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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
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 No. 001-13937
ANTHRACITE CAPITAL, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 13-3978906
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
40 East 52nd Street
New York, New York 10022
(Address of principal executive office) (Zip Code)
(212) 810-3333
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $0.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
8.25% SERIES D CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $0.001 PAR VALUE
(Title of each class) (Name of each exchange on which
registered)
Securities registered pursuant to Section 12(g) of the Act: Not Applicable
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Act. Yes [ ] No [X]
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
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. (See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 on the Exchange Act Rule).
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the registrant's Common Stock, $.001 par value,
held by non-affiliates of the registrant, computed by reference to the closing
sale price of $12.16 as reported on the New York Stock Exchange on June 30,
2006, was $688,497,461 (for purposes of this calculation, affiliates include
only directors and executive officers of the registrant).
The number of shares of the registrant's Common Stock, $.001 par value,
outstanding as of March 16, 2007 was 57,843,696 shares.
Documents Incorporated by Reference: Portions of the registrant's Definitive
Proxy Statement for the 2007 Annual Meeting of Stockholders are incorporated by
reference into Part III.
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ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2006 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. Business ..................................................... 4
Item 1A. Risk Factors ................................................. 20
Item 1B. Unresolved Staff Comments .................................... 27
Item 2. Properties ................................................... 27
Item 3. Legal Proceedings ............................................ 27
Item 4. Submission of Matters to a Vote of Security Holders .......... 27
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities ............ 28
Item 6. Selected Financial Data ...................................... 30
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ... 65
Item 8. Financial Statements and Supplementary Data .................. 69
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ..................................... 115
Item 9A. Controls and Procedures ...................................... 115
Item 9B. Other Information ............................................ 115
PART III
Item 10. Directors, Executive Officers and Corporate Governance ....... 116
Item 11. Executive Compensation ....................................... 116
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters .............................. 116
Item 13. Certain Relationships, Related Transactions and Director
Independence ................................................. 116
Item 14. Principal Accounting Fees and Services ....................... 117
PART IV
Item 15. Exhibits and Financial Statement Schedules ................... 118
Signatures ................................................... 121
2
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained herein constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 with
respect to future financial or business performance, strategies or expectations.
Forward-looking statements are typically identified by words or phrases such as
"trend," "opportunity," "pipeline," "believe," "comfortable," "expect,"
"anticipate," "current," "intention," "estimate," "position," "assume,"
"potential," "outlook," "continue," "remain," "maintain," "sustain," "seek,"
"achieve" and similar expressions, or future or conditional verbs such as
"will," "would," "should," "could," "may" or similar expressions. Anthracite
Capital, Inc. (the "Company") cautions that forward-looking statements are
subject to numerous assumptions, risks and uncertainties, which change over
time. Forward-looking statements speak only as of the date they are made, and
the Company assumes no duty to and does not undertake to update forward-looking
statements. Actual results could differ materially from those anticipated in
forward-looking statements and future results could differ materially from
historical performance.
In addition to factors previously disclosed in the Company's Securities and
Exchange Commission (the "SEC") reports and those identified elsewhere in this
report, the following factors, among others, could cause actual results to
differ materially from forward-looking statements or historical performance:
(1) the introduction, withdrawal, success and timing of business
initiatives and strategies;
(2) changes in political, economic or industry conditions, the interest
rate environment or financial and capital markets, which could result
in changes in the value of the Company's assets;
(3) the relative and absolute investment performance and operations of
BlackRock Financial Management, Inc. (the "Manager");
(4) the impact of increased competition;
(5) the impact of capital improvement projects;
(6) the impact of future acquisitions or divestitures;
(7) the unfavorable resolution of legal proceedings;
(8) the extent and timing of any share repurchases;
(9) the impact, extent and timing of technological changes and the
adequacy of intellectual property protection;
(10) the impact of legislative and regulatory actions and reforms and
regulatory, supervisory or enforcement actions of government agencies
relating to the Company, the Manager, Merrill Lynch & Co., Inc. or The
PNC Financial Services Group, Inc.;
(11) terrorist activities and international hostilities, which may
adversely affect the general economy, domestic and global financial
and capital markets, specific industries, the Company and the
Manager;
(12) the ability of the Manager to attract and retain highly talented
professionals;
(13) fluctuations in foreign currency exchange rates;
(14) the impact of changes to tax legislation and, generally, the tax
position of the Company;
(15) the Manager's ability to successfully integrate the Merrill Lynch
Investment Managers ("MLIM") business with its existing business; and
(16) the ability of the Manager to effectively manage the former MLIM
assets along with its historical assets under management.
Forward-looking statements speak only as of the date they are made. The Company
does not undertake, and specifically disclaims any obligation, to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect the occurrence of anticipated or unanticipated events or
circumstances after the date of such statements.
3
PART I
ITEM 1. BUSINESS
All dollar figures expressed herein are expressed in thousands, except share or
per share amounts.
General
Anthracite Capital, Inc., a Maryland corporation, and subsidiaries
(collectively, the "Company") is a specialty finance company that invests in
commercial real estate assets on a global basis. The Company seeks to generate
income from the spread between the interest income, gains and net operating
income on its commercial real estate assets and the interest expense from
borrowings to finance its investments. The Company's primary activities are
investing in high yielding commercial real estate debt and equity. The Company
combines traditional real estate underwriting and capital markets expertise to
maximize the opportunities arising from the continuing integration of these two
disciplines. The Company focuses on acquiring pools of performing loans in the
form of commercial mortgage-backed securities ("CMBS"), issuing secured debt
backed by CMBS and providing strategic capital for the commercial real estate
industry in the form of mezzanine loan financing. The Company also began
investing in diversified portfolios of commercial real estate in the United
States during December 2005. The Company commenced operations on March 24, 1998.
The Company's primary investment activities are conducted in three investment
sectors:
1) Commercial Real Estate Securities
2) Commercial Real Estate Loans
3) Commercial Real Estate Equity
The commercial real estate securities portfolio provides diversification and
high yields that are adjusted for anticipated losses over a period of time
(typically, a ten-year weighted average life) and can be financed through the
issuance of secured debt that matches the life of the investment. Commercial
real estate loans and equity provide attractive risk adjusted returns over
shorter periods of time through strategic investments in specific property types
or regions.
The Company's common stock, par value $0.001 per share ("Common Stock"), is
traded on the New York Stock Exchange under the symbol "AHR". The Company's
primary long-term objective is to distribute dividends supported by earnings.
The Company establishes its dividend by analyzing the long-term sustainability
of earnings given existing market conditions and the current composition of its
portfolio. This includes an analysis of the Company's credit loss assumptions,
general level of interest rates and projected hedging costs.
The Company is managed by BlackRock Financial Management, Inc. (the "Manager"),
a subsidiary of BlackRock, Inc., a publicly traded (NYSE:BLK) asset management
company with $1.125 trillion of assets under management at December 31, 2006.
The Manager provides an operating platform that incorporates significant asset
origination, risk management, and operational capabilities.
4
COMMERCIAL REAL ESTATE SECURITIES
The following table indicates the amounts of each category of commercial real
estate securities the Company owned at December 31, 2006. The dollar price
("Dollar Price") represents the estimated fair value or adjusted purchase price
of a security, respectively, relative to its par value.
Estimated Adjusted Loss
Commercial Real Estate Fair Dollar Purchase Dollar Adjusted
Securities Par Value Price Price* Price Yield
---------------------- ---------- ---------- ------- ---------- ------ --------
Controlling Class CMBS $ 909,977 $ 587,008 $ 64.51 $ 541,571 $59.64 10.25%
Other Below Investment
Grade CMBS 170,187 196,860 115.67 187,909 94.16 7.68%
Collateralized debt
obligation ("CDO")
investments 406,605 117,246 28.84 114,482 28.16 14.19%
Investment Grade 1,504,479 1,523,633 101.27 1,481,256 97.58 6.20%
Commercial Real
Estate Related
Securities
CMBS interest only
securities ("IOs") 2,980,467 69,352 2.33 69,183 2.32 7.36%
---------- ---------- ------- ---------- ------ -----
5,971,715 2,494,099 41.77 2,394,401 40.10 7.65%
---------- ---------- ------- ---------- ------ -----
* Represents the amortized cost of the Company's investments.
Included in the table above are non-U.S. dollar denominated commercial real
estate securities with a carrying value of $181,597, $37,320, and $4,580 at
December 31, 2006, 2005, and 2004, respectively.
The Company's principal activity is to underwrite and acquire high yield CMBS
that are rated below investment grade (BB+ or lower). The Company's CMBS are
securities backed by pools of loans secured by first mortgages on commercial
real estate throughout the United States and Europe. The commercial real estate
securing the first mortgages consists of income-producing properties including
office buildings, shopping centers, apartment buildings, industrial properties,
healthcare properties, and hotels, among others. The terms of a typical loan
include a fixed rate of interest, thirty-year amortization, some form of
prepayment protection, and a large interest rate increase if not paid off at the
ten-year maturity. The loans are originated by various lenders and pooled
together in trusts which issue securities in the form of various classes of
fixed rate debt secured by the cash flows from the underlying loans. The
securities issued by the trusts are rated by one or more nationally recognized
credit rating organizations and are rated AAA down to CCC. The security that is
affected first by loan losses is not rated. The principal amount of the pools of
loans securing the CMBS securities varies.
The Company focuses on acquiring the securities rated below investment grade.
