an effective shelf registration statement on Form S-3
which registered 100,000,000 shares that could be issued under the
plan. We still sell shares covered by this registration statement
under the plan.
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At
the Market Sales Programs
We have
entered into an ATM Equity Offering
sm
Sales Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner
& Smith Incorporated (or Merrill Lynch), relating to the sale of shares of
our common stock from time to time through Merrill Lynch. We have also
entered into a ATM Equity Sales Agreement with UBS Securities LLC (or UBS
Securities), relating to the sale of shares of our common stock from time to
time through UBS Securities. Under these agreements, sales of the shares,
if any, will be made by means of ordinary brokers’ transaction of the New York
Stock Exchange at market prices.
Legal Proceedings
From
time-to-time, we are involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
our consolidated financial statements.
Employees
As of
December 31, 2009, we and our subsidiaries had 87 full time
employees. None of our employees are subject to any collective
bargaining agreements. We believe we have good relations with our
employees.
Available
Information
Our
investor relations website is
www.annaly.com
.
We make
available on this website under “Financial Reports and SEC filings,” free of
charge, our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports
as soon as reasonably practicable after we electronically file or furnish such
materials to the SEC.
COMPETITION
We believe that our principal
competition in the acquisition and holding of the types of mortgage-backed
securities we purchase are financial institutions such as banks, savings and
loans, life insurance companies, institutional investors such as mutual funds
and pension funds, and certain other mortgage REITs. Some of our
competitors have greater financial resources and access to capital than we
do. Our competitors, as well as additional competitors which may
emerge in the future, may increase the competition for the acquisition of
mortgage-backed securities, which in turn may result in higher prices and lower
yields on assets.
ITEM 1A.
RISK
FACTORS
An
investment in our stock involves a number of risks. Before making an
investment decision, you should carefully consider all of the risks described in
this Form 10-K. If any of the risks discussed in this Form 10-K
actually occur, our business, financial condition and results of operations
could be materially adversely affected. If this were to occur, the
trading price of our stock could decline significantly and you may lose all or
part of your investment.
Risks
Associated with Recent Adverse Developments in the Mortgage Finance and Credit
Markets
Volatile
market conditions for mortgages and mortgage-related assets as well as the
broader financial markets have resulted in a significant contraction in
liquidity for mortgages and mortgage-related assets, which may adversely affect
the value of the assets in which we invest.
Our
results of operations are materially affected by conditions in the markets for
mortgages and mortgage-related assets, including Mortgage-Backed Securities, as
well as the broader financial markets and the economy
generally. Beginning in the summer of 2007, significant adverse
changes in financial market conditions resulted in a deleveraging of the entire
global financial system and the forced sale of large quantities of
mortgage-related and other financial assets. Concerns over economic
recession, geopolitical issues, unemployment, the availability and cost of
financing, the mortgage market and a declining real estate market contributed to
increased volatility and diminished expectations for the economy and
markets. As a result of these conditions, many traditional mortgage
investors suffered severe losses in their residential mortgage portfolios and
several major market participants failed or have been impaired, resulting in a
significant contraction in market liquidity for mortgage-related
assets. This illiquidity negatively affected both the terms and
availability of financing for all mortgage-related assets. Further
increased volatility and deterioration in the markets for mortgages and
mortgage-related assets as well as the broader financial markets may adversely
affect the performance and market value of our Mortgage-Backed
Securities. If these conditions persist, institutions from which we
seek financing for our investments may tighten their lending standards or become
insolvent, which could make it more difficult for us to obtain financing on
favorable terms or at all. Our profitability may be adversely
affected if we are unable to obtain cost-effective financing for our
investments. Continued adverse developments in the broader
residential mortgage market may adversely affect the value of the assets in
which we invest.
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Since the
summer of 2007, the residential mortgage market in the United States experienced
a variety of difficulties and changed economic conditions, including defaults,
credit losses and liquidity concerns. Certain commercial banks,
investment banks and insurance companies have announced extensive losses from
exposure to the residential mortgage market. These losses have
reduced financial industry capital, leading to reduced liquidity for some
institutions. These factors have impacted investor perception of the
risk associated with Mortgage-Backed Securities in which we
invest. As a result, values for Mortgage-Backed Securities in which
we invest have experienced a certain amount of volatility. Further
increased volatility and deterioration in the broader residential mortgage and
Mortgage-Backed Securities markets may adversely affect the performance and
market value of our investments.
Any
decline in the value of our investments, or perceived market uncertainty about
their value, would likely make it difficult for us to obtain financing on
favorable terms or at all, or maintain our compliance with terms of any
financing arrangements already in place.
The
Mortgage-Backed Securities in which we invest are classified for accounting
purposes as available-for-sale. All assets classified as
available-for-sale are reported at fair value with unrealized gains and losses
excluded from earnings and reported as a separate component of stockholders'
equity. As a result, a decline in fair values may reduce the book
value of our assets. Moreover, if the decline in fair value of an
available-for-sale security is other-than-temporarily impaired, such decline
will reduce earnings. If market conditions result in a decline in the
fair value of our Mortgage-Backed Securities, our financial position and results
of operations could be adversely affected.
The
conservatorship of Fannie Mae and Freddie Mac and related efforts, along with
any changes in laws and regulations affecting the relationship between Fannie
Mae and Freddie Mac and the U.S. Government, may adversely affect our
business.
Due to
increased market concerns about Fannie Mae and Freddie Mac’s ability to
withstand future credit losses associated with securities held in their
investment portfolios, and on which they provide guarantees, without the direct
support of the U.S. Government, on July 30, 2008, Congress passed the Housing
and Economic Recovery Act of 2008, or the HERA. Among other things,
the HERA established the Federal Housing Finance Agency, or FHFA, which has
broad regulatory powers over Fannie Mae and Freddie Mac. On September
6, 2008, the FHFA placed Fannie Mae and Freddie Mac into conservatorship and,
together with the Treasury, established a program designed to boost investor
confidence in Fannie Mae’s and Freddie Mac’s debt and mortgage-backed
securities. As the conservator of Fannie Mae and Freddie Mac, the
FHFA controls and directs the operations of Fannie Mae and Freddie Mac and may
(1) take over the assets of and operate Fannie Mae and Freddie Mac with all the
powers of the shareholders, the directors and the officers of Fannie Mae and
Freddie Mac and conduct all business of Fannie Mae and Freddie Mac; (2) collect
all obligations and money due to Fannie Mae and Freddie Mac; (3) perform all
functions of Fannie Mae and Freddie Mac which are consistent with the
conservator’s appointment; (4) preserve and conserve the assets and property of
Fannie Mae and Freddie Mac; and (5) contract for assistance in fulfilling any
function, activity, action or duty of the conservator. A primary focus of this
new legislation is to increase the availability of mortgage financing by
allowing Fannie Mae and Freddie Mac to continue to grow their guarantee business
without limit, while limiting net purchases of Mortgage-Backed Securities to a
modest amount through the end of 2009. It is currently planned for Fannie Mae
and Freddie Mac to reduce gradually their Mortgage-Backed Securities portfolios
beginning in 2010.
In
addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, the
Treasury and FHFA have entered into Preferred Stock Purchase Agreements (PSPAs)
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. On December 24, 2009, the U.S. Treasury amended the terms of
the U.S. Treasury’s PSPAs with Fannie Mae and Freddie Mac to remove
the $200 billion per institution limit established under the PSPAs until the end
of 2012. The U.S. Treasury also amended the PSPAs with respect to the
requirements for Fannie Mae and Freddie Mac to reduce their
portfolios.
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Although
the Treasury has committed capital to Fannie Mae and Freddie Mac, there can be
no assurance that these actions will be adequate for their needs. If these
actions are inadequate, Fannie Mae and Freddie Mac could continue to suffer
losses and could fail to honor their guarantees and other obligations. The
future roles of Fannie Mae and Freddie Mac could be significantly reduced and
the nature of their guarantees could be considerably diminished. Any changes to
the nature of the guarantees provided by Fannie Mae and Freddie Mac could
redefine what constitutes Mortgage-Backed Securities and could have broad
adverse market implications.
On
November 25, 2008, the Federal Reserve announced that it will initiate a program
to purchase $100 billion in direct obligations of Fannie Mae, Freddie Mac and
the FHLBs and $500 billion in agency Mortgage-Backed Securities backed by Fannie
Mae, Freddie Mac and Ginnie Mae. The Federal Reserve stated that its
actions were intended to reduce the cost and increase the availability of credit
for the purchase of houses, and were meant to support housing markets and foster
improved conditions in financial markets more generally. On March 18,
2009, the Federal Reserve increased the size of this program to $200 billion and
$1.25 trillion, respectively. The Federal Reserve has announced
that it intends to wind up this program on March 31, 2010.
The
problems faced by Fannie Mae and Freddie Mac resulting in their being placed
into federal conservatorship have stirred debate among some federal policy
makers regarding the continued role of the U.S. Government in providing
liquidity for mortgage loans. Following expiration of the current
authorization, each of Fannie Mae and Freddie Mac could be dissolved and the
U.S. Government could determine to stop providing liquidity support of any kind
to the mortgage market. The future roles of Fannie Mae and Freddie
Mac could be significantly reduced and the nature of their guarantee obligations
could be considerably limited relative to historical
measurements. Any changes to the nature of their guarantee
obligations could redefine what constitutes a Mortgage-Backed Securities and
could have broad adverse implications for the market and our business,
operations and financial condition. If Fannie Mae or Freddie Mac were
eliminated, or their structures were to change radically (i.e., limitation or
removal of the guarantee obligation), we may be unable to acquire additional
Mortgage-Backed Securities and our existing Mortgage-Backed Securities could be
materially and adversely impacted.
We could
be negatively affected in a number of ways depending on the manner in which
related events unfold for Fannie Mae and Freddie Mac. We rely on our
Mortgage-Backed Securities as collateral for our financings under our repurchase
agreements. Any decline in their value, or perceived market
uncertainty about their value, would make it more difficult for us to obtain
financing on acceptable terms or at all, or to maintain our compliance with the
terms of any financing transactions. Further, the current credit
support provided by the Treasury to Fannie Mae and Freddie Mac, and any
additional credit support it may provide in the future, could have the effect of
lowering the interest rates we expect to receive from Mortgage-Backed
Securities, thereby tightening the spread between the interest we earn on our
Mortgage-Backed Securities and the cost of financing those assets. A
reduction in the supply of Mortgage-Backed Securities could also negatively
affect the pricing of Mortgage-Backed Securities by reducing the spread between
the interest we earn on our portfolio of Mortgage-Backed Securities and our cost
of financing that portfolio.
20
As
indicated above, recent legislation has changed the relationship between Fannie
Mae and Freddie Mac and the U.S. Government and requires Fannie Mae and Freddie
Mac to reduce the amount of mortgage loans they own or for which they provide
guarantees on Mortgage-Backed Securities. Future legislation could
further change the relationship between Fannie Mae and Freddie Mac and the U.S.
Government, and could also nationalize or eliminate such entities
entirely. Any law affecting these GSEs may create market uncertainty
and have the effect of reducing the actual or perceived credit quality of
securities issued or guaranteed by Fannie Mae or Freddie Mac. As a
result, such laws could increase the risk of loss on investments in
Mortgage-Backed Securities guaranteed by Fannie Mae and/or Freddie
Mac. It also is possible that such laws could adversely impact the
market for such securities and spreads at which they trade. All of
the foregoing could materially and adversely affect our business, operations and
financial condition.
Mortgage
loan modification programs, future legislative action and changes in the
requirements necessary to qualify for refinancing a mortgage with Fannie Mae,
Freddie Mac or Ginnie Mae may adversely affect the value of, and the returns on,
the assets in which we invest.
During
the second half of 2008, in 2009, and so far in 2010, the U.S. government,
through the Federal Housing Administration, or FHA, and the FDIC, implemented
programs designed to provide homeowners with assistance in avoiding residential
mortgage loan foreclosures including the Hope for Homeowners Act of 2008, which
allows certain distressed borrowers to refinance their mortgages into
FHA-insured loans. The programs may also involve, among other things,
the modification of mortgage loans to reduce the principal amount of the loans
or the rate of interest payable on the loans, or to extend the payment terms of
the loans. Members of the U.S. Congress have indicated support for
additional legislative relief for homeowners, including an amendment of the
bankruptcy laws to permit the modification of mortgage loans in bankruptcy
proceedings. These loan modification programs, future legislative or
regulatory actions, including amendments to the bankruptcy laws, that result in
the modification of outstanding mortgage loans, as well as changes in the
requirements necessary to qualify for refinancing a mortgage with Fannie Mae,
Freddie Mac or Ginnie Mae may adversely affect the value of, and the returns on,
our Investment Securities. Depending on whether or not we purchased
an instrument at a premium or discount, the yield we receive may be positively
or negatively impacted by any modification.
The
U.S. Government's pressing for refinancing of certain loans may affect
prepayment rates for mortgage loans in Mortgage-Backed Securities.
In
addition to the increased pressure upon residential mortgage loan investors and
servicers to engage in loss mitigation activities, the U.S. Government is
pressing for refinancing of certain loans, and this encouragement may affect
prepayment rates for mortgage loans in Mortgage-Backed Securities. In
connection with government-related securities, in February 2009 President Obama
unveiled the Homeowner Affordability and Stability Plan, which, in part, calls
upon Fannie Mae and Freddie Mac to loosen their eligibility criteria for the
purchase of loans in order to provide access to low-cost refinancing for
borrowers who are current on their mortgage payments but who cannot otherwise
qualify to refinance at a lower market rate. The major change was to
permit an increase in the loan-to-value, or LTV, ratio of a refinancing loan
eligible for sale up to 105%. In July 2009, the FHFA authorized
Fannie Mae and Freddie Mac to raise the present LTV ratio ceiling of 105% to
125%. The charters governing the operations of Fannie Mae and Freddie
Mac prohibit purchases of loans with loan to value ratios in excess of 80%
unless the loans have mortgage insurance (or unless other types of credit
enhancement are provided in accordance with the statutory
requirements). The FHFA, which regulates Fannie Mae and Freddie Mac,
determined that new mortgage insurance will not be required on the refinancing
if the applicable entity already owns the loan or guarantees the related
Mortgage-Backed Securities. Additionally, the Treasury reports that
in some cases a new appraisal will not be necessary upon
refinancing. The Treasury estimates that up to 5,000,000 homeowners
with loans owned or guaranteed by Fannie Mae or Freddie Mac may be eligible for
this refinancing program, which is scheduled to terminate in June
2010.
The HERA
authorized a voluntary FHA mortgage insurance program called HOPE for
Homeowners, or H4H Program, designed to refinance certain delinquent borrowers
into new FHA-insured loans. The H4H Program targets delinquent
borrowers under conventional mortgage loans, as well as under government-insured
or -guaranteed mortgage loans, that were originated on or before January 1,
2008. Holders of existing mortgage loans being refinanced under the
H4H Program must accept a write-down of principal and waive all prepayment
fees. While the use of the program has been extremely limited to
date, Congress continues to amend the program to encourage its
use. The H4H Program is effective through September 30,
2011.
21
To the
extent these and other economic stabilization or stimulus efforts are successful
in increasing prepayment speeds for residential mortgage loans, such as those in
Mortgage-Backed Securities, that could potentially harm our income and operating
results, particularly in connection with loans or Mortgage-Backed Securities
purchased at a premium or our interest-only securities.
The
actions of the U.S. government, Federal Reserve and Treasury, including the
establishment of the TALF and the PPIP, may adversely affect our
business.
The TALF
was first announced by the Treasury on November 25, 2008, and has been expanded
in size and scope since its initial announcement. Under the TALF, the
Federal Reserve Bank of New York makes non-recourse loans to borrowers to fund
their purchase of eligible assets, currently certain asset backed securities but
not residential mortgage-backed securities. The nature of the
eligible assets has been expanded several times. The Treasury has
stated that through its expansion of the TALF, non-recourse loans will be made
available to investors to certain fund purchases of legacy securitization
assets. On March 23, 2009, the Treasury in conjunction with the FDIC,
and the Federal Reserve, announced the PPIP. The PPIP aims to recreate a market
for specific illiquid residential and commercial loans and securities through a
number of joint public and private investment funds. The PPIP is
designed to draw new private capital into the market for these securities and
loans by providing government equity co-investment and attractive public
financing.
It is not
possible to predict how the TALF, the PPIP, or other recent U.S. Government
actions will impact the financial markets, including current significant levels
of volatility, or our current or future investments. To the extent
the market does not respond favorably to these initiatives or they do not
function as intended, our business may not receive any benefits from this
legislation. In addition, the U.S. government, Federal Reserve,
Treasury and other governmental and regulatory bodies have taken or are
considering taking other actions to address the financial crisis. We
cannot predict whether or when such actions may occur, and such actions could
have a dramatic impact on our business, results of operations and financial
condition.
There
can be no assurance that the actions of the U.S. Government, the Federal
Reserve, the Treasury and other governmental and regulatory bodies for the
purpose of stabilizing the financial markets, including the establishment of the
TALF and the PPIP, or market response to those actions, will achieve the
intended effect, that our business will benefit from these actions or that
further government or market developments will not adversely impact
us.
In
response to the financial issues affecting the banking system and the financial
markets and going concern threats to investment banks and other financial
institutions, the U.S. Government, the Federal Reserve, the Treasury and other
governmental and regulatory bodies have taken action to attempt to stabilize the
financial markets. Significant measures include the enactment of the
Economic Stabilization Act of 2008, or the EESA, to, among other things,
establish the Troubled Asset Relief Program, or the TARP; the enactment of the
HERA, which established a new regulator for Fannie Mae and Freddie Mac; the
establishment of the TALF; and the establishment of the PPIP.
There can
be no assurance that the EESA, HERA, TALF, PPIP or other recent U.S. Government
actions will have a beneficial impact on the financial markets, including on
current levels of volatility. To the extent the market does not
respond favorably to these initiatives or these initiatives do not function as
intended, our business may not receive the anticipated positive impact from the
legislation. There can also be no assurance that we will be eligible
to participate in any programs established by the U.S. Government such as the
TALF or the PPIP or, if we are eligible, that we will be able to utilize them
successfully or at all. In addition, because the programs are
designed, in part, to provide liquidity to restart the market for certain of our
targeted assets, the establishment of these programs may result in increased
competition for attractive opportunities in our targeted assets. It
is also possible that our competitors may utilize the programs which would
provide them with attractive debt and equity capital funding from the U.S.
Government. In addition, the U.S. Government, the Federal Reserve, the Treasury
and other governmental and regulatory bodies have taken or are considering
taking other actions to address the financial crisis. We cannot
predict whether or when such actions may occur, and such actions could have a
dramatic impact on our business, results of operations and financial
condition.
22
We
operate in a highly competitive market for investment opportunities and
competition may limit our ability to acquire desirable investments in our target
assets and could also affect the pricing of these securities.
We
operate in a highly competitive market for investment
opportunities. Our profitability depends, in large part, on our
ability to acquire our target assets at attractive prices. In acquiring our
target assets, we will compete with a variety of institutional investors,
including other REITs, specialty finance companies, public and private funds
(including other funds managed by FIDAC), commercial and investment banks,
commercial finance and insurance companies and other financial
institutions. Many of our competitors are substantially larger and
have considerably greater financial, technical, marketing and other resources
than we do. Several other REITs have recently raised, or are expected
to raise, significant amounts of capital, and may have investment objectives
that overlap with ours, which may create additional competition for investment
opportunities. Some competitors may have a lower cost of funds and
access to funding sources that may not be available to us, such as funding from
the U.S. Government, if we are not eligible to participate in programs
established by the U.S. Government. Many of our competitors are not
subject to the operating constraints associated with REIT tax compliance or
maintenance of an exemption from the Investment Company Act. In
addition, some of our competitors may have higher risk tolerances or different
risk assessments, which could allow them to consider a wider variety of
investments and establish more relationships than us. Furthermore,
competition for investments in our target assets may lead to the price of such
assets increasing, which may further limit our ability to generate desired
returns. We cannot assure you that the competitive pressures we face
will not have a material adverse effect on our business, financial condition and
results of operations. Also, as a result of this competition,
desirable investments in our target assets may be limited in the future and we
may not be able to take advantage of attractive investment opportunities from
time to time, as we can provide no assurance that we will be able to identify
and make investments that are consistent with our investment
objectives.
Risks
Related to Our Business
An
increase in the interest payments on our borrowings relative to the interest we
earn on our investment securities may adversely affect our
profitability
We earn
money based upon the spread between the interest payments we earn on our
investment securities and the interest payments we must make on our
borrowings. If the interest payments on our borrowings increase
relative to the interest we earn on our investment securities, our profitability
may be adversely affected. The interest payments on our borrowings
may increase relative to the interest we earn on our adjustable-rate investment
securities for various reasons discussed in this section.
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Differences
in timing of interest rate adjustments on our investment securities and
our borrowings may adversely affect our
profitability
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We rely
primarily on short-term borrowings to acquire investment securities with
long-term maturities. Accordingly, if short-term interest rates
increase, this may adversely affect our profitability.
Most of
the investment securities we acquire are adjustable-rate
securities. This means that their interest rates may vary over time
based upon changes in an objective index, such as:
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LIBOR
. The
interest rate that banks in London offer for deposits in London of U.S.
dollars.
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Treasury
Rate
. A monthly or weekly average yield of benchmark
U.S. Treasury securities, as published by the Federal Reserve
Board.
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CD Rate
. The
weekly average of secondary market interest rates on six-month negotiable
certificates of deposit, as published by the Federal Reserve
Board.
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These
indices generally reflect short-term interest rates. On December 31,
2009, approximately 26%
of our investment
securities were adjustable-rate securities.
23
The
interest rates on our borrowings similarly vary with changes in an objective
index. Nevertheless, the interest rates on our borrowings generally
adjust more frequently than the interest rates on our adjustable-rate investment
securities. For example, on December 31, 2009, our adjustable-rate
investment securities had a weighted average term to next rate adjustment of 33
months, while our borrowings had a weighted average term to next rate adjustment
of 170 days. Accordingly, in a period of rising interest rates, we
could experience a decrease in net income or a net loss because the interest
rates on our borrowings adjust faster than the interest rates on our
adjustable-rate investment securities.
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Interest
rate caps on our investment securities may adversely affect our
profitability
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Our
adjustable-rate investment securities are typically subject to periodic and
lifetime interest rate caps. Periodic interest rate caps limit the amount an
interest rate can increase during any given period. Lifetime interest
rate caps limit the amount an interest rate can increase through maturity of an
investment security. Our borrowings are not subject to similar
restrictions. Accordingly, in a period of rapidly increasing interest
rates, we could experience a decrease in net income or experience a net loss
because the interest rates on our borrowings could increase without limitation
while the interest rates on our adjustable-rate investment securities would be
limited by caps.
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Because we
acquire fixed-rate securities, an increase in interest rates may adversely
affect our profitability
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In a
period of rising interest rates, our interest payments could increase while the
interest we earn on our fixed-rate mortgage-backed securities would not
change. This would adversely affect our profitability. On
December 31, 2009, approximately 74%
of our investment
securities were fixed-rate securities.
An
increase in prepayment rates may adversely affect our profitability
The
mortgage-backed securities we acquire are backed by pools of mortgage
loans. We receive payments, generally, from the payments that are
made on these underlying mortgage loans. When borrowers prepay their
mortgage loans at rates that are faster than expected, this results in
prepayments that are faster than expected on the mortgage-backed
securities. These faster than expected prepayments may adversely
affect our profitability. We often purchase mortgage-backed
securities that have a higher interest rate than the market interest rate at the
time. In exchange for this higher interest rate, we must pay a
premium over the market value to acquire the security. In accordance
with accounting rules, we amortize this premium over the term of the
mortgage-backed security. If the mortgage-backed security is prepaid
in whole or in part prior to its maturity date, however, we must expense all or
a part of the remaining unamortized portion of the premium that was prepaid at
the time of the prepayment. This adversely affects our
profitability.
Prepayment
rates generally increase when interest rates fall and decrease when interest
rates rise, but changes in prepayment rates are difficult to
predict. Prepayment rates also may be affected by conditions in the
housing and financial markets, general economic conditions and the relative
interest rates on fixed-rate and adjustable-rate mortgage loans.
We often
purchase mortgage-backed securities that have a higher coupon rate than the
prevailing market interest rates. In exchange for a higher coupon
rate, we typically pay a premium over par value to acquire these mortgage-backed
securities. In accordance with generally accepted accounting
principles (or GAAP), we amortize the premiums on our mortgage-backed securities
over the life of the related mortgage-backed securities. If the
mortgage loans securing these mortgage-backed securities prepay at a more rapid
rate than anticipated, we will have to amortize our premiums on an accelerated
basis which may adversely affect our profitability. Defaults on
mortgage loans underlying Agency mortgage-backed securities typically have the
same effect as prepayments because of the underlying Agency
guarantee. On February 10, 2010, Fannie Mae and Freddie Mac announced
their intention to significantly increase their purchases of delinquent loans
from the pools of mortgages collateralizing their Agency mortgage-backed
securities beginning in March 2010, which could materially impact the rate of
principal prepayments on our Agency mortgage-backed securities guaranteed by
Fannie Mae and Freddie Mac. As of December 31, 2009, we had net purchase
premiums of $1.2 billion, or 2.0% of current par value, on our Agency
mortgage-backed securities.
We may
seek to reduce prepayment risk by acquiring mortgage-backed securities at a
discount. If a discounted security is prepaid in whole or in part
prior to its maturity date, we will earn income equal to the amount of the
remaining discount. This will improve our profitability if the
discounted securities are prepaid faster than expected.
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We also
can acquire mortgage-backed securities that are less affected by
prepayments. For example, we can acquire CMOs, a type of
mortgage-backed security. CMOs divide a pool of mortgage loans into
multiple tranches that allow for shifting of prepayment risks from slower-paying
tranches to faster-paying tranches. This is in contrast to
pass-through or pay-through mortgage-backed securities, where all investors
share equally in all payments, including all prepayments. As
discussed below, the Investment Company Act of 1940 imposes restrictions on our
purchase of CMOs. As of December 31, 2009, approximately 21%
of our mortgage-backed
securities were CMOs and approximately 79%
of our mortgage-backed
securities were pass-through or pay-through securities.
While we
seek to minimize prepayment risk to the extent practical, in selecting
investments we must balance prepayment risk against other risks and the
potential returns of each investment. No strategy can completely
insulate us from prepayment risk.
An
increase in interest rates may adversely affect our book value
Increases
in interest rates may negatively affect the market value of our investment
securities. Our fixed-rate securities, generally, are more negatively
affected by these increases. In accordance with accounting rules, we
reduce our book value by the amount of any decrease in the market value of our
investment securities.
Failure
to procure funding on favorable terms, or at all, would adversely affect our
results and may, in turn, negatively affect the market price of shares of our
common stock.
The
current dislocation and weakness in the broader mortgage markets could adversely
affect one or more of our potential lenders and could cause one or more of our
potential lenders to be unwilling or unable to provide us with
financing. This could potentially increase our financing costs and
reduce our liquidity. If one or more major market participants fails
or otherwise experiences a major liquidity crisis, as was the case for Bear
Stearns & Co. in March 2008 and Lehman Brothers Holdings Inc. in September
2008, it could negatively impact the marketability of all fixed income
securities, including Agency RMBS, and this could negatively impact the value of
the securities we acquire, thus reducing our net 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 assets at an inopportune time when prices are
depressed.
Our
strategy involves significant leverage
We seek
to maintain a ratio of debt-to-equity of between 8:1 and 12:1, although our
ratio may at times be above or below this amount. We incur this
leverage by borrowing against a substantial portion of the market value of our
investment securities. By incurring this leverage, we can enhance our
returns. Nevertheless, this leverage, which is fundamental to our
investment strategy, also creates significant risks.
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Our
leverage may cause substantial
losses
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Because
of our significant leverage, we may incur substantial losses if our borrowing
costs increase. Our borrowing costs may increase for any of the
following reasons:
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short-term
interest rates increase;
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the
market value of our investment securities
decreases;
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interest
rate volatility increases; or
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the
availability of financing in the market
decreases.
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Our
leverage may cause margin calls and defaults and force us to sell assets
under adverse market
conditions
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Because
of our leverage, a decline in the value of our investment securities may result
in our lenders initiating margin calls. A margin call means that the
lender requires us to pledge additional collateral to re-establish the ratio of
the value of the collateral to the amount of the borrowing. Our
fixed-rate mortgage-backed securities generally are more susceptible to margin
calls as increases in interest rates tend to more negatively affect the market
value of fixed-rate securities.
If we are
unable to satisfy margin calls, our lenders may foreclose on our
collateral. This could force us to sell our investment securities
under adverse market conditions. Additionally, in the event of our
bankruptcy, our borrowings, which are generally made under repurchase
agreements, may qualify for special treatment under the Bankruptcy
Code. This special treatment would allow the lenders under these
agreements to avoid the automatic stay provisions of the Bankruptcy Code and to
liquidate the collateral under these agreements without delay.
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Liquidation
of collateral may jeopardize our REIT
status
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To
continue to qualify as a REIT, we must comply with requirements regarding our
assets and our sources of income. If we are compelled to liquidate
our investment securities, we may be unable to comply with these requirements,
ultimately jeopardizing our status as a REIT and our failure to qualify as a
REIT will have adverse tax consequences.
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We may
exceed our target leverage
ratios
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We seek
to maintain a ratio of debt-to-equity of between 8:1 and
12:1. However, we are not required to stay within this leverage
ratio. If we exceed this ratio, the adverse impact on our financial
condition and results of operations from the types of risks described in this
section would likely be more severe.
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We may not
be able to achieve our optimal
leverage
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We use
leverage as a strategy to increase the return to our
investors. However, we may not be able to achieve our desired
leverage for any of the following reasons:
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we
determine that the leverage would expose us to excessive
risk;
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our
lenders do not make funding available to us at acceptable rates;
or
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our
lenders require that we provide additional collateral to cover our
borrowings.
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We may
incur increased borrowing costs which would adversely affect our
profitability
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Currently,
all of our collateralized borrowings are collateralized borrowings in the form
of repurchase agreements. If the interest rates on these repurchase
agreements increase, it would adversely affect our profitability.
Our
borrowing costs under repurchase agreements generally correspond to short-term
interest rates such as LIBOR or a short-term Treasury index, plus or minus a
margin. The margins on these borrowings over or under short-term
interest rates may vary depending upon:
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the
movement of interest rates;
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the
availability of financing in the market;
or
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the
value and liquidity of our investment
securities.
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If
we are unable to renew our borrowings at favorable rates, our profitability may
be adversely affected
Since we
rely primarily on short-term borrowings, our ability to achieve our investment
objectives depends not only on our ability to borrow money in sufficient amounts
and on favorable terms, but also on our ability to renew or replace on a
continuous basis our maturing short-term borrowings. If we are not
able to renew or replace maturing borrowings, we would have to sell our assets
under possibly adverse market conditions.
26
If
a counterparty to our repurchase transactions defaults on its obligation to
resell the underlying security back to us at the end of the transaction term, or
if the value of the underlying security has declined as of the end of that term,
or if we default on our obligations under the repurchase agreement, we will lose
money on our repurchase transactions.
When
we engage in repurchase transactions, we generally sell securities to lenders
(repurchase agreement counterparties) and receive cash from these
lenders. The lenders are obligated to resell the same securities back
to us at the end of the term of the transaction. 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 (this difference is the haircut), if the
lender defaults on its obligation to resell the same securities back to us, we
may incur a loss on the transaction equal to the amount of the haircut (assuming
there was no change in the value of the securities). We would also
lose money on a repurchase transaction if the value of the underlying securities
has declined as of the end of the transaction term, as we would have to
repurchase the securities for their initial value but would receive securities
worth less than that amount. Further, if we default on one of our
obligations under a repurchase transaction, the lender can terminate the
transaction and cease entering into any other repurchase transactions with
us. Repurchase agreements generally contain cross-default provisions,
so that if a default occurs under any one agreement, the lenders under our other
agreements could also declare a default. Any losses we incur on our
repurchase transactions could adversely affect our earnings and thus our cash
available for distribution to shareholders.
Any
repurchase agreements that we use to finance our assets may require us to
provide additional collateral or pay down debt.
Our
repurchase agreements involve the risk that the market value of the securities
pledged or sold by us to the repurchase agreement counterparty may decline in
value, in which case the counterparty may require us to provide additional
collateral or to repay all or a portion of the funds advanced. We may
not have additional collateral or the funds available to repay our debt at that
time, which would likely result in defaults unless we are able to raise the
funds from alternative sources, which we may not be able to achieve on favorable
terms or at all. Posting additional collateral would reduce our
liquidity and limit our ability to leverage our assets. If we cannot
meet these requirements, the counterparty could accelerate its indebtedness,
increase the interest rate on advanced funds and terminate our ability to borrow
funds from them, which could materially and adversely affect our financial
condition and ability to implement our investment strategy. In
addition, in the event that the counterparty files for bankruptcy or becomes
insolvent, our securities may become subject to bankruptcy or insolvency
proceedings, thus depriving us, at least temporarily, of the benefit of these
assets. Such an event could restrict our access to bank credit
facilities and increase its cost of capital. Repurchase agreement
counterparties may also require us to maintain a certain amount of cash or set
aside assets sufficient to maintain a specified liquidity position that would
enhance our ability to satisfy its collateral obligations. As a
result, we may not be able to leverage our assets as fully as we would choose,
which could reduce our return on assets. In the event that we are
unable to meet these collateral obligations, our financial condition and
prospects could deteriorate rapidly.
