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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 1-13485
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AMERICAN RESIDENTIAL INVESTMENT TRUST, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 33-0741174
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
445 MARINE VIEW AVENUE, SUITE 230 92014
DEL MAR, CALIFORNIA (zip code)
(Address of principal executive
offices)
(858) 350-5000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
Common Stock ($.01 par value) New York Stock Exchange
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
At March 2, 2001, the aggregate market value of the voting stock held by
non-affiliates was $20.3 million, based on the closing price of the common stock
on the New York Stock Exchange.
As of March 2, 2001, there were 8,020,900 shares of the registrant's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement issued in connection
with the Annual Meeting of Stockholders of the registrant to be held on May 24,
2001, are incorporated herein by reference into Part III.
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TABLE OF CONTENTS
PAGE
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PART I
ITEM 1. BUSINESS............................................ 1
ITEM 2. PROPERTIES.......................................... 31
ITEM 3. LEGAL PROCEEDINGS................................... 31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS............................................. 31
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS................................. 32
ITEM 6. SELECTED FINANCIAL DATA............................. 33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION.................. 34
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
MARKET RISK........................................ 38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......... 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................. 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT......................................... 39
ITEM 11. EXECUTIVE COMPENSATION............................. 40
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT......................................... 40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..... 40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K........................................ 40
EXHIBIT INDEX............................................... 41
FINANCIAL STATEMENTS........................................ F-1
SIGNATURES.................................................. S-1
ITEM 1. BUSINESS
THE STATEMENTS CONTAINED IN THIS FORM 10-K THAT ARE NOT PURELY HISTORICAL
ARE FORWARD LOOKING STATEMENTS, INCLUDING STATEMENTS REGARDING THE COMPANY'S
EXPECTATIONS, HOPES, BELIEFS, INTENTIONS, OR STRATEGIES REGARDING THE FUTURE.
STATEMENTS WHICH USE THE WORDS "EXPECTS", "WILL", "MAY", "ANTICIPATES", "GOAL",
"INTENDS", "SEEKS", "STRATEGY" AND DERIVATIVES OF SUCH WORDS ARE FORWARD LOOKING
STATEMENTS. THESE FORWARD LOOKING STATEMENTS, INCLUDING STATEMENTS REGARDING
CHANGES IN THE COMPANY'S FUTURE INCOME, MORTGAGE ASSET PORTFOLIO, DIRECT
ORIGINATION BUSINESS, FINANCINGS, WAYS THE COMPANY MAY SEEK TO GROW INCOME,
INCOME LEVELS, THE COMPANY'S BELIEF REGARDING FUTURE REPAYMENT RATES AND FUTURE
BORROWING COSTS AND THE EFFECT ON THE COMPANY'S INTEREST INCOME, INTEREST
EXPENSE AND OPERATING PERFORMANCE OF CHANGES IN INTEREST RATES, MANAGEMENT
EXPECTATIONS REGARDING FUTURE PROVISIONS FOR LOAN LOSSES, AND THE COMPANY'S
BELIEF IN THE ADEQUACY OF LOAN LOSSES, ARE BASED ON INFORMATION AVAILABLE TO THE
COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY
SUCH FORWARD LOOKING STATEMENT. IT IS IMPORTANT TO NOTE THAT THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE IN SUCH FORWARD LOOKING
STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY ARE THE FACTORS SET FORTH BELOW UNDER THE HEADING "BUSINESS RISKS".
IN PARTICULAR, THE COMPANY'S FUTURE INCOME COULD BE AFFECTED BY INTEREST RATE
INCREASES, HIGH LEVELS OF PREPAYMENTS, MORTGAGE LOAN DEFAULTS, REDUCTIONS IN THE
VALUE OF RETAINED INTEREST IN SECURITIZATIONS, AND INABILITY TO ACQUIRE OR
FINANCE NEW MORTGAGE ASSETS.
GENERAL
American Residential Investment Trust, Inc. (the "Company") was incorporated
in the State of Maryland on February 6, 1997, and is a real estate investment
trust ("REIT"). The Company acquires non-conforming adjustable-rate and
fixed-rate, single-family whole loans (collectively, "Mortgage Loans") through
purchases in the capital markets and through purchases from originators. The
Company has in the past, and may in the future, acquire Mortgage Securities. It
finances its acquisitions with equity and secured borrowings. The Company
generally earns interest on the portion of its portfolio financed with equity
and earns a net interest spread on the portion of its portfolio financed with
secured borrowings. The Company is structured as a REIT, thereby generally
eliminating federal taxes at the corporate level on income it distributes to
stockholders.
The Company has entered into an agreement with Home Asset Management
Corporation (the "Manager") to manage the day-to-day operations of the Company
(the "Management Agreement"). Accordingly, the Company's success depends
significantly on the Manager. Pursuant to the terms of the Management Agreement,
the Manager advises the Company's Board of Directors (the "Board of Directors")
with respect to the formulation of investment criteria and preparation of policy
guidelines, and is compensated based upon the principal amount and type of
Mortgage Securities and Mortgage Loans (collectively, "Mortgage Assets") held by
the Company. The Manager may also earn incentive fees based on the level of net
income of the Company. See "The Management Agreement."
INVESTMENTS
MORTGAGE LOANS
The Company acquires non-conforming, adjustable-rate and fixed-rate
residential Mortgage Loans primarily through bulk purchases from the capital
markets and from other financial institutions. The Company also invests in
Mortgage Loans which it acquires directly from originators. Although the Company
invested in agency mortgage-backed securities and privately issued
mortgage-backed securities (collectively, "Mortgage Securities") backed by
conforming loans in the past, over the past three years the Company has invested
primarily in non-conforming Mortgage Loans, which generally are relatively
higher yielding (adjusted for risk) than conforming Mortgage Loans and Mortgage
Securities.
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The Company only acquires those Mortgage Loans which the Company believes it
has the expertise (with the advice of the Manager) to evaluate and manage and
which are consistent with the Company's balance sheet guidelines and risk
management objectives. The Company also considers (i) the amount and nature of
anticipated cash flows from the Mortgage Assets, (ii) the Company's ability to
pledge the Mortgage Loans to secure collateralized borrowings, (iii) the
increase in the Company's capital requirements resulting from the purchase and
financing of the Mortgage Loans, as determined pursuant to the Company's capital
policies, and (iv) the costs of financing, hedging, managing, servicing,
securitizing and providing for credit losses on the Mortgage Assets. Prior to
the acquisition of Mortgage Loans, potential returns on capital employed are
assessed over the life of the Mortgage Loans and in a variety of interest rates,
yield spread, financing cost, credit loss, and prepayment scenarios. The Board
of Directors can revise the Company's investment policies at its sole
discretion, subject to approval by a majority of the Company's directors who are
not employees or officers of the Company.
The Company initially finances acquisitions of Mortgage Loans with short
term borrowings which generally mature in one year or less. The Company's
objective is to permanently finance its Mortgage Loans ("Bond Collateral") with
long-term non-recourse securitizations. Mortgage Loans are financed with
borrowings that will bear interest at rates which periodically adjust to the
applicable market rate. See "Funding."
All of the Mortgage Loans held by the Company as of December 31, 2000, are
non-conforming Mortgage Loans. The Mortgage Loans are non-conforming primarily
as a result of credit rating of the borrower and consist predominantly of "A-"
and "B" grade, non-conforming Mortgage Loans and to a lesser extent, "C" and "D"
grade Mortgage Loans. The Company grades each Mortgage Loan based predominantly
on the mortgage credit rating of the borrower. See "Underwriting."
Non-conforming Mortgage Loans generally are subject to greater frequency of
delinquency and loss than conforming Mortgage Loans. See "Business
Risks--Borrower Credit May Decrease Value of Mortgage Assets." Accordingly,
lower credit grade Mortgage Loans normally bear a higher rate of interest and
are subject to higher fees (including prepayment fees and late payment
penalties) than conforming Mortgage Loans.
Based upon the Company's review of pricing and risk of Mortgage Loans
available for purchase the Company did not acquire Mortgage Loans during the
year ended December 31, 2000 (See "Underwriting"). Existing Bond Collateral has
declined as a result of natural runoff from $1.2 billion to $855.0 million as of
December 31, 1999 and December 31, 2000, respectively.
REMIC CERTIFICATES
The Company diversified its residential Mortgage Loan sales activities in
1998 to include the securitization of Mortgage Loans through a Real Estate
Mortgage Investment Conduit ("REMIC"). The REMIC, which consisted of pooled
adjustable-rate first-lien mortgages, was issued by American Residential
Holdings, Inc. ("Holdings"), a non-REIT, taxable affiliate of the Company, to
the public through the registration statement of the related underwriter. The
retained interest in securitization consists of assets generated by the
Company's loan securitization. These assets, REMIC subordinate certificates,
were valued at approximately $3.2 million at December 31, 2000.
While the Company does not currently intend to acquire additional residual
interests issued by REMICs, subordinate interests in Mortgage Securities or
interest-only Mortgage Securities, it is not prohibited from doing so under the
terms of its Capital Policy. Residual interests, if acquired by a REIT, would
generate excess inclusion income. See "Federal Income Tax Consequences--Taxation
of Stockholders."
2
MORTGAGE LOAN ACQUISITIONS
ACQUISITIONS
The Company has acquired the majority of its Mortgage Loans to date on a
bulk basis. In some cases, the Mortgage Loans are purchased directly from large
originators and in other cases through a Wall Street investment bank. Bulk
packages are usually greater than $50 million in size and can be as much as
$500 million.
MORTGAGE LOAN ORIGINATION
One of the Company's primary objectives is to diversify its income stream.
Several potential alternatives exist which would position the Company closer to
the loan origination process and thereby reduce the premium paid to acquire
loans and improve the underwriting standards, and our origination and servicing
fees may be offset by origination and servicing expenses.
PRICING
Mortgage Loans acquired on a bulk basis have been priced on either a
negotiated basis with the sellers or pursuant to a bidding process. The Company
sets investment criteria for the Manager to use in developing bids. The criteria
includes risk-adjusted yield requirements. In each case, different prices will
be established for the various types of Mortgage Loans to be acquired or
originated based on current market conditions, the expected financing costs,
prepayment assumptions, and loan loss expectations.
UNDERWRITING
The Company reviews the aggregate attributes of a package of Mortgage Loans,
as specified by the seller of the Mortgage Loans, to determine if the package
conforms to the Company's acquisition criteria. If the Company then elects to
purchase a package of Mortgage Loans, the Company reviews the Mortgage Loan
documentation for conformance to the seller's specifications. In evaluating a
package of Mortgage Loans to be acquired on a bulk basis, the Company reviews
the loan documentation for a large sample, sometimes up to 100%, of the Mortgage
Loans to be acquired. To date, all of the Company's underwriting reviews have
been performed by a nationally recognized third party underwriting review firm
or in-house personnel. The Company also obtains representations and warranties
from the seller with respect to the quality and terms of the Mortgage Loans
being acquired.
The Company considers a variety of factors in determining whether to acquire
a package of Mortgage Loans. These factors generally include the credit grade
and income history of each borrower, the loan-to-value ratio for each property,
the prepayment penalties for the Mortgage Loans, the weighted average coupon of
the Mortgage Loans and the documentation required for approval of the Mortgage
Loans. The Company may also consider other factors with respect to any
individual package under consideration.
Underwriting standards are applied by or on behalf of a lender to evaluate
the borrower's credit standing and repayment ability, and the value and adequacy
of the related mortgaged property as collateral. In general, a prospective
borrower applying for a Mortgage Loan is required to fill out a detailed
application designed to provide to the underwriting officer pertinent credit
information. As part of the description of the borrower's financial condition,
the borrower generally is required to provide a current list of assets and
liabilities and a statement of income and expenses, as well as an authorization
to apply for a credit report which summarizes the borrower's credit history with
local merchants and lenders and any record of bankruptcy. In most cases, an
employment verification is
3
obtained from an independent source (typically the borrower's employer) which
verifies, among other things, the length of employment with that organization,
the current salary, and whether it is expected that the borrower will continue
such employment in the future. If a prospective borrower is self-employed, the
borrower may be required to submit copies of signed tax returns. The borrower
may also be required to authorize verification of deposits at financial
institutions where the borrower has demand or savings accounts.
In most cases, the lender's analysis of the borrower's credit report
includes review of a credit score produced by an independent credit-scoring
firm, such as Fair, Issac and Company ("FICO"). Credit scores estimate, on a
relative basis, which borrowers are most likely to default on Mortgage Loans.
Lower scores imply higher default risks relative to higher scores. FICO scores
are empirically derived from historical credit bureau data and represent a
numerical weighing of a borrower's credit characteristics over a two year
period. A FICO score is generated through the statistical analysis of a number
of credit-related characteristics and variables. Common characteristics include
the following: the number of credit lines (trade lines), payment history, past
delinquencies, severity of delinquencies, current levels of indebtedness, types
of credit and length of credit history. Attributes are the specific values of
each characteristic. A scorecard (the model) is created with weights or points
assigned to each attribute. An individual loan applicant's credit score is
derived by summing together the attribute weights for that applicant.
Substantially all of the Company's Mortgage Assets as of December 31, 2000,
are residential Mortgage Loans made to borrowers with credit ratings below the
conforming Mortgage Loan underwriting guidelines. The following matrix generally
describes the underwriting criteria employed by the originators of the Mortgage
Loans in evaluating the credit quality of non-conforming Mortgage Loans.
MAXIMUM MORTGAGE MAXIMUM
CREDIT DELINQUENCIES CONSUMER DEBT-TO-INCOME
LEVEL DURING LAST YEAR CREDIT RATIOS
------ ----------------- ------------------------------------------------------ --------------
A/A- Up to two 30-day Generally good credit for the last two years, with 45%
minor derogatory accounts permitted. Overall credit
paid as agreed. No bankruptcy, discharge, or notice of
default filings during preceding two years.
B Up to four 30-day Satisfactory credit with recurring 30-day accounts & 50%
or minor 60-day accounts. Isolated judgements and
two 30-day and charge-offs permitted on a case-by-case basis. No
one 60-day bankruptcy, discharge, or notice of default filings
during preceding two years.
C Up to two 60-day Generally fair credit, but the applicant has likely 55%
and one 90-day experienced significant credit prob-lems in the past,
including judgements, charge-offs and collection
accounts. On a case-by-case basis, a notice of
default/ foreclosure filing may have occurred in the
last twelve months with a good explanation. Not
currently in bankruptcy, but may have recently
occurred with proof of dismissal/ discharge.
C-/D Up to one 120-day Generally poor credit, as the applicant may be 60%
currently experiencing significant credit problems,
including being subject to notice of
default/foreclosure fillings or currently in
bankruptcy.
The borrowers credit level usually impacts the maximum loan to (property)
value ratio as well as the interest rate on the mortgage. Typically, at the time
of origination, "A-" loans do not exceed 90%
4
loan to value; "B" loans do not exceed 85% loan to value; "C" loans do not
exceed 75% loan to value and "C-/D" loans do not exceed 65% loan to value.
As of December 31, 2000, approximately 69% of the Company's Mortgage Assets
were grade "A/ A-" at the time of origination and approximately 17% of the
Mortgage Loans were grade "B". At December 31, 2000 the weighted average current
loan to property value ratio for the Company's Mortgage Assets was approximately
78%.
In determining the adequacy of the mortgaged property as collateral, an
appraisal is made of each property considered for financing. The appraiser is
required to inspect the property and verify that it is in good condition and
that construction, if new, has been completed. The appraisal is based on the
market value of comparable homes, the estimated rental income (if considered
applicable by the appraiser) and the cost of replacing the home. The value of
the property being financed, as indicated by the appraisal, must be such that it
currently supports, and is anticipated to support in the future, the outstanding
Mortgage Loan balance.
Once all applicable employment, credit and property information is received,
a determination generally is made as to whether the prospective borrower has
sufficient monthly income available to meet (i) the borrower's monthly
obligations on the proposed Mortgage Loan (determined on the basis of the
monthly payments due in the year of origination) and other expenses related to
the mortgaged property (such as property taxes and hazard insurance), and
(ii) monthly housing expenses and other financial obligations and monthly living
expenses. The underwriting standards may be permitted to vary in appropriate
cases where factors such as low loan-to-value ratios or other compensating
factors exist.
SERVICING
The Company has acquired Mortgage Loans on both a "servicing released" basis
(i.e., the Company acquired both the Mortgage Loans and the rights to service
them) and on a "servicing retained" basis (i.e., the Company acquired the
Mortgage Loans but not the rights to service the Mortgage Loans). Generally,
whether the Mortgage Loans are acquired on a servicing released or servicing
retained basis is determined pursuant to negotiations with the seller.
The Company has contracted with sub-servicers to provide servicing at a cost
of a fixed percentage of the outstanding mortgage balance and the right to hold
escrow account balances and retain certain ancillary charges. In addition, for a
small portion of the Mortgage Loans, the Company will pay the subservicer a
fixed dollar fee plus a percentage of the outstanding Mortgage Loan balance and
a percentage of all amounts collected. The Company believes that the selection
of third party sub-servicers was more cost effective than establishing a
servicing department within the Company. However, part of the Company's
responsibility is to continually monitor the performance of the sub-servicers
through monthly performance reviews. Depending on these sub-servicer reviews,
the Company may in the future form a separate collection group to assist the
sub-servicer in the servicing of these loans. The Company has arranged for the
servicing of the Mortgage Loans with servicing entities that have particular
expertise and experience in the types of Mortgage Loans being acquired. See
"Business Risks"--Loans Serviced by Third Parties."
FUNDING
The Company employs a debt financing strategy to increase its investment in
Mortgage Assets. By using the Company's Mortgage Assets as collateral to borrow
funds, the Company is able to purchase Mortgage Assets with significantly
greater value than its equity. The Company has a targeted leverage ratio of
between 10% and 15% depending on the composition of assets, liabilities and an
assessment of capital call risks. This is generally greater than the levels of
many other companies that invest in
5
Mortgage Assets, including many commercial banks, savings and loans, and
government agencies. See "Capital Guidelines."
The Company's financing strategy is designed to maintain a cushion of equity
sufficient to provide required liquidity to respond to the effects under its
borrowing arrangements of interest rate movements and changes in the market
value of its Mortgage Assets. However, a major disruption of the reverse
repurchase or other markets relied on by the Company for short-term borrowings
could limit the Company's ability to originate mortgages or acquire new
portfolios unless the Company is able to arrange alternative sources of
financing. The Company continues to finance its acquisition of Mortgage Assets
primarily through reverse repurchase agreements and uses securitizations (for
long-term permanent long-term financings) and, to a lesser extent, uses lines of
credit and other financings.
REVERSE REPURCHASE AGREEMENTS (SHORT-TERM BORROWINGS)
The Company has in the past financed a portion of Mortgage Assets through a
form of borrowing known as reverse repurchase agreements. The Company's reverse
repurchase agreements generally require the Company to pledge cash or additional
Mortgage Assets in the event the market value of existing collateral declines.
The Company may enter into committed reverse repurchase agreements in the future
to finance additions to Mortgage Assets. There can be no assurance that the
Company will be able to continue to borrow funds using reverse repurchase
agreements or otherwise finance its Mortgage Loans.
At December 31, 2000, short-term total borrowings outstanding were
$5.1 million. These borrowings were secured by the Company's interest in REMIC
Securities 1999-A Series. At December 31, 2000, the weighted average borrowing
rate for short-term debt was 8.00% per annum.
SECURITIZATIONS (LONG-TERM BORROWINGS)
The Company intends to continue to securitize Mortgage Loans as part of its
overall financing strategyfor all portfolio additions. Securitization is the
process of pooling Mortgage Loans and issuing equity securities, such as
mortgage pass-through certificates, or debt securities, such as Collateralized
Mortgage Obligations ("CMOs"). The Company intends to securitize its Mortgage
Loans primarily by issuing structured debt. Under this approach, for accounting
purposes, the Mortgage Loans so securitized remain on the balance sheet as
assets and the debt obligations (i.e., the CMOs) appear as liabilities. A
structured debt securitization is generally expected to result in substituting
one type of debt financing for another, as proceeds from the structured debt
issuance are applied against preexisting borrowings (i.e., borrowings under
reverse repurchase agreements). The structured debt securities issued will
constitute limited recourse, long term financing, the payments on which
generally correspond to the payments on the Mortgage Loans serving as collateral
for the debt. Such financings are not subject to a margin call if a rapid
increase in rates would reduce the value of the underlying Mortgage Loans and,
hence, reduce the liquidity risk to the Company for the Mortgage Loans so
financed.
The decision to issue CMOs will be based on the Company's current and future
investment needs, market conditions and other factors. Each issue of CMOs is
fully payable from the principal and interest payments on the underlying
Mortgage Loans collateralizing such debt, any cash or other collateral required
to be pledged as a condition to receiving the desired rating on the debt, and
any investment income on such collateral. The Company earns the net interest
spread between the interest income on the Mortgage Loans securing the CMOs and
the interest and other expenses associated with the CMO financing. The net
interest spread may be directly impacted by the levels of prepayment of
6
the underlying Mortgage Loans and, to the extent each CMO class has variable
rates of interest, may be affected by changes in short-term interest rates.
If the Company issues CMOs for financing purposes, it will seek an
investment grade rating for such CMOs by a nationally recognized rating agency.
To secure such a rating, it is often necessary to pledge collateral in excess of
the principal amount of the CMOs to be issued, or to obtain other forms of
credit enhancements such as additional mortgage loan insurance. The need for
additional collateral or other credit enhancements depends upon factors such as
the type of collateral provided and the interest rates paid thereon, the
geographic concentration of the mortgaged property securing the collateral, and
other criteria established by the rating agency. The pledge of additional
collateral would reduce the capacity of the Company to raise additional funds
through short-term secured borrowings or additional CMOs and diminish the
potential expansion of its investment portfolio. As a result, the Company's
objective is to pledge additional collateral for CMOs only in the amount
required to obtain an investment grade rating for the CMOs by a nationally
recognized rating agency. Total credit loss exposure to the Company is limited
to the equity invested in the CMOs at any point in time.
The Company believes that under prevailing market conditions, an issuance of
CMOs receiving other than an investment grade rating would require payment of an
excessive yield to attract investors. No assurance can be given that the Company
will achieve the ratings it plans to seek for the CMOs.
In connection with the securitization of "B" and "C" grade Mortgage Loans,
the levels of subordination required as credit enhancement for the more senior
classes of securities issued in connection therewith would be higher than those
with respect to its "A" grade non-conforming Mortgage Loans. Thus, to the extent
that the Company retains any of the subordinated securities created in
connection with such securitizations and losses with respect to such pools of
"B" and "C" grade Mortgage Loans or Mortgage Loans secured by second liens are
higher than expected, the Company's future operations could be adversely
affected.
During 1998, the Company securitized Mortgage Loans in a CMO through its
wholly owned subsidiary, American Residential Eagle, Inc. ("Eagle"), by issuing
collateralized mortgage bonds ("Long-Term Debt") through a Financial Asset
Securitization Investment Trust ("FASIT"). The bonds were assigned to a FASIT
trust and trust certificates evidencing the assets of the trust were sold to
investors. The trust certificates were issued in classes representing senior,
mezzanine, and subordinate payment priorities. Payments received on
single-family mortgage loans ("Bond Collateral") are used to make payments on
the Long-Term Debt. The obligations under the Long Term Debt are payable solely
from the Bond Collateral and are otherwise non-recourse to the Company. The
maturity of each class of trust certificates is directly affected by the rate of
principal repayments on the related Bond Collateral. The Long-Term Debt is also
subject to redemption according to the specific terms of the indenture pursuant
to which the bonds were issued and the FASIT trust. As a result, the actual
maturity of the Long-Term Debt is likely to occur earlier than its stated
maturity.