The most subordinated CMBS classes are the first to absorb realized losses in
the loan pools. To the extent there are losses in excess of the most
subordinated class' stated entitlement to principal and interest, then the
remaining CMBS classes will bear such losses in order of their relative
subordination. If a loss of face value, or par, is experienced in the underlying
loans, a corresponding reduction in the par of the lowest rated security occurs,
reducing the cash flow entitlement. The majority owner of the first loss
position has the right to influence the workout process and therefore designate
the trust's special servicer. The Company will generally seek to influence the
workout process in each of its CMBS transactions by purchasing the majority of
the trust's non-rated securities and sequentially rated securities as high as
BB+. Typically, the par amount of these below investment grade classes
represents 2.0-3.5% of the par of the underlying loan pools. This is known as
the subordination level because 2.0% - 3.5% of the collateral balance is
subordinated to the senior, investment grade rated securities.
5
Owning commercial real estate loans in these forms allows the Company to earn
its loss-adjusted returns over a period of time while achieving significant
diversification across geographic areas and property types.
Controlling Class CMBS
At December 31, 2006, the Company owned 29 trusts ("Controlling Class") in which
the Company through its investment in subordinated CMBS of such trusts is in the
first loss position. As a result of this investment position, the Company
influences the workout process on $42,398,701 of underlying loans. The total par
amount owned of these subordinated Controlling Class securities is $909,977. The
Company does not own the senior securities that represent the remaining par
amount of the underlying mortgage loans.
Each trust has a designated special servicer. Special servicers are responsible
for carrying out loan loss mitigation strategies. In addition, a special
servicer will advance funds to a trust to maintain principal and interest cash
flows on the trust's securities provided it believes there is a significant
probability of recovering those advances from the underlying borrowers. The
special servicer is paid interest on advanced funds and a fee for its efforts in
carrying out loss mitigation strategies. The special servicer on 25 of the
Company's 29 Controlling Class trusts is Midland Loan Services, Inc., the
special servicer on two such trusts is GMAC Commercial Mortgage Management,
Inc., and the special servicer on the remaining two such trusts is Lennar
Partners, Inc. Midland Loan Services, Inc. is a related party of the Manager.
Prior to acquiring Controlling Class securities, the Company performs a
significant amount of due diligence on the underlying loans to ensure their risk
profiles meet the Company's criteria. Loans that do not meet the Company's
criteria are either removed from the pool or price adjustments occur. The debt
service coverage and loan to value ratios are evaluated to determine if they are
appropriate for each asset class.
As part of its underwriting process, the Company assumes a certain amount of
loans will incur losses over time. In performing continuing credit reviews on
the 29 Controlling Class trusts, the Company estimates that specific losses
totaling $512,916 related to principal of the underlying loans will not be
recoverable, of which $215,816 is expected to occur over the next five years.
The total loss estimate of $512,916 represents 1.21% of the total underlying
loan pools. Due to falling delinquency rates in the CMBS market, the Company no
longer assumes an additional layer of unassigned losses. Previously, the Company
assumed ten to forty basis points of additional defaults would occur with a 35%
loss severity and a one-year recovery period. The effect of this change is to
reduce total losses assumed by 15 to 62 basis points, depending on the deal.
The weighted average loss adjusted yield for all subordinated Controlling Class
securities at December 31, 2006 was 10.25%. If the loss assumptions prove to be
consistent with actual loss experience, the Company will maintain that level of
income for the life of the security. As actual losses differ from the original
loss assumptions, yields are adjusted to reflect the updated assumptions. In
addition, a write-down of the adjusted purchase price or write-up of loss
adjusted yields of the security may be required. (See Item 7A -"Quantitative and
Qualitative Disclosures About Market Risk" for more information on the
sensitivity of the Company's income and adjusted purchase price to changes in
credit experience.)
Once acquired, the Company uses a performance monitoring system to track the
credit experience of the mortgages in the pools securing both the Controlling
Class and the other below investment grade CMBS. The Company receives remittance
reports monthly from the trustees and monitors any
6
delinquent loans or other issues that may affect the performance of the loans.
The special servicer of a loan pool also assists in this process. The Company
reviews its loss assumptions every quarter using updated payment and debt
service coverage information on each loan in the context of economic trends on
both a national and regional level.
The Company's anticipated yields on its investments are based upon a number of
assumptions that are subject to certain business and economic uncertainties and
contingencies. Examples of such contingencies include, among other things, the
timing and severity of expected credit losses, the rate and timing of principal
payments (including prepayments, repurchases, defaults, liquidations, special
servicer fees, and other related expenses), the pass-through or coupon rate, and
interest rate fluctuations. Additional factors that may affect the Company's
anticipated yields on its Controlling Class CMBS include interest payment
shortfalls due to delinquencies on the underlying mortgage loans, the timing and
magnitude of credit losses on the mortgage loans underlying the Controlling
Class CMBS that are a result of the general condition of the real estate market
(including competition for tenants and their related credit quality), and
changes in market rental rates. As these uncertainties and contingencies are
difficult to predict and are subject to future events which may alter these
assumptions, no assurance can be given that the Company's anticipated yields to
maturity will be maintained.
Other Below Investment Grade CMBS
The Company does not typically purchase a BB- or lower rated security unless the
Company is involved in the new issue due diligence process and has a clear
pari-passu alignment of interest with the special servicer, or can appoint the
special servicer. The Company purchases BB+ and BB rated securities at their
original issue or in the secondary market without necessarily having influence
over the workout process. BB+ and BB rated CMBS do not absorb losses until the
BB- and lower rated securities have experienced losses of their entire principal
amounts. The Company believes the subordination levels of these securities
provide additional credit protection and diversification with an attractive risk
return profile.
CDOs
The Company issues secured term debt through its CDO offerings. This entails
creating a special purpose entity that holds assets used to secure the payments
required of the debt issued. For those that qualify as a sale under Statement of
Financial Accounting Standards ("SFAS") No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS No.
140"), the Company records the transaction as a sale and carries any retained
bonds as a component of securities available-for-sale on its consolidated
statement of financial condition. At December 31, 2006 and 2005, respectively,
the Company had retained bonds with an estimated fair value of $114,142 and
$121,159 on its consolidated statement of financial condition related to CDO HY1
and CDO HY2. The Company also owns preferred securities in LEAFs CMBS I Ltd
("Leaf"). Leaf issued non-recourse liabilities secured by investment grade
commercial real estate securities. At December 31, 2006 and 2005, respectively,
Leaf preferred securities were carried at an estimated fair value of $3,104 and
$3,391 on the Company's consolidated statement of financial condition.
Investment Grade Commercial Real Estate Related Securities
The Company also purchases investment grade commercial real estate related
securities in the form of CMBS and unsecured debt of commercial real estate
companies. The addition of these higher rated securities is intended to add
greater stability to the long-term performance of the Company's portfolio as a
whole and to provide greater diversification to optimize secured financing
alternatives. The Company seeks to assemble a portfolio of high quality issues
that will maintain consistent performance over the
7
life of the security.
CMBS IOs
The Company also acquires CMBS IOs. These securities represent a portion of the
interest coupons paid by the underlying loans. The Company views this portfolio
as possessing attractive relative value versus other alternatives. These
securities do not have significant prepayment risk because the underlying loans
generally have prepayment restrictions. Furthermore, the credit risk is also
mitigated because the IO represents a portion of all underlying loans, not
solely the first loss.
COMMERCIAL REAL ESTATE LOANS
The following table summarizes the Company's commercial real estate loan
portfolio by property type at December 31, 2006, 2005, and 2004:
Loans Outstanding Weighted
December 31, 2006 December 31, 2005 December 31, 2004 Average Yield
----------------- ----------------- ----------------- ------------------
Property Type Amount % Amount % Amount % 2006 2005 2004
------------- -------- ------ -------- ------ -------- ------ ---- ---- ----
Office $130,016 27.0% $ 94,432 25.8% $ 88,311 33.5% 8.2% 8.9% 9.2%
Residential 57,917 12.0 57,466 15.7 13,480 5.1 10.7 8.6 12.2
Retail 194,938 40.5 76,502 20.9 59,070 22.4 7.7 7.3 6.6
Hotel 38,899 8.1 79,840 21.8 102,645 39.0 10.0 8.6 7.2
Storage 34,009 7.1 32,913 9.0 -- -- 9.0 9.1 --
Communication Tower -- -- 20,000 5.5 -- -- -- 9.4 --
Industrial 19,317 4.0 2,423 0.7 -- -- 9.1 8.1 --
Other Mixed Use 6,649 1.3 2,230 0.6 -- -- 8.7 8.1 --
-------- ----- -------- ----- -------- ----- ---- --- ----
Total $481,745 100.0% $365,806 100.0% $263,506 100.0% 8.6% 8.5% 8.0%
======== ===== ======== ===== ======== ===== ==== === ====
Included in the table above are non-U.S. dollar denominated commercial real
estate loans with a carrying value of $243,377, $129,951, and $21,119 at
December 31, 2006, 2005, and 2004, respectively. The Company finances its
non-U.S. dollar denominated loans by borrowing in the applicable local currency
and hedging the un-financed portion.
The Company's loan activity is focused on providing mezzanine capital to the
commercial real estate industry. The Company targets real estate operators with
strong track records and compelling business plans designed to enhance the value
of their real estate. These loans generally are subordinated to a senior lender
or first mortgage and are priced to reflect a higher return. The Company has
significant experience in closing large, complex loan transactions and believes
it can deliver a timely and competitive financing package.