Our
hedging strategies expose us to risks
Our
policies permit us to enter into interest rate swaps, caps and floors and other
derivative transactions to help us mitigate our interest rate and prepayment
risks described above. We have used interest rate swaps and interest rate
caps to provide a level of protection against interest rate risks, but no
hedging strategy can protect us completely. 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 protection is sought; and the
duration of the hedge may not match the duration of the related
liability.
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Our hedging
strategies may not be successful in mitigating the risks associated with
interest rates
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We cannot
assure you that our use of derivatives will offset the risks related to changes
in interest rates. It is likely that there will be periods in the future during
which we will incur losses on our derivative financial instruments that will not
be fully offset by gains on our portfolio. The derivative financial
instruments we select may not have the effect of reducing our interest rate
risk. In addition, the nature and timing of hedging transactions may
influence the effectiveness of these strategies. Poorly designed
strategies or improperly executed transactions could significantly increase our
risk and lead to material losses. In addition, hedging strategies
involve transaction and other costs. Our hedging strategy and the
derivatives that we use may not adequately offset the risk of interest rate
volatility or that our hedging transactions may not result in
losses.
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Our use of
derivatives may expose us to counterparty
risks
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We enter
into interest rate swap and cap agreements to hedge risks associated with
movements in interest rates. If a swap counterparty cannot perform under
the terms of an interest rate swap, we would not receive payments due under that
agreement, we may lose any unrealized gain associated with the interest rate
swap, and the hedged liability would cease to be hedged by the interest rate
swap. We may also be at risk for any collateral we have pledged to secure
our obligations under the interest rate swap if the counterparty become
insolvent or file for bankruptcy. Similarly, if a cap counterparty fails
to perform under the terms of the cap agreement, in addition to not receiving
payments due under that agreement that would off-sets our interest expense, we
would also incur a loss for all remaining unamortized premium paid for that
agreement.
We
may face risks of investing in inverse floating rate securities
We may
invest in inverse floaters. The returns on inverse floaters are
inversely related to changes in an interest rate. Generally, income
on inverse floaters will decrease when interest rates increase and increase when
interest rates decrease. Investments in inverse floaters may subject
us to the risks of reduced or eliminated interest payments and losses of
principal. In addition, certain indexed securities and inverse
floaters may increase or decrease in value at a greater rate than the underlying
interest rate, which effectively leverages our investment in such
securities. As a result, the market value of such securities will
generally be more volatile than that of fixed rate securities.
Our
investment strategy may involve credit risk
We may
incur losses if there are payment defaults under our investment
securities.
To date,
substantially all of our mortgage-backed securities have been agency
certificates and agency debentures which, although not rated, carry an implied
“AAA” rating. Agency certificates are mortgage pass-through
certificates where Freddie Mac, Fannie Mae or Ginnie Mae guarantees payments of
principal and interest on the certificates. Agency debentures are
debt instruments issued by Freddie Mac, Fannie Mae, or the FHLB.
Even
though we have only acquired “AAA” securities so far, pursuant to our capital
investment policy, we have the ability to acquire securities of lower credit
quality. Under our policy:
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75%
of our total assets must be high quality mortgage-backed securities and
short-term investments. High quality securities are securities
(1) that are rated within one of the two highest rating categories by
at least one of the nationally recognized rating agencies, (2) that
are unrated but are guaranteed by the United States government or an
agency of the United States government, or (3) that are unrated or whose
ratings have not been updated but that our management determines are of
comparable quality to rated high quality mortgage-backed
securities;
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the
remaining 25% of total assets, may consist of mortgage-backed securities
and other qualified REIT real estate assets which are unrated or rated
less than high quality, but which are at least “investment grade” (rated
“BBB” or better by Standard & Poor’s Corporation (“S&P”) or the
equivalent by another nationally recognized rating organization) or, if
not rated, we determine them to be of comparable credit quality to an
investment which is rated “BBB” or better. In addition, we may
directly or indirectly invest part of this remaining 25% of our assets in
other types of securities, including without limitation, unrated debt,
equity or derivative securities, to the extent consistent with our REIT
qualification requirements. The derivative securities in which
we invest may include securities representing the right to receive
interest only or a disproportionately large amount of interest, as well as
inverse floaters, which may have imbedded leverage as part of their
structural characteristics; and
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We
seek to structure our portfolio to maintain a minimum weighted average
rating (including our deemed comparable ratings for unrated
mortgage-backed securities) of our mortgage-backed securities of at least
single “A” under the S&P rating system and at the comparable level
under the other rating systems.
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If we
acquire securities of lower credit quality, we may incur losses if there are
defaults under those securities or if the rating agencies downgrade the credit
quality of those securities.
We
have not established a minimum dividend payment level
We intend
to pay quarterly dividends and to make distributions to our stockholders in
amounts such that all or substantially all of our taxable income in each year
(subject to certain adjustments) is distributed. This enables us to
qualify for the tax benefits accorded to a REIT under the Code. We
have not established a minimum dividend payment level and our ability to pay
dividends may be adversely affected for the reasons described in this
section. All distributions will be made at the discretion of our
board of directors and will depend on our earnings, our financial condition,
maintenance of our REIT status and such other factors as our board of directors
may deem relevant from time to time.
Because
of competition, we may not be able to acquire mortgage-backed securities at
favorable yields
Our net
income depends, in large part, on our ability to acquire mortgage-backed
securities at favorable spreads over our borrowing costs. In
acquiring mortgage-backed securities, we compete with other REITs, investment
banking firms, savings and loan associations, banks, insurance companies, mutual
funds, other lenders and other entities that purchase mortgage-backed
securities, many of which have greater financial resources than
us. As a result, in the future, we may not be able to acquire
sufficient mortgage-backed securities at favorable spreads over our borrowing
costs.
We
are dependent on our key personnel
We are
dependent on the efforts of our key officers and employees, including Michael A.
J. Farrell, our Chairman of the board of directors, Chief Executive Officer and
President, Wellington J. Denahan-Norris, our Vice Chairman, Chief Operating
Officer and Chief Investment Officer, and Kathryn F. Fagan, our Chief Financial
Officer and Treasurer. The loss of any of their services could have
an adverse effect on our operations. Although we have employment agreements with
each of them, we cannot assure you they will remain employed with
us.
We
and our shareholders are subject to certain tax risks
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Our failure
to qualify as a REIT would have adverse tax
consequences
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We
believe that since 1997 we have qualified for taxation as a REIT for federal
income tax purposes. We plan to continue to meet the requirements for
taxation as a REIT. The determination that we are a REIT requires an
analysis of various factual matters and circumstances that may not be totally
within our control. For example, to qualify as a REIT, at least 75%
of our gross income must come from real estate sources and 95% of our gross
income must come from real estate sources and certain other sources that are
itemized in the REIT tax laws. We are also required to distribute to
stockholders at least 90% of our REIT taxable income (determined without regard
to the deduction for dividends paid and by excluding any net capital
gain). Even a technical or inadvertent mistake could jeopardize our
REIT status. Furthermore, Congress and the Internal Revenue Service
(or IRS) might make changes to the tax laws and regulations, and the courts
might issue new rulings that make it more difficult or impossible for us to
remain qualified as a REIT.
29
If we
fail to qualify as a REIT, we would be subject to federal income tax at regular
corporate rates. Also, unless the IRS granted us relief under certain
statutory provisions, we would remain disqualified as a REIT for four years
following the year we first fail to qualify. If we fail to qualify as
a REIT, we would have to pay significant income taxes and would therefore have
less money available for investments or for distributions to our
stockholders. This would likely have a significant adverse effect on
the value of our securities. In addition, the tax law would no longer
require us to make distributions to our stockholders.
A REIT
that fails the quarterly asset tests for one or more quarters will not lose its
REIT status as a result of such failure if either (i) the failure is regarded as
a de minimis failure under standards set out in the Internal Revenue Code, or
(ii) the failure is greater than a de minimis failure but is attributable to
reasonable cause and not willful neglect. In the case of a greater
than de minimis failure, however, the REIT must pay a tax and must remedy the
failure within 6 months of the close of the quarter in which the failure was
identified. In addition, the Internal Revenue Code provides relief
for failures of other tests imposed as a condition of REIT qualification, as
long as the failures are attributable to reasonable cause and not willful
neglect. A REIT would be required to pay a penalty of $50,000,
however, in the case of each failure.
|
|
·
|
We have
certain distribution
requirements
|
As a
REIT, we must distribute at least 90% of our REIT taxable income (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain). The required distribution limits the amount we have
available for other business purposes, including amounts to fund our
growth. Also, it is possible that because of the differences between
the time we actually receive revenue or pay expenses and the period we report
those items for distribution purposes, we may have to borrow funds on a
short-term basis to meet the 90% distribution requirement.
|
|
·
|
We are also
subject to other tax
liabilities
|
Even if
we qualify as a REIT, we may be subject to certain federal, state and local
taxes on our income and property. Any of these taxes would reduce our
operating cash flow.
|
|
·
|
Limits on
ownership of our common stock could have adverse consequences to you and
could limit your opportunity to receive a premium on our
stock
|
To
maintain our qualification as a REIT for federal income tax purposes, not more
than 50% in value of the outstanding shares of our capital stock may be owned,
directly or indirectly, by five or fewer individuals (as defined in the federal
tax laws to include certain entities). Primarily to facilitate
maintenance of our qualification as a REIT for federal income tax purposes, our
charter will prohibit ownership, directly or by the attribution provisions of
the federal tax laws, by any person of more than 9.8% of the lesser of the
number or value of the issued and outstanding shares of our common stock and
will prohibit ownership, directly or by the attribution provisions of the
federal tax laws, by any person of more than 9.8% of the lesser of the number or
value of the issued and outstanding shares of any class or series of our
preferred stock. Our board of directors, in its sole and absolute
discretion, may waive or modify the ownership limit with respect to one or more
persons who would not be treated as “individuals” for purposes of the federal
tax laws if it is satisfied, based upon information required to be provided by
the party seeking the waiver and upon an opinion of counsel satisfactory to the
board of directors, that ownership in excess of this limit will not otherwise
jeopardize our status as a REIT for federal income tax purposes.
The
ownership limit may have the effect of delaying, deferring or preventing a
change in control and, therefore, could adversely affect our shareholders’
ability to realize a premium over the then-prevailing market price for our
common stock in connection with a change in control.
30
|
|
·
|
A REIT
cannot invest more than 25% of its total assets in the stock or securities
of one or more taxable REIT subsidiaries; therefore, our taxable
subsidiaries cannot constitute more than 25% of our total
assets
|
A taxable
REIT subsidiary is a corporation, other than a REIT or a qualified REIT
subsidiary, in which a REIT owns stock and which elects taxable REIT subsidiary
status. The term also includes a corporate subsidiary in which the
taxable REIT subsidiary owns more than a 35% interest. A REIT may own
up to 100% of the stock of one or more taxable REIT subsidiaries. A
taxable REIT subsidiary may earn income that would not be qualifying income if
earned directly by the parent REIT. Overall, at the close of any
calendar quarter, no more than 25% of the value of a REIT’s assets may consist
of stock or securities of one or more taxable REIT subsidiaries.
The stock
and securities of our taxable REIT subsidiaries are expected to represent less
than 25% of the value of our total assets. Furthermore, we intend to
monitor the value of our investments in the stock and securities of our taxable
REIT subsidiaries to ensure compliance with the above-described 25%
limitation. We cannot assure you, however, that we will always be
able to comply with the 25% limitation so as to maintain REIT
status.
|
|
·
|
Taxable
REIT subsidiaries are subject to tax at the regular corporate rates, are
not required to distribute dividends, and the amount of dividends a
taxable REIT subsidiary can pay to its parent REIT may be limited by REIT
gross income tests
|
A taxable
REIT subsidiary must pay income tax at regular corporate rates on any income
that it earns. Our taxable REIT subsidiaries will pay corporate
income tax on their taxable income, and their after-tax net income will be
available for distribution to us. Such income, however, is not
required to be distributed.
Moreover,
the annual gross income tests that must be satisfied to ensure REIT
qualification may limit the amount of dividends that we can receive from our
taxable REIT subsidiaries and still maintain our REIT
status. Generally, not more than 25% of our gross income can be
derived from non-real estate related sources, such as dividends from a taxable
REIT subsidiary. If, for any taxable year, the dividends we received
from our taxable REIT subsidiaries, when added to our other items of non-real
estate related income, represented more than 25% of our total gross income for
the year, we could be denied REIT status, unless we were able to demonstrate,
among other things, that our failure of the gross income test was due to
reasonable cause and not willful neglect.
The
limitations imposed by the REIT gross income tests may impede our ability to
distribute assets from our taxable REIT subsidiaries to us in the form of
dividends. Certain asset transfers may, therefore, have to be
structured as purchase and sale transactions upon which our taxable REIT
subsidiaries recognize taxable gain.
|
|
·
|
If interest
accrues on indebtedness owed by a taxable REIT subsidiary to its parent
REIT at a rate in excess of a commercially reasonable rate, or if
transactions between a REIT and a taxable REIT subsidiary are entered into
on other than arm’s-length terms, the REIT may be subject to a penalty
tax
|
If
interest accrues on an indebtedness owed by a taxable REIT subsidiary to its
parent REIT at a rate in excess of a commercially reasonable rate, the REIT is
subject to tax at a rate of 100% on the excess of (i) interest payments made by
a taxable REIT subsidiary to its parent REIT over (ii) the amount of interest
that would have been payable had interest accrued on the indebtedness at a
commercially reasonable rate. A tax at a rate of 100% is also imposed
on any transaction between a taxable REIT subsidiary and its parent REIT to the
extent the transaction gives rise to deductions to the taxable REIT subsidiary
that are in excess of the deductions that would have been allowable had the
transaction been entered into on arm’s-length terms. We will
scrutinize all of our transactions with our taxable REIT subsidiaries in an
effort to ensure that we do not become subject to these taxes. We may
not be able to avoid application of these taxes.
31
Risks
of Ownership of Our Common Stock
We
may change our policies without stockholder approval
Our board
of directors and management determine all of our policies, including our
investment, financing and distribution policies. They may amend or revise these
policies at any time without a vote of our stockholders. Policy changes could
adversely affect our financial condition, results of operations, the market
price of our common stock or our ability to pay dividends or
distributions.
Our
governing documents and Maryland law impose limitations on the acquisition of
our common stock and changes in control that could make it more difficult for a
third party to acquire us
Maryland Business
Combination Act
The
Maryland General Corporation Law establishes special requirements for “business
combinations” between a Maryland corporation and “interested stockholders”
unless exemptions are applicable. An interested stockholder is any
person who beneficially owns 10% or more of the voting power of our
then-outstanding voting stock. Among other things, the law prohibits
for a period of five years a merger and other similar transactions between us
and an interested stockholder unless the board of directors approved the
transaction prior to the party’s becoming an interested
stockholder. The five-year period runs from the most recent date on
which the interested stockholder became an interested
stockholder. The law also requires a super majority stockholder vote
for such transactions after the end of the five-year period. This
means that the transaction must be approved by at least:
|
|
·
|
80%
of the votes entitled to be cast by holders of outstanding voting shares;
and
|
|
|
·
|
two-thirds
of the votes entitled to be cast by holders of outstanding voting shares
other than shares held by the interested stockholder or an affiliate of
the interested stockholder with whom the business combination is to be
effected.
|
As
permitted by the Maryland General Corporation Law, we have elected not to be
governed by the Maryland business combination statute. We made this
election by opting out of this statute in our articles of
incorporation. If, however, we amend our articles of incorporation to
opt back in to the statute, the business combination statute could have the
effect of discouraging offers to acquire us and of increasing the difficulty of
consummating any such offers, even if our acquisition would be in our
stockholders’ best interests.
Maryland
Control
Share Acquisition Act
Maryland
law provides that “control shares” of a Maryland corporation acquired in a
“control share acquisition” have no voting rights except to the extent approved
by a vote of the stockholders. Two-thirds of the shares eligible to
vote must vote in favor of granting the “control shares” voting
rights. “Control shares” are shares of stock that, taken together
with all other shares of stock the acquirer previously acquired, would entitle
the acquirer to exercise voting power in electing directors within one of the
following ranges of voting power:
|
|
·
|
One-tenth
or more but less than one third of all voting
power;
|
|
|
·
|
One-third
or more but less than a majority of all voting power;
or
|
|
|
·
|
A
majority or more of all voting
power.
|
Control
shares do not include shares of stock the acquiring person is entitled to vote
as a result of having previously obtained stockholder approval. A
“control share acquisition” means the acquisition of control shares, subject to
certain exceptions.
If a
person who has made (or proposes to make) a control share acquisition satisfies
certain conditions (including agreeing to pay expenses), he may compel our board
of directors to call a special meeting of stockholders to consider the voting
rights of the shares. If such a person makes no request for a
meeting, we have the option to present the question at any stockholders’
meeting.
32
If voting
rights are not approved at a meeting of stockholders then, subject to certain
conditions and limitations, we may redeem any or all of the control shares
(except those for which voting rights have previously been approved) for fair
value. We will determine the fair value of the shares, without regard
to voting rights, as of the date of either:
|
|
·
|
the
last control share acquisition; or
|
|
|
·
|
the
meeting where stockholders considered and did not approve voting rights of
the control shares.
|
If voting
rights for control shares are approved at a stockholders’ meeting and the
acquirer becomes entitled to vote a majority of the shares of stock entitled to
vote, all other stockholders may obtain rights as objecting stockholders and,
thereunder, exercise appraisal rights. This means that you would be
able to force us to redeem your stock for fair value. Under Maryland
law, the fair value may not be less than the highest price per share paid in the
control share acquisition. Furthermore, certain limitations otherwise
applicable to the exercise of dissenters’ rights would not apply in the context
of a control share acquisition. The control share acquisition statute
would not apply to shares acquired in a merger, consolidation or share exchange
if we were a party to the transaction. The control share acquisition
statute could have the effect of discouraging offers to acquire us and of
increasing the difficulty of consummating any such offers, even if our
acquisition would be in our stockholders’ best interests.
The
market price and trading volume of our shares of common stock may be volatile
and issuances of large amounts of shares of our common stock could cause the
market price of our common stock to decline.
As of
February 22, 2010, 553,156,865 shares of our common stock were outstanding. If
we issue a significant number of shares of common stock or securities
convertible into common stock in a short period of time, there could be a
dilution of the existing common stock and a decrease in the market price of the
common stock.
The
market price of our shares of common stock may be highly volatile and could be
subject to wide fluctuations. In addition, the trading volume in our shares of
common stock may fluctuate and cause significant price variations to occur. We
cannot assure you that the market price of our shares of common stock will not
fluctuate or decline significantly in the future. Some of the factors that could
negatively affect our share price or result in fluctuations in the price or
trading volume of our shares of common stock include those set forth under
“Special Note Regarding Forward-Looking Statements” as well as:
·
actual
or anticipated variations in our quarterly operating results or business
prospects;
|
|
·
|
changes
in our earnings estimates or publication of research reports about us or
the real estate industry;
|
·
an
inability to meet or exceed securities analysts' estimates or
expectations;
·
increases
in market interest rates;
·
hedging
or arbitrage trading activity in our shares of common stock;
·
capital
commitments;
·
changes
in market valuations of similar companies;
·
adverse
market reaction to any increased indebtedness we incur in the
future;
·
additions
or departures of management personnel;
33
·
actions
by institutional shareholders;
·
speculation
in the press or investment community;
·
changes
in our distribution policy;
·
general
market and economic conditions; and
|
|
·
|
future
sales of our shares of common stock or securities convertible into, or
exchangeable or exercisable for, our shares of common
stock.
|
Holders
of our shares of common stock will be subject to the risk of volatile market
prices and wide fluctuations in the market price of our shares of common
stock. In addition, many of the factors listed above are beyond our
control. These factors may cause the market price of our shares of common stock
to decline, regardless of our financial condition, results of operations,
business or prospects. It is impossible to assure you that the market prices of
our shares of common stock will not fall in the future.
The
repurchase right in our Convertible Senior Notes triggered by a fundamental
change could discourage a potential acquiror
If we
undergo certain fundamental changes, such as the acquisition of 50% of the
voting power of all shares of our common equity entitled to vote generally in
the election of directors, holders of our Convertible Senior Notes may
require us to repurchase all or a portion of their notes at a price equal to
100% of the principal amount of the notes to be purchased plus any accrued and
unpaid interest up to, but excluding, the repurchase date. We will
pay for all notes so repurchased with shares of our common stock using a price
per share equal to the average daily volume-weighted average price of our common
stock for the 20 consecutive trading days ending on the trading day immediately
prior to the occurrence of the fundamental change. The issuance of
these shares of common stock upon certain fundamental changes could discourage a
potential acquiror.
Broad
market fluctuations could negatively impact the market price of our shares of
common stock.
The stock
market has experienced extreme price and volume fluctuations that have affected
the market price of many companies in industries similar or related to ours and
that have been unrelated to these companies' operating performance. These broad
market fluctuations could reduce the market price of our shares of common stock.
Furthermore, our operating results and prospects may be below the expectations
of public market analysts and investors or may be lower than those of companies
with comparable market capitalizations, which could lead to a material decline
in the market price of our shares of common stock.
Regulatory
Risks
Loss
of Investment Company Act exemption would adversely affect us
We intend
to conduct our business so as not to become regulated as an investment company
under the Investment Company Act. If we fail to qualify for this
exemption, our ability to use leverage would be substantially reduced, and we
would be unable to conduct our business as described in this Form
10-K.
We
currently rely on the exemption from registration provided by Section 3(c)(5)(C)
of the Investment Company Act. Section 3(c)(5)(C) as interpreted by
the staff of the SEC, requires us to invest at least 55% of our assets in
“mortgages and other liens on and interest in real estate” (or Qualifying Real
Estate Assets) and at least 80% of our assets in Qualifying Real Estate Assets
plus real estate related assets. The assets that we acquire,
therefore, are limited by the provisions of the Investment Company Act and the
rules and regulations promulgated under the Investment Company
Act. If the SEC determines that any of these securities are not
qualifying interests in real estate or real estate related assets, adopts a
contrary interpretation with respect to these securities or otherwise believes
we do not satisfy the above exceptions, we could be required to restructure our
activities or sell certain of our assets. We may be required at times
to adopt less efficient methods of financing certain of our mortgage assets and
we may be precluded from acquiring certain types of higher yielding mortgage
assets. The net effect of these factors will be to lower our net
interest income. If we fail to qualify for exemption from
registration as an investment company, our ability to use leverage would be
substantially reduced, and we would not be able to conduct our business as
described. Our business will be materially and adversely affected if
we fail to qualify for this exemption.
34
Compliance
with proposed and recently enacted changes in securities laws and regulations
increase our costs
The
Sarbanes-Oxley Act of 2002 and rules and regulations promulgated by the SEC and
the New York Stock Exchange have increased the scope, complexity and cost of
corporate governance, reporting and disclosure practices. We believe
that these rules and regulations will make it more costly for us to obtain
director and officer liability insurance, and we may be required to accept
reduced coverage or incur substantially higher costs to obtain
coverage. These rules and regulations could also make it more
difficult for us to attract and retain qualified members of management and our
board of directors, particularly to serve on our audit committee.
35
ITEM
1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
PROPERTIES
Our
executive and administrative office is located at 1211 Avenue of the Americas,
Suite 2902 New York, New York 10036, telephone 212-696-0100. This
office is leased under a non-cancelable lease expiring December 31,
2015.
ITEM 3.
LEGAL
PROCEEDINGS
From time
to time, we are involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material effect on our
consolidated financial statements.
ITEM 4.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did
not submit any matters to a vote of our stockholders during the fourth quarter
of 2009.
36
PART II
ITEM
5.
MARKET FOR
REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER
PURCHASES OF EQUITY
SECURITIES
Our common stock began trading publicly
on October 8, 1997 and is traded on the New York Stock Exchange under the
trading symbol “NLY.” As of February 22, 2010, we had 553,156,865
shares of common stock issued and outstanding which were held by approximately
317,979 beneficial holders.
The following table sets forth, for the
periods indicated, the high, low, and closing sales prices per share of our
common stock as reported on the New York Stock Exchange composite tape and the
cash dividends declared per share of our common stock.
|
Stock
Prices
|
||||||||||||
|
High
|
Low
|
Close
|
||||||||||
|
First
Quarter ended March 31, 2009
|
$ | 16.29 | $ | 12.07 | $ | 13.87 | ||||||
|
Second
Quarter ended June 30, 2009
|
$ | 15.56 | $ | 13.21 | $ | 15.14 | ||||||
|
Third
Quarter ended September 30, 2009
|
$ | 19.74 | $ | 14.96 | $ | 18.14 | ||||||
|
Fourth
Quarter ended December 31, 2009
|
$ | 18.99 | $ | 16.74 | $ | 17.35 | ||||||
|
High
|
Low
|
Close
|
||||||||||
|
First
Quarter ended March 31, 2008
|
$ | 21.00 | $ | 14.16 | $ | 15.32 | ||||||
|
Second
Quarter ended June 30, 2008
|
$ | 17.95 | $ | 15.51 | $ | 15.51 | ||||||
|
Third
Quarter ended September 30, 2008
|
$ | 17.00 | $ | 12.92 | $ | 13.45 | ||||||
|
Fourth
Quarter ended December 31, 2008
|
$ | 16.12 | $ | 11.21 | $ | 15.87 | ||||||
|
Common
Dividends
|
||||
|
|
Declared
Per Share
|
|||
|
|
||||
|
First
Quarter ended March 31, 2009
|
$ | 0.75 | ||
|
Second
Quarter ended June 30, 2009
|
$ | 0.69 | ||
|
Third
Quarter ended September 30, 2009
|
$ | 0.60 | ||
|
Fourth
Quarter ended December 31, 2009
|
$ | 0.50 | ||
|
First
Quarter ended March 31, 2008
|
$ | 0.48 | ||
|
Second
Quarter ended June 30, 2008
|
$ | 0.55 | ||
|
Third
Quarter ended September 30, 2008
|
$ | 0.55 | ||
|
Fourth
Quarter ended December 31, 2008
|
$ | 0.50 | ||
We intend
to pay quarterly dividends and to distribute to our stockholders all or
substantially all of our taxable income in each year (subject to certain
adjustments). This will enable us to qualify for the tax benefits
accorded to a REIT under the Code. We have not established a minimum
dividend payment level and our ability to pay dividends may be adversely
affected for the reasons described under the caption “Risk
Factors.” All distributions will be made at the discretion of our
board of directors and will depend on our earnings, our financial condition,
maintenance of our REIT status and such other factors as our board of directors
may deem relevant from time to time. No dividends can be paid on our
common stock unless we have paid full cumulative dividends on our preferred
stock. From the date of issuance of our preferred stock through
December 31, 2009, we have paid full cumulative dividends on our preferred
stock.
37
SHARE
PERFORMANCE GRAPH
The following graph and table set forth
certain information comparing the yearly percentage change in cumulative total
return on our common stock to the cumulative total return of the Standard &
Poor’s Composite 500 stock Index or S&P 500 Index, and the Bloomberg REIT
Mortgage Index, or BBG REIT index, an industry index of mortgage
REITs. The comparison is for the period from December 31, 2004 to
December 31, 2009 and assumes the reinvestment of dividends. The
graph and table assume that $100 was invested in our common stock and the two
other indices on December 31, 2004. Upon written request we will
provide stockholders with a list of the REITs included in the BBG REIT
Index.
|
12/31/2004
|
12/30/2005
|
12/29/2006
|
12/31/2007
|
12/31/2008
|
12/31/2009
|
|||||||||||||||||||
|
Annaly
Capital Management
|
100 | 76 | 95 | 124 | 123 | 145 | ||||||||||||||||||
|
S&P
500 Index
|
100 | 116 | 134 | 141 | 92 | 113 | ||||||||||||||||||
|
BBG
REIT Index
|
100 | 108 | 125 | 83 | 65 | 71 | ||||||||||||||||||
The
information in the share performance graph and table has been obtained from
sources believed to be reliable, but neither its accuracy nor its completeness
can be guaranteed. The historical information set forth above is not
necessarily indicative of future performance. Accordingly, we do not
make or endorse any predictions as to future share performance.
38
EQUITY
COMPENSATION PLAN INFORMATION
We have
adopted a long term stock incentive plan for executive officers, key employees
and nonemployee directors (the Incentive Plan). The Incentive Plan
authorizes the Compensation Committee of the board of directors to grant awards,
including incentive stock options as defined under Section 422 of the Code
(ISOs) and options not so qualified (NQSOs). The Incentive Plan
authorizes the granting of options or other awards for an aggregate of the
greater of 500,000 shares or 9.5% of the outstanding shares of our common stock
up to a ceiling of 8,932,921 shares. For a description of our
Incentive Plan, see Note 13 to the Financial Statements.
The
following table provides information as of December 31, 2009 concerning shares
of our common stock authorized for issuance under our existing Incentive
Plan.
|
Plan
Category
|
Number
of securities to be
issued
upon exercise of outstanding options,
warrants
and rights
|
Weighted-average
exercise
price
of outstanding
options,
warrants and
rights
|
Number
of securities
remaining
available for
future
issuance under
Incentive
Plan (excluding previously issued)
|
|||||||||
|
Equity
compensation plans
approved
by security
holders
|
7,271,503 | $ | 15.20 | 166,850 | (1) | |||||||
|
Equity
compensation plans
not
approved by security
holders
|
- | - | - | |||||||||
|
Total
|
7,271,503 | $ | 15.20 | 166,850 | ||||||||
|
(1)
The Incentive Plan authorizes the granting of options or other awards for
an aggregate of the greater of 500,000 or 9.5% of the outstanding shares
on a fully diluted basis of our common stock up to a ceiling of 8,932,921
shares.
|
||||||||||||
39
ITEM
6.
SELECTED FINANCIAL
DATA
The following selected financial data
are derived from our audited financial statements for the years ended December
31, 2009, 2008, 2007, 2006, and 2005. The selected financial data
should be read in conjunction with the more detailed information contained in
the Financial Statements and Notes thereto and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” included elsewhere in
this Form 10-K.
SELECTED
FINANCIAL DATA
(dollars
in thousands, except for per share data)
|
Statement
of Operations Data
|
For
the Year
Ended
December
31,
2009
|
For
the Year
Ended
December
31,
2008
|
For
the Year
Ended
December
31,
2007
|
For
the Year
Ended
December
31,
2006
|
For
the Year
Ended
December
31,
2005
|
|||||||||||||||
|
Interest
income:
|
||||||||||||||||||||
|
Interest
income
|
$ | 2,922,499 | $ | 3,115,428 | $ | 2,355,447 | $ | 1,221,882 | $ | 705,046 | ||||||||||
|
Securities
loaned
|
103 | - | - | - | - | |||||||||||||||
|
Total
interest income
|
2,922,602 | 3,115,428 | 2,355,447 | 1,221,882 | 705,046 | |||||||||||||||
|
Interest
expense:
|
||||||||||||||||||||
|
Repurchase
agreements
|
1,295,670 | 1,888,912 | 1,926,465 | 1,055,013 | 568,560 | |||||||||||||||
|
Securities
borrowed
|
92 | - | - | - | - | |||||||||||||||
|
Total
interest expense
|
1,295,762 | 1,888,912 | 1,926,465 | 1,055,013 | 568,560 | |||||||||||||||
|
Net
interest income
|
1,626,840 | 1,226,516 | 428,982 | 166,869 | 136,486 | |||||||||||||||
|
Other
income (loss):
|
||||||||||||||||||||
|
Investment
advisory and service fees
|
48,952 | 27,891 | 22,028 | 22,351 | 35,625 | |||||||||||||||
|
Gain
(loss) on sale of investment securities
|
99,128 | 10,713 | 19,062 | (3,862 | ) | (53,238 | ) | |||||||||||||
|
Gain
on termination of interest rate swaps
|
- | - | 2,096 | 10,674 | - | |||||||||||||||
|
Income
from trading securities
|
- | 9,695 | 19,147 | 3,994 | - | |||||||||||||||
|
Dividend
income from available-for-sale equity
securities
|
17,184 | 2,713 | 91 | - | - | |||||||||||||||
|
Loss
on other-than-temporarily impaired securities
|
- | (31,834 | ) | (1,189 | ) | (52,348 | ) | (83,098 | ) | |||||||||||
|
Loss
on receivable from Prime Broker
|
(13,613 | ) | - | - | - | - | ||||||||||||||
|
Unrealized
gain (loss) on interest rate swaps
|
349,521 | (768,268 | ) | - | - | - | ||||||||||||||
|
Total
other income (loss)
|
501,172 | (749,090 | ) | 61,235 | (19,191 | ) | (100,711 | ) | ||||||||||||
|
Expenses:
|
||||||||||||||||||||
|
Distribution
fees
|
1,756 | 1,589 | 3,647 | 3,444 | 8,000 | |||||||||||||||
|
General
and administrative expenses
|
130,152 | 103,622 | 62,666 | 40,063 | 26,278 | |||||||||||||||
|
Total
Expenses
|
131,908 | 105,211 | 66,313 | 43,507 | 34,278 | |||||||||||||||
|
Impairment
of intangible for customer relationships
|
- | - | - | 2,493 | - | |||||||||||||||
|
Income
before loss on equity method investment,
income
taxes and noncontrolling interest
|
1,996,104 | 372,215 | 423,904 | 101,678 | 1,497 | |||||||||||||||
|
Loss
on equity method investment
|
252 | - | - | - | - | |||||||||||||||
|
Income
taxes
|
34,381 | 25,977 | 8,870 | 7,538 | 10,744 | |||||||||||||||
|
Income
(loss) before noncontrolling interest
|
1,961,471 | 346,238 | 415,034 | 94,140 | (9,247 | ) | ||||||||||||||
|
Noncontrolling
interest
|
- | 58 | 650 | 324 | - | |||||||||||||||
|
Net
income (loss)
|
1,961,471 | 346,180 | 414,384 | 93,816 | (9,247 | ) | ||||||||||||||
|
Dividends
on preferred stock
|
18,501 | 21,177 | 21,493 | 19,557 | 14,593 | |||||||||||||||
|
Net
income available (loss related) to common shareholders
|
$ | 1,942,970 | $ | 325,003 | $ | 392,891 | $ | 74,259 | $ | (23,840 | ) |
|
Total
assets
|
$ | 69,376,190 | $ | 57,597,615 | $ | 54,002,514 | $ | 30,715,980 | $ | 16,063,422 | ||||||||||
|
6.00%
Series B Cumulative Convertible Preferred Stock
|
$ | 63,114 | $ | 96,042 | $ | 111,466 | $ | 111,466 | - | |||||||||||
|
Basic
net income (loss) per average common share
|
$ | 3.55 | $ | 0.64 | $ | 1.32 | $ | 0.44 | $ | (0.19 | ) | |||||||||
|
Diluted
net income (loss) per average common share
|
$ | 3.52 | $ | 0.64 | $ | 1.31 | $ | 0.44 | $ | (0.19 | ) | |||||||||
|
Dividends
declared per common share
|
$ | 2.54 | $ | 2.08 | $ | 1.04 | $ | 0.57 | $ | 1.04 |
40
ITEM
7.
