LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Luminent Mortgage Capital, Inc., or the Company, was organized as a Maryland corporation on
April 25, 2003. The Company commenced its operations on June 11, 2003, upon completion of a private
placement offering. On December 18, 2003, the Company completed the initial public offering of its
shares of common stock and began trading on the New York Stock Exchange, or NYSE, under the trading
symbol LUM on December 19, 2003. On March 29, 2004 and October 12, 2006, the Company completed
follow-on public offerings of its common stock.
The Company is a Real Estate Investment Trust, or REIT, which, together with its subsidiaries,
invests in two core mortgage investment strategies. Under its Residential Mortgage Credit strategy,
the Company invests in mortgage loans originated in partnership with selected high-quality
providers within certain established criteria as well as subordinated mortgage-backed securities
that have credit ratings below AAA. Under its Spread strategy, the Company invests primarily in
U.S. agency and other highly-rated single-family, adjustable-rate and hybrid adjustable-rate
mortgage-backed securities.
The Company manages its Residential Mortgage Credit strategy, which is comprised of a mortgage
loan and securitization portfolio and a credit sensitive bond portfolio and its Spread strategy.
Prior to September 26, 2006, one of the portfolios within the Company’s Spread strategy was managed
by an external manager, pursuant to a management agreement.
The information furnished in these unaudited condensed consolidated interim financial
statements reflects all adjustments that are, in the opinion of management, necessary for a fair
statement of the results for the periods presented. These adjustments are of a normal recurring
nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim
statements do not necessarily indicate the results that may be expected for the full year. The
interim financial information should be read in conjunction with the Company’s 2005 Annual Report
on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 9, 2006 (file
number 001-31828).
Descriptions of the significant accounting policies of the Company are included in Note 2 to
the financial statements in the Company’s 2005 Annual Report on Form 10-K. There have been no
significant changes to these policies during 2006. See description of newly adopted and newly
applicable accounting policies below.
Derivative Financial Instruments
Prior to January 1, 2006, the Company entered into certain derivative contracts which were
accounted for under hedge accounting as prescribed by Statement of Financial Accounting Standards,
or SFAS, No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and
interpreted. Effective January 1, 2006, the Company discontinued the use of hedge accounting. All
changes in value of derivative instruments that had previously been accounted for under hedge
accounting are now recognized in other income or expense.
Real Estate Owned
Real estate owned is included in other assets at the lower of its carrying value or fair value
of the property less costs to sell including legal fees, real estate agency fees, property
maintenance costs etc. Differences between the carrying value of the loan prior to foreclosure and
the fair value at the time of foreclosure will be recorded as a charge against the allowance for
loan losses. Any subsequent loss adjustments for decreases in the fair value of the REO property
less cost to sell will be recorded directly to profit and loss in the period incurred. Gains will
be recognized for any subsequent increase in fair value less cost to sell, but not in excess of the
cumulative loss
previously recognized. A gain or loss not previously recognized that results from the sale of
an REO property is recognized at the date of the sale.
6
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Premiums and Discounts on Mortgage-Backed Notes Issued
Premiums and discounts on mortgage-backed notes issued result from proceeds upon issuance to
third parties in excess of or below the par value of the debt issued. Mortgage-backed notes are
carried at their unpaid principal balances, net of any unamortized premium or discount, on the
condensed consolidated balance sheet. Premiums and discounts are amortized into income using an
effective yield methodology and are recorded in interest expense on the condensed consolidated
statement of operations.
Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as
amended, or Code. As such, the Company routinely distributes substantially all of the income
generated from operations to its stockholders. As long as the Company retains its REIT status, it
generally will not be subject to U.S. federal or state corporate taxes on its income to the extent
that it distributes its REIT taxable net income to its stockholders.
The Company has a taxable REIT subsidiary that receives management fees in exchange for
various advisory services provided in conjunction with the Company’s investment strategies. The
taxable REIT subsidiary is subject to corporate income taxes on its taxable income at a combined
federal and state tax rate of 41%. The same taxable REIT subsidiary is subject to the Pennsylvania
Capital Stock and Franchise Tax as well as a Philadelphia Gross Receipts Tax and Philadelphia Net
Income Tax. The Company also has a taxable REIT subsidiary that purchases mortgage loans and
creates securitization entities as a means of securing long-term collateralized financing. This
taxable REIT subsidiary is subject to corporate income taxes on its taxable income at a combined
federal and state tax rate of 41%.
For the three and nine months ended September 30, 2006, the current provision for corporate
net income tax was $0.4 million and $1.1 million, respectively. There were no provisions for income
taxes during the three and nine months ended September 30, 2005.
Recent Accounting Pronouncements
The FASB has placed an item on its SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities project agenda relating to the treatment of
transactions where mortgage-backed securities purchased from a particular counterparty are financed
via a repurchase agreement with the same counterparty. Currently, the Company records such assets
and the related financing gross on its consolidated balance sheet, and the corresponding interest
income and interest expense gross on its consolidated statement of operations. Any change in fair
value of the security is reported through other comprehensive income under SFAS No. 115, Accounting
for Certain Investments in Debt and Equity Securities, because the security is classified as
available-for-sale.
However, in a transaction where the mortgage-backed securities are acquired from and financed
under a repurchase agreement with the same counterparty, the acquisition may not qualify as a sale
from the seller’s perspective under the provisions of SFAS No. 140. In such cases, the seller may
be required to continue to consolidate the assets sold to the Company, based on the seller’s
continuing involvement with such investments. Depending on the ultimate outcome of the FASB
deliberations, the Company may be precluded from presenting the assets gross on its balance sheet
and may instead be required to treat its net investment in such assets as a derivative.
If it is determined that these transactions should be treated as investments in derivatives,
the derivative instruments entered into by the Company in prior years to hedge the Company’s
interest rate exposure with respect to the borrowings under the associated repurchase agreements
may no longer qualify for hedge accounting, and would then, as with the underlying asset
transactions, also be marked to market through the income statement.
7
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
This potential change in accounting treatment does not affect the economics of the
transactions, but does affect how the transactions would be reported in the Company’s consolidated
financial statements. The Company’s cash flows, liquidity and ability to pay dividends would be
unchanged, and the Company does not believe its REIT taxable income or REIT status would be
affected. The Company’s net equity would not be materially affected. At September 30, 2006 and
December 31, 2005, the Company has identified available-for-sale securities with a fair value of
$26.0 million and $19.9 million, respectively, which had been purchased from and financed with the
same counterparty since their purchase. If the Company were to change the current accounting
treatment for these transactions at September 30, 2006 and December 31, 2005, total assets and
total liabilities would each be reduced by approximately $26.0 million and $19.9 million,
respectively.
In June 2006, FASB issued Interpretation, or FIN, No. 48, Accounting for Uncertainty in Income
Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes.
FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. This
interpretation also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company does not expect the adoption of this interpretation
to have a material impact on its financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which is effective
for fiscal years beginning January 1, 2008. This Statement defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value measurements. SFAS No.
157 does not require any new fair value measurements. The adoption of SFAS No. 157 is not expected to have a material impact on the
Company’s financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin, or SAB, No. 108, Financial
Statements — Considering the Effect of Prior Year Misstatements, which is effective for the year
ended December 31, 2006. SAB No. 108 requires a dual approach when quantifying and evaluating the
materiality of a misstatement. Evaluation of an error must be performed from both a financial
position perspective and results of operations perspective. The adoption of SAB No. 108 is not
expected to have a material impact on the Company’s financial statements.
NOTE 2—MORTGAGE-BACKED SECURITIES
The following table summarizes the Company’s mortgage-backed securities classified as
available-for-sale at September 30, 2006 and December 31, 2005, which are carried at fair value (in
thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Amortized cost |
|
$ |
2,125,528 |
|
|
$ |
4,363,923 |
|
Unrealized gains |
|
|
6,053 |
|
|
|
8,357 |
|
Unrealized losses |
|
|
(13,041 |
) |
|
|
(12,677 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
2,118,540 |
|
|
$ |
4,359,603 |
|
|
|
|
|
|
|
|
At September 30, 2006 and December 31, 2005, mortgage-backed securities had a
weighted-average amortized cost, excluding residual interests, of 98.8% and 98.3% of face amount,
respectively.
Actual maturities of mortgage-backed securities are generally shorter than stated contractual
maturities. Actual maturities of the Company’s mortgage-backed securities are affected by the
contractual lives of the underlying mortgages, periodic payments of principal and prepayments of
principal.
8
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
The following table summarizes the Company’s mortgage-backed securities at September 30, 2006,
according to their estimated weighted-average life classifications (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Weighted- |
|
| |
|
|
|
|
|
|
|
|
|
Average |
|
| Weighted-Average Life |
|
Fair Value |
|
|
Amortized Cost |
|
|
Coupon |
|
Less than one year |
|
$ |
552,670 |
|
|
$ |
560,680 |
|
|
|
6.48 |
% |
Greater than one year and less than five years |
|
|
1,506,320 |
|
|
|
1,505,354 |
|
|
|
5.62 |
|
Greater than five years |
|
|
59,550 |
|
|
|
59,494 |
|
|
|
5.58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
2,118,540 |
|
|
$ |
2,125,528 |
|
|
|
5.85 |
% |
|
|
|
|
|
|
|
|
|
|
|
The following table summarizes the Company’s mortgage-backed securities at December 31,
2005, according to their estimated weighted-average life classifications (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Weighted- |
|
| |
|
|
|
|
|
|
|
|
|
Average |
|
| Weighted-Average Life |
|
Fair Value |
|
|
Amortized Cost |
|
|
Coupon |
|
Less than one year |
|
$ |
690,568 |
|
|
$ |
690,539 |
|
|
|
4.51 |
% |
Greater than one year and less than five years |
|
|
3,489,302 |
|
|
|
3,489,179 |
|
|
|
4.35 |
|
Greater than five years |
|
|
179,733 |
|
|
|
184,205 |
|
|
|
6.15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
4,359,603 |
|
|
$ |
4,363,923 |
|
|
|
4.46 |
% |
|
|
|
|
|
|
|
|
|
|
|
The weighted-average lives of the mortgage-backed securities at September 30, 2006 and
December 31, 2005 in the tables above are based upon data provided through subscription-based
financial information services, assuming constant prepayment rates to the balloon or reset date for
each security. The prepayment model considers current yield, forward yield, and steepness of the
yield curve, current mortgage rates, and mortgage rates of the outstanding loans, loan age, margin
and volatility.
The actual weighted-average lives of the mortgage-backed securities could be longer or shorter
than the estimates in the table above depending on the actual prepayment rates experienced over the
lives of the applicable securities and are sensitive to changes in both prepayment rates and
interest rates.
During the three months ended September 30, 2006, the Company sold mortgage-backed securities
totaling $131.0 million and realized gains of $0.3 million and losses of $0.1 million. During the
nine months ended September 30, 2006, the Company sold mortgage-backed securities totaling $3.8
billion and realized gains of $10.0 million and losses of $9.0 million. During the three and nine
months ended September 30, 2005, the Company sold mortgage-backed securities totaling $136.3
million and realized gains of $60 thousand and losses of $129 thousand.
9
LUMINENT MORTGAGE CAPITAL, INC.
NOTES
TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
The following table shows the Company’s mortgage-backed securities’ fair value and gross
unrealized losses, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position at September 30, 2006 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Less than 12 Months |
|
|
12 Months or More |
|
|
Total |
|
| |
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
| |
|
Fir |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
| |
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
Agency-backed
mortgage-backed securities |
|
$ |
48,945 |
|
|
$ |
(171 |
) |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
48,945 |
|
|
$ |
(171 |
) |
Non-agency-backed
mortgage-backed securities |
|
|
500,760 |
|
|
|
(6,225 |
) |
|
|
6,482 |
|
|
|
(6,645 |
) |
|
|
507,242 |
|
|
|
(12,870 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired
mortgage-backed securities |
|
$ |
549,705 |
|
|
$ |
(6,396 |
) |
|
$ |
6,482 |
|
|
$ |
(6,645 |
) |
|
$ |
556,187 |
|
|
$ |
(13,041 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table shows the Company’s mortgage-backed securities’ fair value and gross
unrealized losses, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position at December 31, 2005 (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Less than 12 Months |
|
|
12 Months or More |
|
|
Total |
|
| |
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Gross |
|
| |
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
| |
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
Agency-backed
mortgage-backed securities |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
Non-agency-backed
mortgage-backed securities |
|
|
172,646 |
|
|
|
(12,677 |
) |
|
|
— |
|
|
|
— |
|
|
|
172,646 |
|
|
|
(12,677 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired
mortgage-backed securities |
|
$ |
172,646 |
|
|
$ |
(12,677 |
) |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
172,646 |
|
|
$ |
(12,677 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2006, the Company held approximately $2.1 billion of mortgage-backed
securities at fair value, comprised of approximately $1.5 billion in the Spread portfolio and $0.6
billion in the Residential Mortgage Credit portfolio, net of unrealized gains of $6.1 million and
unrealized losses of $13.0 million. At December 31, 2005, the Company held $4.4 billion of
mortgage-backed securities at fair value, comprised of $4.1 billion in the Spread portfolio and
approximately $0.3 billion in the Residential Mortgage Credit portfolio, net of unrealized gains of
$8.4 million and unrealized losses of $12.7 million.
During the nine months ended September 30, 2006, the Company recognized total impairment
losses on mortgage-backed securities of $2.2 million in the Spread portfolio due to the Company’s
decision to reposition the Spread portfolio. The Company did not intend to hold certain
mortgage-backed securities in the Spread portfolio that were in unrealized loss positions for a
period of time sufficient to allow for recovery in fair value, and therefore impairment losses were
recognized.
At September 30, 2006, the Spread portfolio contained mortgage-backed securities with
unrealized losses of $0.3 million and unrealized gains of approximately $1.3 million. The Company
has the intent and ability to hold these mortgage-backed securities for a period of time, to
maturity if necessary, sufficient to allow for the anticipated recovery in fair value. The
temporary impairment of these mortgage-backed securities results from the fair value of the
mortgage-backed securities falling below their amortized cost basis and is solely attributed to
changes in interest
rates. At September 30, 2006, none of the securities held had been downgraded by a credit
rating agency since their purchase and all of the securities were AAA-rated non-agency-backed or
agency-backed mortgage-backed
10
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
securities. As such, the Company does not believe any of these
securities are other-than-temporarily impaired at September 30, 2006.
Certain of the mortgage-backed securities in the Company’s Residential Mortgage Credit
portfolio are accounted for in accordance with Emerging Issues Task Force, or EITF, 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets. Under EITF 99-20, the Company evaluates whether there is
other-than-temporary impairment by discounting projected cash flows using credit, prepayment and
other assumptions compared to prior period projections. If the discounted projected cash flows have
decreased due to a change in the credit, prepayment and other assumptions, then the mortgage-backed
security must be written down to market value if the market value is below the amortized cost
basis. If there have been no changes to the Company’s assumptions and the change in value is
solely due to interest rate changes, an impairment of a mortgage-backed security is not recognized
in its consolidated statement of operations. It is difficult to predict the timing or magnitude of
these other-than-temporary impairments and impairment losses could be substantial.
At September 30, 2006 and December 31, 2005, the Company had unrealized losses of $12.8
million and $12.7 million in mortgage-backed securities held in the Company’s Residential Mortgage
Credit portfolio. The temporary impairment of the available-for-sale securities results from the
fair value of the mortgage-backed securities falling below their amortized cost basis and is solely
attributed to changes in interest rates. At September 30, 2006 and December 31, 2005, none of the
securities held by the Company had been downgraded by a credit rating agency since their purchase.
The Company intends and has the ability to hold the securities in the Residential Mortgage Credit
portfolio for a period of time, to maturity if necessary, sufficient to allow for the anticipated
recovery in fair value of the securities held. As such, the Company does not believe any of the
securities held at September 30, 2006 or December 31, 2005 are other-than-temporarily impaired.
NOTE 3—LOANS HELD-FOR-INVESTMENT
The following table summarizes the Company’s residential mortgage loans classified as
held-for-investment at September 30, 2006 and December 31, 2005, which are carried at amortized
cost, net of allowance for loan losses (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Principal |
|
$ |
4,116,128 |
|
|
$ |
506,498 |
|
Unamortized premium |
|
|
84,102 |
|
|
|
679 |
|
|
|
|
|
|
|
|
Amortized cost |
|
|
4,200,230 |
|
|
|
507,177 |
|
Allowance for loan losses |
|
|
(3,289 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total residential loans, net of
allowance for loan losses |
|
$ |
4,196,941 |
|
|
$ |
507,177 |
|
|
|
|
|
|
|
|
At September 30, 2006 and December 31, 2005, residential mortgage loans had a
weighted-average amortized cost of 102.0% and 100.1% of face amount, respectively.
11
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
The following table summarizes the changes in the allowance for loan losses for our
residential mortgage loan portfolio during the three and nine months ended September 30, 2006 (in
thousands):
| |
|
|
|
|
|
|
|
|
| |
|
For the Three |
|
|
For the Nine |
|
| |
|
Months Ended |
|
|
Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2006 |
|
Balance, beginning of period |
|
$ |
1,525 |
|
|
$ |
— |
|
Provision for loan losses |
|
|
1,779 |
|
|
|
3,304 |
|
Charge-offs |
|
|
(15 |
) |
|
|
(15 |
) |
|
|
|
|
|
|
|
| |
Balance, end of period |
|
$ |
3,289 |
|
|
$ |
3,289 |
|
|
|
|
|
|
|
|
An allowance for loan losses analysis was performed as of September 30, 2006 and the
Company recorded a $1.8 million and $3.3 million provision for the three months and nine months
ended September 30, 2006, respectively. The Company performed an allowance for loan losses
analysis as of December 31, 2005 and made a determination that no allowance for loan losses was
required for our residential mortgage portfolio. At September 30, 2006, $17.6 million of
residential mortgage loans were 90 days or more past due all of which were on non-accrual status.
No residential mortgage loans were 90 days or more past due at December 31, 2005 and all loans were
accruing interest.
NOTE 4—BORROWINGS
The Company leverages its portfolio of mortgage-backed securities and loans
held-for-investment through the use of repurchase agreements, securitization transactions
structured as secured financings, a commercial paper facility, warehouse lending facilities, junior
subordinated notes and a margin lending facility.
The following table presents summarized information with respect to the Company’s borrowings
at September 30, 2006 (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted- |
|
|
|
|
| |
|
Outstanding |
|
|
Average |
|
|
Fair Value of |
|
| |
|
Borrowings |
|
|
Interest Rate |
|
|
Collateral (1) |
|
Repurchase agreements |
|
$ |
2,528,935 |
|
|
|
5.42 |
% |
|
$ |
2,719,722 |
|
LUM 2005-1 |
|
|
397,117 |
|
|
|
5.61 |
|
|
|
397,721 |
|
LUM 2006-1 |
|
|
510,124 |
|
|
|
5.62 |
|
|
|
510,891 |
|
LUM 2006-2 |
|
|
716,351 |
|
|
|
5.56 |
|
|
|
716,622 |
|
LUM 2006-3 |
|
|
616,334 |
|
|
|
5.65 |
|
|
|
621,190 |
|
LUM 2006-4 |
|
|
346,236 |
|
|
|
5.54 |
|
|
|
346,236 |
|
LUM 2006-6 |
|
|
753,415 |
|
|
|
5.56 |
|
|
|
753,415 |
|
Junior subordinated notes |
|
|
92,788 |
|
|
|
8.60 |
|
|
|
none |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,961,300 |
|
|
|
5.56 |
% |
|
$ |
6,065,797 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Collateral for borrowings consist of mortgage-backed securities available-for-sale and loans
held-for-investment. |
12
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
The following table presents summarized information with respect to the Company’s
borrowings at December 31, 2005 (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted- |
|
|
|
|
| |
|
Outstanding |
|
|
Average |
|
|
Fair Value of |
|
| |
|
Borrowings |
|
|
Interest Rate |
|
|
Collateral (1) |
|
Repurchase agreements |
|
$ |
3,928,505 |
|
|
|
4.25 |
% |
|
$ |
4,157,117 |
|
LUM 2005-1 |
|
|
486,302 |
|
|
|
4.66 |
|
|
|
486,304 |
|
Junior subordinated notes |
|
|
92,788 |
|
|
|
8.18 |
|
|
|
none |
|
Margin lending facility |
|
|
3,548 |
|
|
|
3.85 |
|
|
|
3,548 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
4,511,143 |
|
|
|
4.37 |
% |
|
$ |
4,646,969 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Collateral for borrowings consist of mortgage-backed securities available-for-sale and
loans held-for-investment. |
Repurchase Agreements
The Company has entered into repurchase agreements with third-party financial institutions to
finance the purchase of mortgage-backed securities. The repurchase agreements are short-term
borrowings that bear interest rates that have historically moved in close relationship to the
three-month London Interbank Offered Rate, or LIBOR. At September 30, 2006 and December 31, 2005,
the Company had repurchase agreements with an outstanding balance of $2.5 billion and $3.9 billion,
respectively, and with weighted-average interest rates of 5.42% and 4.25%, respectively. At
September 30, 2006 and December 31, 2005, mortgage-backed securities pledged as collateral for
repurchase agreements had estimated fair values of $2.7 billion and $4.2 billion, respectively.