The types of investments in this class include subordinated participations in
first mortgages, loans secured by partnership interests, preferred equity
interests in real estate limited partnerships and loans secured by second
mortgages. The weighted average life of these investments is generally two to
three years and the investments have fixed or floating rate coupons.
The Company performs significant due diligence before making investments to
evaluate risks and opportunities in this sector. The Company generally focuses
on strong sponsorship, attractive real estate fundamentals, and pricing and
structural characteristics that provide significant influence over the
underlying asset.
The Company's activity in this sector generally has been conducted through
Carbon Capital, Inc. ("Carbon I") and Carbon Capital II, Inc. ("Carbon II", and
collectively with Carbon I, the "Carbon
8
Capital Funds"), private commercial real estate income funds managed by the
Company's Manager. The Company believes the use of the Carbon Capital Funds
allows it to invest in larger institutional quality assets with greater
diversification. The Company's consolidated financial statements include its
share of the net assets and income of the Carbon Capital Funds. At December 31,
2006, the Company owned approximately 20% of Carbon I as well as approximately
26% of Carbon II. The Company's investments in the Carbon Capital Funds at
December 31, 2006 were $72,403, compared with $59,646 at December 31, 2005.
The following table summarizes the loans held by the Carbon Capital Funds at
December 31, 2006, 2005 and 2004.
Loans Outstanding Weighted
December 31, 2006 December 31, 2005 December 31, 2004 Average Yield
----------------- ----------------- ----------------- ------------------
Property Type Amount % Amount % Amount % 2006 2005 2004
------------- -------- ------ -------- ------ -------- ------ ---- ---- ----
Office $162,759 23.1% $128,802 23.0% $135,487 26.1% 10.5% 10.1% 16.3%
Residential 138,713 19.7 192,604 34.3 164,096 31.6 12.3 10.3 10.4
Retail 73,184 10.4 57,791 10.3 101,166 19.5 9.7 13.2 13.6
Hotel 241,086 34.2 146,710 26.1 73,249 14.1 12.1 12.8 11.6
Storage -- -- 10,171 1.8 10,171 2.0 -- 16.4 16.0
Land 53,500 7.6 25,000 4.5 -- -- 12.6 15.2 --
Other Mixed Use 35,384 5.0 -- -- 34,739 6.7 8.8 -- 8.9
-------- ----- -------- ----- -------- ----- ---- ---- ----
Total $704,626 100.0% $561,078 100.0% $518,908 100.0% 11.4% 11.5% 12.7%
======== ===== ======== ===== ======== ===== ==== ==== ====
COMMERCIAL REAL ESTATE EQUITY
At December 31, 2006, the Company had invested an aggregate of $92,603 in
BlackRock Diamond Property Fund, Inc. ("BlackRock Diamond"). BlackRock Diamond
is a private real estate investment trust ("REIT") managed by BlackRock Realty
Advisors, Inc., a subsidiary of the Company's Manager. BlackRock Diamond's
investment objective is to seek a high risk adjusted return through "value
-added" capital appreciation and current income on properties through out the
United States. This means the BlackRock Diamond's focuses on operating
properties that will be repositioned, renovated, or expanded to achieve maximum
returns. Part of the investment strategy includes a budgeted amount of capital
expenditures that are used to improve the value of the investment and realize
the full value potential of a given property. BlackRock Diamond relies on the
Manager's extensive relationships in the real estate markets to source
opportunities. BlackRock Diamond focuses on large urban
locations where it believes the real estate equity markets will outperform.
BlackRock Diamond is an open-end fund. As such, it allows shares to be redeemed
at a price equal to its quarter-end net asset value upon 60 days notice. The
assets are subject to quarterly appraisals with one independent appraisal done
annually. The Company does not pay a separate management fee to the Manager for
management services associated with its investment in BlackRock Diamond.
The Company had a 21% ownership in BlackRock Diamond at December 31, 2006 and
recorded $15,763 of income during 2006 with respect to this investment under the
equity method. At December 31, 2006, the Company had $7,397 of remaining capital
commitments to BlackRock Diamond, all of which was called in January 2007.
FINANCING AND LEVERAGE
The Company has financed its assets with the net proceeds of common stock
offerings, the issuance of common stock under the Company's Dividend
Reinvestment and Stock Purchase Plan (the "Dividend Reinvestment Plan"), the
issuance of preferred stock, long-term secured and unsecured borrowings,
9
short-term borrowings under reverse repurchase agreements and the credit
facilities discussed below. In the future, operations may be financed by
offerings of equity securities, as well as unsecured and secured borrowings. The
Company expects that, in general, it will employ leverage consistent with the
type of assets acquired and the desired level of risk in various investment
environments. The Company's governing documents do not explicitly limit the
amount of leverage that the Company may employ. Instead, the Board of Directors
has adopted an indebtedness policy for the Company that limits its recourse debt
to equity ratio to a maximum of 3.0 to 1. The Company's recourse debt-to-equity
ratio of 1.7 to 1 at December 31, 2006 was in compliance with the policy. The
Company anticipates that it will maintain recourse debt-to-equity ratios between
1.0 to 1 and 3.0 to 1 in the foreseeable future, although this ratio may be
higher or lower at any time. The Board of Directors may change the Company's
indebtedness policy at any time.
REVERSE REPURCHASE AGREEMENTS AND CREDIT FACILITIES
The Company has entered into reverse repurchase agreements to finance its
securities that are not financed under its credit facilities or CDOs. The
reverse repurchase agreements collateralized by most of these securities bear
interest at rates that historically have moved in close relationship to the
London Interbank Offered Rate for U.S. dollar deposits ("LIBOR").
The Company's credit facilities can be used to replace existing reverse
repurchase agreement borrowings and to finance the acquisition of
mortgage-backed securities and commercial real estate loans. Outstanding
borrowings bear interest at a variable rate. The following table summarizes the
Company's credit facilities at December 31, 2006 and 2005:
December 31, 2006 December 31, 2005
--------------------------------- ---------------------------------
Unused Unused
Maturity Facility Total Borrowing Facility Total Borrowing
Date Amount Borrowings Capacity Amount Borrowings Capacity
-------- --------------------------------- ---------------------------------
Greenwich Capital, Inc. (1) 7/7/07 $ 75,000* $12,064 $ --* $ 75,000 $ 75,000 $ --
Deutsche Bank, AG (2) 12/20/07 200,000 49,398 150,602 200,000 181,875 18,125
Bank of America, N.A.(3) 9/17/08 100,000 -- 100,000 n/a n/a n/a
Morgan Stanley Bank (3) (4) 2/16/08 200,000 13,985 186,015 27,800 27,800 --
-------- ------- -------- -------- -------- -------
$575,000 $75,447 $436,617 $302,800 $284,675 $18,125
======== ======= ======== ======== ======== =======
* Commitment expired December 23, 2006. No new borrowings permitted.
(1) USD only
(2) Multicurrency
(3) Non-USD only
(4) Can be increased up to $15,000 based on the change in exchange rates of the
non-US dollar loans. However, any amounts drawn under this provision must
be repaid in ninety days.
The Company is subject to various covenants in its credit facilities, including
maintaining a minimum net worth measured on a book value of $305,000 in
accordance with generally accepted accounting principles in the United States of
America ("GAAP"), a maximum recourse debt-to-equity of 3.0 to 1, a minimum cash
requirement based upon certain debt-to-equity ratios. During the first quarter
of 2007, the Company amended the debt service coverage ratio covenant on its
committed debt facilities. The terms of the calculation were revised and the
debt service coverage ratio was reduced from 1.75 to 1.20. The revised
calculation better reflects the Company's ability to service debt on a cash
basis. At December 31, 2006 and 2005, the Company was in compliance with all
other covenants.
10
Under the credit facilities and the reverse repurchase agreements, the
respective lenders retain the right to mark the underlying collateral to
estimated fair value. A reduction in the value of pledged assets could require
the Company to provide additional collateral or fund cash margin calls. From
time to time, the Company may be required to provide additional collateral or
fund margin calls. The Company maintains adequate liquidity to meet such calls.
Further information with respect to the Company's reverse repurchase agreements,
credit facilities, and commercial mortgage loan pools at December 31, 2006 is
summarized as follows:
Reverse Commercial
Repurchase Credit Mortgage
Agreements Facilities Loan Pools
---------- ---------- -----------
Commercial Real Estate Securities
Outstanding Borrowings $527,316 $ 48,105 $ --
Weighted average borrowing rate 5.38% 6.91% --
Weighted average remaining maturity 79 days 243 days --
Estimated fair value of assets pledged $570,864 $ 69,462* $ --
Residential Mortgage-Backed Securities
Outstanding Borrowings $266,731 $ -- $ --
Weighted average borrowing rate 5.34% -- --
Weighted average remaining maturity 79 days -- --
Estimated fair value of assets pledged $275,729 $ -- $ --
Commercial Mortgage Loan Pools
Outstanding Borrowings $ 5,623 $ 772 $ 1,250,503
Weighted average borrowing rate 6.06% 6.60% 3.99%
Weighted average remaining maturity 8 days 29 days 5.84 years
Estimated fair value of assets pledged $ 7,481 $ 1,209 $ 1,271,014
Commercial Real Estate Loans
Outstanding Borrowings -- $ 26,570 --
Weighted average borrowing rate -- 6.34% --
Weighted average remaining maturity -- 245 days --
Estimated fair value of assets pledged -- $ 41,748 --
* $21,742 of assets pledged are retained CDO bonds.
