FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
Commission File Number 001-13937
---------------
ANTHRACITE CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Maryland 13-3978906
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
345 Park Avenue, New York, New York 10154
----------------------------------- -----
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number including area code): (212) 409-3333
---------------
NOT APPLICABLE
(Former name, former address, and former fiscal year if changed since last
report)
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.
(1) Yes X No __
(2) Yes X No __
As of August 13, 2001, 35,364,012 shares of voting common stock
($.001 par value) were outstanding.
ANTHRACITE CAPITAL, INC.,
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
----
Item 1. Interim Financial Statements.......................................3
Consolidated Statements of Financial Condition
At June 30, 2001 (Unaudited) and
December 31, 2000..................................................3
Consolidated Statements of Operations
For the Three and Six Months Ended June 30, 2001 and
2000 (Unaudited)...................................................4
Consolidated Statement of Changes in Stockholders' Equity
For the Six Months Ended June 30, 2001 (Unaudited).................5
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2001 and 2000 (Unaudited)........6
Notes to Consolidated Financial Statements (Unaudited).............7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................16
Item 3. Quantitative and Qualitative Disclosures about Market Risk........29
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.............................................33
Item 2. Changes in Securities and Use of Proceeds.....................33
Item 3. Defaults Upon Senior Securities...............................33
Item 4. Submission of Matters to a Vote of Security Holders...........33
Item 5. Other Information.............................................33
Item 6. Exhibits and Reports on Form 8-K..............................33
SIGNATURES..................................................................34
Part I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Anthracite Capital, Inc. and Subsidiaries
Consolidated Statements of Financial Condition
(in thousands, except per share data)
===============================================================================================================================
June 30, 2001 December 31, 2000
------------- -----------------
(Unaudited)
ASSETS
Cash and cash equivalents $ 21,624 $ 37,829
Restricted cash equivalents 30,025 9,484
Securities available for sale, at fair value
Subordinated commercial mortgage-backed securities (CMBS) $290,397 $288,686
Investment grade securities 787,340 389,436
-------------- -------------
Total securities available for sale
1,077,737 678,122
Securities held for trading, at fair value 500,646 54,043
Mortgage loan pools available for sale, at fair value - 71,535
Commercial mortgage loans 98,890 153,187
Investments in real estate joint ventures 10,295 10,354
Receivable for investments sold 69,537 -
Other assets 20,207 19,097
-------------- ---------------
Total Assets $ 1,828,961 $1,033,651
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings:
Secured by pledge of subordinated CMBS $165,319 $161,608
Secured by pledge of other securities available for sale
and cash equivalents 651,381 356,491
Secured by mortgage loans pools - 67,367
Secured by pledge of securities held for trading 489,346 55,212
Secured by pledge of investments in real estate joint ventures 2,633 3,385
Secured by pledge of commercial mortgage loans 43,658 75,279
-------------- -------------
Total borrowings $ 1,352,337 $719,342
Payable for investments purchased 94,048 -
Distributions payable 13,387 9,741
Other liabilities 18,457 31,910
-------------- ---------------
Total Liabilities 1,478,229 760,993
-------------- ---------------
10.5% Series A preferred stock, redeemable convertible, liquidation
preference $34,200 30,633 30,404
-------------- ---------------
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $0.001 per share; 400,000 shares authorized; 35,124
shares issued and outstanding in 2001; and 25,136 shares issued and
outstanding in 2000
35 25
10% Series B preferred stock, liquidation preference $55,317 in
2001, $56,525 in 2000 42,086 43,004
Additional paid-in capital 405,206 315,533
Distributions in excess of earnings (13,298) (13,437)
Accumulated other comprehensive loss (113,930) (102,871)
-------------- ---------------
Total Stockholders' Equity 320,099 242,254
-------------- ---------------
Total Liabilities and Stockholders' Equity $1,828,961 $1,033,651
============== ===============
The accompanying notes are an integral part of these financial statements
Anthracite Capital, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
(in thousands, except per share data)
------------------------------------- ------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30, June 30,
------------------------------------- ------------------------------------------
2001 2000 2001 2000
---- ---- ---- ----
-------------------- -----------------------------------------------------------
Income:
Securities available for sale $ 19,204 $ 19,186 $ 36,451 $ 33,528
Commercial mortgage loans 4,209 2,989 10,196 4,977
Mortgage loan pools 137 3,465 1,575 3,465
Trading securities 3,663 - 4,767 -
Earnings from real estate joint ventures 317 - 684 -
Cash and cash equivalents 875 363 1,072 655
-------- --------- -------- --------
Total income 28,405 26,003 54,745 42,625
-------- --------- -------- --------
Expenses:
Interest 9,258 15,096 20,659 22,563
Interest - trading securities 2,407 - 3,278 -
Management and incentive fee 2,668 1,700 5,117 2,990
Other expenses - net 283 548 969 1,435
-------- --------- -------- --------
Total expenses 14,616 17,344 30,023 26,988
-------- --------- -------- --------
Other gain (losses):
Gain on sale of securities available for sale 5,134 682 7,081 705
Gain/loss on securities held for trading (124) - 568 328
Foreign currency gain (loss) 5 (7) 109 (11)
Loss on impairment of asset (5,702) - (5,702) -
-------- --------- -------- --------
Total other gain (loss) (687) 675 2,056 1,022
-------- --------- -------- --------
Income before cumulative transition adjustment 13,102 9,334 26,778 16,659
Cumulative transition adjustment - SFAS 133 - - (1,903) -
-------- --------- -------- --------
Net Income 13,102 9,334 24,875 16,659
-------- --------- -------- --------
Dividends and accretion on preferred stock 2,287 1,575 4,576 2,441
-------- --------- -------- --------
Net Income available to Common Shareholders 10,815 7,759 20,299 $14,218
======== ========= ======== ========
Net income per common share, basic:
Income before cumulative transition adjustment $0.33 $0.34 $0.75 $0.65
Cumulative transition adjustment - SFAS 133 - - (0.06) -
-------- --------- -------- --------
Net income $0.33 $0.34 $0.69 $0.65
======== ========= ======== ========
Net income per common share, diluted:
Income before cumulative transition $0.32 $0.32 $0.71 $0.61
adjustment
Cumulative transition adjustment - SFAS 133 - - (0.06) -
-------- --------- -------- --------
Net income $0.32 $0.32 $0.65 $0.61
======== ========= ======== ========
Weighted average number of shares outstanding:
Basic 32,470 23,115 29,736 22,029
Diluted 36,631 27,196 33,874 26,111
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
For the Six Months Ended June 30, 2001
(in thousands)
===================================================================================================================================
Series Accumulated
Common B Additional Distributions Other Total
Stock, Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders'
Par Value Stock Capital Of Earnings Loss Income Equity
--------- --------- ---------- ------------- ------------- ------------- -----------
Balance at January 1, 2001 $25 $43,004 $315,533 ($13,437) ($102,871) $242,254
Issuance of common stock 9 88,624 88,633
Net income 24,875 $24,875 24,875
Net charge associated with current
period hedging transactions (5,996) (5,996) (5,996)
Net amount reclassified into earnings
due to amortization of de-designated hedges 248 248 248
Cumulative transition adjustment - SFAS 133 1,903 1,903 1,903
Change in net unrealized loss on
securities available for sale, net of
reclassification adjustment (7,214) (7,214) (7,214)
--------------
Other Comprehensive loss (11,059)
Comprehensive Income $13,816
==============
Dividends declared-common stock (20,160) (20,160)
Dividends and accretion on
Preferred stock (4,576) (4,576)
Conversion of Series B preferred stock to
common stock 1 (918) 917 -
Compensation cost - stock options 132 132
----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 2001 $35 $42,086 $405,206 ($13,298) ($113,930) $320,099
=========================================================================================
Disclosure of reclassification adjustment:
Unrealized holding loss $(9,161)
Less: reclassification for realized gains
previously recorded as unrealized 1,947
Net charge associated with current period
hedging transactions (5,996)
Net amount reclassified into earnings due
to amortization of de-designated hedges 248
Cumulative transition adjustment - SFAS 133 1,903
--------------
Net unrealized loss on securities $(11,059)
==============
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)(in thousands)
--------------------------------------------------------------------------------------------------------------------------------
For the Six Months Ended
June 30, 2001 June 30, 2000
------------- -------------
Cash flows from operating activities:
Net income $ 24,875 $ 16,659
Adjustments to reconcile net income to net cash provided by operating activities:
Net (purchase) sale of trading securities (388,353) 328
Amortization on negative goodwill (960) (212)
Cumulative transition adjustment - SFAS 133 1,903 -
Premium amortization, net 4,509 76
Compensation cost - stock options 132 -
Loss on impairment of asset 5,702 -
Non-cash portion of net foreign currency (gain) loss (109) 11
Net (gain) loss on sale of securities (7,649) 729
Distributions from real estate joint ventures in excess of earnings 59 -
Decrease (increase) in other assets 4,694 (13,401)
(Decrease) increase in other liabilities (9,675) 11,486
----------------------- ---------------------
Net cash (used in) provided by operating activities (364,872) 15,676
----------------------- ---------------------
Cash flows from investing activities:
Purchase of securities available for sale (1,262,768) (642,195)
Funding of commercial mortgage loans (13,170) (30,600)
Repayments received from commercial mortgage loans 67,467 -
Increase in restricted cash equivalents (20,541) -
Principal payments received on securities available for sale 29,388 37,588
Principal payments received on mortgage loan pools 10,981 -
Proceeds from sales of securities available for sale and mortgage loan pools 842,238 1,310,456
Net payments under hedging securities (5,695) (2,770)
----------------------- ---------------------
Net cash (used in) provided by investing activities (352,100) 672,479
----------------------- ---------------------
Cash flows from financing activities:
Net increase (decrease) in borrowings 632,995 (713,647)
Proceeds from issuance of common stock, net of offering costs 88,624 -
Distributions on common stock (16,415) (12,156)
Distributions on preferred stock
(4,437) (3,251)
Net proceeds from merger
- 33,380
Acquisition costs against goodwill
- (4,129)
Purchase of common shares
- (39)
----------------------- ---------------------
Net cash provided by (used in) financing activities 700,767 (699,842)
----------------------- ---------------------
Net decrease in cash and cash equivalents (16,205) (11,687)
Cash and cash equivalents, beginning of period 37,829 22,265
----------------------- ---------------------
Cash and cash equivalents, end of period $ 21,624 $ 10,578
======================= =====================
Supplemental disclosure of cash flow information:
Interest paid $ 20,339 $7,195
====================== =====================
Investments purchased not settled $ 94,048 -
====================== =====================
Investments sold not settled $ 69,537 -
====================== =====================
The accompanying notes are an integral part of these financial statements.