At September 30, 2006, repurchase agreements had the following remaining maturities (in
thousands):
| |
|
|
|
|
Overnight 1 day or less |
|
$ |
— |
|
Between 2 and 30 days |
|
|
2,093,935 |
|
Between 31 and 90 days |
|
|
— |
|
Between 91 days and 730 days |
|
|
435,000 |
|
|
|
|
|
Total |
|
$ |
2,528,935 |
|
|
|
|
|
At December 31, 2005, repurchase agreements had the following remaining maturities (in
thousands):
| |
|
|
|
|
Overnight 1 day or less |
|
$ |
— |
|
Between 2 and 30 days |
|
|
1,917,214 |
|
Between 31 and 90 days |
|
|
929,023 |
|
Between 91 and 237 days |
|
|
1,082,268 |
|
|
|
|
|
Total |
|
$ |
3,928,505 |
|
|
|
|
|
13
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
At September 30, 2006, the repurchase agreements had the following counterparties,
amounts at risk and weighted-average remaining maturities (dollars in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted-Average |
|
| |
|
|
|
|
|
Maturity of |
|
| |
|
|
|
|
|
Repurchase |
|
| |
|
Amount at |
|
|
Agreements |
|
| Repurchase Agreement Counterparties |
|
Risk(1) |
|
|
(in days) |
|
Banc of America Securities LLC |
|
$ |
663 |
|
|
|
13 |
|
Barclays Capital, Inc. |
|
|
24,872 |
|
|
|
558 |
|
Bear Stearns & Co. |
|
|
50,664 |
|
|
|
12 |
|
Cantor Fitzgerald |
|
|
4,992 |
|
|
|
25 |
|
Citigroup |
|
|
3,182 |
|
|
|
17 |
|
Countrywide |
|
|
21,782 |
|
|
|
19 |
|
Credit Suisse First Boston |
|
|
3,969 |
|
|
|
18 |
|
Deutsche Bank Securities Inc. |
|
|
1,171 |
|
|
|
25 |
|
Greenwich Capital Markets |
|
|
23,150 |
|
|
|
15 |
|
HSBC Securities Inc. |
|
|
1,634 |
|
|
|
23 |
|
Merrill Lynch Government Securities Inc./Merrill Lynch
Pierce, Fenner & Smith, Inc. |
|
|
5,121 |
|
|
|
5 |
|
UBS Paine Webber |
|
|
7,073 |
|
|
|
13 |
|
Washington Mutual |
|
|
41,314 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
Total |
|
$ |
189,587 |
|
|
|
128 |
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Equal to the sum of the fair value of the securities sold and accrued interest income
minus the sum of repurchase agreement liabilities and accrued interest expense. |
At December 31, 2005, the repurchase agreements had the following counterparties, amounts
at risk and weighted-average remaining maturities (dollars in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted-Average |
|
| |
|
|
|
|
|
Maturity of |
|
| |
|
|
|
|
|
Repurchase |
|
| |
|
Amount at |
|
|
Agreements |
|
| Repurchase Agreement Counterparties |
|
Risk(1) |
|
|
(in days) |
|
Banc of America Securities LLC |
|
$ |
6,992 |
|
|
|
153 |
|
Barclays Capital |
|
|
3,656 |
|
|
|
27 |
|
Bear Stearns & Co. |
|
|
63,412 |
|
|
|
46 |
|
Citigroup |
|
|
8,367 |
|
|
|
172 |
|
Countrywide Securities Corporation |
|
|
9,618 |
|
|
|
129 |
|
Credit Suisse First Boston |
|
|
3,293 |
|
|
|
17 |
|
Deutsche Bank Securities Inc. |
|
|
28,326 |
|
|
|
63 |
|
Goldman Sachs & Co. |
|
|
17,421 |
|
|
|
28 |
|
Greenwich Capital Markets |
|
|
7,618 |
|
|
|
15 |
|
Merrill Lynch Government Securities Inc./Merrill Lynch
Pierce, Fenner & Smith, Inc. |
|
|
24,018 |
|
|
|
78 |
|
Morgan Stanley & Co. Inc. |
|
|
5,922 |
|
|
|
21 |
|
Nomura Securities International, Inc. |
|
|
16,682 |
|
|
|
86 |
|
UBS Securities LLC |
|
|
22,331 |
|
|
|
170 |
|
Wachovia Securities, LLC |
|
|
3,950 |
|
|
|
19 |
|
Washington Mutual |
|
|
3,478 |
|
|
|
27 |
|
|
|
|
|
|
|
|
|
Total |
|
$ |
225,084 |
|
|
|
76 |
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Equal to the sum of the fair value of the securities sold and accrued interest income minus
the sum of repurchase agreement liabilities and accrued interest expense. |
14
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
Mortgage-backed Notes
At September 30, 2006 and December 31, 2005, the Company had mortgage-backed notes with an
outstanding balance of $3.3 billion and $0.5 billion, respectively, and with a weighted-average
borrowing rate of 5.59% and 4.66%, respectively, per annum. The borrowing rates of the
mortgage-backed notes reset monthly based
on LIBOR except for $0.3 billion of the notes which, like the underlying loan collateral, are
fixed for a period of three to five years then become variable based on the average rates of the
underlying loans which will adjust based on LIBOR. Unpaid interest on the mortgage-backed notes
was $3.8 million and $0.3 million at September 30, 2006 and December 31, 2005, respectively. Net
unamortized premiums on the mortgage-backed notes were $2.8 million at September 30, 2006 and there
were no net unamortized premiums at December 31, 2005. The stated maturities of the
mortgage-backed notes at September 30, 2006 were between 2035 and 2046. At September 30, 2006 and
December 31, 2005, residential mortgage loans with an estimated fair value of $3.3 billion and $0.5
billion were pledged as collateral for mortgage-backed notes issued.
Each series of mortgage-backed notes issued by the Company consists of various classes of
securities which bear interest at varying spreads to the underlying interest rate index. The
maturity of each class of securities is directly affected by the rate of principal repayments on
the associated residential mortgage loan collateral. As a result, the actual maturity of each
series of mortgage-backed notes may be shorter than the stated maturity.
Commercial Paper Facility
In August 2006, the Company established a $1.0 billion commercial paper facility, Luminent
Star Funding I, to fund its mortgage-backed security portfolio. Luminent Star Funding is a
single-seller commercial paper program that will provide a financing alternative to repurchase
agreement financing by issuing asset-backed secured liquidity notes that will be rated by the
rating agencies Standard & Poor’s and Moody’s. At September 30, 2006, there was no outstanding
balance on the commercial paper facility.
Warehouse Lending Facilities
Mortgage Loan Financing. During the nine months ended September 30, 2006, the Company
established a $1.0 billion warehouse lending facility with Greenwich Financial Products, Inc. and a
$1.0 billion warehouse lending facility with Barclays Bank plc. Both of these facilities are
structured as repurchase agreements. During 2005, the Company established a $500.0 million
warehouse lending facility with Morgan Stanley Bank, which expired in August 2006, as well as a
$500.0 million warehouse lending facility with Bear Stearns Mortgage Capital Corporation, both in
the form of repurchase agreements. These facilities are the Company’s primary source of funding
for acquiring mortgage loans. All of these warehouse lending facilities are short-term borrowings
that are secured by the loans and bear interest based on LIBOR. In general, the warehouse lending
facilities provide financing for loans for a maximum of 120 days.
The Company acquires residential mortgage loans with the intention of securitizing them and
retaining the securitized mortgage loans in the Company’s portfolio to match the income earned on
mortgage assets with the cost of the related liabilities, also referred to as match-funding the
balance sheet. In order to facilitate the securitization or financing of its loans, the Company
will generally create subordinate certificates, providing a specified amount of credit enhancement,
which the Company intends to retain in its investment portfolio. Proceeds from securitizations are
used to pay down the outstanding balance of warehouse lending facilities.
Asset-backed Securities Financing. During the quarter ended September 30, 2006, the
Company established a $500 million warehouse lending facility with Greenwich Capital Financial Products, Inc.
The facility is intended to be used to purchase mortgage-backed securities rated below AAA and the
Company intends to subsequently finance the securities permanently through collateralized debt
obligations, or CDOs. This warehouse lending facility is considered to be a short-term borrowing
arrangement that will be secured by asset-backed securities and bear
15
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
interest based on LIBOR. With
this new financing facility, the Company will be able to expand its business to include the
securitization of mortgage-backed bonds.
The total borrowing capacity under the Company’s warehouse lending facilities was $3.0 billion
and $1.0 billion at September 30, 2006 and December 31, 2005, respectively. No amounts were
outstanding under any of the warehouse lending facilities at September 30, 2006 and December 31,
2005.
Junior Subordinated Notes
Junior subordinated notes consist of 30-year notes issued in March and December 2005 to Diana
Statutory Trust I, or DST I, and Diana Statutory Trust II, or DST II, respectively, unconsolidated
affiliates of the Company formed to issue $2.8 million of the trusts’ common securities to the
Company and to place $90.0 million of preferred securities privately with unrelated third-party
investors. The note balances and related weighted-average interest rates listed by trust were as
follows at September 30, 2006 and December 31, 2005 (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
September 30, 2006 |
|
|
December 31, 2005 |
|
| |
|
Borrowings |
|
|
Interest |
|
|
Borrowings |
|
|
Interest |
|
| |
|
Outstanding |
|
|
Rate |
|
|
Outstanding |
|
|
Rate |
|
Junior subordinated notes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DST I |
|
$ |
51,550 |
|
|
|
8.16 |
% |
|
$ |
51,550 |
|
|
|
8.16 |
% |
DST II |
|
|
41,238 |
|
|
|
9.14 |
|
|
|
41,238 |
|
|
|
8.21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
92,788 |
|
|
|
8.60 |
% |
|
$ |
92,788 |
|
|
|
8.18 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company pays interest to the trusts quarterly. The DST I notes bear interest at a
fixed rate of 8.16% per annum through March 30, 2010 and, thereafter, at a variable rate equal to
three-month LIBOR plus 3.75% per annum through maturity. The DST II notes bear interest at a
variable rate equal to three-month LIBOR plus 3.75% per annum through maturity. The trusts remit
dividends pro rata to the common and preferred trust securities based on the same terms as the
junior subordinated notes. The DST I notes and trust securities mature in March 2035 and are
redeemable on any interest payment date at the option of the Company in whole, but not in part, on
or after March 30, 2010 at the redemption rate of 100% plus accrued and unpaid interest. Prior to
March 30, 2010, upon the occurrence of a special event relating to certain federal income tax or
investment company events, the Company may redeem the DST I notes in whole, but not in part, at the
redemption rate of 107.5% plus accrued and unpaid interest. The DST II notes and trust securities
mature in December 2035 are redeemable on any interest payment date at the option of the Company in
whole, but not in part, at the redemption rate of 100% plus accrued and unpaid interest.
Unamortized deferred issuance costs associated with the junior subordinated notes amounted to
$2.7 million at September 30, 2006 and $2.8 million at December 31, 2005, and are being amortized
using the effective yield method over the term of the junior subordinated notes.
Margin Lending Facility
The Company has a margin lending facility with its primary custodian from which the Company
may borrow money in connection with the purchase or sale of securities. The terms of the
borrowings, including the rate of interest payable, are agreed to with the custodian for each
amount borrowed. Borrowings are repayable immediately upon demand by the custodian. No borrowings
were outstanding under the margin lending facility at September 30, 2006. At December 31, 2005,
the Company had an outstanding balance against this borrowing facility of $3.5 million at a rate of
3.85%.
16
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)
NOTE 5—CAPITAL STOCK AND EARNINGS PER SHARE
At September 30, 2006 and December 31, 2005, the Company’s charter authorized the issuance of
100,000,000 shares of common stock, par value $0.001 per share, and 10,000,000 shares of preferred
stock, par value $0.001 per share. At September 30, 2006 and December 31, 2005, 40,460,510 and
40,587,245 shares of common stock, respectively, were outstanding and no shares of preferred stock
were outstanding.
On November 7, 2005, the Company announced that its board of directors had authorized a share
repurchase program that permits the Company to repurchase up to 2,000,000 shares of its common
stock at prevailing prices through open market transactions subject to the provisions of SEC Rule
10b-18 and in privately negotiated transactions. On February 9, 2006, the Company announced the
initiation of an additional share repurchase program to acquire an incremental 3,000,000 shares.
Through September 30, 2006, the Company had
repurchased 2,594,285 shares at a weighted-average price of $8.00 and was authorized to acquire up
to 2,405,715 more common shares.
The Company calculates basic net income per share by dividing net income for the period by the
weighted-average shares of its common stock outstanding for that period. Diluted net income per
share takes into account the effect of dilutive instruments, such as stock options and unvested
restricted common stock, but uses the average share price for the period in determining the number
of incremental shares that are to be added to the weighted-average number of shares outstanding.
The following table presents a reconciliation of basic and diluted net income per share for
the three and nine months ended September 30, 2006:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the Three Months |
|
|
For the Nine Months |
|
| |
|
Ended September 30, 2006 |
|
|
Ended September 30, 2006 |
|
| |
|
Basic |
|
|
Diluted |
|
|
Basic |
|
|
Diluted |
|
Net income (loss) (in thousands) |
|
$ |
(6,595 |
) |
|
$ |
(6,595 |
) |
|
$ |
28,748 |
|
|
$ |
28,748 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average number of
common shares outstanding |
|
|
38,695,800 |
|
|
|
38,695,800 |
|
|
|
38,937,454 |
|
|
|
38,937,454 |
|
Additional shares due to
assumed conversion of dilutive
instruments |
|
|
— |
|
|
|
— |
(1) |
|
|
— |
|
|
|
128,952 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted weighted-average
number of common shares
outstanding |
|
|
38,695,800 |
|
|
|
38,365,800 |
|
|
|
38,937,454 |
|
|
|
39,066,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share |
|
$ |
(0.17 |
) |
|
$ |
(0.17 |
) |
|
$ |
0.74 |
|
|
$ |
0.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Conversion of stock options and unvested restricted common stock considered
anti-dilutive. |
17
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)
The following table presents a reconciliation of basic and diluted net income per share for
the three and nine months ended September 30, 2005:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the Three Months |
|
|
For the Nine Months |
|
| |
|
Ended September 30, 2005 |
|
|
Ended September 30, 2005 |
|
| |
|
Basic |
|
|
Diluted |
|
|
Basic |
|
|
Diluted |
|
Net income (in thousands) |
|
$ |
5,229 |
|
|
$ |
5,229 |
|
|
$ |
30,372 |
|
|
$ |
30,372 |
|
Weighted-average number of common shares outstanding |
|
|
40,021,698 |
|
|
|
40,021,698 |
|
|
|
38,478,679 |
|
|
|
38,478,679 |
|
Additional shares due to assumed conversion of
dilutive instruments |
|
|
— |
|
|
|
204,825 |
|
|
|
— |
|
|
|
137,190 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted weighted-average number of common shares
outstanding |
|
|
40,021,698 |
|
|
|
40,226,523 |
|
|
|
38,478,679 |
|
|
|
38,615,869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share |
|
$ |
0.13 |
|
|
$ |
0.13 |
|
|
$ |
0.79 |
|
|
$ |
0.79 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE 6—2003 STOCK INCENTIVE PLANS
The Company adopted a 2003 Stock Incentive Plan, effective June 4, 2003, and a 2003 Outside
Advisors Stock Incentive Plan, effective June 4, 2003, pursuant to which up to 1,000,000 shares of
the Company’s common stock are authorized to be awarded at the discretion of the compensation
committee of the board of directors. On May 25, 2005, these plans were amended to increase the
total number of shares reserved for issuance from 1,000,000 shares to 2,000,000 shares and to set
the share limits at 1,850,000 shares for the 2003 Stock Incentive Plan and 150,000 shares for the
2003 Outside Advisors Stock Incentive Plan. The plans provide for the grant of a variety of
long-term incentive awards to employees and officers of the Company or individual consultants or
advisors who render or have rendered bona fide services as an additional means to attract,
motivate, retain and reward eligible persons. These plans provide for the grant of awards that meet
the requirements of Section 422 of the Code of non-qualified stock options, stock appreciation
rights, restricted stock, stock units and other stock-based awards and dividend equivalent rights.
The maximum term of each grant is determined on the grant date by the compensation committee and
may not exceed 10 years. The exercise price and the vesting requirement of each grant are
determined on the grant date by the compensation committee. The Company uses historical data to
estimate stock option exercise and employee termination in its calculations of stock-based employee
compensation expense and expected terms.
The following table illustrates the common stock available for grant at September 30,
2006:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
2003 Outside |
|
|
|
|
| |
|
2003 Stock |
|
|
Advisors Stock |
|
|
|
|
| |
|
Incentive Plan |
|
|
Incentive Plan |
|
|
Total |
|
Shares reserved for issuance |
|
|
1,850,000 |
|
|
|
150,000 |
|
|
|
2,000,000 |
|
Granted |
|
|
617,666 |
|
|
|
— |
|
|
|
617,666 |
|
Forfeited |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Expired |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available for grant |
|
|
1,232,334 |
|
|
|
150,000 |
|
|
|
1,382,334 |
|
|
|
|
|
|
|
|
|
|
|
18
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)
At September 30, 2006, the Company had outstanding stock options under the plans with
expiration dates of 2013. The following table summarizes all stock option transactions during the
nine months ended September 30, 2006:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted- |
| |
|
Number |
|
Average |
| |
|
of |
|
Exercise |
| |
|
Options |
|
Price |
Outstanding, beginning of period |
|
|
55,000 |
|
|
$ |
14.82 |
|
Granted |
|
|
— |
|
|
|
— |
|
Exercised |
|
|
— |
|
|
|
— |
|
Forfeited |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
Outstanding, end of period |
|
|
55,000 |
|
|
$ |
14.82 |
|
|
|
|
|
|
|
|
|
|
The following table summarizes certain information about stock options outstanding at
September 30, 2006:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Outstanding |
|
Exercisable |
| |
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
| |
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
Average |
|
|
| Range of |
|
|
|
|
|
Remaining |
|
Weighted- |
|
|
|
|
|
Remaining |
|
Weighted- |
| Exercise |
|
Number of |
|
Life |
|
Average |
|
Number of |
|
Life |
|
Average |
| Prices |
|
Options |
|
(in years) |
|
Exercise Price |
|
Options |
|
(in years) |
|
Exercise Price |
$13.00-$14.00 |
|
|
5,000 |
|
|
|
7.1 |
|
|
$ |
13.00 |
|
|
|
3,334 |
|
|
|
7.1 |
|
|
$ |
13.00 |
|
$14.01-$15.00 |
|
|
50,000 |
|
|
|
6.8 |
|
|
|
15.00 |
|
|
|
50,000 |
|
|
|
6.8 |
|
|
|
15.00 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$13.00-$15.00 |
|
|
55,000 |
|
|
|
|
|
|
$ |
14.82 |
|
|
|
53,334 |
|
|
|
|
|
|
$ |
14.87 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of outstanding stock options and exercisable stock options
at September 30, 2006 was zero.
The following table illustrates the changes in nonvested stock options during the nine months
ended
September 30, 2006:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted-Average |
|
| |
|
Number of |
|
|
Grant-Date |
|
| |
|
Options |
|
|
Fair Value |
|
Nonvested, beginning of the period |
|
|
18,333 |
|
|
$ |
0.22 |
|
Granted |
|
|
— |
|
|
|
— |
|
Vested |
|
|
(16,667 |
) |
|
|
(.22 |
) |
Forfeited |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
Nonvested, end of the period |
|
|
1,666 |
|
|
$ |
0.00 |
|
|
|
|
|
|
|
|
The following table illustrates the changes in common stock awards during the nine months
ended September 30, 2006:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted- |
| |
|
Number of |
|
Average |
| |
|
Common Shares |
|
Issue Price |
Outstanding, beginning of period |
|
|
202,829 |
|
|
$ |
10.53 |
|
Issued |
|
|
355,000 |
|
|
|
7.95 |
|
Repurchased |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
Outstanding, end of period |
|
|
557,829 |
|
|
$ |
8.89 |
|
|
|
|
|
|
|
|
|
|
The fair value of common stock awards is determined on the grant date using the closing
stock price on the NYSE that day.
19
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)
The following table illustrates the changes in nonvested common stock awards during the nine
months ended September 30, 2006:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted-Average |
| |
|
Number of |
|
Grant-Date |
| |
|
Common Shares |
|
Fair Value |
Nonvested, beginning of the period |
|
|
194,453 |
|
|
$ |
10.46 |
|
Granted |
|
|
355,000 |
|
|
|
7.95 |
|
Vested |
|
|
(136,622 |
) |
|
|
8.75 |
|
Repurchased |
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
Nonvested, end of the period |
|
|
412,831 |
|
|
$ |
8.87 |
|
|
|
|
|
|
|
|
|
|
Total stock-based employee compensation expense related to common stock awards for the
three months ended September 30, 2006 and 2005 was $384 thousand and $118 thousand, respectively.