11
Further information with respect to the Company's reverse repurchase agreements,
credit facilities, and commercial mortgage loan pools at December 31, 2005 is
summarized as follows:
Commercial
Reverse Mortgage
Repurchase Credit Loan
Agreements Facilities Pools
---------- ----------- -----------
Commercial Real Estate Securities
Outstanding Borrowings $562,315 $ 54,347 $ --
Weighted average borrowing rate 4.53% 5.18% --
Weighted average remaining maturity 28 days 1.97 years --
Estimated fair value of assets pledged $631,795 $ 77,510* $ --
Residential Mortgage-Backed Securities
Outstanding Borrowings $249,122 $ -- $ --
Weighted average borrowing rate 4.34% -- --
Weighted average remaining maturity 24 days -- --
Estimated fair value of assets pledged $258,770 $ -- $ --
Commercial Mortgage Loan Pools
Outstanding Borrowings $ 5,205 $ 772 $ 1,272,931
Weighted average borrowing rate 5.03% 5.80% 3.97%
Weighted average remaining maturity 17 days 1.53 years 6.89 years
Estimated fair value of assets pledged $ 7,321 $ 1,285 $ 1,292,407
Commercial Real Estate Loans
Outstanding Borrowings $ -- $ 229,556 $ --
Weighted average borrowing rate -- 5.29% --
Weighted average remaining maturity -- 1.61 years --
Estimated fair value of assets pledged $ -- $ 337,447 $ --
* $23,233 of assets pledged are retained CDO bonds.
CDOS
The Company finances the majority of its commercial real estate assets with
match funded, secured term debt through CDO offerings. To accomplish this, the
Company forms a special purpose entity ("SPE") and contributes a portfolio
consisting of below investment grade CMBS, investment grade CMBS, unsecured debt
of commercial real estate companies and commercial real estate loans in exchange
for the preferred equity interest in the SPE. With the exceptions of the
Company's fourth and fifth CDOs ("CDO HY1" and "CDO HY2", respectively), these
transactions are considered financings and the SPEs are fully consolidated on
the Company's consolidated financial statements. The SPE then will issue fixed
and floating rate debt secured by the cash flows of the securities in its
portfolio. The SPE will enter into an interest rate swap agreement to convert
the floating rate debt issued to a fixed interest rate, thus matching the cash
flow profile of the underlying portfolio. For those CDOs not denominated in
12
U.S. dollars, the SPE will also enter into currency swap agreements to minimize
any currency exposure. The structure of the CDO debt also eliminates the mark to
market requirement commonly associated with other types of financing, thus
eliminating the need to provide additional collateral if the value of the
underlying portfolio declines. The debt issued by the SPE generally is rated AAA
down to BB. Due to its preferred equity interest, the Company continues to
manage the credit risk of the underlying portfolio as it did prior to the assets
being contributed to the CDO. CDO debt is the Company's preferred capital
structure to maximize returns on these types of portfolios on a non-recourse
basis. Other forms of financing used for these types of assets include
multi-year committed financing facilities and 90-day reverse repurchase
agreements.
At December 31, 2006, outstanding borrowings under the Company's CDOs were
$1,812,574 with a weighted average borrowing rate of 6.02% and a weighted
average maturity of 7.0 years. Estimated fair value of assets pledged was
$2,096,455, consisting of 80.3% of commercial real estate securities and 19.7%
of commercial real estate loans.
At December 31, 2005, outstanding borrowings under the Company's CDOs were
$1,066,930 with a weighted average borrowing rate of 5.86% and a weighted
average maturity of 10.8 years. Estimated fair value of assets pledged was
$1,227,222 consisting of 100.0% of commercial real estate securities.
UNSECURED BORROWINGS
During October 2006, the Company issued $75,000 of unsecured senior notes due in
2016 with a weighted average cost of funds of 7.21%. The unsecured senior notes
can be redeemed in whole by the Company subject to certain provisions, which
could include the payment of fees.
On September 26, 2005, the Company issued $75,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust I, a Delaware
statutory trust ("Trust I"). The trust preferred securities have a thirty-year
term ending October 30, 2035 with interest at a fixed rate of 7.497% for the
first ten years and at a floating rate of three-month LIBOR plus 2.9%
thereafter. The trust preferred securities can be redeemed at par by the Company
beginning in October 2010. Trust I issued $2,380 aggregate liquidation amount of
common securities, representing 100% of the voting common stock of Trust I to
the Company for a purchase price of $2,380. The Company realized net proceeds
from this offering of approximately $72,618.
On February 2, 2006, the Company issued $50,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust II, a Delaware
statutory trust ("Trust II"). The trust preferred securities have a thirty-year
term ending April 30, 2036 with interest at a fixed rate of 7.73% for the first
ten years and at a floating rate of three-month LIBOR plus 2.7% thereafter. The
trust preferred securities can be redeemed at par by the Company beginning in
April 2011. Trust II issued $1,550 aggregate liquidation amount of common
securities, representing 100% of the voting common stock of Trust II to the
Company for a purchase price of $1,550. The Company realized net proceeds from
this offering of approximately $48,491.
On March 16, 2006, the Company issued $50,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust III, a Delaware
statutory trust ("Trust III"). The trust preferred securities have a thirty-year
term ending March 15, 2036 with interest at a fixed rate of 7.77% for the first
ten years and at a floating rate of three-month LIBOR plus 2.7% thereafter. The
trust preferred securities can be redeemed at par by the Company beginning in
March 2011. Trust III issued $1,547 aggregate liquidation amount of common
securities, representing 100% of the voting common stock of Trust III to the
Company for a purchase price of $1,547. The Company realized net proceeds from
this offering of approximately $48,435.
13
EQUITY ISSUANCES
For the years ended December 31, 2006 and 2005, respectively, the Company issued
608,747 and 1,318,568 shares of Common Stock under its Dividend Reinvestment
Plan. Net proceeds under the Dividend Reinvestment Plan to the Company were
approximately $6,517 and $14,327, respectively. Additionally, the Company issued
1,725,000 shares of Common Stock in a follow-on offering at $11.59 per share in
2005.
For the year ended December 31, 2006, the Company issued 664,900 shares of
Common Stock under a sales agency agreement with Brinson Patrick Securities
Corporation. Net proceeds to the Company were approximately $8,625.
On February 12, 2007, the Company issued $86,250 of Series D Cumulative
Redeemable Preferred Stock ("Series D Preferred Stock"), including $11,250 of
Series D Preferred Stock sold to underwriters pursuant to an over-allotment
option. The Series D Preferred Stock will pay an annual dividend of 8.25%.
HEDGING ACTIVITIES
The Company enters into hedging transactions to protect its investment portfolio
and related borrowings from interest rate fluctuations and other changes in
market conditions. From time to time, the Company may modify its exposure to
market interest rates by entering into various financial instruments that adjust
portfolio duration and short-term rate exposure. These financial instruments are
intended to mitigate the effect of changes in interest rates on the value of the
Company's assets and the cost of borrowing. These transactions may include
interest rate swaps, the purchase or sale of interest rate collars, caps or
floors, options, and other hedging instruments. These instruments may be used to
hedge as much of the interest rate risk as the Manager determines is in the best
interest of the Company's stockholders, given the cost of such hedges. The
Manager may elect to have the Company bear a level of interest rate risk that
could otherwise be hedged when the Manager believes, based on all relevant
facts, that bearing such risk is advisable. The Manager has extensive experience
in hedging mortgages, mortgage-related assets and related borrowings with these
types of instruments.
Hedging instruments often are not traded on regulated exchanges, guaranteed by
an exchange or its clearinghouse, or regulated by any U.S. or foreign
governmental authorities. The Company will enter into these transactions only
with counterparties with long-term debt rated A or better by at least one
nationally recognized credit rating organization. The business failure of a
counterparty with which the Company has entered into a hedging transaction most
likely will result in a default, which may result in the loss of unrealized
profits. Although the Company generally will seek to reserve for itself the
right to terminate its hedging positions, it may not always be possible to
dispose of or close out a hedging position without the consent of the
counterparty, and the Company may not be able to enter into an offsetting
contract in order to cover its risk. There can be no assurance that a liquid
secondary market will exist for hedging instruments purchased or sold, and the
Company may be required to maintain a position until exercise or expiration,
which could result in losses.
The Company's hedging activities are intended to address both income and capital
preservation. Income preservation refers to maintaining a stable spread between
yields from mortgage assets and the Company's borrowing costs across a
reasonable range of adverse interest rate environments. Capital preservation
refers to maintaining a relatively steady level in the estimated fair value of
the Company's capital across a reasonable range of adverse interest rate
scenarios. However, no strategy can insulate the Company completely from changes
in interest rates.
14
Interest rate hedging instruments at December 31, 2006 and 2005 consisted of the
following:
At December 31, 2006
--------------------------------------------------
Average
Notional Estimated Unamortized Remaining
Value Fair Value Cost Term (years)
-------- ---------- ----------- ------------
Cash flow hedges $644,200 $5,048 $ -- 7.91
CDO cash flow hedges 895,499 8,230 -- 7.19
Trading swaps 80,000 2,033 -- 3.27
CDO timing swaps 223,445 212 -- 6.08
CDO LIBOR cap 85,000 (38) 1,407 6.40
At December 31, 2005
--------------------------------------------------
Average
Notional Estimated Unamortized Remaining
Value Fair Value Cost Term (years)
-------- ---------- ----------- ------------
Cash flow hedges $500,350 $ 6,234 $ -- 8.42
CDO cash flow hedges 701,603 10,616 -- 7.51
Trading swaps 133,000 4,032 -- 6.83
CDO timing swaps 223,445 (37) -- 7.08
CDO LIBOR cap 85,000 1,419 1,407 7.40
Foreign currency agreements at December 31, 2006 consisted of the following:
At December 31, 2006
----------------------------------------
Average
Estimated Unamortized Remaining
Fair Value Cost Term
----------- ----------- -----------
Currency swaps $ 1,179 $ -- 12.53 years
CDO currency swaps (1,418) -- 12.53 years
Forwards (2,659) -- 10 days
At December 31, 2005
----------------------------------------
Average
Estimated Unamortized Remaining
Fair Value Cost Term
----------- ----------- -----------
Forwards $ 1,108 -- 10 days
The Company did not have any currency swaps at December 31, 2005.