Anthracite Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(In thousands, except per share data)
-------------------------------------------------------------------------------
Note 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Anthracite Capital, Inc. (the "Company"), a Maryland corporation, is a real
estate finance company that generates income based on the spread between
the interest income on its mortgage loans and securities investments and
the interest expense from borrowings used to finance its investments. The
Company seeks to earn high returns on a risk-adjusted basis to support a
consistent quarterly dividend. The Company has elected to be taxed as a
Real Estate Investment Trust, therefore, its income is largely exempt from
corporate taxation. The Company commenced operations on March 24, 1998.
The Company's business focuses on (i) originating high yield commercial
real estate loans, (ii) investing in below investment grade commercial
mortgage backed securities ("CMBS") where the Company has the right to
control the foreclosure/workout process on the underlying loans, and (iii)
acquiring investment grade real estate related securities as a liquidity
diversification.
The accompanying unaudited financial statements have been prepared in
conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
Regulation S-X for interim financial statements. Accordingly, they do not
include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. These financial statements should be read in
conjunction with the annual financial statements and notes thereto included
in the Company's annual report on Form 10-K for 2000 filed with the
Securities and Exchange Commission.
In the opinion of management, the accompanying financial statements contain
all adjustments, consisting of normal and recurring accruals (except for
the cumulative transition adjustment for SFAS 133 in the first quarter 2001
- see note 2), necessary for a fair presentation of the results for the
interim periods. Operating results for interim periods are not necessarily
indicative of the results that may be expected for the entire year.
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
dates of the statements of financial condition and revenues and expenses
for the periods covered. Actual results could differ from those estimates
and assumptions. Significant estimates in the financial statements include
the valuation of the Company's mortgage-backed securities and certain other
investments.
Note 2 ACCOUNTING CHANGE - DERIVATIVE FINANCIAL INSTRUMENTS
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities", as amended and
interpreted, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts and for hedging activities. All derivatives, whether
designated in hedging relationships or not, are required to be recorded on
the balance sheet at fair value. If the derivative is designated as a fair
value hedge, the changes in the fair value of the derivative and of the
hedged item attributable to the hedged risk are recognized in earnings. If
the derivative is designated as a cash flow hedge, the effective portions
of change in the fair value of the derivative are recorded in other
comprehensive income (OCI) and are recognized in the income statement when
the hedged item affects earnings. Ineffective portions of changes in the
fair value of cash flow hedges are recognized in earnings.
On January 1, 2001 the Company reclassified certain of its agency debt
securities, with an amortized cost of $64,432 from available-for-sale to
trading. An interest rate swap agreement with a $25,000 notional amount
that had been designated as hedging these debt securities was similarly
reclassified. The unrealized gain of $895 related to the agency debt
securities and the unrealized loss of $2,830 related to the interest rate
swap as of January 1, 2001 were removed from OCI and recorded as the
cumulative transition adjustment to earnings upon adoption of SFAS 133. The
net cumulative effect of adopting SFAS 133 was ($1,903) and is reflected as
"Cumulative Transition Adjustment - SFAS 133" on the consolidated statement
of operations.
In addition, on January 1, 2001, the Company re-designated interest rate
swap agreements with notional amounts aggregating $98,000 that had been
hedging available-for-sale debt securities as cash flow hedges of its
variable rate borrowings under reverse repurchase agreements. The fair
value of these swap agreements on January 1, 2001, an unrealized loss of
($9,853), remained in OCI at the date of adoption of FAS 133, and
therefore, did not result in a transition adjustment.
Because of the de-designation and re-designation of the $98,000 interest
rate swaps, the Company is required to amortize the related $9,853 recorded
in OCI. Amortization is on a straight-line basis over the shorter of the
life of the swap or the previously hedged assets and is recognized as a
reduction of interest income. For the three and six months ended June 30,
2001, $248 and $497 was amortized as a reduction of interest income
respectively, and $248 will be amortized as a reduction of interest income
each quarter for the next 12 months.
In addition, on January 1, 2001 the Company re-designated interest rate
swap agreements with notional amounts aggregating $57,744 that had been
hedging available-for-sale debt securities as trading securities. These
interest rate swap agreements were sold in January 2001; the loss of $795
is included in gain on securities held for trading. As of December 31, 2000
the accumulated loss for these interest rate swaps was $3,226. This
accumulated loss is being amortized as a reduction of income from
securities available for sale over the weighted average life of the
securities these interest rate swaps were hedging on December 31, 2000. For
the six months ended June 30, 2001 $129 was amortized as a reduction of
interest income.
The Company uses interest rate swaps to manage exposure to variable cash
flows on its borrowings under reverse repurchase agreements and as trading
derivatives intended to offset changes in fair value related to securities
held as trading assets. On the date in which the derivative contract is
entered, the Company designates the derivative as either a cash flow hedge
or a trading derivative.
The Company has entered into reverse repurchase agreements to finance
securities available for sale that are not financed under its lines of
credit. The reverse repurchase agreements bear interest at a LIBOR based
variable rate. Increases in the LIBOR rate could negatively impact
earnings. The interest rate swap agreements allow the Company to receive a
variable rate cash flow based on LIBOR and pay a fixed rate cash flow,
mitigating the impact of this exposure.
As of June 30, 2001, the Company had interest rate swaps with notional
amounts aggregating $251,000 that were designated as cash flow hedges of
borrowings under reverse repurchase agreements. Their aggregate fair value
was a $5,488 liability included in other liabilities on the statement of
financial condition. For the three months ended June 30, 2001, the net
change in the fair value of the interest rate swaps was $7,611 of which
$1,615 of this change in value was deemed ineffective and is included as a
reduction of interest expense and $5,996 was recorded in OCI.
As of June 30, 2001, the Company had interest rate swaps with notional
amounts aggregating $25,000 designated as trading derivatives. Their
aggregate fair value at June 30, 2001 was $(2,192), included in trading
securities. For the three months ended June 30, 2001, the change in fair
value for these trading derivatives was $774 and is included in gain on
securities held for trading in the consolidated statement of operations.
The implementation of SFAS 133 did not change the manner in which the
Company accounts for its forward currency exchange contracts; these
contracts are carried at fair value, with changes in fair value included as
a component of net foreign currency gain or loss in the consolidated
statement of operations.
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objectives and
strategies for undertaking various hedge transactions. The Company
assesses, both at the inception of the hedge and on an on-going basis,
whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in fair values or cash flows of hedged
items. When it is determined that a derivative is not highly effective as a
hedge, the Company discontinues hedge accounting prospectively.
Note 3 RECENT ACCOUNTING PRONOUNCMENTS
In July 2001, the Financial Accounting Standards Board issued Statement No.
141, "Business Combinations" (SFAS 141) and Statement No. 142, "Goodwill
and Other Intangible Assets" (SFAS 142). These statements establish new
standards for accounting and reporting for business combinations and for
goodwill and intangible assets resulting from business combinations. SFAS
141 applies to all business combinations initiated after June 30, 2001; the
Company is required to implement SFAS 142 on January 1, 2002. For the
Company, this will result in the unamortized balance of negative goodwill
being recognized in income during the first quarter of 2002 as the
cumulative effect of implementing the new accounting standard. The Company
estimates that the gain recognized upon implementation will be
approximately $6,596.
In July of 2000, the FASB's Emerging Issues Task Force reached a consensus
on Issue 99-20, "Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interests in Securitized Financial Interests." This
issue provides guidance on the appropriate methodology to be used in
recognizing changes in the estimated yield on asset-backed securities, and
in determining whether impairment exists. This consensus was applied by the
Company beginning in the second quarter of 2001, and did not have an impact
on the Company's financial statements, but it may require earlier
recognition of impairment of CMBS investments than under previous guidance,
should the Company experience credit losses on the loans underlying a CMBS
investment in amounts greater than anticipated at acquisition.
Note 4 NET INCOME PER SHARE
Net income per share is computed in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 128, Earnings Per Share. Basic income
(loss) per share is calculated by dividing net income (loss) available to
common shareholders by the weighted average number of common shares
outstanding during the period. Diluted income (loss) per share is
calculated using the weighted average number of common shares outstanding
during the period plus the additional dilutive effect of common stock
equivalents. The dilutive effect of outstanding stock options is calculated
using the treasury stock method, and the dilutive effect of preferred stock
is calculated using the "if converted" method.
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2001 2000 2001 2000
---- ---- ---- ----
Numerator:
Net Income available to common shareholders
before cumulative transition adjustment $ 10,815 $ 7,759 $ 22,202 $ 14,218
Cumulative transition adjustment - SFAS 133 - - (1,903) -
--------- -------- --------- ---------
Numerator for basic earnings per share 10,815 7,759 20,299 14,218
Effect of 10.5% series A senior cumulative
redeemable preferred stock 904 868 1,804 1,734
--------- -------- --------- ---------
Numerator for diluted earnings per share $11,719 $8,627 $22,103 $15,952
========= ======== ========= =========
Denominator:
Denominator for basic earnings per share--weighted
average common shares outstanding 32,470 23,115 29,737 22,029
Effect of 10.5% series A senior cumulative redeemable
preferred stock 4,106 4,081 4,098 4,082
Dilutive effect of stock options 56 - 40 -
--------- -------- --------- ---------
Denominator for diluted earnings per share--weighted
average common shares outstanding and common share
equivalents outstanding 36,632 27,196 33,875 26,111
========= ======== ========= =========
Basic net income per weighted average common share:
Income before cumulative transition adjustment $0.33 $0.34 $0.75 $0.65
Cumulative transition adjustment - SFAS 133 - - (0.06) -
--------- -------- --------- ---------
Net income $0.33 $0.34 $0.69 $0.65
========= ======== ========= =========
Diluted net income per weighted average common share and
common share equivalents:
Income before cumulative transition adjustment $0.32 $0.32 $0.71 $0.61
Cumulative transition adjustment - SFAS 133 - - (0.06) -
--------- -------- --------- ---------
Net income $0.32 $0.32 $0.65 $0.61
========= ======== ========= =========
Note 5 SECURITIES AVAILABLE FOR SALE
The Company's securities available for sale are carried at estimated fair
value. The amortized cost and estimated fair value of securities available
for sale as of June 30, 2001 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
----------------------------------------------------------------- --------------- --------------- --------------- ----------------
Commercial mortgage-backed securities ("CMBS"):
CMBS IO's $ 78,125 $ 1,591 $ (267) $ 79,449
Investment grade CMBS 31,591 3 (1,591) 30,003
Non-investment grade rated subordinated securities 349,245 441 (85,467) 264,219
Non-rated subordinated securities 34,213 713 (8,748) 26,178
--------------- --------------- --------------- ----------------
Total CMBS 493,174 2,748 (96,073) 399,849
Single-family residential mortgage-backed securities ("RMBS"):
Fixed Rate Securities 44,483 133 (24) 44,592
Home Equity Loans 32,915 729 - 33,644
Hybrid Adjustable Rate Mortgages 68,645 32 - 68,677
Agency adjustable rate securities 120,570 884 (17) 121,437
Agency fixed rate securities 414,043 2 (4,507) 409,538
--------------- --------------- --------------- ----------------
Total RMBS 680,656 1,780 (4,548) 677,888
--------------- --------------- --------------- ----------------
1,173,830 4,528 (100,621) 1,077,737
=============== =============== =============== ================
As of June 30, 2001, an aggregate of $778,181 in estimated fair value of
the Company's securities available for sale was pledged to secure its
collateralized borrowings.