Total stock-based employee compensation expense related to common stock awards for the nine months
ended September 30, 2006 and 2005 was $1.9 million and $0.3 million, respectively. At September 30,
2006, stock-based employee compensation expense of $2.7 million related to nonvested common stock
awards is expected to be recognized over a weighted-average period of 1.1 years.
NOTE 7—THE MANAGEMENT AGREEMENT
On September 26, 2006, the Company completed its transition to full internal management after
reaching agreement with Seneca Capital Management LLC, or SCM, to terminate the Amended and
Restated Management Agreement, or Amended Agreement, described below. Because the Amended
Agreement has been terminated, the Company is no longer required to make regular quarterly
“minimum” payments to SCM through 2007, nor does the Company need to accrue future incentive
compensation expense for SCM. Instead, the Company will pay SCM a total of $5.8 million in cash in
three equal installments: the first installment of $1.9 million was paid on September 29, 2006; the
second installment of $1.9 million was paid on October 31, 2006; and the third installment of $1.9
million will be paid on or before January 2, 2007 in connection with the termination of the Amended
Agreement. As of September 26, 2006, the Company also accelerated the vesting of 138,233 shares of
restricted common stock issued to SCM.
Base management compensation for the three and nine months ended September 30, 2006 was $5.5
million and $6.9 million, respectively, including the installment payments due to SCM related to
the termination agreement. Base management compensation for the three and nine months ended
September 30, 2005 was $1.1 million and $3.3 million, respectively.
Incentive compensation expense for the three and nine months ended September 30, 2006 was $0.5
million and $0.7 million, respectively. Incentive compensation expense for the three and nine
months ended September 30, 2005 was $0.2 million and $1.1 million, respectively. Under the Amended
Agreement, SCM did not earn any incentive compensation during the three and nine months ended
September 30, 2006 and 2005. The incentive compensation expense during the three and nine months
ended September 30, 2006 and 2005 related primarily to restricted common stock awards granted for
incentive compensation earned in prior periods that vested during the periods. The incentive
compensation expense for the three and nine months ended September 30, 2006 also includes the final
vesting of all of restricted stock awards granted to SCM earned in prior periods in connection with
the termination agreement. Subsequent to the termination agreement, the Company will no longer
recognize incentive compensation expense related to restricted stock awards granted to SCM.
At September 30, 2006, the Company recorded the remaining two installment payments of $3.8
million due to SCM related to the termination of the Amended Agreement as a liability. The Company
had not paid SCM base management compensation of $0.9 million at December 31, 2005.
20
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)
The Company entered into the Amended Agreement effective as of March 1, 2005, with SCM. The
Amended Agreement provided, among other things, that the Company pay to SCM, in exchange for
investment management and certain administrative services with respect to certain investments in
the Company’s Spread portfolio, certain fees and reimbursements. SCM was eligible to earn
Applicable Minimum Fees in the event that the aggregate base management compensation and incentive
management compensation calculated was less than the Applicable Minimum Fees per the terms of the
Amended Agreement. As a result of the termination of the Amended Agreement described above, at
September 30, 2006, there are no Applicable Minimum Fees payable to SCM. Under the Amended
Agreement, the base management compensation and incentive management compensation were paid to SCM
by the Company in cash. Base management and incentive compensation were only earned by SCM for
assets that were managed by SCM.
NOTE 8—FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, Disclosure About Fair Value of Financial Instruments, requires disclosure of the
fair value of financial instruments for which it is practicable to estimate that value. The fair
value of mortgage-backed securities available-for-sale and derivative contracts is equal to their
carrying value presented in the consolidated balance sheet. The fair value of cash and cash
equivalents, interest receivable, principal receivable, repurchase agreements, warehouse lending
facilities, unsettled securities purchases and accrued interest expense approximates cost at
September 30, 2006 and December 31, 2005 due to the short-term nature of these instruments. The
carrying value and fair value of the Company’s junior subordinated notes was $92.8 million and
$91.4 million, respectively, at September 30, 2006. The carrying value and fair value of the
Company’s junior subordinated notes was $92.8 million and $91.8 million, respectively, at December
31, 2005. The carrying value and fair value of the Company’s loans held-for-investment was $4.2
billion and $4.2 billion, respectively, at September 30, 2006. The carrying value and fair value
of the Company’s loans held-for-investment was $507.2 million and $507.7 million, respectively, at
December 31, 2005. The carrying value and fair value of the Company’s mortgage-backed notes was
$3.3 billion and $3.6 billion, respectively, at September 30, 2006. The carrying value and fair
value of the Company’s mortgage-backed notes were $486.3 million at December 31, 2005.
NOTE 9—ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following is a summary of the components of accumulated other comprehensive income (loss)
at September 30, 2006 and December 31, 2005 (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
Unrealized holding losses on mortgage-backed securities available-for-sale |
|
$ |
(8,177 |
) |
|
$ |
(116,397 |
) |
Reclassification adjustment for net (gains) losses on mortgage-backed
securities available-for-sale included in net income |
|
|
(990 |
) |
|
|
69 |
|
Impairment losses on mortgage-backed securities |
|
|
2,179 |
|
|
|
112,008 |
|
|
|
|
|
|
|
|
Net unrealized losses on mortgage-backed securities available-for-sale |
|
|
(6,988 |
) |
|
|
(4,320 |
) |
Net deferred realized and unrealized gains on cash flow hedges |
|
|
4,278 |
|
|
|
11,396 |
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss) |
|
$ |
(2,710 |
) |
|
$ |
7,076 |
|
|
|
|
|
|
|
|
NOTE 10—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company seeks to manage its interest rate risk exposure and protect the Company’s
liabilities against the effects of major interest rate changes. Such interest rate risk may arise
from: (1) the issuance and forecasted rollover and repricing of short-term liabilities with fixed
rate cash flows or from liabilities with a contractual
21
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)
variable rate based on LIBOR; (2) the issuance of long-term fixed rate or floating rate debt
through securitization activities or other borrowings or (3) the change in value of loan purchase
commitments. Among other strategies, the Company may use Eurodollar futures contracts, swaption
contracts, interest rate swap contracts and interest rate cap contracts to manage these interest
rate risks.
The following table is a summary of derivative contracts held at September 30, 2006 (in
thousands):
| |
|
|
|
|
| |
|
Estimated |
|
| |
|
Fair Value |
|
Free Standing Derivatives: |
|
|
|
|
Interest rate swap contracts |
|
$ |
5,907 |
|
Interest rate cap contracts |
|
|
1,098 |
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
7,005 |
|
|
|
|
|
The following table is a summary of derivative contracts held at December 31, 2005 (in
thousands):
| |
|
|
|
|
| |
|
Estimated |
|
| |
|
Fair Value |
|
Free Standing Derivatives: |
|
|
|
|
Swaption contracts |
|
$ |
1,531 |
|
Interest rate cap contracts |
|
|
74 |
|
Cash Flow Hedges: |
|
|
|
|
Eurodollar futures contracts sold short |
|
|
4,895 |
|
Interest rate swap contracts |
|
|
4,220 |
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
10,720 |
|
|
|
|
|
Free Standing Derivatives
Free standing derivative contracts are carried on the consolidated balance sheet at fair
value. Net unrealized losses of $12.0 million and net unrealized gains of $0.3 million were
recognized in other income due to the change in fair value of these contracts during the three and
nine months ended September 30, 2006, respectively. In addition, the Company realized net gains on
interest rate swap contracts and Eurodollar futures contracts of $0.5 million and $4.4 million in
other income during the three and nine months ended September 30, 2006, respectively. Net
unrealized gains of $0.5 million and net unrealized losses of $0.4 million were recognized in other
expense due to the change in fair value of these contracts during the three and nine months ended
September 30, 2005, respectively. In addition, net realized losses of $0.1 million were recorded in
other income during the three and nine months ended September 30, 2005.
Cash Flow Hedging Strategies
Prior to January 1, 2006, the Company entered into derivative contracts which were accounted
for under hedge accounting as prescribed by SFAS No. 133. Effective January 1, 2006, the Company
discontinued the use of hedge accounting. Under hedge accounting, prior to the end of the
specified hedge time period, the effective portion of all contract gains and losses (whether
realized or unrealized) was recorded in other comprehensive income or loss. Hedge effectiveness
gains included in accumulated other comprehensive income at December 31, 2005 will be amortized
during the specified hedge time period. Under hedge accounting, realized gains and losses were
reclassified into earnings as an adjustment to interest expense during the specified hedge time
period. Realized gains and losses included in accumulated other comprehensive income at December
31, 2005 will be amortized during the specified hedge time period. All changes in value of
derivative instruments that had previously been accounted for under hedge accounting are recognized
in other income or expense.
22
LUMINENT MORTGAGE CAPITAL, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)
During the three and nine months ended September 30, 2006, interest expense decreased by $0.1
million and $1.6 million, respectively, due to the amortization of net realized gains on Eurodollar
futures contracts and by $0.5 million and $5.3 million of amortization of effectiveness gains on
Eurodollar futures contracts and interest rate swap contracts for the three and nine months ended
September 30, 2006, respectively.
During the three and nine months ended September 30, 2005, losses of $430 thousand and gains
of $43 thousand were recognized in interest expense due to hedge ineffectiveness. During the three
months ended September 30, 2005, interest expense was increased by $0.8 million due to the amortization
of net realized losses on Eurodollar futures contracts and decreased by $4.2 million of net
interest income received from swap contract counterparties. During the nine months ended September
30, 2005, interest expense was decreased by $1.4 million due to the amortization of net realized gains
on Eurodollar futures contracts and $7.4 million of net interest income received from swap contract
counterparties.
Purchase Commitment Derivatives
The Company may enter into commitments to purchase mortgage loans, or purchase commitments,
from the Company’s network of origination partners. Each purchase commitment is evaluated in
accordance with SFAS No. 133 to determine whether the purchase commitment meets the definition of a
derivative instrument. At September 30, 2006, no unrealized gains or losses were recorded on the
Company’s consolidated balance sheet for outstanding purchase commitments. No purchase commitments
were outstanding at December 31, 2005. During the three and nine months ended September 30, 2006,
net realized losses of $0.2 million and $0.6 million, respectively, related to purchase commitment
derivatives were recorded in other expense on the Company’s consolidated statement of operations.
During the three and nine months ended September 30, 2005, net realized gains on purchase
commitments of $0.2 million were recorded in other expense on the Company’s consolidated statement
of operations.
NOTE 11—SUBSEQUENT EVENTS
On October 12, 2006, the Company completed a common stock offering of 6.9 million shares
priced at $10.25 per share. On October 18, 2006, the Company received proceeds from this offering
of $67.6 million, net of underwriting commissions.
Additionally, in October 2006, the Company declared a special cash dividend of $0.075 per
share, payable on November 10, 2006 to stockholders of record on October 20, 2006.
23
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
The following discussion of our financial condition and results of operations should be read
in conjunction with the financial statements and notes to those statements included in Item 1 of
this Quarterly Report on Form 10-Q. This discussion may contain certain forward-looking statements
that involve risks and uncertainties. Forward-looking statements are those that are not historical
in nature. The words “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend” and similar
expressions or the negatives of these words or phrases are intended to identify forward-looking
statements. As a result of many factors, such as those set forth under “Risk Factors” in Item 1A of
this Quarterly Report on Form 10-Q, Item 1A of our 2005 Annual Report on Form 10-K, elsewhere in
this Quarterly Report or incorporated by reference herein, our actual results may differ materially
from those anticipated in such forward-looking statements.
Overview
Executive Summary
Our primary mission is to provide a secure stream of income for our stockholders based on the
steady and reliable payments of residential mortgages made to borrowers of prime credit quality.
We began investing in 2003, with a Spread strategy of investing in high quality, adjustable-rate
and hybrid adjustable-rate mortgage-backed securities and levering these investments primarily
through repurchase agreements. While this strategy has a minimal level of credit risk, it also has
considerable interest rate exposure. The persistently flat yield curve and ongoing Federal Reserve
rate increases since June 2004 have pressured our ability to provide steady income, and led us to
augment our strategy in 2005. This new strategy, which we refer to as our Residential Mortgage
Credit strategy, includes investments in non-agency mortgage-backed securities rated below AAA as
well as prime whole loan purchases and securitizations of those loans, in a manner that should
reduce our exposure to interest rate volatility. We plan to pursue this strategy as our principal
strategy as a means to continue to reduce interest rate risk, and build the basis for dividend
stability and growth.
During the first nine months of 2006, we completed repositioning our portfolios in order to
reduce our exposure to interest rate volatility, such that our Residential Mortgage Credit
portfolio now represents the majority of our overall asset portfolio with investments that are less
sensitive to interest rates, and therefore more predictable and sustainable. As a further result of
this repositioning, approximately 92% of the securities within our spread portfolio now consist of
residential mortgage-backed securities with interest rates that reset within one month or less and
the balance reset within one year. Our credit strategy seeks to structure, acquire and fund
mortgage loans that will provide long-term reliable income to our stockholders. We seek to
accomplish this goal primarily through the purchase of mortgage loans which we design and originate
in partnership with selected high quality providers with whom we have long and well-established
relationships. We then securitize those loans and seek to retain the most valuable tranches of the
securitization. These securitizations reduce our sensitivity to interest rates and help match the
income we earn on our mortgage assets with the cost of our related liabilities. The debt that we
incur in these securitizations is non-recourse to us, however, our mortgage loans are pledged as
collateral for the securities we issue. As a secondary strategy, we invest in subordinated
mortgage-backed securities that have credit ratings below AAA. We do this opportunistically, as we
discover value and credit arbitrage opportunities in the market.
During
September 2006, we entered into a warehouse agreement with Greenwich Capital Financial Products, Inc. whereby
they will finance the purchase of up to $500 million in asset-backed securities. The facility is
intended to be used to purchase mortgage-backed securities rated below AAA and we intend to
subsequently finance the securities permanently through collateralized debt obligations, or CDOs.
CDO transactions will allow us to achieve our objective of matching the income we earn on our
assets, plus the benefit of hedging activities, to our cost of liabilities. We anticipate
completing our first CDO transaction during the first quarter of 2007.
Using
these investment strategies, we seek to acquire mortgage-related assets, finance these
purchases in the capital markets and use leverage in order to provide an attractive return on
stockholders’ equity. We have acquired and will seek to acquire additional assets that will
produce competitive returns, taking into consideration the amount and nature of the anticipated
returns from the investment, our ability to pledge the investment for
24
secured, collateralized
borrowings and the costs associated with financing, managing, securitizing and reserving for these
investments.
During July 2006, we established a relationship with a servicer, Central Mortgage Co., whereby
the servicer would service residential mortgage loans on our behalf in exchange for a fee.
Establishing this relationship will enable us to purchase residential mortgage loans with servicing
released while maintaining the objectives of our operational efficiency. As a result, we will be
able to expand the network of originators from whom we can purchase residential mortgage loans,
without generating a servicing asset that we would need to own and hedge.
We manage the portfolios in our Residential Mortgage Credit strategy and our Spread strategy.
Our business is affected by the following economic and industry factors that may have a
material adverse effect on our financial condition and results of operations:
| |
• |
|
interest rate trends and changes in the yield curve; |
| |
| |
• |
|
rates of prepayment on our mortgage loans and the mortgages underlying
our mortgage-backed securities; |
| |
| |
• |
|
continued creditworthiness of the holders of mortgages underlying our mortgage-related assets; |
| |
| |
• |
|
highly competitive markets for investment opportunities; and |
| |
| |
• |
|
other market developments. |
In addition, several factors relating to our business may also impact our financial condition
and operating performance. These factors include:
| |
• |
|
credit risk as defined by prepayments, delinquencies and defaults on
our mortgage loans and the mortgage loans underlying our
mortgage-backed securities; |
| |
| |
• |
|
overall leverage of our portfolio; |
| |
| |
• |
|
access to funding and adequate borrowing capacity; |
| |
| |
• |
|
negative amortization; |
| |
| |
• |
|
increases in our borrowing costs; |
| |
| |
• |
|
the ability to use derivatives to mitigate our interest rate and prepayment risks; |
| |
| |
• |
|
the market value of our investments; and |
| |
| |
• |
|
compliance with REIT requirements and the requirements to qualify for
an exemption under the Investment Company Act of 1940. |
Refer to “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and in Part
I, Item 1A of our 2005 Annual Report on Form 10-K for additional discussion regarding these and
other risk factors that affect our business. Refer to “Credit Risk” and “Interest Rate Risk” in
Item 7A of this Quarterly Report on Form 10-Q and in our 2005 Annual Report on Form 10-K for
additional credit risk and interest rate risk discussion.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP. These accounting principles require us
to make some complex
25
and subjective decisions and assessments. Our most critical accounting
policies involve decisions and assessments that could significantly affect our reported assets and
liabilities, as well as our reported revenues and expenses. We believe that all of the decisions
and assessments upon which our consolidated financial statements are based were reasonable at the
time made based upon information available to us at that time. See Note 2 to our consolidated
financial statements included in Item 8 of our 2005 Annual Report on Form 10-K for a further
discussion of our significant accounting policies. Management has identified our most critical
accounting policies to be the following:
Classifications of Investment Securities
Our investments in mortgage-backed securities are classified as available-for-sale and are
carried on our consolidated balance sheet at their fair value. Generally, the classification of
securities as available-for-sale results in changes in fair value being recorded as adjustments to
accumulated other comprehensive income or loss, which is a component of stockholders’ equity,
rather than immediately through results of operations. If our available-for-sale securities were
classified as trading securities, our results of operations could experience substantially greater
volatility from period-to-period.
Valuations of Mortgage-backed Securities
Our Spread portfolio of mortgage-backed securities has fair values based on estimates provided
by independent pricing services and dealers in mortgage-backed securities. Because the price
estimates may vary between sources, management makes certain judgments and assumptions about the
appropriate price to use. Different judgments and assumptions could result in different
presentations of value.
We estimate the fair value of our Residential Mortgage Credit portfolio of mortgage-backed
securities using available market information and other appropriate valuation methodologies. We
believe the estimates we use reflect the market values we may be able to receive should we choose
to sell the mortgage-backed securities. Our estimates involve matters of uncertainty, judgment in
interpreting relevant market data and are inherently subjective in nature. Many factors are
necessary to estimate market values, including, but not limited to, interest rates, prepayment
rates, amount and timing of credit losses, supply and demand, liquidity, cash flows and other
market factors. We apply these factors to our portfolio as appropriate in order to determine
market values.
When the fair value of an available-for-sale security is less than its amortized cost,
management considers whether there is an other-than-temporary impairment in the value of the
security. The determination of other-than-temporary impairment is a subjective process, requiring
the use of judgments and assumptions. If management determines an other-than-temporary impairment
exists, the cost basis of the security is written down to the then-current fair value, and the
unrealized loss is recorded in our consolidated statement of operations as if the loss had been
realized in the period of impairment.
Management considers several factors when evaluating securities for other-than-temporary
impairment, including the length of time and extent to which the market value has been less than
the amortized cost, whether the security has been downgraded by a rating agency and our continued
intent and ability to hold the security for a period of time sufficient to allow for any
anticipated recovery in market value. During the nine months ended September 30, 2006, we
recognized impairment losses of $2.2 million in connection with our decision to reposition our
Spread portfolio because we did not have the intent to hold certain securities in our Spread
portfolio for a period of time sufficient to allow for any anticipated recovery in market value.
At September 30, 2006, we had unrealized losses on our mortgage-backed securities classified as
available-for-sale of $13.0 million which, if the prices do not recover, may result in the
recognition of future losses.
The determination of other-than-temporary impairment is evaluated at least quarterly. If
future evaluations conclude that impairment is other-than-temporary, we may need to realize a loss
that would have an impact on our results of operations.
26
Loans Held-for-Investment
We purchase pools of residential mortgage loans through our network of origination partners.
Mortgage loans are designated as held-for-investment as we have the intent and ability to hold them
for the foreseeable future, and until maturity or payoff. Mortgage loans that are considered to be
held-for-investment are carried at their unpaid principal balances, including unamortized premium
or discount and allowance for loan losses.
Allowance and Provision for Loan Losses
We maintain an allowance for loan losses at a level that we believe is adequate based on an
evaluation of known and inherent risks related to our loan investments. When determining the
adequacy of the allowance for loan losses, we consider historical and industry loss experience,
economic conditions and trends, the estimated fair values of our loans, credit quality trends and
other factors that we determine are relevant. In our review of national and local economic trends
and conditions we consider, among other factors, national unemployment data, changes in housing
appreciation and whether specific geographic areas where we have significant loan concentrations
are experiencing adverse economic conditions and events such as natural disasters that may affect
the local economy or property values.