OPERATING POLICIES
The Company has adopted compliance guidelines, including restrictions on
acquiring, holding, and selling assets, to ensure that the Company meets the
requirements for qualification as a REIT under the United States Internal
Revenue Code of 1986, as amended (the "Code"), and is excluded from regulation
as an investment company under the Investment Company Act of 1940, as amended
(the "Investment Company Act"). Before acquiring any asset, the Manager
determines whether such asset would constitute a "Real Estate Asset" under the
REIT provisions of the Code. The Company regularly monitors purchases of
commercial real estate assets and the income generated from such assets,
including income from its hedging activities, in an effort to ensure that at all
times the Company's assets and income meet the requirements for qualification as
a REIT and exclusion under the Investment Company Act.
15
In order to maintain the Company's REIT status, the Company generally intends to
distribute to its stockholders aggregate dividends equaling at least 90% of its
taxable income each year. The Code permits the Company to fulfill this
distribution requirement by the end of the year following the year in which the
taxable income was earned.
REGULATION
The Company intends to continue to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. Under the
Investment Company Act, a non-exempt entity that is an investment company is
required to register with the SEC and is subject to extensive, restrictive, and
potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends, and transactions with
affiliates. The Investment Company Act exempts entities that are "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate" ("Qualifying Interests"). Under current
interpretation by the staff of the SEC, to qualify for this exemption, the
Company, among other things, must maintain at least 55% of its assets in
Qualifying Interests. Substantially all of the Company's interests in
residential mortgage-backed securities ("RMBS") are Qualifying Interests.
A portion of the CMBS acquired by the Company are collateralized by pools of
first mortgage loans where the Company can monitor the performance of the
underlying mortgage loans through loan management, servicing rights and
workout/foreclosure rights with respect to the underlying mortgage loans. When
such arrangements exist, the Company believes that the related Controlling Class
CMBS constitute Qualifying Interests for purposes of the Investment Company Act.
Therefore, the Company believes that it should not be required to register as an
"investment company" under the Investment Company Act as long as it continues to
invest in a sufficient amount of such Controlling Class CMBS and/or in other
Qualifying Interests.
If the SEC or its staff were to take a different position with respect to
whether the Company's Controlling Class CMBS constitute Qualifying Interests,
the Company could be required to modify its business plan so that either (i) it
would not be required to register as an investment company or (ii) it would
register as an investment company under the Investment Company Act. In such
event, modification of the Company's business plan so that it would not be
required to register as an investment company might entail a disposition of a
significant portion of the Company's Controlling Class CMBS or the acquisition
of significant additional assets, such as agency pass-through and other
mortgage-backed securities, which are Qualifying Interests and modification of
the Company's business plan to register as an investment company could result in
increased operating expenses and could entail reducing the Company's
indebtedness, which also could require it to sell a significant portion of its
assets. No assurances can be given that any such dispositions or acquisitions of
assets, or de-leveraging, could be accomplished on favorable terms.
Consequently, any such modification of the Company's business plan could have a
material adverse effect on the Company. Further, if it were established that the
Company were operating as an unregistered investment company, there would be a
risk that the Company would be subject to monetary penalties and injunctive
relief in an action brought by the SEC, that the Company would be unable to
enforce contracts with third parties, and that third parties could seek to
obtain rescission of transactions undertaken during the period it was
established that the Company was an unregistered investment company. Any such
results would be likely to have a material adverse effect on the Company.
COMPETITION
The Company's net income depends, in large part, on the Company's ability to
acquire commercial real estate assets at favorable spreads over the Company's
borrowing costs. In acquiring commercial real
16
estate assets, the Company competes with other mortgage REITs, specialty finance
companies, savings and loan associations, banks, mortgage bankers, insurance
companies, mutual funds, institutional investors, investment banking firms,
other lenders, governmental bodies, and other entities. In addition, there are
numerous mortgage REITs with asset acquisition objectives similar to the
Company's, 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 commercial real estate assets suitable for purchase by the Company.
Some of the Company's competitors are significantly larger than the Company,
have access to greater capital and other resources, and may have other
advantages over the Company. In addition to existing companies, other companies
may be organized for purposes similar to that of the Company, including
companies organized as REITs focused on purchasing commercial real estate
assets. A proliferation of such companies may increase the competition for
equity capital and thereby adversely affect the market price of the Company's
Common Stock.
EMPLOYEES
The Company does not have any employees. The Company's officers, each of whom is
a full-time employee of the Manager, perform the duties required pursuant to the
Management Agreement (as defined below) with the Manager and the Company's
bylaws.
MANAGEMENT AGREEMENTS
The Company has a Management Agreement, an administrative services agreement and
an accounting services agreement with the Manager, the employer of certain
directors and all of the officers of the Company, under which the Manager and
the Company's officers manage the Company's day-to-day investment operations,
subject to the direction and oversight of the Company's Board of Directors.
Pursuant to the Management Agreement and these other agreements, the Manager and
the Company's officers formulate investment strategies, arrange for the
acquisition of assets, arrange for financing, monitor the performance of the
Company's assets and provide certain other advisory, administrative and
managerial services in connection with the operations of the Company. For
performing certain of these services, the Company pays the Manager under the
Management Agreement a base management fee equal to 2.0% of the quarterly
average total stockholders' equity for the applicable quarter.
To provide an incentive, the Manager is entitled to receive an incentive fee
under the Management Agreement equal to 25% of the amount by which the rolling
four-quarter GAAP net income before the incentive fee exceeds the greater of
8.5% or 400 basis points over the ten-year Treasury note multiplied by the
adjusted per share issue price of the Company's Common Stock ($11.37 per common
share at December 31, 2006). Additionally, up to 30% of the incentive fees
earned in 2005 or after may be paid in shares of the Company's Common Stock
subject to certain provisions under a compensatory deferred stock plan approved
by the stockholders of the Company in 2006. The Board of Directors also
authorized a stock based incentive plan where one-half of one percent of common
shares outstanding was paid to the Manager in 2006.
The Company's unaffiliated directors approved an extension of the Management
Agreement to March 30, 2008 at the Board's March 2007 meeting.
The Manager primarily engages in four investment activities in its capacity as
Manager on behalf of the Company: (i) acquiring and originating commercial real
estate loans and other real estate related assets; (ii) asset/liability and risk
management, hedging of floating rate liabilities, and financing, management and
disposition of assets, including credit and prepayment risk management; (iii)
surveillance and restructuring of real estate loans and (iv) capital management,
structuring, analysis, capital raising, and
17
investor relations activities. At all times, the Manager and the Company's
officers are subject to the direction and oversight of the Company's Board of
Directors.
The Company may terminate, or decline to renew the term of, the Management
Agreement without cause at any time upon 60 days' written notice by a majority
vote of the unaffiliated directors. Although no termination fee is payable in
connection with a termination for cause, in connection with a termination
without cause, the Company must pay the Manager a termination fee, which could
be substantial. The amount of the termination fee will be determined by
independent appraisal of the value of the Management Agreement. Such appraisal
is to be conducted by a nationally-recognized appraisal firm mutually agreed
upon by the Company and the Manager. The other agreements the Company has with
the Manager also may be terminated by the Company; in the case of the
administrative services agreement, at any time upon 60 days' written notice, and
in the case of the accounting services agreement, following the 24 month
anniversary thereof, on 60 days' written notice prior to the 12 month
anniversary thereof, or upon 60 days' written notice following the termination
of the Management Agreement.
In addition, the Company has the right at any time during the term of the
Management Agreement to terminate the Management Agreement without the payment
of any termination fee upon, among other things, a material breach by the
Manager of any provision contained in the Management Agreement that remains
uncured at the end of the applicable cure period.
TAXATION OF THE COMPANY
The Company has elected to be taxed as a REIT under the Code, commencing with
its taxable year ended December 31, 1998, and the Company intends to continue to
operate in a manner consistent with the REIT provisions of the Code. The
Company's qualification as a REIT depends on its ability to meet the various
requirements imposed by the Code, through actual operating results, asset
holdings, distribution levels, and diversity of stock ownership.
Provided the Company continues to qualify for taxation as a REIT, it generally
will not be subject to Federal corporate income tax on its net income that is
currently distributed to stockholders. This treatment substantially eliminates
the "double taxation" (at the corporate and stockholder levels) that generally
results from an investment in a corporation. If the Company fails to qualify as
a REIT in any taxable year, its taxable income would be subject to Federal
income tax at regular corporate rates (including any applicable alternative
minimum tax). Even if the Company qualifies as a REIT, it will be subject to
Federal income and excise taxes on its undistributed income.