Also, during 1998, the Company securitized Mortgage Loans in a "REMIC"
through an affiliate, Holdings. The Company accounted for the REMIC
securitization as a sale of Mortgage Loans and recorded a gain on the
transaction. The Company, through Holdings, retained an interest in this
securitization having a fair value of $3.2 million as of December 31, 2000. The
value of this residual interest is subject to all of the same risks impacting
the Company relative to the level of prepayments, increasing interest rates,
credit exposure and liquidity. A decline in the value of this investment could
adversely impact book equity and the Company's financial condition and results
of operations.
During 1999, the Company issued, through Eagle and its wholly owned
subsidiary, American Residential Eagle 2 Inc. ("Eagle 2"), three new series of
mortgage backed bonds (Long-Term Debt). Two series of these bonds were
non-recourse obligations of a trust formed and wholly-owned by Eagle. All series
of these bonds were secured by the assets of the trust, which consist of both
adjustable rate and fixed rate mortgage loans secured by first liens on one- to
four-family residential properties.
7
Payments received on Bond Collateral are used to make payments on the Long-Term
Debt. Payments received on the mortgage loans in excess of obligations due under
the Long-Term Debt are remitted to the Company on a monthly basis by the
independent trustee. The obligations under the Long-Term Debt are payable solely
from the Bond Collateral and are otherwise non-recourse to the Company. The
maturity of the bonds is directly affected by the rate of principal repayments
on the related Bond Collateral. The Long-Term Debt is also subject to redemption
by the Company according to the specific terms of the indenture pursuant to
which the bonds were issued. As a result, the actual maturity of the Long-Term
Debt is likely to occur earlier than its stated maturity.
During the second quarter of 2000, the Company, through it's subsidiary
known as Eagle Inc, conveyed an interest in approximately $56.2 million of
mortgage loans to Countrywide Home Loans, Inc. in exchange for a specified cash
sum and certain REMIC securities. Under generally accepted accounting
principles, the transaction was treated as an issuance of Long-Term Debt,
Series 2000-2, secured by the mortgage loans. The Series 2000-2 Long-Term Debt
consists of five classes, each of which bears interest at an adjustable rate.
The stated maturity for the Series 2000-2 Long-Term Debt is June 25, 2031,
however, since the maturity of the debt is directly affected by the rate of
principal repayments of the related mortgage loans, the actual maturity is
likely to occur earlier than stated maturity.
At December 31, 2000, total long-term borrowings outstanding were
approximately $797.2 million, with Mortgage Loans valued at approximately
$854.9 million pledged to secure such borrowings. These borrowings are carried
on the balance sheet at historical cost, which approximates market value even
with a two year fixed interest rate provision on bond collateral.
CAPITAL GUIDELINES
The Company's capital management goal is to strike a balance between the
under-utilization of leverage, which could reduce potential returns to
stockholders, and the over-utilization of leverage, which could reduce the
Company's ability to meet its obligations during periods of adverse market
conditions. For this purpose, the Company has established various risk
management policies and processes. For example, the Company and the Board of
Directors regularly review the Company's leverage and exposure to liquidity
risks to determine leverage ranges and the level of new Mortgage Asset
acquisition activity. For limited periods, the Company may exceed its desired
leverage range, but it is anticipated that in most circumstances the desired
leverage will be achieved over time without specific action by the Company or
the Manager through the natural process of mortgage principal repayments and
increases in Mortgage Loan acquisition activities. The Company anticipates that
the actual leverage is likely to be the lowest during periods following new
equity offerings and during periods of falling interest rates and that the
actual leverage is likely to be the highest during periods after the acquisition
of large bulk Mortgage Loan packages. The Board of Directors has the discretion
to modify the Company's policies and restrictions without stockholder consent.
There are no restrictions on the Company's ability to incur debt and there can
be no assurance the level of debt that the Company is authorized to incur will
not be increased by the Board of Directors.
The Company, with the advice of the Manager, assigns to each Mortgage Asset
a specified amount of capital to be maintained against it by aggregating three
key components. The first component of the Company's capital allocation process
is the current aggregate over-collateralization amount the lenders (or bond
trustees) require the Company to hold as capital. The Company is required to
pledge as collateral Mortgage Assets with a market value that exceeds the amount
it borrows. The overcollateralization levels are determined by the lender based
on the risk characteristics and liquidity of that Mortgage Asset. For example,
overcollaterallization levels on individual borrowings could range from 3% to 5%
for Mortgage Securities and Mortgage Loans and 1% to 10% for CMOs.
8
The second component of the Company's capital allocation process is the
"liquidity capital cushion." The Company expects that substantially all of its
reverse repurchase agreements will require the Company to deposit additional
collateral in the event the market value of existing collateral declines. The
liquidity cushion is an additional amount of capital in excess of the haircut
maintained by the Company designed to assist the Company in meeting the demands
of the lenders for additional collateral should the market value of the
Company's Mortgage Assets decline. Alternatively, the Company might sell
Mortgage Assets to reduce the borrowings. See "Business Risks--Investments in
Mortgage Assets May Be Illiquid."
Finally, the Board of Directors establishes, subject to revision from time
to time, leverage and cash reserve guidelines based on the composition of assets
and liabilities and assessments of capital call risks. The Board of Directors
reviews on a periodic basis various analyses prepared by the Manager of the
risks inherent in the Company's balance sheet, including an analysis of the
effects of various scenarios on the Company's net cash flow, net income,
dividends, liquidity and net market value. Should the Board of Directors
determine, in its discretion, that leverage or the minimum required cash
reserves are either too low or too high, the Board of Directors will raise or
lower capital guidelines accordingly.
At December 31, 2000, book equity capital to total fair value of the
Company's assets was approximately 8.68%. This percentage may fluctuate from
time to time, as the composition of the balance sheet changes, haircut levels
required by lenders change, the value of the Mortgage Assets change and as the
capital cushion percentages are adjusted over time. The Company will actively
monitor and adjust, if necessary, its policies and processes, both on an
aggregate portfolio level as well as on an individual pool or Mortgage Loan
basis. The Company expects to take into consideration current market conditions
and a variety of interest rate scenarios, avilability and cost of hedge
instruments, performance of Mortgage Assets, credit risk, prepayment of Mortgage
Assets, general economic conditions, potential issuance of additional equity,
pending acquisitions or sales of Mortgage Assets, Mortgage Loan securitizations
and the general availability of financing.
RISK MANAGEMENT
Prior to arranging the acquisition of Mortgage Assets by the Company, the
Manager gives consideration to balance sheet management and risk diversification
issues. A specific Mortgage Asset which is being evaluated for potential
acquisition is deemed more or less valuable to the Company to the extent it
serves to increase or decrease certain interest rate or prepayment risks which
may exist in the balance sheet, to diversify or concentrate credit risk, and to
meet the cash flow and liquidity objectives the Company may establish for its
balance sheet from time to time. Accordingly, an important part of the Mortgage
Assets evaluation process is a simulation, using the Manager's risk management
model, of the addition of proposed Mortgage Assets and its associated borrowings
and hedgings to the balance sheet and an assessment of the impact any proposed
acquisition of Mortgage Assets would have on the risks in, and returns generated
by, the Company's balance sheet as a whole over a variety of scenarios.
INTEREST RATE RISK MANAGEMENT
To the extent consistent with its election to qualify as a REIT, the Company
has implemented certain processes and periodically uses interest rate agreements
and other hedging instruments intended to protect the Company against
significant changes in interest rates.
The Company's primary risks associated with changes in interest rates are
(i) the differences between the interest rate adjustment period of its Mortgage
Assets and related borrowings (gap risk), See "ITEM 7a Quantitative and
Qualitative Disclosure About Market Risk", (ii) lifetime and periodic
9
rate adjustment caps on its Mortgage Assets, (iii) the differences between
interest rate adjustment indices of its Mortgage Assets and related borrowings
(basis risk), and (iv) prepayments on mortgage assets associated with declining
mortgage interest rates (see Prepayment Risk Management Process and High Level
of Mortgage Asset Prepayments Will Reduce Operating Income). The gap risk
(mismatch of assets and liabilities) is especially acute with fixed rate
Mortgage Loans and intermediate adjustable Mortgage Loans. Intermediate
adjustable Mortgage Loans are fixed for a set period and then convert to a
six-month adjustable rate. The fixed period is usually two to five years. The
Manager monitors and evaluates the results of its hedging strategy and adjusts
its hedging strategy as it deems is in the best interest of the Company.
The Company has periodically used hedging instruments it considered most
appropriate to limit its exposure to interest rate risk. The Company may enter
into additional types of hedging transactions in the future if its management
believes there exists a significant risk to operations.
Hedging involves transaction and other costs, and such costs increase as the
period covered by the hedging protection increases and also increase in periods
of rising and fluctuating interest rates. For example, in a typical interest
rate cap agreement, the cap purchaser makes an initial lump sum cash payment to
the cap seller in exchange for the sellers' promise to make cash payments to the
purchaser on fixed dates during the contract term if prevailing interest rates
exceed the rate specified in the interest rate cap agreement. Because of the
cost involved, the Company may be prevented from effectively hedging its
interest rate risks without significantly reducing the Company's return on
equity.
The unamortized cost of the interest rate cap agreements ("cap") at
December 31, 2000, was approximately $1.1 million. Cap premiums are amortized
from the effective date of the cap through the termination date on a
straight-line basis. See "Recent Accounting Developments" for discussion of
future accounting treatment of interest rate cap agreements. For the year ended
December 31, 2000, the interest rate cap agreement amortization expense was
approximately $995,000. Income from the cap agreements during this period
totaled $295 thousand. There were no floor agreements and consequently no income
from floor agreements for the year ending December 31, 2000. There were three
expirations of cap agreements during the year ending December 31, 2000, with a
combined notional amount of approximately $311 million. For the year ended
December 31, 2000, cap expense equaled approximately 0.067% of the average
balance of the Company's Mortgage Assets and 0.073% of the average balance of
the Company's interest bearing liabilities. For such period, the cap expense was
approximately 0.80% of net interest income from Mortgage Assets. At
December 31, 2000, the cap range of strike rates was 6.75% to 7.1% and the
weighted average strike rate was approximately 7.0%. At December 31, 2000, cap
agreements had a combined notional amount of $741 million. The Company's current
interest rate cap agreements have notional face amounts which vary over time.
All of the interest rate caps reference the one month LIBOR.
Certain of the federal income tax requirements that the Company must satisfy
to qualify as a REIT limit the Company's ability to fully hedge its interest
rate and prepayment risks. The Manager monitors carefully, and may have to
limit, the Company's asset/liability management program to assure that it does
not realize excessive hedging income, or hold hedging assets having excess value
in relation to total assets, which would result in the Company's
disqualification as a REIT or, in the case of excess hedging income, the payment
of a penalty tax for failure to satisfy certain REIT income tests under the
Code, provided such failure was for reasonable cause. In addition,
asset/liability management involves transaction costs which increase
dramatically as the period covered by the hedging protection increases.
Therefore, the Company may be prevented from effectively hedging its interest
rate and prepayment risks. See "Federal Income Tax Consequences--Requirements
for Qualification as a REIT."
In particular, income from hedging the Company's variable rate borrowings
(other than with hedging instruments that are Qualified REIT Assets) qualifies
for the 95% of income test, but not for the 75% of income test, for REIT
qualification. The Company must limit its income from such hedging
10
or the sale of hedging contracts, along with other types of income that
qualifies for the 95% of income test, but not for the 75% of income test, to
less than 25% of the Company's gross revenues. In addition, hedging instruments,
such as swaps, caps, floors, collars, and financial futures contracts, are
securities for purposes of the quarterly asset tests for REIT qualification. The
Company must ascertain that securities, including the hedging instruments (other
than hedging instruments that are Qualified REIT Assets), issued by a single
issuer do not account for 5% or more of the value of the Company's assets as of
the last day of each calendar quarter. The Company does not expect to encounter
material problems complying with these tests.
Although the Company believes that, with the advice of the Manager, it has
developed a cost effective interest rate risk management program to provide a
level of protection against interest rate risks, developing an effective program
is complex and no program can completely insulate the Company from the effects
of interest rate changes. Further, the cost of hedging transactions and the
federal tax laws applicable to REITs may limit the Company's ability to fully
hedge its interest rate risks.
PREPAYMENT RISK MANAGEMENT PROCESS
The Company has sought to minimize the effects on operations caused by
faster than anticipated prepayment rates by lowering premiums paid to acquire
mortgages and by purchasing Mortgage Loans with prepayment penalties. Prepayment
penalties typically expire two to five years from origination and the penalty
(subject to state-by-state laws) can range from approximately $800 to $4,000 on
a $100,000 loan. There can be no assurance that the Company's efforts to reduce
prepayment rates will be successful.
The amortized cost of the Company's total Mortgage Assets at December 31,
2000, was equal to 104.0% of the face value of the underlying Mortgage Loans.
The amortized cost of the Company's Bond Collateral at December 31, 2000, was
equal to 104.0% of the face value of the Bond Collateral.
CREDIT RISK MANAGEMENT
The Company reviews with the Manager credit risks and other risks of loss
associated with each investment and determines the appropriate level of reserves
to be established in the accounting records. In addition, the Company attempts
to diversify its Mortgage Asset portfolio to avoid undue geographic, issuer,
industry and certain other types of concentrations. The Company has obtained
protection against some risks from loan origination sellers and servicers
through representations and warranties and through mortgage pool insurance. The
Board of Directors monitors the overall portfolio risk and will increase the
allowance for Mortgage Loan losses when it believes appropriate.
In order to reduce the credit risks associated with acquisitions of Mortgage
Loans, the Company, with the advice of the Manager (i) employs a quality control
program, (ii) acquires Mortgage Loans that represent a broad range of moderate
risks as opposed to a concentrated risk, (iii) monitors the credit quality of
newly acquired and existing Mortgage Assets, and (iv) periodically adjusts the
Mortgage Loan loss allowances. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations." The Company also has arranged
for servicing of its Mortgage Loans with servicing entities that have particular
expertise and experience in the types of Mortgage Loans acquired and monitor the
performance of these servicers monthly. See "Business Risks--Borrower Credit May
Decrease Value of Mortgage Loans," "Characteristics of Underlying Property May
Decrease Value of Mortgage Loans," and "Loans Serviced by Third Parties."
The Company may sell Mortgage Assets from time to time for a number of
reasons, including, without limitation, to dispose of Mortgage Assets as to
which credit risk concerns have arisen, to seek to reduce interest rate risk, to
substitute one type of Mortgage Asset for another to seek to improve yield or to
maintain compliance with the 55% requirement under the Investment Company Act,
and
11
generally to restructure the balance sheet when Management deems such action
advisable. The REIT provisions of the Code limit in certain respects the ability
of the Company to sell Mortgage Assets.
FEDERAL INCOME TAX CONSEQUENCES
The Company intends to maintain its status as a REIT for federal income tax
purposes. A corporation qualifying as a REIT may avoid corporate income taxation
by distributing dividends equal to its taxable income to its stockholders
annually. The Company is organized in conformity with the requirements for
qualification and taxation as a REIT under the Code.
The provisions of the Code are highly technical and complex. This summary is
not intended to be a detailed discussion of all applicable provisions of the
Code, the rules and regulations promulgated thereunder, or the administrative
and judicial interpretations thereof. The Company has not obtained a ruling from
the Internal Revenue Service (the "Service") with respect to tax considerations
relevant to its organization or operation, or to an acquisition of its common
stock. This summary is not intended to be a substitute for prudent tax planning,
and each stockholder of the Company is urged to consult its own tax advisor with
respect to these and other federal, state and local tax consequences of the
acquisition, ownership and disposition of shares of the common stock of the
Company and any potential changes in applicable law.
REQUIREMENTS FOR QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, the Company must meet
certain tests which are described in brief below.
STOCK OWNERSHIP TESTS
For all taxable years after the first taxable year for which a REIT election
is made, the Company's shares of stock must be transferable and must be held by
a minimum of 100 persons for at least 335 days of a 12 month year (or a
proportionate part of a short tax year). The Company must also use the calendar
year as its taxable year. In addition, at all times during the second half of
each taxable year, no more than 50% in value of the shares of any class of the
stock of the Company may be owned directly or indirectly by five or fewer
individuals. The Company intends to satisfy both the 100 stockholder and 50%/5
stockholder individual ownership limitations described above for as long as it
seeks qualification as a REIT. The Company uses the calendar year as its taxable
year for income tax purposes.
12
ASSET TESTS
On the last day of each calendar quarter, at least 75% of the value of the
Company's assets must consist of Qualified REIT Assets, government securities,
cash and cash items (the "75% of assets test"). The Company believes that
substantially all of its assets are and will continue to be Qualified REIT
Assets. Qualified REIT Assets include interests in real property, interests in
Mortgage Loans secured by real property and interests in REMICs.
On the last day of each calendar quarter, of the investments in securities
not included in the 75% of assets test, the value of any one issuer's securities
may not exceed 5% by value of the Company's total assets, and the Company may
not own more than 10% of any one issuer's outstanding voting securities. If such
limits are ever exceeded, the Company intends to take appropriate remedial
action to dispose of such excess assets within the 30 day period after the end
of the calendar quarter, as permitted under the Code.
GROSS INCOME TESTS
The Company must satisfy the following income-based tests for each year in
order to qualify as a REIT.
1. THE 75% TEST. At least 75% of the Company's gross income (the "75% of
income test") for the taxable year must be derived from qualified REIT assets.
The investments that the Company has made and intends to make will give rise
primarily to mortgage interest qualifying under the 75% of income test.
2. THE 95% TEST. In addition to deriving 75% of its gross income from the
sources listed above, at least an additional 20% of the Company's gross income
for the taxable year must be derived from those sources, or from dividends,
interest or gains from the sale or disposition of stock or other securities that
are not dealer property (the "95% of income test"). In order to help ensure
compliance with the 95% of income test and the 75% of income test, the Company
intends to limit substantially all of the assets that it acquires to Qualified
REIT Assets. The policy of the Company to maintain REIT status may limit the
type of assets, including hedging contracts, that the Company otherwise might
acquire.
If the Company fails to satisfy one or both of the 75% or 95% of income
tests for any year, it may face either (a) assuming such failure was for
reasonable cause and not willful neglect, a 100% tax on the greater of the
amounts of income by which it failed to comply with the 75% test of income or
the 95% of income test, reduced by estimated related expenses or (b) loss of
REIT status.
DISTRIBUTION REQUIREMENT
The Company must distribute to its stockholders on a pro rata basis an
amount equal to (i) 95% of its taxable income before deduction of dividends paid
and excluding net capital gain, plus (ii) 95% of the excess of the net income
from foreclosure property over the tax imposed on such income by the Code less
(iii) any "excess noncash income" (the "95% distribution test"). The Company
intends to make distributions to its stockholders in amounts sufficient to meet
the 95% distribution test.
A nondeductible excise tax, equal to 4% of the excess of such required
distributions over the amounts actually distributed will be imposed on the
Company for each calendar year to the extent that dividends paid during the year
(or declared during the last quarter of the year and paid during January of the
succeeding year) are less than the sum of (i) 85% of the Company's "ordinary
income," (ii) 95% of the Company's capital gain net income plus, and
(iii) income not distributed in earlier years.
13
RECORDKEEPING REQUIREMENTS
As a REIT, the Company is required to maintain records regarding the actual
and constructive ownership of its shares, and other information, and within
30 days after the end of its taxable year, to demand statements from persons
owning above specified level of the Company's shares (generally stockholders
owning more than 1% of the Company's outstanding stock). The Company must
maintain, as part of the Company's records, a list of those persons failing or
refusing to comply with this demand. Stockholders who fail or refuse to comply
with the demand must submit a statement with their tax returns setting forth the
actual stock ownership and other information. The Company also is required to
maintain permanent records of its assets as of the last day of each calendar
quarter. The Company intends to maintain the records and demand statements as
required by these regulations.
TAXATION OF STOCKHOLDERS
For any taxable year in which the Company is treated as a REIT for federal
income purposes, amounts distributed by the Company to its stockholders will be
included by the stockholders as ordinary income for federal income tax purposes
unless properly designated by the Company as capital gain dividends. In the
latter case, the distributions will be taxable to the stockholders as long-term
capital gains. Any loss on the sale or exchange of shares of the stock of the
Company held by a stockholder for six months or less will be treated as a
long-term capital loss to the extent of any capital gain dividend received on
the stock held by such stockholders. If the Company makes distributions to its
stockholders in excess of its current and accumulated operations and profits,
those distributions will be considered first a tax-free return of capital,
reducing the tax basis of a stockholder's share until the tax basis is zero.
Such distributions in excess of the tax basis will be taxable as gain realized
from the sale of the Company's shares.
Distributions by the Company will not be eligible for the dividends received
deduction for corporations. Stockholders may not deduct any net operating losses
or capital losses of the Company.
The Company does not expect to acquire or retain residual interests issued
by REMICs. Such residual interests, if acquired by a REIT, would generate excess
inclusion income that, among other things, is fully taxable as unrelated
business taxable income ("UBTI") to Tax Exempt Entities. Potential investors,
and in particular Tax Exempt Entities, are urged to consult with their tax
advisors concerning this issue.
The Company will notify stockholders after the close of the Company's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such month will be deemed to have been received by the stockholders and
paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year.
RECENT TAX LEGISLATION
The REIT Modernization Act, enacted in December 1999, contains several
provisions affecting REITs. REITs are able to own directly the stock of taxable
subsidiaries. Previously, REITs were generally limited to holding non-voting
preferred stock in taxable affiliates. The value of all taxable subsidiaries of
a REIT is limited to 20% of the total value of the REIT's assets. As of
January 1, 2001, existing taxable subsidiaries have to be converted to qualified
taxable REIT subsidiaries, unless the existing taxable subsidiary has been in
place since July 12, 1999, and there has been no material change in the taxable
subsidiary's assets or business since that time. In addition, a REIT is subject
to a 100% penalty tax equal to any rents or charges that the REIT imposed on the
taxable subsidiary in excess of the arm's length price for comparable services.
14
Further, under the Act, the minimum dividend distributions of a REIT has to
equal 90% of taxable income, down from 95% of taxable income under previous law.
This provision also was effective as of January 1, 2001. Under this provision,
the Company is able to retain a greater percentage of its after-tax earnings if
desired.
INVESTMENT COMPANY ACT
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act of 1940. If
the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment Company
Act of 1940 exempts entities that are "primarily engaged in the business of
purchasing or otherwise acquiring mortgages and other liens on and interest in
real estate" ("Qualifying Interests"). Under current interpretation of the staff
of the Securities and Exchange Commission, in order to qualify for this
exemption, the Company must maintain at least 55% of its assets directly in
Qualifying Interests. In addition, unless certain mortgage securities represent
all the certificates issued with respect to an underlying pool of mortgages,
such mortgage securities may be treated as securities separate from the
underlying mortgage loans and, thus, may not be considered Qualifying Interests
for purposes of the 55% requirement.
COMPETITION
The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. There can be no assurance
that the Company will be able to acquire sufficient Mortgage Assets at spreads
above the Company's cost of funds. In acquiring Mortgage Assets, the Company
will compete with investment banking firms, savings and loan associations,
banks, mortgage bankers, insurance companies, mutual funds, other lenders,
FHLMC, FNMA, GNMA and other entities purchasing Mortgage Assets, many of which
have greater financial resources than the Company. In addition, there are
several REITs similar to the Company, and others may be organized in the future.
The effect of the existence of additional REITs may be to increase competition
for the available supply of Mortgage Assets suitable for purchase by the
Company. The Company will face competition from companies already established in
these markets. There can be no assurance that the Company will be able to
successfully compete with its competition.