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We are a
REIT that owns and manages a portfolio of principally mortgage-backed
securities. Our principal business objective is to generate net
income for distribution to our stockholders from the spread between the interest
income on our investment securities and the costs of borrowing to finance our
acquisition of investment securities and from dividends we receive from our
subsidiaries. Our wholly-owned subsidiaries offer diversified real
estate, asset management and other financial services. FIDAC and
Merganser are our wholly-owned taxable REIT subsidiaries that are registered
investment advisors that generate advisory and service fee
income. RCap is our wholly-owned broker dealer taxable REIT
subsidiary which generates fee income.
We are
primarily engaged in the business of investing, on a leveraged basis, in
mortgage pass-through certificates, collateralized mortgage obligations and
other mortgage-backed securities representing interests in or obligations backed
by pools of mortgage loans issued or guaranteed by Federal Home Loan Mortgage
Corporation (“Freddie Mac”), Federal National Mortgage Association (“Fannie
Mae”) and the Government National Mortgage Association (“Ginnie Mae”)
(collectively, “Mortgage-Backed Securities”). We also invest in
Federal Home Loan Bank (“FHLB”), Freddie Mac and Fannie Mae
debentures. The Mortgage-Backed Securities and agency debentures are
collectively referred to herein as “Investment Securities.”
Under our
capital investment policy, at least 75% of our total assets must be comprised of
high-quality mortgage-backed securities and short-term
investments. High quality securities means securities that (1) are
rated within one of the two highest rating categories by at least one of the
nationally recognized rating agencies, (2) are unrated but are guaranteed by the
United States government or an agency of the United States government, or (3)
are unrated but we determine them to be of comparable quality to rated
high-quality mortgage-backed securities.
The
remainder of our assets, comprising not more than 25% of our total assets, may
consist of other qualified REIT real estate assets which are unrated or rated
less than high quality, but which are at least “investment grade” (rated “BBB”
or better by Standard & Poor’s Corporation (“S&P”) or the equivalent by
another nationally recognized rating agency) or, if not rated, we determine them
to be of comparable credit quality to an investment which is rated “BBB” or
better. In addition, we may directly or indirectly invest part of
this remaining 25% of our assets in other types of securities, including without
limitation, unrated debt, equity or derivative securities, to the extent
consistent with our REIT qualification requirements. The derivative
securities in which we invest may include securities representing the right to
receive interest only or a disproportionately large amount of interest, as well
as inverse floaters, which may have imbedded leverage as part of their
structural characteristics.
41
We may
acquire Mortgage-Backed Securities backed by single-family residential mortgage
loans as well as securities backed by loans on multi-family, commercial or other
real estate related properties. To date, substantially all
of the Mortgage-Backed Securities that we have acquired have been backed by
single-family residential mortgage loans.
We have
elected to be taxed as a REIT for federal income tax
purposes. Pursuant to the current federal tax regulations, one of the
requirements of maintaining our status as a REIT is that we must distribute at
least 90% of our REIT taxable income (determined without regard to the deduction
for dividends paid and by excluding any net capital gain) to our stockholders,
subject to certain adjustments.
The
results of our operations are affected by various factors, many of which are
beyond our control. Our results of operations primarily depend on,
among other things, our net interest income, the market value of our assets and
the supply of and demand for such assets. Our net interest income,
which reflects the amortization of purchase premiums and accretion of discounts,
varies primarily as a result of changes in interest rates, borrowing costs and
prepayment speeds, the behavior of which involves various risks and
uncertainties. Prepayment speeds, as reflected by the Constant
Prepayment Rate, or CPR, and interest rates vary according to the type of
investment, conditions in financial markets, competition and other factors, none
of which can be predicted with any certainty. In general, as
prepayment speeds on our Mortgage-Backed Securities portfolio increase, related
purchase premium amortization increases, thereby reducing the net yield on such
assets. The CPR on our Mortgage-Backed Securities portfolio averaged
19% ,13% and 15% for the years ended December 31, 2009, 2008 and 2007,
respectively. Since changes in interest rates may significantly
affect our activities, our operating results depend, in large part, upon our
ability to effectively manage interest rate risks and prepayment risks while
maintaining our status as a REIT.
The
table below provides quarterly information regarding our average balances,
interest income, yield on assets, average repurchase agreement balances,
interest expense, cost of funds, net interest income and net interest rate
spreads for the quarterly periods presented.
|
Average
Investment
Securities
Held
(1)
|
Total
Interest
Income
|
Yield
on Average Investment
Securities
|
Average
Balance
of
Repurchase Agreements
|
Interest
Expense
|
Average
Cost of Funds
|
Net
Interest Income
|
Net
Interest
Rate
Spread
|
|||||||||||||||||||||||||
|
(ratios
for the quarters have been annualized, dollars in
thousands)
|
||||||||||||||||||||||||||||||||
|
Quarter
Ended
December
31, 2009
|
$ | 58,554,200 | $ | 2,922,602 | 4.99% | $ | 52,361,607 | $ | 1,295,762 | 2.47% | $ | 1,626,840 | 2.52% | |||||||||||||||||||
|
Quarter
Ended
September
30, 2009
|
$ | 60,905,025 | $ | 744,523 | 4.89% | $ | 54,914,435 | $ | 307,777 | 2.24% | $ | 436,746 | 2.65% | |||||||||||||||||||
|
Quarter
Ended
June
30, 2009
|
$ | 56,420,189 | $ | 710,401 | 5.04% | $ | 50,114,663 | $ | 322,596 | 2.57% | $ | 387,805 | 2.47% | |||||||||||||||||||
|
Quarter
Ended
March
31, 2009
|
$ | 54,763,268 | $ | 716,015 | 5.23% | $ | 48,497,444 | $ | 378,625 | 3.12% | $ | 337,390 | 2.11% | |||||||||||||||||||
(1) Does
not reflect unrealized gains/(losses).
The
following table presents the CPR experienced on our Mortgage-Backed Securities
portfolio, on an annualized basis, for the quarterly periods
presented.
|
Quarter Ended
|
CPR
|
|||
|
December
31, 2009
|
19% | |||
|
September
30, 2009
|
21% | |||
|
June
30, 2009
|
19% | |||
|
March
31, 2009
|
16% | |||
42
We
believe that the CPR in future periods will depend, in part, on changes in and
the level of market interest rates across the yield curve, with higher CPRs
expected during periods of declining interest rates and lower CPRs expected
during periods of rising interest rates.
We
continue to explore alternative business strategies, alternative investments and
other strategic initiatives to complement our core business strategy of
investing, on a leveraged basis, in high quality Investment
Securities. No assurance, however, can be provided that any such
strategic initiative will or will not be implemented in the future.
For the
purposes of computing ratios relating to equity measures, throughout this
report, equity includes Series B preferred stock, which has been treated under
GAAP as temporary equity. In this “Management Discussion and Analysis
of Financial Condition and Results of Operations”, net income attributable to
controlling interest is referred to as net income.
Recent Developments
The
liquidity crisis which commenced in August 2007 continues through the fourth
quarter of 2009. During this period of market dislocation, fiscal and
monetary policymakers have established new liquidity facilities for primary
dealers and commercial banks, reduced short-term interest rates, and passed
legislation that is intended to address the challenges of mortgage borrowers and
lenders. This legislation, the Housing and Economic Recovery Act of
2008, seeks to forestall home foreclosures for distressed borrowers and assist
communities with foreclosure problems. Although these aggressive
steps are intended to protect and support the US housing and mortgage market, we
continue to operate under difficult market conditions.
Subsequent
to June 30, 2008, there were increased market concerns about Freddie Mac and
Fannie Mae’s ability to withstand future credit losses associated with
securities held in their investment portfolios, and on which they provide
guarantees, without the direct support of the U.S. Government. In
September 2008, Fannie Mae and Freddie Mac were placed into the conservatorship
of the Federal Housing Finance Agency, or FHFA, their federal regulator,
pursuant to its powers under The Federal Housing Finance Regulatory Reform Act
of 2008, a part of the Housing and Economic Recovery Act of 2008. As
the conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the
operations of Fannie Mae and Freddie Mac and may (1) take over the assets of and
operate Fannie Mae and Freddie Mac with all the powers of the shareholders, the
directors, and the officers of Fannie Mae and Freddie Mac and conduct all
business of Fannie Mae and Freddie Mac; (2) collect all obligations and money
due to Fannie Mae and Freddie Mac; (3) perform all functions of Fannie Mae and
Freddie Mac which are consistent with the conservator’s appointment; (4)
preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and
(5) contract for assistance in fulfilling any function, activity, action or duty
of the conservator.
In
addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, the
Treasury and FHFA have entered into Preferred Stock Purchase Agreements (PSPAs)
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. On December 24, 2009, the U.S. Treasury amended
the terms of the U.S. Treasury’s PSPAs with Fannie Mae and Freddie
Mac to remove the $200 billion per institution limit established under the PSPAs
until the end of 2012. The U.S. Treasury also amended the PSPAs with
respect to the requirements for Fannie Mae and Freddie Mac to reduce their
portfolios.
43
The
Emergency Economic Stabilization Act of 2008, or EESA, was also
enacted. The EESA provides the U.S. Secretary of the Treasury with
the authority to establish a Troubled Asset Relief Program, or TARP, to purchase
from financial institutions up to $700 billion of equity or preferred
securities, residential or commercial mortgages and any securities, obligations,
or other instruments that are based on or related to such mortgages, that in
each case was originated or issued on or before March 14, 2008, as well as any
other financial instrument that the U.S. Secretary of the Treasury, after
consultation with the Chairman of the Board of Governors of the Federal Reserve
System, determines the purchase of which is necessary to promote financial
market stability, upon transmittal of such determination, in writing, to the
appropriate committees of the U.S. Congress. The EESA also provides
for a program that would allow companies to insure their troubled
assets.
In
addition, the U.S. Government, the Board of Governors of the Federal Reserve
System, or Federal Reserve, and other governmental and regulatory bodies have
taken or are considering taking other actions to address the financial
crisis. The Term Asset-Backed Securities Loan Facility, or TALF, was
first announced by the U.S. Department of Treasury, or the Treasury, on November
25, 2008, and has been expanded in size and scope since its initial
announcement. Under the TALF, the Federal Reserve Bank of New York
makes non-recourse loans to borrowers to fund their purchase of eligible assets,
currently certain asset-backed securities but not residential mortgage-backed
securities. On March 23, 2009, the U.S. Treasury
announced preliminary plans to expand the TALF beyond non-mortgage ABS to
include legacy securitization assets, including non-Agency RMBS and CMBS that
were originally rated AAA and issued prior to January 1, 2009. On May
1, 2009, the Federal Reserve published the terms for the expansion of TALF to
CMBS and announced that, beginning in June 2009, up to $100 billion of TALF
loans would be available to finance purchases of CMBS. The Federal
Reserve has also announced that, beginning in July 2009, eligible legacy CMBS
may also be purchased under the TALF. Many legacy CMBS, however, have
had their ratings downgraded, and at least one rating agency, S&P, has
announced that further downgrades are likely in the future as property values
have declined. These downgrades may significantly reduce the quantity
of legacy CMBS that are TALF eligible. There can be no assurance that
we will be able to utilize this program successfully or at all.
In
addition, on March 23, 2009 the government announced that the Treasury in
conjunction with the Federal Deposit Insurance Corporation, or FDIC, and the
Federal Reserve, would create the Public-Private Investment Program, or
PPIP. The PPIP aims to recreate a market for specific illiquid
residential and commercial loans and securities through a number of joint public
and private investment funds. The PPIP is designed to draw new
private capital into the market for these securities and loans by providing
government equity co-investment and attractive public financing. As
these programs are still in early stages of operations, it is not possible for
us to predict how these programs will impact our business.
There can
be no assurance that the EESA, TALF, PPIP or other policy initiatives will have
a beneficial impact on the financial markets, including current extreme levels
of volatility. We cannot predict whether or when such actions may
occur or what impact, if any, such actions could have on our business, results
of operations and financial condition.
The
liquidity crisis could adversely affect one or more of our lenders and could
cause one or more of our lenders to be unwilling or unable to provide us with
additional financing. This could potentially increase our financing
costs and reduce liquidity. If one or more major market participants
fails, it could negatively impact the marketability of all fixed income
securities, including agency mortgage securities, and this could negatively
impact the value of the securities in our portfolio, thus reducing its net book
value. Furthermore, if many of our lenders are unwilling or unable to
provide us with additional financing, we could be forced to sell our Investment
Securities at an inopportune time when prices are depressed. Even
with the current situation in the mortgage sector we do not anticipate having
difficulty converting our assets to cash or extending financing, due to the fact
that our investment securities have an actual or implied “AAA” rating and
principal payment is guaranteed.
Critical
Accounting Policies
Management’s
discussion and analysis of financial condition and results of operations is
based on the amounts reported in our financial statements. These
financial statements are prepared in conformity with GAAP. In
preparing the financial statements, management is required to make various
judgments, estimates and assumptions that affect the reported
amounts. Changes in these estimates and assumptions could have a
material effect on our financial statements. The following is a
summary of our policies most affected by management’s judgments, estimates and
assumptions.
Fair Value of Investment
Securities
: All assets classified as available-for-sale are
reported at fair value, based on market prices. Although we generally
intend to hold most of our Investment Securities until maturity, we may, from
time to time, sell any of our Investment Securities as part our overall
management of our portfolio. Accordingly, we are required to classify
all of our Investment Securities as available-for-sale. Our policy is
to obtain fair values from independent sources. Fair values from
independent sources are compared to internal prices for
reasonableness. Management evaluates securities for
other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such
evaluation. The determination of whether a security is
other-than-temporarily impaired involves judgments and assumptions based on
subjective and objective factors. Consideration is given to (1) our
intent to sell the Investment Securities, (2) whether it is more likely than not
that we will be required to sell the Investment Securities before recovery, or
(3) whether we do not expect to recover the entire amortized cost basis of the
Investment Securities. Further, the security is analyzed for credit
loss (the difference between the present value of cash flows expected to be
collected and the amortized cost basis). The credit loss, if any,
will then be recognized in the statement of earnings, while the balance of
impairment related to other factors will be recognized in other comprehensive
income (“OCI”).
44
Interest
Income
: Interest income is accrued based on the outstanding
principal amount of the Investment Securities and their contractual
terms. Premiums and discounts associated with the purchase of the
Investment Securities are amortized or accreted into interest income over the
projected lives of the securities using the interest method. Our
policy for estimating prepayment speeds for calculating the effective yield is
to evaluate historical performance, Wall Street consensus prepayment speeds, and
current market conditions. If our estimate of prepayments is
incorrect, we may be required to make an adjustment to the amortization or
accretion of premiums and discounts that would have an impact on future
income.
Derivative Financial
Instruments/Hedging Activity:
Prior to the fourth quarter of
2008, we designated interest rate swaps as cash flow hedges, whereby the swaps
were recorded at fair value on our balance sheet as assets and liabilities with
any changes in fair value recorded in OCI. In a cash flow hedge, a
swap would exactly match the pricing date of the relevant repurchase
agreement. Through the end of the third quarter of 2008 we continued
to be able to effectively match the swaps with the repurchase agreements
therefore entering into effective hedge transactions. However, due to
the volatility of the credit markets, it is no longer practical to match the
pricing dates of both the swaps and the repurchase agreements.
As a
result, we voluntarily discontinued hedge accounting after the third quarter of
2008 through a combination of de-designating previously defined hedge
relationships and not designating new contracts as cash flow hedges. The
de-designation of cash flow hedges requires that the net derivative gain or loss
related to the discontinued cash flow hedge should continue to be reported in
accumulated OCI, unless it is probable that the forecasted transaction will not
occur by the end of the originally specified time period or within an additional
two-month period of time thereafter. We continue to hold repurchase
agreements in excess of swap contracts and have no indication that interest
payments on the hedged repurchase agreements are in jeopardy of
discontinuing. Therefore, the deferred losses related to these
derivatives that have been de-designated will not be recognized immediately and
will remain in OCI. These losses are reclassified into earnings
during the contractual terms of the swap agreements starting as of October 1,
2008. Changes in the unrealized gains or losses on the interest rate swaps
subsequent to September 30, 2008 are reflected in our statement of
operations.
Repurchase
Agreements
: We finance the acquisition of our Investment
Securities through the use of repurchase agreements. Repurchase
agreements are treated as collateralized financing transactions and are carried
at their contractual amounts, including accrued interest, as specified in the
respective agreements. Repurchase agreements entered into by RCap are
matched with reverse repurchase agreements and are recorded on trade date with
the duration of such repurchase agreements mirroring those of the matched
reverse repurchase agreements. These repurchase agreements entered
into by RCap are recorded at the contract amount and margin calls are filled by
RCap as required based on any deficiencies in collateral versus the contract
price. The repurchase agreements are recorded at the contract amount
and margin calls are filled by RCap as required based on any deficiencies in
collateral versus the contract price. RCap generates income from the spread
between what is earned on the reverse repurchase agreements and what is paid on
the repurchase agreements. Intercompany transactions are eliminated
in the statement of financial condition, statement of operations, and statement
of cash flows. Cash flows related to RCap’s repurchase agreements are
included in cash flows from operating activity.
Income Taxes
: We
have elected to be taxed as a REIT and intend to comply with the provisions of
the Internal Revenue Code of 1986, as amended (or the Code), with respect
thereto. Accordingly, we will not be subjected to federal income tax
to the extent of our distributions to shareholders and as long as certain asset,
income and stock ownership tests are met. We, FIDAC, Merganser, and
RCap have made separate joint elections to treat FIDAC, Merganser, and RCap as
taxable REIT subsidiaries. As such, FIDAC, Merganser, and RCap are
taxable as domestic C corporations and subject to federal and state and local
income taxes based upon their taxable income.
45
Impairment
of Goodwill and Intangibles
: Our acquisition of FIDAC and
Merganser were accounted for using the purchase method. The cost of
FIDAC and Merganser were allocated to the assets acquired, including
identifiable intangible assets and the liabilities assumed, based on their
estimated fair values at the date of acquisition. The excess of cost over the
fair value of the net assets acquired was recognized as
goodwill. Goodwill and finite-lived intangible assets are
periodically reviewed for potential impairment. This evaluation
requires significant judgment.
Recent
Accounting Pronouncements:
General
Principles
Generally Accepted
Accounting Principles (ASC 105)
In June
2009, the Financial Accounting Standards Board (“FASB”) issued
The Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles
(Codification) which revises the framework for selecting the
accounting principles to be used in the preparation of financial statements that
are presented in conformity with Generally Accepted Accounting Principles
(“GAAP”). The objective of the Codification is to establish the FASB
Accounting Standards Codification (“ASC”) as the source of authoritative
accounting principles recognized by the FASB. Codification was
effective September 30, 2009. In adopting the Codification, all
non-grandfathered, non-SEC accounting literature not included in the
Codification is superseded and deemed non-authoritative. Codification
requires any references within the consolidated financial statements be modified
from FASB issues to ASC. However, in accordance with the FASB
Accounting Standards Codification Notice to Constituents (v 2.0), we will not
reference specific sections of the ASC but will use broad topic
references.
Our
recent accounting pronouncements section has been reformatted to reflect the
same organizational structure as the ASC. Broad topic references will
be updated with pending content as they are released.
Assets
Investments in Debt and
Equity Securities (ASC 320)
New
guidance was provided to make impairment guidance more operational and to
improve the presentation and disclosure of other-than-temporary impairments
(“OTTI”) on debt and equity securities in financial statements. This
guidance was also the result of the Securities and Exchange Commission (“SEC”)
mark-to-market study mandated under the Emergency Economic Stabilization Act of
2008 (“EESA”). The SEC’s recommendation was to “evaluate the need for
modifications (or the elimination) of current OTTI guidance to provide for a
more uniform system of impairment testing standards for financial
instruments.” The guidance revises the OTTI evaluation
methodology. Previously the analytical focus was on whether we had
the “intent and ability to retain its investment in the debt security for a
period of time sufficient to allow for any anticipated recovery in fair
value.” Now the focus is on whether we have (1) the intent to
sell the Investment Securities, (2) it is more likely than not that it will be
required to sell the Investment Securities before recovery, or (3) it does not
expect to recover the entire amortized cost basis of the Investment
Securities. Further, the security is analyzed for credit loss, (the
difference between the present value of cash flows expected to be collected and
the amortized cost basis). The credit loss, if any, will then be
recognized in the statement of operations, while the balance of impairment
related to other factors will be recognized in Other Comprehensive
Income. This guidance became effective for all interim and annual
reporting periods ending after June 15, 2009 with early adoption permitted for
periods ending after March 15, 2009 and we decided to early
adopt. For the year ended December 31, 2009, we did not have
unrealized losses in Investment Securities that were deemed
other-than-temporary.
Broad
Transactions
Business Combinations (ASC
805)
This
guidance establishes principles and requirements for recognizing and measuring
identifiable assets and goodwill acquired, liabilities assumed and any
noncontrolling interest in a business combination at their fair value at
acquisition date. ASC 805 alters the treatment of acquisition-related
costs, business combinations achieved in stages (referred to as a step
acquisition), the treatment of gains from a bargain purchase, the recognition of
contingencies in business combinations, the treatment of in-process research and
development in a business combination as well as the treatment of recognizable
deferred tax benefits. ASC 805 is effective for business combinations
closed in fiscal years beginning after December 15, 2008 and is applicable
to business acquisitions completed after January 1, 2009. We did
not make any business acquisitions during the year ended December 31,
2009. The adoption of ASC 805 did not have a material impact on our
consolidated financial statements.
46
Consolidation (ASC
810)
On
January 1, 2009, FASB amended the guidance concerning noncontrolling interests
in consolidated financial statements, which requires us to make certain changes
to the presentation of its financial statements. This guidance
requires us to classify noncontrolling interests (previously referred to as
“minority interest”) as part of consolidated net income and to include the
accumulated amount of noncontrolling interests as part of stockholders’
equity. Similarly, in its presentation of stockholders’ equity, we
distinguish between equity amounts attributable to controlling interest and
amounts attributable to the noncontrolling interests – previously classified as
minority interest outside of stockholders’ equity. In addition to these
financial reporting changes, this guidance provides for significant changes in
accounting related to noncontrolling interests; specifically, increases and
decreases in its controlling financial interests in consolidated subsidiaries
will be reported in equity similar to treasury stock transactions. If
a change in ownership of a consolidated subsidiary results in loss of control
and deconsolidation, any retained ownership interests are re-measured with the
gain or loss reported in net earnings.
Effective
January 1, 2010, the consolidation standards have been amended by ASU
2009-17. This amendment updates the existing standard and eliminates
the exemption from consolidation of a Qualified Special Purpose Entity
(“QSPE”). The update requires an enterprise to perform an
analysis to determine whether the enterprise’s variable interest or interests
give it a controlling financial interest in a variable interest entity
(VIE). The analysis identifies the primary beneficiary of a VIE as
the enterprise that has both: a) the power to direct the activities that most
significantly impact the entity’s economic performance and b) the obligation to
absorb losses of the entity or the right to receive benefits from the entity
which could potentially be significant to the VIE. The update
requires enhanced disclosures to provide users of financial statements with more
transparent information about an enterprises involvement in a
VIE. Further, ongoing assessments of whether an enterprise is the
primary beneficiary on a VIE are required. At this time, the
amendment has no material effect on our financial statements.
On
January 27, 2010, the FASB voted to indefinitely defer the effective date
of ASU 2009-17 for a reporting enterprises interest in entities for
which it is industry practice to issue financial statements in accordance with
investment company standards (ASC 946). This deferral is expected to
most significantly affect reporting entities in the investment management
industry. We are evaluating the effect of this update, however, as it
stands, the update would have no material effect on the financial
statements.
Derivatives and Hedging (ASC
815)
Effective
January 1, 2009 and adopted by us prospectively, the FASB issued additional
guidance attempting to improve the transparency of financial
reporting by mandating the provision of additional information about how
derivative and hedging activities affect an entity’s financial position,
financial performance and cash flows. This guidance changed the
disclosure requirements for derivative instruments and hedging activities by
requiring enhanced disclosure about (1) how and why an entity uses derivative
instruments, (2) how derivative instruments and related hedged items are
accounted for, and (3) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash
flows. To adhere to this guidance, qualitative disclosures about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts, gains and losses on derivative instruments, and disclosures
about credit-risk-related contingent features in derivative agreements must be
made. This disclosure framework is intended to better convey the
purpose of derivative use in terms of the risks that an entity is intending to
manage. We discontinued hedge accounting as of September 30, 2008,
and therefore the effect of the adoption of this guidance was an increase in
footnote disclosures.
Fair Value Measurements and
Disclosures (ASC 820)
In
response to the deterioration of the credit markets, FASB issued guidance
clarifying how Fair Value Measurements should be applied when valuing securities
in markets that are not active. The guidance provides an illustrative
example, utilizing management’s internal cash flow and discount rate assumptions
when relevant observable data do not exist. It further clarifies how
observable market information and market quotes should be considered when
measuring fair value in an inactive market. It reaffirms the notion
of fair value as an exit price as of the measurement date and that fair value
analysis is a transactional process and should not be broadly applied to a group
of assets. The guidance was effective upon issuance including prior
periods for which financial statements had not been issued. The
implementation of this guidance did not have a material effect on the fair value
of our assets since our methodology is consistent with the new
guidance.
47
In
October 2008 the EESA was signed into law. Section 133 of the EESA
mandated that the SEC conduct a study on mark-to-market accounting
standards. The SEC provided its study to the U.S. Congress on
December 30, 2008. Part of the recommendations within the study
indicated that “fair value requirements should be improved through development
of application and best practices guidance for determining fair value in
illiquid or inactive markets.” As a result of this study and the
recommendations therein, on April 9, 2009, the FASB issued additional guidance
for determining fair value when the volume and level of activity for the asset
or liability have significantly decreased when compared with normal market
activity for the asset or liability (or similar assets or
liabilities). The guidance gives specific factors to evaluate if
there has been a decrease in normal market activity and if so, provides a
methodology to analyze transactions or quoted prices and make necessary
adjustments to fair value. The objective is to determine the point
within a range of fair value estimates that is most representative of fair value
under current market conditions. This guidance became effective
for us June 30, 2009 with early adoption permitted for periods ending
after March 31, 2009. The adoption does not have a major impact on
the manner in which we estimate fair value, nor does it have any impact on our
financial statement disclosures.
In August
2009, FASB provided further guidance (ASU 2009-05) regarding the fair value
measurement of liabilities. The guidance states that a quoted price
for the identical liability when traded as an asset in an active market is a
Level 1 fair value measurement. If the value must be adjusted for
factors specific to the liability, then the adjustment to the quoted price of
the asset shall render the fair value measurement of the liability a lower level
measurement. This guidance has no material effect on the fair
valuation of our liabilities.
In
September 2009, FASB issued guidance (ASU 2009-12) on measuring the fair value
of certain alternative investments. This guidance offers investors a
practical expedient for measuring the fair value of investments in certain
entities that calculate net asset value (NAV) per share. If an
investment falls within the scope of the ASU, the reporting entity is permitted,
but not required to use the investment’s NAV to estimate its fair
value. This guidance has no material effect on the fair valuation of
our assets. We do not hold any assets qualifying under this
guidance.
In
January 2010, FASB issued guidance (ASU 2010-06) which increases disclosure
regarding the fair value of assets. The key provisions of this
guidance include the requirement to disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 including a description
of the reason for the transfers. Previously this was only required of
transfers between Level 2 and Level 3 assets. Further, reporting
entities are required to provide fair value measurement disclosures for each
class of assets and liabilities; a class is potentially a subset of the assets
or liabilities within a line item in the statement of financial
position. Additionally, disclosures about the valuation techniques
and inputs used to measure fair value for both recurring and nonrecurring fair
value measurements are required for either Level 2 or Level 3
assets. This portion of the guidance is effective for the Company for
December 31, 2009. The guidance also requires that the disclosure on any Level 3
assets presents separately information about purchases, sales, issuances and
settlements. In other words, Level 3 assets are presented on a gross
basis rather than as one net number. However, this last portion of
the guidance is not effective for us until December 15,
2010. Adoption of this guidance results in increased footnote
disclosure.
Financial Instruments (ASC
821-10-50)
On April
9, 2009, the FASB issued guidance which requires disclosures about fair value of
financial instruments for interim reporting periods as well as in annual
financial statements. The guidance became effective for us on June
30, 2009. The adoption did not have any impact on financial reporting
as all financial instruments are currently reported at fair value in both
interim and annual periods.
48
Subsequent Events (ASC
855)
General
standards governing accounting for and disclosure of events that occur after the
balance sheet date but before the financial statements are issued or are
available to be issued. ASC 855 also provides guidance on the period after
the balance sheet date during which management of a reporting entity should
evaluate events or transactions that may occur for potential recognition or
disclosure in the financial statements, the circumstances under which an entity
should recognize events or transactions occurring after the balance sheet date
in its financial statements and the disclosures that an entity should make about
events or transactions occurring after the balance sheet date. We
adopted the guidance effective June 30, 2009, and adoption had no impact on our
consolidated financial statements. We evaluated subsequent events
through February 24, 2010.
Transfers and Servicing (ASC
860-10-50)
In
February 2008 FASB issued guidance addressing whether transactions where assets
purchased from a particular counterparty and financed through a repurchase
agreement with the same counterparty can be considered and accounted for as
separate transactions, or are required to be considered “linked” transactions
and may be considered derivatives. This guidance requires purchases
and subsequent financing through repurchase agreements be considered linked
transactions unless all of the following conditions apply: (1) the initial
purchase and the use of repurchase agreements to finance the purchase are not
contractually contingent upon each other; (2) the repurchase financing entered
into between the parties provides full recourse to the transferee and the
repurchase price is fixed; (3) the financial assets are readily obtainable in
the market; and (4) the financial instrument and the repurchase agreement are
not coterminous. This guidance was effective January 1, 2009 and the
implementation did not have a material effect on our financial
statements.
On June
12, 2009, the FASB issued guidance an amendment update to the accounting
standards governing the transfer and servicing of financial assets. This
amendment updates the existing standard and eliminates the concept of
a Qualified Special Purpose Entity (“QSPE”); clarifies the surrendering of
control to effect sale treatment; and modifies the financial components approach
– limiting the circumstances in which a financial asset or portion thereof
should be derecognized when the transferor maintains continuing
involvement. It defines the term “Participating
Interest.” Under this standard update, the transferor must recognize
and initially measure at fair value all assets obtained and liabilities incurred
as a result of a transfer, including any retained beneficial interest.
Additionally, the amendment requires enhanced disclosures regarding the
transferors risk associated with continuing involvement in any transferred
assets. The amendment is effective beginning January 1,
2010. We have determined the amendment has no material effect on the
financial statements.