To estimate the allowance for loan losses, we first identify impaired loans. Loans purchased
with relatively smaller balances and substantially similar characteristics are evaluated
collectively for impairment. Seriously delinquent loans with balances greater than $1.0 million are
evaluated individually. Loans are considered impaired when, based on current information, it is
probable that we will be unable to collect all amounts due according to the contractual terms of
the loan agreement, including interest payments. Impaired loans are carried at the lower of the
recorded investment in the loan or the fair value of the collateral less costs to dispose of the
property.
Our allowance for loan losses is established using mortgage industry experience and rating
agency projections for loans with characteristics which are broadly similar to our portfolio. This
analysis begins with actual 60 day or more delinquencies in our portfolio, and projects ultimate
default experience (i.e., the rate at which loans will go to liquidation) on those loans based on
mortgage industry loan delinquency migration statistics. For all loans showing indications of
probable default, we apply a “severity” factor for each loan, again using loss severity projections
from a model developed by a major rating agency for loans broadly similar to the loans in our
portfolio. Management then uses judgment to ensure all relevant factors that could affect our loss
levels are considered and would adjust the allowance for doubtful accounts if we believe that an
adjustment is warranted. Over time, as our loan portfolio seasons and generates actual loss
experience, we will incorporate our actual loss history for forecasting losses and establishing
credit reserves.
Loans 90 days or more past due are placed on non-accrual status and all previously recognized
interest income is reversed.
Interest Income Recognition
Interest income on our mortgage-backed securities is accrued based on the coupon rate and the
outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or
accreted as adjustments to interest income over the lives of the securities using the effective
yield method adjusted for the effects of estimated prepayments based on Statement of Financial
Accounting Standards, or SFAS, No. 91, Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases. If our estimate of prepayments
is incorrect, we may be required to make an adjustment to the amortization or accretion of premiums
and discounts that would have an impact on our future results of operations. Certain of the
mortgage-backed securities in our Residential Mortgage Credit portfolio are accounted for in
accordance with Emerging Issues Task Force, or EITF, 99-20, Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.
Interest income is recognized using the effective yield method. The prospective method is used for
adjusting the level yield used to recognize interest income when estimates of future cash flows
over the remaining life of the security either increase or decrease. Cash flows are
27
projected
based on management’s assumptions for prepayment rates and credit losses. Actual economic
conditions may produce cash flows that could differ significantly from projected cash flows, and
differences could result in an increase or decrease in the yield used to record interest income or
could result in impairment losses.
Interest income on our mortgage loans is accrued and credited to income based on the carrying
amount and contractual terms or estimated life of the assets using the effective yield method in
accordance with SFAS No. 91. The accrual of interest on impaired loans is discontinued when, in
management’s opinion, the borrower may be unable to meet payments as they become due. When an
interest accrual is discontinued, all associated unpaid accrued interest income is reversed against
current period operating results. Interest income is subsequently recognized only to the extent
cash payments are received.
Securitizations
We create securitization entities as a means of securing long-term, non-recourse
collateralized financing for our residential mortgage loan portfolio and matching the income earned
on residential mortgage loans with the cost of related liabilities, otherwise referred to as match
funding our balance sheet. Residential mortgage loans are transferred to a separate
bankruptcy-remote legal entity from which private-label multi-class mortgage-backed notes are
issued. On a consolidated basis, securitizations are accounted for as secured financings as
defined by SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, and, therefore, no gain or loss is recorded in connection with the
securitizations. Each securitization entity is evaluated in accordance with Financial Accounting
Standards Board, or FASB, Interpretation, or FIN, 46(R), Consolidation of Variable Interest
Entities, and we have determined that we are the primary beneficiary of the securitization
entities. As such, the securitization entities are consolidated into our consolidated balance
sheet subsequent to securitization. Residential mortgage loans transferred to securitization
entities collateralize the mortgage-backed notes issued, and, as a result, those investments are
not available to us, our creditors or stockholders. All discussions relating to securitizations
are on a consolidated basis and do not necessarily reflect the separate legal ownership of the
loans by the related bankruptcy-remote legal entity.
Accounting for Derivative Financial Instruments and Hedging Activities
We may enter into a variety of derivative contracts, including futures contracts, swaption
contracts, interest rate swap contracts, interest rate cap contracts, as a means of mitigating our
interest rate risk on forecasted interest expense as well as to mitigate our credit risk on credit
sensitive mortgage-backed securities. Effective January 1, 2006, we discontinued the use of hedge
accounting. All changes in value of derivative contracts that had previously been accounted for
under hedge accounting have been recorded in other income or expense and could potentially result
in increased volatility in our results of operations.
We may enter into commitments to purchase mortgage loans, or purchase commitments, from our
network of origination partners. Each purchase commitment is evaluated in accordance with SFAS No.
133 to determine whether the purchase commitment meets the definition of a derivative instrument.
Purchase commitments that meet the definition of a derivative instrument are recorded at their
estimated fair value on the consolidated balance sheet and any change in fair value of the purchase
commitment is recognized in other income or expense. Upon settlement of the loan purchase, the
purchase commitment derivative is derecognized and is included in the cost basis of the loans
purchased.
Recent Accounting Pronouncements
The FASB has placed an item on its SFAS No. 140 project agenda relating to the treatment of
transactions where mortgage-backed securities purchased from a particular counterparty are financed
via a repurchase agreement with the same counterparty. Currently, we record such assets and the
related financing gross on our consolidated balance sheet and the corresponding interest income and
interest expense gross on our consolidated statement of operations. Any change in fair value of the
security is reported through other comprehensive income under SFAS No. 115, because the security is
classified as available-for-sale.
28
However, in a transaction where the mortgage-backed securities are acquired from and financed
under a repurchase agreement with the same counterparty, the acquisition may not qualify as a sale
from the seller’s perspective under the provisions of SFAS No. 140. In such cases, the seller may
be required to continue to consolidate the assets sold to us, based on the seller’s continuing
involvement with such investments. Depending on the ultimate outcome of the FASB deliberations, we
may be precluded from presenting the assets gross on our consolidated balance sheet and instead be
required to treat our net investment in such assets as a derivative.
If it is determined that these transactions should be treated as investments in derivatives,
the derivative instruments entered into by us in prior years to hedge our interest rate exposure
with respect to the borrowings under the associated repurchase agreements may no longer qualify for
hedge accounting, and would then, as with the underlying asset transactions, also be marked to
market through our consolidated statement of operations.
This potential change in accounting treatment does not affect the economics of the
transactions but does affect how the transactions would be reported in our consolidated financial
statements. Our cash flows, liquidity and ability to pay a dividend would be unchanged, and we do
not believe our REIT taxable income or REIT status would be affected. Our net equity would not be
materially affected. At September 30, 2006 and December 31, 2005, we have identified
available-for-sale securities with a fair value of $26.0 million and $19.9 million, respectively,
which had been purchased from and financed with the same counterparty. If we were to change the
current accounting treatment for these transactions at September 30, 2006 and December 31, 2005,
total assets and total liabilities would each be reduced by approximately $26.0 million and $19.9
million, respectively.
In June 2006, FASB issued Interpretation, or FIN, No. 48, Accounting for Uncertainty in Income
Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes.
FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. This
interpretation also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. We do not expect the adoption of this interpretation to have a
material impact on our financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which is effective
for fiscal years beginning January 1, 2008. This Statement defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value measurements. SFAS No.
157 does not require any new fair value measurements. The adoption of SFAS No. 157 is not expected to have a material impact on the
Company’s financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin, or SAB, No. 108, Financial
Statements – Considering the Effect of Prior Year Misstatements, which is effective for the year
ended December 31, 2006. SAB No. 108 requires a dual approach when quantifying and evaluating the
materiality of a misstatement. Evaluation of an error must be performed from both a financial
position perspective and results of operations perspective. The adoption of SAB No. 108 is not
expected to have a material impact on the Company’s financial statements.
Results of Operations
For the three months ended September 30, 2006 and 2005, net loss was $6.6 million, or $0.17
per weighted-average share outstanding (basic and diluted), and net income was $5.2 million, or
$0.13 per weighted-average share outstanding (basic and diluted), respectively. For the nine months
ended September 30, 2006 and 2005, net income was $28.7 million, or $0.74 per weighted-average
share outstanding (basic and diluted), and $30.4 million, or $0.79 per weighted-average share
outstanding (basic and diluted), respectively. Results for the three and nine months ended
September 30, 2006, include certain non-recurring expenses including one-time charges of $6.1
million, related to our agreement to terminate our Amended and Restated Management Agreement, or
Amended Agreement, with Seneca Capital Management LLC, or SCM. In addition, net unrealized losses
on derivative instruments of $12.0 million and unrealized gains of $0.3 million were recognized
during the three and nine months ended September 30, 2006, respectively, due to our decision to
discontinue the use of hedge accounting as of January 1, 2006.
29
Total interest income from mortgage assets was $95.1 million and $46.3 million for the three
months ended September 30, 2006 and 2005, respectively. The increase in interest income is
primarily due to higher yields on our mortgage assets that have resulted from the restructuring and
sale of assets in our Spread portfolio and the redeployment of our capital into the higher-yielding
assets of our Residential Mortgage Credit portfolio during 2006. Interest expense for the three
months ended September 30, 2006 and 2005 was $73.1 million and $38.2 million, respectively. The
increase in interest expense is primarily due to higher rates on our funding liabilities related to
the shift to mortgage-backed notes from repurchase agreements, as well as increases in overall
levels of both funding liabilities and interest rates between September 30, 2005 and September 30,
2006. The shift in funding liabilities reflects the repositioning of our portfolios in order to
reduce our exposure to interest rate volatility and help match the income we earn on our mortgage
assets with the cost of our related liabilities.
Total interest income from mortgage assets was $231.6 million and $131.3 million for the nine
months ended September 30, 2006 and 2005, respectively. The year-over-year increase in interest
income is primarily due to higher yields on our mortgage assets that have resulted from the
restructuring and sale of assets in our Spread portfolio and the redeployment of our capital into
the higher-yielding assets of our Residential Mortgage Credit portfolio during 2006. Interest
expense for the nine months ended September 30, 2006 and 2005 was $172.6 million and $90.9 million,
respectively. The increase in interest expense is primarily due to higher rates on our funding
liabilities related to the shift to mortgage-backed notes from repurchase agreements, as well as an
increase in the overall levels of both funding liabilities and interest rates between September 30,
2005 and September 30, 2006.
The table below details the components of our net interest spread for the three and nine
months ended September 30, 2006 and 2005:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
Nine Months Ended |
| |
|
September 30, |
|
September 30, |
| |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Weighted-average yield on average earning
assets, net of premium amortization or
discount accretion |
|
|
6.84 |
% |
|
|
3.79 |
% |
|
|
6.32 |
% |
|
|
3.70 |
% |
Weighted-average cost of total liabilities |
|
|
5.40 |
|
|
|
3.29 |
|
|
|
4.94 |
|
|
|
2.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest spread |
|
|
1.44 |
% |
|
|
0.50 |
% |
|
|
1.38 |
% |
|
|
0.96 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average yield on average earning assets, net of premium amortization or discount
accretion, is defined as total interest income earned divided by the weighted-average amortized
cost of our mortgage assets during the period. Weighted-average mortgage earning assets during the
three months ended September 30, 2006 and 2005 were $5.6 billion and $4.9 billion, respectively,
and during the nine months ended September 30, 2006 and 2005 were $4.9 billion and $4.7 billion,
respectively.
We define our weighted-average cost of total liabilities as total interest expense divided by
the weighted-average amount of our financing liabilities during the period, including repurchase
agreements, mortgage-backed notes, warehouse lending facilities and junior subordinated notes.
Interest expense consists of interest payments on our debt and consolidated mortgage-backed notes
issued, less the amortization of mortgage-backed securities issuance premiums. Mortgage-backed
securities issuance premiums are created when interest-only securities and other mortgage-backed
securities are issued at prices greater than principal value.
30
Interest expense for the three and nine months ended September 30, 2006 was as follows
(dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months |
|
|
Percentage |
|
|
Nine Months |
|
|
Percentage |
|
| |
|
Ended |
|
|
of Average |
|
|
Ended |
|
|
of Average |
|
| |
|
September 30, |
|
|
Financing |
|
|
September 30, |
|
|
Financing |
|
| |
|
2006 |
|
|
Liabilities |
|
|
2006 |
|
|
Liabilities |
|
Interest expense on mortgage-backed notes |
|
$ |
38,372 |
|
|
|
2.83 |
% |
|
$ |
84,119 |
|
|
|
2.41 |
% |
Interest expense on repurchase agreement liabilities |
|
|
31,043 |
|
|
|
2.29 |
|
|
|
81,547 |
|
|
|
2.33 |
|
Interest expense on warehouse lending facilities |
|
|
3,378 |
|
|
|
0.25 |
|
|
|
8,849 |
|
|
|
0.25 |
|
Interest expense on junior subordinated notes |
|
|
1,973 |
|
|
|
0.15 |
|
|
|
5,790 |
|
|
|
0.17 |
|
Amortization of net realized gains on futures and interest
rate swap contracts |
|
|
(580 |
) |
|
|
(0.04 |
) |
|
|
(6,924 |
) |
|
|
(0.20 |
) |
Net interest income on interest rate swap contracts |
|
|
(1,087 |
) |
|
|
(0.08 |
) |
|
|
(798 |
) |
|
|
0.02 |
) |
Other |
|
|
50 |
|
|
| nm | |
|
|
50 |
|
|
| nm | |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense |
|
$ |
73,149 |
|
|
|
5.40 |
% |
|
$ |
172,633 |
|
|
|
4.94 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense for the three and nine months ended September 30, 2005 was as follows
(dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months |
|
|
Percentage |
|
|
Nine Months |
|
|
Percentage |
|
| |
|
Ended |
|
|
of Average |
|
|
Ended |
|
|
of Average |
|
| |
|
September 30, |
|
|
Financing |
|
|
September 30, |
|
|
Financing |
|
| |
|
2005 |
|
|
Liabilities |
|
|
2005 |
|
|
Liabilities |
|
Interest expense on repurchase agreement liabilities |
|
$ |
39,578 |
|
|
|
3.41 |
% |
|
$ |
96,865 |
|
|
|
2.92 |
% |
Interest expense on warehouse lending facilities |
|
|
585 |
|
|
|
0.05 |
|
|
|
585 |
|
|
|
0.02 |
|
Interest expense on junior subordinated notes |
|
|
1,034 |
|
|
|
0.09 |
|
|
|
2,239 |
|
|
|
0.06 |
|
Net hedge ineffectiveness (gains) losses on futures and
interest rate swap contracts |
|
|
430 |
|
|
|
0.03 |
|
|
|
(42 |
) |
|
|
nm |
|
Amortization of net realized (gains) losses on futures
and interest rate swap contracts |
|
|
799 |
|
|
|
0.07 |
|
|
|
(1,395 |
) |
|
|
(0.04 |
) |
Net interest income on interest rate swap
contracts |
|
|
(4,196 |
) |
|
|
(0.36 |
) |
|
|
(7,395 |
) |
|
|
(0.22 |
) |
Other |
|
|
11 |
|
|
| nm | |
|
|
21 |
|
|
| nm | |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense |
|
$ |
38,241 |
|
|
|
3.29 |
% |
|
$ |
90,878 |
|
|
|
2.74 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average financing liabilities during the three months ended September 30, 2006
and 2005 were $5.3 billion and $4.5 billion, respectively. Weighted-average financing liabilities
during the nine months ended September 30, 2006 and 2005 were $4.6 billion and $4.4 billion,
respectively.
Return on average equity for the three months ended September 30, 2006 and 2005 was (6.6)% and
4.9%, respectively, and for the nine months ended September 30, 2006 and 2005 was 9.7% for both
periods. We define return on average equity as annualized net income divided by weighted-average
stockholders’ equity. Weighted-average stockholders’ equity for the three months ended September
30, 2006 and 2005 was $395.1 million and $420.3 million, respectively, and for the nine months
ended September 30, 2006 and 2005 was $395.1 million and $419.3 million, respectively.
31
Other income and expense for the three and nine months ended September 30, 2006, was net other
expense of $11.5 million and net other income of $2.3 million, respectively, and other income and
expense for the three and nine months ended September 30, 2005, was net other income of $0.5
million and net other expense of $0.4 million, respectively, as summarized in the following table
(dollars in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the Three |
|
|
For the Nine |
|
| |
|
Months Ended |
|
|
Months Ended |
|
| |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Realized and unrealized gains
(losses) on derivative instruments,
net |
|
$ |
(11.7 |
) |
|
$ |
0.6 |
|
|
$ |
4.1 |
|
|
$ |
(0.3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales of mortgage-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains |
|
|
0.3 |
|
|
|
— |
|
|
|
10.0 |
|
|
|
— |
|
Losses |
|
|
(0.1 |
) |
|
|
(0.1 |
) |
|
|
(9.0 |
) |
|
|
(0.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other-than-temporary impairment losses |
|
|
— |
|
|
|
— |
|
|
|
(2.2 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other expense |
|
|
— |
|
|
|
— |
|
|
|
(0.6 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
(11.5 |
) |
|
$ |
0.5 |
|
|
$ |
2.3 |
|
|
$ |
(0.4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The fluctuation in net realized and unrealized gains (losses) on derivative instruments for
the three and nine months ended September 30, 2006 is primarily due to our decision to discontinue
the use of hedge accounting as of January 1, 2006, and therefore all changes in value of derivative
instruments that had previously been accounted for under hedge accounting are recognized in other
income or expense. During the nine months ended September 30, 2006, we sold mortgage-backed
securities totaling $3.8 billion, primarily as a result of repositioning our balance sheet. During
the three months ended September 30, 2005, we sold $136.3 million of mortgage-backed securities to
reduce leverage and rebalance our portfolios. Other income for the nine months ended September 30,
2006, includes other-than-temporary impairment losses on mortgage-backed securities in our Spread
portfolio related to certain Spread assets that we did not intend to hold until their maturity or
their unrealized losses recovered.
Operating expenses for the three months ended September 30, 2006 and 2005 were $16.6 million
and $3.4 million, respectively. For the nine months ended September 30, 2006 and 2005, operating
expenses were $31.5 million and $9.7 million, respectively. The year-over-year increases in
operating expenses are primarily due to increased operating expenses that are required to manage
our Residential Mortgage Credit strategy as well as increased management compensation and incentive
compensation expenses related to the termination of the Amended Agreement with SCM.
During the quarter ended September 30, 2006, we completed our transition to full internal
management after reaching agreement with SCM to terminate the Amended Agreement described below.
Because the Amended Agreement has been terminated, we are no longer required to make regular
quarterly “minimum” payments to SCM through 2007, nor do we need to accrue future incentive
compensation expense for SCM. Instead, we will pay SCM a total of $5.8 million in cash in three
equal installments: the first installment of $1.9 million was paid on September 29, 2006; the
second installment of $1.9 million was paid on October 31, 2006; and the third installment of $1.9
million will be paid on or before January 2, 2007 in connection with the termination of the Amended
Agreement. As of September 26, 2006, we also accelerated the vesting of 138,233 shares of
restricted common stock issued to SCM.
Base management compensation for the three and nine months ended September 30, 2006 was $5.5
million and $6.9 million, respectively, including the installment payments due to SCM related to
the termination agreement described above. Base management compensation for the three and nine
months ended September 30, 2005 was $1.1 million and $3.3 million, respectively. Pursuant to the
Amended Agreement, base management compensation due to SCM was calculated based on a percentage of
our average net worth that was managed by SCM, and also was subject to a minimum fee. The amount
of assets managed by SCM decreased substantially during the first quarter of 2006 and further
decreased in the second and third quarters of 2006 as a result of redeploying assets from the
Spread portfolio managed by SCM into our other portfolios. Consequently, the base management fee
calculated pursuant to
32
the “average net worth” formula was lower than the minimum fee payment due
to SCM of $0.7 million for the first and second quarters of 2006. As a result, $1.4 million of the
base management compensation expense for the nine months ended September 30, 2006 represents the
minimum fee due to SCM.
Incentive compensation expense for the three and nine months ended September 30, 2006 was $0.5
million and $0.7 million, respectively. Incentive compensation expense for the three and nine
months ended September 30, 2005 was $0.2 million and $1.1 million, respectively. Under the Amended
Agreement, SCM did not earn any incentive compensation during the three and nine months ended
September 30, 2006 and 2005. The incentive compensation expense during the three and nine months
ended September 30, 2006 and 2005 related primarily to restricted common stock awards granted for
incentive compensation earned in prior periods that vested during the periods. The incentive
compensation expense for the three and nine months ended September 30, 2006 also includes the final
vesting of all of the restricted stock awards granted to SCM earned in prior periods in connection
with the termination agreement. Effective September 30, 2006, we will no longer recognize incentive
compensation expense related to restricted stock awards granted to SCM.