EMPLOYEES
Currently, the Company and the Manager each employ six executive officers
and ten additional employees. Each of the executive officers has between 11 and
25 years experience, and collectively, they have an average of 24 years of
experience in the residential mortgage industry. Four executive officers worked
together previously as a management team.
THE MANAGEMENT AGREEMENT
TERM OF THE MANAGEMENT AGREEMENT AND TERMINATION FEE
The Company entered into a Management Agreement with the Manager for an
initial term of two years beginning February 11, 1997. The Management Agreement
will be renewed automatically for successive one year periods unless a notice of
non-renewal is timely delivered by the Company. The Company may elect to prevent
the automatic renewal of the Management Agreement only by vote of both a
majority of the Board of Directors and a majority of the directors who are not
executive officers or employees of the Company followed by delivery of a written
notice of non-renewal to the Manager at least 60 days prior to the end of the
then current period of the Management Agreement. The Management Agreement will
terminate at the expiration of the then-current period in which such
15
notice of non-renewal is delivered. Upon non-renewal of the Management Agreement
without cause, a termination fee will be payable to the Manager. See "Management
Fees." In addition, the Company has the right to terminate the Management
Agreement at any time upon the happening of certain specified events, after
notice and an opportunity to cure, including a material breach by the Manager of
any provision contained in the Management Agreement. Upon such a termination for
cause, no termination fee will be payable to the Manager. The Manager is
currently in default of certain debt covenants. The senior note holders have not
issued waivers, however the parties continue to operate under the original terms
of the Management Agreement (see Default of Manager under Securities Purchase
Agreement; Restrictive Covenants).
ADMINISTRATIVE SERVICES PROVIDED BY THE MANAGER
The Manager is responsible for the day-to-day operations of the Company and
performs such services and activities relating to the assets and operations of
the Company as may be appropriate, including:
(i) serving as the Company's consultant with respect to the formulation
of investment criteria and the preparation of policy guidelines;
(ii) assisting the Company in developing criteria for Mortgage Asset
purchase commitments that are specifically tailored to the Company's long
term investment objectives and making available to the Company its knowledge
and experience with respect to Mortgage Loan underwriting criteria;
(iii) representing the Company in connection with the purchase of, and
commitment to purchase, Mortgage Assets, including the formation of Mortgage
Asset purchase commitment criteria;
(iv) arranging for the issuance of Mortgage Securities from pools of
Mortgage Loans and providing the Company with supporting services in
connection with the creation of Mortgage Securities;
(v) furnishing reports and statistical and economic research to the
Company regarding the Company's activities and the performance of the
Manager;
(vi) monitoring and providing to the Board of Directors on an ongoing
basis price information and other data, which price information and other
data shall be obtained from certain nationally recognized dealers and other
entities that maintain markets in Mortgage Assets as selected by the Board
of Directors from time to time, and providing advice to the Board of
Directors to aid the Board of Directors in the selection of such dealers and
other entities;
(vii) administering the day-to-day operations of the Company and
performing and supervising the performance of such other administrative
functions necessary in the management of the Company as may be agreed upon
by the Manager and the Board of Directors, including the collection of
revenues and the payment of the Company's expenses, debts and obligations
and maintenance of appropriate computer services to perform such
administrative functions;
(viii) designating a servicer and/or subservicer for those Mortgage
Loans sold to the Company by originators that have elected not to service
such Mortgage Loans and arranging for the monitoring and administering of
such servicer and subservicer;
(ix) counseling the Company in connection with policy decisions to be
made by the Board of Directors;
16
(x) evaluating and recommending hedging strategies to the Board of
Directors and, upon approval by the Board of Directors, facilitating the
implementation and monitoring the performance of these strategies;
(xi) supervising compliance with the REIT provisions of the Code and
Investment Company Act of 1940 status, including setting up a system to
monitor hedging activities on a periodic basis for such compliance;
(xii) establishing quality control procedures for the Mortgage Assets of
the Company, including audits of Mortgage Loan underwriting files and the
hiring of any agents with such particular knowledge and expertise as may be
appropriate to perform any such quality control procedures, and
administering, performing and supervising the performance of the quality
control procedures of the Company and performing and supervising the
performance of such other functions related thereto necessary or advisable
to assist in the performance of such procedures and the attainment of the
purposes thereof;
(xiii) upon request by and in accordance with the directions of the
Board of Directors, investing or reinvesting any money of the Company;
(xiv) conducting, or causing to be conducted, a legal document review of
each Mortgage Loan acquired to verify the accuracy and completeness of the
information contained in the Mortgage Loans, security instruments and other
pertinent documents in the mortgage file;
(xv) providing the Company with data processing, legal and
administrative services to the extent required to implement the business
strategy of the Company;
(xvi) providing all actions necessary for compliance by the Company with
all federal, state and local regulatory requirements applicable to the
Company in respect of its business activities, including preparing or
causing to be prepared all financial statements required under applicable
regulations and contractual undertakings and all reports and documents, if
any, required under the Securities Exchange Act of 1934, as amended;
(xvii) providing all actions necessary to enable the Company to make
required federal, state and local tax filings and reports and to generally
enable the Company to maintain its status as a REIT, including soliciting
stockholders for required information to the extent provided in the REIT
provisions of the Code;
(xviii) communicating on behalf of the Company with the holders of the
equity and debt securities of the Company as required to satisfy the
reporting and other requirements of any governmental bodies or agencies and
to maintain effective relations with such holders; and
(xix) performing such other services as may be required from time to
time for management and other activities relating to the assets of the
Company as the Board of Directors shall reasonably request or the Manager
shall deem appropriate under the particular circumstances.
Except in certain circumstances, the Manager may not assign its rights and
duties under the Management Agreement, in whole or in part, without the written
consent of the Company and the consent of a majority of the Company's
independent directors who are not affiliated with the Manager.
SERVICING OF THE MORTGAGE LOANS
The Company has acquired certain of its Mortgage Loans on a servicing
released basis. The Manager has entered into contracts with other parties to
provide sub-servicing for the Company. The Manager will monitor the
sub-servicing of the Mortgage Loans. Such monitoring includes, but not be
limited to, the following: (i) serving as the Company's consultant with respect
to the servicing of Mortgage Loans; (ii) collection of information and
submission of reports pertaining to the Mortgage
17
Loans and to moneys remitted to the Manager or the Company by any servicer;
(iii) periodic review and evaluation of the performance of each servicer to
determine its compliance with the terms and conditions of the applicable
sub-servicing or servicing agreement and, if deemed appropriate, recommending to
the Company the termination of such agreement; (iv) acting as a liaison between
servicers and the Company and working with servicers to the extent necessary to
improve their servicing performance; (v) review of and recommendations as to
fire losses, easement problems and condemnation, delinquency and foreclosure
procedures with regard to the Mortgage Loans; (vi) review of servicer's
delinquency, foreclosure and other reports on Mortgage Loans; (vii) supervising
claims filed under any mortgage insurance policies; and (viii) enforcing the
obligation of any servicer to repurchase Mortgage Loans from the Company.
LIMITS OF RESPONSIBILITY
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for thereunder and will
not be responsible for any action of the Board of Directors in following or
declining to follow its advice or recommendations. The Manager, its directors,
officers, stockholders and employees will not be liable to the Company, any
issuer of Mortgage Securities, any subsidiary of the Company, the Company's
independent directors, the Company's stockholders or any subsidiary's
stockholders for acts performed in accordance with and pursuant to the
Management Agreement, except by reason of acts or omissions constituting bad
faith, willful misconduct, gross negligence or reckless disregard of their
duties under the Management Agreement. The Manager does not have significant
assets other than its interest in the Management Agreement. Consequently, there
can be no assurance that the Company would be able to recover any damages for
claims it may have against the Manager. The Company has agreed to indemnify the
Manager, and its respective directors, officers, stockholders and employees with
respect to all expenses, losses, damages, liabilities, demands, charges and
claims arising from any acts or omissions of the Manager made in good faith in
the performance of its duties under the Management Agreement and not
constituting bad faith, willful misconduct, gross negligence or reckless
disregard of its duties. The Management Agreement does not limit or restrict the
right of the Manager or any of its officers, directors, employees or affiliates
to engage in any business or to render services of any kind to any other person,
including the purchase of, or rendering advice to others purchasing Mortgage
Assets which meet the Company's policies and criteria, except that the Manager
and its officers, directors or employees will not be permitted to provide for
any such services to any residential mortgage REIT, other than the Company or
another REIT sponsored by the Manager or its affiliates, which has operating
policies and strategies different in one or more material respects from those of
the Company, as confirmed by a majority of the independent directors of the
Company.
RELATIONSHIP BETWEEN THE MANAGER AND THE COMPANY
In addition to the Management Agreement between the Manager and the Company,
the Manager also has limited rights in the shares of the Company's common stock
held by MDC REIT Holdings, LLC ("MDC-REIT") an intermediate holding company. The
Manager contributed $20 million in 1997 to MDC-REIT which used the funds to
acquire the shares of the Company's common stock. In exchange for its
contribution to MDC-REIT, the Manager received a senior right to receive
distributions from MDC-REIT equal to 5% per quarter of the capital contributed
by the Manager, compounded quarterly to the extent unpaid. After payment of the
preference amount in full, the Manager has a right to receive approximately 50%
of any remaining distributions in repayment of its capital contribution. The
Manager has also been appointed to oversee the day-to-day operations of
MDC-REIT. However, after payment in full of its preference amount and return of
its capital contribution, the Manager will have no further rights to
distributions from MDC-REIT. MDC-REIT's
18
sole asset is its shares of the Company's common stock and its sole source of
income is dividends declared by the Company.
MANAGEMENT FEES
The Manager receives an annual base management fee payable monthly in
arrears of an amount representing the monthly portion of the per annum
percentage of "gross mortgage assets" of the Company and its subsidiaries. These
fees shall be applicable during the entire operational stage of the Company's
business. The Company pays to the Manager the following management fees and
incentive compensation:
- 1/8 of 1% per year, paid monthly (the "Agency Percentage"), of the
principal amount of Agency Securities;
- 3/8 of 1% per year, paid monthly (the "Non-Agency Percentage"), of the
principal amount of all other Mortgage Assets; and
- 25% of the amount by which the Company's net income (calculated prior to
deduction of this incentive compensation fee) exceeds the annualized
return on equity equal to the average Ten Year U.S. Treasury Rate plus 2%.
The term "gross mortgage assets" means for any month the aggregate book
value of the consolidated Mortgage Assets of the Company and its subsidiaries,
before allowances for depreciation or bad debts or other similar non-cash
allowances, computed at the end of such month prior to any dividend distribution
made during each month.
The incentive compensation calculation and payment are made quarterly in
arrears. The term "Return on Equity" is calculated for any quarter by dividing
the Company's Net Income for the quarter by its Average Net Worth for the
quarter. For such calculations, the "Net Income" of the Company means the net
income of the Company determined in accordance with GAAP before the Manager's
incentive compensation, the deduction for dividends paid and net operating loss
deductions arising from losses in prior periods. A deduction for the Company's
interest expenses for borrowed money is taken when calculating Net Income.
"Average Net Worth" for any period means (i) $20,165,000 plus (ii) the
arithmetic average of the sum of the gross proceeds from any offering of its
equity securities by the Company, before deducting any underwriting discount and
commissions and other expenses and costs relating to the offering, plus the
Company's retained earnings (without taking into account any losses incurred in
prior periods and excluding amounts reflecting taxable income to be distributed
as dividends and amounts reflecting valuation allowance adjustments) computed by
taking the daily average of such values during such period. The definition
"Return on Equity" is used only for purposes of calculating the incentive
compensation payable, and is not related to the actual distributions received by
stockholders. The incentive compensation payments to the Manager are made before
any income distributions are made to the stockholders of the Company.
The Manager's base management fee is calculated by the Manager within
15 days after the end of each month, and such calculation is promptly delivered
to the Company. The Company is obligated to pay the amount of the final base
management fee in excess of the amount paid to the Manager at the beginning of
the month pursuant to the Manager's good faith estimate within 30 days after the
end of each month. The Company pays the incentive fee with respect to each
fiscal quarter within 15 days following the delivery to the Company of the
Manager's written statement setting forth the computation of the incentive fee
for such quarter. The Manager computes the annual incentive fee within 45 days
after the end of each fiscal year, and any required adjustments are paid by the
Company or the Manager within 15 days after the delivery of the Manager's
written computation to the Company.
19
TERMINATION FEES
The Company may elect to prevent the automatic renewal of the Management
Agreement by vote of both a majority of the Board of Directors and a majority of
the directors who are not executive officers or employees of the Company
followed by delivery of a written notice of non-renewal to the Manager at least
60 days prior to the end of the then-current period of the Management Agreement.
The Management Agreement shall terminate at the expiration of the then-current
period in which such notice of non-renewal is delivered. Upon non-renewal of the
Management Agreement without cause, a termination fee will be payable to the
Manager, in an amount equal to the greater of (i) the fair value of the
Management Agreement as established by an independent appraiser, or (ii) three
times the total of the base and incentive compensation fees paid to the Manager
for the four most recently completed calendar quarters ending on or prior to the
date of termination. In addition, the Company has the right to terminate the
Management Agreement at any time upon the occurrence of certain specified
events, after notice and an opportunity to cure, including a material breach by
the Manager of any provision contained in the Management Agreement. Upon such a
termination for cause, no termination fee will be payable to the Manager.
EXPENSES
The Company pays all operating expenses, except those specifically required
to be borne by the Manager under the Management Agreement. The operating
expenses required to be borne by the Manager include the compensation and other
employment costs of the Manager's officers in their capacities as such and the
cost of office space and out-of-pocket costs, equipment and other personnel
required for performance of the Company's day-to-day operations. The expenses
that are paid by the Company will include issuance and transaction costs
incident to the acquisition, disposition and financing of investments, regular
legal and auditing fees and expenses, the fees and expenses of the Company's
directors, premiums for directors' and officers' liability insurance, premiums
for fidelity and errors and omissions insurance, sub-servicing expenses, the
costs of printing and mailing proxies and reports to stockholders, and the fees
and expenses of the Company's custodian and transfer agent, if any. The Company,
rather than the Manager, is also required to pay expenses associated with
litigation and other extraordinary or non-recurring expenses. Expense
reimbursements are made monthly.
SALARY REIMBURSEMENTS
The Company employs certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers, so that such employees may maintain certain benefits that are
available only to employees of the Company under the Code. These benefits
include the ability to receive incentive stock options under the 1997 Stock
Option Plan and to participate in the Company's Employee Stock Purchase Plan. In
order to receive the aggregate benefits of the Management Agreement originally
negotiated between the Company and the Manager, the Company pays the base
salaries of such employees and is reimbursed quarterly by the Manager for all
costs incurred with respect to such payments. At December 31, 2000, the Company
had advanced approximately $285,000 to the Manager for payroll advances.
BUSINESS RISKS
HIGH LEVELS OF MORTGAGE ASSET PREPAYMENTS WILL REDUCE OPERATING INCOME
The levels of prepayments of Mortgage Assets purchased with a premium by the
Company directly impacts the level of amortization of capitalized premiums. The
Company uses a calculation for determining the premium amortization which is
based on the interest method. If prepayment levels
20
exceed projections used for the premium amortization calculation, the potential
exists for impairment write-downs as a result of under amortized premiums.
Mortgage Asset prepayment rates generally increase when new Mortgage Loan
interest rates fall below the current interest rates on Mortgage Loans.
Prepayment experience also may be affected by the expiration of prepayment
penalty clauses, the ability of the borrower to obtain a more favorable Mortgage
Loan, geographic location of the property securing the adjustable-rate Mortgage
Loans, the assumability of a Mortgage Loan, conditions in the housing and
financial markets and general economic conditions. The level of prepayments is
also subject to the same seasonal influences as the residential real estate
industry with prepayment rates generally being highest in the summer months and
lowest in the winter months. The Company experienced high levels of prepayments
during 1999 through 2000 on its CMO/FASIT segment of its Mortgage Loan portfolio
due principally to the fact that the underlying adjustable rate loans were
subject to their first initial interest rate adjustment (after being fixed for
the first two years), prepayment penalty clauses expired and borrowers were able
to secure more favorable rates by refinancing. The Company anticipates that
overall prepayment rates are likely to increase in 2001 as loans in the 1999-A
and 1999-2 segments of the portfolio reach re-set dates where the underlying
loans subject to rate increases and prepayment penalties expire. There can be no
assurance that the Company will be able to achieve or maintain lower prepayment
rates or that prepayment penalty income will offset premium amortization
expense. Accordingly, the Company's financial condition and results of
operations could be materially adversely affected.
As of December 31, 2000 approximately 74% of the Mortgage Loan portfolio had
prepayment penalty clauses, with a weighted average of 14 months remaining
before prepayment penalties expire. Prepayment penalty clauses serve as a
deterrent to early prepayments and the penalties collected help to offset the
premium amortization expense. However, prepayment penalty fees may be in an
amount which is less than the figure which would fully compensate the Company
for its remaining capitalized premiums, and prepayment penalty provisions may
expire before the prepayment occurs.
BORROWER CREDIT MAY DECREASE VALUE OF MORTGAGE ASSETS
During the time the Company holds Mortgage Loans Held-for-Investment, Bond
Collateral or Retained Interest in Securitizations it is subject to credit
risks, including risks of borrower defaults, bankruptcies and special hazard
losses that are not covered by standard hazard insurance (such as those
occurring from earthquakes or floods). In the event of a default on any Mortgage
Loan held by the Company or mortgages underlying Bond Collateral or Retained
Interest in Securitization, the Company will bear the risk of loss of principal
to the extent of any deficiency between the value of the secured property and
the amount owing on the Mortgage Loan, less any payments from an insurer or
guarantor. Although the Company has established an allowance for Mortgage Loan
losses, there can be no assurance that any allowance for Mortgage Loan losses
which is established will be sufficient to offset losses on Mortgage Loans in
the future.
Credit risks associated with non-conforming Mortgage Loans, especially
sub-prime Mortgage Loans, may be greater than those associated with Mortgage
Loans that conform to Fannie Mae ("FNMA") and Freddie Mac ("FHLMC") guidelines.
The principal difference between sub-prime Mortgage Loans and conforming
Mortgage Loans typically include one or more of the following: worse credit and
income histories of the mortgagors, higher loan-to-value ratios, reduced or
alternative documentation required for approval of the mortgagors, different
types of properties securing the Mortgage Loans, higher loan sizes and the
mortgagor's non-owner occupancy status with respect to the mortgaged property.
As a result of these and other factors, the interest rates charged on
non-conforming Mortgage Loans are often higher than those charged for conforming
Mortgage Loans. The combination of different underwriting criteria and higher
rates of interest may lead to higher delinquency rates and/or credit losses for
non-conforming as compared to conforming Mortgage Loans
21
and thus require high loan loss allowances. All of the Company's Mortgage Loans
at December 31, 2000 were originated as sub-prime Mortgage Loans.
A down turn in the national economy and the resultant adverse impact on
employment rates could adversely affect Mortgage Loan defaults. Additional
credit could become scarce in such an environment and therefore risk of loss
through loan default and decreased property value could increase. The Company
feels their reserves for such occurrences are adequate based on current
forecasts but reserves may be inadequate should economic conditions worsen
significantly causing higher then expected defaults and property value
decreases.
Even assuming that properties secured by the Mortgage Loans held by the
Company provide adequate security for such Mortgage Loans, substantial delays
could be encountered in connection with the foreclosure of defaulted Mortgage
Loans, with corresponding delays in the receipt of related proceeds by the
Company. State and local statutes and rules may delay or prevent the Company's
foreclosure on or sale of the mortgaged property and typically prevent the
Company from receiving net proceeds sufficient to repay all amounts due on the
related Mortgage Loan.
Defaulted Mortgage Loans also cease to be eligible collateral for reverse
repurchase borrowings, and therefore have to be financed by the Company from
other funds until ultimately liquidated. The Company attempts to mitigate this
risk by utilizing long-term financing vehicles. At December 31, 2000, there were
no reverse repurchase borrowings.
INABILITY TO ACQUIRE MORTGAGE ASSETS
The Company's net interest income will depend, in large part, on the
Company's ability to acquire Mortgage Assets on acceptable terms and at
favorable spreads over the Company's borrowing costs. There can be no assurance
that the Company will be able to replenish the Mortgage Asset portfolio as
prepayments occur. In acquiring Mortgage Assets, the Company will compete with
numerous other financial institutions. The effect of the existence of these
competitors may be to increase competition for the available supply or price of
Mortgage Assets suitable for purchase by the Company. There can be no assurance
that the Company will be able to successfully compete with its competition.
To the extent that the Company is unable to fully invest in a sufficient
amount of Mortgage Loans meeting its criteria, the Company's results of
operations will be materially adversely affected.
The Company may acquire Mortgage Assets with geographic, originators,
insurer and other types of concentrations. Accordingly, a significant portion of
the Company's Mortgage Assets may be subject to the risks associated with a
single type of occurrence. In the event of such an occurrence, the adverse
effects on the Company's results of operations will be significantly greater
than if the Company's Mortgage Assets were diversified with respect to such
factors.
The Company's ability to acquire Mortgage Assets is also dependent on the
availability of financing to fund these acquisitions. See "Failure to Renew or
Obtain Adequate Funding May Adversely Affect Results of Operations".
PREPAYMENTS, CREDIT LOSSES AND INCREASES IN SHORT TERM INTEREST MAY ADVERSELY
AFFECT THE VALUE OF RETAINED INTEREST IN SECURITIZATION
In 1998, the Company diversified its residential Mortgage Loan sales
activities to include the securitization of such loans through a Real Estate
Mortgage Investment Conduit ("REMIC"). The REMIC consisted of pooled, first-lien
mortgages and was issued by Holdings to the public through a registration
statement of an underwriter. The interest-only strip referred to as the Class
"X" Certificate was created in the process of the securitization and transferred
from Holdings to Eagle. The value of this investment is impacted by the level of
future prepayments, credit loss and net interest spread on
22
the underlying mortgages. During the year ending December 31, 2000, the Company
incurred a $5.1 million impairment charge related to its retained interest in a
REMIC securitization (the "Residual"). Generally accepted accounting principles
"GAAP" require that any decline in residual asset value that is other than
temporary be reflected through the Company's current period income statement.
There are no other retained interests in securitizations owned by the Company.
THE DIRECT ORIGINATION OF RESIDENTIAL MORTGAGES IS SUBJECT TO A VARIETY OF
BUSINESS RISKS INCLUDING OVERHEAD EXPOSURE, REGULATORY OVERSIGHT, COMPETITION
AND POSSIBLE INTEREST RATE EXPOSURE ASSOCIATED WITH COMMITMENTS TO FUND
MORTGAGES
The Company intends to begin originating Mortgage Loans during 2001. The
business of originating Mortgage Loans is subject to various risks such as
overhead costs that may not be offset by origination fees and revenues, risks
associated with non-compliance with various sate and federal laws covering
mortgage lending practices, disclosures and loan documentation, pressure on
profit margins caused by a very competitive mortgage marketplace, and potential
exposure to interest rate risk in the event that the Company makes commitments
to borrowers to fund loans at a certain interest rate and prevailing interest
rates increase. The Company and the Manager intend to use the extensive
experience and skill of its executive team and employees, and to hire additional
highly experienced staff, to manage all of the risks inherent in originating
mortgages, but there can be no such assurances that all of these risks will be
fully mitigated.
The primary strategy to change the composition of its revenue sources is for
the company to establish mortgage banking operating capabilities. The Company is
in the process of establishing the required infrastructure to originate, sell
and service loans.