49
Results
of Operations:
Net
Income Summary
For the
year ended December 31, 2009, our net income was $2.0 billion or $3.55 basic
income per average share related to common shareholders, as compared to $346.2
million net income or $0.64 basic net income per average share for the year
ended December 31, 2008. and net income was $414.4 million or $1.32
basic net income per average share related to common shareholders for the year
ended December 31, 2007. Net income per average share increased by
$2.91 per average share available to common shareholders and total net income
increased $1.7 billion for the year ended December 31, 2009, when compared to
the year ended December 31, 2008. We attribute the increase in total
net income for the year ended December 31, 2009 from the year ended December 31,
2008 in part to recording of unrealized gains related to interest rate swaps of
$349.5 million for the year ended December 31, 2009, comparison to an unrealized
loss of $768.3 million which was recorded in for the year ended December 31,
2008. Net income for the year ended December 31, 2009, also increased
due to net interest income increasing by $400.3 million for the year ended
December 31, 2009, as compared to the year ended December 31, 2008, due to the
improved interest rate spread. For the year ended December 31, 2009,
net gain on sale of Mortgage-Backed Securities was $99.1 million, as compared to
a net gain of $10.7 million for the year ended December 31, 2008.
We
attribute the decrease in total net income for the year ended December 31, 2008,
compared to the year ended December 31, 2007, primarily to recording of
unrealized losses related to interest rate swaps in the fourth quarter of 2008.
An unrealized loss of $768.3 million was recorded in the income statement for
the year ended December 31, 2008, as the result of de-designation of cash flow
hedges. Prior to the fourth quarter of 2008, we recorded changes in
the fair values in our interest rate swaps in the Accumulated Other
Comprehensive Income in our Statement of Financial Condition. The
interest rate spread increased from 0.70% for the year ended December 31, 2007,
to 1.81% for the year ended December 31, 2008. For the year ended
December 31, 2008, net gain on sale of Mortgage-Backed Securities was $10.7
million, as compared to a net gain of $19.1 million in 2007. The
table below presents the net income (loss) summary for the years ended December
31, 2009, 2008, and 2007.
Net
Income Summary
(dollars in thousands,
except for per share data)
|
Year
Ended
December
31,
2009
|
Year
Ended
December
31,
2008
|
Year
Ended
December
31,
2007
|
||||||||||
|
Interest
income
|
||||||||||||
|
Investments
|
$ | 2,922,499 | $ | 3,115,428 | $ | 2,355,447 | ||||||
|
Securities
loaned
|
103 | - | - | |||||||||
|
Total
interest income
|
2,922,602 | 3,115,428 | 2,355,447 | |||||||||
|
Interest
expense
|
||||||||||||
|
Repurchase
agreements
|
1,295,670 | 1,888,912 | 1,926,465 | |||||||||
|
Securities
borrowed
|
92 | - | - | |||||||||
|
Total
interest expense
|
1,295,762 | 1,888,912 | 1,926,465 | |||||||||
|
Net
interest income
|
1,626,840 | 1,226,516 | 428,982 | |||||||||
|
Other
income (loss):
|
||||||||||||
|
Investment
advisory and service fees
|
48,952 | 27,891 | 22,028 | |||||||||
|
Gain
on sale of investment securities
|
99,128 | 10,713 | 19,062 | |||||||||
|
Gain
on termination of interest rate swaps
|
- | - | 2,096 | |||||||||
|
Income
from trading securities
|
- | 9,695 | 19,147 | |||||||||
|
Dividend
income from available-for-sale equity securities
|
17,184 | 2,713 | 91 | |||||||||
|
Loss
on other-than-temporarily impaired securities
|
- | (31,834 | ) | (1,189 | ) | |||||||
|
Loss
on receivable from Prime Broker
|
(13,613 | ) | - | - | ||||||||
|
Unrealized
gain (loss) on interest rate swaps
|
349,521 | (768,268 | ) | - | ||||||||
|
Total
other income (loss)
|
501,172 | (749,090 | ) | 61,235 | ||||||||
|
Expenses:
|
||||||||||||
|
Distribution
fees
|
1,756 | 1,589 | 3,647 | |||||||||
|
General
and administrative expenses
|
130,152 | 103,622 | 62,666 | |||||||||
|
Total
expenses
|
131,908 | 105,211 | 66,313 | |||||||||
|
Income
before loss on equity method investment, income taxes and
noncontrolling interest
|
1,996,104 | 372,215 | 423,904 | |||||||||
|
Loss
on equity method investment
|
252 | - | - | |||||||||
|
Income
taxes
|
34,381 | 25,977 | 8,870 | |||||||||
|
Net
income
|
1,961,471 | 346,238 | 415,034 | |||||||||
|
Noncontrolling
interest
|
- | 58 | 650 | |||||||||
|
Net
income attributable to controlling interest
|
1,961,471 | 346,180 | 414,384 | |||||||||
|
Dividends
on preferred stock
|
18,501 | 21,177 | 21,493 | |||||||||
|
Net
income available to common shareholders
|
$ | 1,942,970 | $ | 325,003 | $ | 392,891 | ||||||
|
Weighted
average number of basic common shares
outstanding
|
546,973,036 | 507,024,596 | 297,488,394 | |||||||||
|
Weighted
average number of diluted common shares
outstanding
|
553,129,907 | 507,024,596 | 306,263,766 | |||||||||
|
Basic
net income per average common share
|
$ | 3.55 | $ | 0.64 | $ | 1.32 | ||||||
|
Diluted
net income per average common share
|
$ | 3.52 | $ | 0.64 | $ | 1.31 | ||||||
|
Average
total assets
|
$ | 65,224,198 | $ | 58,540,508 | $ | 41,834,831 | ||||||
|
Average
equity
|
$ | 8,644,228 | $ | 6,679,431 | $ | 3,710,821 | ||||||
|
Return
on average total assets
|
3.01 | % | 0.59 | % | 0.99 | % | ||||||
|
Return
on average equity
|
22.69 | % | 5.18 | % | 11.17 | % | ||||||
50
Interest Income and Average Earning
Asset Yield
We had
average earning assets of $58.6 billion for the year ended December 31,
2009. We had average earning assets of $56.0 billion for the year
ended December 31, 2008. We had average earning assets of $40.8
billion for the year ended December 31, 2007. Our primary source of
income is interest income. Our interest income was $2.9 billion for
the year ended December 31, 2009, $3.1 billion for the year ended December 31,
2008, and $2.4 billion for the year ended December 31, 2007. The
yield on average investment securities was 4.99%, 5.57%, and 5.77% for the
respective years. The prepayment speeds increased to an average of
19% CPR for the year ended December 31, 2009 from an average of 10% CPR for the
year ended December 31, 2008. For the year ended December 31, 2009,
as compared to the year ended December 31, 2008, interest income declined by
$193.0 million, due to the decline in yield on average investment securities of
58 basis points. Interest income increased by $760.0 million for the
year ended December 31, 2008, as compared to the year ended December 31, 2007,
due to the increased average assets of $15.2 billion.
Interest Expense and the Cost of
Funds
Our
largest expense is the cost of borrowed funds. We had average
borrowed funds of $52.4 billion and total interest expense of $1.3 billion for
the year ended December 31, 2009. We had average borrowed funds of
$50.3 billion and total interest expense of $1.9 billion for the year ended
December 31, 2008. We had average borrowed funds of $38.0 billion and
total interest expense of $1.9 billion for the year ended December 31,
2007. Our average cost of funds was 2.47% for the year ended December
31, 2009 and 3.76% for the year ended December 31, 2008 and 5.07 % for the year
ended December 31, 2007. The cost of funds rate decreased by 129
basis points and the average borrowed funds increased by $2.1 billion for the
year ended December 31, 2009 when compared to the year ended December 31,
2008. The cost of funds rate decreased by 131 basis points and the
average borrowed funds increased by $12.3 billion for the year ended December
31, 2008 when compared to the year ended December 31, 2007. Interest
expense for the year ended December 31, 2009 decreased by $593.1 million over
the prior year due to the substantial decrease in the average cost of funds
rate. Interest expense for the year-ended December 31, 2008 remained
constant at $1.9 billion when compared to December 31, 2007. Our average cost of
funds was 2.14% above average one-month LIBOR and 1.36% above average six-month
LIBOR for the year ended December 31, 2009. Our average cost of funds
was 1.08% below average one-month LIBOR and 0.70% below average six-month LIBOR
for the year ended December 31, 2008. Our average cost of funds was
0.12% below average one-month LIBOR and 0.12% below average six-month LIBOR for
the year ended December 31, 2007.
The table
below shows our average borrowed funds and average cost of funds as compared to
average one-month and average six-month LIBOR for the years ended December 31,
2009, 2008, 2007, 2006, and 2005 and the four quarters in 2009.
51
Average Cost of
Funds
(Ratios
for the four quarters in 2009 have been annualized, dollars in
thousands)
|
Average
Borrowed
Funds
|
Interest
Expense
|
Average
Cost
of Funds
|
Average
One-
Month
LIBOR
|
Average
Six-Month
LIBOR
|
Average
One-Month
LIBOR Relative to Average Six-Month LIBOR
|
Average
Cost of Funds Relative to Average
One-Month
LIBOR
|
Average
Cost
of
Funds
Relative
to Average
Six-Month
LIBOR
|
|||||||||||||||||||
|
For
the Year Ended
December
31, 2009
|
$ | 52,361,607 | $ | 1,295,762 | 2.47% | 0.33% | 1.11% | 0.78% | 2.14% | 1.36% | ||||||||||||||||
|
For
the Year Ended
December
31, 2008
|
$ | 50,270,226 | $ | 1,888,912 | 3.76% | 2.68% | 3.06% | (0.38%) | 1.08% | 0.70% | ||||||||||||||||
|
For
the Year Ended
December
31, 2007
|
$ | 37,967,215 | $ | 1,926,465 | 5.07% | 5.19% | 5.19% | (0.00%) | (0.12%) | (0.12%) | ||||||||||||||||
|
For
the Year Ended
December
31, 2006
|
$ | 21,399,130 | $ | 1,055,013 | 4.93% | 5.03% | 5.21% | (0.18%) | (0.10%) | (0.28%) | ||||||||||||||||
|
For
the Year Ended
December
31, 2005
|
$ | 17,408,828 | $ | 568,560 | 3.27% | 3.33% | 3.72% | (0.39%) | (0.06%) | (0.45%) | ||||||||||||||||
|
For
the Quarter Ended
December
31, 2009
|
$ | 55,919,885 | $ | 286,764 | 2.05% | 0.24% | 0.52% | 0.28% | 1.81% | 1.53% | ||||||||||||||||
|
For
the Quarter Ended
September
30, 2009
|
$ | 54,914,435 | $ | 307,777 | 2.24% | 0.27% | 0.84% | (0.57%) | 1.97% | 1.40% | ||||||||||||||||
|
For
the Quarter Ended
June
30, 2009
|
$ | 50,114,663 | $ | 322,596 | 2.57% | 0.37% | 1.39% | (1.02%) | 2.20% | 1.18% | ||||||||||||||||
|
For
the Quarter Ended
March
31, 2009
|
$ | 48,497,444 | $ | 378,625 | 3.12% | 0.46% | 1.74% | (1.28%) | 2.66% | 1.38% | ||||||||||||||||
Net Interest Income
Our net interest income, which equals
interest income less interest expense, totaled $1.6 billion for the year ended
December 31, 2009, $1.2 billion for the year ended December 31, 2008
and $429.0 million for the year ended December 31, 2007. Our net
interest income increased by $400.3 million for the year ended December 31,
2009, as compared to the year ended December 31, 2008 because of the increased
interest rate spread. Our net interest rate spread for the year ended
December 31, 2009 was 2.52%, which was 71 basis points greater than the interest
rate spread of for the year ended December 31, 2008 of 1.81%. This 71
basis point increase in interest rate spread for 2009 over the spread for 2008
was the result of the decrease in the average cost of funds of 129 basis points,
which was only partially offset by a decrease in average yield on average
interest earning assets of 58 basis points. Our net interest income
increased for the year ended December 31, 2008, as compared to the year ended
December 31, 2007, because of the increased average asset base of $12.2 billion
in 2008 and the increased interest rate spread of 111 basis points.
The table below shows our interest
income by average Investment Securities held, total interest income, yield on
average interest earning assets, average balance of repurchase agreements,
interest expense, average cost of funds, net interest income, and net interest
rate spread for the years ended December 31, 2009, 2008, 2007, 2006, and 2005
and the four quarters in 2009.
52
Net
Interest Income
(Ratios
for the four quarters in 2009 have been annualized, dollars in
thousands)
|
Average
Investment
Securities
Held
|
Total
Interest
Income
|
Yield
on Average Interest Earning Assets
|
Average
Balance
of
Repurchase
Agreements
|
Interest
Expense
|
Average
Cost
of
Funds
|
Net
Interest Income
|
Net
Interest
Rate
Spread
|
|||||||||||||||||||||||||
|
For
the Year Ended
December
31, 2009
|
$ | 58,554,200 | $ | 2,922,602 | 4.99% | $ | 52,361,607 | $ | 1,295,762 | 2.47% | $ | 1,626,840 | 2.52% | |||||||||||||||||||
|
For
the Year Ended
December
31, 2008
|
$ | 55,962,519 | $ | 3,115,428 | 5.57% | $ | 50,270,226 | $ | 1,888,912 | 3.76% | $ | 1,226,516 | 1.81% | |||||||||||||||||||
|
For the
Year Ended
December
31, 2007
|
$ | 40,800,148 | $ | 2,355,447 | 5.77% | $ | 37,967,215 | $ | 1,926,465 | 5.07% | $ | 428,982 | 0.70% | |||||||||||||||||||
|
For
the Year Ended
December
31, 2006
|
$ | 23,029,195 | $ | 1,221,882 | 5.31% | $ | 21,399,130 | $ | 1,055,013 | 4.93% | $ | 166,869 | 0.38% | |||||||||||||||||||
|
For
the Year Ended
December
31, 2005
|
$ | 18,543,749 | $ | 705,046 | 3.80% | $ | 17,408,827 | $ | 568,560 | 3.27% | $ | 136,486 | 0.53% | |||||||||||||||||||
|
For
the Quarter Ended
December
31, 2009
|
$ | 62,128,320 | $ | 751,663 | 4.84% | $ | 55,919,885 | $ | 286,764 | 2.05% | $ | 464,899 | 2.79% | |||||||||||||||||||
|
For
the Quarter Ended
September
30, 2009
|
$ | 60,905,025 | $ | 744,523 | 4.89% | $ | 54,914,435 | $ | 307,777 | 2.24% | $ | 436,746 | 2.65% | |||||||||||||||||||
|
For
the Quarter Ended
June
30, 2009
|
$ | 56,420,189 | $ | 710,401 | 5.04% | $ | 50,114,663 | $ | 322,596 | 2.57% | $ | 387,805 | 2.47% | |||||||||||||||||||
|
For
the Quarter Ended
March
31, 2009
|
$ | 54,763,268 | $ | 716,015 | 5.23% | $ | 48,497,444 | $ | 378,625 | 3.12% | $ | 337,390 | 2.11% | |||||||||||||||||||
Investment Advisory and Service
Fees
FIDAC and Merganser are registered
investment advisors specializing in managing fixed income
securities. At December 31, 2009, FIDAC and Merganser had under
management approximately $11.5 billion in net assets and $19.1 billion in gross
assets, compared to $7.0 billion in net assets and $15.3 billion in gross assets
at December 31, 2008. FIDAC had $3.1 billion in net assets and $15.4 billion in
gross assets at December 31, 2007. Net investment advisory and
service fees for the years ended December 31, 2009, 2008, and 2007 totaled $47.2
million, $26.3 million, and $18.4 million, respectively, net of fees paid to
third parties pursuant to distribution service agreements for facilitating and
promoting distribution of shares or units to FIDAC’s clients. Gross
assets under management will vary from time to time because of changes in the
amount of net assets FIDAC and Merganser manage as well as changes in the amount
of leverage used by the various funds and accounts FIDAC
manages.
Gains and Losses on Sales of Investment
Securities and Interest Rate Swaps
For the
year ended December 31, 2009, we sold Investment Securities with a carrying
value of $4.6 billion for aggregate net gain of $99.1 million. For
the year ended December 31, 2008, we sold Investment Securities with a carrying
value of $15.1 billion for an aggregate net gain of $10.7
million. For the year ended December 31, 2007, we sold investment
securities with an aggregate historical amortized value of $4.9 billion for a
net gain of $19.1 million. In addition, for the year ended December
31, 2007, we had a $2.1 million gain on the termination of interest rate swaps
with a notional amount of $900 million. We do not expect to sell
assets on a frequent basis, but may from time to time sell existing assets to
move into new assets, which our management believes might have higher
risk-adjusted returns, or to manage our balance sheet as part of our
asset/liability management strategy.
Income
from Trading Securities
During
the year ended December 31, 2009, there was no income from trading
securities. Gross income from trading securities totaled $9.7
million, and $19.1 million for the years ended December 31, 2008 and
2007.
Dividend
Income from Available-For-Sale Equity Securities
Dividend
income from our investment in Chimera totaled $17.2 million for the year ended
December 31, 2009, $2.7 million for the year ended December 31, 2008 and $91,000
for the year ended December 31, 2007.
53
Loss
on Other-Than-Temporarily Impaired Securities
At each
quarter end, we review each of our securities to determine if an
other-than-temporary impairment charge would be necessary. We will
take these charges if we determine that we do not intend to hold securities that
were in an unrealized loss position for a period of time, to maturity if
necessary, sufficient for a forecasted market price recovery up to or beyond the
cost of the investments or we are required to sell for regulatory or other
reasons. For the year ended December 31, 2009 there was no loss on
other-than-temporarily impaired securities. For the years ended December 31,
2008 and 2007 the loss on other-than-temporarily impaired securities totaled
$31.8 million and $1.2 million, respectively.
General and Administrative
Expenses
General
and administrative (or G&A) expenses were $130.2 million for the year ended
December 31, 2009, $103.6 million for the year ended December 31, 2008, and
$62.7 million for the year ended December 31, 2007. G&A
expenses as a percentage of average total assets was 0.20%, 0.18%, and 0.15% for
the years ended December 31, 2009, 2008, and 2007, respectively. The
increase in G&A expenses of $26.6 million for the year December 31, 2009 was
primarily the result of increased compensation costs related to us and our
subsidiaries. Staff increased from 39 at the end of 2007 to 65 at the
end of 2008 and 87 at the end of 2009.
The table
below shows our total G&A expenses as compared to average total assets and
average equity for the years ended December 31, 2009, 2008, 2007, 2006, and 2005
and the four quarters in 2009.
G&A Expenses and
Operating Expense Ratios
(ratios
for the quarters have been annualized, dollars in thousands)
|
Total
G&A Expenses
|
Total
G&A Expenses/Average Assets
|
Total
G&A Expenses/Average Equity
|
||||||||||
|
For
the Year Ended December 31, 2009
|
$ | 130,152 | 0.20 | % | 1.51 | % | ||||||
|
For
the Year Ended December 31, 2008
|
$ | 103,622 | 0.18 | % | 1.55 | % | ||||||
|
For
the Year Ended December 31, 2007
|
$ | 62,666 | 0.15 | % | 1.69 | % | ||||||
|
For
the Year Ended December 31, 2006
|
$ | 40,063 | 0.17 | % | 2.00 | % | ||||||
|
For
the Year Ended December 31, 2005
|
$ | 26,278 | 0.14 | % | 1.63 | % | ||||||
|
For
the Quarter Ended December 31, 2009
|
$ | 36,880 | 0.21 | % | 1.55 | % | ||||||
|
For
the Quarter Ended September 30, 2009
|
$ | 33,344 | 0.19 | % | 1.47 | % | ||||||
|
For
the Quarter Ended June 30, 2009
|
$ | 30,046 | 0.19 | % | 1.41 | % | ||||||
|
For
the Quarter Ended March 31, 2009
|
$ | 29,882 | 0.20 | % | 1.54 | % | ||||||
Net Income and Return on Average
Equity
Our net
income was $2.0 billion for the year ended December 31, 2009, $346.2 million for
the year ended December 31, 2008, and $414.4 million for the year ended December
31, 2007. Our return on average equity was 22.69% for the year ended
December 31, 2009, 5.18% for the year ended December 31, 2008, and 11.17% for
the year ended December 31, 2007. Net income increased by $1.6
billion for the year ended December 31, 2009, as compared to the year ended
December 31, 2008, primarily due to the improved interest rate spread, resulting
in an increase in net interest income of $400.3 million, the unrealized gain on
interest rate swaps of $349.5 million, and the gain on sale of Mortgage-Backed
Securities of $99.1 million. We attribute the decrease in total net
income for the year ended December 31, 2008 from the year ended December 31,
2007 primarily to the de-designation of interest rate swaps as cash flow hedges
in the fourth quarter of 2008, which resulted in an unrealized loss of $768.3
million being recorded in the income statement for the year ended December 31,
2008. Prior to the fourth quarter of 2008 and the de-designation of
cash flow hedges, we recorded these changes in the market values of interest
rate swaps in the Statement of Financial Condition.
The table
below shows our net interest income, net investment advisory and service fees,
gain (loss) on sale of Mortgage-Backed Securities and termination of interest
rate swaps, loss on other-than-temporarily impaired securities, income from
trading securities, G&A expenses, income taxes, impairment of intangibles
for customer relationships, noncontrolling interest, each as a percentage of
average equity, and the return on average equity for the years ended December
31, 2009, 2008, 2007, 2006, and 2005, and the four quarters in
2009.
54
Components of Return on
Average Equity
(Ratios
for the quarters have been annualized)
|
Net
Interest Income/
Average
Equity
|
Net
Investment Advisory and Service Fees/Average Equity
|
Gain/(Loss)
on Sale of Mortgage-Backed Securities and Realized and Unrealized
Gain/(Loss) Interest Rate Swaps/ Average Equity
|
Loss
on other-than-temporarily impaired securities or Loss on receivable from
Prime Broker/
Average
Equity
|
Income
from
trading
securities/
Average
Equity
|
Dividend
income from available-for-sale equity securities and Loss on Equity Method
Investment
|
G&A
Expenses/ Average Equity
|
Income
Taxes/
Average Equity
|
Impairment
of
intangible
for customer relationships/
Average
Equity
|
Non-controlling
interest/
Average
Equity
|
Return
on Average Equity
|
||||||||||||||||||||||||||||||||||
|
For
the Year Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
December
31, 2009
|
18.82 | % | 0.55 | % | 5.19 | % | (0.16 | %) | - | 0.20 | % | (1.51 | %) | (0.40 | %) | - | - | 22.69 | % | |||||||||||||||||||||||||
|
For
the Year Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
December
31, 2008
|
18.36 | % | 0.39 | % | (11.34 | %) | (0.48 | %) | 0.15 | % | 0.04 | % | (1.55 | %) | (0.39 | %) | - | - | 5.18 | % | ||||||||||||||||||||||||
|
For
the Year Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
December
31, 2007
|
11.56 | % | 0.50 | % | 0.57 | % | (0.03 | %) | 0.52 | % | 0.00 | % | (1.69 | %) | (0.24 | %) | - | (0.02 | %) | 11.17 | % | |||||||||||||||||||||||
|
For
the Year Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
December
31, 2006
|
8.32 | % | 0.94 | % | 0.34 | % | (2.61 | %) | 0.20 | % | - | (2.00 | %) | (0.38 | %) | (0.12 | %) | (0.01 | %) | 4.68 | % | |||||||||||||||||||||||
|
For
the Year Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
December
31, 2005
|
8.45 | % | 1.71 | % | (3.30 | %) | (5.15 | %) | - | - | (1.63 | %) | (0.67 | %) | - | - | (0.57 | %) | ||||||||||||||||||||||||||
|
For
the Quarter Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
December
31, 2009
|
19.58 | % | 0.61 | % | 12.79 | % | (0.57 | %) | - | 0.31 | % | (1.55 | %) | (0.44 | %) | - | - | 30.73 | % | |||||||||||||||||||||||||
|
For
the Quarter Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
September
30, 2009
|
19.30 | % | 0.63 | % | (5.66 | %) | - | - | 0.24 | % | (1.47 | %) | (0.42 | %) | 12.60 | % | 19.30 | % | 12.60 | % | ||||||||||||||||||||||||
|
For
the Quarter Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
June
30, 2009
|
18.30 | % | 0.53 | % | 10.97 | % | - | - | 0.15 | % | (1.41 | %) | (0.37 | %) | 28.17 | % | 18.30 | % | 28.17 | % | ||||||||||||||||||||||||
|
For
the Quarter Ended
|
||||||||||||||||||||||||||||||||||||||||||||
|
March
31, 2009
|
17.41 | % | 0.38 | % | 2.09 | % | - | - | 0.05 | % | (1.54 | %) | (0.33 | %) | 18.06 | % | 17.41 | % | 18.06 | % | ||||||||||||||||||||||||
Financial
Condition
Investment Securities, Available for
Sale
Substantially
all of our Mortgage-Backed Securities at December 31, 2009, 2008, and 2007 were
adjustable-rate or fixed-rate mortgage-backed securities backed by single-family
mortgage loans. Substantially all of the mortgage assets underlying
these mortgage-backed securities were secured with a first lien position on the
underlying single-family properties. Substantially all of our
mortgage-backed securities were FHLMC, FNMA or GNMA mortgage pass-through
certificates or CMOs, which carry an implied “AAA” rating. All of our
agency debentures are callable and carry an implied “AAA” rating. We
carry all of our earning assets at fair value.
We
accrete discount balances as an increase in interest income over the life of
discount investment securities and we amortize premium balances as a decrease in
interest income over the life of premium investment securities. At
December 31, 2009, 2008, and 2007 we had on our balance sheet a total of $49.2
million, $64.4 million and $77.4 million, respectively, of unamortized discount
(which is the difference between the remaining principal value and current
historical amortized cost of our investment securities acquired at a price below
principal value) and a total of $1.3 billion, $619.5 million and
$405.8 million, respectively, of unamortized premium (which is the difference
between the remaining principal value and the current historical amortized cost
of our investment securities acquired at a price above principal
value).
We
received mortgage principal repayments of $13.8 billion for the year ended
December 31, 2009, $8.6 billion for the year ended December 31, 2008, and $6.8
billion for the year ended December 31, 2007. The average prepayment
speed for the year ended December 31, 2009, 2008 and 2007 was 19%, 13%, and 15%,
respectively. During the year ended December 31, 2009, the average
CPR increased to 19% from 13% during the year ended December 31, 2008, due to an
increase in refinancing activity. Given our current portfolio
composition, if mortgage principal prepayment rates were to increase over the
life of our mortgage-backed securities, all other factors being equal, our net
interest income would decrease during the life of these mortgage-backed
securities as we would be required to amortize our net premium balance into
income over a shorter time period. Similarly, if mortgage principal
prepayment rates were to decrease over the life of our mortgage-backed
securities, all other factors being equal, our net interest income would
increase during the life of these mortgage-backed securities as we would
amortize our net premium balance over a longer time period.
55
The table
below summarizes certain characteristics of our Investment Securities at
December 31, 2009, 2008, 2007, 2006, and 2005 and September 30, 2009, June 30,
2009, and March 31, 2009.
Investment
Securities
(dollars
in thousands)
|
Principal
Amount
|
Net
Premium
|
Amortized
Cost
|
Amortized
Cost/Principal Amount
|
Fair
Value
|
Fair
Value/Principal Amount
|
Weighted
Average
Yield
|
|||||||||||||||||||
|
At
December 31, 2009
|
$ | 62,508,927 | $ | 1,247,717 | $ | 63,756,644 | 102.00% | $ | 65,721,477 | 105.14% | 4.51% | ||||||||||||||
|
At
December 31, 2008
|
$ | 54,508,672 | $ | 555,043 | $ | 55,063,715 | 101.02% | $ | 55,645,940 | 102.09% | 5.15% | ||||||||||||||
|
At
December 31, 2007
|
$ | 52,569,598 | $ | 328,376 | $ | 52,897,974 | 100.62% | $ | 53,133,443 | 101.07% | 5.75% | ||||||||||||||
|
At
December 31, 2006
|
$ | 30,134,791 | $ | 140,709 | $ | 30,275,500 | 100.47% | $ | 30,217,009 | 100.27% | 5.63% | ||||||||||||||
|
At
December 31, 2005
|
$ | 15,915,801 | $ | 220,637 | $ | 16,136,438 | 101.39% | $ | 15,929,864 | 100.09% | 4.68% | ||||||||||||||
|
At
September 30, 2009
|
$ | 64,253,006 | $ | 1,126,493 | $ | 65,379,499 | 101.75% | $ | 67,463,376 | 105.00% | 4.70% | ||||||||||||||
|
At
June 30, 2009
|
$ | 63,300,232 | $ | 924,873 | $ | 64,225,105 | 101.46% | $ | 65,782,019 | 103.92% | 4.75% | ||||||||||||||
|
At
March 31, 2009
|
$ | 56,718,404 | $ | 668,295 | $ | 57,386,699 | 101.18% | $ | 58,785,456 | 103.64% | 4.98% | ||||||||||||||
The table
below summarizes certain characteristics of our Investment Securities at
December 31, 2009, 2008, 2007, 2006, and 2005 and September 30, 2009, June 30,
2009, and March 31, 2009. The index level for adjustable-rate
Investment Securities is the weighted average rate of the various short-term
interest rate indices, which determine the coupon rate.
Adjustable-Rate Investment
Security Characteristics
(dollars
in thousands)
|
Principal
Amount
|
Weighted
Average
Coupon
Rate
|
Weighted
Average
Term to
Next
Adjustment
|
Weighted
Average
Lifetime
Cap
|
Weighted
Average Asset
Yield
|
Principal
Amount at Period End as % of Total Investment
Securities
|
|||||||||||||
|
At
December 31, 2009
|
$ | 16,196,473 | 4.55% |
33
months
|
10.09% | 3.23% | 25.91% | |||||||||||
|
At
December 31, 2008
|
$ | 19,540,152 | 4.75% |
36
months
|
10.00% | 3.93% | 35.85% | |||||||||||
|
At
December 31, 2007
|
$ | 15,331,447 | 5.90% |
39
months
|
9.89% | 5.63% | 29.16% | |||||||||||
|
At
December 31, 2006
|
$ | 8,493,242 | 5.72% |
19
months
|
9.76% | 5.57% | 28.18% | |||||||||||
|
At
December 31, 2005
|
$ | 9,699,133 | 4.76% |
22
months
|
10.26% | 4.74% | 60.94% | |||||||||||
|
At
September 30, 2009
|
$ | 18,561,525 | 4.59% |
33
months
|
10.11% | 3.37% | 28.89% | |||||||||||
|
At
June 30, 2009
|
$ | 19,657,988 | 4.64% |
34
months
|
10.12% | 3.49% | 31.06% | |||||||||||
|
At
March 31, 2009
|
$ | 19,558,480 | 4.66% |
34
months
|
10.06% | 3.74% | 34.48% | |||||||||||
Fixed-Rate Investment
Security Characteristics
(dollars
in thousands)
|
Principal
Amount
|
Weighted
Average Coupon Rate
|
Weighted
Average Asset Yield
|
Principal
Amount at Period
End
as % of Total Investment Securities
|
||||||||||
|
At
December 31, 2009
|
$ | 46,312,455 | 5.78% | 4.95% | 74.09% | ||||||||
|
At
December 31, 2008
|
$ | 34,968,520 | 6.13% | 5.84% | 64.15% | ||||||||
|
At
December 31, 2007
|
$ | 37,238,151 | 6.00% | 5.80% | 70.84% | ||||||||
|
At
December 31, 2006
|
$ | 21,641,549 | 5.83% | 5.65% | 71.82% | ||||||||
|
At
December 31, 2005
|
$ | 6,216,668 | 5.37% | 4.60% | 39.06% | ||||||||
|
At
December 31, 2004
|
$ | 5,579,030 | 5.24% | 3.89% | 29.17% | ||||||||
|
At
September 30, 2009
|
$ | 45,691,481 | 5.89% | 5.14% | 71.11% | ||||||||
|
At
June 30, 2009
|
$ | 43,642,244 | 5.94% | 5.32% | 68.94% | ||||||||
|
At
March 31, 2009
|
$ | 37,159,924 | 6.08% | 5.64% | 65.52% | ||||||||
At
December 31, 2009 and 2008, we held Investment Securities with coupons linked to
various indices. The following tables detail the portfolio
characteristics by index.