The following table sets forth certain information relating to the
aggregate principal balance and payment status of delinquent mortgage loans
underlying the subordinated CMBS held by the Company as of June 30, 2001:
------------------------------------------------------------------------
June 30, 2001
------------------------------------------------------------------------
Number of % of
Principal Loans Collateral
------------------------------------------------------------------------
Past due 30 to 60 days $17,002 7 0.19%
------------------------------------------------------------------------
Past due 60 to 90 days $16,891 2 0.18%
------------------------------------------------------------------------
Past due 90 or more $34,072 6 0.37%
------------------------------------------------------------------------
Real Estate owned $8,851 1 0.10%
------------------------------------------------------------------------
Total Delinquent $76,816 16 0.84%
------------------------------------------------------------------------
Total Principal Balance $9,092,199 1,756
------------------------------------------------------------------------
The Company's delinquency experience of 0.84% is compared to the 0.95% for
directly comparable collateral experience shown in the Lehman Brothers CMBS
1998 vintage collateral delinquency index.
To the extent that realized losses, if any, or such resolutions differ
significantly from the Company's original loss estimates, it may be
necessary to reduce the projected GAAP yield on the applicable CMBS
investment to better reflect such investment's expected earnings net of
expected losses, from the date of purchase. While realized losses on
individual assets may be higher or lower than original estimates, the
Company currently believes its aggregate loss estimates and GAAP yields are
appropriate.
As of June 30, 2001, the anticipated weighted average unleveraged yield to
maturity based upon adjusted cost of the Company's subordinated CMBS was
9.88% per annum, and of the Company's other securities available for sale
was 6.15% per annum. The Company's anticipated yields to maturity on its
subordinated CMBS and other securities available for sale are based upon a
number of assumptions that are subject to certain business and economic
uncertainties and contingencies. Examples of these include, among other
things, the rate and timing of principal payments (including prepayments,
repurchases, defaults and liquidations), the pass-through or coupon rate
and interest rate fluctuations. Additional factors that may affect the
Company's anticipated yields to maturity on its subordinated CMBS include
interest payment shortfalls due to delinquencies on the underlying mortgage
loans, and the timing and magnitude of credit losses on the mortgage loans
underlying the subordinated CMBS that are a result of the general condition
of the real estate market (including competition for tenants and their
related credit quality) and changes in market rental rates. As these
uncertainties and contingencies are difficult to predict and are subject to
future events, which may alter these assumptions, no assurance can be given
that the anticipated yields to maturity, discussed above and elsewhere,
will be achieved.
As part of the acquisition of CORE Cap, Inc. in May 2000 the Company
inherited three securities backed by franchise loans originated by
Franchise Mortgage Acceptance Corporation ("FMAC"). The securities were the
class B, C and D securities issued by the FMACT 1998 - BA trust. The total
principal amount of all three securities was $47,609. The respective credit
ratings at the date of acquisition were AA, A and BBB. The Company
immediately sold the class D security at a gain of approximately $150. In
October 2000 the Company sold $10,000 of principal amount of the class C
security at a loss of approximately $990. The Company currently owns
$16,366 of class B principal and $10,829 of class C principal. The trust is
collateralized by loans on 365 properties to 75 borrowers. The properties
are largely franchise restaurants and gas station convenience stores.
Collateral performance has been poor. In March of 2001 the class B
securities were downgraded to BBB and the class C securities were
downgraded to BB. In July 2001 the class B was downgraded to BBB and class
C was downgraded to B.
Although the class C bond is current on all payments, the Company concluded
that due to poor collateral performance, future cash flows on the class C
bond were not likely to be received as originally provided and,
accordingly, the bond was deemed to be impaired. The Company performed an
analysis assuming 40% of the underlying collateral balance was
nonrecoverable. Given the current level of credit enhancement to the class
C securities the loss would amount to 51% of the current principal amount
over time. Under this scenario a yield of approximately 14% results in a
dollar price of 40. As a point of comparison the yield on the 10 year
Treasury on June 30, 2001 was 5.41%. During the second quarter of 2001, the
Company took a charge to income of $5,702 on the class C bond, to write
this bond down to its estimated fair value. At June 30, 2001, the fair
value of class B was marked at a dollar price of 70 and the class C was
marked at a dollar price of 40. As of August 10, 2001, both bonds were
current on all payments. The Company anticipates the class B bond will
remain current.
Note 6 SECURITIES HELD FOR TRADING
Securities held for trading reflect short-term trading strategies, which
the Company employs from time to time, designed to generate economic and
taxable gains. As part of its trading strategies, the Company may acquire
long or short positions in U.S. Treasury or agency securities, forward
commitments to purchase such securities, financial futures contracts and
other fixed income or fixed income derivative securities. Any taxable gains
from such strategies will be applied as an offset against the tax basis
capital loss carry forward that the Company incurred during 1998 as a
result of the sale of a substantial portion of its securities available for
sale.
The Company's securities held for trading are carried at estimated fair
value. At June 30, 2001, the Company's securities held for trading
consisted of FNMA and Federal Home Loan Mortgage Pools with an estimated
fair value of $502,838 and a interest rate swap agreement which represented
a notional amount of $25,000 and a fair value of $(2,192). The FNMA
Mortgage Pools, and the underlying mortgages, bear interest at fixed rates
for specified periods, generally three to seven years after which the rates
are periodically reset to market. The Federal Home Loan Mortgage Pools and
the underlying mortgages generally bear interest at fixed rates through
maturities of fifteen to thirty years.
The Company's trading strategies are subject to the risk of unanticipated
changes in the relative prices of long and short positions in trading
securities, but are designed to be relatively unaffected by changes in the
overall level of interest rates.
Note 7 COMMERCIAL MORTGAGE LOANS
A summary of activity for commercial mortgage loans at June 30, 2001 is as
follows:
Balance at January 1, 2001 $153,187
Principal payments received during the period (1,867)
Proceeds from repayment of mortgage loans (65,600)
Funding of mortgage loan 13,170
--------------
Balance at June 30, 2001 $98,890
==============
On June 25, 2001, the Company funded a $13,170 mezzanine loan secured by a
first mortgage on a commercial office condominium located in New York City.
The loan is subordinate to a $38,500 A rated note and a $6,080 BBB- rated
note, which BBB- note is also owned by the Company. The entire principal
balance of the Company's investment is pledged to secure borrowings.
Current payments are interest only based upon LIBOR plus a spread. The loan
matures in January 2004, and may be extended by the borrower for two
additional twelve-month periods. As of June 30, 2001, the interest rate was
7.98% and the borrower has made all payments when due.
Note 8 COMMON STOCK
On February 14, 2001 the Company completed a secondary offering of
4,000,000 shares of its common stock in an underwritten public offering.
The aggregate net proceeds to the Company (after deducting underwriting
fees and expenses) were approximately $33,200. The Company had granted the
underwriters an option, exercisable for 30 days, to purchase up to 600,000
additional shares of common stock to cover over-allotments. This option was
exercised on March 13, 2001 and resulted in net proceeds to the Company of
approximately $5,000.
On May 11, 2001, the Company completed another secondary offering of
4,000,000 shares of its common stock in an underwritten public offering.
The aggregate net proceeds to the Company (after deducting underwriting
fees and expenses) were approximately $37,800. The Company had granted the
underwriters an option, exercisable for 30 days, to purchase up to 600,000
additional shares of common stock to cover over-allotments. This option was
exercised on June 6, 2001 and resulted in net proceeds to the Company of
approximately $5,675.
On June 22, 2001, the Company declared distributions to its common
shareholders of $0.32 per share, payable on July 31, 2001 to stockholders
of record on June 29, 2001. For U.S. Federal income tax purposes, the
dividends are expected to be ordinary income to the Company's shareholders.
During the second quarter of 2001, the Company issued 718,000 shares of
common stock under its Dividend Reinvestment Plan. Net proceeds to the
Company were approximately $7,065. No shares were issued in the second
quarter of 2000 under the Dividend Reinvestment Plan.
Note 9 TRANSACTIONS WITH AFFILIATES
The Company has a management agreement (the "Management Agreement") with
BlackRock Financial Management, Inc. (the "Manager"), a majority owned
indirect subsidiary of PNC Financial Services Group, Inc. ("PNC Bank") and
the employer of certain directors and officers of the Company, under which
the Manager manages the Company's day-to-day operations, subject to the
direction and oversight of the Company's Board of Directors. The Management
Agreement expires on March 20, 2002. The Company pays the Manager an annual
base management fee equal to a percentage of the average invested assets of
the Company as defined in the Management Agreement. The base management fee
is equal to 1% per annum of the average invested assets rated less than BB-
or not rated, 0.75% of average invested assets rated BB- to BB+, and 0.35%
of average invested assets rated above BB+.
The Company incurred $2,109 and $3,980 in base management fees in
accordance with the terms of the Management Agreement for the three and six
months ended June 30, 2001 and $1,614 and $2,904 in base management fees
for the three and six months ended June 30, 2000. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements
to the Manager of $68 and $156 for certain expenses incurred on behalf of
the Company during the three and six months ended June 30, 2001. No
reimbursement of expenses were incurred during the six months ended June
30, 2000.