If in any taxable year the Company fails to qualify as a REIT and, as a result,
incurs additional tax liability, the Company may need to borrow funds or
liquidate certain investments in order to pay the applicable tax, and the
Company would not be compelled to make distributions under the Code. Unless
entitled to relief under certain statutory provisions, the Company would also be
disqualified from treatment as a REIT for the four taxable years following the
year during which qualification is lost. Although the Company currently intends
to operate in a manner designed to qualify as a REIT, it is possible that future
economic, market, legal, tax, or other considerations may cause the Company to
fail to qualify as a REIT or may cause the Board of Directors to revoke the
Company's REIT election.
The Company and its stockholders may be subject to foreign, state, and local
taxation in various foreign, state, and local jurisdictions, including those in
which it or they transact business or reside. The state and local tax treatment
of the Company and its stockholders may not conform to the Company's Federal
income tax treatment.
18
WEBSITE
The Company's website address is www.anthracitecapital.com. The Company makes
available free of charge through its website its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, all amendments to
those reports and other filings as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC, and also makes
available on its website the charters for the Audit, Compensation and Nominating
and Corporate Governance Committees of the Board of Directors and its Codes of
Business Conduct and Ethics, as well as its corporate governance guidelines.
Copies in print of these documents are available upon request to the Secretary
of the Company at the address indicated on the cover of this report. To
communicate with the Board of Directors electronically, the Company has
established an e-mail address, anthracitebod@blackrock.com, to which
stockholders may send correspondence to the Board of Directors or any such
individual directors or group or committee of directors.
In accordance with New York Stock Exchange ("NYSE") Rules, on June 6, 2006, the
Company filed the annual certification by its Chief Executive Officer certifying
that he was unaware of any violation by the Company of the NYSE's corporate
governance listing standards at the time of the certification.
19
ITEM 1A. RISK FACTORS
RISKS
Risk is an inherent part of investing in high yielding commercial real estate
debt and equity. Risk management is considered to be of paramount importance to
the Company's day-to-day operations. Consequently, the Company devotes
significant resources across all its operations to the identification,
measurement, monitoring, management and analysis of risk.
RISKS RELATED TO THE MANAGER
Conflicts of interest of the Manager may result in decisions that do not
fully reflect stockholders' best interests.
The Company and the Manager have common officers and directors, which may
present conflicts of interest in the Company's dealings with the Manager
and its affiliates, including the Company's purchase of assets originated
by such affiliates.
The Manager and its employees may engage in other business activities that
could reduce the time and effort spent on the management of the Company.
The Manager also provides services to REITs not affiliated with the
Company. As a result, there may be a conflict of interest between the
operations of the Manager and its affiliates in the acquisition and
disposition of commercial real estate assets. In addition, the Manager and
its affiliates may from time to time purchase commercial real estate assets
for their own account and may purchase or sell assets from or to the
Company. For example, BlackRock Realty Advisors, Inc., a subsidiary of the
Manager, provides real estate equity and other real estate related products
and services in a variety of strategies to its institutional investor
client base. In doing so, it purchases real estate on behalf of its clients
that may underlie the real estate loans and securities the Company
acquires, and consequently depending on the factual circumstances involved,
there may be conflicts between the Company and those clients. Such
conflicts may result in decisions and allocations of commercial real estate
assets by the Manager, or decisions by the Manager's affiliates, that are
not in the Company's best interests.
Although the Company has adopted investment guidelines, these guidelines
give the Manager significant discretion in investing. The Company's
investment and operating policies and the strategies that the Manager uses
to implement those policies may be changed at any time without the consent
of stockholders.
The Company is dependent on the Manager, and the termination by the Company
of its Management Agreement with the Manager could result in a termination
fee.
The Company's success is dependent on the Manager's ability to attract and
retain quality personnel. The market for portfolio managers, investment
analysts, financial advisers and other professionals is extremely
competitive. There can be no assurance the Manager will be successful in
its efforts to recruit and retain the required personnel.
The Management Agreement between the Company and the Manager provides for
base management fees payable to the Manager without consideration of the
performance of the Company's portfolio and also provides for incentive fees
based on certain performance criteria, which could result in the Manager
recommending riskier or more speculative investments. Termination of the
Management Agreement between the Company and the Manager by the
20
Company would result in the payment of a substantial termination fee, which
could adversely affect the Company's financial condition. Termination of
the Management Agreement by the Company could also adversely affect the
Company if the Company were unable to find a suitable replacement.
There is a limitation on the liability of the Manager.
Pursuant to the Management Agreement, the Manager will not assume any
responsibility other than to render the services called for under the
Management Agreement and will not be responsible for any action of the
Company's Board of Directors in following or declining to follow its advice
or recommendations. The Manager and its directors and officers will not be
liable to the Company, any of its subsidiaries, its unaffiliated directors,
its stockholders or any subsidiary's stockholders for acts performed in
accordance with and pursuant to the Management Agreement, except by reason
of acts constituting bad faith, willful misconduct, gross negligence or
reckless disregard of their duties under the management agreement. The
Company has agreed to indemnify the Manager and its directors and officers
with respect to all expenses, losses, damages, liabilities, demands,
charges and claims arising from acts of the Manager not constituting bad
faith, willful misconduct, gross negligence or reckless disregard of
duties, performed in good faith in accordance with and pursuant to the
Management Agreement.
RISKS RELATED TO THE COMPANY'S BUSINESS
Interest rate fluctuations will affect the value of the Company's
commercial real estate assets, net income and common stock.
Interest rates are highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international economic and
political considerations and other factors. Interest rate fluctuations can
adversely affect the income and value of the Company's common stock in many
ways and present a variety of risks, including the risk of a mismatch
between asset yields and borrowing rates, variances in the yield curve,
changing prepayment rates and margin calls.
The Company's operating results depend in large part on differences between
the income from its assets (net of credit losses) and borrowing costs. The
Company funds a substantial portion of its assets with borrowings that have
interest rates that reset relatively rapidly, such as monthly or quarterly.
The Company anticipates that, in most cases, the income from its
floating-rate assets will respond more slowly to interest rate fluctuations
than the cost of borrowings, creating a potential mismatch between asset
yields and borrowing rates. Consequently, changes in interest rates,
particularly short-term interest rates, may influence the Company's net
income. Increases in these rates tend to decrease the Company's net income
and estimated fair value of the Company's net assets. Interest rate
fluctuations that result in the Company's interest expense exceeding
interest income would result in the Company incurring operating losses.
The Company also invests in fixed-rate mortgage-backed securities. In a
period of rising interest rates, the Company's interest payments could
increase while the interest the Company earns on its fixed-rate
mortgage-backed securities would not change. This would adversely affect
the Company's profitability.
The relationship between short-term and long-term interest rates often is
referred to as the "yield curve." Ordinarily, short-term interest rates are
lower than long-term interest rates. If short-term
21
interest rates rise disproportionately relative to long-term interest rates
(a flattening of the yield curve), the Company's borrowing costs may
increase more rapidly than the interest income earned on the Company's
assets. Because the Company's borrowings primarily will bear interest at
short-term rates and the Company's assets primarily will bear interest at
medium-term to long-term rates, a flattening of the yield curve tends to
decrease the Company's net income and estimated fair value of the Company's
net assets. Additionally, to the extent cash flows from long-term assets
that return scheduled and unscheduled principal are reinvested, the spread
between the yields of the new assets and available borrowing rates may
decline and also may tend to decrease the net income and estimated fair
value of the Company's net assets. It is also possible that short-term
interest rates may adjust relative to long-term interest rates such that
the level of short-term rates exceeds the level of long-term rates (a yield
curve inversion). In this case, the Company's borrowing costs may exceed
the Company's interest income and operating losses could be incurred.
A portion of the Company's commercial real estate assets are financed under
90-day repurchase agreements and committed borrowing facilities which are
subject to mark-to-market risk. Such secured financing arrangements provide
for an advance rate based upon a percentage of the estimated fair value of
the asset being financed. Market movements that cause asset values to
decline would require a margin call or a cash payment to maintain the
relationship between asset value and amount borrowed.
The Company's investments may be subject to impairment charges.
The Company periodically evaluates its investments for impairment
indicators. The judgment regarding the existence of impairment indicators
is based on a variety of factors depending on the nature of the investment
and the manner in which the income related to such investment is calculated
for purposes of the Company's financial statements. If the Company
determines that a significant impairment has occurred, the Company would be
required to make an adjustment to the net carrying value of the investment,
which could adversely affect the Company's results of operations in the
applicable period.
Interest rate caps on the Company's RMBS may adversely affect the Company's
profitability.
The Company's adjustable-rate RMBS typically are subject to periodic and
lifetime interest rate caps. Periodic interest rate caps limit the amount
an interest rate can increase during any given period. Lifetime interest
rate caps limit the amount an interest rate can increase through maturity
of a mortgage-backed security. The Company's borrowings are not subject to
similar restrictions. Accordingly, in a period of rapidly increasing
interest rates, the Company could experience a decrease in net income or a
net loss because the interest rates on its borrowings could increase
without limitation while the interest rates on its adjustable-rate
mortgage-backed securities would be limited by caps.
The Company's assets include subordinated CMBS which are subordinate in
right of payment to more senior securities.
The Company's assets include a significant amount of subordinated CMBS,
which are the most subordinate class of securities in a structure of
securities secured by a pool of loans and accordingly are the first to bear
the loss upon a restructuring or liquidation of the underlying collateral
and the last to receive payment of interest and principal. The Company may
not recover the full amount or, in extreme cases, any of its initial
investment in such subordinated interests. Additionally, estimated fair
values of these subordinated interests tend to be more
22
sensitive to changes in economic conditions than more senior interests. As
a result, such subordinated interests generally are not actively traded and
may not provide holders thereof with liquidity of investment.