The Management Agreement does not limit or restrict the right of the Manager
or any of its officers, directors, employees or affiliates to engage in any
business or to render services of any kind to any other person, including
purchasing, or rendering advice to others purchasing, Mortgage Assets which meet
the Company's policies and criteria, except that the Manager and its officers,
directors, or employees will not be permitted to provide any such services to
any REIT which invests primarily in residential Mortgage Assets, other than the
Company.
REQUIREMENTS TO MAINTAIN OVERCOLLATERALIZATION ACCOUNTS
Due to the underlying loan to collateral values established by the Company's
short term lenders, the Company may be subject to calls for additional capital
in the event of adverse market conditions. Such conditions include (i) higher
than expected levels of prepayments or borrower defaults on Mortgage Loans and
(ii) sudden increases in interest rates. Although its long-term financing
agreements are non-recourse, net interest income from the Bond Collateral can be
"trapped" to pay down debt in order for the Company to maintain its
over-collateralization requirements. As such, the Company would not be able to
use this income to purchase loans, pay management fees, or pay dividends or
other expenses. There can be no assurances that the Company will not be required
to reduce or cease new loan purchases activity or dividends should it be
required to divert cash flow to maintain collateral requirements. See
"Business--Funding," and "--Capital Guidelines."
MORTGAGE ASSETS PLEDGED TO SECURE LONG-TERM DEBT
A substantial portion of the Company's Mortgage Assets at December 31, 2000
were pledged as Bond Collateral to secure Long-Term Debt. These assets are
subject to the terms of the Long-Term Debt agreements and may not be separately
sold or exchanged. While the Company may sell its interests in the Bond
Collateral subject to the liens and other restrictions of the Long-Term Debt
agreements, there is not a liquid market for such encumbered interests and a
significant liquidity discount would be applied. As such, the Company would
expect to receive less than its book value should it sell its interests in the
Bond Collateral.
23
CHARACTERISTICS OF UNDERLYING PROPERTY MAY DECREASE VALUE OF MORTGAGE LOANS
Although the Company intends to seek geographic diversification of the
properties which are collateral for the Company's Mortgage Loans, it does not
intend to set specific diversification requirements (whether by state, zip code
or other geographic measure). Concentration in any one geographic area will
increase the exposure of the Company's Mortgage Assets to the economic and
natural hazard risks associated with that area.
Certain properties securing Mortgage Loans may be contaminated by hazardous
substances resulting in reduced property values. If the Company forecloses on a
defaulted Mortgage Loan collateralized by such property, the Company may be
subject to environmental liabilities regardless of whether the Company was
responsible for the contamination.
The results of the Company's Mortgage Loan acquisition program may also be
affected by various factors, many of which are beyond the control of the
Company, such as (i) economic conditions affecting real estate values,
(ii) interest rate levels and the availability of credit to refinance such
Mortgage Loans at or prior to maturity, and (iii) increased operating costs,
including energy costs, real estate taxes and costs of compliance with
regulations.
INTEREST RATE INCREASES MAY REDUCE INCOME FROM OPERATIONS
The majority of the Company's Mortgage Loans have a repricing frequency of
two years or less, while substantially all of the Company's borrowings have a
repricing frequency of one month or less. Accordingly, the interest rates on the
Company's borrowings may be based on interest rate indices which are different
from, and adjust more rapidly than, the interest rate indices of its related
Mortgage Loans. Consequently, increases in (short-term) interest rates may
significantly influence the Company's net interest income. While increases in
short-term interest rates will increase the yields on a portion of the Company's
adjustable-rate Mortgage Loans, rising short term rates will also increase the
cost of borrowings by the Company. To the extent such costs rise more than the
yields on such Mortgage Loans, the Company's net interest income will be reduced
or a net interest loss may result. The Company mitigates its "gap' risk by
purchasing interest rate hedges (referred to as "caps'), however potential
income from these hedges may only partially offset the adverse impact of rising
borrowing costs.
ACCUMULATION RISK ASSOCIATED WITH MORTGAGE LOANS HELD-FOR-INVESTMENT
At various points in time, the Company purchases and holds Mortgage Loans
which are primarily financed with short-termborrowings. Typically mortgages are
accumulated for one to six months and then securitized and transferred into Bond
Collateral. During the accumulation period the loans are financed with
short-term reverse repurchase agreements. Although the reverse repurchase
agreements are committed, lenders have the right to mark the mortgage collateral
to market and potentially increase the Company's cash equity investment in the
mortgage collateral. During periods of rising interest rates or turbulent market
conditions, the market value of these loans may be adversely impacted. At
December 31, 2000 there were no Mortgage Loans being financed by short-term
reverse repurchase agreements.
FAILURE TO SUCCESSFULLY MANAGE INTEREST RATE RISKS MAY ADVERSELY AFFECT RESULTS
OF OPERATIONS
The Company will follow a program intended to protect against interest rate
changes. However, developing an effective interest rate risk management strategy
is complex and no management strategy can completely insulate the Company from
risks associated with interest rate changes. In addition, hedging involves
transaction costs. In the event the Company hedges against interest rate risks,
the Company may substantially reduce its net income. Further, the federal tax
laws applicable to REITs may limit the Company's ability to fully hedge its
interest rate risks. Such federal tax laws may prevent
24
the Company from effectively implementing hedging strategies that, absent such
restrictions, would best insulate the Company from the risks associated with
changing interest rates. See "Business--Risk Management--Interest Rate Risk
Management."
Currently, the Company has entered into hedging transactions which seek to
protect only against gap risk associated with significant increases in interest
rates Accordingly, the Company may not be adequately protected against risks
associated with interest rate increases and such increases could adversely
affect the Company's financial condition and results of operations.
FAILURE TO RENEW OR OBTAIN ADEQUATE FUNDING MAY ADVERSELY AFFECT RESULTS OF
OPERATIONS
The Company currently relies on short term borrowings to fund the initial
acquisitions of Mortgage Loans. Accordingly, the ability of the Company to
achieve its investment objectives depends on its ability (i) to borrow money in
sufficient amounts and on favorable terms, (ii) to renew or replace on a
continuous basis its maturing short term borrowings and (iii) to successfully
leverage its Mortgage Assets. In addition, the Company is dependent upon a few
lenders to provide the primary credit facilities for its purchases of Mortgage
Assets. Any failure to obtain or renew adequate funding under these facilities
or other financings on favorable terms, could reduce the Company's net interest
income and have a material adverse effect on the Company's operations. During
the year ending December 31, 2000, the Company did not use the reverse
repurchase financing facility and plans to let the facility expire. In the near
term the Company will rely upon uncommitted financing to meet short-term needs.
The Company expects to enter into committed facilities as the need arises. There
can be no assurances that these facilities will be procured.
The Company is not subject to statutory, regulatory or third party
limitations on incurring debt. Accordingly, there are no restrictions on the
Company's ability to incur debt and there can be no assurance that the level of
debt that the Company incurs will not be increased by the Board of Directors.
See "Policies and Strategies May Be Revised at the Discretion of the Board of
Directors."
The Company has historically relied upon securitization as a means of
securing long-term debt. There can be no assurances that this asset-backed
securitization vehicle will be available to the Company in the future.
LOANS SERVICED BY THIRD PARTIES
All of the Company's Mortgage Loans are serviced by sub-servicers. The
Company continually monitors the performance of the sub-servicers through
performance reviews, comparable statistics for delinquencies and on-site visits.
The Company has on occasion determined that sub-servicers have not followed
standard collection and servicing practices related to the Company's Mortgage
Loans which the Company believes have lead to increased delinquencies and higher
loan losses on selected defaulted Mortgage Loans segments. The Company and the
Manager continue to monitor these servicers, have put these entities on notice
of such deficiencies, and have instituted other mitigating processes. The
Company has arranged for servicing with entities that have particular expertise
in non-conforming Mortgage Loans. Although the Company has established these
relationships and procedures, there can be no assurance that these sub-servicers
will service the Company's Mortgage Loans in such a way as to minimize
delinquency rates and/or credit losses and not cause an adverse effect on the
Company's results of operations.
DEFAULT OF MANAGER UNDER SECURITIES PURCHASE AGREEMENT; RESTRICTIVE COVENANTS
In connection with the private financing of the Manager and the Company, the
Company, the Manager and MDC-REIT entered into a Securities Purchase Agreement
dated as of February 11, 1997 (the "Securities Purchase Agreement") with the
institutional investors therein (the "Investors") providing for, among other
things, the purchase by the Investors of senior secured notes of the
25
Manager due February 11, 2002 (the "Notes"). Pursuant to the Securities Purchase
Agreement, the Company must comply with various covenants, including covenants
restricting the Company's investment, hedging and leverage policies, leverage
ratio and indebtedness levels, and business and tax status. These restrictions
may limit the Company's ability to adequately respond to changing market
conditions, even when such changes may be in the best interest of the Company,
which could have a material adverse effect on the Company's financial condition
and results of operations.
The Manager's default on its obligations with respect to the Notes, or
failure of the Company to comply with various restrictive covenants could result
in a default and termination of the Management Agreement, in which case the
operations of the Company could be adversely affected pending either the
engagement of a new manager or the development internally of the resources
necessary to manage the operation of the Company. The Manager is currently in
default of its covenants. The senior note holders have not issued waivers,
however the parties continue to operate under the terms of the Management
Agreement. In addition, MDC-REIT has pledged 1.6 million shares of its common
stock of the Company to secure the Manager's obligations under the Securities
Purchase Agreement. As a result of the defaults under the Securities Purchase
Agreement, the pledged shares could be transferred to the holders of the Notes,
who will then have certain demand registration rights.
INVESTMENTS IN MORTGAGE ASSETS MAY BE ILLIQUID
Although the Company expects that a majority of the Company's future
investments will be in Mortgage Assets for which a resale market exists, certain
of the Company's future investments may lack a regular trading market and may be
illiquid. In addition, during turbulent market conditions, the liquidity of all
of the Company's Mortgage Assets may be adversely impacted.
There is no limit to the percentage of the Company's investments that may be
invested in illiquid Mortgage Assets. In the event the Company requires
additional cash as a result of a margin call pursuant to its financing
agreements or otherwise, the Company may be required to liquidate Mortgage
Assets on unfavorable terms. The Company's inability to liquidate Mortgage
Assets could render it insolvent.
EXECUTIVE OFFICERS OF THE COMPANY
The following table presents certain information concerning the executive
officers of the Company:
NAME AGE POSITION(1)
---- -------- -----------
John M. Robbins(2)............... 53 Chairman of the Board, Chief
Executive Officer
Jay M. Fuller(2)................. 50 President, Chief Operating
Officer
Judith A. Berry.................. 47 Executive Vice President and
Chief Financial Officer
Charles H. Eshom................. 44 Senior Vice President, Capital
Markets
Clayton W. Strittmatter.......... 38 Senior Vice President, Finance
Lisa S. Faulk.................... 42 Senior Vice President, Operations
------------------------
(1) Each executive officer holds the same position with the Manager.
(2) Mr. Robbins and Mr. Fuller are founders of the Company.
26
JOHN M. ROBBINS has served as Chairman of the Board of Directors and Chief
Executive Officer and Director of the Company since its formation in
February 1997. Prior to joining the Company, Mr. Robbins was Chairman of the
Board of American Residential Mortgage Corporation from 1990 until 1994 and
President of American Residential Mortgage Corporation from the time he
co-founded it in 1983 until 1994. He also served as Executive Vice President of
Imperial Savings Association from 1983 to 1987. Mr. Robbins has worked in the
mortgage banking industry since 1973. Mr. Robbins has served two terms on the
Board of Governors and the Executive Committee of the Mortgage Association of
America, and was appointed to its first Board of Directors. He has also served
on FNMA's National Advisory Board. Mr. Robbins is currently a director of Garden
Fresh Restaurant Corporation, Accredited Home Lenders, and is a trustee of the
University of San Diego.
JAY M. FULLER has served as President, Chief Operating Officer and Director
of the Company since its formation in February 1997. Prior to joining the
Company Mr. Fuller served as President of Victoria Mortgage from 1995 to 1996.
Mr. Fuller was an Executive Vice President and Chief Administration Officer of
American Residential Mortgage Corporation from 1985 to 1994 and Senior Vice
President from 1983 to 1985. In these capacities, at various times, Mr. Fuller
was responsible for, among other things, Mortgage Loan originations and
servicing for American Residential Mortgage Corporation. Mr. Fuller has worked
in the mortgage banking industry continuously since 1975. Mr. Fuller currently
serves on the Board of Directors of Friends of Santa Fe Christian Schools.
JUDITH A. BERRY has served as Executive Vice President and Chief Financial
Officer of the Company since June, 1999. From 1996 to 1999 Ms. Berry was
President of Directors Acceptance, the Subprime Mortgage Division of Norwest
Mortgage, Inc. (now Wells Fargo). Ms. Berry was Executive Vice President and
Chief Financial Officer of American Residential Mortgage Corporation from 1989
to 1994. Between 1984 and 1989, she was Senior Vice President of Acquisitions
and New Business Development for American Residential Mortgage Corporation.
Ms. Berry was an audit manager for Arthur Young, now Ernst & Young from 1978 to
1984. Ms. Berry received a BS in Business Administration from San Diego State
University in 1977 and is a Certified Public Accountant in California.
CHARLES H. ESHOM was appointed to the position of Senior Vice President,
Capital Markets, responsible for the areas of portfolio management for the
Company, effective January 1, 2001. Prior to joining the Company, Mr. Eshom
served as an outside consultant performing similar duties. Mr. Eshom served in a
number of senior management positions for affiliated entities of Wells Fargo and
Directors Mortgage from 1987 to 2000. He was responsible for overseeing various
risk management functions, including secondary marketing, credit policy, quality
control, loan production operations and servicing performance. From 1987 to
1995, Mr. Eshom served as one of the senior officers of Directors Mortgage
responsible for all capital markets related functions. Mr. Eshom began his
financial services career in 1982 as a Loan Officer with Shearson/American
Express Mortgage. Mr. Eshom holds a B.S. in Business Administration and an
M.B.A. in Finance from California State Polytechnic University, Pomona, CA.
CLAYTON W. STRITTMATTER has served as Senior Vice President, Finance, since
August 2000. Mr. Strittmatter was Vice President, Finance and was in charge of
corporate borrowing facilities, cash management and investor relations for the
Company since its formation in February 1997. Prior to joining the Company,
Mr. Strittmatter served as Vice President of finance for Ameriquest Mortgage
Corporation, a division of Long Beach Mortgage Company. Previously, he held a
number of executive positions with American Residential Mortgage Corporation.
Mr. Strittmatter has a B.S. in Business Finance from San Diego State University.
LISA S. FAULK has served as Senior Vice President, Operations, of the
Company since October 1997. Prior to joining the Company, Ms. Faulk served as
Vice President, Conduit Underwriting, for Advanta Mortgage Corporation where she
managed the Conduit Division's
27
underwriting, funding and processing functions in the non-conforming credit
markets. Ms. Faulk was Vice President, Manager Credit Risk Review, for HomeFed
Bank, Federal Savings Bank from 1984 to 1993. Ms. Faulk has a B.S. in Business
Finance from Oregon State University.
28
GLOSSARY
AS USED IN THIS FORM 10-K, THE CAPITALIZED AND OTHER TERMS LISTED BELOW HAVE THE
MEANINGS INDICATED.
"AGENCY SECURITIES" means mortgage participation certificates issued by FHLMC,
FNMA or GNMA. These securities entitle the holder to receive a pass-through of
principal and interest payments on the underlying pool of Mortgage Loans and are
issued or guaranteed by federal government sponsored agencies.
"BASIS RISK" is the difference and timing of the index used to adjust the
interest rate (yield) on assets, and the index used to adjust the interest rate
on liabilities.
"CMO" means Collateralized Mortgage Obligation.
"CODE" means the Internal Revenue Code of 1986, as amended.
"COUPON RATE" means, with respect to Mortgage Assets, the annualized cash
interest income annually received from the asset, expressed as a percentage of
the face value of the asset.
"EARNING ASSETS" means, with respect to Mortgage Assets, the annualized cash
interest income actually received from the asset, expressed as a percentage of
the face value of the asset.
"EQUITY-FUNDED LENDING" means the portion of the Company's earning assets
acquired using the Company's equity capital.
"FASIT" means Financial Asset Securitization Investment Trust.
"FHLMC" means the Federal Home Loan Mortgage Corporation.
"FNMA" means the Federal National Mortgage Association.
"FULLY-INDEXED RATE" means, with respect to adjustable-rate Mortgage Assets, the
rate that would be paid by the borrower ("gross") or received by the Company as
owner of the Mortgage Assets ("net") if the coupon rate on the adjustable-rate
Mortgage Assets were able to adjust immediately to a market rate without being
subject to adjustment periods, periodic caps, or life caps. It is equal to the
current yield of the adjustable-rate Mortgage Assets index plus the gross or net
margin.
"GAP RISK" means the timing difference (mis-match) between the repricing of
interest rate sensitive (variable rate) assets and interest rate sensitive
(variable rate) liabilities.
"GNMA" means the Government National Mortgage Association.
"INTEREST RATE ADJUSTMENT INDICES" means, in the case of Mortgage Assets, any of
the objective indices based on the market interest rates of a specified debt
instrument (such as United States Treasury Bills in the case of the Treasury
Index and United States dollar deposits in London in the case of LIBOR) or based
on the average interest rate of a combination of debt instruments (such as the
11th District Cost of Funds Index), used as a reference base to reset the
interest rate for each adjustment period on the Mortgage Asset, and in the case
of borrowings, is used herein to mean the market interest rates of a specified
debt instrument (such as reverse repurchase agreements for Mortgage Securities)
as well as any of the objective indices described above that are used as a
reference base to reset the interest rate for each adjustable period under the
related borrowing instrument.
"INTEREST RATE ADJUSTMENT PERIOD" means, in the case of Mortgage Assets, the
period of time set forth in the debt instrument that determines when the
interest rate is adjusted and, with respect to borrowings, is used to mean the
term to maturity of a short term, fixed-rate debt instrument (such as a 30-day
reverse repurchase agreement) as well as the period of time set forth in a long
term, adjustable-rate debt instrument that determines when the interest rate is
adjusted.
29
"LIFETIME INTEREST RATE CAP" or "LIFE CAP" means the maximum coupon rate that
may accrue during any period over the term of an adjustable-rate Mortgage Loan
or, in the case of a Mortgage Security, the maximum weighted average coupon rate
that may accrue during any period over the term of such Mortgage Security.
"LIQUIDITY CAPITAL CUSHION" is a term defined in the Company's Capital Policy.
It represents a portion of the capital the Company is required to maintain as
part of this policy in order to continue to make asset acquisitions. The
liquidity capital cushion is that part of the required capital base which is in
excess of the Company's haircut requirements.
"MORTGAGE ASSETS" means Mortgage Securities, Mortgage Loans Held-for-Investment
and Bond Collateral
"MORTGAGE LOANS" means Mortgage Loans secured by residential or mixed use
properties.
"MORTGAGE SECURITIES" means Agency Mortgage-Backed Securities and Privately
Issued Mortgage-Backed Securities.
"NONCONFORMING MORTGAGE LOANS" means conventional single-family and multifamily
Mortgage Loans that do not conform to one or more requirements of CHLMC or FNMA
for participation in one or more of such agencies' mortgage loss credit support
programs.
"PERIODIC INTEREST RATE CAP" or "PERIODIC CAP" means the maximum change in the
coupon rate permissible under the terms of the loan at each coupon adjustable
date. Periodic caps limit both the speed by which the coupon rate can adjust
upwards in a rising interest rate environment and the speed by which the coupon
rate can adjust downward in a falling rate environment.
"PRIVATELY ISSUED SECURITIES" means mortgage participation certificates issued
by certain private institutions. These securities entitle the holder to receive
a pass-through of principal and interest payments on the underlying pool of
Mortgage Loans and are issued or guaranteed by the private institution.
"REIT PROVISIONS OF THE CODE" means sections 856 through 860 of the Code.
"REMIC" means Real Estate Mortgage Investment Conduit.
"SPREAD LENDING" means the portion of the Company's earning assets acquired
using borrowed funds.
"TEN YEAR U.S. TREASURY RATE" for a quarterly period shall mean the arithmetic
average of the weekly per annum Ten Year Average Yields published by the Federal
Reserve Board during such quarter. In the event that the Federal Reserve Board
does not publish a weekly per annum ten Year Average Yield during any week in a
quarter, then the Ten Year U.S. Treasury Rate for such week shall be the weekly
per annum Ten Year Average Yield published by any Federal Reserve Bank or by any
U.S. Government department or agency selected by the Company for such week. In
the event that the Company determines in good faith that for any reason the
Company cannot determine the Ten Year U.S. Treasury Rate for any quarter as
provided above, then the Ten Year U.S. Treasury Rate for such quarter shall be
the arithmetic average of the Per Annum average yields to maturity based upon
the daily closing bids during such quarter for each of the issues of actively
traded marketable U.S. treasury fixed interest rate securities (other than
securities which can, at the option of the holder, be surrendered at face value
in payment of any federal estate tax) with a final maturity date not less than
eight nor more than twelve years from the date of each such quotation, as chosen
and for each business day or less frequently if daily quotations shall not be
generally available in each such quarterly period in New York City and quoted to
the Company by at least three recognized dealers in U.S. Government securities
selected by the Company.
30
ITEM 2. PROPERTIES
The Company's and the Manager's executive offices are located at 445 Marine
View Avenue, Suite 230, Del Mar, California. The Company and the Manager
currently occupy approximately 7,000 square feet of space. The Manager leases
facilities pursuant to a lease expiring on April 1, 2002. The cost for this
space for the year ended December 31, 2000, was approximately $179,000.
Management believes that these facilities are adequate for the Company's and the
Manager's foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2000, there were no material pending legal proceedings to
which the Company was a party or of which any of its property was subject.
On January 3, 2001, the Company filed a lawsuit in the California Superior
Court in San Diego seeking to recover damages arising from its purchase of a
pool of residential mortgage loans from Lehman Capital, a Division of Lehman
Brothers Holdings, Inc., in late 1997 and early 1998. In addition to Lehman
Capital, the lawsuit names Long Beach Mortgage Company, Inc. as a defendant.
The complaint seeks damages for losses arising out of the Company's
agreement to purchase loans from Lehman Capital, which had acquired the loans
from Long Beach Mortgage Co. Lehman Capital assigned the loans and its agreement
with Long Beach Mortgage Co. to the Company. The complaint alleges, among other
claims, that Lehman Capital and Long Beach Mortgage Co. breached their
obligations to the Company under the purchase agreements for the sale of the
loans. The complaint also seeks recovery from Lehman Capital and Long Beach
Mortgage Co. for negligent misrepresentations made in connection with the sale
of the loans. The complaint alleges damages for the losses incurred due to
Lehman Capital and Long Beach Mortgage Co.'s failure to repurchase a number of
these loans, which damages are estimated to exceed $5,000,000, for additional
damages including repayment of all, or a portion of, the premium paid to Lehman
Capital on such loans and for damages equal to the lost return on the loans,
measured as if the loans had performed as represented.
The Company believes that its present allowance is adequate to cover future
losses arising from the matters alleged in the complaint. Litigation expenses
expected to be incurred in prosecuting the lawsuit have not been provided for
and will reduce earnings in future periods as the suit progresses. The timing
and amount of such expenses are uncertain.
The lawsuit is presently in the discovery phase. The outcome of litigation
is always uncertain and the facts involved in the allegations of the Company's
lawsuit are complex. No assurance can be given that the Company will recover all
or any portion of the amounts claimed. No resolution can be expected to occur
for an extended period of time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
31
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock began trading on October 29, 1997, and is traded
on the New York Stock Exchange under the trading symbol INV. As of December 31,
2000, the Company had 8,055,500 shares of common stock issued and outstanding
which was held by 49 holders of record.