Servicing expense, which is a required expense for all of our mortgage loans
held-for-investment, was $3.5 million and $7.5 million for the three and nine months ended
September 30, 2006, respectively, and was $47 thousand for each of the same periods in 2005. In
addition, salaries and benefits were $2.9 million and $7.4 million during the three and nine months
ended September 30, 2006, respectively, versus $0.8 million and $1.7 million during the three and
nine months ended September 30, 2005, respectively, and reflects the addition of three new
employees during the fourth quarter of 2005 and 15 new employees during the first nine months of
2006. In addition, for three and nine months ended September 30, 2006, we recorded a provision for
loan losses of $1.8 million and $3.3 million, respectively, based on an analysis of our portfolio
of loans held-for-investment at the end of the second and third quarters of 2006.
We have a taxable REIT subsidiary that receives management fees in exchange for various
advisory services provided in conjunction with our investment strategies. The taxable REIT
subsidiary is subject to corporate income taxes on its taxable income at a combined federal and
state tax rate of 41%. The same taxable REIT subsidiary is subject to the Pennsylvania Capital
Stock and Franchise Tax as well as a Philadelphia Gross Receipts Tax and Philadelphia Net Income
Tax. In addition, we have a taxable REIT subsidiary that purchases mortgage loans and creates
securitization entities as a means of securing long-term collateralized financing. This taxable
REIT subsidiary is subject to corporate income taxes on its taxable income at a combined federal
and state tax rate of 41%.
For the three and nine months ended September 30, 2006, our current provision for corporate
net income tax was $0.4 million and $1.1 million, respectively. We made no provisions for income
taxes during the three and nine months ended September 30, 2005.
REIT taxable net income
We calculate REIT taxable net income according to the requirements of the Code, rather than
GAAP. We believe that REIT taxable net income is an important measure of our financial performance
because REIT taxable net income, and not GAAP net income, is the basis upon which we make our cash
distributions that enable us to maintain our REIT status.
We estimate our REIT taxable net income at certain times during the course of each fiscal year
based upon a variety of information from third parties, although we do not receive some of this
information before we complete our estimates. As a result, our REIT taxable net income estimates
during the course of each fiscal year are subject to adjustments to reflect not only the subsequent
receipt of new information as to future events but also the subsequent receipt of information as to
past events. Our REIT taxable net income is also subject to changes in the Code, or in the
interpretation of the Code, with respect to our business model. REIT taxable net income for each
fiscal year does not become final until we file our tax return for that fiscal year.
33
The following table reconciles our GAAP net income to our REIT taxable net income for the nine
months ended September 30, 2006 and September 30, 2005 (in thousands, except share and per share
amounts):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the Nine Months Ended September 30, 2006 |
|
|
For the Nine Months Ended September 30, 2005 |
|
| |
|
GAAP |
|
|
Adjustments |
|
|
REIT |
|
|
GAAP |
|
|
Adjustments |
|
|
REIT |
|
| |
|
Statement |
|
|
to GAAP |
|
|
Taxable |
|
|
Statement |
|
|
to GAAP |
|
|
Taxable |
|
| |
|
of |
|
|
Statement of |
|
|
Statement of |
|
|
of |
|
|
Statement of |
|
|
Statement of |
|
| |
|
Operations |
|
|
Operations |
|
|
Operations |
|
|
Operations |
|
|
Operations |
|
|
Operations |
|
Net Interest Income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread portfolio |
|
$ |
69,757 |
|
|
$ |
(7,904 |
) |
|
$ |
61,853 |
|
|
$ |
126,906 |
|
|
$ |
— |
|
|
$ |
126,906 |
|
Mortgage loan and
securitization portfolio |
|
|
133,667 |
|
|
|
(80,070 |
) |
|
|
53,597 |
|
|
|
715 |
|
|
|
(4 |
) |
|
|
711 |
|
Credit sensitive bond portfolio |
|
|
28,176 |
|
|
|
(68 |
) |
|
|
28,108 |
|
|
|
3,703 |
|
|
|
— |
|
|
|
3,703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income |
|
|
231,600 |
|
|
|
(88,042 |
) |
|
|
143,558 |
|
|
|
131,324 |
|
|
|
(4 |
) |
|
|
131,320 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
|
172,633 |
|
|
|
(76,432 |
) |
|
|
96,201 |
|
|
|
90,878 |
|
|
|
182 |
|
|
|
91,060 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income |
|
|
58,967 |
|
|
|
(11,610 |
) |
|
|
47,357 |
|
|
|
40,446 |
|
|
|
(186 |
) |
|
|
40,260 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Income (expense): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized and unrealized gains
(losses) on derivative
instruments |
|
|
4,087 |
|
|
|
(4,087 |
) |
|
|
— |
|
|
|
(311 |
) |
|
|
311 |
|
|
|
— |
|
Gains (losses) on sales of
mortgage-backed securities |
|
|
990 |
|
|
|
(990 |
) |
|
|
— |
|
|
|
(69 |
) |
|
|
69 |
|
|
|
— |
|
Impairment losses on
mortgage-backed securities |
|
|
(2,179 |
) |
|
|
2,179 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Other income (expense) |
|
|
(608 |
) |
|
|
405 |
|
|
|
(203 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other income (expense) |
|
|
2,290 |
|
|
|
(2,493 |
) |
|
|
(203 |
) |
|
|
(380 |
) |
|
|
380 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Management compensation expense
to related party |
|
|
6,921 |
|
|
|
(3,942 |
) |
|
|
2,979 |
|
|
|
3,254 |
|
|
|
— |
|
|
|
3,254 |
|
Incentive compensation expense to
related parties |
|
|
791 |
|
|
|
1,706 |
|
|
|
2,497 |
|
|
|
1,128 |
|
|
|
(502 |
) |
|
|
626 |
|
Salaries and benefits |
|
|
7,375 |
|
|
|
(650 |
) |
|
|
6,725 |
|
|
|
1,702 |
|
|
|
(240 |
) |
|
|
1,462 |
|
Servicing expense |
|
|
7,546 |
|
|
|
(6,231 |
) |
|
|
1,315 |
|
|
|
47 |
|
|
|
— |
|
|
|
47 |
|
Provision for loan losses |
|
|
3,304 |
|
|
|
(3,304 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Professional services |
|
|
2,181 |
|
|
|
(176 |
) |
|
|
2,005 |
|
|
|
1,588 |
|
|
|
— |
|
|
|
1,588 |
|
Board of directors expense |
|
|
301 |
|
|
|
— |
|
|
|
301 |
|
|
|
351 |
|
|
|
— |
|
|
|
351 |
|
Insurance expense |
|
|
444 |
|
|
|
— |
|
|
|
444 |
|
|
|
415 |
|
|
|
— |
|
|
|
415 |
|
Custody expense |
|
|
324 |
|
|
|
(62 |
) |
|
|
262 |
|
|
|
319 |
|
|
|
— |
|
|
|
319 |
|
Other general and administrative
expenses |
|
|
2,265 |
|
|
|
79 |
|
|
|
2,344 |
|
|
|
890 |
|
|
|
387 |
|
|
|
1,277 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses |
|
|
31,452 |
|
|
|
(12,580 |
) |
|
|
18,872 |
|
|
|
9,694 |
|
|
|
(355 |
) |
|
|
9,339 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes |
|
|
29,805 |
|
|
|
(1,523 |
) |
|
|
28,282 |
|
|
|
30,372 |
|
|
|
549 |
|
|
|
30,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes |
|
|
1,057 |
|
|
|
(1,038 |
) |
|
|
19 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
28,748 |
|
|
$ |
(485 |
) |
|
$ |
28,263 |
|
|
$ |
30,372 |
|
|
$ |
549 |
|
|
$ |
30,921 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share — basic |
|
$ |
0.74 |
|
|
|
|
|
|
|
|
|
|
$ |
0.79 |
|
|
|
|
|
|
|
|
|
Net income per share — diluted |
|
$ |
0.74 |
|
|
|
|
|
|
|
|
|
|
$ |
0.79 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average number of shares
outstanding – basic |
|
|
38,937,454 |
|
|
|
|
|
|
|
|
|
|
|
38,478,679 |
|
|
|
|
|
|
|
|
|
Weighted-average number of shares
outstanding – diluted |
|
|
39,066,406 |
|
|
|
|
|
|
|
|
|
|
|
38,615,869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REIT taxable net income per share |
|
|
|
|
|
|
|
|
|
$ |
0.71 |
|
|
|
|
|
|
|
|
|
|
$ |
0.78 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average shares outstanding on
dividend record dates during the
year |
|
|
|
|
|
|
|
|
|
|
39,652,028 |
|
|
|
|
|
|
|
|
|
|
|
39,775,656 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34
Our net interest spread on a REIT taxable net income basis, net of servicing expense, was
1.13% and 0.95% for the nine months ended September 2006 and September 2005, respectively.
Undistributed REIT taxable net income for the nine months ended September 30, 2006 and 2005
was as follows (dollars in thousands, except per share data):
| |
|
|
|
|
|
|
|
|
| |
|
Nine Months |
|
|
Nine Months |
|
| |
|
Ended |
|
|
Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2006 |
|
|
2005 |
|
Undistributed REIT taxable net income, beginning of period |
|
$ |
3,154 |
|
|
$ |
1,794 |
|
REIT taxable net income earned during period |
|
|
28,263 |
|
|
|
30,921 |
|
Distributions declared during period, net of dividend
equivalent rights on restricted stock |
|
|
(21,742 |
) |
|
|
(28,750 |
) |
Other adjustments |
|
|
(214 |
) |
|
|
— |
|
|
|
|
|
|
|
|
Undistributed REIT taxable net income, end of period |
|
$ |
9,461 |
|
|
$ |
3,965 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash distributions per share declared during period |
|
$ |
0.55 |
|
|
$ |
0.74 |
|
|
|
|
|
|
|
|
Percentage of REIT taxable net income distributed |
|
|
76.9 |
% |
|
|
93.0 |
% |
|
|
|
|
|
|
|
On October 10, 2006, we declared a special cash dividend of $0.075 per share
(approximately $3.6 million) payable on November 10, 2006 to stockholders of record on October 20,
2006.
We believe that these presentations of our REIT taxable net income are useful to investors
because they are directly related to the distributions we make in order to retain our REIT status.
REIT taxable net income entails certain limitations, and, by itself, is an incomplete measure of
our financial performance over any period. As a result, our REIT taxable net income should be
considered in addition to, and not as a substitute for, our GAAP-based net income as a measure of
our financial performance.
Financial Condition
Mortgage Assets
Mortgage-backed securities
At September 30, 2006 and December 31, 2005, we held $2.1 billion and $4.4 billion,
respectively, of mortgage-backed securities. As previously announced, we have changed our
investment strategy to make it less interest-rate sensitive, and thereby have redeployed assets
from our Spread portfolio to our Residential Mortgage Credit portfolio.
35
The following table presents our mortgage-backed securities at September 30, 2006 and December
31, 2005 classified as either Residential Mortgage Credit portfolio assets or Spread portfolio
assets and further classified by type of issuer and/or by rating categories.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
September 30, 2006 |
|
|
December 31, 2005 |
|
| |
|
|
|
|
|
Percentage |
|
|
|
|
|
|
Percentage |
|
| |
|
|
|
|
|
of Total |
|
|
|
|
|
|
of Total |
|
| |
|
|
|
|
|
Mortgage- |
|
|
|
|
|
|
Mortgage- |
|
| |
|
Market |
|
|
backed |
|
|
Market |
|
|
backed |
|
| (dollars in thousands) |
|
Value |
|
|
securities |
|
|
Value |
|
|
securities |
|
Residential Mortgage Credit Portfolio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade MBS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA/Aa rating |
|
$ |
106,937 |
|
|
|
5.0 |
% |
|
$ |
30,623 |
|
|
|
0.7 |
% |
A/A rating |
|
|
236,402 |
|
|
|
11.2 |
|
|
|
64,957 |
|
|
|
1.5 |
|
BBB/Baa rating |
|
|
123,295 |
|
|
|
5.8 |
|
|
|
28,546 |
|
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investment-grade MBS |
|
|
466,634 |
|
|
|
22.0 |
|
|
|
124,126 |
|
|
|
2.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average credit rating |
|
|
A |
|
|
|
|
|
|
|
A |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-investment-grade MBS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BB/Ba rating |
|
|
124,868 |
|
|
|
5.9 |
|
|
|
121,128 |
|
|
|
2.8 |
|
Not rated |
|
|
9,010 |
|
|
|
0.4 |
|
|
|
20,818 |
|
|
|
0.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-investment-grade MBS |
|
|
133,878 |
|
|
|
6.3 |
|
|
|
141,946 |
|
|
|
3.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average credit rating (1) |
|
|
BB |
|
|
|
|
|
|
|
BB+ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Residential Mortgage Credit portfolio |
|
|
600,512 |
|
|
|
28.3 |
|
|
|
266,072 |
|
|
|
6.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average credit rating (1) |
|
|
A- |
|
|
|
|
|
|
|
BBB |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Portfolio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency MBS |
|
|
121,764 |
|
|
|
5.7 |
|
|
|
1,203,255 |
|
|
|
27.6 |
|
AAA/Aaa rating |
|
|
1,396,264 |
|
|
|
65.9 |
|
|
|
2,890,276 |
|
|
|
66.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Spread portfolio |
|
|
1,518,028 |
|
|
|
71.7 |
|
|
|
4,093,531 |
|
|
|
93.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average credit rating |
|
|
AAA |
|
|
|
|
|
|
|
AAA |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total mortgage-backed securities |
|
$ |
2,118,540 |
|
|
|
100.0 |
% |
|
$ |
4,359,603 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average credit rating |
|
|
AA |
|
|
|
|
|
|
|
AA+ |
|
|
|
|
|
|
|
|
| (1) |
|
Weighted-average credit rating excludes non-rated mortgage-backed securities of
$9.0 million and $20.8 million at September 30, 2006 and December 31, 2005,
respectively. |
Loans held-for-investment
At September 30, 2006 and December 31, 2005, our residential mortgage loans
held-for-investment totaled $4.2 billion and $0.5 billion, respectively, including unamortized
premium of $84.1 million and $0.7 million, respectively. Our residential mortgage loans at
September 30, 2006 are comprised of $4.1 billion of adjustable-rate and hybrid adjustable-rate
mortgage loans that collateralize debt obligations and $1.9 million of adjustable-rate mortgage
loans pending securitization. Our residential mortgage loans at December 31, 2005 were comprised
of $0.5 billion of hybrid adjustable-rate mortgage loans that collateralized debt obligations. We
intend to securitize subsequent acquisitions of loans, maintain those loans as held-for-investment
on our consolidated balance sheet and account for the securitizations as financings under SFAS No.
140.
36
At September 30, 2006, our residential mortgage loans held-for-investment consisted of the
following (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Months to |
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Reset of |
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans After |
|
|
|
|
|
|
Principal |
|
|
Loans |
|
| |
|
Weighted- |
|
|
Weighted- |
|
|
Weighted- |
|
|
Effect of |
|
|
|
|
|
|
Amount of |
|
|
Delinquent > |
|
| |
|
Average |
|
|
Average |
|
|
Average |
|
|
Cost of |
|
|
|
|
|
|
Loans |
|
|
90 days as a |
|
| |
|
Interest |
|
|
Maturity |
|
|
Months to |
|
|
Funds |
|
|
Principal |
|
|
Delinquent |
|
|
Percentage of |
|
| Description |
|
Rate |
|
|
Date |
|
|
Reset |
|
|
Hedging (1) |
|
|
Balance |
|
|
> 90 days |
|
|
Total Principal |
|
Floating rate mortgage |
|
7.68% |
|
2036 |
|
1 |
|
1 |
|
$ |
3,409,000 |
|
|
$ |
9,377 |
|
|
0.23% |
3-Year hybrid mortgage |
|
6.28% |
|
2036 |
|
28 |
|
20 |
|
|
77,573 |
|
|
|
679 |
|
|
0.02% |
5-Year hybrid mortgage |
|
6.25% |
|
2035 |
|
50 |
|
23 |
|
|
629,555 |
|
|
|
7,508 |
|
|
0.18% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
7.44% |
|
2036 |
|
9 |
|
5 |
|
$ |
4,116,128 |
|
|
$ |
17,564 |
|
|
0.43% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
We attempt to mitigate our interest rate risk by hedging the cost of liabilities
related to our 3-year and 5-year hybrid residential mortgage loans. Amounts reflect the
effect of these hedges on the months to reset of our residential mortgage loans. In
addition, the financing for $278.5 million of our 3-year and 5-year hybrid residential
mortgage loans is, like the underlying collateral, fixed for a period of three to five
years then becomes variable based upon the average rates of the underlying loans which will
adjust based on LIBOR. The weighted-average period to reset of the debt we use to acquire
residential mortgage loans was match funded approximately 5 months at September 30, 2006. |
At December 31, 2005, our residential loans held-for-investment consisted of the
following (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Months to |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Reset of |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans After |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted- |
|
|
Weighted- |
|
|
Effect of |
|
|
|
|
|
|
Principal |
|
| |
|
Weighted- |
|
|
Average |
|
|
Average |
|
|
Cost of |
|
|
|
|
|
|
Amount of Loans |
|
| |
|
Average |
|
|
Maturity |
|
|
Months to |
|
|
Funds |
|
|
Principal |
|
|
Delinquent |
|
| Description |
|
Interest Rate |
|
|
Date |
|
|
Reset |
|
|
Hedging (1) |
|
|
Balance |
|
|
> 90 days |
|
3-Year hybrid mortgage |
|
5.83% |
|
2035 |
|
34 |
|
2 |
|
$ |
32,890 |
|
|
$ |
— |
|
5-Year hybrid mortgage |
|
6.11% |
|
2035 |
|
57 |
|
2 |
|
|
473,608 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
6.09% |
|
2035 |
|
56 |
|
2 |
|
$ |
506,498 |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
We attempt to mitigate our interest rate risk by hedging the cost of liabilities
related to our 3-year and 5-year hybrid residential mortgage loans. Amounts reflect the
effect of these hedges on the months to reset of our residential mortgage loans. The
weighted-average period to reset of the debt we use to acquire residential mortgage loans
was match funded approximately one month at December 31, 2005. |
37
The following table summarizes key metrics of our loans held-for-investment at September
30, 2006 (dollars in thousands):
| |
|
|
|
|
Unpaid principal balance |
|
$ |
4,116,128 |
|
Number of loans |
|
|
10,504 |
|
Average loan balance |
|
$ |
392 |
|
Weighted-average coupon rate |
|
|
7.44 |
% |
Weighted-average lifetime cap |
|
|
10.45 |
% |
Weighted-average original term, in months |
|
|
368 |
|
Weighted-average remaining term, in months |
|
|
360 |
|
Weighted-average loan-to-value ratio (LTV) |
|
|
75.7 |
% |
Weighted-average FICO score |
|
|
711 |
|
Top five geographic concentrations (% exposure): |
|
|
|
|
California |
|
|
59.8 |
% |
Florida |
|
|
8.3 |
% |
Arizona |
|
|
4.2 |
% |
Virginia |
|
|
3.7 |
% |
Nevada |
|
|
3.2 |
% |
Occupancy status: |
|
|
|
|
Owner occupied |
|
|
87.2 |
% |
Investor |
|
|
12.8 |
% |
Property type: |
|
|
|
|
Single-family |
|
|
84.0 |
% |
Condominium |
|
|
9.9 |
% |
Other residential |
|
|
6.1 |
% |
Collateral type: |
|
|
|
|
Alt A – first lien |
|
|
100.0 |
% |
The following table summarizes key metrics of our loans held-for-investment at December
31, 2005 (dollars in thousands):
| |
|
|
|
|
Unpaid principal balance |
|
$ |
506,498 |
|
Number of loans |
|
|
1,163 |
|
Average loan balance |
|
$ |
436 |
|
Weighted-average coupon rate |
|
|
6.09 |
% |
Weighted-average lifetime cap |
|
|
11.31 |
% |
Weighted-average original term, in months |
|
|
360 |
|
Weighted-average remaining term, in months |
|
|
357 |
|
Weighted-average loan-to-value ratio (LTV) |
|
|
75.1 |
% |
Weighted-average FICO score |
|
|
712 |
|
Top five geographic concentrations (% exposure): |
|
|
|
|
California |
|
|
38.9 |
% |
Virginia |
|
|
11.1 |
% |
Florida |
|
|
8.5 |
% |
Arizona |
|
|
6.2 |
% |
Maryland |
|
|
5.4 |
% |
Occupancy status: |
|
|
|
|
Owner occupied |
|
|
93.7 |
% |
Investor |
|
|
6.3 |
% |
Property type: |
|
|
|
|
Single-family |
|
|
87.0 |
% |
Condominium |
|
|
9.7 |
% |
Other residential |
|
|
3.3 |
% |
Collateral type: |
|
|
|
|
Alt A-first lien |
|
|
100.0 |
% |
At September 30, 2006, 31 of the 10,504 loans in our $4.1 billion residential mortgage
loan portfolio were 90 days or more delinquent with an aggregate balance of $17.6 million,
representing 43 basis points (0.43%) of the residential mortgage loan portfolio, and were on
non-accrual status. At December 31, 2005, we had no loans that were 90 days or more delinquent and
all of our loans were accruing interest.