The Company will also pay the Manager, as incentive compensation, an amount
equal to 25% of the funds from operations of the Company (as defined) plus
gains (minus losses) from debt restructuring and sales of property, before
incentive compensation, in excess of the amount that would produce an
annualized return on equity equal to 3.5% over the ten-year U.S. Treasury
Rate as defined in the Management Agreement. For purposes of the incentive
compensation calculation, equity is generally defined as proceeds from
issuance of Common Stock before underwriting discounts and commissions and
other costs of issuance. The Company incurred $559 and $1,137 in incentive
compensation for the three and six months ended June 30, 2001 and $86 for
the three and six months ended June 30, 2000.
Under the terms of an administration agreement, the Manager provides
financial reporting, audit coordination and accounting oversight services.
The Company pays the Manager a monthly administrative fee at an annual rate
of 0.06% of the first $125 million of average net assets, 0.04% of the next
$125 million of average net assets and 0.03% of average net assets in
excess of $250 million subject to a minimum annual fee of $120. For the
three and six months ended June 30, 2001, the administration fee was $35
and $66. For the three and six months ended June 30, 2000 the
administration fee was $30 and $60.
On March 30, 2001, the Company purchased two certificates representing a 1%
interest in PNC Loan Trust - III for an aggregate investment of $1,732.
These certificates were purchased from PNC Bank, an affiliate of the
Company. The assets of the Trusts consist of commercial mortgage loans
originated or acquired by PNC. The Company has a committed line of credit
for $4,500 from PNC Funding Corp., a wholly owned indirect subsidiary of
PNC Bank, to borrow up to 90% of the fair market value of the Company's
interest in such Trusts. Outstanding borrowings against this line of credit
bear interest at a LIBOR based variable rate. As of June 30, 2001, there
were no outstanding borrowings against this line of credit.
During the three months ended March 30, 2001, the Company purchased twelve
certificates each representing a 1% interest in different classes of Owner
Trust NS I Trust ("Owner Trusts") for an aggregate investment of $37,868.
These certificates were purchased from PNC Bank. The assets of the Owner
Trusts consist of commercial mortgage loans originated or acquired by an
affiliate of PNC. The Company entered into a $50,000 committed line of
credit from PNC Funding Corp. to borrow up to 95% of the fair market value
of the Company's interest in the Owner Trusts. Outstanding borrowings
against this line of credit bear interest at a LIBOR based variable rate.
As of June 30, 2001, there was $27,310 borrowed under this line of credit.
The Company earned $592 and $717 from the Owner Trusts and paid interest of
approximately $432 and $531 to PNC Funding Corp. as interest on borrowings
under a related line of credit for the three and six months ended June 30,
2001. During the three months ended June 30, 2001, the Company sold four
Owner Trusts. The gain on the sale of those Owner Trusts was $45.
Note 10 BORROWINGS
Certain information with respect to the Company's collateralized borrowings
at June 30, 2001 is summarized as follows:
Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loans Agreements Borrowings
--------------------- ----------------------- ----------------------
Outstanding borrowings $ 119,729 $1,232,608 $1,352,337
Weighted average borrowing rate 5.01% 3.97% 4.49%
Weighted average remaining maturity 274 days 19 days 42 days
Estimated fair value of assets pledged $156,958 $1,325,239 $1,482,197
As of June 30, 2001, $24,803 of borrowings outstanding under the lines of
credit were denominated in pounds sterling and interest payable is based on
sterling LIBOR.
As of June 30, 2001, the Company's collateralized borrowings had the
following remaining maturities:
Lines of Reverse Total
Credit and Repurchase Collateralized
Term Loan Agreements Borrowings
---------------------- ----------------------- ------------------------
Within 30 days - $1,232,608 $1,232,608
31 to 59 days - - -
Over 60 days 119,729 - 119,729
------------------ ----------------------- ----------------------------
$119,729 $1,232,608 $1,352,337
================== ======================= ============================
Under the lines of credit and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
estimated market value. A reduction in the value of its pledged assets will
require the Company to provide additional collateral or fund margin calls.
From time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.
During the second quarter the Company extended its $185,000 committed
credit facility with Deutsche Bank, AG until July 18, 2002.
The Company has a facility with ABN Amro, in the amount of $200,000, which
matured on June 18, 2001. Borrowings under this facility were repaid in
April 2001 when the sale of the mortgage loan pool assets was completed.
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
General:
During the second quarter of 2001 the Company increased its quarterly
dividend rate to $0.32 per share. This contributed to the second quarter's
total return of 23% with performance during the first two quarters
exceeding 50%. The Company is focused on increasing scale with the
long-term goals of increasing earnings, increasing dividends and providing
greater financial flexibility. So far this year the Company has raised over
$85 million through accretive common stock offerings. The Company is
currently deploying its new capital in the investment grade real estate
related securities sector employing greater leverage and less credit risk
to create a higher level of operating earnings. This strategy will be
followed by a continued focus on strategic redeployment of this capital
into the high yield commercial real estate loan portfolio, and the below
investment grade CMBS creating a sustainable level of higher earnings on a
risk adjusted basis. The Company believes that this approach will allow
shareholders to benefit from rising dividends, improved stock market
valuation and more flexible financing opportunities.
The Company's business focuses on (i) originating high yield commercial
real estate loans, which includes senior interests in partnerships that own
real property and are reported as real estate or joint venture investments,
(ii) investing in below investment grade commercial mortgage backed
securities ("CMBS") where the Company has the right to control the
foreclosure/workout process on the underlying loans, and (iii) acquiring
investment grade real estate related securities.
The Company's management believes that this represents an integrated
strategy where each line of business supports the others and creates
additional value for shareholders over and above operating each line in
isolation. The commercial real estate loans provide high risk adjusted
returns for shorter periods of time, the CMBS portfolio provides
diversification and high loss adjusted returns over a weighted average life
of approximately 10 years, and the investment grade securities investments
are an actively managed portfolio that supports the liquidity needs of the
Company while earning attractive returns.
These strategies are pursued within an aggregate risk management framework
that seeks to limit the exposure of the Company's equity and earnings to
changes in interest rates and other factors beyond the Company's control.
The principal risks that the Company faces are (i) credit risk on the high
yield real estate loans and securities it underwrites, (ii) interest rate
risk on the spread between the rates (typically one month LIBOR) at which
the Company borrows and the generally longer term rates (as represented by
the U.S. Ten Year Treasury) at which the Company lends, and (iii) funding
risk in the amount and cost of debt financing employed by the Company over
time versus the level of such funding that is sustainable by the financing
markets. These risks are discussed in more detail below, under the heading,
"Quantitative and Qualitative Disclosures About Market Risk" and under
"Capital Resources and Liquidity".
The following discussion should be read in conjunction with the financial
statements and related notes. Dollar amounts are expressed in thousands,
other than per share amounts.
Market Conditions and their Effect on Company Performance:
Two of the most significant factors that affect the Company's earnings are
credit experience and the relationship of long term interest rates to short
term interest rates. The Company's interest income from credit sensitive
securities is based on a loss adjusted yield. The Company establishes loss
assumptions on the pools of loans underlying its CMBS portfolios. It then
computes a loss adjusted yield based on the assumed cash flows that are
projected after applying the loss assumptions. To the extent that actual
losses are substantially similar to the loss assumptions the loss adjusted
yield would stay constant. If actual losses are greater or lower than
expectations the loss adjusted yields would be decreased or increased
respectively.
The relationship of long term rates to short term rates is important
because the Company invests over the long term and finances for a short
term. When long term rates exceed short term rates (i.e. the yield curve is
steep) the Company will generally report higher earnings. When short term
rates are higher than long term rates (an inverted yield curve) the Company
will generally report lower earnings.
Credit Experience: The Company considers delinquency information from the
Lehman Brothers Conduit Guide for 1998 transactions to be the most relevant
measure of market conditions applicable to its below investment grade CMBS
holdings. Pursuant to these statistics as of June 30, 2001, 40
securitizations were included and 0.95% of principal balances were
delinquent, compared to 0.99% as of March 31, 2001. The broader measure of
all transactions issued since 1994 and tracked in the Conduit Guide also
provides relevant comparable information. As of June 30, 2001, 190
securitizations were being monitored among the larger universe and 0.93% of
the outstanding balances were delinquent, compared to an overall
delinquency rate of 0.94% across 180 transactions as of March 31, 2001.
Morgan Stanley Dean Witter (MSDW) also tracks CMBS loan delinquencies using
a slightly smaller universe. Their index tracks all CMBS transactions with
more than $200,000 of collateral that have been seasoned for at least one
year. This will generally adjust for the lower delinquencies that occur in
newly originated collateral. As of June 30, 2001, MSDW delinquencies on 158
securitizations were 1.21% of current balances. As of March 31, 2001, this
same index tracked 150 securitizations with delinquencies of 1.27%. Over
the life of these types of transactions, and as the economy slows,
delinquencies and losses will naturally increase.
The Company's below investment grade CMBS represent approximately $613,845
of face value collateralized by underlying pools of first lien commercial
mortgages. The CMBS owned by the Company include 1,756 loans with an
aggregate principal balance of over $9.0 billion as of June 30, 2001. The
Company is in a first loss position with respect to these loans. The
Company manages its credit risk through conservative underwriting,
diversification, active monitoring of loan performance and exercise of its
right to control the workout process as early as possible. All of these
processes are based on the extensive intranet-based analytic systems
developed by BlackRock.
The following table shows the comparison of delinquencies:
------------------------------------------------------------------------------------------------------------------------------
March 31, 2001 June 30,2001
------------------------------------------------------------------------------------------------------------------------------
Number Number
Principal of % of of % of
Loans Collateral Principal Loans Collateral
------------------------------------------------------------------------------------------------------------------------------
Past due 30 to 60 days $3,234 1 0.04% $17,002 7 0.19%
------------------------------------------------------------------------------------------------------------------------------
Past due 60 to 90 days 21,586 4 0.24% $16,891 2 0.18%
------------------------------------------------------------------------------------------------------------------------------
Past due 90 or more 27,879 6 0.31% $34,072 6 0.37%
------------------------------------------------------------------------------------------------------------------------------
Real Estate owned 10,107 2 0.11% $8,851 1 0.10%
------------------------------------------------------------------------------------------------------------------------------
Total Delinquent $62,806 13 0.69% $76,816 16 0.84%
------------------------------------------------------------------------------------------------------------------------------
Total Principal Balance $9,101,437 1,760 $9,092,199 1,756
------------------------------------------------------------------------------------------------------------------------------
Of the 16 delinquent loans as of June 30, 2001, six were delinquent due to
technical reasons, one was REO and being marketed for sale, three were in
foreclosure, and the remaining six loans were in workout negotiations.