The following table sets forth, for the periods indicated, the high, low and
closing sales prices per share of common stock as reported on the New York Stock
Exchange composite tape common stock.
STOCK PRICES
------------------------------------
2000 HIGH LOW CLOSE
---- --------- ----------- ----------
Year ended December 31, 2000................................ 7 1 5/8 2 3/16
Fourth quarter ended December 31, 2000...................... 3 3/4 1 5/8 2 3/16
Third quarter ended September 30, 2000...................... 4 1/2 2 7/16 3 1/4
Second quarter ended June 30, 2000.......................... 6 1/4 3 15/16 4 1/8
First quarter ended March 31, 2000.......................... 7 5 1/4 5 3/4
1999
------------------------------------------------------------
Year ended December 31, 1999................................ 8 3/4 5 7/16 6 7/8
Fourth quarter ended December 31, 1999...................... 8 3/4 5 1/2 6 7/8
Third quarter ended September 30, 1999...................... 8 3/8 7 1/16 8 3/8
Second quarter ended June 30, 1999.......................... 8 1/2 7 1/16 7 3/8
First quarter ended March 31, 1999.......................... 8 1/4 5 7/16 8 1/4
The Company intends to pay quarterly dividends and to make such
distributions to its stockholders in amounts such that all or substantially all
of its taxable income (subject to certain adjustments) is distributed so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by the Company at the discretion of the Board of
Directors and will depend on the operations of the Company, financial condition
of the Company, maintenance of REIT status and such other factors as the Board
of Directors may deem relevant from time to time.
The following table sets forth, for the periods indicated, the dividends
paid in 1999 and 2000:
CASH
DIVIDEND
----------
DATE DATE AMOUNT DIVIDEND
DECLARED PAYABLE PER SHARE TOTAL
---------- ---------- --------- ---------
12/14/2000.. 1/31/2001 0.20 1,611,100
10/19/2000.. 11/7/2000 0.20 1,611,100
7/20/2000.. 8/7/2000 0.20 1,611,100
4/20/2000.. 5/10/2000 0.20 1,611,100
12/16/1999.. 1/31/2000 0.30 2,416,650
10/21/1999.. 11/8/1999 0.27 2,174,985
7/21/1999.. 8/6/1999 0.25 2,013,875
4/22/1999.. 5/10/1999 0.20 1,611,100
32
ITEM 6. SELECTED FINANCIAL DATA
The following selected Statement of Operations and Balance Sheet data as of
December 31, 2000, 1999, 1998 and 1997, and for the years ended December 31,
2000, 1999 and 1998 and for the period from February 11, 1997 (commencement of
operations) through December 31, 1997, has been derived from the Company's
consolidated financial statements audited by KPMG LLP, independent auditors,
whose report with respect thereto appears on page F-2. Such selected financial
data should be read in conjunction with those consolidated financial statements
and the accompanying notes thereto and with "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" also included
elsewhere herein.
FOR THE PERIOD FROM
FEBRUARY 11, 1997
(COMMENCEMENT OF
FOR THE FOR THE FOR THE OPERATIONS)
YEAR ENDED YEAR ENDED YEAR ENDED THROUGH
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
------------------ ------------------ ------------------ -------------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Total interest income.......... $ 86,537 $ 79,119 $ 68,407 $ 14,096
Total interest expense......... 69,328 49,644 45,190 9,517
Premium amortization........... 10,773 16,625 13,311 1,797
Premium write-down............. -- 12,294 -- --
Provision for loan losses...... 4,884 3,650 3,470 --
Loss on sale of mortgage-backed
securities................... -- -- 5,912 --
Impairment loss on retained
interest in securitization... 5,093 -- -- --
Operating expenses............. 12,305 5,205 4,082 379
Net income (loss).............. (6,198) (3,850) (1,214) 2,403
Net income (loss) per share of
common stock -- basic........ (0.77) (0.48) (0.15) 0.83
Net income (loss) per share of
common stock -- diluted...... (0.77) (0.48) (0.15) 0.82
Weighted average number of
shares -- basic.............. 8,020,900 8,055,500 8,090,772 2,879,487
Weighted average number of
shares -- diluted............ 8,020,900 8,055,500 8,090,772 2,929,009
Dividends declared per share... 0.80 1.02 0.83 0.84
Noninterest expense as percent
of average assets............ 1.57% 0.90% 2.21% 0.13%
AS OF AS OF AS OF AS OF
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
BALANCE SHEET DATA:
Mortgage securities
available-for-sale, net....... $ -- $ -- $ 6,617 $387,099
Mortgage loans held-for-
investment, net, pledged...... -- 126,216 179,009 162,762
Bond collateral, mortgage
loans......................... 847,265 1,153,731 417,808 --
Total assets.................... 882,573 1,313,342 656,772 561,834
Short-term debt................. 5,083 119,003 166,214 451,288
Long-term debt, net............. 797,182 1,103,258 385,290 --
Stockholders' equity............ 76,627 86,854 101,971 106,569
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE STATEMENTS CONTAINED IN THIS FORM 10-K THAT ARE NOT PURELY HISTORICAL
ARE FORWARD LOOKING STATEMENTS, INCLUDING STATEMENTS REGARDING THE COMPANY'S
EXPECTATIONS, HOPES, BELIEFS, INTENTIONS, OR STRATEGIES REGARDING THE FUTURE.
STATEMENTS WHICH USE THE WORDS "EXPECTS", "WILL", "MAY", "ANTICIPATES", "GOAL",
"INTENDS", "SEEKS", "STRATEGY" AND DERIVATIVES OF SUCH WORDS ARE FORWARD LOOKING
STATEMENTS. THESE FORWARD LOOKING STATEMENTS, INCLUDING STATEMENTS REGARDING
CHANGES IN THE COMPANY'S FUTURE INCOME, MORTGAGE ASSET PORTFOLIO, DIRECT
ORIGINATION BUSINESS, FINANCINGS, WAYS THE COMPANY MAY SEEK TO GROW INCOME,
INCOME LEVELS, THE COMPANY'S BELIEF REGARDING FUTURE PREPAYMENT RATES AND FUTURE
BORROWING COSTS, AND THE EFFECT ON THE COMPANY'S INTEREST INCOME, INTEREST
EXPENSE AND OPERATING PERFORMANCE OF CHANGES IN INTEREST RATES, ARE BASED ON
INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES
NO OBLIGATION TO UPDATE ANY SUCH FORWARD LOOKING STATEMENT. IT IS IMPORTANT TO
NOTE THAT THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE IN
SUCH FORWARD LOOKING STATEMENTS. AMONG THE FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY ARE THE FACTORS SET FORTH UNDER ITEM 1 UNDER THE
HEADING "BUSINESS RISKS". IN PARTICULAR, THE COMPANY'S FUTURE INCOME COULD BE
AFFECTED BY INTEREST RATE INCREASES, HIGH LEVELS OF PREPAYMENTS, MORTGAGE LOAN
DEFAULTS, REDUCTIONS IN THE VALUE OF RETAINED INTEREST IN SECURITIZATIONS, AND
INABILITY TO ACQUIRE OR FINANCE NEW MORTGAGE ASSETS.
OVERVIEW
The Company's revenue primarily consists of interest income generated from
its Mortgage Assets and its cash and investment balances (collectively, "earning
assets"), prepayment penalty income, income generated by equity in income of
American Residential Holdings, Inc.and management fees..
The Company funds its acquisitions of earning assets with both its equity
capital and with borrowings. For that portion of the Company's earning assets
funded with equity capital ("equity-funded lending"), net interest income is
derived from the average yield on earning assets. Due to the adjustable-rate
nature of the majority of its earning assets, the Company expects that income
from this source will tend to increase as interest rates rise and will tend to
decrease as interest rates fall, but only after the expiration of any initial
fixed teaser periods and then only periodically once or twice each year.
For that portion of the Company's earning assets funded with borrowings
("spread lending"), the resulting net interest income is a function of the
volume of spread lending and the difference between the Company's average yield
on earning assets and the cost of borrowed funds. Gross income from spread
lending will generally decrease following an increase in short term interest
rates due to increases in borrowing costs but a lag in adjustments to the
earning asset yields. Yields on adjustable rate loans generally adjust based on
a short term interest rate index, but the majority of the Company's earning
assets are adjustable rate loans which are subject to an initial fixed teaser
period of two years, and then adjust periodically every six months. Gross income
from spread lending will generally increase following a fall in short term
interest rates due to decreases in borrowing costs and a lag in downward
adjustments to the earning asset yields.
The Company's primary expenses, beside its borrowing costs, are amortization
of loan purchase premiums, provision for loan losses, losses on sale of real
estate owned ("REO"), management and administrative expenses and interest rate
cap and floor agreement expenses. Provision for loan losses represent the
Company's best estimate of expenses related to loan defaults. Losses on the sale
of REO represent a shortfall between sale proceeds and the net carrying amount
of the property. The carrying value does included a reduction (credit provision)
to reflect an estimate of net proceeds at time of sale. Premiums are amortized
using the interest method over their estimated lives. Management fees and
administrative costs are generally based on the size of the earning asset
portfolio Interest rate cap and floor agreement costs are based on size of the
portfolio subject to gap risk and the market prices for interest rate cap
agreements.
34
During the third and fourth quarter of 2000 the Company recorded
approximately $5.1 million of impairment charges related to its retained
interest in a REMIC securitization (the "Residual"). GAAP requires that any
decline in residual asset value that is other than temporary be reflected
through the Company's current period income statement. Decreases in interest
spreads, along with higher than anticipated loan prepayment rates, caused the
impairment. The loans backing the Residual were purchased, securitized in a
REMIC and sold in June of 1998. There are no other retained interests in
securitizations owned by the Company.
One of the Company's primary objectives is to diversify the income stream.
This would mean, less reliance on spread lending and more upon mortgage loan
related acitivities. Several potential alternatives exist which would position
the Company closer to the loan orgination process and thereby reduce the premium
for loan acquisition and improve the underwriting standards. These alternatives
may or may not be through a taxable entity. One alternative in pursuing this
diversity is to become a direct loan orginator. There can be no assurance,
however, that the Company's strategy will be successful or that the Company will
increase or maintain its income level.
RESULTS OF OPERATIONS
For the years ended December 31, 2000 and December 31, 1999 the Company
generated a net loss of approximately $6.2 and $3.9 million, respectively. Net
loss per share of common stock was $0.77 and $0.48 for the years ended
December 31, 2000 and December 31, 1999, respectively. The net loss in 2000 was
in a large part due to an impairment loss on retained interest in a
securitization (see discussion earlier in "overview" section) and spread
compression. Spread compression in 2000, was a result of a 100 basis point
increase in borrowing rates from 6.00% in December of 1999 to 7.00% in December
of 2000, which was not offset by a corresponding increase in asset yields. The
Company's decision to not purchase new assets during the year has resulted in a
decline in the portfolio balance. A decline in the size of the portfolio has
reduced the relative level of interest income (although interest income
increased in 2000, there would have been a larger increase if asset yields had
increased) and operating cash flow available to fund new portfolio asset
acquisitions. Net interest rate margin (the spread between asset yields and
borrowing rates) may increase in 2001 if the recent interest rate reductions by
the Federal Reserve continue. Asset yields are expected to increase by mid-2001
when the rates on the majority of the Company's mortgage loans are expected to
contractually increase, with a corresponding widening of the net interest
margin. However, with limited cash flow available to fund new portfolio
acquisitions and the Company's desire to deploy capital to build its mortgage
loan origination capability, it is likely that the portfolio size will continue
to decline, unless the Company obtains new equity capital. Consequently,
decreases in the size of the mortgage portfolio may continue to negatively
impact the Company's financial condition and results of operations. The net loss
in 1999 was directly attributable to the write-down of premium on Bond
Collateral (Mortgage Loans) in the amount of approximately $12.3 million. These
loans were purchased in 1997 and early 1998 when non-conforming loans were
selling significantly above par.
The growth in Mortgage Asset interest income of $9.0 million, and the
decrease in net interest spread of $12.3 million between the years ended
December 31, 2000, and December 31, 1999, were primarily due to a higher average
portfolio. Net interest spread decreased as a result of higher average borrowing
interest expense associated with increased borrowing costs not matched by
increased mortgage asset yields.
Net interest income increased $5.9 million from the prior period ended
December 31, 1999. This was primarily due to a premium write-down expense of
$12.3 million taken during the period ending December 31, 1999.
Premium amortization expense represents the amortization of purchase
premiums paid for Mortgage Loans acquired in excess of the par value of the
loans. Premium amortization expense was approximately $10.8 million for the year
ended December 31, 2000 and $16.6 million for the year
35
ended December 31, 1999. Lower premium amortization expense is due to a decrease
in amortization expense on the FASIT protfolio offset by increased amortization
on the 1999-1 and 1999-A portfolios. Additionally, increased levels of
prepayments in the fourth quarter of 1999 on the CMO/FASIT segment of Bond
Collateral (Mortgage Loans) lead to a premium write-down of $12.3 million in the
fourth quarter of 1999. The following chart represents constant repayment rates
("CPRs"):
CPR RATES
------------------------------
LIFE SIX THREE
TIME MONTHS MONTHS
-------- -------- --------
DECEMBER 31, 2000
Bond collateral:
CMO/FASIT 1998-1.......................................... 45.6% 48.2% 43.6%
COM 1999-1................................................ 33.3% 41.1% 41.4%
CMO 1999-2................................................ 19.8% 20.7% 22.0%
CMO/REMIC 1999-A.......................................... 17.0% 22.0% 18.9%
CMO 2000-2................................................ 15.0% n/a 18.3%
CPR RATES
------------------------------
LIFE SIX THREE
TIME MONTHS MONTHS
-------- -------- --------
DECEMBER 31, 1999
Bond collateral:
CMO/FASIT 1998-1.......................................... 35.6% 50.6% 56.2%
COM 1999-1................................................ 19.4% 19.1% 20.5%
CMO 1999-2................................................ 12.6% -- 12.1%
CMO/REMIC 1999-A.......................................... 12.8% -- 12.7%
At December 31, 2000, unamortized premiums as a percentage of the remaining
principal amount of Bond Collateral (Mortgage Loans) were 4.00%, as compared to
3.71% at December 31, 1999. These levels are relatively low compared to 8.16% at
December 31, 1998. This is primarily due to the write-down of premiums on the
CMO/FASIT portfolio during the year ending December 31, 1999. The chart below
provides a breakdown of prepayment coverage and the weighted average months
remaining until the next interest rate adjustment for each segment of the
Mortgage Loan Portfolio:
PERCENTAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
OF LOANS WITH MONTHS REMAINING MONTHS UNTIL
PRINCIPAL PREPAYMENT ON PREPAYMENT INITIAL INTEREST
BALANCE PENALTIES COVERAGE* RATE ADJUSTMENT
--------- ------------- ---------------- ----------------
(DOLLARS IN THOUSANDS)
Bond Collateral, Mortgage
Loans:
CMO/FASIT 1998-1............. $ 91,250 15% 14 0
COM 1999-1................... 116,760 57% 14 4
CMO 1999-2................... 313,392 86% 15 6
CMO/REMIC 1999-A............. 246,198 84% 11 6
CMO 2000-2................... 51,414 92% 20 15
-------- --- -- --
$819,014 74% 13 6
======== === == ==
------------------------
* Prepayment coverage is the number of months remaining before the prepayment
clause in the mortgage loan contracts expire and borrowers may perpay the
loan without prepayment penalty charges.
Most of the intermediate adjustable rate mortgages in the CMO/FASIT and
1999-1 segments of the Bond Collateral portfolio have reached their first
contractual interest rate adjustment (increase) and prepayment penalties on
these loans have expired, resulting in a higher probability of refinancing
36
and principal prepayments. The Company anticipates that prepayment rates on the
newer Mortgage Loans will increase as these predominately adjustable rate loans
reach their initial adjustments or when prepayment penalty clauses expire. There
can be no assurance that the Company will be able to achieve or maintain lower
prepayment rates or that prepayment rates will not increase. The Company's
financial condition and results of operations could be materially adversely
affected if prepayment levels increase significantly.
During 2000, other operating income increased approximately $106 thousand
over the year ended December 31, 1999 primarily due to an increase of
approximately $426 thousand in equity income from American Residential
Holdings, Inc. (a non-consolidated taxable subsidiary) partially offset by a
decrease in prepayment penalty income of approximately $141 thousand.
For the year ended December 31, 2000, other expenses increased approximately
$7.1million over the year ended December 31, 1999. During 2000 the Company
incurred a loss on the sale of real estate owned of increased by $900 thousand
and management fees increased approximately $295 thousand as a result of the
Company's Mortgage Loans having a higher average balance in 2000 than 1999.
Throughout 2000 Mortgage Loan balances have declined, but the average Mortgage
Loan balance in 2000 was higher than in 1999. General and administrative
expenses increased approximately $665 thousand from the year ended December 31,
1999 to the year ended December 31, 2000. The increase in general and
administrative expenses is primarily the result of adding employees, an increase
in professional fees for legal work to expand state licensing, administration of
REO and pursuing loan repurchases by loan sellers, an increase in computer
software amortization and excise taxes.
The Company held Mortgage Assets of approximately $855 million as of
December 31, 2000, comprised mainly of Mortgage Loans held as Bond Collateral.
This compares to $1.3 billion as of December 31, 1999 comprised of Mortgage
Loans held for investment, net pledged, of approximately $126.2 million and Bond
Collateral of approximately $1.2 billion.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended December 31, 2000, net cash provided by operating
activities was approximately $23.7 million. The difference between net cash
provided by operating activities and the net loss of approximately $6.2 million
was primarily the result of premium amortization; a decrease in accrued interest
receivable, and an impairment loss on retained interest in and provision for
loan losses. During the year ended December 31, 1999, net cash provided by
operating activities was approximately $27.7 million. The difference between net
cash provided by operating activities and the net loss of approximately
$3.9 million was primarily the result of premium amortization and write-down of
mortgage asset premiums and provision for loan losses.
Net cash provided by investing activities for the year ended December 31,
2000, was approximately $410.7 million. Net cash was positively impacted by:
principal payments on bond collateral of approximately $334.6 million; the sale
of mortgage loans held-for-investment of approximately $66.5 million; and
proceeds from the sale of real estate owned of approximately $8.7 million. Net
cash used in investing activities for the year ended December 31, 1999, was
approximately $717.2 million. Net cash used for the year was negatively affected
by the purchase of Mortgage Loans in the amount of approximately
$990.6 million, and the purchase of interest rate cap agreements of
approximately $1.7 million. Net cash used in investing activities for the year
ended December 31, 1999, was positively affected by principal payments of
approximately $266.2 million, sale of mortgage securities of approximately
$3.2 million and proceeds from the sale of real estate owned of approximately
$5.6 million.
For the year ended December 31, 2000, net cash used in financing activities
was approximately $428.2 million. Major components of net cash used include:
payments on long-term debt of approximately $363.0 million; decrease in
short-term debt of approximately $113.9 million and payment of dividends of
approximately $7.3 million. These cash uses were partially offset by the
issuance of
37
CMO bonds of approximately $56.2 million. For the year ended December 31, 1999,
net cash provided by financing activities was approximately $663.5 million
offset by the payment of dividends totaling $7 million. Net cash provided by
financing activities was positively affected by the issuance of long-term debt
in the amount of approximately $958.3 million and an increase in net borrowings
from long-term debt of approximately $7.1 million. Net cash provided by
financing activities was negatively impacted by a decrease in net borrowings
from reverse repurchase agreements of approximately $47.2 million, payments on
long-term debt of approximately $244.3 million and dividends paid of
approximately $7.0 million.
The financial condition of the Company can be affected by turmoil in world
markets as well as domestic liquidity problems. As stated earlier, the Company
intends to seek new financing sources as the need arises. There can be no
assurance that the Company will be able to secure new short or long-term
financing or that financing will be available on favorable terms. See "Business
Risks--FAILURE TO RENEW OR OBTAIN ADEQUATE FUNDING MAY ADVERSELY AFFECT RESULTS
OF OPERATIONS."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
REPRICING OF INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2000, are anticipated
by the Company to reprice in each of the future time periods shown. The amount
of assets and liabilities shown which reprice during a particular period were
determined based on contractual maturity adjusted for estimated prepayments.
Estimated prepayments are based on the Company's historical experience. For fair
value of financial instruments as of December 31, 2000, see Note 10. "Fair Value
of Financial Instruments." (Dollars in thousands.)
AT DECEMBER 31, 2000
---------------------------------------------------------------------------------------------------
MORE THAN MORE THAN MORE THAN MORE THAN MORE THAN
3 MONTHS 3 MONTHS TO 6 MONTHS TO 1 YEAR TO 3 YEARS TO 5 YEARS TO FAIR
OR LESS 6 MONTHS 1 YEAR 3 YEARS 5 YEARS 30 YEARS TOTAL VALUE
--------- ----------- ----------- --------- ---------- ---------- --------- ---------
Interest-earning
assets:
Cash and cash
equivalents........ 14,688 -- -- -- -- -- 14,688 14,688
Mortgage loans held-
for-investment,
net, pledged....... -- -- -- -- -- -- -- --
Bond collateral...... 127,122 397,889 57,139 153,727 -- 111,388 847,265 842,252
Retained interest in
securitization..... 3,249 -- -- -- -- -- 3,249 3,249
Interest rate
agreements......... 1,115 -- -- -- -- -- 1,115 --
Due from affiliate... 355 -- -- -- -- -- 355 355
--------- -------- -------- ------- ----- ------- --------- ---------
Total
interest-earning
assets........... 146,529 397,889 57,139 153,727 -- 111,388 866,672 860,544
========= ======== ======== ======= ===== ======= ========= =========
Interest-bearing
liabilities:
Short-term debt...... 5,083 -- -- -- -- -- 5,083 5,083
Long-term debt,
net................ 746,148 -- -- -- -- 51,034 797,182 797,182
Due to affiliate..... 1,347 -- -- -- -- -- 1,347 1,347
--------- -------- -------- ------- ----- ------- --------- ---------
Total
interest-bearing
liabilities...... 752,578 -- -- -- -- 51,034 803,612 803,612
========= ======== ======== ======= ===== ======= ========= =========
Interest rate
sensitivity gap(1)... (606,049) 397,889 57,139 153,727 -- 60,354 63,060 56,932
Cumulative interest
rate sensitivity
gap.................. (606,049) (208,160) (151,021) 2,706 2,706 63,060
38
AT DECEMBER 31, 1999
---------------------------------------------------------------------------------------------------
MORE THAN MORE THAN MORE THAN MORE THAN MORE THAN
3 MONTHS 3 MONTHS TO 6 MONTHS TO 1 YEAR TO 3 YEARS TO 5 YEARS TO FAIR
OR LESS 6 MONTHS 1 YEAR 3 YEARS 5 YEARS 30 YEARS TOTAL VALUE
--------- ----------- ----------- --------- ---------- ---------- --------- ---------
Interest-earning
assets:
Cash and cash
equivalents........ 8,550 -- -- -- -- -- 8,550 8,550
Mortgage loans held-
for-investment,
net, pledged....... -- -- -- 126,216 -- -- 126,216 126,216
Bond collateral...... 195,341 125,832 28,784 659,137 19,837 124,800 1,153,731 1,153,731
Retained interest in
securitization..... 6,610 -- -- -- -- -- 6,610 6,610
Interest rate
agreements......... 1,556 -- -- -- -- -- 1,556 1,294
Due from affiliate... 394 -- -- -- -- -- 394 394
--------- -------- -------- ------- ------ ------- --------- ---------
Total
interest-earning
assets........... 212,451 125,832 28,784 785,353 19,837 124,800 1,297,057 1,296,795
========= ======== ======== ======= ====== ======= ========= =========
Interest-bearing
liabilities:
Short-term debt...... 119,003 -- -- -- -- -- 119,003 119,003
Long-term debt,
net................ 1,043,513 -- -- -- -- 59,745 1,103,258 1,103,258
Due to affiliate..... 597 -- -- -- -- -- 597 597
--------- -------- -------- ------- ------ ------- --------- ---------
Total
interest-bearing
liabilities...... 1,163,113 -- -- -- -- 59,745 1,222,858 1,222,858
========= ======== ======== ======= ====== ======= ========= =========
Interest rate
sensitivity gap(1)... (950,662) 125,832 28,784 785,353 19,837 65,055 74,199 73,937
Cumulative interest
rate sensitivity
gap.................. (950,662) (824,830) (796,046) (10,693) 9,144 74,199
--------------------------
(1) Interest rate sensitivity gap represents the difference between net
interest-earning assets and interest-bearing liabilities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the related notes,
together with the Independent Auditor's Report thereon are set forth on
pages F-2 through F-29 on this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 with respect to directors is
incorporated herein by reference to the information contained under the headings
"Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive Proxy Statement for the Company's annual
meeting of stockholders to be held May 24, 2001 (the "Proxy Statement"). The
information required with respect to executive officers is set forth in Item 1
of this report under the caption "Executive Officers of the Company."