We performed an allowance for loan losses analysis as of September 30, 2006 and recorded a
$1.8 million and $3.3 million provision for loan losses for the three months and nine months ended
September 30, 2006,
38
respectively, representing 8 basis points (0.08%) of the residential mortgage
portfolio. Our allowance for loan losses was established using industry experience and rating
agency projections for loans with characteristics which are broadly similar to our portfolio. This
analysis begins with actual 60 day or more delinquencies in our portfolio, and projects ultimate
default experience (i.e., the rate at which loans will go to liquidation) on those loans based on
industry loan delinquency migration statistics. For all loans showing indications of probable
default, we apply a “severity” factor for each loan, again using loss severity projections from a
model developed by a major rating agency for loans broadly similar to the loans in our portfolio.
Management then uses judgment to ensure all relevant factors that could affect our loss levels are
considered and would adjust the allowance for doubtful accounts if we believe that an adjustment is
warranted. This analysis was the basis for our $2.5 million general allocated allowance at
September 30, 2006. Seriously delinquent loans with balances greater than $1.0 million are
evaluated individually. Loans are considered impaired when, based on current information, it is
probable that we will be unable to collect all amounts due according to the contractual terms of
the loan agreement, including interest payments. Impaired loans are carried at the lower of the
recorded investment in the loan or the fair value of the collateral less costs to dispose of the
property. We recorded a specific reserve for loans meeting these criteria of $0.8 million at
September 30, 2006. We did not record an unallocated allowance for loan losses at September 30,
2006 as we did not identify any factors in the portfolio which warranted such an allowance.
We performed an allowance for loan losses analysis as of December 31, 2005, and we made a
determination that no allowance for loan losses was required for our residential mortgage loan
portfolio as of December 31, 2005. Charge-offs for the three months and nine months ended
September 30, 2006 totaling $15 thousand were recorded in our residential mortgage loan portfolio.
Mortgage-Backed Notes
We create securitization entities as a means of securing long-term collateralized financing
for our residential mortgage loan portfolio, matching the income earned on residential mortgage
loans with the cost of related liabilities, otherwise referred to as “match-funding” our balance
sheet. We may use derivative instruments, such as interest rate swaps to achieve this result.
Residential mortgage loans are transferred to a separate bankruptcy-remote legal entity from which
private-label multi-class mortgage-backed securities are issued. These mortgage-backed securities
are carried at their unpaid principal balances net of any unamortized discount or premium. On a
consolidated basis, securitizations are accounted for as secured financings as defined by SFAS No.
140 and, therefore, no gain or loss is recorded in connection with the securitizations. The
treatment of securitization transactions can be different for taxation purposes than under GAAP.
Each securitization entity was evaluated in accordance with FIN 46(R), and we have determined that
we are the primary beneficiary of the securitization entities. As such, the securitization
entities are consolidated into our consolidated balance sheet subsequent to securitization.
Residential mortgage loans transferred to securitization entities collateralize the mortgage-backed
securities issued, and, as a result, those investments are not available to us, our creditors or
stockholders. All discussions relating to securitizations are on a consolidated basis and do not
necessarily reflect the separate legal ownership of the loans by the related bankruptcy-remote
legal entity.
During the third quarter of 2006, we issued approximately $772.7 million of mortgage-backed
notes. We retained $19.3 million of the resulting securities for our securitized residential loan
portfolio and placed $753.4 million with third-party investors. During the nine months ended
September 30, 2006, we issued approximately $3.8 billion of mortgage-backed notes. We retained
$767.3 million of the resulting securities for our securitized residential loan portfolio and
placed $3.1 billion with third-party investors. All of the mortgage-backed notes issued were
priced with interest indexed to one-month LIBOR except for $0.3 billion of the notes which, like
the underlying loan collateral, are fixed for a period of 3 to 5 years then become variable based
on the average rates of the underlying loans which will adjust based on LIBOR. We did not issue
mortgage-backed notes during the three and nine months ended September 30, 2005.
At September 30, 2006 and December 31, 2005, we had mortgage-backed notes with an outstanding
balance of $3.3 billion and $0.5 billion, respectively, and with a weighted-average borrowing rate
of 5.59% and 4.66% per annum, respectively. The borrowing rates of the mortgage-backed notes reset
monthly based on LIBOR except for $0.3 billion of notes as previously explained. Unpaid interest
on the mortgage-backed notes was $3.8
39
million and $0.3 million at September 30, 2006 and December
31, 2005, respectively. Net unamortized premium on the mortgage-backed notes was $2.8 million at
September 30, 2006 and there was no unamortized premium at December 31, 2005. The stated
maturities of the mortgage-backed notes at September 30, 2006 were from 2035 to 2046, and, at
December 31, 2005, were 2035. At September 30, 2006 and December 31, 2005, residential mortgage
loans with an estimated fair value of $3.3 billion and $0.5 billion, respectively, were pledged as
collateral for mortgage-backed notes issued.
Each series of mortgage-backed notes that we issued consisted of various classes of securities
that bear interest at varying spreads to the underlying interest rate index. The maturity of each
class of securities is directly affected by the rate of principal repayments on the associated
residential mortgage loan collateral. As a result, the actual maturity of each series of
mortgage-backed notes may be shorter than its stated maturity.
The following table highlights the securitizations we have completed through September 30,
2006, as of each transaction execution date (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
|
Total |
| |
|
2005-1 |
|
2006-1 |
|
2006-2 |
|
2006-3 |
|
2006-4 |
|
2006-5 |
|
2006-6 |
|
Portfolio |
Loans, unpaid
principal balance |
|
$ |
520,568 |
|
|
$ |
576,122 |
|
|
$ |
801,474 |
|
|
$ |
682,535 |
|
|
$ |
497,220 |
|
|
$ |
508,789 |
|
|
$ |
772,732 |
|
|
$ |
4,359,440 |
|
Mortgage-backed
notes issued to
third parties |
|
|
500,267 |
|
|
|
536,657 |
|
|
|
746,973 |
|
|
|
654,270 |
|
|
|
376,148 |
|
|
|
— |
|
|
|
753,415 |
|
|
|
3,567,730 |
|
Debt retained |
|
|
20,301 |
|
|
|
39,465 |
|
|
|
54,501 |
|
|
|
28,265 |
|
|
|
121,072 |
|
|
|
508,789 |
|
|
|
19,317 |
|
|
|
791,710 |
|
Retained investment
grade % (1) |
|
|
3.1 |
% |
|
|
3.9 |
% |
|
|
3.7 |
% |
|
|
2.9 |
% |
|
|
21.1 |
% |
|
|
97.2 |
% |
|
|
1.0 |
% |
|
|
16.0 |
% |
Retained
non-investment
grade % (1) |
|
|
0.8 |
% |
|
|
3.0 |
% |
|
|
3.1 |
% |
|
|
1.3 |
% |
|
|
3.2 |
% |
|
|
2.8 |
% |
|
|
1.5 |
% |
|
|
2.2 |
% |
Cost of debt on
AAA-rated
mortgage-backed
notes – spread to
LIBOR (2) |
|
|
0.27 |
% |
|
|
0.28 |
% |
|
|
0.22 |
% |
|
|
0.23 |
% |
|
|
0.21 |
% |
|
|
0.21 |
% |
|
|
0.22 |
% |
|
|
0.23 |
% |
|
|
|
| (1) |
|
Retained tranches as a percentage of total mortgage-backed notes issued. |
| |
| (2) |
|
LUM 2006-3 cost of debt excludes $267.4 million of AAA mortgage-backed notes which, like the
underlying loan collateral, are fixed for three to five years then become variable based upon
the average rates of the underlying loans which will adjust based on LIBOR. |
40
The following table presents the rating categories of the mortgage-backed securities
issued in our securitizations completed through September 30, 2006, as of each execution date
(dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
LUM |
|
|
LUM |
|
|
LUM |
|
|
LUM |
|
|
LUM |
|
|
LUM |
|
|
LUM |
|
|
Total |
|
| |
|
2005-1 |
|
|
2006-1 |
|
|
2006-2 |
|
|
2006-3 |
|
|
2006-4 |
|
|
2006-5 |
|
|
2006-6 |
|
|
Portfolio |
|
Transaction
execution date |
|
|
11/2/05 |
|
|
|
1/26/06 |
|
|
|
2/23/06 |
|
|
|
4/28/06 |
|
|
|
5/28/06 |
|
|
|
6/29/06 |
|
|
|
9/28/06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed notes issued
to third-party investors |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA/Aaa rating |
|
$ |
482,307 |
|
|
$ |
517,069 |
|
|
$ |
717,320 |
|
|
$ |
597,700 |
|
|
$ |
376,148 |
|
|
$ |
— |
|
|
$ |
712,846 |
|
|
$ |
3,403,390 |
|
AA/Aa rating |
|
|
17,960 |
|
|
|
19,588 |
|
|
|
29,653 |
|
|
|
56,570 |
|
|
|
— |
|
|
|
— |
|
|
|
29,364 |
|
|
|
153,135 |
|
A/A rating |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
11,205 |
|
|
|
11,205 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Mortgage-backed notes
issues to third-party
investors |
|
$ |
500,267 |
|
|
$ |
536,657 |
|
|
$ |
746,973 |
|
|
$ |
654,270 |
|
|
$ |
376,148 |
|
|
$ |
— |
|
|
$ |
753,415 |
|
|
$ |
3,567,730 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total collateral |
|
|
96.1 |
% |
|
|
93.1 |
% |
|
|
93.2 |
% |
|
|
95.9 |
% |
|
|
75.7 |
% |
|
|
— |
|
|
|
97.5 |
% |
|
|
81.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt retained |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA/Aaa rating |
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
66,378 |
|
|
$ |
457,910 |
|
|
$ |
— |
|
|
$ |
524,288 |
|
AA/Aa rating |
|
|
6,767 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
18,397 |
|
|
|
21,369 |
|
|
|
— |
|
|
|
46,533 |
|
A/A rating |
|
|
4,165 |
|
|
|
13,251 |
|
|
|
18,434 |
|
|
|
9,852 |
|
|
|
12,430 |
|
|
|
9,667 |
|
|
|
3,864 |
|
|
|
71,663 |
|
BBB/Bbb rating |
|
|
5,206 |
|
|
|
8,930 |
|
|
|
11,221 |
|
|
|
9,649 |
|
|
|
7,707 |
|
|
|
5,851 |
|
|
|
3,864 |
|
|
|
52,428 |
|
BB/Ba rating |
|
|
1,301 |
|
|
|
7,202 |
|
|
|
10,419 |
|
|
|
1,879 |
|
|
|
6,215 |
|
|
|
6,614 |
|
|
|
6,954 |
|
|
|
40,584 |
|
B/B rating |
|
|
— |
|
|
|
5,761 |
|
|
|
8,015 |
|
|
|
1,569 |
|
|
|
5,469 |
|
|
|
3,816 |
|
|
|
— |
|
|
|
24,630 |
|
Not rated |
|
|
— |
|
|
|
4,321 |
|
|
|
6,412 |
|
|
|
1,257 |
|
|
|
4,476 |
|
|
|
3,562 |
|
|
|
4,635 |
|
|
|
24,663 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total mortgage-backed notes
retained |
|
|
17,439 |
|
|
|
39,465 |
|
|
|
54,501 |
|
|
|
24,206 |
|
|
|
121,072 |
|
|
|
508,789 |
|
|
|
19,317 |
|
|
|
784,789 |
|
Overcollateralization |
|
|
2,862 |
|
|
|
— |
|
|
|
— |
|
|
|
4,059 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,922 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total debt retained |
|
$ |
20,301 |
|
|
$ |
39,465 |
|
|
$ |
54,501 |
|
|
$ |
28,265 |
|
|
$ |
121,072 |
|
|
$ |
508,789 |
|
|
$ |
19,317 |
|
|
$ |
791,710 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage of total collateral |
|
|
3.9 |
% |
|
|
6.9 |
% |
|
|
6.8 |
% |
|
|
4.1 |
% |
|
|
24.3 |
% |
|
|
100.0 |
% |
|
|
2.5 |
% |
|
|
18.2 |
% |
41
Asset Repricing Characteristics
The following table summarizes the repricing characteristics of our mortgage assets by
portfolio, and further classified by asset type and frequency of repricing of their coupon rate
(dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
September 30, 2006 |
|
|
December 31, 2005 |
|
| |
|
Carrying |
|
|
Portfolio |
|
|
Carrying |
|
|
Portfolio |
|
| |
|
Value |
|
|
Mix |
|
|
Value |
|
|
Mix |
|
Residential Mortgage Credit Portfolio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ARM residential loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reset 1 month or less |
|
$ |
3,409,000 |
|
|
|
54.0 |
% |
|
$ |
— |
|
|
|
— |
% |
Reset >1 month but < 12 months |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Reset >12 months but < 60
months |
|
|
707,128 |
|
|
|
11.2 |
|
|
|
506,498 |
|
|
|
10.4 |
|
Reset > 60 months |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Unamortized premium |
|
|
84,102 |
|
|
|
1.3 |
|
|
|
679 |
|
|
nm |
|
Allowance for loan losses |
|
|
(3,289 |
) |
|
nm |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total |
|
|
4,196,941 |
|
|
|
66.5 |
|
|
|
507,177 |
|
|
|
10.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ARM residential mortgage-backed
securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reset 1 month or less |
|
|
599,049 |
|
|
|
9.5 |
|
|
|
266,072 |
|
|
|
5.5 |
|
Reset >1 month but < 12 months |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Reset >12 months but < 60
months |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Reset > 60 months |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total |
|
|
599,049 |
|
|
|
9.5 |
|
|
|
266,072 |
|
|
|
5.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-rate residential mortgage-backed
securities: |
|
|
1,463 |
|
|
nm |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Spread Portfolio |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage-backed securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reset 1 month or less |
|
|
1,396,264 |
|
|
|
22.1 |
|
|
|
8,610 |
|
|
|
0.2 |
|
Reset >1 month but < 12 months |
|
|
121,764 |
|
|
|
1.9 |
|
|
|
476,828 |
|
|
|
9.8 |
|
Reset >12 months but < 60
months |
|
|
— |
|
|
|
— |
|
|
|
2,756,195 |
|
|
|
56.6 |
|
Reset > 60 months |
|
|
— |
|
|
|
— |
|
|
|
851,898 |
|
|
|
17.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sub-total |
|
|
1,518,028 |
|
|
|
24.0 |
|
|
|
4,093,531 |
|
|
|
84.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Mortgage Assets |
|
$ |
6,315,481 |
|
|
|
100.0 |
% |
|
$ |
4,866,780 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
nm = not meaningful
At September 30, 2006 and December 31, 2005, the weighted-average period to reset of our
total mortgage assets was six months and 2.8 years, respectively. We attempt to mitigate our
interest rate risk by hedging the cost of liabilities related to our 3-year and 5-year hybrid
residential mortgage loans. Our net asset/liability duration gap was approximately negative two
months at September 30, 2006. Our net asset/liability duration gap was approximately seven months
at December 31, 2005.
Total mortgage assets had a weighted-average coupon of 6.90% and 4.62% at September 30, 2006
and December 31, 2005, respectively.
Our mortgage assets are typically subject to periodic and lifetime interest rate caps.
Periodic interest rate caps limit the amount by which the interest rate on a mortgage can increase
during any given period. Lifetime interest rate caps limit the amount by which an interest rate can
increase through the term of a mortgage. The weighted-average lifetime cap of our mortgage-backed
securities was 11.84% and 9.23% at September 30, 2006 and December 31, 2005, respectively. The
weighted-average lifetime cap of our loans held-for-investment was 10.45% and 11.31% at September
30, 2006 and December 31, 2005, respectively.
The periodic adjustments to the interest rates of our mortgage assets are based on changes in
an objective index. Substantially all of our mortgage assets adjust their interest rates based on:
(1) the U.S. Treasury index, or
42
Treasury, which is a monthly or weekly average yield of benchmark
U.S. Treasury securities published by the Federal Reserve Board; (2) the London Interbank Offered
Rate, or LIBOR; (3) Moving Treasury Average, or MTA or (4) Cost of Funds Index, or COFI.
In addition, the financing for $278.5 million of our 3-year and 5-year hybrid residential
mortgage loans is, like the underlying collateral, fixed for a period of 3 to 5 years then becomes
variable based upon the average rates of the underlying loans which will adjust based on LIBOR.
The percentages of the mortgage assets in our investment portfolio at September 30, 2006 that
were indexed to interest rates were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
LIBOR |
|
Treasury |
|
MTA |
|
COFI |
Mortgage-backed
securities |
|
|
97 |
% |
|
|
3 |
% |
|
|
— |
% |
|
|
— |
% |
Loans held-for-investment |
|
|
19 |
|
|
|
— |
|
|
|
81 |
|
|
nm |
nm = not meaningful
The percentages of the mortgages assets in our investment portfolio at December 31, 2005
that were indexed to interest rates were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
LIBOR |
|
Treasury |
|
MTA |
|
COFI |
Mortgage-backed
securities |
|
|
65 |
% |
|
|
35 |
% |
|
|
— |
% |
|
|
— |
% |
Loans held-for-investment |
|
|
100 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
The principal payment rate on our total mortgage assets, an annual rate of principal
paydowns for our mortgage assets relative to the outstanding principal balance of our total
mortgage assets, was 16% and 33% for the three months ended September 30, 2006 and September 30,
2005, respectively. The principal payment rate attempts to predict the percentage of principal
that will paydown over the next 12 months based on historical principal paydowns. The principal
payment rate cannot be considered an indication of future principal repayment rates because actual
changes in market interest rates will have a direct impact on the principal prepayments in our
portfolio.
Liquidity and Capital Resources
At September 30, 2006, the primary source of funds for our loan origination and securitization
portfolio was $3.3 billion of non-recourse mortgage-backed notes, with a weighted-average borrowing
rate of 5.59%. In addition, we had a $500.0 million warehouse lending facility with Bear Stearns
Mortgage Capital Corporation that was established in October 2005, a $1.0 billion warehouse lending
facility with Greenwich Financial Products, Inc. that was established in January 2006 and a $1.0
billion warehouse lending facility with Barclays Bank plc that was established in July 2006. All
three warehouse lending facilities are structured as repurchase agreements. We also established a
$500 million warehouse lending facility with Greenwich Capital Financial Products, Inc. in September 2006 to
provide financing for our CDO business. There were no outstanding borrowings on our warehouse
lending facilities at September 30, 2006 or December 31, 2005.
The residential mortgage loans we acquire are initially financed with our warehouse lending
facilities, with the intention of ultimately securitizing the loans and financing them with
permanent non-recourse mortgage-backed notes. Proceeds from our securitizations are used to pay
down the outstanding balance of our warehouse lending facilities. We intend to match the income
that we earn on our mortgage loans, plus the benefit of any hedging activities, with the cost of
the liabilities related to our mortgage loans, a process known as “match-funding” our balance
sheet. In order to facilitate the securitization and permanent financing of our mortgage loans, we
will generally create subordinated certificates, providing a specified amount of credit
enhancement, which we intend to retain on our balance sheet.
43
Certain mortgage loans that we purchase permit negative amortization. A negative amortization
provision in a mortgage allows the borrower to defer payment of a portion or all of the monthly
interest accrued on the mortgage and to add the deferred interest amount to the mortgage’s
principal balance. As a result, during periods of negative amortization the principal balances of
negatively amortizing mortgages will increase and their weighted-average lives will extend.
Luminent’s mortgage loans generally can experience negative amortization to a maximum amount of
110-115% of the original mortgage loan balance. As a result, given the relatively low average
loan-to-value ratio of 76% on our portfolio, our portfolio would still have a significant
homeowners’ equity cushion even if all negatively-amortizing loans reached their maximum permitted
amount of negative amortization.
Luminent has structured all of its negatively amortizing mortgage loans into various
securitizations and has retained ownership in these securitizations in part or whole in the form of
mortgage-backed securities. These securitization structures effectively prevent the disbursement
of deferred interest which arises from negative amortization. Deferred interest increases the bond
balances of the securitization structure and is not disbursed from the structure.
Securitization structures allocate the principal payments and prepayments on mortgage loans,
including loans with negative amortization features. To date, prepayments on our mortgage loans
with negative amortization have been sufficient to offset negative amortization such that all our
securitization structures have made all their required payments to bond holders.