56
Adjustable-Rate Investment Securities by Index
December 31,
2009
|
One-Month
Libor
|
Six-
Month
Libor
|
Twelve
Month Libor
|
12-Month
Moving Average
|
11
th
District
Cost of Funds
|
1-Year
Treasury Index
|
Monthly
Federal
Cost
of Funds
|
Other
Indexes
(1)
|
|||||||||||||||||
|
Weighted
Average Term to Next Adjustment
|
1
mo.
|
16
mo.
|
45
mo.
|
1
mo.
|
7
mo.
|
50 mo.
|
1
mo.
|
12
mo.
|
||||||||||||||||
|
Weighted
Average Annual Period Cap
|
6.40% | 1.58% | 2.01% | 0.42% | 0.77% | 1.95% | 0.00% | 1.82% | ||||||||||||||||
|
Weighted
Average Lifetime Cap at
December
31, 2009
|
7.04% | 11.20% | 10.85% | 8.12% | 0.51% | 10.98% | 13.43% | 11.71% | ||||||||||||||||
|
Investment Principal
Value as Percentage of
Investment
Securities
at
December
31, 2009
|
4.59% | 1.40% | 15.77% | 1.10% | 0.76% | 2.15% | 0.09% | 0.05% |
|
|
(1)
|
Combination
of indexes that account for less than 0.05% of total investment
securities.
|
Adjustable-Rate Investment
Securities by Index
December 31,
2008
|
One-
Month
Libor
|
Six-
Month
Libor
|
Twelve
Month
Libor
|
12-Month
Moving Average
|
11
th
District
Cost
of
Funds
|
1-Year
Treasury Index
|
Monthly
Federal
Cost
of
Funds
|
Other
Indexes
(1)
|
|||||||||||||||||
|
Weighted
Average Term to Next Adjustment
|
1
mo.
|
25
mo.
|
55
mo.
|
1
mo.
|
1
mo.
|
37 mo.
|
1
mo.
|
14
mo.
|
||||||||||||||||
|
Weighted
Average Annual Period Cap
|
6.28% | 1.95% | 1.98% | 0.00% | 1.26% | 1.93% | 0.00% | 1.94% | ||||||||||||||||
|
Weighted
Average Lifetime Cap at
December
31, 2008
|
7.07% | 10.87% | 10.92% | 8.86% | 11.35% | 10.86% | 13.44% | 11.98% | ||||||||||||||||
|
Investment Principal
Value as Percentage of
Investment
Securities at December 31, 2008
|
8.11% | 2.53% | 19.32% | 0.99% | 0.60% | 4.12% | 0.11% | 0.07% |
|
|
(1)
|
Combination
of indexes that account for less than 0.05% of total investment
securities.
|
Reverse
Repurchase Agreements
At
December 31, 2009 and 2008, we lent $259.0 million and $562.1 million,
respectively, to Chimera in a weekly reverse repurchase
agreement. This amount is included in the principal amount which
approximates fair value in our Statement of Financial Condition. The
interest rate at December 31, 2009 and December 31, 2008 was at the rate of
1.72% and 1.43%, respectively. The collateral for this loan is
mortgage-backed securities with a fair value of $314.3 million and $680.8
million at December 31, 2009 and 2008, respectively.
At
December 31, 2009, RCap, in its ordinary course of business, financed though
matched reverse repurchase agreements, at market rates, $69.7 million for a fund
that is managed by FIDAC. At December 31, 2009, RCap had an
outstanding reverse repurchase agreement with a non-affiliate of $425.0
million.
Receivable
from Prime Broker on Equity Investment
The net
assets of the investment fund we owned are subject
to English bankruptcy law, which governs the
administration of Lehman Brothers International (Europe) (in
administration) (“LBIE”), as well as the law of New York, which governs the
contractual documents. We invested approximately $45.0 million in the
fund and have redeemed approximately $56.0 million. The current
assets of the fund still remain at LBIE and affiliates of LBIE and the ultimate
recovery of such amount remains uncertain. We have entered into the
Claims Resolution Agreement between LBIE and certain eligible offerees effective
December 29, 2009 with respect to these assets (the “CRA”).
Certain
of our assets subject to the CRA are held directly at LBIE and we have valued
such assets in accordance with the valuation date set forth in the CRA and the
pricing information provided to the Company by LBIE. The valuation
date with respect to these assets as set forth in the CRA is September 19,
2008.
Certain
of our assets subject to the CRA are not held directly at LBIE and are believed
to be held at affiliates of LBIE. Given the great degree of
uncertainty as to the status of our assets that are not directly held by LBIE
and are believed to be held at affiliates of LBIE, the Company has valued such
assets at an 80% discount. The value of the net assets that are not
directly held by LBIE and are believed to be held at affiliates of LBIE is
determined on the basis of the best information available to us from time to
time, legal and professional advice obtained for the purpose of determining the
rights, and on the basis of a number of assumptions which we believe to be
reasonable.
57
We can
provide no assurance, however, that it will recover all or any portion of any of
the net assets of the investment fund following completion
of LBIE’s administration (and any subsequent
liquidation).
Borrowings
As of
December 31, 2009, our debt has consisted entirely of borrowings collateralized
by a pledge of our Investment Securities. These borrowings appear on
our balance sheet as repurchase agreements. At December 31, 2009, we
had established uncommitted borrowing facilities in this market with 30 lenders
in amounts which we believe are in excess of our needs. All of our
Investment Securities are currently accepted as collateral for these
borrowings. However, we limit our borrowings, and thus our potential
asset growth, in order to maintain unused borrowing capacity and thus increase
the liquidity and strength of our balance sheet. For the year ended
December 31, 2009, the term to maturity of our borrowings ranged from one day to
10 years. Additionally, we have entered into structured borrowings
giving the counterparty the right to call the balance prior to
maturity. For the year ended December 31, 2008, the term to maturity
of our borrowings ranged from one day to three years. Additionally,
we have entered into structured borrowings giving the counterparty the right to
call the balance prior to maturity. At December 31, 2009, the
weighted average cost of funds for all of our borrowings was 2.11%, with the
effect of the interest rate swaps, and the weighted average term to next rate
adjustment was 170 days. At December 31, 2008, the weighted average
cost of funds for all of our borrowings was 4.08%, with the effect of the
interest rate swaps, and the weighted average term to next rate adjustment was
238 days.
On
February 9, 2010, the Company issued $500.0 million in aggregate principal
amount of its 4% convertible senior notes due 2015 (“Convertible Senior Notes”)
for net proceeds following underwriting expenses of approximately $484.8
million. Interest on the notes will be paid semi-annually at a rate
of 4% per year and the notes will mature on February 15, 2015 unless earlier
repurchased or converted. The notes will be convertible into shares
of Common Stock at an initial conversion rate of 46.6070 shares of Common Stock
per $1,000 principal amount of notes, which is equivalent to an initial
conversion price of approximately $21.456 per share of Common Stock, subject to
adjustment in certain circumstances.
Liquidity
Liquidity,
which is our ability to turn non-cash assets into cash, allows us to purchase
additional investment securities and to pledge additional assets to secure
existing borrowings should the value of our pledged assets
decline. Potential immediate sources of liquidity for us include cash
balances and unused borrowing capacity. Unused borrowing capacity
will vary over time as the market value of our investment securities
varies. Our non-cash assets are largely actual or implied AAA assets,
and accordingly, we have not had, nor do we anticipate having, difficulty in
converting our assets to cash. Our balance sheet also generates
liquidity on an on-going basis through mortgage principal repayments and net
earnings held prior to payment as dividends. Should our needs ever
exceed these on-going sources of liquidity plus the immediate sources of
liquidity discussed above, we believe that in most circumstances our investment
securities could be sold to raise cash. The maintenance of liquidity
is one of the goals of our capital investment policy. Under this
policy, we limit asset growth in order to preserve unused borrowing capacity for
liquidity management purposes.
Borrowings
under our repurchase agreements increased by $7.9 billion to $54.6 billion at
December 31, 2009, from $46.7 billion at December 31, 2008. Even
though borrowing increased over the year, leverage declined from 6.4:1 to
5.7:1.
We
anticipate that, upon repayment of each borrowing under a repurchase agreement,
we will use the collateral immediately for borrowing under a new repurchase
agreement. We have not at the present time entered into any
commitment agreements under which the lender would be required to enter into new
repurchase agreements during a specified period of time, nor do we presently
plan to have liquidity facilities with commercial banks.
58
Under our
repurchase agreements, we may be required to pledge additional assets to our
repurchase agreement counterparties (i.e., lenders) in the event the estimated
fair value of the existing pledged collateral under such agreements declines and
such lenders demand additional collateral (a “margin call”), which may take the
form of additional securities or cash. Similarly, if the estimated
fair value of investment securities increases due to changes in market interest
rates of market factors, lenders may release collateral back to
us. Specifically, margin calls result from a decline in the value of
our Mortgage-Backed Securities securing our repurchase agreements, prepayments
on the mortgages securing such Mortgage-Backed Securities and to changes in the
estimated fair value of such Mortgage-Backed Securities generally due to
principal reduction of such Mortgage-Backed Securities from scheduled
amortization and resulting from changes in market interest rates and other
market factors. Through December 31, 2009, we did not have any margin
calls on our repurchase agreements that we were not able to satisfy with either
cash or additional pledged collateral. However, should prepayment
speeds on the mortgages underlying our Mortgage-Backed Securities and/or market
interest rates suddenly increase, margin calls on our repurchase agreements
could result, causing an adverse change in our liquidity position.
The
following table summarizes the effect on our liquidity and cash flows from
contractual obligations for repurchase agreements, interest expense on
repurchase agreements, the non-cancelable office lease and employment agreements
at December 31, 2009. The table does not include the effect of net
interest rate payments under our interest rate swap agreements. The
net swap payments will fluctuate based on monthly changes in the receive
rate. At December 31, 2009, the interest rate swaps had a net
negative fair value of $527.9 million.
|
(dollars in thousands)
|
||||||||||||||||||||
|
Contractual
Obligations
|
Within
One
Year
|
One
to
Three
Years
|
Three
to
Five
Years
|
More
than
Five
Years
|
Total
|
|||||||||||||||
|
Repurchase
agreements
|
$ | 48,718,129 | $ | 3,530,000 | $ | 950,000 | $ | 1,400,000 | $ | 54,598,129 | ||||||||||
|
Interest
expense on repurchase
agreements,
based on rates at 12-31-09
|
238,568 | 263,722 | 136,699 | 145,909 | 784,898 | |||||||||||||||
|
Long-term
operating lease obligations
|
1,993 | 4,250 | 3,847 | - | 10,090 | |||||||||||||||
|
Employment
contracts
|
88,682 | 4,181 | - | - | 92,683 | |||||||||||||||
|
Total
|
$ | 49,047,372 | $ | 3,802,153 | $ | 1,090,546 | $ | 1,545,909 | $ | 55,485,800 | ||||||||||
Stockholders’ Equity
During
the year ended December 31, 2009, 423,160 options were exercised under the
Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise
price of $4.9 million. During the year ended December 31, 2009, 7,550
shares of restricted stock were issued under the Incentive Plan.
During
the year ended December 31, 2009, 1.4 million shares of Series B Preferred Stock
were converted into 2.8 million shares of common stock.
During
the year ended December 31, 2009, we raised $141.8 million by issuing 8.4
million shares through the Direct Purchase and Dividend Reinvestment
Program.
During
the year ended December 31, 2008, we raised $93.7 million by issuing 5.8 million
shares through our Direct Purchase and Dividend Reinvestment
Program.
During
the year ended December 31, 2008, 300,000 options were exercised under the
Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise
price of $2.8 million.
During the year ended December 31, 2008, 634,000 shares of
Series B Preferred Stock converted into 1.3 million shares of common
stock.
59
On May
13, 2008 we entered into an underwriting agreement pursuant to which we sold
69,000,000 shares of our common stock for net proceeds following underwriting
expenses of approximately $1.1 billion. This transaction settled on May 19,
2008.
On
January 23, 2008 we entered into an underwriting agreement pursuant to which we
sold 58,650,000 shares of our common stock for net proceeds following
underwriting expenses of approximately $1.1 billion. This transaction
settled on January 29, 2008.
On August
3, 2006, we entered into an ATM Equity Offering
(sm)
Sales Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner
& Smith Incorporated, relating to the sale of shares of our common stock
from time to time through Merrill Lynch. Sales of the shares, if any, are made
by means of ordinary brokers' transaction on the New York Stock Exchange. During
the year ended December 31, 2009, there were no shares issued pursuant to this
program. During the year ended December 31, 2008, 588,000 shares of
the Company’s common stock were issued pursuant to this program, totaling $11.5
million in net proceeds.
On August
3, 2006, we entered into an ATM Equity Sales Agreement with UBS Securities LLC,
relating to the sale of shares of our common stock from time to time through UBS
Securities. Sales of the shares, if any, are made by means of ordinary brokers'
transaction on the New York Stock Exchange. During the year ended
December 31, 2009, there were no shares issued pursuant to this program. During
the year ended December 31, 2008, 3.8 million shares of the Company’s common
stock were issued pursuant to this program, totaling $60.3 million in net
proceeds.
Unrealized
Gains and Losses
With our “available-for-sale”
accounting treatment, unrealized fluctuations in market values of assets do not
impact our GAAP or taxable income but rather are reflected on our balance sheet
by changing the carrying value of the asset and stockholders’ equity under
“Accumulated Other Comprehensive Income (Loss).” As a result of the
de-designation of interest rate swaps as cash flow hedges during the quarter
ended December 31, 2009, unrealized gains and losses in our interest rate swaps
impact our GAAP income.
As a result of this mark-to-market
accounting treatment, our book value and book value per share are likely to
fluctuate far more than if we used historical amortized cost
accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may not be
meaningful.
The table below shows unrealized gains
and losses on the Investment Securities, available-for-sale equity securities
and interest rate swaps in our portfolio prior to de-designation.
|
Unrealized
Gains and Losses
(dollars
in thousands)
|
||||||||||||||||||||
|
At
December 31,
|
||||||||||||||||||||
|
2009
|
2008
|
2007
|
2006
|
2005
|
||||||||||||||||
|
Unrealized
gain
|
$ | 2,093,709 | $ | 785,087 | $ | 379,348 | $ | 112,596 | $ | 5,027 | ||||||||||
|
Unrealized
loss
|
(202,392 | ) | (532,857 | ) | (531,545 | ) | (188,708 | ) | (211,601 | ) | ||||||||||
|
Net
Unrealized (loss) gain
|
$ | 1,891,317 | $ | 252,230 | $ | (152,197 | ) | $ | (76,112 | ) | $ | (206,574 | ) | |||||||
Unrealized
changes in the estimated net fair value of investment securities have one direct
effect on our potential earnings and dividends: positive changes increase our
equity base and allow us to increase our borrowing capacity while negative
changes tend to limit borrowing capacity under our capital investment
policy. A very large negative change in the net fair value of our
investment securities might impair our liquidity position, requiring us to sell
assets with the likely result of realized losses upon sale.
Leverage
Our debt-to-equity ratio at December
31, 2009, 2008 and 2007 was 5.7:1, 6.4:1and 8.7:1, respectively. We
generally expect to maintain a ratio of debt-to-equity of between 8:1 and 12:1,
although the ratio may vary from this range from time to time based upon various
factors, including our management’s opinion of the level of risk of our assets
and liabilities, our liquidity position, our level of unused borrowing capacity
and over-collateralization levels required by lenders when we pledge assets to
secure borrowings.
60
Our
target debt-to-equity ratio is determined under our capital investment
policy. Should our actual debt-to-equity ratio increase above the
target level due to asset acquisition or market value fluctuations in assets, we
would cease to acquire new assets. Our management will, at that time,
present a plan to our board of directors to bring us back to our target
debt-to-equity ratio; in many circumstances, this would be accomplished over
time by the monthly reduction of the balance of our Mortgage-Backed Securities
through principal repayments.
Asset/Liability Management and Effect
of Changes in Interest Rates
We
continually review our asset/liability management strategy with respect to
interest rate risk, mortgage prepayment risk, credit risk and the related issues
of capital adequacy and liquidity. Our goal is to provide attractive
risk-adjusted stockholder returns while maintaining what we believe is a strong
balance sheet.
We seek
to manage the extent to which our net income changes as a function of changes in
interest rates by matching adjustable-rate assets with variable-rate
borrowings. In addition, we have attempted to mitigate the potential
impact on net income of periodic and lifetime coupon adjustment restrictions in
our portfolio of investment securities by entering into interest rate
swaps. At December 31, 2009, we had entered into swap agreements with
a total notional amount of $21.5 billion. We agreed to pay a weighted
average pay rate of 3.85% and receive a floating rate based on one month
LIBOR. At December 31, 2008, we had entered into swap agreements with
a total notional amount of $17.6 billion. We agreed to pay a weighted
average pay rate of 4.66% and receive a floating rate based on one month
LIBOR. We may enter into similar derivative transactions in the
future by entering into interest rate collars, caps or floors or purchasing
interest only securities.
Changes
in interest rates may also affect the rate of mortgage principal prepayments
and, as a result, prepayments on mortgage-backed securities. We seek
to mitigate the effect of changes in the mortgage principal repayment rate by
balancing assets we purchase at a premium with assets we purchase at a
discount. To date, the aggregate premium exceeds the aggregate
discount on our mortgage-backed securities. As a result, prepayments,
which result in the expensing of unamortized premium, will reduce our net income
compared to what net income would be absent such prepayments.
Off-Balance
Sheet Arrangements
We do not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. Further, we have
not guaranteed any obligations of unconsolidated entities nor do we have any
commitment or intent to provide funding to any such entities. As
such, we are not materially exposed to any market, credit, liquidity or
financing risk that could arise if we had engaged in such
relationships.
Capital Resources
At December 31, 2009, we had no
material commitments for capital expenditures.
Inflation
Virtually all of our assets and
liabilities are financial in nature. As a result, interest rates and
other factors drive our performance far more than does
inflation. Changes in interest rates do not necessarily correlate
with inflation rates or changes in inflation rates. Our financial
statements are prepared in accordance with GAAP and our dividends are based upon
our net income as calculated for tax purposes; in each case, our activities and
balance sheet are measured with reference to historical cost or fair market
value without considering inflation.
61
Other
Matters
We calculate that at least 75% of our
assets were qualified REIT assets, as defined in the Code for the years ended
December 31, 2009 and 2008. We also calculate that our revenue
qualifies for the 75% source of income test and for the 95% source of income
test rules for the years ended December 31, 2009, 2008 and 2007 and for each
quarter therein. Consequently, we met the REIT income and asset test.
We also met all REIT requirements regarding the ownership of our common stock
and the distribution of our net income. Therefore, for the years
ended of December 31, 2009, 2008, and 2007, we believe that we qualified as a
REIT under the Code.
We at all times intend to conduct our
business so as not to become regulated as an investment company under the
Investment Company Act of 1940, or the Investment Company Act. If we
were to become regulated as an investment company, then our use of leverage
would be substantially reduced. The Investment Company Act exempts
entities that are “primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate” (qualifying
interests). Under current interpretation of the staff of the SEC, in
order to qualify for this exemption, we must maintain at least 55% of our assets
directly in qualifying interests and at least 80% of our assets in qualifying
interests plus other real estate related assets. In addition, unless
certain mortgage securities represent all the certificates issued with respect
to an underlying pool of mortgages, the Mortgage-Backed Securities may be
treated as securities separate from the underlying mortgage loans and, thus, may
not be considered qualifying interests for purposes of the 55%
requirement. We calculate that as of December 31, 2009 and December
31, 2008, we were in compliance with this requirement.
62
ITEM
7A
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET
RISK
Market risk is the exposure to loss
resulting from changes in interest rates, foreign currency exchange rates,
commodity prices and equity prices. The primary market risk to which
we are exposed is interest rate risk, which is highly sensitive to many factors,
including governmental monetary and tax policies, domestic and international
economic and political considerations and other factors beyond our
control. Changes in the general level of interest rates can affect
our net interest income, which is the difference between the interest income
earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by affecting the spread
between our interest-earning assets and interest-bearing
liabilities. Changes in the level of interest rates also can affect
the value of our Mortgage-Backed Securities and our ability to realize gains
from the sale of these assets. We may utilize a variety of financial
instruments, including interest rate swaps, caps, floors, inverse floaters and
other interest rate exchange contracts, in order to limit the effects of
interest rates on our operations. When we use these types of
derivatives to hedge the risk of interest-earning assets or interest-bearing
liabilities, we may be subject to certain risks, including the risk that losses
on a hedge position will reduce the funds available for payments to holders of
securities and that the losses may exceed the amount we invested in the
instruments.
Our profitability and the value of our
portfolio (including interest rate swaps) may be adversely affected during any
period as a result of changing interest rates. The following table
quantifies the potential changes in net interest income and portfolio value,
should interest rates go up or down 25, 50 and 75 basis points, assuming the
yield curves of the rate shocks will be parallel to each other and the current
yield curve. All changes in income and value are measured as
percentage changes from the projected net interest income and portfolio value at
the base interest rate scenario. The base interest rate scenario
assumes interest rates at December 31, 2009 and various estimates regarding
prepayment and all activities are made at each level of rate
shock. Actual results could differ significantly from these
estimates.
|
Change
in Interest Rate
|
Projected
Percentage Change in
Net
Interest Income
|
Projected
Percentage Change
in
Portfolio
Value, with Effect of Interest Rate Swaps
|
||||
|
-75
Basis Points
|
2.38% | 0.42% | ||||
|
-50
Basis Points
|
1.56% | 0.24% | ||||
|
-25
Basis Points
|
0.77% | 0.02% | ||||
|
Base
Interest Rate
|
- | - | ||||
|
+25
Basis Points
|
(1.30%) | (0.27%) | ||||
|
+50
Basis Points
|
(2.87%) | (0.49%) | ||||
|
+75
Basis Points
|
(4.44%) | (0.67%) |
ASSET AND LIABILITY
MANAGEMENT
Asset and liability management is
concerned with the timing and magnitude of the repricing of assets and
liabilities. We attempt to control risks associated with interest
rate movements. Methods for evaluating interest rate risk include an
analysis of our interest rate sensitivity "gap," which is the
difference between interest-earning assets and interest-bearing
liabilities maturing or repricing within a given time period. A gap
is considered positive when the amount of interest-rate sensitive assets exceeds
the amount of interest-rate sensitive liabilities. A gap is
considered negative when the amount of interest-rate sensitive liabilities
exceeds interest-rate sensitive assets. During a period of rising
interest rates, a negative gap would tend to adversely affect net interest
income, while a positive gap would tend to result in an increase in net interest
income. During a period of falling interest rates, a negative gap
would tend to result in an increase in net interest income, while a positive gap
would tend to affect net interest income adversely. Because different
types of assets and liabilities with the same or similar maturities may react
differently to changes in overall market rates or conditions, changes in
interest rates may affect net interest income positively or negatively even if
an institution were perfectly matched in each maturity category.
63
The following table sets forth the
estimated maturity or repricing of our interest-earning assets and
interest-bearing liabilities at December 31, 2009. The amounts of
assets and liabilities shown within a particular period were determined in
accordance with the contractual terms of the assets and liabilities, except
adjustable-rate loans, and securities are included in the period in which their
interest rates are first scheduled to adjust and not in the period in which they
mature and does include the effect of the interest rate swaps. The
interest rate sensitivity of our assets and liabilities in the table could vary
substantially based on actual prepayment experience.
|
Within
3
Months
|
4-12
Months
|
More
than
1
Year
to
3
Years
|
3
Years and
Over
|
Total
|
||||||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||||||
|
Rate
Sensitive Assets:
|
||||||||||||||||||||
|
Investment
Securities (Principal)
|
$ | 4,382,076 | $ | 3,134,226 | $ | 7,180,432 | $ | 47,812,193 | $ | 62,508,927 | ||||||||||
|
Cash
Equivalents
|
1,504,568 | - | - | - | 1,504,568 | |||||||||||||||
|
Reverse
Repurchase
Agreements
|
753,757 | - | - | - | 753,757 | |||||||||||||||
|
Securities
Borrowed
|
29,077 | - | - | - | 29,077 | |||||||||||||||
|
Total
Rate Sensitive Assets
|
6,669,478 | 3,134,226 | 7,180,432 | 47,812,193 | 64,796,329 | |||||||||||||||
|
Rate
Sensitive Liabilities:
|
||||||||||||||||||||
|
Repurchase
Agreements,
|
||||||||||||||||||||
|
with
the effect of swaps
|
25,948,432 | 6,009,947 | 11,345,250 | 11,294,500 | 54,598,129 | |||||||||||||||
|
Securities
Loaned
|
29,057 | - | - | - | 29,057 | |||||||||||||||
|
Total
Rate Sensitive Liabilities
|
25,977,489 | 6,009,947 | 11,345,250 | 11,294,500 | 54,627,186 | |||||||||||||||
|
Interest
rate sensitivity gap
|
$ | (19,308,011 | ) | $ | (2,875,721 | ) | $ | (4,164,818 | ) | $ | 36,517,693 | $ | 10,169,143 | |||||||
|
Cumulative
rate sensitivity gap
|
$ | (19,308,011 | ) | $ | (22,183,732 | ) | $ | (26,348,550 | ) | $ | 10,169,143 | |||||||||
|
Cumulative
interest rate
sensitivity
gap as a percentage of
total
rate-sensitive assets
|
(31 | %) | (35 | %) | (42 | %) | 16 | % | ||||||||||||
Our
analysis of risks is based on management’s experience, estimates, models and
assumptions. These analyses rely on models which utilize estimates of
fair value and interest rate sensitivity. Actual economic conditions
or implementation of investment decisions by our management may produce results
that differ significantly from the estimates and assumptions used in our models
and the projected results shown in the above tables and in this
report. These analyses contain certain forward-looking statements and
are subject to the safe harbor statement set forth under the heading, “Special
Note Regarding Forward-Looking Statements.”
64
ITEM
8
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
Our
financial statements and the related notes, together with the Report of
Independent Registered Public Accounting Firm thereon, are set forth on pages
F-1 through F-27 of this Form 10-K.
ITEM
9
CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL
DISCLOSURE
None.
ITEM
9A
CONTROLS
AND
PROCEDURES
Our
management, including our Chief Executive Officer (the “CEO”) and Chief
Financial Officer (the “CFO”), reviewed and evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of
the period covered by this annual report. Based on that review and
evaluation, the CEO and CFO have concluded that our current disclosure controls
and procedures, as designed and implemented, (1) were effective in ensuring that
information regarding the Company and its subsidiaries is accumulated and
communicated to our management, including our CEO and CFO, by our employees, as
appropriate to allow timely decisions regarding required disclosure and (2) were
effective in providing reasonable assurance that information the Company must
disclose in its periodic reports under the Securities Exchange Act is recorded,
processed, summarized and reported within the time periods prescribed by the
SEC’s rules and forms.
There
have been no changes in the Company’s internal controls over financial reporting
that occurred during the quarter ended December 31, 2009 that have materially
affected, or are reasonably likely to affect its internal control over financial
reporting.
Management
Report On Internal Control Over Financial Reporting
Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial
reporting is defined in Rules 13a-15(f) under the Securities Exchange Act as a
process designed by, or under the supervision of, the Company’s principal
executive and principal financial officers and effected by the Company’s Board
of Directors, management and other personnel to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles and includes those policies and procedures
that:
|
•
|
pertain
to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of the assets of the
Company;
|
|
•
|
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
|
|
•
|
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. As a result, even systems determined
to be effective can provide only reasonable assurance regarding the preparation
and presentation of financial statements. Moreover, projections of
any evaluation of effectiveness to future periods are subject to the risks that
controls may become inadequate because of changes in conditions or that the
degree of compliance with the policies or procedures may
deteriorate.
65
The
Company’s management assessed the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2009. In making
this assessment, the Company’s management used criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control-Integrated
Framework.
Based
on management’s assessment, the Company’s management believes that, as of
December 31, 2009, the Company’s internal control over financial reporting was
effective based on those criteria. The Company’s independent
registered public accounting firm, Deloitte & Touche LLP, has issued an
attestation report on the Company’s internal control over financial
reporting. This report appears on page F-1 of this annual report on
Form 10-K.
ITEM
9B.
OTHER INFORMATION
None.
PART III
ITEM
10
DIRECTORS, EXECUTIVE
OFFICERS AND CORPORATE GOVERNANCE
The
information required by Item 10 as to our directors is incorporated herein by
reference to the proxy statement to be filed with the SEC within 120 days after
December 31, 2009. The information regarding our executive officers
required by Item 10 appears in Part I of this Form 10-K. The
information required by Item 10 as to our compliance with Section 16(a) of the
Securities Exchange Act of 1934 is incorporated by reference to the proxy
statement to be filed with the SEC within 120 days after December 31,
2009.
We have
adopted a Code of Business Conduct and Ethics within the meaning of Item 406(b)
of Regulation S-K. This Code of Business Conduct and Ethics applies
to our principal executive officer, principal financial officer and principal
accounting officer. This Code of Business Conduct and Ethics is
publicly available on our website at
www.annaly.com
. If
we make substantive amendments to this Code of Business Conduct and Ethics or
grant any waiver, including any implicit waiver, we intend to disclose these
events on our website.
The
information regarding certain matters pertaining to our corporate governance
required by Item 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated
by reference to the Proxy Statement to be filed with the SEC within 120 days
after December 31, 2009.
ITEM
11
EXECUTIVE
COMPENSATION
The
information required by Item 11 is incorporated herein by reference to the proxy
statement to be filed with the SEC within 120 days after December 31,
2009.
ITEM
12
SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The
information required by Item 12 is incorporated herein by reference to the proxy
statement to be filed with the SEC within 120 days after December 31,
2009.
ITEM
13
CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The
information required by Item 13 is incorporated herein by reference to the proxy
statement to be filed with the SEC within 120 days after December 31,
2009.
ITEM
14
PRINCIPAL ACCOUNTANT FEES
AND SERVICES
The
information required by Item 14 is incorporated herein by reference to the proxy
statement to be filed with the SEC within 120 days after December 31,
2009.
66
PART IV
ITEM
15
EXHIBITS, FINANCIAL
STATEMENT SCHEDULES.
(a) Documents
filed as part of this report:
1. Financial
Statements.
2. Schedules
to Financial Statements:
All
financial statement schedules not included have been omitted because they are
either inapplicable or the information required is provided in our Financial
Statements and Notes thereto, included in Part II, Item 8, of this Annual Report
on Form 10-K.
3. Exhibits:
|
Exhibit
Number
|
Exhibit
Description
|
|
|
3.1
|
Articles
of Amendment and Restatement of the Articles of Incorporation of the
Registrant (incorporated by reference to Exhibit 3.2 to the Registrant’s
Registration Statement on Form S-11 (Registration No. 333-32913) filed
with the Securities and Exchange Commission on August 5,
1997).
|
|
|
3.2
|
Articles
of Amendment of the Articles of Incorporation of the Registrant
(incorporated by reference to Exhibit 3.1 of the Registrant’s Registration
Statement on Form S-3 (Registration Statement 333-74618) filed with the
Securities and Exchange Commission on June 12, 2002).
|
|
|
3.3
|
Articles
of Amendment of the Articles of Incorporation of the Registrant
(incorporated by reference to Exhibit 3.1 of the Registrant's Form 8-K
(filed with the Securities and Exchange Commission on August 3,
2006).
|
|
|
3.4
|
Form
of Articles Supplementary designating the Registrant’s 7.875% Series A
Cumulative Redeemable Preferred Stock, liquidation preference $25.00 per
share (incorporated by reference to Exhibit 3.3 to the Registrant’s 8-A
filed April 1, 2004).
|
|
|
3.5
|
Articles
Supplementary of the Registrant’s designating an additional 2,750,000
shares of the Company’s 7.875% Series A Cumulative Redeemable Preferred
Stock, as filed with the State Department of Assessments and Taxation of
Maryland on October 15, 2004 (incorporated by reference to Exhibit 3.2 to
the Registrant’s 8-K filed October 4, 2004).
|
|
|
3.6
|
Articles
Supplementary designating the Registrant’s 6% Series B Cumulative
Convertible Preferred Stock, liquidation preference $25.00 per share
(incorporated by reference to Exhibit 3.1 to the Registrant’s 8-K filed
April 10, 2006).
|
|
|
3.7
|
Bylaws
of the Registrant, as amended (incorporated by reference to Exhibit 3.3 to
the Registrant’s Registration Statement on Form S-11 (Registration No.
333-32913) filed with the Securities and Exchange Commission on August 5,
1997).
|
|
|
4.1
|
Specimen
Common Stock Certificate (incorporated by reference to Exhibit 4.1 to
Amendment No. 1 to the Registrant’s Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on September 17, 1997).
|
|
|
4.2
|
Specimen
Preferred Stock Certificate (incorporated by reference to Exhibit 4.2 to
the Registrant’s Registration Statement on Form S-3 (Registration No.
333-74618) filed with the Securities and Exchange Commission on December
5, 2001).
|
|
|
4.3
|
Specimen
Series A Preferred Stock Certificate (incorporated by reference to Exhibit
4.1 of the Registrant's Registration Statement on Form 8-A filed with the
SEC on April 1, 2004).
|
|
|
4.4
|
Specimen
Series B Preferred Stock Certificate (incorporated by reference to Exhibit
4.1 to the Registrant’s Form 8-K filed with the Securities and Exchange
Commission on April 10, 2006).
|
|
| 4.5 | Form of Indenture with Wells Fargo Bank, National Association, as Trustee (incorporated by reference to Exhibit 4.5 to the Registrant’s Registration Statement on Form S-3 (Registration Statement) filed with the Securities and Exchange Commission on February 8, 2010). | |
| 4.6 | Indenture, dated as of February 12, 2010, between the Company and Wells Fargo Bank, National Association, (incorporated by reference to Exhibit 4.1 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 12, 2010). | |
| 4.7 | Supplemental Indenture, dated as of February 12, 2010, between the Company and Wells Fargo Bank, National Association, (incorporated by reference to Exhibit 4.2 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 12, 2010). | |
| 4.8 | Form of 4.00% Convertible Senior Note due 2015 (included in Exhibit 4.2 hereto) (incorporated by reference to Exhibit 4.3 to the Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 12, 2010). |
67
|
10.1
|
Long-Term
Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the
Registrant’s Registration Statement on Form S-11 (Registration No.