39
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to
the information contained under the heading "Executive Compensation and Other
Matters" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to
the information contained under the heading "Stock Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to
the information contained under the headings "Compensation Committee Interlocks
and Insider Participation" and "Certain Transactions" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. The following financial statements of the Company are included in
Part II, Item 8 of this Annual Report on Form 10-K:
Independent Auditors' Report;
Consolidated Balance Sheets as of December 31, 2000, and December 31,
1999;
Consolidated Statements of Operations and Comprehensive Income (Loss) for
the three year period ended December 31, 2000;
Consolidated Statements of Stockholders' Equity for each of the years in
the three-years ended December 31, 2000;
Consolidated Statements of Cash Flows for each of the years in the years
ended December 31, 2000 and December 31, 1999;
Notes to Consolidated Financial Statements.
2. Financial Statements Schedules.
All financial statement schedules have been omitted because they are either
inapplicable or the information required is provided in the Company's
Financial Statements and Notes thereto, included in Part II, Item 8 of this
Annual Report on Form 10-K.
40
3. Exhibits:
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
(1) 3.1 Articles of Amendment and Restatement of the Registrant
(1) 3.2 Amended and Restated Bylaws of the Registrant
(1) 4.1 Registration Rights Agreement dated February 11, 1997
(2) 4.2 Articles Supplementary dated February 22, 1999
(2) 4.3 Rights Plan by and between the Company and American Stock
Transfer and Trust Company dated as of February 2, 1999
(4) 4.4 Indenture dated as of June 1, 1998, between American
Residential Eagle Bond Trust 1999-2 (a wholly-owned,
consolidated subsidiary of the Registrant) and First Union
National Bank, as Trustee
(5) 4.5 Indenture dated as of April 1, 1999, between American
Residential Eagle Bond Trust 1999-1 (a wholly-owned,
consolidated subsidiary of the Registrant) and Norwest Bank
Minnesota, National Association, as Trustee
(6) 4.6 Indenture dated as of July 1, 1999, between American
Residential Eagle Bond Trust 1999-2 (a wholly-owned,
consolidated subsidiary of the Registrant) and Norwest Bank
Minnesota, National Association, as Trustee
(1) 10.1 Management Agreement between the Registrant and Home Asset
Management Corp. dated February 11, 1997 and Amendment
thereto
(1) +10.2 Employment and Noncompetition Agreement between Home Asset
Management Corp. and John Robbins dated February 11, 1997
and Amendment thereto
(1) +10.3 Employment and Noncompetition Agreement between Home Asset
Management Corp. and Jay Fuller dated February 11, 1997 and
Amendment thereto
(3) 10.5a Lisa Faulk Employment Letter, as amended
(7) +10.5b Judith A. Berry Employment and Noncompetition Agreement
(1) +10.6 1997 Stock Incentive Plan
(1) +10.7 Form of 1997 Stock Option Plan, as amended
(1) +10.8 Form of 1997 Outside Directors Stock Option Plan
(1) +10.9 Form of Employee Stock Purchase Plan
(1) 10.10 Securities Purchase Agreement between Registrant, Home Asset
Management Corp. and MDC REIT Holdings, LLC dated February
11, 1997
(1) +10.11 Form of Subscripton Agreement dated February 11, 1997
(1) 10.12 Secured Promissory Note dated June 25, 1997
(1) 10.13 Lease Agreement with Louis and Louis dated March 7, 1997
(1) +10.14 Form of Indemnity Agreement
(3) 10.15 Master Repurchase Agreement--Confidential Treatment
Requested and Granted
41
EXHIBIT
NUMBER DESCRIPTION
--------------------- -----------
+10.16 Charles H. Eshom Employment Letter dated December 27, 2000
(3) 21.1 Subsidiaries of Registrant
23.1 Consent of KPMG LLP
------------------------
+ Management Contract or Compensatory Plan
(1) Incorporated by reference to Registration Statement on Form S-11 filed
September 25, 1997 (File No. 333-33679)
(2) Incorporated by reference to Current Reports on Form 8-K filed February 17,
1999 (File No. 001-13485)
(3) Incorporated by reference to the Company's Annual Report on Form 10-K for
the Fiscal year ended 1997 filed March 31, 1998
(4) Incorporated by reference to Current Reports on Form 8-K (File No.333-47311)
(5) Incorporated by reference to Current Reports on Form 8-K (File No. 333-5932)
(6) Incorporated by reference to Current Reports on Form 8-K (File No.
333-70189-01)
(7) Incorporated by reference to the Company's Annual Report on Form 10-K for
the Fiscal year ended 1999 filed March 30, 2000
(a) Reports on Form 8-K:
NONE
42
FINANCIAL STATEMENTS AND INDEPENDENT AUDITORS' REPORT
FOR INCLUSION IN FORM 10-K
FILED WITH
SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 2000
INDEX TO FINANCIAL STATEMENTS
American Residential Investment Trust, Inc.
PAGE
--------
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations and Comprehensive
Income (Loss)............................................. F-4
Consolidated Statements of Stockholders' Equity............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
American Residential Investment Trust, Inc.
Del Mar, California:
We have audited the accompanying consolidated balance sheets of American
Residential Investment Trust, Inc. and subsidiaries (the Company) as of
December 31, 2000 and 1999, and the related consolidated statements of
operations and comprehensive income (loss), stockholders' equity and cash flows
for each of the years in the three-year period ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2000, and 1999, and the results of their operations and their cash
flows for each of the years in the three-year period ended December 31, 2000 in
conformity with accounting principals generally accepted in the United States of
America.
KPMG LLP
San Diego, California
January 28, 2001
F-2
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
DECEMBER 31, 2000 DECEMBER 31, 1999
----------------- -----------------
Cash and cash equivalents................................... $ 14,688 $ 8,550
Mortgage loans held-for-investment, net, pledged............ -- 126,216
Bond collateral, mortgage loans, net........................ 847,265 1,153,731
Bond collateral, real estate owned.......................... 7,685 5,187
Retained interest in securitization......................... 3,249 6,610
Interest rate cap agreements................................ 1,115 1,556
Accrued interest receivable, net............................ 6,315 9,665
Due from affiliate.......................................... 355 394
Investment in American Residential Holdings, Inc............ 1,480 881
Other assets................................................ 421 552
-------- ----------
$882,573 $1,313,342
======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Short-term debt............................................. $ 5,083 $ 119,003
Long-term debt, net......................................... 797,182 1,103,258
Accrued interest payable.................................... 309 619
Due to affiliate............................................ 1,347 597
Accrued expenses and other liabilities...................... 143 176
Management fees payable..................................... 271 418
Accrued dividends........................................... 1,611 2,417
-------- ----------
Total liabilities......................................... 805,946 1,226,488
Stockholders' Equity:
Preferred stock, par value $.01 per share; 1,000 shares
authorized; no shares issued and outstanding.............. -- --
Common stock, par value $.01 per share; 25,000,000 shares
authorized; 8,055,500 shares issued and 8,020,900
outstanding in 2000 and 8,055,500 shares issued and
outstanding in 1999....................................... 81 81
Treasury Stock (34,600 shares).............................. (84) --
Additional paid-in-capital.................................. 109,271 109,271
Accumulated other comprehensive income (loss)............... -- (2,500)
Accumulated deficit......................................... (32,641) (19,998)
-------- ----------
Total stockholders' equity................................ 76,627 86,854
-------- ----------
$882,573 $1,313,342
======== ==========
See accompanying notes to consolidated financial statements.
F-3
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- -----------------
Interest income:
Mortgage assets............................ $86,347 $77,367 $67,667
Cash and investments....................... 880 3,531 1,819
Interest rate cap and floor agreement
expense.................................. (690) (1,779) (1,079)
------- ------- -------
Total interest income.................... 86,537 79,119 68,407
Interest expense............................. 69,328 49,644 45,190
------- ------- -------
Net interest spread.......................... 17,209 29,475 23,217
Premium amortization....................... 10,773 16,625 13,311
Premium write-down......................... -- 12,294 --
------- ------- -------
Net interest income.......................... 6,436 556 9,906
Provision for loan losses.................. 4,884 3,650 3,470
------- ------- -------
Net interest income (loss) after provision
for loan losses............................ 1,552 (3,094) 6,436
------- ------- -------
Other operating income:
Management fee income...................... 323 472 420
Equity in income of American Residential
Holdings, Inc............................ 599 173 1,118
Prepayment penalty income.................. 3,633 3,774 806
Gain on sale of mortgage backed
securities............................... -- 30 --
------- ------- -------
Total other operating income............. 4,555 4,449 2,344
------- ------- -------
Net operating income......................... 6,107 1,355 8,780
Other expenses:
Loss on sale of real estate owned, net..... 1,229 349 --
Loss on loan sales, net.................... 167 -- 5,912
Impairment loss on retained interest in
securitization........................... 5,093 -- --
Management fees............................ 3,852 3,557 2,466
General and administrative expenses........ 1,964 1,299 1,616
------- ------- -------
Total other expenses..................... 12,305 5,205 9,994
------- ------- -------
Net income (loss)............................ (6,198) (3,850) (1,214)
------- ------- -------
Other comprehensive income (loss):
Unrealized holding gain (loss)............. -- (3,050) (2,062)
Reclassification adjustment included in
income................................... 2,500 -- 5,912
------- ------- -------
Comprehensive income (loss).................. $(3,698) $(6,900) $ 2,636
======= ======= =======
Net income (loss) per share of Common Stock--
Basic...................................... $ (0.77) $ (0.48) $ (0.15)
Net income (loss) per share of Common Stock--
Diluted.................................... (0.77) (0.48) (0.15)
Dividends per share of Common Stock.......... 0.80 1.02 0.83
See accompanying notes to consolidated financial statements.
F-4
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
ACCUMULATED RETAINED
COMMON STOCK ADDITIONAL OTHER CUMULATIVE EARNINGS
-------------------- TREASURY PAID-IN COMPREHENSIVE DIVIDENDS (ACCUMULATED
SHARES AMOUNT STOCK CAPITAL INCOME/(LOSS) DECLARED DEFICIT) TOTAL
--------- -------- -------- ---------- -------------- ---------- ------------ --------
Balance December 31,
1997..................... 8,114,000 $81 $ -- $109,786 $(3,300) $ (2,401) $ 2,403 $106,569
--------- --- ---- -------- ------- -------- ------- --------
Purchase and retirement of
common stock............. (58,500) -- -- (492) -- -- -- (492)
Offering costs............. -- -- -- (23) -- -- -- (23)
Other comprehensive
income................... -- -- -- -- 3,850 -- -- 3,850
Net loss................... -- -- -- -- -- -- (1,214) (1,214)
Dividends declared......... -- -- -- -- -- (6,719) -- (6,719)
--------- --- ---- -------- ------- -------- ------- --------
Balance December 31,
1998..................... 8,055,500 81 -- 109,271 550 (9,120) 1,189 101,971
--------- --- ---- -------- ------- -------- ------- --------
Other comprehensive loss... -- -- -- -- (3,050) -- -- (3,050)
Net loss................... -- -- -- -- -- -- (3,850) (3,850)
Dividends declared......... -- -- -- -- -- (8,217) -- (8,217)
--------- --- ---- -------- ------- -------- ------- --------
Balance December 31,
1999..................... 8,055,500 81 -- 109,271 (2,500) (17,337) (2,661) 86,854
--------- --- ---- -------- ------- -------- ------- --------
Treasury Stock............. 34,600 (84) (84) -- -- -- -- (84)
Other comprehensive
income................... -- -- -- 2,500 -- -- 2,500 2,500
Net Income................. -- -- -- -- -- (6,198) (6,198) (6,198)
Dividends declared......... -- -- -- -- (6,445) -- (6,445) (6,445)
--------- --- ---- -------- ------- -------- ------- --------
Balance at December 31,
2000..................... 8,020,900 $81 $(84) $109,271 $ -- $(23,782) $(8,859) $ 76,627
========= === ==== ======== ======= ======== ======= ========
See accompanying notes to consolidated financial statements.
F-5
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................................... $ (6,198) $ (3,850) $ (1,214)
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of mortgage assets premiums................ 10,773 28,919 13,311
Amortization of interest rate cap agreements............ 995 797 779
Amortization of CMO capitalized costs................... 1,071 446 --
Amortization of CMO premium............................. (156) (158) (79)
Provision for loan losses............................... 4,884 3,650 3,470
Equity in undistributed income of American Residential
Holdings, Inc......................................... (599) (173) (1,118)
(Increase) decrease in deposits to
over-collateralization account........................ 768 (898) (1,513)
Impairment loss on retained interest in
securitization........................................ 5,093 -- --
Loss on sale of mortgage securities..................... -- (30) --
Loss on sale of real estate owned....................... 3,139 349 --
Loss on loan sales...................................... 167 -- --
(Increase) decrease in accrued interest receivable...... 3,350 (950) (2,096)
(Increase) decrease in other assets..................... 131 (364) 43
(Increase) decrease in due from affiliate............... 39 212 (337)
Decrease in accrued interest payable.................... (310) (607) (613)
Increase (decrease) in accrued expenses and management
fees payable.......................................... (180) 117 (363)
Increase in due to affiliate............................ 750 211 386
-------- -------- --------
Net cash provided by operating activities............... 23,717 27,671 10,656
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans held-for-investment........... -- (990,557) (649,605)
Purchase of interest rate cap agreements.................. (554) (1,679) (1,042)
Purchase of retained interest in securitization........... -- -- (6,699)
Purchase of mortgage loans held for investment............ (622) -- --
Sale of mortgage loans held for investment................ 66,525 -- --
Principal payments on mortgage securities
available-for-sale...................................... 1,962 3,428 150,101
Principal payments on mortgage loans
held-for-investment..................................... -- 27,531 29,089
Principal payments on bond collateral..................... 334,630 235,223 71,586
Proceeds from sale of mortgage securities
available-for-sale...................................... -- 3,225 227,760
Proceeds from sale of mortgage loans
held-for-investment..................................... -- -- 103,525
Proceeds from sale of real estate owned................... 8,726 5,602 --
Investment in American Residential Holdings, Inc.......... -- -- (475)
Dividends recorded from American Residential Holdings,
Inc..................................................... -- -- 885
-------- -------- --------
Net cash provided by (used in) investing activities..... 410,667 (717,227) (74,875)
CASH FLOWS FROM FINANCING ACTIVITIES:....................... --
Issuance of long-term debt................................ 56,210 958,319 457,011
Decrease in net borrowings from short-term debt........... (113,920) (47,211) (285,074)
Net proceeds from stock issuance.......................... -- -- (23)
Purchase of common stock.................................. -- -- (492)
Increase in net borrowings from long-term debt............ -- 7,054 --
Increase in capitalized costs............................. -- (3,439) --
Dividends paid............................................ (7,250) (7,008) (6,809)
Payments on long-term debt................................ (362,986) (244,254) (71,642)
Purchase of Treasury Stock................................ (84) -- --
Issuance of CMO/FASIT bonds............................... (216) -- --
-------- -------- --------
Net cash provided by (used in) financing activities..... (428,246) 663,461 92,971
Net increase (decrease) in cash and cash equivalents........ 6,138 (26,095) 28,752
Cash and cash equivalents at beginning of period............ 8,550 34,645 5,893
-------- -------- --------
Cash and cash equivalents at end of period.................. $ 14,688 $ 8,550 $ 34,645
Supplemental information -- interest paid................... $ 67,633 $ 48,830 $ 45,463
======== ======== ========
Non-cash transactions:
Dividends declared and unpaid............................. $ 1,611 $ 2,417 $ 1,208
======== ======== ========
Transfer from mortgage loans held-for-investment, net to
bond collateral......................................... $ 58,279 $664,006 $497,653
======== ======== ========
Transfers from bond collateral to real estate owned....... $ 14,363 $ 11,029 $ 490
======== ======== ========
See accompanying notes to consolidated financial statements.
F-6
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements include the accounts of American
Residential Investment Trust, Inc. ("AmRES"), a Maryland corporation, American
Residential Eagle, Inc., ("Eagle"), a Delaware special purpose corporation and
wholly-owned subsidiary of AmRES and American Residential Eagle 2, Inc. ("Eagle
2"), a Delaware limited purpose corporation and wholly-owned subsidiary of Eagle
(collectively "AmRIT"). Substantially all of the assets of Eagle and Eagle 2 are
pledged or subordinated to support long-term debt in the form of collateralized
mortgage bonds ("Long-Term Debt") and are not available for the satisfaction of
general claims of AmRIT. American Residential Holdings, Inc. ("Holdings"), is an
affiliate of AmRES and accounted for under the equity method. AmRIT and Holdings
are together referred to as (the "Company"). The Company's exposure to loss on
the assets pledged as collateral is limited to its net investment, as the
Long-Term Debt is non-recourse to the Company. All significant intercompany
balances and transactions with Eagle and Eagle 2 have been eliminated in the
consolidation of AmRIT. Certain amounts for prior periods have been reclassified
to conform with the current year's presentation.
During the first half of 1998, the Company formed Holdings, through which a
portion of the Company's non-conforming adjustable-rate and fixed-rate,
single-family whole loans (collectively, "Mortgage Loans"), acquisition and
finance activities are conducted. AmRIT owns all of the preferred stock and has
a non-voting 95% economic interest in Holdings. Because AmRIT does not control
Holdings, its investment in Holdings is accounted for under the equity method.
Under this method, original equity investments in Holdings are recorded at cost
and adjusted by AmRIT's share of earnings or losses and decreased by dividends
received.
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management of the Company to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenue and
expenses during the reported period. Actual results could differ from those
estimates.
ORGANIZATION
AmRES commenced operations on February 11, 1997. AmRES was financed through
a private equity funding from its manager, Home Asset Management Corporation
(the "Manager"). AmRES operates as a mortgage real estate investment trust
("REIT") which has elected to be taxed as a REIT for Federal income tax
purposes, which generally will allow AmRES to pass its income through to its
stockholders without payment of corporate level Federal income tax, provided
that the Company distributes at least 90% of its taxable income to stockholders.
During 1998, AmRES formed Eagle, a special-purpose finance subsidiary. Holdings,
a non-REIT, taxable affiliate of the Company, was established during the first
half of 1998. During 1999, AmRES formed Eagle 2, a limited-purpose corporation
and wholly-owned subsidiary of Eagle. The Company acquires residential mortgage
loans ("Mortgage Loans"). These Mortgage Loans are typically secured by
single-family real estate properties throughout the United States. The Company
utilizes both debt and equity to finance its acquisitions. The Company may also
use securitization techniques to enhance the value and liquidity of the
Company's Mortgage Loans and may sell Mortgage Loans from time to time.
The Company sold residential mortgage loans in the second quarter of 1998
through the use of a Real Estate Mortgage Investment Conduit ("REMIC"). The
REMIC, which consisted of pooled
F-7
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
adjustable-rate first-lien mortgages, was issued by Holdings to the public
through the registration statement of the related underwriter.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, cash and cash equivalents
include cash on hand and highly liquid investments with original maturities of
three months or less.
MORTGAGE ASSETS
The Company's Mortgage Assets consist of Mortgage Loans secured by
residential properties (Mortgage Loans).
MORTGAGE LOANS HELD-FOR-INVESTMENT AND BOND COLLATERAL
Mortgage loans held-for-investment and Bond Collateral include various types
of adjustable-rate and fixed-rate loans secured by mortgages on single-family
residential real estate properties. Premiums related to these loans are
amortized over their estimated lives using the interest method. Loans are
continually evaluated for collectibility and, if appropriate, the loan may be
placed on non-accrual status. Generally, loans are placed in non-accrual status
that are in foreclosure or non-performing bankruptcy, i.e. loans in bankruptcy
and not performing according to the bankruptcy plan that is established with the
trustee. When loans are placed on non-accrual status, all interest previously
accrued but not collected is reversed against current period interest income.
Income on non-accrual loans is subsequently recognized only to the extent that
the loan becomes current and the loans principal balance is deemed collectible.
Loans are restored to accrual status when loans become well secured and are in
the process of collection.
The Company considers a loan to be impaired when, based upon current
information and events, it believes it will be unable to collect all amounts due
according to the contractual terms of the loan agreement. Given the homogeneous
nature of the loan portfolio, loans are evaluated for impairment collectively.
Many factors are considered in the determination of impairment. The measurement
of collateral dependent loans is based on the fair value of the loan's
collateral.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for losses on Mortgage Loans
Held-for-Investment and Bond Collateral, Mortgage Loans at an amount which it
believes is sufficient to provide adequate protection against losses in the
mortgage loan portfolio. The allowance for losses is determined primarily on the
basis of management's judgment of net loss potential including specific
allowances for known impaired loans, changes in the nature and volume of the
portfolio, value of the collateral and current economic conditions that may
affect the borrower's ability to pay. A provision is recorded for all loans or
portions thereof deemed to be uncollectible thereby increasing the allowance for
loan losses. Subsequent recoveries on mortgage loans previously charged off are
credited to the allowance.
INTEREST RATE CAP AGREEMENTS
The Company uses interest rate cap agreements (the "Cap Agreements") for
interest rate risk protection. The Cap Agreements are purchased primarily to
reduce the Company's gap risk (the timing
F-8
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
difference or mis-match between the repricing of interest rate sensitive assets
and interest rate sensitive liabilities). The Company periodically evaluates the
effectiveness of these Cap Agreements under various interest rate scenarios.
The cost of the Cap Agreements are amortized over the life of the Cap
Agreements using the straight-line method. The Company has credit risk to the
extent counterparties to the Cap Agreements do not perform their obligations
under the Cap Agreements. In order to reduce this risk and to achieve
competitive pricing, the Company has entered into Cap Agreements only with
counterparties which are investment grade rated. With the implementation of
SFAS 133 (See "Recent Accounting Developments"), the cost of Cap Agreements will
be marked to market beginning in 2001.
INCOME TAXES
AmREIT has elected to be taxed as a REIT and complies with REIT provisions
of the Internal Revenue Code of 1986 as amended (the "Code") and the
corresponding provisions of State law. Accordingly, AmREIT will not be subject
to federal or state income tax to the extent of its distributions to
stockholders. In order to maintain its status as a REIT, AmREIT is required,
among other requirements, to distribute at least 90% of its taxable income.