Realizing the estimated losses on all the properties currently in
delinquency would not cause the Company to change its loss adjusted yields.
The 16 delinquent loans do not indicate any weakness in any geographic area
or property type.
The Company's delinquency experience of 0.84% remains slightly better than
the 0.95% for directly comparable collateral experience shown in the Lehman
Brothers Conduit Guide for 1998 Transactions.
During the second quarter of 2001 the Company also experienced early
payoffs of $5,008, representing 0.55% of the existing pool balance. These
loans were paid at par with no loss. The anticipated losses attributable to
these loans will be reallocated to the loans remaining in the pools.
During the second quarter one REO property was sold. The realized loss to
the trust is expected to be approximately $1,000. This is well within
expectations and will not cause a change in loss-adjusted yields on the
portfolio. Total realized losses in the underlying pools for the year 2001
is $3,455. This is in line with expectations.
Yield Curve: During the second quarter of 2001 the yield on the ten-year
U.S. Treasury Note increased by 49 basis points from 4.92% to 5.41%. The
Federal Reserve Board continued its policy of reducing short-term interest
rates. The most recent reduction in short rates came on June 27, 2001 with
a 25 basis point reduction. This marked the sixth easing move of the year -
the prior five each were reductions of 50 basis points. The Fed Funds
target has dropped to 3.75% from 6.50% at the beginning of the year. The
next meeting of the Federal Reserve Board is scheduled for August 21, 2001.
The chart below compares the rate for the ten-year U.S. Treasury securities
to the one-month LIBOR rate.
Ten Year One month
U.S Treasury Securities LIBOR Difference
----------------------- --------- ----------
June 30, 2001 5.40% 3.86% 1.53%
March 31, 2001 4.92% 5.09% 0.17%
June 30, 2000 6.02% 6.66% (0.64%)
The decrease in LIBOR from March 31, 2001 to June 30, 2001 had a positive
impact on the Company's financing costs and net income.
Approximately $83,000 of the Company's assets earn interest at rates that
are determined with reference to LIBOR. The Company also had $276,000
notional amount of interest rate swap agreements where the Company pays a
fixed rate of interest and receives a floating rate based on LIBOR. All of
the Company's borrowings bear interest at rates that are determined with
reference to LIBOR. The Company has a net inverse exposure to LIBOR, such
that decreases in LIBOR will cause earnings to increase and increases in
LIBOR will cause earnings to decrease.
Real Estate Capital Markets: The valuation of the Company's CMBS assets
depends on credit spreads, interest rates and liquidity of the real estate
capital markets. The Company also finances itself based on the value of
these assets.
Credit Spreads: CMBS exhibited slight spread widening at the double-B
rating level and very modest spread tightening at the single-B level as
shown in the chart below. Despite increased CBO activity, older, seasoned
BB-rated classes traded approximately 20 basis points wider than new issue
bonds due to lack of two ratings, frequently lacking one from Moody's.
Single-B bonds are not typically part of arbitrage CBO's but have been
included in CBO issues done by first-loss buyers as part of long-term
funding strategies. Low interest rates and steady credit spreads for
borrowers has sparked increased CMBS issuance. First half domestic issuance
of $32.6 billion represents a 56% increase over 2000's first half issuance
of $20.9 billion. During the first half of the year REIT equities had a
total return of 10.4% that exceeded the returns of both the Russell 2000
index (+6.3%) and the S&P 500 (-6.5%).
Corporate bonds continued to rebound from their underperformance in the
fourth quarter of 2000 increasing the relative attractiveness of CMBS.
BB CMBS BB Corporate Difference
June 30, 2001 564 419 145
March 31, 2001 556 448 108
Dec. 31, 2000 558 523 35
B CMBS B Corporate Difference
June 30, 2001 983 785 198
March 31, 2001 990 818 172
Dec. 31, 2000 987 978 9
Source: Lehman Brothers CMBS High Yield Index & Lehman Brothers
High Yield Index
The unrealized loss on the Company's holdings of CMBS at June 30, 2001 was
$93,012. This decline in the value of the investment portfolio represents
market valuation changes and is not due to credit experience or credit
expectations. The adjusted purchase price of the Company's CMBS portfolio
as of June 30, 2001 represents approximately 62% of its par amount. As the
portfolio matures the Company expects to recoup the unrealized loss,
provided that the credit losses experienced are not greater than the credit
losses assumed in the purchase analysis. The Company performs a detailed
review of its loss assumptions on a quarterly basis and will adjust them
when it believes that credit experience or expectations justify such an
adjustment. As of June 30, 2001 the Company concluded that real estate
credit fundamentals remain solid, and there has been no material change in
the credit quality of its portfolio.
As the portfolio matures and expected losses occur subordination levels of
the lower rated classes of a CMBS investment will be reduced. This will
cause the lower rated classes to be downgraded. This is the natural course
for this type of security and is built into the loss expectations of the
portfolio. This would negatively affect the market value and liquidity of
the portfolio, but will not affect its credit performance.
Real Estate: The slowdown in real GDP growth continues to affect property
markets across the country. Reduction in tenant demand for office space has
increased vacancy rates, particularly in markets that had experienced the
greatest absorption in 2000. Retail properties have seen sales remain
relatively stable as consumers have continued to spend. It is generally
believed that continued strength in residential housing has provided
consumers with increased asset values and a source of borrowing power.
Owners of retail properties continue to "re-cycle" space retrieved from
tenants who have closed stores to increase profitability or ceased
operations. Multifamily markets continue to benefit from increased demand
as larger numbers of 20-29 and 65+ year olds enter their prime renting
years. Supply of multifamily space is expected to lag demand nationally in
2001, although in selected markets higher supply will suppress rent growth.
Lodging markets have slowed in tandem with the slower economy. Growth in
revenue-per-available-room "revpar" has turned in a negative 3.8% in the
second quarter. Since hotels have the shortest lease terms (nightly
turnover) they exhibit the greatest sensitivity to changes in GDP growth.
Commercial Lending: The Company also owns five mezzanine whole loans and
two preferred equity interests in partnerships that own office buildings.
The Company's commercial loan portfolio generally emphasizes larger
transactions located in metropolitan markets as compared to the loans in
the CMBS portfolio. The credit performance of the Company's commercial
mortgage backed securities remains consistent with expectations. There are
no delinquencies on the Company's direct holdings of commercial mezzanine
loans.
During fiscal year 2001 two loans have paid down their principal in full
representing over $65,000 in proceeds. In March the Santa Monica Loan paid
off in full its $35,000 loan balance and in June The New York Loan Paid off
in full its $30,600 loan balance. These loans generated a realized return
to the Company of over 22.5%. The contribution of these two loans to net
income prior to their repayment was approximately $6,000 on an annualized
basis.
On June 25, 2001, the Company funded a $13,170 mezzanine loan secured by a
first mortgage on a commercial office condominium located in New York City.
The loan is subordinate to a $38,500 A rated note and a $6,080 BBB- rated
note, of which the BBB- note is also owned by the Company. The entire
principal balance of the Company's investment is pledged to secure
borrowings. Current payments are interest only based upon LIBOR plus a
spread. The loan matures in January 2004, and may be extended by the
borrower for two additional twelve-month periods. As of June 30, 2001, the
interest rate was 7.98% and the borrower has made all payments when due.
Investment Grade Real Estate Related Securities: The yields on residential
mortgage backed securities (RMBS) rose along with longer dated fixed income
securities as investors grew fearful of the inflationary potential of an
economic recovery. Declining prepayments and a steeper yield curve improved
the fundamentals for residential mortgages evidenced by tightening spreads
to both treasuries and swaps.
Investment Grade CMBS yields followed RMBS as spreads tightened on
fundamentals but absolute yields increased. The low delinquency rates of
commercial mortgages in general continued to help the performance of this
assets class.
The proceeds from the Company's two equity raises and commercial mortgage
paydowns have been redeployed into RMBS to the maximum amount permitted by
the Company's debt to capital covenants. The Company's RMBS portfolio
currently consists of approximately $1.2 billion worth of residential
mortgage backed Securities financed with over $1.1 billion of reverse
repurchase agreements.
As part of the acquisition of CORE Cap, Inc. in May 2000 the Company
inherited three securities backed by franchise loans originated by
Franchise Mortgage Acceptance Corporation ("FMAC"). The securities were the
class B, C and D securities issued by the FMACT 1998 - BA trust. The total
principal amount of all three securities was $47,609. The respective credit
ratings at the date of acquisition were AA, A and BBB. The Company
immediately sold the class D security at a gain of approximately $150. In
October 2000 the Company sold $10,000 of principal amount of the class C
security at a loss of approximately $990. The Company currently owns
$16,366 of class B principal and $10,829 of class C principal. The trust is
collateralized by loans on 365 properties to 75 borrowers. The properties
are largely franchise restaurants and gas station convenience stores.
Collateral performance has been poor. In March of 2001 the class B
securities were downgraded to BBB and the class C securities were
downgraded to BB. In July 2001 the class B was downgraded to BBB and class
C was downgraded to B.
Although the class C bond is current on all payments, the Company concluded
that due to poor collateral performance, future cash flows on the class C
bond were not likely to be received as originally provided and,
accordingly, the bond was deemed to be impaired. The Company performed an
analysis assuming 40% of the underlying collateral balance was
nonrecoverable. Given the current level of credit enhancement to the class
C securities the loss would amount to 51% of the current principal amount
over time. Under this scenario a yield of approximately 14% results in a
dollar price of 40. As a point of comparison the yield on the 10 year
Treasury on June 30, 2001 was 5.41%. During the second quarter of 2001, the
Company took a charge to income of $5,702 on the class C bond, to write
this bond down to its estimated fair value. At June 30, 2001, the fair
value of class B was marked at a dollar price of 70 and the class C was
marked at a dollar price of 40. As of August 10, 2001, both bonds were
current on all payments. The Company anticipates the class B bond will
remain current.