A reconciliation of the cash flows on our residential mortgage loans which have negatively
amortizing loans and the mortgage-backed notes backed by those residential mortgage loans during
the nine months ended September 30, 2006 was as follows (dollars in thousands):
| |
|
|
|
|
Principal payments received on residential mortgage loans |
|
$ |
182,267 |
|
Principal distributed to mortgage-backed note holders (1) |
|
|
(142,923 |
) |
|
|
|
|
Principal receipts used for interest payments on mortgage-backed notes |
|
|
39,344 |
|
|
|
|
|
|
Interest cash receipts on residential mortgage loans for interest and other fee income,
net of servicing and other reimbursements |
|
|
54,676 |
|
Interest payments to mortgage-backed note holders (1) |
|
|
(94,020 |
) |
|
|
|
|
Interest payments on mortgage-backed notes in excess of interest cash receipts |
|
|
(39,344 |
) |
|
|
|
|
|
|
|
|
|
Net cash flow |
|
$ |
— |
|
|
|
|
|
|
|
|
| (1) |
|
Amount includes principal and interest distributed on bonds retained by us. |
Our projections of estimated prepayments on negatively amortizing loans indicate that our
securitizations will continue to support required payments to the holders of the mortgage-backed
notes issued by us.
The primary source of funds used to finance our mortgage-backed securities at September 30,
2006 consisted of repurchase agreements totaling $2.5 billion with a weighted-average current
borrowing rate of 5.42%. We expect to continue to borrow funds for our mortgage-backed securities
through repurchase agreements. At September 30, 2006, we had established 20 borrowing arrangements
with various investment banking firms and other lenders, 13 of which were in use on September 30,
2006. Increases in short-term interest rates could negatively impact the valuation of our
mortgage-backed securities that we are financing with repurchase agreements, which could limit our
future borrowing ability or cause our repurchase agreement counterparties to initiate margin calls.
Amounts due upon maturity of our repurchase agreements will be funded primarily through the
rollover/reissuance of repurchase agreements and monthly principal and interest payments received
on our mortgage-backed securities. In August 2006, we established a $1.0 billion commercial paper
facility, Luminent Star Funding I, to fund its mortgage-backed security portfolio. Luminent Star
Funding is a single-seller commercial paper program that will provide a financing alternative to
repurchase agreement financing by issuing asset-backed secured liquidity notes that will be rated
by the rating agencies Standard & Poor’s and Moody’s. At September 30, 2006, there was no
outstanding balance on the commercial paper facility.
44
In September 2006, we entered into a $435 million term repurchase agreement with Barclays
Capital. We intend to use the facility to acquire AAA-rated mortgage-backed securities. The
facility has a term of up to two years and is expected to decrease our liquidity risk by reducing
our reliance on short-term repurchase agreement financing.
The following table describes the private-label, non-recourse multi-class mortgage-backed
notes that were issued to provide permanent funding of our residential mortgage loans in the nine
months ended September 30, 2006, as of each transaction execution date (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
|
LUM |
| |
|
2006-1 |
|
2006-2 |
|
2006-3 |
|
2006-4 |
|
2006-5 |
|
2006-6 |
Transaction execution date: |
|
|
1/26/06 |
|
|
|
2/23/06 |
|
|
|
4/28/06 |
|
|
|
5/28/06 |
|
|
|
6/29/06 |
|
|
|
9/28/06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans, unpaid principal
balance |
|
$ |
576,122 |
|
|
$ |
801,474 |
|
|
$ |
682,535 |
|
|
$ |
497,220 |
|
|
$ |
508,789 |
|
|
$ |
772,732 |
|
Mortgage-backed notes
issued to third parties |
|
|
536,657 |
|
|
|
746,973 |
|
|
|
654,270 |
|
|
|
376,148 |
|
|
|
— |
|
|
|
753,415 |
|
Debt retained |
|
|
39,465 |
|
|
|
54,501 |
|
|
|
28,265 |
|
|
|
121,072 |
|
|
|
508,789 |
|
|
|
19,317 |
|
At September 30, 2006, we had mortgage-backed notes totaling $3.3 billion with a
weighted-average borrowing rate of 5.59% per annum. The borrowing rates of the mortgage-backed
notes reset monthly based on one-month LIBOR with the exception of $0.3 billion of non-retained
mortgage-backed notes which, like the underlying loan collateral, are fixed for a period of 3 to 5
years then become variable based on the average rates of the underlying loans which will adjust
based on LIBOR.
We have a margin lending facility with our primary custodian from which we may borrow money in
connection with the purchase or sale of securities. The terms of the borrowings, including the
rate of interest payable, are agreed to with the custodian for each amount borrowed. Borrowings
are repayable upon demand by the custodian. No borrowings were outstanding under the margin
lending facility at September 30, 2006.
We employ a leverage strategy to increase our mortgage-related assets by borrowing against
existing mortgage-related assets and using the proceeds to acquire additional mortgage-related
assets. At September 30, 2006, the overall borrowing leverage ratio for our entire portfolio was
15.1 times.
For liquidity, we also rely on cash flows from operations, primarily monthly principal and
interest payments to be received on our mortgage-backed securities, as well as any primary
securities offerings authorized by our board of directors.
On November 6, 2006, we paid a cash distribution of $0.30 per share to our stockholders of
record on October 9, 2006. Additionally, on October 10, 2006, we declared a special cash dividend
of $0.075 per share, payable on November 10, 2006 to stockholders of record on October 20, 2006. On
July 24, 2006, we paid a cash distribution of $0.20 per share to our stockholders of record on June
22, 2006. On May 10, 2006, we paid a cash distribution of $0.05 per share to our stockholders of
record on April 10, 2006. These distributions are taxable dividends and not considered a return of
capital. We did not distribute $3.9 million of our REIT taxable net income for the year ended
December 31, 2005. We declared a spillback distribution in this amount during the quarter ended
September 30, 2006.
We believe that equity capital, combined with the cash flows from operations, securitizations
and the utilization of borrowings, will be sufficient to enable us to meet anticipated liquidity
requirements. If our cash resources are at any time insufficient to satisfy our liquidity
requirements, we may be required to liquidate mortgage-related assets or sell debt or additional
equity securities. If required, the sale of mortgage-related assets at prices lower than the
carrying value of such assets could result in losses and reduced income.
We have a shelf registration statement on Form S-3 that was declared effective by the SEC on
January 21, 2005. Under this shelf registration statement, we may offer and sell any combination
of common stock, preferred stock, warrants to purchase common stock or preferred stock and debt
securities in one or more offerings up to total
45
proceeds of $500.0 million. Each time we offer to
sell securities, a supplement to the prospectus will be provided containing specific information
about the terms of that offering. On February 7, 2005, we entered into a Controlled Equity Offering
Sales Agreement with Cantor Fitzgerald & Co., or Cantor Fitzgerald, through which we may sell
common stock or preferred stock from time to time through Cantor Fitzgerald acting as agent and/or
principal in privately negotiated and/or at-the-market transactions under this shelf registration
statement. During the three and nine months ended September 30, 2006, we sold approximately 1.4
million shares of common stock pursuant to this agreement resulting in net proceeds of
approximately $14.3 million. At September 30, 2006, total proceeds of up to $454.2 million remain
available to us to offer and sell under this shelf registration statement. Subsequent to September
30, 2006, we have sold approximately 0.3 million shares of common stock pursuant to the Cantor
Fitzgerald agreement resulting in net proceeds of approximately $2.9 million. In addition, on
October 13, 2006, we issued 6.9 million shares of our common stock at $10.25 per share as a result
of completing a public offering issued pursuant to this shelf registration statement. As a result
of these transactions, as of October 13, 2006, the remaining proceeds available to us to offer and
sell under this shelf registration statement was $380.5 million.
We have a shelf registration statement on Form S-3 with respect to our Direct Stock Purchase
and Dividend Reinvestment Plan, or the Plan, that was declared effective by the SEC on June 28,
2005. The Plan offers stockholders, or persons who agree to become stockholders, the option to
purchase shares of our common stock and/or to automatically reinvest all or a portion of their
quarterly dividends in our shares. During the three and nine months ended September 30, 2006, we
issued no new shares of common stock through the Plan.
In November 2005, we announced a stock repurchase program permitting us to acquire up to
2,000,000 shares of our common stock. In February 2006, we announced an additional stock
repurchase program to acquire an incremental 3,000,000 shares. During the three and nine months
ended September 30, 2006, we repurchased a total of 42,235 shares and 1,919,235 shares,
respectively, at a weighted-average price of $7.06 per share and $8.22 per share, respectively.
From the inception of our repurchase program through September 30, 2006, we have repurchased a
total of 2,594,285 shares at a weighted-average price of $8.00 per share. We will, at our
discretion, purchase shares at prevailing prices through open market transactions subject to the
provisions of SEC Rule 10b-18 and in privately negotiated transactions.
In July 2006, we announced that our $2.5 billion securitization shelf registration statement
filed on Form S-3 was declared effective by the SEC. The name of our securitization shelf is Lares
Asset Securitization, Inc. Under this shelf registration statement, we may administer our own
securitizations by offering securities collateralized by loans we acquire. Each time we offer to
sell securities, a supplement to the prospectus will be provided containing specific information
about the terms of that offering. LUM 2006-6 was our first securitization completed under this
shelf registration statement.
Additionally, in August 2006, we closed a $1.0 billion program to finance our purchases of
Agency and AAA-rated mortgage-backed securities through a subsidiary we called Luminent Star
Funding I. Luminent Star Funding is a single-seller commercial paper program that will provide a
financing alternative to repurchase agreement financing by issuing asset-backed secured liquidity
notes that will be rated by the rating agencies Standard & Poor’s and Moody’s. At September 30,
2006, there was no outstanding balance on the commercial paper facility.
We may increase our capital resources by making additional offerings of equity and debt
securities, possibly including classes of preferred stock, common stock, medium-term notes,
collateralized mortgage obligations and senior or subordinated notes. Such financings will depend
on market conditions for raising capital and for the investment of any net proceeds from such
capital raises. All debt securities, other borrowings and classes of preferred stock will be
senior to our common stock in any liquidation of us.
Inflation
Virtually all of our assets and liabilities are financial in nature. As a result, interest
rates and other factors influence our performance far more so than inflation does. Changes in
interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our
consolidated financial statements are prepared in accordance with
46
accounting principles generally
accepted in the United States, and our distributions are determined by our board of directors
primarily based on our REIT taxable net income as calculated pursuant to the Code; in each case,
our activities and balance sheet are measured with reference to historical cost and/or fair market
value without considering inflation.
Contractual Obligations and Commitments
The table below summarizes our contractual obligations at September 30, 2006. The table
excludes accrued interest payable on our variable rate liabilities, and payments due under interest
rate swaps because those contracts do not have fixed and determinable payments:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
| |
|
|
|
|
|
Less than 1 |
|
|
|
|
|
|
3 – 5 |
|
|
|
|
| (in millions) |
|
Total |
|
|
year |
|
|
1 – 3 years |
|
|
years |
|
|
More than 5 years |
|
Repurchase agreements |
|
$ |
2,528.9 |
|
|
$ |
2,528.9 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
Mortgage-backed notes (1) |
|
|
3,339.6 |
|
|
|
706.0 |
|
|
|
1,579.8 |
|
|
|
993.4 |
|
|
|
60.4 |
|
Junior subordinated notes
(2) |
|
|
107.4 |
|
|
|
4.1 |
|
|
|
10.5 |
|
|
|
— |
|
|
|
92.8 |
|
Facilities leases |
|
|
1,129.6 |
|
|
|
243.7 |
|
|
|
407.0 |
|
|
|
305.4 |
|
|
|
173.5 |
|
Management fees |
|
|
3.8 |
|
|
|
3.8 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
7,109.3 |
|
|
$ |
3,486.5 |
|
|
$ |
1,997.3 |
|
|
$ |
1,298.8 |
|
|
$ |
326.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
The mortgage-backed notes have stated maturities through 2046; however, the expected maturity is subject to change based on the
prepayments and loan losses of the underlying mortgage loans. In addition, we may exercise a redemption option and thereby effect
termination and early retirement of the mortgage-backed notes. The payments represented reflect our assumptions for prepayment and
credit losses at September 30, 2006 and assume we will exercise our redemption option. |
| |
| (2) |
|
Certain of our junior subordinated notes bear interest at a fixed rate per annum through March 30, 2010 and, thereafter, at a
variable rate. Payments due by period reflect total principal due on all junior subordinated notes plus interest payments due
during the fixed rate period of certain of the notes. See Note 4 to our consolidated financial statements in Part 1, Item 1 of this
Quarterly Report on Form 10-Q for further discussion about the preferred securities of subsidiary trusts and junior subordinated
notes. |
Off-Balance Sheet Arrangements
In 2005, we completed two trust preferred securities offerings in the aggregate amount of
$90.0 million. We received proceeds, net of debt issuance costs, from the preferred securities
offerings in the amount of $87.2 million. We believe that none of the commitments of these
unconsolidated special purpose entities expose us to any greater loss than is already reflected on
our consolidated balance sheet. Our total contractual obligation and payments due by period are
summarized in the table above. See Note 4 to our consolidated financial statements in Part 1, Item
1, of this Quarterly Report on Form 10-Q for further discussion about the preferred securities of
subsidiary trusts and junior subordinated notes.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The primary components of our market risk are credit risk and interest rate risk as described
below. While we do not seek to avoid risk completely, we do seek to assume risk that can be
quantified from historical experience, to manage that risk, to earn sufficient compensation to
justify taking those risks and to maintain capital levels consistent with the risks we undertake or
to which we are exposed.
Credit Risk
We are subject to credit risk in connection with our investments in residential mortgage loans
and credit sensitive mortgage-backed securities rated below AAA. The credit risk related to these
investments pertains to the ability and willingness of the borrowers to pay, which is assessed
before credit is granted or renewed and periodically reviewed throughout the loan or security term.
We believe that loan credit quality is primarily determined by the borrowers’ credit profiles and
loan characteristics.
47
We use a comprehensive credit review process. Our analysis of loans includes borrower
profiles, as well as valuation and appraisal data. Our resources included sophisticated industry
and rating agency software. We also outsource underwriting services to identify higher risk loans,
either due to borrower credit profiles or collateral valuation issues. Through statistical sampling
techniques, we create adverse credit and valuation samples, which we review by hand. We reject
loans that fail to conform to our standards. We also create samples of loans with layered risk
characteristics, such as investor occupancy and cash out, and review their constituent loans in
detail. We accept only those loans which meet our careful underwriting criteria.
Once we own a loan, our surveillance process includes ongoing analysis through our proprietary
data warehouse and servicer files. We are proactive in our analysis of payment behavior and in
loss mitigation through our servicing relationships.
We are also subject to credit risk in connection with our investments in mortgage-backed
securities in our Spread portfolio, which is mitigated by holding securities that are either
guaranteed by government or government-sponsored agencies or have credit ratings of AAA.
Concentration Risk
Inadequate diversification of our loan portfolio, such as geographic regions, may result in
losses. As part of our underwriting process, we diversify the geographic concentration risk
exposure in our portfolios.
Interest Rate Risk
We are subject to interest rate risk in connection with our investments in residential
mortgage loans, adjustable-rate, hybrid adjustable-rate and fixed-rate mortgage-backed securities
and our related debt obligations, which include mortgage-backed notes, warehouse lending
facilities, derivative contracts and repurchase agreements.
Effect on Net Interest Income
We finance our mortgage loans held-for-investment through a combination of warehouse lending
facilities initially, and non-recourse mortgage-backed notes following the securitization of our
loans. Our mortgage loan assets consist of a combination of adjustable-rate mortgage loans and
hybrid adjustable-rate mortgage loans. The interest rates on our warehouse lending facilities and
non-recourse mortgage-backed notes generally reset on a monthly basis. In general, we use
derivative contracts to match-fund the cost of our related borrowings with the income that we
expect to earn from our hybrid adjustable-rate mortgage loans that currently have fixed coupon
rates. If our hedging activities are effective, over a variety of interest rate scenarios the
change in income from our mortgage loans held-for-investment, plus the benefit or cost of our
related hedging activities, will generally offset the change in the cost of our related borrowings
such that the net interest spread from our mortgage loans will remain substantially unchanged.
We finance our adjustable-rate, hybrid adjustable-rate and fixed-rate mortgage-backed
securities with short-term borrowings under repurchase agreements. During periods of rising
interest rates, the borrowing costs associated with hybrid-adjustable rate (during the fixed-rate
component of such securities) and fixed-rate mortgage-backed securities tend to increase while the
income earned on such hybrid adjustable-rate and fixed-rate mortgage-backed securities may remain
substantially unchanged. This effect results in a narrowing of the net interest spread between the
related assets and borrowings with respect to our hybrid adjustable-rate and fixed-rate
mortgage-backed securities and may even result in losses. With respect to our adjustable-rate
mortgage-backed securities, during a period of rising interest rates the adjustable coupon rates on
our adjustable-rate mortgage-backed securities would increase along with the increase in their
related borrowing costs such that the net interest spread on these assets would remain
substantially unchanged.
As a means to mitigate the negative impact of a rising interest rate environment on the net
interest spread of our hybrid adjustable-rate and fixed-rate mortgage-backed securities, we may
enter into derivative contracts, such as
48
Eurodollar futures contracts, interest rate swap
contracts, interest rate cap contracts and swaption contracts. Hedging techniques are based, in
part, on assumed levels of prepayments of the hybrid adjustable-rate and fixed-rate mortgage-backed
securities that are being hedged. If actual prepayments are slower or faster than assumed, the
life of the hybrid adjustable-rate and fixed-rate mortgage-backed securities being hedged will be
longer or shorter, which could reduce the effectiveness of any hedging strategies that we may
utilize and may result in losses on such transactions. Hedging strategies involving the use of
derivative securities are highly complex and may produce volatile returns.
All of our hedging activities are also limited by the asset and sources-of-income requirements
applicable to us as a REIT.
Extension Risk
Hybrid adjustable-rate mortgage loans and hybrid adjustable-rate mortgage-backed securities
have interest rates that are fixed for the first few years of the mortgage loan or mortgage-backed
security — typically three, five, seven or 10 years — and thereafter their interest rates reset
periodically. At September 30, 2006, 11.4% of our total mortgage assets were comprised of hybrid
adjustable-rate mortgage loans and there were no hybrid adjustable-rate mortgage-backed securities.
We compute the projected weighted-average life of our hybrid adjustable-rate mortgage loans and
mortgage-backed securities based on the market’s assumptions regarding the rate at which the
borrowers will prepay our hybrid adjustable-rate mortgage loans and the mortgage loans underlying
our hybrid adjustable-rate mortgage-backed securities. During a period of interest rate increases,
prepayment rates on our hybrid adjustable-rate mortgage loans and the mortgage loans underlying our
hybrid adjustable-rate mortgage-backed securities may decrease (see Prepayment Risk below) and
cause the weighted-average life of our hybrid adjustable-rate mortgage loans and hybrid
adjustable-rate mortgage-backed securities to lengthen. During a period of interest rate
decreases, prepayment rates on our hybrid adjustable-rate mortgage loans and the mortgage loans
underlying our hybrid adjustable-rate mortgage-backed securities may increase (see Prepayment Risk
below) and cause the weighted-average life of our hybrid adjustable-rate mortgage loans and hybrid
adjustable-rate mortgage-backed securities to shorten. The possibility that our hybrid
adjustable-rate mortgage loans and hybrid adjustable-rate mortgage-backed securities may lengthen
due to slower prepayment activity is commonly known as “extension risk.”
When we acquire hybrid adjustable-rate mortgage loans or hybrid adjustable-rate
mortgage-backed securities, and finance them with borrowings, we may, but are not required to,
enter into derivative contracts to effectively fix, or hedge, our borrowing costs for a period
close to the anticipated weighted-average life of the fixed-rate portion of the related hybrid
adjustable-rate mortgage loan or hybrid adjustable-rate mortgage-backed security. This hedging
strategy is designed to protect us from rising interest rates because the borrowing costs are fixed
for the duration of the fixed-rate portion of the related hybrid adjustable-rate mortgage loan or
hybrid adjustable-rate mortgage-backed security. Depending upon the type of derivative contract
that we use to hedge these borrowing costs however, extension risk related to the hybrid
adjustable-rate mortgage loans or hybrid adjustable-rate mortgage-backed securities being hedged
may cause a mismatch with the hedging instruments and negatively impact the desired result from our
hedging activities. In extreme situations, we may be forced to sell assets and incur losses to
maintain adequate liquidity.
Certain mortgage loans that we purchase directly and certain mortgage loans collateralizing
mortgage-backed securities that we purchase permit negative amortization. A negative amortization
provision in a mortgage loan allows the borrower to defer payment of a portion or all of the
monthly interest accrued on the mortgage loan and to add the deferred interest amount to the
principal balance of the mortgage loan. As a result, during periods of negative amortization the
principal balances of negatively amortizing mortgage loans will increase and their weighted-average
lives will extend.
Interest Rate Cap Risk
We also invest in residential mortgage loans and adjustable-rate and hybrid adjustable-rate
mortgage-backed securities that are based on mortgages that are typically subject to periodic and
lifetime interest rate caps.
49
These interest rate caps limit the amount by which the coupon rate of
these mortgage loans and adjustable-rate and hybrid adjustable-rate mortgage-backed securities may
change during any given period.