INCOME (LOSS) PER SHARE
The following table illustrates the computation of basic and diluted income
(loss) per share (in thousands, except share and per share data):
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- -----------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Numerator:
Numerator for basic income (loss) per share
net earnings............................... $ (6,198) $ (3,850) $ (1,214)
Denominator:
Denominator for basic income per share --
weighted average number of common shares
outstanding during the period.............. 8,020,900 8,055,500 8,090,772
Incremental common shares attributable to
exercise of outstanding options............ -- -- --
--------- --------- ---------
Denominator for diluted income per share..... 8,020,900 8,055,500 8,090,772
Basic income (loss) per share................ $ (0.77) $ (0.48) $ (0.15)
Diluted income (loss) per share.............. $ (0.77) $ (0.48) $ (0.15)
At December 31, 2000 and 1999 there were 938,100 and 791,400 options
respectively that were antidilutive and, therefore, not included in the
calculation above.
COMPREHENSIVE INCOME (LOSS)
The Company recognizes comprehensive income (loss) as part of the Statement
of Operations and Comprehensive Income (Loss) and is disclosed as part of
stockholders' equity in accumulated other
F-9
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
comprehensive income (loss). Comprehensive income (loss) consists of net income
(loss) and net unrealized gains (losses) on retained interest in securitization.
SEGMENTS
The Company adopted the provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," in 1998. This statement
establishes standards for the way companies report information about operating
segments in annual financial statements. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The Company has determined that it does not have any separately
reportable business segments.
STOCK OPTIONS
The Company elected to apply the APB Opinion 25 in accounting for its plans:
the 1997 Stock Incentive Plan, 1997 Stock Option Plan, 1997 Employee Stock
Purchase Plan and 1997 Outside Directors Stock Option Plan and, accordingly, no
compensation cost has been recognized in the financial statements. SFAS 123
requires pro forma disclosures of net income (loss) computed as if the fair
value based method had been applied for in financial statements of companies
that continue to follow current practice in accounting for such arrangements
under Opinion 25.
RECENT ACCOUNTING DEVELOPMENTS
In March 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation," an interpretation of Accounting Principles Board ("APB") Opinion
No. 25. FASB Interpretation No. 44 clarifies certain issues related to the
application of APB Opinion 25 and became effective July 1, 2000, with certain
conclusions covering specific events that occurred either after December 15,
1998 or January 12, 2000. FASB Interpretation No. 44 did not have a material
effect on the Company's financial position or results of operations.
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," (Statement 140). Statement 140 replaces
FASB Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
(Statement 125). It revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carries over most of Statement 125's provisions without
reconsideration. Statement 140 provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of liabilities.
Those standards are based on consistent application of a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets when
control has been surrendered and derecognizes liabilities when extinguished.
Statement 140 provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured borrowings.
Statements of Financial Accounting Standards No. 133. In June 1998, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133")
F-10
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognizes all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available for sale security or a
foreign-currency-denominated forecasted transaction.
Under SFAS 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000.
On January 1, 2001, we adopted SFAS 133, and at that time, determined that
our interest rate cap agreements did not meet the hedging requirements of
SFAS 133. Previously, we had designated these interest rate cap agreements as
hedges to assure that we maintained a positive gap between the cost of borrowing
and the yield on our mortgage portfolio. As required under SFAS 133, derivative
gains and losses not considered effective in hedging the change in expected cash
flows of the hedged item are recognized immediately in the income statement.
With the implementation of SFAS 133, we recorded transition amounts
associated with establishing the fair values of the derivative instruments on
the balance sheet as a decrease of $1,106,000 to net income (loss). Under old
accounting rules, the Company would have expensed derivative instrument cost
over their effective period.
(IN THOUSANDS)
--------------
Summary of transition adjustment at January 1:
Balance Sheet
Assets
Interest Rate Cap Agreements............................ ($1,106)
($1,106)
=======
Liabilities and Stockholders' Equity
Accumulated Deficit..................................... ($1,106)
($1,106)
-------
Statement of Income
Cumulative effect of a change in accounting principle..... ($1,106)
=======
Net Income................................................ ($1,106)
-------
The transition adjustment will be presented as a cumulative effect
adjustment as described in Accounting Principles Board Opinion No. 20,
Accounting Changes, in our 2001 financial statements. The transition amounts
were determined based on the interpretive guidance issued to date by the
Financial Accounting Standards Board. The Financial Accounting Standards Board
continues to issue
F-11
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
interpretive guidance which could require changes in our application of the
standard and adjustment to the transition amounts. SFAS 133, as applied to our
risk management strategies, may increase or decrease reported net income and
stockholders' equity prospectively, depending on future levels of interest rates
and other variables affecting the fair values of derivative instruments but will
have no effect on cash flows or the overall economics of the transactions.
Statement 133, as amended by SFAS No. 137 "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of FASB
Statement No. 133" and Statement 138, continues to be effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000.
In June 2000, the FASB issued Statement of Financial Accounting Standards
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities, an amendment of FASB Statement No. 133" (Statement 138). Statement
138 addresses a limited number of issues causing implementation difficulties for
numerous entities that are required to apply Statement 133.
Statement 140 is effective for transfers and servicing of financial assets
and extinguishments of liabilities occurring after March 31, 2001. Statement 140
is effective for recognition and reclassification of collateral and for
disclosures relating to securitization transactions and collateral for fiscal
years ending after December 15, 2000. Disclosures about securitization and
collateral accepted need not be reported for periods ending on or before
December 15, 2000, for which financial statements are presented for comparative
purposes.
Statement 140 is to be applied prospectively with certain exceptions. Other
than those exceptions, earlier or retroactive application of its accounting
provisions is not permitted. The Company has complied with the disclosure
requirements of SFAS 140.
NOTE 2. MORTGAGE LOANS HELD-FOR-INVESTMENT, NET, PLEDGED
AmREIT purchases certain non-conforming Mortgage Loans to be held as
long-term investments. At December 31, 2000 and 1999, Mortgage Loans held for
investment consist of the following (dollars in thousands):
2000 1999
-------- --------
Mortgage loans held-for-investment, principal............. $ -- $122,036
Unamortized premium....................................... -- 4,343
Allowance for loan losses................................. -- (163)
----- --------
$ -- $126,216
===== ========
A summary of the activity in the allowance for loan losses is as follows
(dollars in thousands):
2000 1999
-------- --------
Balance beginning of year................................... $ 163 $ 817
Provision (credit) charged to operating expense............. (153) 1,025
Transfer to CMO/FASIT....................................... (10) (1,679)
----- ------
Balance end of year......................................... $ -- $ 163
===== ======
F-12
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. MORTGAGE LOANS HELD-FOR-INVESTMENT, NET, PLEDGED (CONTINUED)
At December 31, 2000, there were no Mortgage Loans. The weighted average net
coupon on the Mortgage Loans for the year ended December 31, 1999 was 9.17% per
annum. All Mortgage Loans have a repricing frequency of five years or less. At
December 31, 1999, approximately 29% of the collateral was located in California
with no other state representing more than 6%.
NOTE 3. BOND COLLATERAL, MORTGAGE LOANS
AmRIT has pledged collateral in order to secure the Long-Term Debt issued in
the form of CMOs. Bond Collateral consists primarily of adjustable-rate,
conventional, 30-year mortgage loans secured by first liens on one- to
four-family residential properties. All Bond Collateral is pledged to secure
repayment of the related Long-Term Debt obligation. All principal and interest
(less servicing and related fees) on the Bond Collateral is remitted to a
trustee and is available for payment on the Long-Term Debt obligation. The
obligations under the Long-Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to AmRIT.
The components of the Bond Collateral at December 31, 2000 and 1999 are
summarized as follows (dollars in thousands):
CMO/ CMO/
REMIC REMIC CMO CMO CMO/FASIT
2000-2 1999-A 1999-2 1999-1 1998-1 TOTAL
SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION BOND COLLATERAL
-------------- -------------- -------------- -------------- -------------- ---------------
AT DECEMBER 31, 2000
Mortgage loans........... $51,414 $246,198 $313,392 $116,760 $ 91,250 $ 819,014
Unamoritized premium..... 1,885 8,877 12,470 5,323 4,213 32,768
Allowance for loan
losses................. (196) (621) (1,399) (1,413) (888) (4,517)
------- -------- -------- -------- -------- ----------
$53,103 $254,454 $324,463 $120,670 $ 94,575 $ 847,265
======= ======== ======== ======== ======== ==========
Weighted average net
coupon................. 9.09% 9.48% 8.98% 10.08% 12.08% 9.63%
Unamortized premiums as a
percent of Mortgage
Loans.................. 3.67% 3.61% 3.98% 4.56% 4.62% 4.00%
AT DECEMBER 31, 1999
Mortgage loans........... $ -- $319,606 $385,795 $200,884 $210,584 $1,116,869
Unamoritized premium..... -- 12,227 14,284 8,622 6,279 41,412
Allowance for loan
losses................. -- (298) (332) (1,443) (2,477) (4,550)
------- -------- -------- -------- -------- ----------
$ -- $331,535 $399,747 $208,063 $214,386 $1,153,731
======= ======== ======== ======== ======== ==========
Weighted average net
coupon................. 0.00% 9.39% 9.03% 8.91% 10.15% 9.32%
Unamortized premiums as a
percent of Mortgage
Loans.................. 0.00% 3.83% 3.70% 4.29% 2.98% 3.71%
At December 31, 2000 and 1999, approximately 25% and 38%, respectively of
the collateral was located in California for the CMO/FASIT 1998-1 and no other
state represented more than 8%,
F-13
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. BOND COLLATERAL, MORTGAGE LOANS (CONTINUED)
respectively. At December 31, 2000 and 1999, approximately 33% and 38%
respectively of the collateral was located in California for the CMO 1999-1 and
no other state represented more than 6% and 7% respectively. At December 31,
2000 and 1999, approximately 21% respectively of the collateral was located in
California for the CMO 1999-2 and no other state represented more than 7%
respectively. At December 31, 2000 and 1999, approximately 11% and 13% of the
collateral was located in Michigan for the CMO/REMIC 1999-A and no other state
represented more than 10% respectively. At December 31, 2000, approximately 24%
of the collateral was located in California for the CMO 2000-2 and no other
state represented more than 7%.
Non-accrual loans included in the Company's Bond Collateral, Mortgage Loans
as of December 31, 2000 and 1999 were approximately $48.1million and
$37.5 million, respectively. There was no specific related allowance for 2000 or
1999.
A summary of the activity in the allowance for loan losses is as follows
(dollars in thousands):
2000 1999 1998
-------- -------- --------
Balance beginning of year................................... $4,550 $4,966 $ --
Provision charged to operating expense...................... 5,037 2,625 2,361
Loans charged-off net of recoveries......................... (393) (873) --
Charge offs upon transfer to real estate owned.............. (4,687) (2,536) (125)
Reclassification to interest allowance...................... -- (1,311) --
Transfer from Mortgage Loans Held-for-Investment............ 10 1,679 2,730
------ ------ ------
Balance end of year......................................... $4,517 $4,550 $4,966
====== ====== ======
NOTE 4. BOND COLLATERAL, REAL ESTATE OWNED
The Company owned 120 properties and 68 properties as of December 31, 2000
and 1999, respectively. Upon transfer of the loans to real estate owned, the
Company recorded a corresponding charge against the allowance for loan losses to
write-down the real estate owned to fair value less estimated cost of disposal.
At December 31, 2000 and 1999, real estate owned totaled approximately
$7.7 million and $5.2 million, respectively.
NOTE 5. RETAINED INTEREST IN SECURITIZATION
Retained interest in securitization consists of assets generated and
retained in conjunction with the Company's 1998-1 REMIC securitization. A
summary of these assets at December 31, 2000 and 1999 were as follows (dollars
in thousands):
2000 1999
-------- --------
REMIC subordinate certificates.............................. $1,089 $6,950
Overcollateralization account............................... 2,160 2,160
Unrealized gain (loss)...................................... -- (2,500)
------ ------
$3,249 $6,610
====== ======
The Company classified the 1998-1 REMIC securities as available-for-sale
securities and carries them at market value. The fair value of the retained
interest is determined by computing the present
F-14
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. RETAINED INTEREST IN SECURITIZATION (CONTINUED)
value of the excess of the weighted-average coupon of the residential mortgages
sold (12.65%) over the sum of: (1) the coupon on the senior interest (7.10%),
and (2) a servicing fee paid to the servicer of the residential mortgages
(0.50%) and other fees, and taking into account expected estimated losses to be
incurred on the portfolio of residential mortgages sold over the estimated lives
of the residential mortgages and using an estimated future average prepayment
assumption of 34% per year for 2000 and 35% per year for 1999. The prepayment
assumption used in estimating the cash flows is based on recent evaluations of
the actual prepayments of the related portfolio and on market prepayment rates
on new portfolios of similar residential mortgages, taking into consideration
the current interest rate environment and its expected impact on the estimated
future prepayment rate. The estimated cash flows expected to be received by the
Company are discounted at an interest rate that the Company believes is
commensurate with the risk of holding such a financial instrument. The rate used
to discount the cash flows coming out of the trust was approximately 10%. To the
extent that actual future excess cash flows are different from estimated excess
cash flows, the fair value of the Company's retained interest could change.
Under the terms of the securitization, the retained interest is required to
build over-collateralization to specified levels using the excess cash flows
described above until set percentages of the securitized portfolio are attained.
Future cash flows to the retained interest holder are all held by the REMIC
trust until a specific percentage of either the original or current certificate
balance is attained which percentage can be raised if certain charge-offs and
delinquency ratios are exceeded. The certificate holders' recourse for credit
losses is limited to the amount of over-collateralization held in the REMIC
trust. Upon maturity of the certificates or upon exercise of an option ("clean
up call") to repurchase all the remaining residential mortgages once the balance
of the residential mortgages in the trust are reduced to 10% of the original
balance of the residential mortgages in the trust, any remaining amounts in the
trust are distributed. The current amount of any over-collateralization balance
held by the trust is recorded as part of the retained interest.
In future periods, the Company will recognize additional revenue from the
retained interest if the actual performance of the mortgage loans is higher than
the original estimate or the Company may increase the estimated fair value of
the retained interest. If the actual performance of the mortgage loans is lower
than the original estimate, then an adjustment to the carrying value of the
retained interest may be required if the estimated fair value of the retained
interest is less than its carrying value.
NOTE 6. INTEREST RATE CAP AGREEMENTS
The amortized cost of the Company's interest rate cap agreements was
$1.1 million net of accumulated amortization of $667 thousand and $1.6 million
net of accumulated amortization of $1.1 million at December 31, 2000 and 1999,
respectively.
CAP AGREEMENTS
The Company had five and four outstanding Cap Agreements at December 31,
2000 and 1999, respectively. Potential future earnings from each of these Cap
Agreements are based on variations in the one month London Interbank Offered
Rate ("LIBOR"). The Cap Agreements at December 31, 2000 and 1999 have
contractually stated notional amounts which vary over the life of the Cap
Agreements. Under these Cap Agreements the Company will receive cash payments
should the
F-15
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. INTEREST RATE CAP AGREEMENTS (CONTINUED)
agreed-upon reference rate, one month LIBOR, increase above the strike rates of
the Cap Agreements. There was approximately $295,000 and approximately $104,000
in income for the years ended December 31, 2000 and 1999 respectively for Cap
Agreements, offset by $995,000 and $797,000 in Cap Agreement amortization.
All of the adjustable-rate mortgage securities and mortgage loans are
limited by periodic caps (generally interest rate adjustments are limited to no
more than 1% every six months) and lifetime interest rate caps.
FLOOR AGREEMENTS
The Company had no outstanding floor agreements at December 31, 2000, or
December 31, 1999. The Company had no floor agreement expense in 2000 and
approximately $1.1 million floor agreement expense which was included in hedge
expense in 1999.
Interest rate agreements outstanding at December 31, 2000 and 1999 are as
follows (dollars in thousands):
2000
---------------------------------------------------------------------------
AVERAGE CAP FLOOR
NOTIONAL FACE CAP STRIKE FLOOR STRIKE
AMOUNT RATE RATE INDEX EXPIRES
------------- ---------- ------------ ------------- ---------------
First Union................. $364,000 6.750% -- 1 mo. LIBOR July, 2001
Merrill Lynch............... 227,100 7.120% -- 1 mo. LIBOR December, 2001
Merrill Lynch............... 111,200 7.120% -- 1 mo. LIBOR December, 2001
Solomon Smith Barney........ 47,600 7.120% -- 1 mo. LIBOR December, 2001
Solomon Smith Barney........ 97,100 7.120% -- 1 mo. LIBOR December, 2001
1999
---------------------------------------------------------------------------
AVERAGE CAP FLOOR
NOTIONAL FACE CAP STRIKE FLOOR STRIKE
AMOUNT RATE RATE INDEX EXPIRES
------------- ---------- ------------ ------------- ---------------
Lehman Brothers............ $ 44,994 8.105% -- 1 mo. LIBOR April, 2000
CS First Boston............ 85,378 8.114% -- 1 mo. LIBOR April, 2000
First Union................ 364,000 6.750% -- 1 mo. LIBOR July, 2001
Bear Stearns............... 200,000 6.250% -- 1 mo. LIBOR September, 2000
NOTE 7. SHORT-TERM DEBT
The Company had entered into reverse repurchase agreements with two lenders
to finance the acquisition of Mortgage Loans. The Company had a $100 million
committed and $100 million uncommitted agreement with Bear Stearns, which
expired on July 31, 2000, and a $100 million committed agreement with Morgan
Stanley Mortgage Corporation, Inc. which expired March 10, 2000. When the
reverse repurchase agreements are in use, they are collateralized by a portion
of the Company's Mortgage Loans.
There were no Mortgage Loans reverse repurchase agreements outstanding at
December 31, 2000. At December 31, 1999, the Company had approximately
$119.0 million of Mortgage Loans reverse repurchase agreements outstanding with
a weighted average borrowing rate of 6.05%. The maximum
F-16
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. SHORT-TERM DEBT (CONTINUED)
month end balance and the average balance outstanding for the twelve months
ended December 31, 1999, were approximately $406.0 million and $141.3 million,
respectively.
The weighted average remaining maturity was one day at December 31,1999.
At December 31, 1999, the Mortgage Loans reverse repurchase agreements had
the following characteristics (dollars in thousands):
DECEMBER 31, 1999
---------------------------------------
REPURCHASE UNDERLYING INTEREST RATE
LIABILITY COLLATERAL (PER ANNUM)
---------- ---------- -------------
Bear Stearns........................................ $119,003 $122,017 6.05%
At December 31, 2000, short-term borrowings outstanding were 5.1 million.
These borrowings were secured by the Company's interest in REMIC Securities
1999-A Series. Interest is payable monthly at LIBOR plus 150 basis points. The
note is due February 26, 2001.
NOTE 8. LONG-TERM DEBT, NET
During the second quarter of 1999, AmRIT, through its wholly owned
subsidiary, Eagle, issued approximately $229.0 million of a single class of
mortgage backed notes (Long-Term Debt). The notes are principally secured by the
assets of the trust, which consist primarily of fixed and adjustable rate
mortgage loans secured by first liens on one-to-four family residential
properties. Payments received on the mortgage loans ("Bond Collateral") are used
to make payments on the Long-Term Debt. The obligations under the Long-Term Debt
are payable solely from the Bond Collateral and are otherwise non-recourse to
AmRIT. The maturity of the notes is directly affected by the rate of principal
repayments on the related Bond Collateral. The Long-Term Debt is also subject to
redemption according to the specific terms of the indenture pursuant to which
the notes were issued. As a result, the actual maturity of the Long-Term Debt is
likely to occur earlier than its stated maturity.
During the third quarter of 1999, AmRIT, through its wholly owned
subsidiary, Eagle, issued approximately $394.1 million of Series 1999-2 mortgage
backed bonds (Long-Term Debt) in two classes. The bonds are non-recourse
obligations of a trust formed and wholly-owned by Eagle. The Class A-1 Bonds of
approximately $332.4 million are secured by the assets of the trust, which
consist of approximately $339.8 million in adjustable-rate mortgage loans
secured by first liens on one- to four-family residential properties. The
interest rate for the Class A-1 Bonds is variable based on one-month LIBOR. The
Class A-2 Bonds of approximately $61.7 million are secured by approximately
$63 million in fixed-rate mortgage loans secured by first liens on one- to
four-family residential properties. The interest rate on the Class A-2 Bonds is
7.09%. "Bond Collateral" is used to make payments on the Long-Term Debt.
Payments received on the mortgage loans in excess of obligations due under the
Long-Term Debt agreement are remitted to the Company on a monthly basis by the
Bond Trustee. The obligations under the Long-Term Debt are payable solely from
the Bond Collateral and are otherwise non-recourse to AmRIT. While the stated
maturity of the bonds is July 25, 2029, the actual maturity of the bonds is
directly affected by the rate of principal repayments on the related Bond
Collateral. The Long-Term Debt is also subject to redemption by the Company
according to the specific terms of the indenture pursuant to which the bonds
were issued. As a result, the actual maturity of the Long-Term Debt is likely to
occur earlier than its stated maturity.
F-17
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. LONG-TERM DEBT, NET (CONTINUED)
During the third quarter of 1999, Greenwich Capital Financial
Products, Inc. ("GCFP") conveyed to AmRIT, Mortgage Loans consisting of first
lien, fully-amortizing, residential mortgage loans ("Mortgage Loans") with
original terms to maturity of 30 years and an aggregate scheduled principal
balance as of the close of business on August 1, 1999, of $335.2 million. AmRIT
then conveyed an interest in the Mortgage Loans to Greenwich Financial Asset
Securities Corp. in exchange for a specified cash sum and certain REMIC
securities. Under generally accepted accounting principles, the transaction was
treated as an issuance of Long Term Debt, Series 1999-A, secured by the Mortgage
Loans. The Series 1999-A Long-Term Debt consists of two classes: Class A-1 which
had an initial principal amount of approximately $335.2 million and Class S-1
which is an interest only class. The interest rate for the Class A-1 is variable
based on the one-month LIBOR. The interest rate for the Class S-1 begins at
3.5%, declines by 0.5% each year for two years and then declines to 0.00% at the
end of year three. The stated maturity for the Class A-1 is August, 2029,
however, since the maturity of the debt is directly affected by the rate of
principal repayments of the related Mortgage Loans, the actual maturity of the
Class A-1 is likely to occur earlier than its stated maturity.
AmRIT conveyed to Eagle, which in turn conveyed to Eagle 2, AmRIT's
remaining interest in the Mortgage Loans (subject to the Series 1999-A Long Term
Debt) and received as payment a combination of cash and credit for an additional
capital contribution. Pursuant to an Agreement with GCFP ("Financing
Agreement"), Eagle 2 pledged its interest in the Mortgage Loans as collateral to
secure a term loan made to it by GCFP, and directed the Trustee to remit all
collections, distributions or other income with respect to the Mortgage Loans
(net of amounts due on the Series 1999-A Long Term Debt) directly to GCFP to
prepay outstanding principal and interest.
The initial principal amount of the loan under the Financing Agreement was
equal to 55% of the market value (as defined therein) of the Mortgage Loans (or
approximately $7.1 million). To maintain a substantial level of over
collateralization during the term of the loan, the Financing Agreement requires
Eagle 2 to maintain a specified level of collateral (including the mortgage
Loans and any additional collateral pledged by Eagle 2). In the event that the
collateral value of the Mortgage Loans and other pledged collateral is
determined to be less than required, GCFP may require Eagle 2 to deliver
additional cash, securities or additional collateral or to repay principal in
the amount of such deficiency; the failure to do so would constitute an event of
default. The loan matures on February 26, 2001.