Recent Events:
The Company recently obtained the consent of the holders of the Series A
preferred stock to increase the Company's debt to capital ratio for a
period of one year. Under the terms of the preferred stock, the Company was
not permitted to have a debt to capital ratio of more than 4.5:1. Beginning
on August 1, 2001 the Company may maintain a debt to capital ratio of 5.0:1
until July 31, 2002. This 5.0:1 ratio is the same limit in other borrowing
facilities; so no other waivers were required. The Company will use this
increased borrowing ability to acquire additional RMBS to take advantage of
investment opportunities available in the current steep yield curve
environment. The Company will not increase its aggregate leverage ratios on
its high yielding CMBS or mezzanine loan portfolios.
At the beginning of the third quarter of 2001, the Company entered into a
$50 million commitment to acquire shares in Carbon Capital, Inc., a private
commercial real estate income opportunity fund managed by BlackRock
Financial Management, Inc., who is also the manager of the Company. This
commitment deploys a portion of the Company's excess liquidity into
mezzanine lending with better diversification and on a more cost effective
basis. By participating in Carbon, the Company seeks to reduce its maximum
exposure to any given mezzanine holding while improving the return on
invested capital. Anthracite does not pay BlackRock management or incentive
fees through Carbon and has received a reduced fee for this investment on
its own management contract with BlackRock. This transaction was reviewed
by outside council and approved by the Company's unaffiliated Directors in
June of 2001.
It is anticipated that funds will be drawn over time as opportunities are
identified. Carbon will be managed by the same management team that has
been managing the Company's commercial loan portfolio. The risk profile of
Carbon is substantially similar to the Company's commercial loan program
and the structure of Carbon is a Real Estate Investment Trust so the tax
and regulatory issues are identical.
Funds From Operations (FFO): Most industry analysts, including the Company,
consider FFO an appropriate supplementary measure of operating performance
of a REIT. In general, FFO adjusts net income for non-cash charges such as
depreciation, certain amortization expenses and gains or losses from debt
restructuring and sales of property. However, FFO does not represent cash
provided by operating activities in accordance with GAAP and should not be
considered an alternative to net income as an indication of the results of
the Company's performance or to cash flows as a measure of liquidity.
The Company computes FFO in accordance with the definition recommended by
the National Association of Real Estate Investment Trusts. The Company
believes that the exclusion from FFO of gains or losses from sales of
property was not intended to address gains or losses from sales of
securities as it applies to the Company. Accordingly, the Company includes
gains or losses from sales of securities in its calculation of FFO.
The Company's FFO for the three months ended June 30, 2001 and 2000 was
$13,102, and $9,334, respectively, and $24,875 and $16,659 for the six
months ended June 30, 2001 and 2000, respectively. FFO was the same as its
reported GAAP net income for the periods. The Company reported cash flows
(used in) provided by operating activities of $(364,872) and $15,676, cash
flows (used in) provided by investing activities of $(352,100) and of
$672,479 and cash flows provided by (used in) financing activities of
$700,767 and $(699,842) in its statement of cash flows for the six months
ended June 30, 2001 and 2000, respectively.
Results of Operations: Net income for the three and six months ended June
30, 2001 was $13,102, or $0.33 per share ($0.32 diluted), and $24,875, or
$0.69 ($0.65 diluted), respectively. Net income for the three and six
months ended June 30, 2000 was $9,334, or $0.34 per share ($0.32 diluted),
and $16,659, or $0.65 ($0.61 diluted), respectively.
The following tables sets forth information regarding the total amount of
income from certain of the Company's interest-earning assets.
For the Three Months Ended June 30,
2001 2000
Interest Interest
Income Income
--------------------- ---------------------
CMBS $14,207 $9,333
Other securities available for sale 4,997 9,853
Commercial mortgage loans 4,209 2,989
Mortgage loan pools 137 3,465
Trading securities 3,663 -
Cash and cash equivalents 875 363
--------------------- ---------------------
Total $28,088 $26,003
===================== =====================
For the Six Months Ended June 30,
2001 2000
Interest Interest
Income Income
--------------------- ---------------------
CMBS $24,514 $18,425
Other securities available for sale 11,937 15,103
Commercial mortgage loans 10,196 4,977
Mortgage loan pools 1,575 3,465
Trading securities 4,767 -
Cash and cash equivalents 1,072 655
--------------------- ---------------------
Total $54,061 $42,625
===================== =====================
In addition to the foregoing, the Company earned $317 and $684 from real
estate joint ventures during the three and the six months ended June 30,
2001, respectively.
Interest Expense: The following table sets forth information regarding the
total amount of interest expense from certain of the Company's
collateralized borrowings. Information is based on daily average balances
during the period.
For the Three Months Ended June 30,
2001 2000
Interest Interest
Expense Expense
----------------------- -------------------
Reverse repurchase agreements $9,392 $4,807
Lines of credit and term loan 2,273 10,289
----------------------- -------------------
Total $ 11,665 $15,096
======================= ===================
For the Six Months Ended June 30,
2001 2000
Interest Interest
Expense Expense
----------------------- -------------------
Reverse repurchase agreements $ 18,148 $10,609
Lines of credit and term loan 5,789 11,954
----------------------- -------------------
Total $ 23,937 $22,563
======================= ===================
Net Interest Margin and Net Interest Spread from the Portfolio: The Company
considers its portfolio to consist of its securities available for sale,
mortgage loan pools, commercial mortgage loans, and cash and cash
equivalents because these assets relate to its core strategy of acquiring
and originating high yield loans and securities backed by commercial real
estate, while at the same time maintaining a portfolio of liquid investment
grade securities to enhance the Company's liquidity.
Net interest margin from the portfolio is annualized net interest income
from the portfolio divided by the average market value of interest-earning
assets in the portfolio. Net interest income from the portfolio is total
interest income from the portfolio less interest expense relating to
collateralized borrowings. Net interest spread from the portfolio equals
the yield on average assets for the period less the average cost of funds
for the period. The yield on average assets is interest income from the
portfolio divided by average amortized cost of interest earning assets in
the portfolio. The average cost of funds is interest expense from the
portfolio divided by average outstanding collateralized borrowings.
The following chart describes the interest income, interest expense, net
interest margin, and net interest spread for the Company's portfolio.
Interest income for the three months ended June 30, 2001 does not include
earnings from real estate joint ventures of $317 and interest expense of
$41. There were no earnings from real estate joint ventures for the three
months ended June 30, 2000.
For the Three Months Ended
June 30, 2001 June 30, 2000
------------------------- ----------------------
Interest income $28,088 $26,003
Interest expense $11,624 $15,906
Net interest margin 4.95% 4.19%
Net interest spread 3.54% 2.82%
Other Expenses: Expenses other than interest expense consist primarily of
management fees and general and administrative expenses. The Company
incurred $2,109 and $3,980 in base management fees in accordance with the
terms of the Management Agreement for the three and six months ended June
30, 2001 and $1,614 and $2,904 in base management fees for the six months
ended June 30, 2000. The Company incurred $559 and $1,137 in incentive
compensation for the three and six months ended June 30, 2001 and $86 for
the three and six months ended June 30, 2000. In accordance with the
provisions of the Management Agreement, the Company recorded reimbursements
to the Manager of $68 and $156 for certain expenses incurred on behalf of
the Company during the three and six months ended June 30, 2001. No
reimbursement of expenses were incurred during the six months ended June
30, 2000. Other expenses - net of $283 and $969 for the three and six
months ended June 30, 2001, and $548 and $1,435 for the three and six
months ended June 30, 2000, were comprised of accounting agent fees,
custodial agent fees, directors' fees, fees for professional services,
insurance premiums, broken deal expenses, due diligence costs and
amortization of negative goodwill.
Other Gains (Losses): During the six months ended June 30, 2001 and 2000
the Company sold a portion of its securities available-for-sale for total
proceeds of $842,238 and $1,310,456, which resulted in a realized gain of
$5,134 and $682 for the three months ended June 30, 2001 and 2000,
respectively and $7,081 and $705 for the six months ended June 30, 2001 and
2000, respectively. The (loss) gain on securities held for trading were
$(124) for the three months ended June 30, 2001 and $568 and $324 for the
six months ended June 30, 2001 and 2000, respectively. There were no
purchases or sales of trading securities for the three months ended June
30, 2000. The foreign currency gains (losses) of $5 and $(7) for the three
months ended June 30, 2001 and 2000, and $109 and $(11) for the six months
ended June 30, 2001 and 2000 respectively, relate to the Company's net
investment in a commercial mortgage loan denominated in pounds sterling and
associated hedging.
Dividends Declared: On June 22, 2001, the Company declared distributions to
its shareholders of $.32 per share, payable on July 31, 2001 to
shareholders of record on June 29, 2001.
Tax Basis Net Income and GAAP Net Income: Net income as calculated for tax
purposes (tax basis net income) was estimated at $19,844, or $0.54 ($0.50
diluted) per share, and $35,054, or $1.02 ($0.95 diluted) per share, for
the three and six months ended June 30, 2001, compared to a net income as
calculated in accordance with GAAP of $13,102, or $0.33 ($0.32 diluted) per
share, and $24,875, or $0.69 ($0.65 diluted) per share, respectively.
Differences between tax basis net income and GAAP net income arise for
various reasons. For example, in computing income from its subordinated
CMBS for GAAP purposes, the Company takes into account estimated credit
losses on the underlying loans whereas for tax basis income purposes, only
actual credit losses are taken into account. As there were no actual credit
losses incurred in 2001, tax basis income for subordinate CMBS is higher
the GAAP income. Certain general and administrative expenses may differ due
to differing treatment of the deductibility of such expenses for tax basis
income. Also, differences could arise in the treatment of premium and
discount amortization on the Company's securities available for sale.