333-32913) filed with the Securities and Exchange Commission on August 5,
1997).*
|
|
|
10.2
|
Form
of Master Repurchase Agreement (incorporated by reference to
Exhibit 10.7 to the Registrant’s Registration Statement on Form S-11
(Registration No. 333-32913) filed with the Securities and Exchange
Commission on August 5, 1997).
|
|
|
10.3
|
Amended
and Restated Employment Agreement, effective as of June 4, 2004, between
the Registrant and Michael A.J. Farrell (incorporated by reference to
Exhibit 10.3 of the Registrant’s Form 10-K filed with the Securities and
Exchange Commission on March 10, 2005).*
|
|
|
10.4
|
Amended
and Restated Employment Agreement, dated as of February 25, 2008, between
the Registrant and Wellington J. Denahan (incorporated by reference to
Exhibit 10.4 of the Registrant’s Form 10-K filed with the Securities and
Exchange Commission on February 26, 2008).*
|
|
|
10.5
|
Amended
and Restated Employment Agreement, effective as of June 4, 2004,between
the Registrant and Kathryn F. Fagan (incorporated by reference to Exhibit
10.5 of the Registrant’s Form 10-K filed with the Securities and Exchange
Commission on March 10, 2005).*
|
|
|
10.6
|
Amended
and Restated Employment Agreement, effective as of June 4, 2004, between
the Registrant and James P. Fortescue (incorporated by reference to
Exhibit 10.7 of the Registrant’s Form 10-K filed with the Securities and
Exchange Commission on March 10, 2005).*
|
|
|
10.7
|
Amended
and Restated Employment Agreement, dated as of January 23, 2006, between
the Registrant and Jeremy Diamond (incorporated by reference to Exhibit
10.7 of the Registrant’s Form 10-K filed with the Securities and Exchange
Commission on March 13, 2006).*
|
|
|
10.8
|
Amended
and Restated Employment Agreement, dated as of January 23, 2006, between
the Registrant and Ronald D. Kazel (incorporated by reference to Exhibit
10.7 of the Registrant’s Form 10-K filed with the Securities and Exchange
Commission on March 13, 2006).*
|
|
|
10.9
|
Amended
and Restated Employment Agreement, dated as of April 21, 2006, between the
Registrant and Rose-Marie Lyght (incorporated by reference to Exhibit 10.9
of the Registrant’s Form 10-Q filed with the Securities and Exchange
Commission on May 9, 2006).*
|
|
|
10.10
|
Amended
and Restated Employment Agreement, effective as of June 4, 2004, between
the Registrant and Kristopher R. Konrad (incorporated by reference to
Exhibit 10.11 of the Registrant’s Form 10-K filed with the Securities and
Exchange Commission on March 10, 2005).*
|
|
|
10.11
|
Amended
and Restated Employment Agreement, dated January 23, 2006, between the
Registrant and R. Nicholas Singh (incorporated by reference to
Exhibit 10.7 of the Registrant’s Form 10-K filed with the Securities and
Exchange Commission on March 13, 2006).*
|
|
|
12.1
|
Computation
of ratio of earnings to combined fixed charges and preferred stock
dividends.
|
|
|
21.1
|
Subsidiaries
of Registrant.
|
|
|
23.1
|
Consent
of Independent Registered Public Accounting Firm.
|
|
|
31.1
|
Certification
of Michael A.J. Farrell, Chairman, Chief Executive Officer, and President
of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
31.2
|
Certification
of Kathryn F. Fagan, Chief Financial Officer and Treasurer of the
Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
32.1
|
Certification
of Michael A.J. Farrell, Chairman, Chief Executive Officer, and President
of the Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
|
32.2
|
Certification
of Kathryn F. Fagan, Chief Financial Officer and Treasurer of the
Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
Exhibit
101.INS XBRL
|
Instance
Document*A*
|
|
|
Exhibit
101.SCH XBRL
|
Taxonomy
Extension Schema Document* *
|
|
|
Exhibit
101.CAL XBRL
|
Taxonomy
Extension Calculation Linkbase Document**
|
|
|
Exhibit
101.DEF XBRL
|
Additional
Taxonomy Extension Definition Linkbase Document Created**
|
|
|
Exhibit
101.LAB XBRL
|
Taxonomy
Extension Label Linkbase Document* *
|
|
|
Exhibit
101.PRE XBRL
|
Taxonomy
Extension Presentation Linkbase Document* *
|
68
* Exhibit
Numbers 10.1 and 10.3-10.11 are management contracts or compensatory plans
required to be filed as Exhibits to this Form 10-K.
** Submitted
electronically herewith. Attached as Exhibit 101 to this report are
the following documents formatted in XBRL (Extensible Business Reporting
Language): (i) Consolidated Statements of Financial Condition at December 31,
2009 and December 31, 2008; (ii) Consolidated Statements of Operations and
Comprehensive Income (Loss) for the years ended December 31, 2009, 2008 and
2007; (iii) Consolidated Statement of Stockholders' Equity for the years ended
December 31, 2009, 2008 and 2007; (iv) Consolidated Statements of Cash Flows for
the years ended December 31, 2009, 2008 and 2007; and (v) Notes to Consolidated
Financial Statements. Users of this data are advised pursuant to Rule
406T of Regulation S-T that this interactive data file is deemed not filed or
part of a registration statement or prospectus for purposes of sections 11 or 12
of the Securities Act of 1933, is deemed not filed for purposes of section 18 of
the Securities and Exchange Act of 1934, and otherwise is not subject to
liability under these sections.
69
ANNALY
CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
|
Page
|
||||
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
|
F-1 | |||
|
CONSOLIDATED
FINANCIAL STATEMENTS FOR THE YEARS ENDED
|
||||
|
DECEMBER
31, 2009 and 2008:
|
||||
|
Consolidated
Statements of Financial Condition
|
F-2 | |||
|
Consolidated
Statements of Operations and Comprehensive Income (Loss)
|
F-3 | |||
|
Consolidated
Statements of Stockholders’ Equity
|
F-4 | |||
|
Consolidated
Statements of Cash Flows
|
F-5 | |||
|
Notes
to Consolidated Financial Statements
|
F-6 | |||
70
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of
Annaly
Capital Management, Inc.
New York,
New York
We have
audited the accompanying consolidated statements of financial condition of
Annaly Capital Management, Inc. and subsidiaries (the "Company") as of December
31, 2009 and 2008, and the related consolidated statements of operations and
comprehensive income (loss), stockholders' equity, and cash flows for each of
the three years in the period ended December 31, 2009. We also have
audited the Company'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. The Company's management is responsible for
these financial statements, 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 Report
On Internal Control Over Financial Reporting at Item 9A. Our
responsibility is to express an opinion on these financial statements and an
opinion on the Company's internal control over financial reporting 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 and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included 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, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting
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 audits also included performing such other
procedures as we considered necessary in the circumstances. We
believe that our audits provide a reasonable basis for our
opinions.
A
company's internal control over financial reporting is a process designed by, or
under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial
statements.
Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Annaly Capital Management,
Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their
operations and their 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. Also, in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2009, based on the criteria established in
Internal Control — Integrated
Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission.
/s/
Deloitte & Touche LLP
New York,
New York
February
24, 2010
F-1
Item1. Financial
Statements
ANNALY
CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
DECEMBER
31, 2009 AND 2008
(dollars
in thousands)
|
December
31, 2009
|
December
31, 2008
|
|||||||
|
ASSETS
|
||||||||
|
Cash
and cash equivalents
|
$ | 1,504,568 | $ | 909,353 | ||||
|
Reverse
repurchase agreements with affiliate
|
328,757 | 562,119 | ||||||
|
Reverse
repurchase agreements
|
425,000 | - | ||||||
|
Mortgage-Backed
Securities, at fair value
|
64,805,725 | 55,046,995 | ||||||
|
Agency
debentures, at fair value
|
915,752 | 598,945 | ||||||
|
Investment
with affiliates
|
242,198 | 52,795 | ||||||
|
Securities
borrowed
|
29,077 | - | ||||||
|
Receivable
for Mortgage-Backed Securities sold
|
732,134 | 75,546 | ||||||
|
Accrued
interest and dividends receivable
|
318,919 | 282,532 | ||||||
|
Receivable
from Prime Broker
|
3,272 | 16,886 | ||||||
|
Receivable
for advisory and service fees
|
12,566 | 6,103 | ||||||
|
Intangible
for customer relationships, net
|
10,491 | 12,380 | ||||||
|
Goodwill
|
27,917 | 27,917 | ||||||
|
Interest
rate swaps, at fair value
|
5,417 | - | ||||||
|
Other
assets
|
14,397 | 6,044 | ||||||
|
Total
assets
|
$ | 69,376,190 | $ | 57,597,615 | ||||
|
LIABILITIES AND STOCKHOLDERS’
EQUITY
|
||||||||
|
Liabilities:
|
||||||||
|
Repurchase
agreements
|
$ | 54,598,129 | $ | 46,674,885 | ||||
|
Payable
for Investment Securities purchased
|
4,083,786 | 2,062,030 | ||||||
|
Accrued
interest payable
|
89,460 | 199,985 | ||||||
|
Dividends
payable
|
414,851 | 270,736 | ||||||
|
Securities
loaned
|
29,057 | - | ||||||
|
Accounts
payable and other liabilities
|
10,005 | 8,380 | ||||||
|
Interest
rate swaps, at fair value
|
533,362 | 1,102,285 | ||||||
|
Total
liabilities
|
59,758,650 | 50,318,301 | ||||||
|
6.00%
Series B Cumulative Convertible Preferred Stock:
4,600,000
shares authorized 2,604,614
and
4,496,525
shares
issued
and
outstanding, respectively.
|
63,114 | 96,042 | ||||||
|
Commitments
and contingencies
|
- | - | ||||||
|
Stockholders’
Equity:
|
||||||||
|
7.875%
Series A Cumulative Redeemable Preferred Stock:
7,412,500
shares authorized, issued and outstanding
|
177,088 | 177,088 | ||||||
|
Common
stock: par value $.01 per share; 987,987,500 shares
authorized,
553,134,877 and, 541,475,366 issued and outstanding,
respectively
|
5,531 | 5,415 | ||||||
|
Additional
paid-in capital
|
7,817,454 | 7,633,438 | ||||||
|
Accumulated
other comprehensive income
|
1,891,317 | 252,230 | ||||||
|
Accumulated
deficit
|
(336,964 | ) | (884,899 | ) | ||||
|
Total
stockholders’ equity
|
9,554,426 | 7,183,272 | ||||||
|
Total
liabilities, Series B Cumulative Convertible
Preferred
Stock and stockholders’ equity
|
$ | 69,376,190 | $ | 57,597,615 | ||||
See notes
to consolidated financial statements.
F-2
ANNALY
CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
YEARS
ENDED DECEMBER 31, 2009, 2008, AND 2007
(dollars
in thousands, except per share amounts)
|
For
the Year
Ended
December
31,
2009
|
For
the Year
Ended
December
31,
2008
|
For
the Year
Ended
December 31,
2007
|
||||||||||
|
Interest
income
|
||||||||||||
|
Investments
|
$ | 2,922,499 | $ | 3,115,428 | $ | 2,355,447 | ||||||
|
Securities
loaned
|
103 | - | - | |||||||||
|
Total
interest income
|
2,922,602 | $ | 3,115,428 | $ | 2,355,447 | |||||||
|
Interests
expense
|
||||||||||||
|
Repurchase
agreements
|
1,295,670 | 1,888,912 | 1,926,465 | |||||||||
|
Securities
borrowed
|
92 | - | - | |||||||||
|
Total
interest expense
|
1,295,762 | 1,888,912 | 1,926,465 | |||||||||
|
Net
interest income
|
1,626,840 | 1,226,516 | 428,982 | |||||||||
|
Other
income (loss):
|
||||||||||||
|
Investment
advisory and service fees
|
48,952 | 27,891 | 22,028 | |||||||||
|
Gain
on sale of Investment Securities
|
99,128 | 10,713 | 19,062 | |||||||||
|
Gain
on termination of interest rate swaps
|
- | - | 2,096 | |||||||||
|
Income
from trading securities
|
- | 9,695 | 19,147 | |||||||||
|
Dividend
income from available-for-sale equity securities
|
17,184 | 2,713 | 91 | |||||||||
|
Loss
on other-than-temporarily impaired securities
|
- | (31,834 | ) | (1,189 | ) | |||||||
|
Loss
on receivable from Prime Broker
|
(13,613 | ) | - | - | ||||||||
|
Unrealized
gain (loss) on interest rate swaps
|
349,521 | (768,268 | ) | - | ||||||||
|
Total other income
(loss)
|
501,172 | (749,090 | ) | 61,235 | ||||||||
|
Expenses:
|
||||||||||||
|
Distribution
fees
|
1,756 | 1,589 | 3,647 | |||||||||
|
General
and administrative expenses
|
130,152 | 103,622 | 62,666 | |||||||||
|
Total
expenses
|
131,908 | 105,211 | 66,313 | |||||||||
|
Income
before loss on equity method investments, income
taxes
and noncontrolling interest
|
1,996,104 | 372,215 | 423,904 | |||||||||
|
Loss
on equity method investment
|
252 | - | - | |||||||||
|
Income
taxes
|
34,381 | 25,977 | 8,870 | |||||||||
|
Net
income
|
1,961,471 | 346,238 | 415,034 | |||||||||
|
Noncontrolling
interest
|
- | 58 | 650 | |||||||||
|
Net
income attributable to controlling interest
|
1,961,471 | 346,180 | 414,384 | |||||||||
|
Dividends
on preferred stock
|
18,501 | 21,177 | 21,493 | |||||||||
|
Net
income available to common shareholders
|
$ | 1,942,970 | $ | 325,003 | $ | 392,891 | ||||||
|
Net
income available per share to common shareholders:
|
||||||||||||
|
Basic
|
$ | 3.55 | $ | 0.64 | $ | 1.32 | ||||||
|
Diluted
|
$ | 3.52 | $ | 0.64 | $ | 1.31 | ||||||
|
Weighted
average number of common shares
outstanding
:
|
||||||||||||
|
Basic
|
546,973,036 | 507,024,596 | 297,488,394 | |||||||||
|
Diluted
|
553,130,643 | 507,024,596 | 306,263,766 | |||||||||
|
Net
income attributable to controlling interest
|
$ | 1,961,471 | $ | 346,180 | $ | 414,384 | ||||||
|
Other
comprehensive income (loss):
|
||||||||||||
|
Unrealized
gain on available-for-sale securities
|
1,513,397 | 319,226 | 322,264 | |||||||||
|
Unrealized
gain (loss) on interest rate swaps
|
224,818 | 64,080 | (378,380 | ) | ||||||||
|
Reclassification
adjustment for net (gains) loss
included
in net income
|
(99,128 | ) | 21,121 | (19,969 | ) | |||||||
|
Other
comprehensive income (loss)
|
1,639,087 | 404,427 | (76,085 | ) | ||||||||
|
Comprehensive
income attributable to controlling interest
|
$ | 3,600,558 | $ | 750,607 | $ | 338,299 | ||||||
See notes
to consolidated financial statements.
F-3
ANNALY
CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY
YEARS
ENDED DECEMBER 31, 2009, 2008, AND 2007
(dollars
in thousands, except per share data)
|
Preferred
Stock
|
Common
Stock
Par
Value
|
Additional
Paid-In
Capital
|
Accumulated
Other
Comprehensive
Income
(Loss)
|
Accumulated
Deficit
|
Total
|
|||||||||||||||||||
|
BALANCE,
DECEMBER 31, 2006
|
177,088 | 2,053 | 2,615,016 | (76,112 | ) | (175,004 | ) | 2,543,041 | ||||||||||||||||
|
Net
income attributable to controlling interest
|
- | - | - | - | 414,384 | - | ||||||||||||||||||
|
Other
comprehensive loss
|
- | - | - | (76,085 | ) | - | - | |||||||||||||||||
|
Comprehensive
income
|
- | - | - | - | - | 338,299 | ||||||||||||||||||
|
Exercise
of stock options
|
- | - | 576 | - | - | 576 | ||||||||||||||||||
|
Stock
option expense and long-term compensation expense
|
- | - | 1,355 | - | - | 1,355 | ||||||||||||||||||
|
Net
proceeds from follow-on offerings
|
- | 1,829 | 2,483,700 | - | - | 2,485,529 | ||||||||||||||||||
|
Net
proceeds from ATM program
|
- | 56 | 80,862 | - | - | 80,918 | ||||||||||||||||||
|
Net
proceeds from direct purchase and dividend reinvestment
|
- | 80 | 116,413 | - | - | 116,493 | ||||||||||||||||||
|
Preferred
Series A dividends declared $1.97 per share
|
- | - | - | - | (14,593 | ) | (14,593 | ) | ||||||||||||||||
|
Preferred
Series B dividends declared $1.50 per share
|
- | - | - | - | (6,900 | ) | (6,900 | ) | ||||||||||||||||
|
Common
dividends declared, $1.04 per share
|
- | - | - | - | (339,780 | ) | (339,780 | ) | ||||||||||||||||
|
BALANCE,
DECEMBER 31, 2007
|
177,088 | 4,018 | 5,297,922 | (152,197 | ) | (121,893 | ) | 5,204,938 | ||||||||||||||||
|
Net
income attributable to controlling interest
|
- | - | - | - | 346,180 | - | ||||||||||||||||||
|
Other
comprehensive income
|
- | - | - | 404,427 | - | - | ||||||||||||||||||
|
Comprehensive
income
|
- | - | - | - | - | 750,607 | ||||||||||||||||||
|
Exercise
of stock options and stock grants
|
- | 3 | 2,777 | - | - | 2,780 | ||||||||||||||||||
|
Stock
option expense and long-term compensation expense
|
- | - | 2,534 | - | - | 2,534 | ||||||||||||||||||
|
Conversion
of Series B cumulative convertible Preferred
Stock
|
- | 13 | 15,411 | - | - | 15,424 | ||||||||||||||||||
|
Stock
granted in acquisition
|
- | 2 | 3,123 | - | - | 3,125 | ||||||||||||||||||
|
Net
proceeds from follow-on offerings
|
- | 1,277 | 2,146,266 | - | - | 2,147,543 | ||||||||||||||||||
|
Net
proceeds from ATM program
|
- | 44 | 71,788 | - | - | 71,832 | ||||||||||||||||||
|
Net
proceeds from direct purchase and dividend reinvestment
|
- | 58 | 93,617 | - | - | 93,675 | ||||||||||||||||||
|
Preferred
Series A dividends declared $1.97 per share
|
- | - | - | - | (14,594 | ) | (14,594 | ) | ||||||||||||||||
|
Preferred
Series B dividends declared $1.50 per share
|
- | - | - | - | (6,583 | ) | (6,583 | ) | ||||||||||||||||
|
Common
dividends declared, $2.08 per share
|
- | - | - | - | (1,088,009 | ) | (1,088,009 | ) | ||||||||||||||||
|
BALANCE,
DECEMBER 31, 2008
|
$ | 177,088 | $ | 5,415 | $ | 7,633,438 | $ | 252,230 | $ | (884,899 | ) | $ | 7,183,272 | |||||||||||
|
Net
income
|
- | - | - | - | 1,961,471 | - | ||||||||||||||||||
|
Other
comprehensive income
|
- | - | - | 1,639,087 | - | - | ||||||||||||||||||
|
Comprehensive
income
|
- | - | - | - | - | 3,600,558 | ||||||||||||||||||
|
Exercise
of stock options and stock grants
|
- | 4 | 4,911 | - | - | 4,915 | ||||||||||||||||||
|
Stock
option expense and long-term compensation expense
|
- | - | 4,514 | - | - | 4,514 | ||||||||||||||||||
|
Conversion
of Series B cumulative convertible Preferred
Stock
|
- | 28 | 32,900 | - | - | 32,928 | ||||||||||||||||||
|
Net
proceeds from direct purchase and dividend reinvestment
|
- | 84 | 141,691 | - | - | 141,775 | ||||||||||||||||||
|
Preferred
Series A dividends declared $1.97 per share
|
- | - | - | - | (14,593 | ) | (14,593 | ) | ||||||||||||||||
|
Preferred
Series B dividends declared $1.50 per share
|
- | - | - | - | (3,908 | ) | (3,908 | ) | ||||||||||||||||
|
Common
dividends declared, $2.54 per share
|
- | - | - | - | (1,395,035 | ) | (1,395,035 | ) | ||||||||||||||||
|
BALANCE,
DECEMBER 31, 2009
|
$ | 177,088 | $ | 5,531 | $ | 7,817,454 | $ | 1,891,317 | $ | (336,964 | ) | $ | 9,554,426 | |||||||||||
See notes
to consolidated financial statements
F-4
ANNALY
CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
YEARS
ENDED DECEMBER 31, 2009, 2008, AND 2007
(dollars
in thousands)
|
For
the Year
Ended
December
31,
2009
|
For
the Year
Ended
December
31,
2008
|
For
the Year
Ended
December
31,
2007
|
||||||||||
|
Cash
flows from operating activities:
|
||||||||||||
|
Net
income
|
$ | 1,961,471 | $ | 346,238 | $ | 415,034 | ||||||
|
Adjustments
to reconcile net income to net cash provided
|
||||||||||||
|
by
operating activities:
|
||||||||||||
|
Net
income attributable to non controlling interest
|
- | (58 | ) | (650 | ) | |||||||
|
Amortization
of Mortgage Backed Securities premiums
and
discounts, net
|
253,683 | 99,603 | 65,185 | |||||||||
|
Amortization
of intangibles
|
2,316 | 4,133 | 1,377 | |||||||||
|
Amortization
of trading securities premiums and discounts
|
- | (3 | ) | (11 | ) | |||||||
|
(Gain)
loss on sale of Investment Securities
|
(99,128 | ) | (10,713 | ) | (19,062 | ) | ||||||
|
Gain
on termination of interest rate swaps
|
- | - | (2,096 | ) | ||||||||
|
Stock
option and long-term compensation expense
|
4,514 | 2,534 | 1,355 | |||||||||
|
Unrealized
(gain) loss on interest rate swaps
|
(349,521 | ) | 768,268 | - | ||||||||
|
Loss
on investment with affiliate, equity method
|
252 | - | - | |||||||||
|
Net
realized gain on trading investments
|
- | (12,578 | ) | (4,430 | ) | |||||||
|
Unrealized
depreciation (appreciation) on trading investments
|
- | 2,994 | (11,013 | ) | ||||||||
|
Loss
on other-than-temporarily impaired securities
|
- | 31,834 | 1,189 | |||||||||
|
Increase
in accrued interest and dividend receivable
|
(35,574 | ) | (8,405 | ) | (123,322 | ) | ||||||
|
(Increase)
decrease in other assets
|
(8,780 | ) | 340 | (2,264 | ) | |||||||
|
Purchase
of trading securities
|
- | (13,048 | ) | (18,479 | ) | |||||||
|
Proceeds
from sale of trading securities
|
- | 30,986 | 23,640 | |||||||||
|
Purchase
of trading securities sold, not yet purchased
|
- | (22,290 | ) | (13,620 | ) | |||||||
|
Proceeds
from trading securities sold, not yet purchased
|
- | 21,483 | 21,489 | |||||||||
|
Proceeds
from repurchase agreements from Broker Dealer
|
301,505,728 | - | - | |||||||||
|
Payments
on repurchase agreements from Broker Dealer
|
(291,820,728 | ) | - | - | ||||||||
|
Proceeds
from reverse repo from Broker Dealer
|
(3,595,580 | ) | - | - | ||||||||
|
Payments
on reverse repo from Broker Dealer
|
3,100,827 | - | - | |||||||||
|
Proceeds
from securities borrowed
|
152,027 | - | - | |||||||||
|
Payments
on securities borrowed
|
(181,104 | ) | - | - | ||||||||
|
Proceeds
from securities loaned
|
197,100 | - | - | |||||||||
|
Payments
on securities loaned
|
(168,043 | ) | - | - | ||||||||
|
(Increase)
decrease in advisory and service fees receivable
|
(6,462 | ) | 345 | (420 | ) | |||||||
|
(Decrease)
increase in interest payable
|
(110,524 | ) | (57,623 | ) | 173,610 | |||||||
|
Increase
(decrease) in accounts payable and other liabilities
|
1,624 | (28,867 | ) | 17,872 | ||||||||
|
Loss
on receivable from Prime Broker
|
13,613 | (16,886 | ) | - | ||||||||
|
Reduction
of net assets in the fund
|
- | (28,704 | ) | - | ||||||||
|
Net
cash provided by operating activities
|
10,817,711 | 1,109,583 | 525,384 | |||||||||
|
Cash
flows from investing activities:
|
||||||||||||
|
Purchase
of Mortgage-Backed Securities
|
(24,992,434 | ) | (25,281,183 | ) | (32,832,687 | ) | ||||||
|
Proceeds
from sale of Investment Securities
|
4,029,801 | 15,491,408 | 4,847,909 | |||||||||
|
Principal
payments of Mortgage-Backed Securities
|
13,796,269 | 8,619,102 | 6,831,406 | |||||||||
|
Agency
debentures called
|
602,000 | (500,000 | ) | - | ||||||||
|
Purchase
of agency debentures
|
(918,765 | ) | - | (256,241 | ) | |||||||
|
Investment
in affiliates
|
(157,995 | ) | (26,283 | ) | (54,324 | ) | ||||||
|
Payments
on reverse repurchase agreements
|
(10,051,980 | ) | (562,119 | ) | - | |||||||
|
Proceeds
from reverse repurchase agreements
|
10,355,095 | - | - | |||||||||
|
Investment
to purchase subsidiary
|
- | (12,628 | ) | - | ||||||||
|
Net
cash used in investing activities
|
(7,338,009 | ) | (2,271,703 | ) | (21,463,937 | ) | ||||||
|
Cash
flows from financing activities:
|
||||||||||||
|
Proceeds
from repurchase agreements
|
327,758,745 | 434,042,799 | 393,750,907 | |||||||||
|
Principal
payments on repurchase agreements
|
(329,520,501 | ) | (433,414,474 | ) | (375,218,367 | ) | ||||||
|
Proceeds
from exercise of stock options
|
4,914 | 2,780 | 576 | |||||||||
|
Proceeds
from termination of interest rate swaps
|
- | - | 2,096 | |||||||||
|
Proceeds
from direct purchase and dividend reinvestment
|
141,775 | 93,675 | 116,493 | |||||||||
|
Net
proceeds from follow-on offerings
|
- | 2,147,543 | 2,485,529 | |||||||||
|
Net
proceeds from ATM programs
|
- | 71,832 | 80,918 | |||||||||
|
Noncontrolling
interest
|
- | (1,574 | ) | (3,750 | ) | |||||||
|
Dividends
paid
|
(1,269,420 | ) | (975,068 | ) | (263,671 | ) | ||||||
|
Net
cash (used) provided by financing activities
|
(2,884,487 | ) | 1,967,513 | 20,950,731 | ||||||||
|
Net
increase in cash and cash equivalents
|
595,215 | 805,393 | 12,178 | |||||||||
|
Cash
and cash equivalents, beginning of period
|
909,353 | 103,960 | 91,782 | |||||||||
|
Cash
and cash equivalents, end of period
|
$ | 1,504,568 | $ | 909,353 | $ | 103,960 | ||||||
|
Supplemental
disclosure of cash flow information:
|
||||||||||||
|
Interest
paid
|
$ | 1,406,287 | $ | 1,946,535 | $ | 1,752,855 | ||||||
|
Taxes
paid
|
$ | 42,268 | $ | 18,866 | $ | 10,272 | ||||||
|
Noncash
investing activities:
|
||||||||||||
|
Receivable
for Investment Securities Sold
|
$ | 732,134 | $ | 75,546 | $ | 276,737 | ||||||
|
Payable
for Investment Securities Purchased
|
$ | 4,083,786 | $ | 2,062,030 | $ | 1,677,131 | ||||||
|
Net
change in unrealized gain (loss) on available-for-sale
securities
and interest rate swaps, net of reclassification
adjustment
|
$ | 1,639,087 | $ | 404,427 | $ | (76,085 | ) | |||||
|
Noncash financing
activities
:
|
||||||||||||
|
Dividends
declared, not yet paid
|
$ | 414,851 | $ | 270,736 | $ | 136,618 | ||||||
See notes
to consolidated financial statements.
F-5
ANNALY
CAPITAL MANAGEMENT, INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
1. ORGANIZATION
AND SIGNIFICANT ACCOUNTING POLICIES
Annaly
Capital Management, Inc. (“Annaly” or the “Company”) was incorporated in
Maryland on November 25, 1996. The Company commenced its operations
of purchasing and managing an investment portfolio of mortgage-backed securities
on February 18, 1997, upon receipt of the net proceeds from the private
placement of equity capital, and completed its initial public offering on
October 14, 1997. The Company is a real estate investment trust
(“REIT”) under the Internal Revenue Code of 1986, as amended. Fixed
Income Discount Advisory Company (“FIDAC”) is a registered investment advisor
and is a wholly owned taxable REIT subsidiary of the Company. On June
27, 2006, the Company made a majority equity investment in an affiliated
investment fund (the “Fund”), which is now wholly owned by the
Company.
During the third
quarter of 2008, the Company formed RCap Securities Inc.
(“RCap”). RCap was granted membership in the Financial Industry
Regulatory Authority (“FINRA”) on January 26, 2009, and operates as
broker-dealer. RCap is a wholly owned taxable REIT subsidiary of the
Company. On October 31, 2008, the Company acquired Merganser Capital
Management, Inc. (“Merganser”). Merganser is a registered investment
advisor and is a wholly owned taxable REIT subsidiary of the
Company.
A summary of the Company’s
significant accounting policies follows
:
The
consolidated financial statements include the accounts of the Company, FIDAC,
Merganser, RCap and the Fund. All intercompany balances and
transactions have been eliminated. The noncontrolling interest in the
earnings of the Fund is reflected as noncontrolling interest in the consolidated
financial statements.
Cash and Cash
Equivalents
- Cash and
cash equivalents include cash on hand and cash held in money market funds on an
overnight basis
.
Reverse Repurchase
Agreements
-
The
Company may invest its daily available cash balances via reverse repurchase
agreements to provide additional yield on its assets. These
investments will typically be recorded as short term investments and will
generally mature daily. Reverse repurchase agreements are recorded at
cost and are collateralized by mortgage-backed securities pledged by the
counterparty to the agreement. Reverse repurchase agreements entered
into by RCap are part of the subsidiary’s daily matched book trading
activity. These reverse repurchase agreements are recorded on trade
date at the contract amount, are collateralized by mortgage backed securities
and generally mature within 90 days. Margin calls are made by RCap as
appropriate based on the daily valuation of the underlying collateral versus the
contract price. RCap generates income from the spread between what is
earned on the reverse repurchase agreements and what is paid on the matched
repurchase agreements. Cash flows related to RCap’s matched book
activity are included in cash flows from operating activity.
Securities borrowed and loaned
transactions –
RCap records securities borrowed and loaned transactions
at the amount of cash collateral advanced or received. Securities borrowed
transactions require RCap to provide the counterparty with collateral in the
form of cash, or other securities. RCap receives collateral in the form of cash
or other securities for securities loaned transactions. For these transactions,
the fees received or paid by RCap are recorded as interest income or expense. On
a daily basis, RCap monitors the market value of securities borrowed or loaned
against the collateral value and RCap may require counterparties to deposit
additional collateral or return collateral pledged, when
appropriate.
Mortgage-Backed Securities and
Agency Debentures
- The Company invests primarily in mortgage
pass-through certificates, collateralized mortgage obligations and other
mortgage-backed securities representing interests in or obligations backed by
pools of mortgage loans, and certificates guaranteed by the Government National
Mortgage Association (“GNMA”) (collectively, “Mortgage-Backed
Securities”). The Company also invests in agency debentures issued by
Federal Home Loan Bank (“FHLB”), Federal Home Loan Mortgage Corporation
(“FHLMC”), and Federal National Mortgage Association (“FNMA”). The
Mortgage-Backed Securities and agency debentures are collectively referred to
herein as “Investment Securities.”
F-6
The
Company is required to classify its Investment Securities as either trading
investments, available-for-sale investments or held-to-maturity
investments. Although the Company generally intends to hold most of
its Investment Securities until maturity, it may, from time to time, sell any of
its Investment Securities as part of its overall management of its
portfolio. Accordingly, the Company classifies all of its Investment
Securities as available-for-sale. All assets classified as
available-for-sale are reported at estimated fair value, based on market prices
from independent sources, with unrealized gains and losses excluded from
earnings and reported as a separate component of stockholders’
equity. The Company’s investment in Chimera Investment Corporation
(“Chimera”) is accounted for as available-for-sale equity
securities. The Company’s investment in CreXus Investment Corp.
(“CreXus”) is accounted for under the equity method.
Management
evaluates securities for other-than-temporary impairment at least on a quarterly
basis, and more frequently when economic or market concerns warrant such
evaluation. The Company determines if it (1) has the intent to sell
the Investment Securities, (2) is more likely than not that it will be required
to sell the securities before recovery, or (3) does not expect to recover the
entire amortized cost basis of the Investment Securities. Further,
the security is analyzed for credit loss (the difference between the present
value of cash flows expected to be collected and the amortized cost
basis). The credit loss, if any, will then be recognized in the
statement of earnings, while the balance of impairment related to other factors
will be recognized in other comprehensive income (“OCI”). There were
no losses on other-than-temporarily impaired securities for the year ended
December 31, 2009. The loss on other-than-temporarily impaired
securities was $31.8 million and $1.2 million during the years ended December
31, 2008 and 2007, respectively.