During the second quarter of 2000, AmRIT, through its wholly-owned
subsidiary, Eagle, conveyed an interest in approximately $56.2 million of
mortgage loans to Countrywide Home Loans, Inc. in exchange for a specified cash
sum and certain REMIC securities. Under generally accepted accounting
principles, the transaction was treated as an issuance of Long-Term Debt,
Series 2000-2, secured by the mortgage loans. The Series 2000-2 Long-Term Debt
consists of five classes, each of which bears interest at an adjustable rate.
The stated maturity for the Series 2000-2 Long-Term Debt is June 25, 2031,
however, since the maturity of the debt is directly affected by the rate of
principal repayments of the related mortgage loans, the actual maturity is
likely to occur earlier than stated maturity.
The components of the Long-Term Debt at December 31, 2000, and December 31,
1999, along with selected other information are summarized below (dollars in
thousands):
F-18
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DOLLARS IN THOUSANDS
-------------------- CMO/ CMO/
REMIC REMIC CMO CMO CMO/FASIT
2000-2 1999-A 1999-2 1999-1 1998-1 TOTAL
SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION SECURITIZATION LONG-TERM DEBT
AT DECEMBER 31, 2000 -------------- -------------- -------------- -------------- -------------- --------------
Long-Term debt........... $50,871 $239,617 $306,274 $113,874 $ 88,946 $ 799,582
CMO premium, net......... -- -- -- -- 78 78
Capitalized costs on
long-term debt......... (195) (23) (1,372) (785) (103) (2,478)
------- -------- -------- -------- -------- ----------
Total Long-Term debt..... $50,676 $239,594 $304,902 $113,089 $ 88,921 $ 797,182
======= ======== ======== ======== ======== ==========
Weighted average
financing rates........ 7.01% 6.79% 6.98% 6.97% 7.74% 7.00%
AT DECEMBER 31, 1999
Long-Term debt........... $ -- $317,057 $376,855 $198,228 $208,120 $1,100,260
CMO premium, net......... -- -- -- -- 237 237
Capitalized costs on
long-term debt......... -- (30) (1,679) (1,299) (329) (3,337)
------- -------- -------- -------- -------- ----------
Total Long-Term debt
(1).................... $ -- $317,027 $375,176 $196,929 $208,028 $1,097,160
======= ======== ======== ======== ======== ==========
Weighted average
financing rates........ -- 5.57% 6.11% 5.94% 5.98% 5.90%
------------------------
(1) The GCFP Note was classified as Long-Term debt in 1999 with a balance of
approximately $6.1 million. These borrowings were secured by the Company's
interest in REMIC Securities 1999-A Series. Interest is payable monthly at
LIBOR plus 150 basis points. The note is due February 26, 2001.
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments amounts have been
determined by the Company's management using available market information and
appropriate valuation methodologies; however, considerable judgement is
necessarily required to interpret market data to develop estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or
F-19
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
estimation methodologies may have a material effect on the estimated fair value
amounts. The fair value as of December 31, 2000 and 1999 is as follows (dollars
in thousands):
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- --------- ---------
2000 1999
------------------- ---------------------
Assets:
Cash and cash equivalents.......................... $14,688 $14,688 $ 8,550 $ 8,550
Mortgage Loans held-for-investment................. -- -- 126,216 126,216
Bond collateral.................................... 847,265 842,252 1,153,731 1,142,810
Retained interest in securitization................ 3,249 3,249 6,610 6,610
Interest rate agreements........................... 1,115 9 1,556 1,294
Due from affiliate................................. 355 355 394 394
Liabilities:
Short-term debt.................................... 5,083 5,083 119,003 119,003
Long-term debt..................................... 797,182 797,182 1,103,258 1,103,258
Due to affiliate................................... 1,347 1,347 597 597
The following describes the methods and assumptions used by the Company in
estimating fair values.
CASH AND CASH EQUIVALENTS
The carrying amount for cash and cash equivalents approximates fair value
because these instruments are demand deposits and money market mutual funds and
do not present unanticipated interest rate or credit concerns.
RETAINED INTEREST IN SECURITIZATION
This security is classified as available-for-sale and as such is carried at
fair value. See "Notes to the Consolidated Financial Statements--Note 5.
Retained Interest in Securitization" for a description of the valuation
methodology.
MORTGAGE LOANS HELD-FOR-INVESTMENT
The fair value for Mortgage Loans and held-for-investment is estimated based
on quoted market prices from dealers and brokers for similar types of Mortgage
Assets.
The fair value for Bond Collateral is estimated based on quoted market
prices from dealers and brokers for similar types of mortgage loans. Market
prices reflect various assumptions as to prepayment rates, loan losses and
financing costs.
INTEREST RATE CAP AGREEMENTS
The fair value of interest rate cap agreements is estimated based upon
general market prices from dealers.
F-20
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
DUE FROM AFFILIATE
The fair value of due from affiliate approximates the carrying amount
because of the short-term nature of the asset.
SHORT-TERM DEBT
The fair value of reverse repurchase agreements approximates the carrying
amounts because of the short term nature of the liabilities.
LONG-TERM DEBT
The fair value of long-term debt is estimated based upon all long-term debt
being at variable rates and therefore cost equals fair market value.
DUE TO AFFILIATE
The fair value of due to affiliate approximates the carrying amount because
of the short-term nature of the liability.
NOTE 10. STOCK OPTION PLANS
The Company has adopted the 1997 Stock Incentive Plan (the "Incentive Plan")
and the 1997 Stock Option Plan (the "Option Plan") for executive officers and
key employees and has adopted the 1997 Outside Directors Option Plan (the
"Directors Plan") for directors who are not employees of the Company.
The Incentive Plan, the Option Plan and the Directors Plan authorize the
Board of Directors (or a committee appointed by the Board of Directors) to grant
incentive stock options ("ISOs"), as defined under section 422 of the Code,
options not so qualified ("NQSOs"), and stock appreciation rights ("SAR's") to
such eligible recipients.
F-21
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. STOCK OPTION PLANS (CONTINUED)
During the period from February 11, 1997 (commencement of operations)
through December 31,, 2000, the Company granted 938,100 options as follows:
TOTAL OPTIONS W/
ISO NON-QUALIFIED OPTIONS SAR'S
-------- ------------- -------- ----------
1997 STOCK INCENTIVE PLAN GRANTS:
February 11, 1997 @ 12.50/share.................... 99,200 216,000 315,200 280,000
1997 STOCK OPTION PLAN GRANTS:
October 27, 1997 @ 15.00/share..................... 104,801 232,999 337,800 --
December 15, 1997 @ 15.00/share.................... 4,267 72,133 76,400 --
1997 OUTSIDE DIRECTORS STOCK OPTIONS GRANTS:
October 27, 1997 @ 15.00/share..................... -- 30,000 30,000 --
------- ------- -------- -------
Options Outstanding at December 31, 1997........... 208,268 551,132 759,400 280,000
------- ------- -------- -------
1997 STOCK OPTION PLAN GRANTS:
April 8, 1998 @ 13.69/share........................ 9,000 -- 9,000 --
October 1, 1998 @ 6.13/share....................... 2,500 -- 2,500 --
------- ------- -------- -------
OPTIONS ISSUED IN 1998............................. 11,500 -- 11,500 --
------- ------- -------- -------
OPTIONS TERMINATED IN 1998......................... (26,667) (48,333) (75,000)
------- ------- -------- -------
NET OPTIONSTERMINATED IN 1998...................... (15,167) (48,333) (63,500) --
------- ------- -------- -------
1997 STOCK OPTION PLAN GRANTS:
April 19, 1999 @ 8.06/share........................ 2,500 -- 2,500 --
April 30, 1999 @ 7.50/share........................ 1,500 -- 1,500 --
May 6 1999 @ 7.25/share............................ 224,700 -- 224,700 --
June 16, 1999 @ 7.50/share......................... 100,000 -- 100,000 --
July 16, 1999 @ 7.75/share......................... 35,000 -- 35,000 --
August 16, 1999 @ 7.06/share....................... 5,000 -- 5,000 --
1997 OUTSIDE DIRECTORS STOCK OPTIONS GRANTS:
May 19, 1999 @ 7.88/share.......................... 30,000 -- 30,000 --
------- ------- -------- -------
OPTIONS ISSUED IN 1999............................. 398,700 -- 398,700 --
OPTIONS TERMINATED IN 1999......................... (32,567) (40,933) (73,500)
------- ------- -------- -------
NET OPTIONS ISSUED IN 1999......................... 366,133 (40,933) 325,200
------- ------- -------- -------
1997 STOCK OPTION PLAN GRANTS:
August 10, 2000 @ 4.063/share...................... 15,000 -- 15,000 --
November 3, 2000 @ 3.125/share..................... 5,000 -- 5,000 --
December 1, 2000 @ 2.75/share...................... 2,500 -- 2,500 --
December 15, 2000 @ 2.188/share.................... 2,500 -- 2,500 --
------- ------- -------- -------
OPTIONS ISSUED IN 2000............................. 25,000 -- 25,000 --
------- ------- -------- -------
OPTIONS TERMINATED IN 2000......................... (81,067) (26,933) (108,000) --
------- ------- -------- -------
NET OPTIONS TERMINATED IN 2000..................... (56,067) (26,933) (83,000) --
------- ------- -------- -------
TOTAL OPTIONS OUTSTANDING AT DECEMBER 31, 2000..... 503,167 434,933 938,100 280,000
======= ======= ======== =======
F-22
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. STOCK OPTION PLANS (CONTINUED)
The Incentive Plan was adopted on February 11, 1997 (the "Effective Date"),
and a total 315,200 shares of common stock have been reserved for issuance. All
stock options granted under the Incentive Plan vest at the earlier of a
four-year period from the date of grant or once the Company issues an aggregate
of $150 million of new equity, and will expire within ten years after the date
of grant.
The Company also has adopted the 1997 Employee Stock Purchase Plan (the
"Purchase Plan") which permits eligible employees to purchase common stock at a
discount through accumulated payroll deductions. No shares were issued under the
Purchase Plan as of December 31, 2000.
As of December 31, 2000, the following options were reserved for issuance
under the Company's option plans:
1997 1997
1997 1997 EMPLOYEE OUTSIDE
STOCK STOCK STOCK DIRECTOR
INCENTIVE OPTION PURCHASE STOCK OPTION
PLAN PLAN PLAN PLAN TOTAL
--------- -------- -------- ------------ ---------
Total Options Authorized................... 315,200 774,800 20,000 60,000 1,170,000
Total Options Issued....................... 300,800 577,300 -- 60,000 938,100
------- ------- ------ ------ ---------
Options Reserved for Issuance.............. 14,400 197,500 20,000 -- 231,900
======= ======= ====== ====== =========
FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
----------------- ----------------- -----------------
Loss as reported............................. $(6,198) $(3,850) $(1,214)
======= ======= =======
Pro forma net loss........................... $(6,550) $(4,197) $(1,440)
======= ======= =======
Basic loss per share as reported............. $ (0.77) $ (0.48) $ (0.15)
======= ======= =======
Diluted loss per share as reported........... $ (0.77) $ (0.48) $ (0.15)
======= ======= =======
Pro forma basic loss per share............... $ (0.81) $ (0.52) $ (0.18)
======= ======= =======
Pro forma diluted loss per share............. $ (0.81) $ (0.52) $ (0.18)
======= ======= =======
The derived fair value of the options granted during the years ended
December 31, 2000 and 1999 was approximately $24,000 and $606,000 respectively,
or a per option fair value of $0.95 and $1.52 respectively, using the
Black-Scholes option pricing model with the following assumptions for 2000; a
weighted average expected dividend yield of 29.96%, a weighted average risk-free
interest rate of 5.83%, expected life of 5 years, and expected volatility of
60.89%, for 1999: a weighted average expected dividend yield of 13.63%, a
weighted average risk-free interest rate of 5.53%, expected life of 5 years, and
expected volatility of 60.89% for 1999.
NOTE 11. STOCKHOLDERS' EQUITY
On December 17, 1998, the Company declared a dividend of $1.2 million or
$0.15 per share. The dividend was paid on January 28, 1999 to holders of record
of common stock as of December 31, 1998. On October 15, 1998, the Company
declared a dividend of $967,000 or $0.12 per share. The dividend was paid on
November 2, 1998, to holders of record of common stock as of October 26, 1998.
On
F-23
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. STOCKHOLDERS' EQUITY (CONTINUED)
July 13, 1998, the Company declared a dividend of $2.3 million or $0.28 per
share. The dividend was paid on July 31, 1998, to holders of record of common
stock as of July 24, 1998. On April 14, 1998, the Company declared a dividend of
$2.3 million or $0.28 per share. The dividend was paid on April 30, 1998, to
holders of record of common stock as of April 24, 1998.
On December 16, 1999, the Company declared a dividend of $2.4 million or
$0.30 per share. The dividend was paid on January 31, 2000, to holders of record
of common stock as of December 31, 1999. On October 21, 1999, the Company
declared a dividend of $2.2 million or $0.27 per share the dividend was paid on
November 8, 1999, to stockholders of record as of November 1, 1999. On July 21,
1999, the Company declared dividend of $2.0 million or $0.25 per share. The
dividend was paid on August 6, 1999, to stockholders of record as of July 30,
1999. On April 22, 1999, the Company declared a dividend of $1.6 million or
$0.20 per share. The dividend was paid on May 10, 1999 to stockholders of record
as of May 3, 1999.
On December 14, 2000, the Company declared a dividend of $1.6 million or
$0.20 per share. The dividend was paid on January 31, 2001 to holders of record
of common stock as of January 3, 2001. On October 20, 2000, the Company declared
a dividend of $1.6 million or $0.20 per share dividend payable on November 7,
2000 to stockholders of record as of October 31, 2000. On July 20, 2000, the
Company declared dividend of $1.6 million or $0.20 per share. The dividend was
paid on August 7, 2000 to stockholders of record as of July 31, 1999. On
April 20, 1999 the Company declared a dividend of $1.6 million or $0.20 per
share. The dividend was paid on May 10, 2000 to stockholders of record as of
May 3, 2000.
During 2000, the Company repurchased 34,600 shares of common stock. The
Company paid approximately $84,000 for the repurchased shares. For accounting
purposes the stock is treated as Treasury Stock until the Company decides to
retire or resell the stock.
On February 8, 1999, the Company adopted a Stockholder Rights Plan (the
"Plan") designed to enable all Company stockholders to realize the full value of
their investment and to provide for fair and equal treatment for all
stockholders in the event that an unsolicited attempt is made to acquire the
Company. The adoption of the Plan is intended as a means to guard against any
potential use of takeover tactics designed to gain control of the Company
without paying all stockholders full and fair value for their stock. The
distribution of the Rights is not in response to any proposal to acquire the
Company and the Board is not aware of any such effort.
Under the Plan, stockholders will receive one Right to purchase one
one-hundredth of a share of a new series of preferred stock for each outstanding
share of the Company's common stock held of record at the close of business on
February 26, 1999, or thereafter.
The Rights, which will trade with the common stock, become exercisable to
purchase one one-hundredth of a share of the new preferred stock, at $30.00 per
Right, when someone acquires 15% or more of the Company's common stock or
announces a tender offer which could result in such person owning 15% or more of
the common stock. Each one one-hundredth of a share of the new preferred stock
has terms designed to make it substantially the economic equivalent of one share
of common stock. The Rights can be redeemed by the Board of directors for $0.01.
Under certain circumstances, if someone acquires 15% or more of the common
stock, the Rights permit stockholders other than the acquiror to purchase common
stock having a market value of twice the exercise price of the Rights, in lieu
of the preferred stock. In addition, in the event of certain business
combinations, the
F-24
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. STOCKHOLDERS' EQUITY (CONTINUED)
Rights permit purchase of the common stock of an acquiror at a 50% discount.
Rights held by the acquiror will become null and void in both cases. The rights
expire on February 2, 2009. The Rights distribution will not be taxable to
stockholders and will be issued to stockholders of record on February 26, 1999.
NOTE 12. STOCK SPLIT AND AUTHORIZED SHARES
On October 20, 1997, the Company increased the number of total authorized
shares of common stock to 25,000,000 from 4,000,000. Under the articles of
incorporation, as amended on October 20, 1997, the Company is authorized to
issue any class of capital stock, common stock or preferred stock, up to the
aggregate authorized amount of 25,001,000 shares, all of which has been
initially designated as common stock. All unissued shares may be reclassified by
the Board of Directors as one or more series of preferred stock.
NOTE 13. MANAGEMENT AGREEMENT
Effective February 11, 1997, the Company entered into a Management Agreement
with the Manager for an initial term of two years, to provide management
services to the Company. The agreement automatically renews unless terminated by
AmRES.
The Manager receives management fees and incentive compensation as follows:
- 1/8 of 1% per year, to be paid monthly, of the principal amount of agency
securities;
- 3/8 of 1% per year, to be paid monthly, of the principal amount of all
Mortgage Loans other than agency securities; and
- 25% of the amount by which the Company's net income (before deducting the
amount to be paid as incentive compensation) exceeds the annualized return
on equity equal to the average ten year U.S. Treasury Rate plus 2%.
Management fees of approximately $3.9 million, $3.6 million and
$2.4 million were recorded for the years ended December 31, 2000, 1999 and 1998,
respectively. The incentive compensation is calculated for each fiscal quarter,
and paid to the Manager quarterly in arrears before any income distributions are
made to stockholders. There was no incentive compensation for the years ended
December 31, 2000 and 1999.
The Company will employ certain employees of the Manager involved in the
day-to-day operations of the Company, including the Company's executive
officers, so that such employees may maintain certain benefits that are
available only to employees of the Company under the Code. These benefits
include the ability to receive incentive stock options under the 1997 Stock
Option Plan and to participate in the Employee Stock Purchase Plan. In order to
receive the aggregate benefits of the Management Agreement originally negotiated
between the Company and the Manager, the Company will pay the base salaries of
such employees and will be reimbursed by the Manager for all costs incurred with
respect to such payments.
The Manager's default on certain debt or failure of the Company to comply
with various restrictive covenants, could result in a default and termination of
the Management Agreement, in which case the operations of the Company could be
adversely affected pending either the engagement of a new manager or the
development internally of the resources necessary to manage the operation of the
F-25
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. MANAGEMENT AGREEMENT (CONTINUED)
Company. The Manager is currently in default of certain debt covenants. The
senior note holders have not issued waivers, however the parties continue to
operate under the original terms of the Management Agreement. In addition, MDC
Reit Holdings, LLC ("MDC-REIT") has pledged 1.6 million shares of its common
stock of the Company to secure the Manager's obligations under the Securities
Purchase Agreement. As a result of the defaults under the Securities Purchase
Agreement, the pledged shares could be transferred to the holders of the Notes,
who will then have certain demand registration rights.
NOTE 14. RELATED PARTY TRANSACTIONS
During the year ended December 31, 1998, the Company purchased approximately
$24 million of Mortgage Loans from an affiliated entity of one of its directors.
In the opinion of management, these purchases were made in the normal course of
business at terms consistent with the Company's general purchasing policies.
On June 1, 1998, the Company sold approximately $98.2 million par value
Mortgage Loans to Holdings for total consideration of $103.5 million. Management
believes the loans were sold at fair value at the time of the transaction.
On June 30, 1998, Holdings transferred the Class "X" Certificate to the
Company as part of the purchase price of Mortgage Loans purchased from the
Company on June 1, 1998. The Class "X" Certificate had a fair value of
$6.6 million at the time of the transfer.
F-26
AMERICAN RESIDENTIAL INVESTMENT TRUST, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15. SELECTED QUARTERLY FINANCIAL DATA
Selected quarterly financial data for 2000 and 1999 is as follows (dollars
in thousands, except per share data):
FOR THE FOR THE FOR THE FOR THE
QUARTER QUARTER QUARTER QUARTER
ENDED ENDED ENDED ENDED
DEC. 31, 2000 SEPT. 30, 2000 JUNE 30, 2000 MARCH 31, 2000
------------- -------------- ------------- --------------
Total interest income..................... $19,258 $19,875 $22,334 $25,070
Interest expense.......................... 15,624 16,925 17,923 18,856
Premium amortization...................... 2,338 2,500 2,497 3,438
Provision for loan losses................. 991 2,396 1,095 402
Net interest income (loss)................ 305 (1,946) 819 2,374
Other operating income.................... 1,173 1,006 1,329 1,047
Other expenses............................ 1,654 1,791 1,849 1,918
Impairment on retained interest in
securitization.......................... 391 4,702 -- --
Net income (loss)......................... (567) (7,433) 299 1,503
Net income per share of
common stock -- basic..................... (0.07) (0.92) 0.04 0.19
Net income per share of common stock --
diluted................................. (0.07) (0.92) 0.04 0.19
FOR THE FOR THE FOR THE FOR THE
QUARTER QUARTER QUARTER QUARTER
ENDED ENDED ENDED ENDED
DEC. 31, 1999 SEPT. 30, 1999 JUNE 30, 1999 MARCH 31, 1999
------------- -------------- ------------- --------------
Total interest income..................... $25,846 $22,060 $17,027 $14,186
Interest expense.......................... 17,798 14,159 9,614 8,073
Premium amortization...................... 4,035 4,853 4,022 3,715
Premium write-down........................ 12,294 -- -- --
Provision for loan losses................. 942 804 954 950
Net interest income (loss)................ (9,224) 2,244 2,437 1,449
Other operating income.................... 1,142 1,389 992 926
Other expenses............................ 1,574 1,467 1,404 760
Net income (loss)......................... (9,655) 2,166 2,025 1,614
Net income per share of common stock --
basic................................... (1.20) 0.27 0.25 0.20
Net income per share of common stock --
diluted................................. (1.20) 0.27 0.25 0.20
NOTE 16. COMMITMENTS AND CONTINGENCIES
On January 28, 2000, the Company sold $66.0 million in Mortgage Loans
Held-for-Investment back to the originator that sold these loans to the Company
during the fourth quarter of 1999. Certain irregularities were discovered during
the Company's routine post-funding quality control review related to
underwriting compliance and loan documents. The buyback was pursuant to certain
representations and warranty obligations of the originator related to
underwriting criteria and regulatory compliance.
F-27
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form 10-K and has duly caused this Form 10-K to be
signed on its behalf by the undersigned, thereto duly authorized, in the City of
San Diego, State of California, on the 29th day of March, 2001.
AMERICAN RESIDENTIAL INVESTMENT
TRUST, INC.
By: /s/ JOHN M. ROBBINS
-----------------------------------------
John M. Robbins
CHIEF EXECUTIVE OFFICER
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JOHN M. ROBBINS Chairman of the Board and March 29, 2001
------------------------------------------- Chief Executive Officer
John M. Robbins (Principal Executive
Officer)
/s/ JAY M. FULLER President and Chief March 29, 2001
------------------------------------------- Operating Officer
Jay M. Fuller Principal Operating
Officer)
/s/ JUDITH A. BERRY Chief Financial Officer March 29, 2001
------------------------------------------- (Principal Financial and
Judith A. Berry Accounting Officer)
/s/ JAMES BROWN Director March 29, 2001
-------------------------------------------
H. James Brown
/s/ DAVID DE LEEUW Director March 29, 2001
-------------------------------------------
David De Leeuw
/s/ RAY MCKEWON Director March 29, 2001
-------------------------------------------
Ray McKewon
/s/ RICHARD J. PRATT, PH.D. Director March 29, 2001
-------------------------------------------
Richard J. Pratt, Ph.D.
/s/ MARK J. REIDY, PH.D. Director March 29, 2001
-------------------------------------------
Mark J. Reidy, Ph.D.
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