A reconciliation of GAAP net income to tax basis net income is as follows:
For the Three For the Six
Months Ended Months Ended
June 30, 2001 June 30, 2001
---------------------------------------------------
GAAP net income $13,102 $ 24,875
FAS 133 adjustment - 1,903
Loss (Gain) on trading securities (54) 465
Loss on Impairment of asset 5,702 5,702
Subordinate CMBS income differences 1,094 2,109
---------------------------------------------------
Tax basis net income $19,844 $35,054
===================================================
For the Three For the Six
Months Ended Months Ended
June 30, 2000 June 30, 2000
---------------------------------------------------
GAAP net income $ 9,334 $ 16,659
Subordinate CMBS income differences 658 1,651
CORE Cap merger expenses (2,300) (2,300)
-----------------------------------------------
Tax basis net income $ 7,692 $ 16,010
===================================================
Changes in Financial Condition
Securities Available for Sale: The Company's securities available for sale,
which are carried at estimated fair value, included the following at June
30, 2001 and December 31, 2000:
June 30, 2001 December 31,
Estimated 2000 Estimated
Fair Fair
Security Description Value Percentage Value Percentage
---------------------------------------------------------- ------------------ --------------- ----------------- ----------------
Commercial mortgage-backed securities:
CMBS IO's $ 79,449 7.4% $ 68,844 10.2%
Investment grade CMBS 30,003 2.8 54,905 8.1
Non-investment grade rated subordinated securities 264,219 24.5 261,489 38.5
Non-rated subordinated securities 26,178 2.4 27,197 4.0
------------------ --------------- ----------------- ----------------
399,849 37.1 412,435 60.8
------------------ --------------- ----------------- ----------------
Single-family residential mortgage-backed securities:
Fixed Rate Securities 44,592 4.1
Home Equity Loans 33,644 3.1
Hybrid Adjustable Rate Mortgages 68,677 6.4
Agency adjustable rate securities 121,437 11.3 160,928 23.7
Agency fixed rate securities 409,538 38.0 104,759 15.5
------------------ --------------- ----------------- ----------------
677,888 62.9 265,687 39.2
------------------ --------------- ----------------- ----------------
$1,077,737 100.0% $678,122 100.0%
================== =============== ================= ================
Borrowings: As of June 30, 2001, the Company's debt consisted of
line-of-credit borrowings, term loans and reverse repurchase agreements,
collateralized by a pledge of most of the Company's securities available
for sale, securities held for trading, mortgage loans held for sale and its
commercial mortgage loans. The Company's financial flexibility is affected
by its ability to renew or replace on a continuous basis its maturing
short-term borrowings. As of June 30, 2001, the Company has obtained
financing in amounts and at interest rates consistent with the Company's
short-term financing objectives.
Under the lines of credit, term loans, and the reverse repurchase
agreements, the lender retains the right to mark the underlying collateral
to market value. A reduction in the value of its pledged assets will
require the Company to provide additional collateral or fund margin calls.
From time to time, the Company expects that it will be required to provide
such additional collateral or fund margin calls.
The following table sets forth information regarding the Company's
collateralized borrowings.
For the Six Months Ended
June 30, 2001
------------------------------------------------------------------
June 30, 2001 Maximum Range of
Balance Balance Maturities
---------------------- -------------------- ----------------------
Reverse repurchase agreements $1,232,608 $1,266,970 2 to 30 days
Line of credit and term loan borrowings 119,729 $205,889 230 to 384 days
---------------------- -------------------- ----------------------
Hedging Instruments: Effective January 1, 2001, the Company adopted SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities", as
amended, which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts and for hedging activities.
As a result, on January 1, 2001 the Company reclassified certain of its
agency debt securities, with an amortized cost of $64,432 from
available-for-sale to trading. An interest rate swap agreement with a
$25,000 notional amount that had been designated as hedging these debt
securities was similarly reclassified. The unrealized gain of $895 related
to the debt securities and the unrealized loss of $2,830 related to the
interest rate swap were removed from other comprehensive income and
recorded as the cumulative transition adjustment to earnings upon adoption
of SFAS 133. The net cumulative effect of adopting SFAS 133 was ($1,903) or
($0.06) per share, and is reflected as cumulative transition adjustment on
the statement of operations.
In addition, on January 1, 2001, the Company re-designated interest rate
swap agreements with notional amounts aggregating $98,000 that had been
hedging available-for-sale debt securities as cash flow hedges of its
variable rate borrowings under reverse repurchase agreements. The fair
value of these swap agreements on January 1, 2001, an unrealized loss of
($9,853), remained in other comprehensive income at the date of adoption of
FAS 133, and therefore, did not result in a transition adjustment.
In addition, on January 1, 2001 the Company re-designated interest rate
swap agreements with notional amounts aggregating $57,744 that had been
hedging available-for-sale debt securities as trading securities. These
interest rate swap agreements were sold in January 2001; the loss of $795
is included in gain on securities held for trading.
Capital Resources and Liquidity: Liquidity is a measurement of the
Company's ability to meet potential cash requirements, including ongoing
commitments to repay borrowings, fund investments, loan acquisition and
lending activities and for other general business purposes. The primary
sources of funds for liquidity consist of collateralized borrowings,
principal and interest payments on and maturities of securities available
for sale, securities held for trading and commercial mortgage loans, and
proceeds from sales thereof.
To the extent that the Company may become unable to maintain its borrowings
at their current level due to changes in the financing markets for the
Company's assets, the Company may be required to sell assets in order to
achieve lower borrowing levels. In this event, the Company's level of net
earnings would decline. The Company's principal strategies for mitigating
this risk are to maintain portfolio leverage at levels it believes are
sustainable, to diversify the sources and types of available borrowing and
capital and to maintain at least 25% of equity in liquid assets that can be
converted into cash if required. The current liquid assets ratio is 54%.
The Company has utilized committed bank facilities, preferred stock, and
will consider resecuritization or other achievable term funding of existing
assets.
On February 14, 2001 the Company completed a secondary offering of
4,000,000 shares of its common stock in an underwritten public offering.
The aggregate net proceeds to the Company (after deducting underwriting
fees and expenses) were approximately $33,200. The Company had granted the
underwriters an option, exercisable for 30 days, to purchase up to 600,000
additional shares of common stock to cover over-allotments. This option was
exercised on March 13, 2001 and resulted in net proceeds to the Company of
approximately $5,000.
On May 11, 2001 the Company completed another secondary offering of
4,000,000 shares of its common stock in an underwritten public offering.
The aggregate net proceeds to the Company (after deducting underwriting
fees and expenses) were approximately $37,800. The Company had granted the
underwriters an option, exercisable for 30 days, to purchase up to 600,000
additional shares of common stock to cover over-allotments. This option was
exercised on June 6, 2001 and resulted in net proceeds to the Company of
approximately $5,675.
As of June 30, 2001, $154,140 of the Company's $185,000 committed credit
facility with Deutsche Bank, AG was available for future borrowings, and
$134,873 was available under the Company's $200,000 term facility with
Merrill Lynch.
The Company's operating activities (used) provided cash of $(364,872) and
$15,676 during the six months ended June 30, 2001, and 2000, respectively,
primarily through net income and, in 2001, net purchases of trading
securities.
The Company's investing activities (used) provided cash totaling $(352,100)
and $672,479 during the six months ended June 30, 2001, and 2000,
respectively, primarily to purchase securities available-for-sale and to
fund commercial mortgage loans, offset by principal payments received on
securities available-for-sale, mortgage loans, and proceeds from sales of
securities available-for-sale.
The Company's financing activities provided (used) cash of $700,767 and
$(699,842) during the six months ended June 30, 2001 and 2000,
respectively, primarily from repayment of short-term borrowings and payment
of distributions, offset in 2001, by proceeds from the issuance of common
stock and short term borrowings.
Although the Company's portfolio of securities available-for-sale was
acquired at a net discount to the face amount of such securities, the
Company has received to date and expects to continue to receive sufficient
cash flows from these securities to fund distributions to the Company's
stockholders.
The Company is subject to various covenants in its lines of credit,
including maintaining a minimum GAAP net worth of $140,000, a
debt-to-equity ratio not to exceed 4.5 to 1, a minimum cash requirement
based upon certain debt to equity ratios, a minimum debt service coverage
ratio of 1.5, and a minimum liquidity reserve of $10,000. Additionally, the
Company's GAAP net worth cannot decline by more than 37% during the course
of any two consecutive fiscal quarters. As of June 30, 2001, the Company
was in compliance with all such covenants.
The Company's ability to execute its business strategy depends to a
significant degree on its ability to obtain additional capital. Factors
which could affect the Company's access to the capital markets, or the
costs of such capital, include changes in interest rates, general economic
conditions and perception in the capital markets of the Company's business,
covenants under the Company's current and future credit facilities, results
of operations, leverage, financial conditions and business prospects. There
can be no assurance that the Company will be able to effectively fund
future growth. Except as discussed herein, management is not aware of any
other trends, events, commitments or uncertainties that may have a
significant effect on liquidity.
REIT Status: The Company has elected to be taxed as a REIT and to comply
with the provisions of the Code, with respect thereto. Accordingly, the
Company generally will not be subject to Federal income tax to the extent
of its distributions to stockholders and as long as certain asset, income
and stock ownership tests are met. The Company may, however, be subject to
tax at corporate rates or at excise tax rates on net income or capital
gains not distributed.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk: Market risk is the exposure to loss resulting from changes in
interest rates, credit curve spreads, foreign currency exchange rates,
commodity prices and equity prices. The primary market risks to which the
Company is exposed are interest rate risk and credit curve risk. Interest
rate risk is highly sensitive to many factors, including governmental,
monetary and tax policies, domestic and international economic and
political considerations and other factors beyond the control of the
Company.
Credit risk is highly sensitive to dynamics of the markets for commercial
mortgage securities and other loans and securities held by the Company.
Credit risk is valued based on a spread over comparable maturity Treasury
obligations. This spread represents the additional compensation required by
investors to assume the credit risk of a debt obligation. Excessive supply
of these assets combined with reduced demand will cause the market to
require a higher yield. This demand for higher yield will cause the market
to use a higher spread over the U.S. Treasury securities yield curve, or
other benchmark interest rates, to value these assets. Changes in the
general level of the U.S. Treasury yield curve can have significant effects
on the market value of the Company's portfolio.
The Company may utilize a variety of financial instruments, including
interest rate swaps, caps, floors and other interest rate exchange
contracts, in order to limit the effects of fluctuations in interest rates
on its operations. The use of these types of derivatives to hedge
interest-earning assets and/or interest-bearing liabilities carries certain
risks, including the risk that losses on a hedge position will reduce the
funds available for payments to holders of securities and, indeed, that
such losses may exceed the amount invested in such instruments. A hedge may
not perform its intended purpose of offsetting losses or increased costs.