The
estimated fair value of Investment Securities, available-for-sale equity
securities, receivable from prime broker and interest rate swaps is equal to
their carrying value presented in the consolidated statements of financial
condition. Cash and cash equivalents, reverse repurchase agreements,
securities borrowed, receivable for Mortgage-Backed Securities sold, accrued
interest and dividends receivable, receivable for advisory and service fees,
repurchase agreements with maturities shorter than one year, payable for
Investment Securities purchased, securities loaned, dividends payable, accounts
payable and other liabilities, and accrued interest payable, generally
approximates fair value at December 31, 2009 due to the short term nature of
these financial instruments. The estimated fair value of long term
structured repurchase agreements is reflected in the Note 9 to the financial
statements.
Interest
income is accrued based on the outstanding principal amount of the Investment
Securities and their contractual terms. Premiums and discounts
associated with the purchase of the Investment Securities are amortized into
interest income over the projected lives of the securities using the interest
method. The Company’s policy for estimating prepayment speeds for
calculating the effective yield is to evaluate historical performance, consensus
prepayment speeds, and current market conditions. Dividend income on
available-for-sale equity securities is recorded on the ex-date on an accrual
basis.
Investment
Securities transactions are recorded on the trade date. Purchases of
newly-issued securities are recorded when all significant uncertainties
regarding the characteristics of the securities are removed, generally shortly
before settlement date. Realized gains and losses on sales of
Investment Securities are determined on the specific identification
method.
Derivative Financial
Instruments/Hedging Activity
-
Prior
to the fourth quarter of 2008, the Company designated interest rate swaps as
cash flow hedges, whereby the swaps were recorded at fair value on the balance
sheet as assets and liabilities with any changes in fair value recorded in
OCI. In a cash flow hedge, a swap would exactly match the pricing
date of the relevant repurchase agreement. Through the end of the
third quarter of 2008 the Company continued to be able to effectively match the
swaps with the repurchase agreements therefore entering into effective hedge
transactions. However, due to the volatility of the credit markets,
it was no longer practical to match the pricing dates of both the swaps and the
repurchase agreements.
F-7
As a
result, the Company voluntarily discontinued hedge accounting after the third
quarter of 2008 through a combination of de-designating previously defined hedge
relationships and not designating new contracts as cash flow hedges. The
de-designation of cash flow hedges requires that the net derivative gain or loss
related to the discontinued cash flow hedge should continue to be reported in
accumulated OCI, unless it is probable that the forecasted transaction will not
occur by the end of the originally specified time period or within an additional
two-month period of time thereafter. The Company continues to hold
repurchase agreements in excess of swap contracts and has no indication that
interest payments on the hedged repurchase agreements are in jeopardy of
discontinuing. Therefore, the deferred losses related to these
derivatives that have been de-designated will not be recognized immediately and
will remain in OCI. These losses are reclassified into earnings during the
contractual terms of the swap agreements starting as of October 1, 2008.
Changes in the unrealized gains or losses on the interest rate swaps subsequent
to September 30, 2008 are reflected in the Company’s statement of
operations.
Credit Risk
– The Company has
limited its exposure to credit losses on its portfolio of Investment Securities
by only purchasing securities issued by FHLMC, FNMA, or GNMA and agency
debentures issued by the FHLB, FHLMC and FNMA. The payment of
principal and interest on the FHLMC, and FNMA Mortgage-Backed Securities are
guaranteed by those respective agencies, and the payment of principal and
interest on the GNMA Mortgage-Backed Securities are backed by the full faith and
credit of the U.S. government. Principal and interest on agency
debentures are guaranteed by the agency issuing the
debenture. Substanially all of the Company’s Investment Securities
have an actual or implied “AAA” rating. The Company faces credit risk
on the portions of its portfolio which are not Investment
Securities.
Market Risk -
The current
situation in the mortgage sector and the current weakness in the broader
mortgage market could adversely affect one or more of the Company’s lenders and
could cause one or more of the Company’s lenders to be unwilling or unable to
provide additional financing. This could potentially increase the
Company’s financing costs and reduce liquidity. If one or more major
market participants fails, it could negatively impact the marketability of all
fixed income securities, including government mortgage
securities. This could negatively impact the value of the securities
in the Company’s portfolio, thus reducing its net book value. Furthermore,
if many of the Company’s lenders are unwilling or unable to provide additional
financing, the Company could be forced to sell its Investment Securities at
an inopportune time when prices are depressed. Even with the
current situation in the mortgage sector, the Company does not anticipate having
difficulty converting its assets to cash or extending financing terms due to the
fact that its Investment Securities have an actual or implied “AAA” rating and
principal payment is guaranteed by FHLMC, FNMA, or GNMA.
Trading Securities and Trading
Securities sold, not yet purchased -
Trading securities and trading
securities sold, not yet purchased, are presented in the consolidated statements
of financial conditions as a result of consolidating the financial statements of
the Fund, and are carried at fair value. The realized and unrealized
gains and losses, as well as other income or loss from trading securities, are
recorded in the income from trading securities balance in the accompanying
consolidated statements of operations.
Trading
securities sold, not yet purchased, represent obligations of the Fund to deliver
the specified security at the contracted price, and thereby create a liability
to purchase the security in the market at prevailing prices.
Repurchase Agreements
- The
Company finances the acquisition of its Investment Securities through the use of
repurchase agreements. Repurchase agreements are treated as
collateralized financing transactions and are carried at their contractual
amounts, including accrued interest, as specified in the respective
agreements.
Cumulative Convertible Preferred
Stock
- The Series B Preferred Stock contains fundamental change
provisions that allow the holder to redeem the Series B Preferred Stock for cash
if certain events occur. As redemption under these provisions is not
solely within the Company’s control, the Company has classified the Series B
Preferred Stock as temporary equity in the accompanying consolidated statements
of financial condition. The Company has analyzed whether the embedded
conversion option should be bifurcated and has determined that bifurcation is
not necessary.
Income Taxes
- The Company
has elected to be taxed as a REIT and intends to comply with the provisions of
the Internal Revenue Code of 1986, as amended (the “Code”), with respect
thereto. Accordingly, the Company will not be subjected to federal
income tax to the extent of its distributions to shareholders and as long as
certain asset, income and stock ownership tests are met. The Company
and each of its subsidiaries, FIDAC, Merganser, and RCap have made separate
joint election to treat the subsidiaries as a taxable REIT
subsidiary. As such, each of the taxable REIT subsidiaries are
taxable as a domestic C corporation and subject to federal, state, and local
income taxes based upon its taxable income. The affiliated investment
fund is a partnership and the income and expense flow through to the
Company.
F-8
Goodwill and Intangible assets -
The Company’s acquisitions of FIDAC and Merganser were accounted for
using the purchase method. Under the purchase method, net assets and
results of operations of acquired companies are included in the consolidated
financial statements from the date of acquisition. In addition, the costs of
FIDAC and Merganser were allocated to the assets acquired, including
identifiable intangible assets, and the liabilities assumed based on their
estimated fair values at the date of acquisition. The excess of purchase price
over the fair value of the net assets acquired was recognized as
goodwill. Goodwill and intangible assets are periodically (but not
less frequently than annually) reviewed for potential
impairment. Intangible assets with an estimated useful life are
expected to amortize over a 10.5 year weighted average time
period. During the years ended December 31, 2009, 2008 and 2007,
there were no impairment losses.
Stock Based Compensation
-
The Company is required to measure and recognize in the consolidated financial
statements the compensation cost relating to share-based payment
transactions. The compensation cost is reassessed based on the
fair value of the equity instruments issued.
The
Company recognizes compensation expense on a straight-line basis over the
requisite service period for the entire award (that is, over the requisite
service period of the last separately vesting portion of the
award). The Company estimated fair value using the Black-Scholes
valuation model.
A
Summary of Recent Accounting Pronouncements Follows:
General
Principles
Generally Accepted
Accounting Principles
In June
2009, the Financial Accounting Standards Board (“FASB”) issued
The Accounting Standards
Codification
(Codification) which revises the framework for selecting the
accounting principles to be used in the preparation of financial statements that
are presented in conformity with Generally Accepted Accounting Principles
(“GAAP”). The objective of the Codification is to establish the FASB
Accounting Standards Codification (“ASC”) as the source of authoritative
accounting principles recognized by the FASB. Codification was
effective for interim and annual periods ended after September 15,
2009. In adopting the Codification, all non-grandfathered, non-SEC
accounting literature not included in the Codification is superseded and deemed
non-authoritative. Codification requires any references within the
Company’s consolidated financial statements be modified from FASB issues to
ASC. However, in accordance with the FASB Accounting Standards
Codification Notice to Constituents (v 2.0), the Company will not reference
specific sections of the ASC but will use broad topic references.
The
Company’s recent accounting pronouncements section has been reformatted to
reflect the same organizational structure as the ASC. Broad topic
references will be updated with pending content as they are
released.
F-9
Assets
Investments in Debt and
Equity Securities (ASC 320)
New
guidance was provided to make impairment guidance more operational and to
improve the presentation and disclosure of other-than-temporary impairments
(“OTTI”) on debt and equity securities in financial statements. This
guidance was also the result of the Securities and Exchange Commission (“SEC”)
mark-to-market study mandated under the Emergency Economic Stabilization Act of
2008 (“EESA”). The SEC’s recommendation was to “evaluate the need for
modifications (or the elimination) of current OTTI guidance to provide for a
more uniform system of impairment testing standards for financial
instruments.” The guidance revises the OTTI evaluation
methodology. Previously the analytical focus was on whether the
company had the “intent and ability to retain its investment in the debt
security for a period of time sufficient to allow for any anticipated recovery
in fair value.” Now the focus is on whether the company (1) has
the intent to sell the Investment Securities, (2) is more likely than not that
it will be required to sell the Investment Securities before recovery, or (3)
does not expect to recover the entire amortized cost basis of the Investment
Securities. Further, the security is analyzed for credit loss, (the
difference between the present value of cash flows expected to be collected and
the amortized cost basis). The credit loss, if any, will then be
recognized in the statement of operations, while the balance of impairment
related to other factors will be recognized in OCI. This guidance
became effective for all of the Company’s interim and annual reporting periods
ending June 30, 2009 with early adoption permitted for periods ending March 31,
2009 and the Company decided to early adopt. For the year ended
December 31, 2009, the Company did not have unrealized losses in Investment
Securities that were deemed other-than-temporary.
Broad
Transactions
Business Combinations (ASC
805)
This
guidance establishes principles and requirements for recognizing and measuring
identifiable assets and goodwill acquired, liabilities assumed and any
noncontrolling interest in a business combination at their fair value at
acquisition date. ASC 805 alters the treatment of acquisition-related
costs, business combinations achieved in stages (referred to as a step
acquisition), the treatment of gains from a bargain purchase, the recognition of
contingencies in business combinations, the treatment of in-process research and
development in a business combination as well as the treatment of recognizable
deferred tax benefits. ASC 805 is effective for business combinations
closed in fiscal years beginning after December 15, 2008 and is applicable
to business acquisitions completed after January 1, 2009. The
Company did not make any business acquisitions during the year ended December
31, 2009. The adoption of ASC 805 did not have a material impact on the
Company’s consolidated financial statements.
Consolidation (ASC
810)
On
January 1, 2009, FASB amended the guidance concerning noncontrolling interests
in consolidated financial statements, which requires the Company to make certain
changes to the presentation of its financial statements. This
guidance requires the Company to classify noncontrolling interests (previously
referred to as “minority interest”) as part of consolidated net income and to
include the accumulated amount of noncontrolling interests as part of
stockholders’ equity. Similarly, in its presentation of stockholders’
equity, the Company distinguishes between equity amounts attributable to
controlling interest and amounts attributable to the noncontrolling interests –
previously classified as minority interest outside of stockholders’
equity. In addition to these financial reporting changes, this guidance
provides for significant changes in accounting related to noncontrolling
interests; specifically, increases and decreases in its controlling financial
interests in consolidated subsidiaries will be reported in equity similar to
treasury stock transactions. If a change in ownership of a consolidated
subsidiary results in loss of control and deconsolidation, any retained
ownership interests are re-measured with the gain or loss reported in net
earnings.
Effective
January 1, 2010, the consolidation standards have been amended by ASU
2009-17. This amendment updates the existing standard and eliminates
the exemption from consolidation of a Qualified Special Purpose Entity
(“QSPE”). The update requires an enterprise to perform an
analysis to determine whether the enterprise’s variable interest or interests
give it a controlling financial interest in a variable interest entity (“VIE”).
The analysis identifies the primary beneficiary of a VIE as the enterprise that
has both: a) the power to direct the activities that most significantly impact
the entity’s economic performance and b) the obligation to absorb losses of the
entity or the right to receive benefits from the entity which could potentially
be significant to the VIE. The update requires enhanced disclosures
to provide users of financial statements with more transparent information about
an enterprises involvement in a VIE. Further, ongoing assessments of
whether an enterprise is the primary beneficiary of a VIE are
required. At this time, the amendment has no material effect on
the Company financial statements.
On
January 27, 2010, the FASB voted to indefinitely defer the effective date
of ASU 2009-17 for a reporting enterprises interest in entities for
which it is industry practice to issue financial statements in accordance with
investment company standards (ASC 946). This deferral is
expected to most significantly affect reporting entities in the investment
management industry. The Company is evaluating the effect of this
update, however, as it stands, the update would have no material effect on the
financial statements.
F-10
Derivatives and Hedging (ASC
815)
Effective
January 1, 2009 and adopted by the Company prospectively, the FASB issued
additional guidance attempting to improve the transparency of
financial reporting by mandating the provision of additional information about
how derivative and hedging activities affect an entity’s financial position,
financial performance and cash flows. This guidance changed the
disclosure requirements for derivative instruments and hedging activities by
requiring enhanced disclosure about (1) how and why an entity uses derivative
instruments, (2) how derivative instruments and related hedged items are
accounted for, and (3) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash
flows. To adhere to this guidance, qualitative disclosures about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts, gains and losses on derivative instruments, and disclosures
about credit-risk-related contingent features in derivative agreements must be
made. This disclosure framework is intended to better convey the
purpose of derivative use in terms of the risks that an entity is intending to
manage. The effect of the adoption of this guidance was an increase
in financial statement note disclosures.
Fair Value Measurements and
Disclosures (ASC 820)
In
response to the deterioration of the credit markets, FASB issued guidance
clarifying how Fair Value Measurements should be applied when valuing securities
in markets that are not active. The guidance provides an illustrative
example, utilizing management’s internal cash flow and discount rate assumptions
when relevant observable data do not exist. It further clarifies how
observable market information and market quotes should be considered when
measuring fair value in an inactive market. It reaffirms the notion
of fair value as an exit price as of the measurement date and that fair value
analysis is a transactional process and should not be broadly applied to a group
of assets. The guidance was effective upon issuance including prior
periods for which financial statements had not been issued. The
implementation of this guidance did not have a material effect on the fair value
of the Company’s assets since the Company previous methodology is consistent
with the new guidance.
In
October 2008 the EESA was signed into law. Section 133 of the EESA
mandated that the SEC conduct a study on mark-to-market accounting
standards. The SEC provided its study to the U.S. Congress on
December 30, 2008. Part of the recommendations within the study
indicated that “fair value requirements should be improved through development
of application and best practices guidance for determining fair value in
illiquid or inactive markets.” As a result of this study and the
recommendations therein, on April 9, 2009, the FASB issued additional guidance
for determining fair value when the volume and level of activity for the asset
or liability have significantly decreased when compared with normal market
activity for the asset or liability (or similar assets or
liabilities). This guidance became effective for the Company June 30,
2009 with early adoption permitted for periods ending after March 31,
2009. The adoption does not have a major impact on the manner in
which we estimate fair value, nor does it have any impact on our financial
statement disclosures.
In August
2009, FASB provided further guidance (ASU 2009-05) regarding the fair value
measurement of liabilities. The guidance states that a quoted price
for the identical liability when traded as an asset in an active market is a
Level 1 fair value measurement. If the value must be adjusted for
factors specific to the liability, then the adjustment to the quoted price of
the asset shall render the fair value measurement of the liability a lower level
measurement. This guidance has no material effect on the fair
valuation of the Company’s liabilities.
In
September 2009, FASB issued guidance (ASU 2009-12) on measuring the fair value
of certain alternative investments. This guidance offers investors a
practical expedient for measuring the fair value of investments in certain
entities that calculate net asset value (“NAV”) per share. If an
investment falls within the scope of the ASU, the reporting entity is permitted,
but not required to use the investment’s NAV to estimate its fair
value. This guidance has no material effect on the fair valuation of
the Company’s assets, as the Company does not hold any assets qualifying under
this guidance.
F-11
In
January 2010, FASB issued guidance (ASU 2010-06) which increases disclosure
regarding the fair value of assets. The key provisions of this
guidance include the requirement to disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 including a description
of the reason for the transfers. Previously this was only required of
transfers between Level 2 and Level 3 assets. Further, reporting
entities are required to provide fair value measurement disclosures for each
class of assets and liabilities; a class is potentially a subset of the assets
or liabilities within a line item in the statement of financial
position. Additionally, disclosures about the valuation techniques
and inputs used to measure fair value for both recurring and nonrecurring fair
value measurements are required for either Level 2 or Level 3
assets. This portion of the guidance is effective for the Company for
December 31, 2009. The guidance also requires that the disclosure on any Level 3
assets presents separately information about purchases, sales, issuances and
settlements. In other words, Level 3 assets are presented on a gross
basis rather than as one net number. However, this last portion of
the guidance is not effective for the Company until December 15,
2010. Adoption of this guidance results is increased financial
statement note disclosure for the Company.
Financial Instruments (ASC
820)
On April
9, 2009, the FASB issued guidance which requires disclosures about fair value of
financial instruments for interim reporting periods as well as in annual
financial statements. The guidance became effective for the Company
on June 30, 2009. The adoption did not have any impact on financial
reporting as all financial instruments are currently reported at fair value in
both interim and annual periods.
Subsequent Events (ASC
855)
ASC 855
provides general standards governing accounting for and disclosure of events
that occur after the balance sheet date but before the financial statements are
issued or are available to be issued. ASC 855 also provides guidance on
the period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements, the circumstances under
which an entity should recognize events or transactions occurring after the
balance sheet date in its financial statements and the disclosures that an
entity should make about events or transactions occurring after the balance
sheet date. The Company adopted the guidance effective June 30, 2009, and
adoption had no impact on the Company’s consolidated financial
statements. The Company evaluated subsequent events through February
24, 2010.
Transfers and Servicing (ASC
860-10-50)
In
February 2008 FASB issued guidance addressing whether transactions where assets
purchased from a particular counterparty and financed through a repurchase
agreement with the same counterparty can be considered and accounted for as
separate transactions, or are required to be considered “linked” transactions
and may be considered derivatives. This guidance requires purchases
and subsequent financing through repurchase agreements be considered linked
transactions unless all of the following conditions apply: (1) the initial
purchase and the use of repurchase agreements to finance the purchase are not
contractually contingent upon each other; (2) the repurchase financing entered
into between the parties provides full recourse to the transferee and the
repurchase price is fixed; (3) the financial assets are readily obtainable in
the market; and (4) the financial instrument and the repurchase agreement are
not coterminous. This guidance was effective for the Company on
January 1, 2009 and the implementation did not have a material effect on the
financial statements of the Company.
On June
12, 2009, the FASB issued guidance an amendment update to the accounting
standards governing the transfer and servicing of financial assets .This
amendment updates the existing standard and eliminates the
concept of a Qualified Special Purpose Entity (“QSPE”); clarifies the
surrendering of control to effect sale treatment; and modifies the financial
components approach – limiting the circumstances in which a financial asset or
portion thereof should be derecognized when the transferor maintains continuing
involvement. It defines the term “Participating
Interest”. Under this standard update, the transferor must recognize
and initially measure at fair value all assets obtained and liabilities incurred
as a result of a transfer, including any retained beneficial interest.
Additionally, the amendment requires enhanced disclosures regarding the
transferors risk associated with continuing involvement in any transferred
assets. The amendment is effective beginning January 1,
2010. The Company believes the amendment has no material effect
on the financial statements.
F-12
2.
MORTGAGE-BACKED SECURITIES
The
following tables present the Company’s available-for-sale Mortgage-Backed
Securities portfolio as of December 31, 2009 and 2008 which were carried at
their fair value:
|
December
31, 2009
|
Federal
Home Loan
Mortgage
Corporation
|
Federal
National
Mortgage
Association
|
Government
National
Mortgage
Association
|
Total
Mortgage-
Backed
Securities
|
||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||
|
Mortgage-Backed
|
||||||||||||||||
|
Securities,
gross
|
$ | 18,973,616 | $ | 41,836,554 | $ | 779,109 | $ | 61,589,279 | ||||||||
|
Unamortized
discount
|
(20,210 | ) | (28,167 | ) | - | (48,377 | ) | |||||||||
|
Unamortized
premium
|
301,700 | 974,861 | 20,382 | 1,296,943 | ||||||||||||
|
Amortized
cost
|
19,255,106 | 42,783,248 | 799,491 | 62,837,845 | ||||||||||||
|
Gross
unrealized gains
|
717,749 | 1,318,066 | 21,944 | 2,057,759 | ||||||||||||
|
Gross
unrealized losses
|
(27,368 | ) | (61,739 | ) | (772 | ) | (89,879 | ) | ||||||||
|
Estimated
fair value
|
$ | 19,945,487 | $ | 44,039,575 | $ | 820,663 | $ | 64,805,725 | ||||||||
|
Amortized
Cost
|
Gross
Unrealized
Gain
|
Gross
Unrealized
Loss
|
Estimated
Fair
Value
|
|||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||
|
Adjustable
rate
|
$ | 16,345,988 | $ | 513,820 | $ | (68,488 | ) | $ | 16,791,320 | |||||||
|
Fixed
rate
|
46,491,857 | 1,543,939 | (21,391 | ) | 48,014,405 | |||||||||||
|
Total
|
$ | 62,837,845 | $ | 2,057,759 | $ | (89,879 | ) | $ | 64,805,725 | |||||||
|
December
31, 2008
|
Federal
Home Loan
Mortgage
Corporation
|
Federal
National
Mortgage
Association
|
Government
National
Mortgage
Association
|
Total
Mortgage-
Backed
Securities
|
||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||
|
Mortgage-Backed
|
||||||||||||||||
|
Securities,
gross
|
$ | 19,898,430 | $ | 32,749,123 | $ | 1,259,118 | $ | 53,906,671 | ||||||||
|
Unamortized
discount
|
(26,733 | ) | (36,647 | ) | (787 | ) | (64,167 | ) | ||||||||
|
Unamortized
premium
|
212,354 | 381,433 | 25,694 | 619,481 | ||||||||||||
|
Amortized
cost
|
20,084,051 | 33,093,909 | 1,284,025 | 54,461,985 | ||||||||||||
|
Gross
unrealized gains
|
297,366 | 468,824 | 14,606 | 780,796 | ||||||||||||
|
Gross
unrealized losses
|
(71,195 | ) | (123,443 | ) | (1,148 | ) | (195,786 | ) | ||||||||
|
Estimated
fair value
|
$ | 20,310,222 | $ | 33,439,290 | $ | 1,297,483 | $ | 55,046,995 | ||||||||
|
Amortized
Cost
|
Gross
Unrealized
Gain
|
Gross
Unrealized
Loss
|
Estimated
Fair
Value
|
|||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||
|
Adjustable
rate
|
$ | 19,509,017 | $ | 287,249 | $ | (178,599 | ) | $ | 19,617,667 | |||||||
|
Fixed
rate
|
34,952,968 | 493,547 | (17,187 | ) | 35,429,328 | |||||||||||
|
Total
|
$ | 54,461,985 | $ | 780,796 | $ | (195,786 | ) | $ | 55,046,995 | |||||||
F-13
Actual
maturities of Mortgage-Backed Securities are generally shorter than stated
contractual maturities because actual maturities of Mortgage-Backed Securities
are affected by the contractual lives of the underlying mortgages, periodic
payments of principal, and prepayments of principal. The following
table summarizes the Company’s Mortgage-Backed Securities on December 31, 2009
and 2008, according to their estimated weighted-average life
classifications:
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Weighted-Average
Life
|
Fair
Value
|
Amortized
Cost
|
Fair
Value
|
Amortized
Cost
|
||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||
|
Less
than one year
|
$ | 2,796,707 | $ | 2,762,873 | $ | 4,147,646 | $ | 4,181,282 | ||||||||
|
Greater
than one year and less than five years
|
55,780,372 | 54,070,493 | 37,494,312 | 37,102,706 | ||||||||||||
|
Greater
than or equal to five years
|
6,228,646 | 6,004,479 | 13,405,037 | 13,177,997 | ||||||||||||
|
Total
|
$ | 64,805,725 | $ | 62,837,845 | $ | 55,046,995 | $ | 54,461,985 | ||||||||
The
weighted-average lives of the Mortgage-Backed Securities at December 31, 2009
and 2008 in the table above are based upon data provided through
subscription-based financial information services, assuming constant principal
prepayment rates to the reset date of each security. The prepayment
model considers current yield, forward yield, steepness of the yield curve,
current mortgage rates, mortgage rate of the outstanding loans, loan age, margin
and volatility. The actual weighted average lives of the
Mortgage-Backed Securities could be longer or shorter than
estimated.
The
following table presents the gross unrealized losses, and estimated fair value
of the Company’s Mortgage-Backed Securities by length of time that such
securities have been in a continuous unrealized loss position at December 31,
2009 and December 31, 2008.
|
Unrealized
Loss Position For:
(dollars
in thousands)
|
||||||||||||||||||||||||
|
Less
than 12 Months
|
12
Months or More
|
Total
|
||||||||||||||||||||||
|
Estimated
Fair
Value
|
Unrealized
Losses
|
Estimated
Fair
Value
|
Unrealized
Losses
|
Estimated
Fair
Value
|
Unrealized
Losses
|
|||||||||||||||||||
|
December
31, 2009
|
$ | 4,818,239 | $ | (22,869 | ) | $ | 2,802,920 | $ | (67,010 | ) | $ | 7,621,159 | $ | (89,879 | ) | |||||||||
|
December
31, 2008
|
$ | 4,631,897 | $ | (65,790 | ) | $ | 4,267,448 | $ | (129,996 | ) | $ | 8,899,345 | $ | (195,786 | ) | |||||||||
The
decline in value of these securities is solely due to market conditions and not
the quality of the assets. Substantially all of the Mortgage-Backed
Securities are “AAA” rated or carry an implied “AAA” rating. The
investments are not considered other-than-temporarily impaired because the
Company currently has the ability and intent to hold the investments to maturity
or for a period of time sufficient for a forecasted market price recovery up to
or beyond the cost of the investments or we are required to sell for regulatory
or other reasons. Also, the Company is guaranteed payment of the
principal amount of the securities by the government agency which created
them.
The
adjustable rate Mortgage-Backed Securities are limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every nine
months) and lifetime caps. The weighted average lifetime cap was
10.1% at December 31, 2009 and 10.0% at December 31, 2008.
During
the year ended December 31, 2009, the Company sold $4.6 billion of
Mortgage-Backed Securities, resulting in a realized gain of $99.1
million. During the year ended December 31, 2008, the Company sold
$15.1 billion of Mortgage-Backed Securities, resulting in a realized gain of
$10.7 million.
F-14
3. AGENCY
DEBENTURES
At
December 31, 2009, the Company owned agency debentures with a carrying value of
$915.8 million, including an unrealized loss of $3.0 million. At
December 31, 2008, the Company owned agency debentures with a carrying value of
$598.9 million including an unrealized loss of $2.8 million.
4. AVAILABLE
FOR SALE EQUITY SECURITIES
All of
the available-for-sale equity securities are shares of Chimera and are reported
at fair value. The Company owned approximately 45.0 million shares of
Chimera at a fair value of approximately $174.5 million at December 31, 2009 and
approximately 15.3 million shares of Chimera at fair value of approximately
$52.8 million at December 31, 2008. At December 31, 2009 and December
31, 2008, the investment in Chimera had an unrealized gain of $35.7 million and
$4.0 million, respectively. Chimera is externally managed by FIDAC
pursuant to a management agreement.
Although
the Company has the intent and ability to retain the investment in Chimera
indefinitely, the Company determined that an other-than-temporarily impaired
charge of $31.8 million was appropriate in the third quarter of 2008 and is
reflected in the income statement for the year ended of December 31, 2008. This
determination is based on the extent of the decline in value of the Chimera
shares combined with the current state of the mortgage and credit
markets.
5.
INVESTMENT
IN AFFILIATE, EQUITY METHOD
During
the year ended December 31, 2009, the Company acquired 4,527,778 shares of
CreXus Investment Corp. (“CreXus”) common stock at a price of $15.00 per
share. The Company owns 25% of CreXus and accounts for its investment
using the equity method. CreXus is externally managed by FIDAC
pursuant to a management agreement. The quoted fair value of the
Company’s investment in CreXus was $63.2 million at December 31,
2009.
6. REVERSE
REPURCHASE AGREEMENT
At
December 31, 2009 and 2008, the Company had lent $259.0 million and $562.1
million, respectively, to Chimera in a reverse repurchase agreement which is
callable weekly. This amount is included in the principal amount
which approximates fair value in the Company’s Statements of Financial
Condition. The interest rate at December 31, 2009 and December 31,
2008 was at the rate of 1.72% and 1.43%, respectively. The collateral
for this loan is mortgage-backed securities with a fair value of $314.3 million
and $680.8 million at December 31, 2009 and 2008, respectively.
At
December 31, 2009, RCap, in its ordinary course of business, financed though
matched reverse repurchase agreements, at market rates, $69.7 million for a fund
that is managed by FIDAC. At December 31, 2009, RCap had an
outstanding reverse repurchase agreement with a non-affiliate of $425.0
million.
The
Company reports cash flows on reverse repurchase agreements as investment
activites in the Statements of Cash Flows. RCap reports cash flows on
reverse repurchase agreements as operating activities in the Statements of Cash
Flows.
7. RECEIVABLE
FROM PRIME BROKER
The net
assets of the investment fund owned by the Company are subject
to English bankruptcy law, which governs the
administration of Lehman Brothers International (Europe) (in
administration) (“LBIE”), as well as the law of New York, which governs the
contractual documents. The Company invested approximately $45.0
million in the fund and has redeemed approximately $56.0 million. The
current assets of the fund still remain at LBIE and affiliates of LBIE and the
ultimate recovery of such amount remains uncertain. The Company has
entered into the Claims Resolution Agreement (the “CRA”) between LBIE and
certain eligible offerees effective December 29, 2009 with respect to these
assets.
F-15
Certain
of the Company’s assets subject to the CRA are held directly at LBIE and the
Company has valued such assets in accordance with the valuation date set forth
in the CRA and the pricing information provided to the Company by
LBIE. The valuation date with respect to these assets as set forth in
the CRA is September 19, 2008.
Certain
of the Company’s assets subject to the CRA are not held directly at LBIE and are
believed to be held at affiliates of LBIE. Given the great degree of
uncertainty as to the status of the Company’s assets that are not directly held
by LBIE and are believed to be held at affiliates of LBIE, the Company has
valued such assets at an 80% discount, or $3.3 million. The value of
the net assets that are not directly held by LBIE and are believed to be held at
affiliates of LBIE is determined on the basis of the best information available
to us from time to time, legal and professional advice obtained for the purpose
of determining the rights, and on the basis of a number of assumptions which we
believe to be reasonable.
The
Company can provide no assurance, however, that it will recover all or any
portion of any of the net assets of the investment fund following completion
of LBIE’s administration (and any subsequent
liquidation).
8. FAIR
VALUE MEASUREMENTS
The
valuation hierarchy is based upon the transparency of inputs to the valuation of
an asset or liability as of the measurement date. The three levels
are defined as follows:
Level 1–
inputs to the valuation methodology are quoted prices (unadjusted) for identical
assets and liabilities in active markets.
Level 2 –
inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
financial instrument.
Level 3 –
inputs to the valuation methodology are unobservable and significant to overall
fair value.
Available
for sale equity securities are valued based on quoted prices (unadjusted) in an
active market. Mortgage-Backed Securities and interest rate swaps are
valued using quoted prices for similar assets and dealer quotes. The
dealer will incorporate common market pricing methods, including a spread
measurement to the Treasury curve or interest rate swap curve as well as
underlying characteristics of the particular security including coupon, periodic
and life caps, rate reset period and expected life of the
security. Management ensures that current market conditions are
represented. Management compares similar market transactions and
comparisons to a pricing model. The Company’s Investment Securities
characteristics are as follows:
|
Weighted
Average
Coupon
on
Fixed
Rate
Securities
|
Weighted
Average
Coupon
on
Adjustable
Rate
Securities
|
Weighted
Average
Yield
|
Weighted
Average
Lifetime
Cap
on
Adjustable
Rate
Securities
|
Weighted
Average
Term
to
Next
Adjustment
on
Adjustable
Rate
Securities
|
|
|
At
December 31, 2009
|
5.78%
|
4.55%
|
4.51%
|
10.09%
|
33
months
|
|
At
December 31, 2008
|
6.13%
|
4.75%
|
5.15%
|
10.00%
|
36
months
|
F-16
The
Company’s financial assets and liabilities carried at fair value on a recurring
basis are valued as follows:
|
Level
1
|
Level
2
|
Level
3
|
||||||||||
|
At
December 31, 2009
|
(dollars
in thousands)
|
|||||||||||
|
Assets:
|
||||||||||||
|
Mortgage-Backed
Securities
|
$ | - | $ | 64,805,725 | - | |||||||
|
Agency
debentures
|
- | 915,752 | - | |||||||||
|
Available
for sale equity securities
|
174,533 | - | - | |||||||||
|
Interest
rate swaps
|
5,417 | |||||||||||
|
Liabilities:
|
||||||||||||
|
Interest
rate swaps
|
- | 533,362 | - | |||||||||
|
At
December 31, 2008
|
||||||||||||
|
Assets:
|
||||||||||||
|
Mortgage-Backed
Securities
|
$ | - | $ | 55,046,995 | - | |||||||
|
Agency
debentures
|
- | 598,945 | - | |||||||||
|
Available
for sale equity securities
|
52,795 | - | - | |||||||||
|
Liabilities:
|
||||||||||||
|
Interest
rate swaps
|
- | 1,102,285 | - | |||||||||
The
classification of assets and liabilities by level remains unchanged at December
31, 2009, when compared to the previous quarter.