The Company's assets include mezzanine loans which have greater risks of
loss than more senior loans.
The Company's assets include a significant amount of mezzanine loans that
involve a higher degree of risk than long-term senior mortgage loans. In
particular, a foreclosure by the holder of the senior loan could result in
the mezzanine loan becoming unsecured. Accordingly, the Company may not
recover some or all of its investment in such a mezzanine loan.
Additionally, the Company may permit higher loan to value ratios on
mezzanine loans than it would on conventional mortgage loans when the
Company is entitled to share in the appreciation in value of the property
securing the loan.
Prepayment rates can increase which would adversely affect yields on the
Company's investments.
The yield on investments in mortgage loans and mortgage-backed securities
and thus the value of the Company's common stock is sensitive to changes in
prevailing interest rates and changes in prepayment rates, which results in
a divergence between the Company's borrowing rates and asset yields,
consequently reducing future income derived from the Company's investments.
The Company's ownership of non-investment grade commercial real estate
assets subjects the Company to an increased risk of loss which could
adversely affect yields on the Company's investments.
The Company acquires commercial real estate loans and non-investment grade
mortgage-backed securities, which are subject to greater risk of credit
loss on principal and non-payment of interest in contrast to investments in
senior investment grade securities.
The Company's commercial real estate assets are subject to certain risks.
The Company acquires, accumulates and securitizes commercial real estate
assets as part of its investment strategy. While exposed to such commercial
real estate assets, either as collateral for a real estate security or
directly, the Company is subject to risks of borrower defaults,
bankruptcies, fraud and special hazard losses that are not covered by
standard hazard insurance. Insurance on owned real estate, commercial
mortgage loans and real estate securities collateral may not cover all
losses.
The Company's commercial mortgage loans are subject to certain risks.
The costs of financing and hedging the commercial mortgage loans can exceed
the interest income on the commercial mortgage loans. In the event of any
default under commercial mortgage loans held by the Company, the Company
will bear the risk of loss of principal to the extent of any deficiency
between the value of the commercial mortgage collateral and the principal
amount of the commercial mortgage loan. In addition, delinquency and loss
ratios on the Company's commercial mortgage loans are affected by the
performance of third-party servicers and special servicers.
23
The Company invests in multifamily and commercial loans which involve a
greater risk of loss than single family loans.
The Company's investments include multifamily and commercial real estate
loans which are considered to involve a higher degree of risk than single
family residential lending because of a variety of factors, including
generally larger loan balances, dependency for repayment on successful
operation of the mortgaged property and tenant businesses operating
therein, and loan terms that include amortization schedules longer than the
stated maturity which provide for balloon payments at stated maturity
rather than periodic principal payments. In addition, the value of
multifamily and commercial real estate can be affected significantly by the
supply and demand in the market for that type of property.
Limited recourse loans limit the Company's recovery to the value of the
mortgaged property.
A substantial portion of the commercial mortgage loans the Company acquires
may contain limitations on the mortgagee's recourse against the borrower.
In other cases, the mortgagee's recourse against the borrower is limited by
applicable provisions of the laws of the jurisdictions in which the
mortgaged properties are located or by the mortgagee's selection of
remedies and the impact of those laws on that selection. In those cases, in
the event of a borrower default, recourse may be limited to only the
specific mortgaged property and other assets, if any, pledged to secure the
relevant commercial mortgage loan. As to those commercial mortgage loans
that provide for recourse against the borrower and their assets generally,
such recourse may not provide a recovery in respect of a defaulted
commercial mortgage loan equal to the liquidation value of the mortgaged
property securing that commercial mortgage loan.
The volatility of certain mortgaged property values may adversely affect
the Company's commercial mortgage loans.
Commercial and multifamily property values and net operating income derived
therefrom are subject to volatility and may be affected adversely by a
number of factors, including, but not limited to, national, regional and
local economic conditions (which may be adversely affected by plant
closings, industry slowdowns and other factors); local real estate
conditions (such as an oversupply of housing, retail, industrial, office or
other commercial space); changes or continued weakness in specific industry
segments; perceptions by prospective tenants, retailers and shoppers of the
safety, convenience, services and attractiveness of the property; the
willingness and ability of the property's owner to provide capable
management and adequate maintenance; construction quality, age and design;
demographic factors; retroactive changes to building or similar codes; and
increases in operating expenses (such as energy costs).
Leveraging the Company's investments may increase the Company's exposure to
loss.
The Company leverages its investments and thereby increases the volatility
of its income and net asset value that may result in operating or capital
losses. If borrowing costs increase, or if the cash flow generated by the
Company's assets decreases, the Company's use of leverage will increase the
likelihood that the Company will experience reduced or negative cash flow
and reduced liquidity.
The Company's investments may be illiquid and their value may decrease.
Many of the Company's assets are relatively illiquid. In addition, certain
of the mortgage-backed securities that the Company has acquired or will
acquire will include interests that have not been
24
registered under the relevant securities laws, resulting in a prohibition
against transfer, sale, pledge or other disposition of those
mortgage-backed securities except in a transaction that is exempt from the
registration requirements of, or otherwise in accordance with, those laws.
The Company's ability to vary its portfolio in response to changes in
economic and other conditions may be relatively limited. The estimated fair
value of any of the Company's assets could decrease in the future.
The Company's hedging transactions can limit the Company's gains and
increase the Company's exposure to losses.
The Company uses hedging strategies that involve risk and that may not be
successful in insulating the Company from exposure to changing interest and
prepayment rates. A liquid secondary market may not exist for hedging
instruments purchased or sold, and the Company may be required to maintain
a position until exercise or expiration, which could result in losses.
The Company's non-U.S. investments are subject to currency rate exposure
and the uncertainty of foreign laws and markets which could adversely
affect the Company's income.
Failure to maintain REIT status would have adverse tax consequences.
To continue to qualify as a REIT, the Company must comply with requirements
regarding the nature of its assets and its sources of income. If the
Company is compelled to liquidate its mortgage-backed securities, the
Company may be unable to comply with these requirements, ultimately
jeopardizing its status as a REIT.
If in any taxable year the Company fails to qualify as a REIT:
- the Company would be subject to Federal and state income tax on
its taxable income at regular corporate rates;
- the Company would not be allowed to deduct distributions to
stockholders in computing its taxable income; and
- unless the Company were entitled to relief under the Code, the
Company also would be disqualified from treatment as a REIT for
the four taxable years following the year during which the
Company lost qualification.
If the Company fails to qualify as a REIT, the Company might need to borrow
funds or liquidate some investments in order to pay the additional tax
liability. Accordingly, funds available for investment or distribution to
the Company's stockholders would be reduced for each of the years involved.
Qualification as a REIT involves the application of highly technical and
complex provisions of the Code to the Company's operations and the
determination of various factual matters and circumstances not entirely
within the Company's control. There are only limited judicial or
administrative interpretations of these provisions. Although the Company
operates in a manner consistent with the REIT qualification rules, the
Company may not remain so qualified.
In addition, the rules dealing with Federal income taxation are constantly
under review by persons involved in the legislative process and by the
Internal Revenue Service and the United States Department of the Treasury.
Changes to the tax law could adversely affect the Company's stockholders.
25
Increased competition in the marketplace may adversely affect the Company's
ability to acquire assets.
Because of increased competition in the marketplace, the Company may not be
able to acquire mortgage-backed securities at favorable yields.
Failure to maintain an exemption from the Investment Company Act would
restrict the Company's operating flexibility.
The Company conducts its business so as not to become regulated as an
investment company under the Investment Company Act. Accordingly, the
Company does not expect to be subject to the restrictive provisions of the
Investment Company Act. Failure to maintain an exemption from the
Investment Company Act would adversely affect the Company's ability to
operate.
The Company may become subject to environmental liabilities.
The Company may become subject to environmental risks when it acquires
interests in properties with material environmental problems. Such
environmental risks include the risk that operating costs and values of
these assets may be adversely affected by the obligation to pay for the
cost of complying with existing environmental laws, ordinances and
regulations, as well as the cost of complying with future legislation. Such
laws often impose liability regardless of whether the owner or operator
knows of, or was responsible for, the presence of such hazardous or toxic
substances. The costs of investigation, remediation or removal of hazardous
substances could exceed the value of the property. The Company's income and
ability to make distributions to stockholders could be affected adversely
by the existence of an environmental liability with respect to the
Company's properties.
26
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Company does not maintain an office. It does not pay rent and utilizes the
offices of the Manager, located at 40 East 52nd Street, New York, New York
10022.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2006, there were no pending legal proceedings in which the
Company was a defendant or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the
fourth quarter of 2006 through the solicitation of proxies or otherwise.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Common Stock has been listed and traded on the New York Stock
Exchange under the symbol "AHR" since its initial public offering in March 1998.
The following table sets forth, for the periods indicated, the high, low and
last sale prices in dollars on the New York Stock Exchange for the Company's
Common Stock and the dividends declared by the Company with respect to the
periods indicated as were traded during these respective time periods.
Dividends
High Low Last Sale Declared
------ ------ --------- ---------
2006
First Quarter....... $11.22 $10.56 $10.98 $0.28
Second Quarter...... 12.28 10.27 12.16 0.29
Third Quarter....... 13.44 11.86 12.86 0.29
Fourth Quarter...... 14.42 11.50 12.73 0.29
2005
First Quarter....... 12.21 10.85 11.14 0.28
Second Quarter...... 12.40 10.50 11.85 0.28
Third Quarter....... 12.19 11.33 11.58 0.28
Fourth Quarter...... 11.28 10.16 10.53 0.28
On March 2, 2007, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $12.10. At March 2, 2007, there
were approximately 1,089 record holders of the Common Stock. This figure does
not reflect beneficial ownership of shares held in nominee name.