Moreover, with respect to certain of the instruments used as hedges, the
Company is exposed to the risk that the counter parties with which the
Company trades may cease making markets and quoting prices in such
instruments, which may render the Company unable to enter into an
offsetting transaction with respect to an open position. If the Company
anticipates that the income from any such hedging transaction will not be
qualifying income for REIT income test purposes, the Company may conduct
part or all of its hedging activities through a to-be-formed corporate
subsidiary that is fully subject to federal corporate income taxation. The
profitability of the Company may be adversely affected during any period as
a result of changing interest rates.
The following tables quantify the potential changes in the Company's
Portfolio Net Market Value and net interest income under various interest
rate and credit-spread scenarios. Portfolio Net Market Value is defined as
the value of interest-earning assets net of the value of interest-bearing
liabilities. It is evaluated using an assumption that interest rates, as
defined by the U.S. Treasury yield curve, or credit spreads, as defined by
the U.S. Interest rate swap curve, increase or decrease up to 200 basis
points and the assumption that the yield curves of the rate shocks will be
parallel to each other. Portfolio Net Market Value in the Credit Spread
Movements scenario is calculated using the assumption that the U.S.
Treasury yield curve remains constant. The Company feels that 200 basis
point variations encompasses periods of significant volatility in these
markets.
Net interest income is defined as interest income earned from
interest-earning assets net of the interest expense incurred by the
interest bearing liabilities. It is evaluated using the assumptions that
interest rates, as defined by the U.S. LIBOR curve, increase or decrease by
200 basis points and the assumption that the yield curves of the LIBOR rate
shocks will be parallel to each other.
All changes in income and value are measured as percentage changes from the
respective values calculated in the scenario labeled as "Base Case." The
base interest rate scenario assumes interest rates as of June 30, 2001.
Actual results could differ significantly from these estimates.
Projected Percentage Change In Portfolio Net Market Value
Given U.S. Treasury Yield Curve Movements
Change in Projected Change in
Treasury Yield Curve, Portfolio
+/- Basis Points Net Market Value
------------------------------- ------------------------
-200 8.3%
-100 4.9%
-50 2.7%
Base Case 0
+50 (3.0)%
+100 (6.5)%
+200 (14.5)%
Projected Percentage Change In Portfolio Net Market Value
Given Credit Spread Movements
Change in Projected Change in
Credit Spreads, Portfolio
+/- Basis Points Net Market Value
------------------------------- --------------------------
-200 44.6%
-100 21.8%
-50 10.8%
Base Case 0
+50 (10.5)%
+100 (20.8)%
+200 (40.6)%
Projected Percentage Change In Portfolio Net Interest Income and
Change in Net Income per Share Given LIBOR Movements
Projected Change in Projected Change in Net
Change in LIBOR, Portfolio Income per Share
+/- Basis Points Net Interest Income
--------------------------- ------------------------- ------------------------
-100 14.0% $0.29
-50 7.0% $0.15
Base Case 0 0
+50 (7.0)% $(0.15)
+100 (14.0)% $(0.29)
Credit Risk: Credit risk is the exposure to loss from loan defaults.
Default rates are subject to a wide variety of factors, including, but not
limited to, property performance, property management, supply/demand
factors, construction trends, consumer behavior, regional economics,
interest rates, the strength of the American economy, and other factors
beyond the control of the Company.
All loans are subject to a certain probability of default. The nature of
the CMBS assets owned are such that all losses experienced by a pool of
mortgages will be borne by the Company. Changes in the expected default
rates of the underlying mortgages will significantly affect the value of
the Company, the income it accrues and the cash flow it receives. An
increase in default rates will reduce the book value of the Company's
assets and the Company earnings and cash flow available to fund operations
and pay dividends. This change in value can be independent of changes in
spreads, as actual credit experience and pricing of credit are not
necessarily correlated.
The Company manages credit risk through the underwriting process,
establishing loss assumptions, and careful monitoring of loan performance.
Before acquiring a security that represents a pool of loans, the Company
will perform a rigorous analysis of the quality of substantially all of the
loans proposed for that security. As a result of this analysis, loans with
unacceptable risk profiles will be removed from the proposed security.
Information from this review is then used to establish loss assumptions.
The Company will assume that a certain portion of the loans will default
and calculate an expected, or loss adjusted yield based on that assumption.
After the securities have been acquired the Company monitors the
performance of the loans, as well as external factors that may affect their
value. Factors that indicate a higher loss severity or timing experience is
likely to cause a reduction in the expected yield and therefore reduce the
earnings of the Company, and may require a significant write down of
assets.
For purposes of illustration, a doubling of the losses in the Company's
credit sensitive portfolio, without a significant acceleration of those
losses would reduce the expected yield on adjusted purchase price from
9.78% to 8.35%. This would reduce GAAP income going forward by
approximately $0.15 per common share and cause a significant write down in
assets at the time the loss assumption is changed. The amount of the
write-down depends on several factors but it could be in excess of $100 per
share.
Asset and Liability Management: Asset and liability management is concerned
with the timing and magnitude of the repricing and/or maturing of assets
and liabilities. It is the objective of the Company to attempt to control
risks associated with interest rate movements. In general, management's
strategy is to match the term of the Company's liabilities as closely as
possible with the expected holding period of the Company's assets. This is
less important for those assets in the Company's portfolio considered
liquid as there is a very stable market for the financing of these
securities.
The Company uses interest rate duration as its primary measure of interest
rate risk. This metric, expressed when considering any existing leverage,
allows the Company's management to approximate changes in the net market
value of the Company's portfolio given potential changes in the U.S.
Treasury yield curve. Interest rate duration considers both assets and
liabilities. As of June 30, 2001 the Company's duration on equity was
approximately 5.69 years. This implies that a parallel shift of the U.S.
Treasury yield curve of 100 basis points would cause the Company's net
asset value to increase or decrease by approximately 5.69%. Because the
Company's assets, and their markets, have other, more complex sensitivities
to interest rates, the Company's management believes that this metric
represents a good approximation of the change in portfolio net market value
in response to changes in interest rates, though actual performance may
vary due to changes in prepayments, credit spreads and increased market
volatility.
Other methods for evaluating interest rate risk, such as interest rate
sensitivity "gap" (defined as the difference between interest-earning
assets and interest-bearing liabilities maturing or repricing within a
given time period), are used but are considered of lesser significance in
the daily management of the Company's portfolio. The majority of the
Company's assets pay a fixed coupon and the income from such assets are
relatively unaffected by interest rate changes. The majority of the
Company's liabilities are borrowings under its line of credit or reverse
repurchase agreements that bear interest at variable rates that reset
monthly. Given this relationship between assets and liabilities, the
Company's interest rate sensitivity gap is highly negative. This implies
that a period of falling short-term interest rates will tend to increase
the Company's net interest income while a period of rising short-term
interest rates will tend to reduce the Company's net interest income.
Management considers this relationship when reviewing the Company's hedging
strategies. Because different types of assets and liabilities with the same
or similar maturities react differently to changes in overall market rates
or conditions, changes in interest rates may affect the Company's net
interest income positively or negatively even if the Company were to be
perfectly matched in each maturity category.
The Company currently has positions in forward currency exchange contracts
to hedge currency exposure in connection with its commercial mortgage loan
denominated in pounds sterling. The purpose of the Company's foreign
currency-hedging activities is to protect the Company from the risk that
the eventual U.S. dollar net cash inflows from the commercial mortgage loan
will be adversely affected by changes in exchange rates. The Company's
current strategy is to roll these contracts from time to time to hedge the
expected cash flows from the loan. Fluctuations in foreign exchange rates
are not expected to have a material impact on the Company's net portfolio
value or net interest income.
Forward-Looking Statements: Certain statements contained herein are not,
and certain statements contained in future filings by the Company with the
SEC in the Company's press releases or in the Company's 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 the Company's control) may
be identified by reference to a future period or periods, or by the use of
forward-looking terminology, such as "may," "will," "believe," "expect,"
"anticipate," "continue," or similar terms or variations on those terms, or
the negative of those terms. Actual results could differ materially from
those set forth in forward-looking statements due to a variety of factors,
including, but not limited to, those related to the economic environment,
particularly in the market areas in which the Company operates, competitive
products and pricing, fiscal and monetary policies of the U.S. Government,
changes in prevailing interest rates, acquisitions and the integration of
acquired businesses, credit risk management, asset/liability management,
the financial and securities markets and the availability of and costs
associated with sources of liquidity. Additional information regarding
these and other important factors that could cause actual results to differ
from those in the Company's forward looking statements are contained under
the section entitled "Risk Factors" in the Company's Registration Statement
on Form S-3 (File No. 333-64900), as filed with the SEC on July 20, 2001,
and in the Company's Registration Statement on Form S-4 (File
No.333-33596), as filed with the SEC on March 30, 2000, as amended by
Amendment No.1 to the Company's Registration Statement on Form S-4, as
filed with the SEC on April 11, 2000, and the Company's prospectus
supplement, dated May 7, 2001, to the prospectus dated February 13, 2001,
as filed with the SEC on May 8, 2001 (File No. 333-75473). The Company
hereby incorporates by reference those risk factors in this Form 10-Q. The
Company does not undertake, and specifically disclaims any obligation, to
publicly release the result of any revisions which may be made to any
forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 2001 there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Rider X
On May 21, 2001, the Company held its annual meeting of shareholders.
The shareholders voted, in person or by proxy, for (i) the election of
three nominees to serve on the Board of Directors for a term of three
years or until their respective successors are duly elected and qualify
and (ii) the ratification of the appointment of Deloitte & Touche LLP as
the independent auditors of the Company for the fiscal year ending
December 31, 2001. The results of the voting are shown below:
Director Votes Cast For Withheld
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Donald G. Drapkin 26,334,446 46,439
Carl F. Geuther 26,342,446 38,439
Leon T. Kendall 26,337,210 43,675
Independent Auditor Votes Cast For Votes Cast Against and Withheld
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Deloitte & Touche 26,238,859 142,026
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 27.1 - Financial Data Schedule (filed herewith)
(b) Reports on Form 8-K
(c) None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ANTHRACITE CAPITAL, INC.
Dated: August 14, 2001 By: /s/ Hugh R. Frater
---------------------------------
Name: Hugh R. Frater
Title: President and Chief Executive Officer
(authorized officer of registrant)
Dated: August 14, 2001 By: /s/ Richard M. Shea
------------------------------
Name: Richard M. Shea
Title: Chief Operating Officer and Chief
Financial Officer (principal accounting
officer)