9. REPURCHASE
AGREEMENTS
The
Company had outstanding $54.6 billion and $46.7 billion of repurchase agreements
with weighted average borrowing rates of 2.11% and 4.08%, after giving effect to
the Company’s interest rate swaps, and weighted average remaining maturities of
170 days and 238 days as of December 31, 2009 and December 31, 2008,
respectively. Investment Securities pledged as collateral under these
repurchase agreements and interest rate swaps had an estimated fair value of
$57.9 billion at December 31, 2009 and $51.8 billion at December 31,
2008.
At
December 31, 2009 and 2008, the repurchase agreements had the following
remaining maturities:
|
December
31, 2009
|
December
31, 2008
|
|||||||
|
(dollars
in thousands)
|
||||||||
|
1
day
|
$ | - | $ | - | ||||
|
Within
30 days
|
38,341,206 | 32,025,186 | ||||||
|
30
to 59 days
|
7,163,255 | 5,205,352 | ||||||
|
60
to 89 days
|
192,005 | 209,673 | ||||||
|
90
to 119 days
|
139,966 | 254,674 | ||||||
|
Over
120 days
|
8,761,696 | 8,980,000 | ||||||
|
Total
|
$ | 54,598,128 | $ | 46,674,885 | ||||
The
Company did not have an amount at risk greater than 10% of the equity of the
Company with any
counterparty
as of December 31, 2009 or December 31, 2008.
The
Company has entered into repurchase agreements which provide the counterparty
with the right to call the balance prior to maturity date. These
repurchase agreements totaled $7.0 billion and the fair value of the option to
call was ($352.4 million) at December 31, 2009. The repurchase
agreements totaled $8.1 billion and the fair value of the option to call was
($574.3) at December 31, 2008. Management has determined that the
call option is not required to be bifurcated as it is deemed clearly and closely
related to the debt instrument, therefore the fair value of the option is not
recorded in the consolidated financial statements.
F-17
The
structured repurchase agreements are modeled and priced as pay fixed versus
receive floating interest rate swaps whereby the fixed receiver has the option
to cancel the swap after an initial lockout period. Therefore the structured
repurchase agreements are priced as a combination of an interest rate swaps with
an embedded call options.
The
Company reports cash flows repurchase agreements as investment activites in the
Statements of Cash Flows. RCap reports cash flows on repurchase
agreements as financing activities in the Statements of Cash Flows
10. INTEREST
RATE SWAPS
In
connection with the Company’s interest rate risk management strategy, the
Company economically hedges a portion of its interest rate risk by entering into
derivative financial instrument contracts. As of December 31, 2009,
such instruments are comprised of interest rate swaps, which in effect modify
the cash flows on repurchase agreements. The use of interest rate
swaps creates exposure to credit risk relating to potential losses that could be
recognized if the counterparties to these instruments fail to perform their
obligations under the contracts. In the event of a default by the
counterparty, the Company could have difficulty obtaining its Mortgage-Backed
Securities pledged as collateral for swaps. The Company does not
anticipate any defaults by its counterparties.
The
Company’s swaps are used to lock in the fixed rate related to a portion of its
current and anticipated future 30-day term repurchase agreements.
The
location and fair value of derivative instruments reported in the Consolidated
Statement of Financial Position as of December 31, 2009 are as
follows:
|
Location
on Statement
of
Financial Condition
|
Notional
Amount
(dollars
in thousands)
|
Net
Estimated Fair
Value/Carrying
Value
(dollars
in thousands)
|
|||||||
|
December
31, 2009
|
Liabilities
|
$ | 18,823,300 | $ | 533,362 | ||||
|
December
31, 2009
|
Assets
|
$ | 2,700,000 | $ | 5,417 | ||||
|
December
31, 2008
|
Liabilities
|
$ | 17,615,750 | $ | 1,102,285 | ||||
The
effect of derivatives on the Statement of Operations and Comprehensive Income is
as follows:
|
Location
on Statement of Operations and Comprehensive Income
|
||||||||
|
Interest
Expense
|
Unrealized
Gain (Loss) on
Interest
Rate Swaps
|
|||||||
|
(dollars
in thousands)
|
||||||||
|
For
the Year Ended December 31, 2009
|
$ | 743,982 | $ | 349,521 | ||||
|
For
the Year Ended December 31, 2008
|
$ | 327,402 | $ | (768,268 | ) | |||
The
weighted average pay rate at December 31, 2009 was 3.85% and the weighted
average receive rate was 0.25%. The weighted average pay rate at
December 31, 2008 was 4.66% and the weighted average receive rate was
1.88%.
11.
PREFERRED STOCK AND
COMMON STOCK
(A)
Common Stock Issuances
During
the year ended December 31, 2009, 423,160 options were exercised under the
Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise
price of $4.9 million. During the year ended December 31, 2009, 7,550
shares of restricted stock were issued under the Incentive Plan.
During
the year ended December 31, 2009, 1.4 million shares of Series B Preferred Stock
were converted into 2.8 million shares of common stock,
respectively.
F-18
During
the year ended December 31, 2009, the Company raised $141.8 million by issuing
8.4 million shares, through the Direct Purchase and Dividend Reinvestment
Program.
On May
13, 2008 the Company entered into an underwriting agreement pursuant to which it
sold 69,000,000 shares of its common stock for net proceeds following
underwriting expenses of approximately $1.1 billion. This transaction settled on
May 19, 2008.
On
January 23, 2008 the Company entered into an underwriting agreement pursuant to
which it sold 58,650,000 shares of its common stock for net proceeds following
underwriting expenses of approximately $1.1 billion. This transaction settled on
January 29, 2008.
During
the year ended December 31, 2008, the Company raised $93.7 million by issuing
5.8 million shares, through the Direct Purchase and Dividend Reinvestment
Program.
During
the year ended December 31, 2008, 300,000 options were exercised under the
Long-Term Stock Incentive Plan, or Incentive Plan, for an aggregate exercise
price of $2.8 million.
During
the year ended December 31, 2008, 634,000 shares of Series B Preferred Stock
were converted into 1.3 million shares of common stock,
respectively.
On August
3, 2006, the Company entered into an ATM Equity Offering
(sm)
Sales Agreement with Merrill Lynch & Co. and Merrill Lynch, Pierce, Fenner
& Smith Incorporated, relating to the sale of shares of the Company’s common
stock from time to time through Merrill Lynch. Sales of the shares, if any, are
made by means of ordinary brokers' transaction on the New York Stock Exchange.
During the year ended December 31, 2009, there were no shares issued pursuant to
this program. During the year ended December 31, 2008, 588,000 shares
of the Company’s common stock were issued pursuant to this program, totaling
$11.5 million in net proceeds.
On August
3, 2006, the Company entered into an ATM Equity Sales Agreement with UBS
Securities LLC, relating to the sale of shares of the Company’s common stock
from time to time through UBS Securities. Sales of the shares, if any, will be
made by means of ordinary brokers' transaction on the New York Stock Exchange.
During the year ended December 31, 2009, there were no shares issued pursuant to
this program. During the year ended December 31, 2008, 3.8 million shares of the
Company’s common stock were issued pursuant to this program, totaling $60.3
million in net proceeds.
(B)
Preferred Stock
At
December 31, 2009 and 2008, the Company had issued and outstanding 7,412,500
shares of Series A Cumulative Redeemable Preferred Stock (“Series A Preferred
Stock”), with a par value $0.01 per share and a liquidation preference of $25.00
per share plus accrued and unpaid dividends (whether or not declared). The
Series A Preferred Stock must be paid a dividend at a rate of 7.875% per year on
the $25.00 liquidation preference before the common stock is entitled to receive
any dividends. The Series A Preferred Stock is redeemable at $25.00 per share
plus accrued and unpaid dividends (whether or not declared) exclusively at the
Company's option commencing on April 5, 2009 (subject to the Company's right
under limited circumstances to redeem the Series A Preferred Stock earlier in
order to preserve its qualification as a REIT). The Series A Preferred Stock is
senior to the Company's common stock and is on parity with the Series B
Preferred Stock with respect to dividends and distributions, including
distributions upon liquidation, dissolution or winding up. The Series A
Preferred Stock generally does not have any voting rights, except if the Company
fails to pay dividends on the Series A Preferred Stock for six or more quarterly
periods (whether or not consecutive). Under such circumstances, the Series A
Preferred Stock, together with the Series B Preferred Stock, will be entitled to
vote to elect two additional directors to the Board, until all unpaid dividends
have been paid or declared and set apart for payment. In addition, certain
material and adverse changes to the terms of the Series A Preferred Stock cannot
be made without the affirmative vote of holders of at least two-thirds of the
outstanding shares of Series A Preferred Stock and Series B Preferred Stock.
Through December 31, 2009, the Company had declared and paid all required
quarterly dividends on the Series A Preferred Stock.
F-19
At
December 31, 2009 and 2008, the Company had issued and outstanding 2,604,614 and
4,496,525, respectively, shares of Series B Cumulative Convertible Preferred
Stock (“Series B Preferred Stock”), with a par value $0.01 per share and a
liquidation preference of $25.00 per share plus accrued and unpaid dividends
(whether or not declared). The Series B Preferred Stock must be paid a dividend
at a rate of 6% per year on the $25.00 liquidation preference before the common
stock is entitled to receive any dividends.
The
Series B Preferred Stock is not redeemable. The Series B Preferred Stock is
convertible into shares of common stock at a conversion rate that adjusts from
time to time upon the occurrence of certain events, including if the Company
distributes to its common shareholders in any calendar quarter cash dividends in
excess of $0.11 per share. Initially, the conversion rate was 1.7730 shares of
common shares per $25 liquidation preference. At December 31,
2008, the conversion ratio was 2.0650 shares of common stock per $25 liquidation
preference. Commencing April 5, 2011, the Company has the right in
certain circumstances to convert each Series B Preferred Stock into a number of
common shares based upon the then prevailing conversion rate. The Series B
Preferred Stock is also convertible into common shares at the option of the
Series B preferred shareholder at anytime at the then prevailing conversion
rate. The Series B Preferred Stock is senior to the Company's common stock and
is on parity with the Series A Preferred Stock with respect to dividends and
distributions, including distributions upon liquidation, dissolution or winding
up. The Series B Preferred Stock generally does not have any voting rights,
except if the Company fails to pay dividends on the Series B Preferred Stock for
six or more quarterly periods (whether or not consecutive). Under such
circumstances, the Series B Preferred Stock, together with the Series A
Preferred Stock, will be entitled to vote to elect two additional directors to
the Board, until all unpaid dividends have been paid or declared and set apart
for payment. In addition, certain material and adverse changes to the terms of
the Series B Preferred Stock cannot be made without the affirmative vote of
holders of at least two-thirds of the outstanding shares of Series B Preferred
Stock and Series A Preferred Stock. Through December 31, 2009, the Company had
declared and paid all required quarterly dividends on the Series B Preferred
Stock. During the year ended December 31, 2009, 1.4 million shares of
Series B Preferred Stock were converted into 2.8 million shares of common
stock. During the year ended December 31, 2008, 634,000 shares of
Series B Preferred Stock were converted into 1.3 million shares of common
stock.
(C)
Distributions to Shareholders
During
the year ended December 31, 2009, the Company declared dividends to common
shareholders totaling $1.4 billion or $2.54 per share, of which $414.9 million
were paid to shareholders on January 28, 2010. During the year ended
December 31, 2009, the Company declared dividends to Series A Preferred
shareholders totaling approximately $14.6 million or $1.97 per share, and Series
B shareholders totaling approximately $3.9 million or $1.50 per share, which
were paid to shareholders on December 31, 2009.
During
the year ended December 31, 2008, the Company declared dividends to common
shareholders totaling $1.1 billion or $2.08 per share, of which $270.7 million
were paid to shareholders on January 29, 2009. During the year ended
December 31, 2008, the Company declared dividends to Series A Preferred
shareholders totaling approximately $14.6 million or $1.97 per share, and Series
B shareholders totaling approximately $6.6 million or $1.50 per share, which
were paid to shareholders on December 31, 2008.
12. NET
INCOME PER COMMON SHARE
The
following table presents a reconciliation of the net income and shares used in
calculating basic and diluted earnings per share for the years ended December
31, 2009, 2008, and 2007.
|
For
the years ended
(amounts
in thousands)
|
||||||||||||
|
December
31,
2009
|
December
31,
2008
|
December
31,
2007
|
||||||||||
|
Net
income attributable to controlling interest
|
$ | 1,961,471 | $ | 346,180 | $ | 414,384 | ||||||
|
Less:
Preferred stock dividends
|
18,501 | 21,177 | 21,493 | |||||||||
|
Net
income available to common shareholders, prior to
adjustment
for Series B dividends, if necessary
|
1,942,970 | 325,003 | 392,891 | |||||||||
|
Add:
Preferred Series B dividends, if Series B
shares
are dilutive
|
3,908 | - | 6,900 | |||||||||
|
Net
income available to common shareholders, as adjusted
|
$ | 1,946,877 | $ | 325,003 | $ | 399,791 | ||||||
|
Weighted
average shares of common stock
outstanding-basic
|
546,973 | 507,025 | 297,488 | |||||||||
|
Add: Effect
of dilutive stock options and Series
|
||||||||||||
|
B
Cumulative Convertible Preferred Stock
|
6,158 | - | 8,775 | |||||||||
|
Weighted
average shares of common
stock
outstanding-diluted
|
553,131 | 507,025 | 306,263 | |||||||||
F-20
Options
to purchase 2.8 million shares of common stock, were outstanding and considered
anti-dilutive as their exercise price and option expense exceeded the average
stock price for the year ended December 31, 2009. Options to purchase 5.2
million shares of common stock, were outstanding and considered anti-dilutive as
their exercise price and option expense exceeded the average stock price for the
year ended December 31, 2008. The Series B Cumulative Convertible Preferred
Stock was anti-dilutive for the year ended December 31, 2008.
13.
LONG-TERM STOCK
INCENTIVE PLAN
The
Company has adopted a long term stock incentive plan for executive officers, key
employees and non-employee directors (the “Incentive Plan”). The
Incentive Plan authorizes the Compensation Committee of the board of directors
to grant awards, including non-qualified options as well as incentive stock
options as defined under Section 422 of the Code. The Incentive Plan
authorizes the granting of options or other awards for an aggregate of the
greater of 500,000 shares or 9.5% of the diluted outstanding shares of the
Company’s common stock, up to ceiling of 8,932,921 shares. Stock
options are issued at the current market price on the date of grant, subject to
an immediate or four year vesting in four equal installments with a contractual
term of 5 or 10 years. The grant date fair value is calculated using
the Black-Scholes option valuation model.
|
For
the year ended
|
||||||||||||||||
|
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
|
Number
of
Shares
|
Weighted
Average
Exercise
Price
|
Number
of
Shares
|
Weighted
Average
Exercise
Price
|
|||||||||||||
|
Options
outstanding at the beginning of
year
|
5,180,164 | $ | 15.87 | 3,437,267 | $ | 15.23 | ||||||||||
|
Granted
|
2,535,750 | 13.26 | 2,043,700 | 16.02 | ||||||||||||
|
Exercised
|
(423,161 | ) | 11.72 | (293,243 | ) | 9.59 | ||||||||||
|
Forfeited
|
(10,000 | ) | 15.61 | (2,550 | ) | 15.84 | ||||||||||
|
Expired
|
(11,250 | ) | 17.32 | (5,010 | ) | 20.67 | ||||||||||
|
Options
outstanding at the end of period
|
7,271,503 | $ | 15.20 | 5,180,164 | $ | 15.87 | ||||||||||
|
Options
exercisable at the end of the period
|
1,869,678 | $ | 16.96 | 2,119,964 | $ | 16.36 | ||||||||||
The
weighted average remaining contractual term was approximately 7.6 years for
stock options outstanding and approximately 4.7 years for stock options
exercisable as of December 31, 2009. As of December 31, 2009, there
was approximately $13.1 million of total unrecognized compensation cost related
to nonvested share-based compensation awards. That cost is expected
to be recognized over a weighted average period of 3.0 years.
The
weighted average remaining contractual term was approximately 7.6 years for
stock options outstanding and approximately 5.6 years for stock options
exercisable as of December 31, 2008. As of December 31, 2008, there
was approximately $9.3 million of total unrecognized compensation cost related
to nonvested share-based compensation awards. That cost is expected
to be recognized over a weighted average period of 3.0 years.
F-21
14. INCOME
TAXES
As a
REIT, the Company is not subject to federal income tax on earnings distributed
to its shareholders. Most states recognize REIT status as well. The Company has
decided to distribute the majority of its income and retain a portion of the
permanent difference between book and taxable income arising from Section 162(m)
of the Code pertaining to employee remuneration.
During
the year ended December 31, 2009, the Company’s taxable REIT subsidiaries
recorded $9.7 million of income tax expense for income attributable to those
subsidiaries, and the portion of earnings retained based on Code Section 162(m)
limitations. During the year ended December 31, 2009, the Company
recorded $24.7 million of income tax expense for a portion of earnings retained
based on Section 162(m) limitations.
During
the year ended December 31, 2008, FIDAC recorded $4.0 million of income tax
expense for income attributable to FIDAC, and the portion of earnings retained
based on Code Section 162(m) limitations. During the year ended
December 31, 2008, Merganser recorded $94,000 of income tax expense for income
attributable to Merganser. During the year ended December 31, 2008,
the Company recorded $21.9 million of income tax expense for a portion of
earnings retained based on Section 162(m) limitations. The effective
tax rate was 53% for the year ended December 31, 2008.
During
the year ended December 31, 2007, the Company did not record income tax expense
for income attributable to FIDAC, its taxable REIT subsidiary, and the portion
of earnings retained based on Code Section 162(m) limitations. During
the year ended December 31, 2007, the Company recorded $9.0 million of income
tax expense for a portion of earnings retained based on Section 162(m)
limitations. The effective tax rate was 51% for the year ended
December 31, 2007.
The
Company’s effective tax rate was 52%, 53%, and 51%, for the years ended December
31, 2009, 2008, and 2007, respectively. These rates were calculated
based on the Companies estimated taxable income after dividends paid deduction
and differ from the federal statutory rate as a result of state and local taxes
and permanent difference pertaining to employee remuneration as discussed
above.
The
statutory combined federal, state, and city corporate tax rate is
45%. This amount is applied to the amount of estimated REIT taxable
income retained (if any, and only up to 10% of ordinary income as all capital
gain income is distributed) and to taxable income earned at the taxable
subsidiaries. Thus, as a REIT, the Company’s effective tax rate is
significantly less as it is allowed to deduct dividend
distributions.
15. LEASE
COMMITMENTS AND CONTINGENCIES
The
Company has a non-cancelable lease for office space, which commenced in May 2002
and was to expire in December 2009. The Company amended this lease to increase
the amount of space it leases and extended it to December
2015. Merganser has a non-cancelable lease for office space, which
commenced on May 2003 and expires in May 2014. The Company’s
aggregate future minimum lease payments total $10.1
million. The following table details the lease payments, net of
sub-lease receipts.
|
Year
Ending December
|
Lease
Commitment
|
Sublease
Income
|
Net
Amount
|
|||||||||
|
(dollars
in thousands)
|
||||||||||||
|
2010
|
$ | 2,049 | $ | 56 | $ | 1,993 | ||||||
|
2011
|
2,120 | - | 2,120 | |||||||||
|
2012
|
2,130 | - | 2,130 | |||||||||
|
2013
|
2,170 | - | 2,170 | |||||||||
|
Thereafter
|
1,677 | - | 1,677 | |||||||||
| $ | 10,146 | $ | 56 | $ | 10,090 | |||||||
From time
to time, the Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material effect on the
Company’s consolidated financial statements and therefore no accrual is required
as of December 31, 2009 and 2008.
Merganser’s
prior owners may receive additional consideration as an earn-out during 2012 if
Merganser meets specific performance goals under the merger
agreement. The Company cannot currently calculate how much
consideration will be paid under the earn-out provisions because the payment
amount will vary depending upon whether and the extent to which Merganser
achieves specific performance goals. Any amounts paid under this
provision will be recorded as additional goodwill.
F-22
16.
INTEREST RATE RISK
The
primary market risk to the Company is interest rate risk. Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond the Company’s control. Changes in the
general level of interest rates can affect net interest income, which is the
difference between the interest income earned on interest-earning assets and the
interest expense incurred in connection with the interest-bearing liabilities,
by affecting the spread between the interest-earning assets and interest-bearing
liabilities. Changes in the level of interest rates also can affect
the value of the Investment Securities and the Company’s ability to realize
gains from the sale of these assets. A decline in the value of the
Investment Securities pledged as collateral for borrowings under repurchase
agreements could result in the counterparties demanding additional collateral
pledges or liquidation of some of the existing collateral to reduce borrowing
levels. Liquidation of collateral at losses could have an adverse
accounting impact, as discussed in Note 1.
The
Company seeks to manage the extent to which net income changes as a function of
changes in interest rates by matching adjustable-rate assets with variable-rate
borrowings. The Company may seek to mitigate the potential impact on
net income of periodic and lifetime coupon adjustment restrictions in the
portfolio of Investment Securities by entering into interest rate agreements
such as interest rate caps and interest rate swaps. As of December 31, 2009 and
2008, the Company entered into interest rate swaps to pay a fixed rate and
receive a floating rate of interest, with a total notional amount of $21.5
billion and $17.6 billion, respectively.
Changes
in interest rates may also have an effect on the rate of mortgage principal
prepayments and, as a result, prepayments on Mortgage-Backed
Securities. The Company will seek to mitigate the effect of changes
in the mortgage principal repayment rate by balancing assets purchased at a
premium with assets purchased at a discount. To date, the aggregate
premium exceeds the aggregate discount on the Mortgage-Backed
Securities. As a result, prepayments, which result in the expensing
of unamortized premium, will reduce net income compared to what net income would
be absent such prepayments.
17. RELATED
PARTY TRANSACTIONS
At
December 31, 2009 and 2008, the Company had lent $259.0 million and $562.1
million, respectively, to Chimera in a reverse repurchase agreement that is
callable weekly. This amount is included in the principal amount
which approximates fair value in the Company’s Statement of Financial
Condition. The interest rate at December 31, 2009 and December 31,
2008 was at the rate of 1.72% and 1.43%, respectively.
At
December 31, 2009, the Company had $8.8 billion of repurchase agreements
outstanding with RCap. The weighted average interest rate is 0.35%
and the terms are one to two months. These agreements are
collateralized by agency mortgage backed securities, with an estimated market
value of $9.2 billion. For the year ended December 31, 2009, RCap had $18.0
million in interest income from the Company.
On
April 15, 2009, the Company purchased approximately 25.0 million shares of
Chimera common stock at a price of $3.00 for aggregate proceeds of approximately
$74.9 million. On May 27, 2009, the Company purchased approximately 4.7
million shares of Chimera common stock at a price of $3.22 for aggregate
proceeds of approximately $15.2 million. On October 29, 2008, the Company
purchased approximately 11.7 million shares of Chimera common stock at a price
of $2.25 per share for aggregate proceeds of approximately $26.3 million.
Chimera is managed by FIDAC, and the Company owns approximately 6.8% of
Chimera's common stock.
18. SUBSEQUENT
EVENTS
On
February 9, 2010, the Company issued $500.0 million in aggregate principal
amount of its 4% convertible senior notes due 2015. Interest on the notes will
be paid semi-annually at a rate of 4% per year and the notes will mature on
February 15, 2015 unless earlier repurchased or converted. The notes
will be convertible into shares of Annaly’s common stock. The notes will be
convertible at an initial conversion rate of 46.6070 shares of common stock per
$1,000 principal amount of notes, which is equivalent to an initial conversion
price of approximately $21.456 per share of common stock, subject to adjustment
in certain circumstances.
F-23
19. SUMMARIZED
QUARTERLY RESULTS (UNAUDITED)
The
following is a presentation of the quarterly results of operations for the year
ended December 31, 2009.
|
March
31,
|
June
30,
|
September
30,
|
December
31,
|
|||||||||||||
|
2009
|
2009
|
2009
|
2009
|
|||||||||||||
|
(dollars
in thousands, expect per share data)
|
||||||||||||||||
|
Interest
income
|
||||||||||||||||
|
Investments
|
$ | 716,015 | $ | 710,401 | $ | 744,523 | $ | 751,560 | ||||||||
|
Securities
loaned
|
- | - | - | 103 | ||||||||||||
|
Total
interest income
|
716,015 | 710,401 | 744,523 | 751,663 | ||||||||||||
|
Interest
expense
|
||||||||||||||||
|
Investments
|
378,625 | 322,596 | 307,777 | 286,672 | ||||||||||||
|
Securities
borrowed
|
- | - | - | 92 | ||||||||||||
|
Total
interest expense
|
378,625 | 322,596 | 307,777 | 286,764 | ||||||||||||
|
Net
interest income
|
337,390 | 387,805 | 436,746 | 464,899 | ||||||||||||
|
Other
income (loss)
|
||||||||||||||||
|
Investment
advisory and service fees
|
7,761 | 11,736 | 14,620 | 14,835 | ||||||||||||
|
Gain
on sale of Mortgage-Backed Securities
|
5,023 | 2,364 | 591 | 91,150 | ||||||||||||
|
Dividend
income from available-for-sale equity securities
|
918 | 3,221 | 5,398 | 7,647 | ||||||||||||
|
Loss
from Prime Broker
|
- | - | - | (13,613 | ) | |||||||||||
|
Unrealized
gain (loss) on interest rate swaps
|
35,545 | 230,207 | (128,687 | ) | 212,456 | |||||||||||
|
Total
other income (loss)
|
49,247 | 247,528 | (108,078 | ) | 312,475 | |||||||||||
|
Expenses
|
||||||||||||||||
|
Distribution
fees
|
428 | 432 | 478 | 418 | ||||||||||||
|
General
and administrative expenses
|
29,882 | 30,046 | 33,344 | 36,880 | ||||||||||||
|
Total
expenses
|
30,310 | 30,478 | 33,822 | 37,298 | ||||||||||||
|
Income
before loss on equity method investments and
income
taxes
|
356,327 | 604,855 | 294,846 | 740,076 | ||||||||||||
|
Loss
on equity method investment
|
- | - | - | 252 | ||||||||||||
|
Income
taxes
|
6,434 | 7,801 | 9,657 | 10,489 | ||||||||||||
|
Net
income
|
349,893 | 597,054 | 285,189 | 729,335 | ||||||||||||
|
Dividends
on preferred stock
|
4,626 | 4,625 | 4,625 | 4,625 | ||||||||||||
|
Net
income available to common shareholders
|
$ | 345,267 | $ | 592,429 | $ | 280,564 | $ | 724,710 | ||||||||
|
Net
income available per share to common shareholders:
|
||||||||||||||||
|
Basic
|
$ | 0.64 | $ | 1.09 | $ | 0.51 | $ | 1.31 | ||||||||
|
Diluted
|
$ | 0.63 | $ | 1.08 | $ | 0.51 | $ | 1.30 | ||||||||
|
Weighted
average number of common shares outstanding:
|
||||||||||||||||
|
Basic
|
542,903,110 | 544,344,844 | 547,611,480 | 552,917,499 | ||||||||||||
|
Diluted
|
548,551,328 | 550,099,709 | 553,376,285 | 559,332,320 | ||||||||||||
F-24
The
following is a presentation of the quarterly results of operations for the year
ended December 31, 2008.
|
March
31,
2008
|
June
30,
2008
|
September
30,
2008
|
December
31,
2008
|
|||||||||||||
|
(dollars
in thousands, except per share data)
|
||||||||||||||||
|
Interest
income
|
$ | 791,128 | $ | 773,359 | $ | 810,659 | $ | 740,282 | ||||||||
|
Interest
expense
|
537,606 | 442,251 | 458,250 | 450,805 | ||||||||||||
|
Net
interest income
|
253,522 | 331,108 | 352,409 | 289,477 | ||||||||||||
|
Other
income:
|
||||||||||||||||
|
Investment
advisory and service fees
|
6,598 | 6,406 | 7,663 | 7,224 | ||||||||||||
|
Gain
(loss) on sale of Investment Securities
|
9,417 | 2,830 | (1,066 | ) | (468 | ) | ||||||||||
|
Income
(loss) from trading securities
|
1,854 | 2,180 | 7,671 | (2,010 | ) | |||||||||||
|
Dividend
income from available-for-sale equity
securities
|
941 | 580 | 580 | 612 | ||||||||||||
|
Loss
on other-than-temporarily impaired securities
|
- | - | (31,834 | ) | - | |||||||||||
|
Unrealized
loss on interest rate swaps
|
- | - | - | (768,268 | ) | |||||||||||
|
Total
other income (loss)
|
18,810 | 11,996 | (16,986 | ) | (762,910 | ) | ||||||||||
|
Expenses:
|
||||||||||||||||
|
Distribution
fees
|
633 | 370 | 299 | 287 | ||||||||||||
|
General
and administrative expenses
|
23,995 | 27,215 | 25,455 | 26,957 | ||||||||||||
|
Total
expenses
|
24,628 | 27,585 | 25,754 | 27,244 | ||||||||||||
|
Income
(loss) before income taxes
|
247,704 | 315,519 | 309,669 | (500,677 | ) | |||||||||||
|
Income
taxes
|
4,610 | 7,527 | 7,538 | 6,302 | ||||||||||||
|
Net
income (loss)
|
243,094 | 307,992 | 302,131 | (506,979 | ) | |||||||||||
|
Noncontrolling
interest
|
58 | - | - | - | ||||||||||||
|
Net
income (loss) attributable to controlling interest
|
243,036 | 307,992 | 302,131 | (506,979 | ) | |||||||||||
|
Dividends
on preferred stock
|
5,373 | 5,334 | 5,335 | 5,135 | ||||||||||||
|
Net
income (loss) available (related) to common
shareholders
|
$ | 237,663 | $ | 302,658 | $ | 296,796 | $ | (512,114 | ) | |||||||
|
Weighted
average number of basic common shares outstanding
|
443,812,432 | 503,758,079 | 538,706,131 | 541,099,147 | ||||||||||||
|
Weighted
average number of diluted common shares outstanding
|
452,967,457 | 512,678,975 | 547,882,488 | 541,099,147 | ||||||||||||
|
Net
income available to common
shareholders
per average common share:
|
|
|||||||||||||||
|
Basic
|
$ | 0.54 | $ | 0.60 | $ | 0.55 | $ | (0.95 | ) | |||||||
|
Diluted
|
$ | 0.53 | $ | 0.59 | $ | 0.54 | $ | (0.95 | ) | |||||||
F-25
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, in the city of New York, State of
New York.
|
ANNALY
CAPITAL MANAGEMENT, INC.
|
||
|
Date:
February 24, 2010
|
By:
|
/s/ Michael A. J.
Farrell
|
|
Michael
A. J. Farrell
|
||
|
Chairman,
Chief Executive Officer, and
President
|
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 date indicated.
|
Signature
|
Title
|
Date
|
|
|
/s/ KEVIN P. BRADY
Kevin
P. Brady
|
Director
|
February
24, 2010
|
|
|
/s/ KATHRYN F. FAGAN
Kathryn
F. Fagan
|
Chief
Financial Officer and Treasurer
(principal
financial and accounting officer)
|
February
24, 2010
|
|
|
/s/ MICHAEL A.J. FARRELL
Michael
A. J. Farrell
|
Chairman
of the Board, Chief Executive
Officer,
President and Director (principal
executive
officer)
|
February
24, 2010
|
|
|
/s/ JONATHAN D. GREEN
Jonathan
D. Green
|
Director
|
February
24, 2010
|
|
|
/
s/ MICHAEL E. HAYLON
Michael
E. Haylon
|
Director
|
February
24, 2010
|
|
|
/
s/ JOHN A. LAMBIASE
John
A. Lambiase
|
Director
|
February
24, 2010
|
|
|
/s/ E. WAYNE NORDBERG
E.
Wayne Nordberg
|
Director
|
February
24, 2010
|
|
|
/s/ DONNELL A. SEGALAS
Donnell
A. Segalas
|
Director
|
February
24, 2010
|
|
|
/s/ WELLINGTON DENAHAN-NORRIS
Wellington
Denahan-Norris
|
Vice
Chairman of the Board, Chief
Investment
Officer, Chief Operating
Officer
and Director
|
February
24, 2010
|
II-1
TABLE OF CONTENTS