However, the borrowing costs related to our mortgage assets are not subject to similar
restrictions. Therefore, in a period of increasing interest rates, interest rate costs on the
borrowings for our mortgage assets could increase without the limitation of interest rate caps,
while the corresponding increase in coupon rates on our residential mortgage loans and
adjustable-rate and hybrid adjustable-rate mortgage-backed securities could be limited by interest
rate caps. This problem will be magnified to the extent that we acquire mortgage loans and
adjustable-rate and hybrid adjustable-rate mortgage-backed securities that are not based on
mortgages that are fully-indexed.
In addition, our residential mortgage loans and adjustable-rate and hybrid adjustable-rate
mortgage-backed securities may be subject to periodic payment caps that result in some portion of
the interest being deferred and added to the principal outstanding. The presence of these payment
caps could result in our receipt of less cash income on our residential mortgage loans and
adjustable-rate and hybrid adjustable-rate mortgage-backed securities than we need in order to pay
the interest cost on our related borrowings. These factors could lower our net interest income or
cause a net loss during periods of rising interest rates, which would negatively impact our
financial condition, cash flows and results of operations.
We may purchase a variety of hedging instruments to mitigate these risks.
Prepayment Risk
Prepayments are the full or partial unscheduled repayment of principal prior to the original
term to maturity of a mortgage loan. Prepayment rates for mortgage loans and mortgage loans
underlying mortgage-backed securities generally increase when prevailing interest rates fall below
the market rate existing when the mortgages were originated. Prepayment rates on adjustable-rate
and hybrid adjustable-rate mortgage-backed securities generally increase when the difference
between long-term and short-term interest rates declines or becomes negative. Prepayments of
mortgage-backed securities could harm our results of operations in several ways. Some of our
adjustable-rate mortgage loans and the mortgage loans underlying our adjustable-rate
mortgage-backed securities may bear initial “teaser” interest rates that are lower than their
“fully-indexed” rate, which refers to the applicable index rates plus a margin. In the event that
we owned such an adjustable-rate mortgage loan or adjustable-rate mortgage-backed security and it
is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, then we would
have held such loan or security while it was less profitable and lost the opportunity to receive
interest at the fully-indexed rate over the expected life of the mortgage loan or adjustable-rate
mortgage-backed security. In addition, we currently own mortgage loans and mortgage-backed
securities that were purchased at a premium. The prepayment of such mortgage loans and
mortgage-backed securities at a rate faster than anticipated would result in a write-off of any
remaining capitalized premium amount and a consequent reduction of our net interest income by such
amount. Finally, in the event that we are unable to acquire new mortgage loans and mortgage-backed
securities to replace the prepaid mortgage loans and mortgage-backed securities, our financial
condition, cash flow and results of operations could be negatively impacted. At September 30,
2006, 70.1% of our mortgage loans contained prepayment penalty provisions. Generally, mortgage
loans with prepayment penalty provisions are less likely to prepay than loans without prepayment
penalty provisions.
Effect on Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have
on the market value of our assets, liabilities and our hedging instruments. We are exposed to the
risk that the market value of our assets will increase or decrease at different rates from those of
our liabilities and our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our assets,
liabilities and hedging instruments. Duration essentially measures the market price volatility of
financial instruments as interest rates change. We generally calculate duration using various
financial models and empirical data. Different models and methodologies can produce different
duration numbers for the same financial instruments.
50
The following sensitivity analysis table shows the estimated impact on the fair value of our
interest rate-sensitive assets, liabilities and hedging instruments at September 30, 2006, assuming
rates throughout the entire yield curve instantaneously fall 100 basis points, rise 100 basis
points and rise 200 basis points:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Interest Rates |
|
|
|
|
|
Interest Rates |
|
Interest Rates |
| |
|
Fall 100 |
|
|
|
|
|
Rise 100 |
|
Rise 200 |
| (in millions) |
|
Basis Points |
|
Unchanged |
|
Basis Points |
|
Basis Points |
| |
|
|
Mortgage-Backed Securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
2,120.6 |
|
|
$ |
2,118.5 |
|
|
$ |
2,116.4 |
|
|
$ |
2,114.4 |
|
Change in fair value |
|
|
2.1 |
|
|
|
— |
|
|
|
(2.1 |
) |
|
|
(4.2 |
) |
Change as a percent of fair value |
|
|
0.1 |
% |
|
|
— |
|
|
|
(0.1 |
)% |
|
|
(0.2 |
)% |
| |
Hedge Instruments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
(5.9 |
) |
|
$ |
7.0 |
|
|
$ |
25.0 |
|
|
$ |
47.5 |
|
Change in fair value |
|
|
(12.9 |
) |
|
|
— |
|
|
|
18.0 |
|
|
|
40.5 |
|
Change as a percent of fair value |
|
nm |
|
|
|
— |
|
|
nm |
|
|
nm |
|
| |
| |
| |
Mortgage Loans Held-for-Investment (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
4,147.0 |
|
|
$ |
4,116.1 |
|
|
$ |
4,085.3 |
|
|
$ |
4,054.4 |
|
Change in fair value |
|
|
30.9 |
|
|
|
— |
|
|
|
(30.9 |
) |
|
|
(61.7 |
) |
Change as a percent of fair value |
|
|
0.8 |
% |
|
|
— |
|
|
|
(0.8 |
)% |
|
|
(1.5 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase Agreements (1)(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
2,528.9 |
|
|
$ |
2,528.9 |
|
|
$ |
2,528.9 |
|
|
$ |
2,528.9 |
|
Change in fair value |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Change as a percent of fair value |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed Notes (1)(2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
3,342.4 |
|
|
$ |
3,342.4 |
|
|
$ |
3,342.4 |
|
|
$ |
3,342.4 |
|
Change in fair value |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Change as a percent of fair value |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Mortgage-backed Notes (2)(3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
285.5 |
|
|
$ |
279.2 |
|
|
$ |
273.1 |
|
|
$ |
267.2 |
|
Change in fair value |
|
|
6.3 |
|
|
|
— |
|
|
|
(6.1 |
) |
|
|
(12.0 |
) |
Change as a percent of fair value |
|
|
2.2 |
% |
|
|
— |
|
|
|
(2.2 |
)% |
|
|
(4.3 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Junior Subordinated Notes (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value |
|
$ |
95.1 |
|
|
$ |
91.4 |
|
|
$ |
87.7 |
|
|
$ |
84.3 |
|
Change in fair value |
|
|
3.7 |
|
|
|
— |
|
|
|
(3.7 |
) |
|
|
(7.1 |
) |
Change as a percent of fair value |
|
|
4.0 |
% |
|
|
— |
|
|
|
(4.0 |
)% |
|
|
(7.8 |
)% |
|
|
|
| (1) |
|
The fair value of the repurchase agreements and mortgage-backed notes would not change
materially due to the short-term nature of these instruments. |
| |
| (2) |
|
This asset or liability is carried on the consolidated balance sheet at amortized cost
and therefore a change in interest rates would not affect the carrying value of the asset
or liability. |
| |
| (3) |
|
Represents mortgage-backed notes which are not short-term in nature. |
nm = not meaningful
There are many simplifying assumptions made in the preparation of the table above, and as
such this table is not a precise predictor of what would actually happen to the fair values of our
assets, liabilities and hedging instruments in the interest rate scenarios described above. In
addition, it is important to note that the impact of changing interest rates on fair value can
change significantly when interest rates change beyond 100 basis points from current levels.
Therefore, the volatility in the fair value of our assets could increase significantly when
interest rates change beyond 100 basis points. In addition, other factors impact the fair value of
our interest rate-sensitive investments and hedging instruments, such as the shape of the yield
curve, market expectations as to future interest rate changes, implied and real volatility and
other market conditions. Accordingly, in the event of changes in actual interest rates, the change
in the fair value of our assets would likely differ from that shown above and such difference might
be material and adverse to our stockholders.
51
Risk Management
To the extent consistent with maintaining our status as a REIT, we seek to manage our interest
rate risk exposure to protect our portfolio of mortgage-backed securities and related debt against
the effects of major interest rate changes. We generally seek to manage our interest rate risk by:
| |
• |
|
monitoring and adjusting, if necessary, the reset index and interest rate related to
our mortgage-backed securities and our borrowings; |
| |
| |
• |
|
attempting to structure our borrowing agreements to have a range of different
maturities, terms, amortizations and interest rate adjustment periods; |
| |
| |
• |
|
using derivatives, financial futures, swaps, options, caps, floors and forward sales to
adjust the interest rate sensitivity of our mortgage-backed securities and our borrowings;
and |
| |
| |
• |
|
actively managing, on an aggregate basis, the interest rate indices, interest rate
adjustment periods and gross reset margins of our mortgage-backed securities and the
interest rate indices and adjustment periods of our borrowings. |
Item 4. Controls and Procedures.
Conclusion Regarding Disclosure Controls and Procedures
At September 30, 2006, our principal executive officer and our principal financial officer
have performed an evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, or Exchange Act) and concluded
that our disclosure controls and procedures are effective to ensure that information required to be
disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the SEC rules and forms.
Changes in Internal Control Over Financial Reporting
There were no material changes in our internal control over financial reporting (as defined in
Rule 13a-15(f) under the Exchange Act) that occurred during the third quarter of our fiscal year
ending December 31, 2006 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
52
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
At September 30, 2006, no legal proceedings were pending to which we were party or of which
any of our properties were subject.
Item 1A. Risk Factors
For additional risk factor information about us, please refer to Item 1A of our Annual Report
on Form 10-K for the year ended December 31, 2005, which is incorporated herein by reference.
A significant portion of our mortgages permit negative amortization. Negative amortization
can increase the overall risk of our Residential Mortgage Credit portfolio and could adversely
impact our results of operations or financial condition.
Certain mortgages that we purchase directly and certain mortgages collateralizing
mortgage-backed securities that we purchase permit negative amortization. A negative amortization
provision in a mortgage allows the borrower to defer payment of a portion or all of the monthly
interest accrued on the mortgage and to add the deferred interest amount to the principal balance
of the mortgage. As a result, during periods of negative amortization the principal balances of
negatively amortizing mortgages will increase and their weighted-average life will extend.
When a mortgage or a mortgage collateralizing a mortgage-backed security experiences negative
amortization, we continue to recognize interest income on the mortgage or mortgage-backed security
although we are not receiving cash in an amount equal to the deferred portion of the interest
income. As a result, when we recognize and distribute income to our stockholders related to
negatively amortizing mortgages, we may experience negative cash flow. This negative cash flow
could adversely impact our results of operations or financial condition.
In addition, when a mortgage experiences negative amortization, the principal balance of the
mortgage increases while the underlying market value of the related mortgaged property can remain
flat or decrease. In such cases, the then current loan-to-value ratio of the negatively amortizing
mortgage increases. Increasing current loan-to-value ratios on mortgages correspondingly increase
the likelihood and severity of potential credit losses related to those mortgages. Accordingly,
higher current loan-to-value ratios could adversely impact our results of operations or financial
condition. At September 30, 2006, the weighted-average loan-to-value ratio of the residential
mortgage loans in our portfolio was 75.7%
To the extent a mortgage experiences negative amortization such that its loan-to-value ratio
exceeds the fair market value of the real estate securing the mortgage at the time we purchased the
mortgage, that mortgage will no longer constitute a qualifying asset for the 55% test we are
required to meet under the Investment Company Act of 1940, as amended. If we fail to satisfy the
55% test, our ability to use leverage would be substantially reduced, and we would be unable to
conduct our business in accordance with our operating policies. In addition, any portion of the
principal balance of a negative-amortization mortgage that exceeds the appraised value of the
underlying mortgaged property at the time we purchased it will constitute a non-qualifying asset
for purposes of the 75% asset test, and produce non-qualifying income for purposes of the 75% gross
income test, applicable to REITs under federal income tax law. Any failure to comply with these
tests could result in application of monetary penalties and potential loss of our REIT status. The
residential mortgage loans in our portfolio contain caps which prohibit the unpaid principal
balance from increasing to an amount in excess of 110% to 115% of the original unpaid principal
balance.
53
The timing and amount of our cash distributions may experience volatility.
It is our policy to make distributions to our stockholders of all or substantially all of our
REIT taxable net income in each fiscal year, subject to certain adjustments, which, along with
other factors, should enable us to qualify for the tax benefits accorded to a REIT under the Code.
We estimate our REIT taxable net income at certain times during the course of each fiscal year
based upon a variety of information from third parties, although we do not receive some of this
information before we complete our estimates As a result, our REIT taxable net income estimates
during the course of each fiscal year are subject to adjustments to reflect not only the subsequent
receipt of new information as to future events but also the subsequent receipt of information as to
past events. Our REIT taxable net income is also subject to changes in the Code, or in the
interpretation of the Code, with respect to our business model. REIT taxable net income for each
fiscal year does not become final until we file our tax return for that fiscal year.
We do not intend to establish minimum distributions for the foreseeable future. Our ability
to make distributions might be harmed by various risks, including the risk factors described in our
2005 Annual Report on Form 10-K. All distributions will be made at the discretion of our board of
directors and will depend on our earnings, our financial condition, maintenance of our REIT status
and such other factors as our board of directors deems relevant from time to time. Our ability to
make distributions to our stockholders in the future is dependent on these factors.
We may be subject to the risks associated with inadequate or untimely services from
third-party service providers, which could adversely impact our results of operations or financial
condition.
Our loans and loans underlying securities are serviced by third party service providers who
specialize in the underwriting, processing, closing and servicing of mortgage loans. These
arrangements allow us to increase the volume of the loans we purchase and securitize without
incurring the expenses associated with servicing operations. However, as with any external service
provider, we are subject to the risks associated with inadequate or untimely services and are
dependent upon the availability and quality of the performance of such providers. Although we
perform reviews of data received from third-party service providers, we may not detect errors
and/or omissions of data. To the extent we receive incorrect information that is not detected or do
not receive information necessary to properly manage and report on our mortgage assets, our results
of operations and financial condition could be adversely impacted.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
a. None
b. None
c. The following table summarizes share purchases in the third quarter of 2006 under our
stock repurchase programs:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
(a) Total |
|
(b) |
|
(c) Total Number of |
|
(d) Maximum Number |
| |
|
Number of |
|
Average |
|
Shares Purchased as Part |
|
of Shares that May Yet |
| |
|
Shares |
|
Price Paid |
|
of Publicly Announced |
|
Be Purchased Under the |
| Period |
|
Purchased |
|
per Share |
|
Program |
|
Programs (1) |
July 1 – 31, 2006 |
|
|
1,200 |
|
|
$ |
9.00 |
|
|
|
1,200 |
|
|
|
2,446,750 |
|
August 1 – 31, 2006 |
|
|
41,035 |
|
|
|
7.00 |
|
|
|
41,035 |
|
|
|
2,405,715 |
|
September 1 – 30, 2006 |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,405,715 |
|
|
|
|
| (1) |
|
Our initial stock repurchase program was announced on November 7, 2005 and authorized us to repurchase up
to a total of 2,000,000 of our common shares. In February 2006, we announced an additional stock repurchase
program to repurchase up to 3,000,000 shares of our common stock. We can repurchase shares in the open market
or through privately negotiated transactions from time to time at management’s discretion until we repurchase
a total of 5,000,000 common shares or our Board of Directors determines to terminate the program. |
54
Item 3. Defaults Upon Senior Notes.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
The exhibits listed on the Exhibit Index (following the Signatures section of this report) are
included, or incorporated by reference, in this Quarterly Report on Form 10-Q.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1394,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
| |
|
|
|
|
| |
LUMINENT MORTGAGE CAPITAL, INC.
|
|
| |
By: |
/s/ GAIL P. SENECA
|
|
| |
|
Gail P. Seneca |
|
| |
|
Chief Executive Officer
(Principal Executive Officer) |
|
| |
| |
|
|
|
|
| |
Date: November 9, 2006 |
| |
| |
By: |
/s/ CHRISTOPHER J. ZYDA
|
|
| |
|
Christopher J. Zyda |
|
| |
|
Chief Financial Officer
(Principal Financial and Accounting Officer) |
|
| |
|
| |
Date: November 9, 2006 |
56
EXHIBIT INDEX
Pursuant to Item 601(a) (2) of Regulation S-K, this exhibit index immediately precedes any
exhibits filed herewith.
The following exhibits are included, or incorporated by reference, in this Quarterly Report on
Form 10-Q and are numbered in accordance with Item 601 of Regulation S-K.
| |
|
|
| Exhibit |
|
|
| Number |
|
Description |
3.1
|
|
Second Articles of Amendment and Restatement (4) |
|
|
|
3.2
|
|
Third Amended and Restated Bylaws (9) |
|
|
|
4.1
|
|
Form of Common Stock Certificate (1) |
|
|
|
4.2
|
|
Registration Rights Agreement, dated as of June 11, 2003, by and between the Registrant and
Friedman, Billings, Ramsey & Co., Inc. (for itself and for the benefit of the holders from
time to time of registrable securities issued in the Registrant’s June 2003, private
offering) (1) |
|
|
|
10.1 †
|
|
2003 Stock Incentive Plan, as amended (10) |
|
|
|
10.2 †
|
|
Form of Incentive Stock Option under the 2003 Stock Incentive Plan (1) |
|
|
|
10.3 †
|
|
Form of Non Qualified Stock Option under the 2003 Stock Incentive Plan (1) |
|
|
|
10.4 †
|
|
2003 Outside Advisors Stock Incentive Plan, as amended (10) |
|
|
|
10.5 †
|
|
Form of Non Qualified Stock Option under the 2003 Outside Advisors Stock Incentive Plan (1) |
|
|
|
10.6 †
|
|
Form of Indemnity Agreement (1) |
|
|
|
10.7 †
|
|
Form of Restricted Stock Award Agreement for Christopher J. Zyda (1) |
|
|
|
10.8 †
|
|
Form of Restricted Stock Award Agreement for Seneca (3) |
|
|
|
10.9
|
|
Controlled Equity Offering Sales Agreement dated February 7, 2005, between the Registrant
and Cantor Fitzgerald & Co. (6) |
|
|
|
10.10 †
|
|
Employment Agreement dated December 20, 2005, between the Registrant and S. Trezevant Moore,
Jr. (12) |
|
|
|
10.11 †
|
|
Employment Agreement dated December 20, 2005, between the Registrant and Gail P. Seneca (12) |
|
|
|
10.12 †
|
|
Employment Agreement dated as of December 20, 2005, by and between the Registrant and
Christopher J. Zyda (12) |
|
|
|
10.13
|
|
Direct Stock Purchase and Dividend Reinvestment Plan dated June 29, 2005 (11) |
|
|
|
14.1
|
|
Code of Business Conduct and Ethics (1) |
|
|
|
14.2
|
|
Corporate Governance Guidelines (5) |
57
| |
|
|
| Exhibit |
|
|
| Number |
|
Description |
31.1 *
|
|
Certification of Gail P. Seneca, Chairman of the Board of Directors and Chief Executive
Officer of the Registrant, pursuant to Rules 13a-14(a) and 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
|
|
|
31.2 *
|
|
Certification of Christopher J. Zyda, Chief Financial Officer of the Registrant, pursuant to
Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 |
|
|
|
32.1 *
|
|
Certification of Gail P. Seneca, Chairman of the Board of Directors and Chief Executive
Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 |
|
|
|
32.2 *
|
|
Certification of Christopher J. Zyda, Chief Financial Officer of the Registrant, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|
|
|
99.1
|
|
Charter of the Audit Committee of the Board of Directors (1) |
|
|
|
99.2
|
|
Charter of the Compensation Committee of the Board of Directors (1) |
|
|
|
99.3
|
|
Charter of the Governance and Nominating Committee of the Registrant’s Board of Directors (1) |
|
|
|
| (1) |
|
Incorporated by reference to our Registration Statement on Form S-11 (Registration No. 333-107984)
which became effective under the Securities Act of 1933, as amended, on December 18, 2003. |
| |
| (2) |
|
Incorporated by reference to our Current Report Form 8-K filed on December 23, 2003. |
| |
| (3) |
|
Incorporated by reference to our Registration Statement on Form S-11 (Registration No. 333-107981)
which became effective under the Securities Act of 1933, as amended, on February 13, 2004. |
| |
| (4) |
|
Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. |
| |
| (5) |
|
Incorporated by reference to our Registration Statement on Form S-11 (Registration No. 333-113493)
which became effective under the Securities act of 1933, as amended, on March 30, 2004. |
| |
| (6) |
|
Incorporated by reference to our Current Report on Form 8-K filed on February 8, 2005. |
| |
| (7) |
|
Incorporated by reference to our Current Report on Form 8-K filed on April 1, 2005. |
| |
| (8) |
|
Incorporated by reference to our Current Report on Form 8-K filed on March 14, 2005. |
| |
| (9) |
|
Incorporated by reference to our Current Report on Form 8-K filed on August 9, 2005. |
| |
| (10) |
|
Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2005. |
| |
| (11) |
|
Incorporated by reference to our Registration Statement on Form S-3 (Registration No. 333-125479)
which became effective under the Securities act of 1933, as amended, on June 28, 2005. |
| |
| (12) |
|
Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2005. |
| |
| * |
|
Filed herewith. |
| |
| † |
|
Denotes a management contract or compensatory plan. |
58