28
Information relating to the Company's equity compensation plans in the
Company's definitive proxy statement for its 2007 Annual Meeting of
Stockholders (the "Proxy Statement"), to be filed with the SEC, is
incorporated herein by reference.
The Company made no purchases of its equity securities in 2006.
Recent Sales of Unregistered Securities
During the year ended December 31, 2006, the Company issued 194,077 shares of
unregistered Common Stock with an aggregate value of $2,164,979 as follows.
Pursuant to resolutions of the Board of Directors which authorized that a
portion of incentive fees earned by the Manager may be paid in shares of the
Company's Common Stock, the Company issued 189,077 shares to the Manager as
payment of a portion of the Manager's incentive fees. The Company issued 5,000
shares to its unaffiliated directors pursuant to its annual grant of restricted
stock to unaffiliated directors as part of their annual compensation. The
issuances of common stock were made in reliance upon the exemption from
registration under Section 4(2) of the Securities Act.
29
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below at and for the years ended December
31, 2006, 2005, 2004, 2003, and 2002 has been derived from the Company's audited
financial statements. This information should be read in conjunction with "Item
1. Business" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations", as well as the audited financial
statements and notes thereto included in "Item 8. Financial Statements and
Supplementary Data".
For the Year Ended December 31,
--------------------------------------------------------------
2006 2005 2004 2003 2002
---------- ---------- ---------- ---------- ----------
(In thousands, except per share data)
Operating Data:
Interest income $ 275,986 $ 231,768 $ 194,967 $ 159,456 $ 160,199
Other income 27,431 12,146 8,899 4,322 2,246
Interest expense 212,388 163,458 128,166 83,249 65,018
Other operating expenses 25,830 19,181 12,383 11,707 14,850
Other gains (losses) (1) 13,906 9,322 (20,125) (77,464) (28,949)
Cumulative transition adjustment (2) -- -- -- -- 6,327
Income from discontinued operations (3) 1,366
Net income (loss) 80,471 70,597 43,192 (8,642) 59,955
Net income (loss) available to common
stockholders 75,079 65,205 25,768 (16,386) 54,793
Per Share Data:
Net income (loss):
Basic 1.31 1.20 0.50 (0.34) 1.18
Diluted 1.31 1.20 0.50 (0.34) 1.18
Dividends declared per common share 1.15 1.12 1.12 1.26 1.40
Balance Sheet Data:
Total assets 5,218,263 4,234,825 3,729,134 2,398,846 2,640,558
Total liabilities 4,562,154 3,636,807 3,215,396 1,981,416 2,234,342
Total stockholders' equity 656,109 598,018 513,738 417,430 406,216
(1) Other gains (losses) for the year ended December 31, 2006 of $13,906
consist primarily of a loss of $(7,880) related to impairments on assets, a
gain of $3,254 related to securities held-for-trading, a gain of $2,161
related to foreign currency, a loss of $(12,661) related to a change in the
Company's hedging policy and a gain of $29,032 related to the sale of
securities available-for-sale. Other gains (losses) for the year ended
December 31, 2005 of $9,322 consist primarily of a loss of $(5,088) related
to impairments on assets and a gain of $16,543 related to securities
available-for-sale. Other gains (losses) for the year ended December 31,
2004 of $(20,125) consist primarily of a gain of $17,544 related to
securities available-for-sale, a loss of $(26,018) related to impairments
on assets and a loss of $(11,464) related to securities held-for-trading.
Other gains (losses) for the year ended December 31, 2003 of $(77,464)
consist primarily of a loss of $(32,426) related to impairments on assets
and a loss of $(38,206) related to securities held-for-trading. Other gains
(losses) for the year ended December 31, 2002 of $(28,949) consist
primarily of a loss of $(10,273) related to impairments on assets, a loss
of $(29,255) related to securities held-for-trading, and a gain of $11,391
related to the sale of securities available-for-sale.
30
(2) The cumulative transition adjustment represents the Company's adoption of
SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS No. 142") for the
year ended December 31, 2002.
(3) The Company purchased a defaulted loan from a Controlling Class CMBS trust
during the first quarter of 2006. The Company sold the property during the
second quarter of 2006 and recorded a gain from discontinued operations of
$1,366 on the consolidated statement of operations.
31
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
All dollar figures expressed herein are expressed in thousands, except share and
per share amounts.
General
Anthracite Capital, Inc., a Maryland corporation, and subsidiaries
(collectively, the "Company") is a specialty finance company that invests in
commercial real estate assets on a global basis. The Company seeks to generate
income from the spread between the interest income, gains and net operating
income on its commercial real estate assets and the interest expense from
borrowings to finance its investments. The Company's primary activities are
investing in high yielding commercial real estate debt and equity. The Company
combines traditional real estate underwriting and capital markets expertise to
maximize the opportunities arising from the continuing integration of these two
disciplines. The Company focuses on acquiring pools of performing loans in the
form of commercial mortgage-backed securities ("CMBS"), issuing secured debt
backed by CMBS and providing strategic capital for the commercial real estate
industry in the form of mezzanine loan financing. The Company also began
investing in diversified portfolios of commercial real estate in the United
States during December 2005. The Company commenced operations on March 24, 1998.
The Company's common stock is traded on the New York Stock Exchange under the
symbol "AHR". The Company's primary long-term objective is to distribute
dividends supported by earnings. The Company establishes its dividend by
analyzing the long-term sustainability of earnings given existing market
conditions and the current composition of its portfolio. This includes an
analysis of the Company's credit loss assumptions, general level of interest
rates and projected hedging costs.
The Company's principal focus is to invest in a diverse portfolio of primarily
high yield commercial real estate loans and CMBS. The CMBS that the Company
purchases are fixed income instruments similar to bonds that carry an interest
coupon and stated principal. The cash flow used to pay the interest and
principal on the CMBS comes from a designated pool of first mortgage loans on
commercial real estate (the "Underlying Loans"). Underlying Loans usually are
originated by commercial banks or investment banks and are secured by a first
mortgage on office buildings, retail centers, apartment buildings, hotels and
other types of commercial real estate. A typical loan pool may contain several
hundred Underlying Loans with principal amounts of as little as $1,000 to over
$100,000. The pooling concept permits significant geographic diversification.
Converting loans into CMBS in this fashion allows investors to purchase these
securities in global capital markets and to participate in the commercial real
estate sector with significant diversification among property types, sizes and
locations in one fixed income investment.
The type of CMBS issued from a typical loan pool is generally broken down by
credit rating. The highest rated CMBS will receive payments of principal first
and is therefore least exposed to the credit performance of the Underlying Loan.
These securities will carry a credit rating of AAA and will be issued with a
principal amount that represents some portion of the total principal amount of
the Underlying Loan pool.
The CMBS that receive principal payments last are generally rated below
investment grade (BB+ or lower.) As the last to receive principal, these CMBS
are also the first to absorb any credit losses incurred in the Underlying Loan
pool. Typically, the principal amount of these below investment grade classes
represents 2.0-3.5% of the principal of the Underlying Loan pools. The investor
that owns the lowest rated, or non-rated, CMBS class is designated as the
controlling class representative for the underlying loan pool. This designation
allows the holder to assert a significant degree of influence over
32
any workouts or foreclosures of defaulted Underlying Loans. These securities are
generally issued with a high yield to compensate for the credit risk inherent in
owning the CMBS class which is the first to absorb losses.
The Company's high yield commercial real estate loan strategy encompasses B
notes (defined below) and mezzanine loans. B notes and mezzanine loans are based
on a similar concept of investing in a portion of the principal and interest of
a specific loan instead of a pool of loans as in CMBS. In the case of B notes
the principal amount of a single loan is separated into a senior interest ("A
note") and a junior interest ("B note"). Prior to a borrower default, the A note
and the B note receive principal and interest pari passu; however after a
borrower default, the A note would receive its principal and interest first and
the B note would absorb the credit losses that occur, if any, up to the full
amount of its principal. The B note holder generally has certain rights to
influence workouts or foreclosures. The Company invests in B notes as they
provide relatively high yields with a degree of influence over dispositions.
Mezzanine loans generally are secured by ownership interests in an entity that
owns real estate. These loans generally are subordinate to a first mortgage and
would absorb a credit loss prior to the senior mortgage holder.
The Company is managed by BlackRock Financial Management, Inc. (the "Manager"),
a subsidiary of BlackRock, Inc., a publicly traded (NYSE:BLK) asset management
company with $1.125 trillion of assets under management at December 31, 2006.
The Company believes that the trend toward highly structured investment products
requires significant expertise in traditional real estate underwriting as well
as in the capital markets. Through its external management contract with the
Manager, the Company can source and manage more opportunities by taking
advantage of a unique platform that combines these two disciplines.
The table below is a summary of the Company's investments by asset class for the
last five years:
Carrying Value at December 31,
---------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
----------------- ----------------- ----------------- ----------------- -----------------
Amount % Amount % Amount % Amount % Amount %
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Commercial real estate
securities $2,494,099 53.0% $2,005,383 49.7% $1,623,939 44.6% $1,393,010 62.8% $ 894,345 35.9%
Commercial mortgage
loan pools(1) 1,271,014 27.0 1,292,407 32.0 1,312,045 36.1 -- -- -- --
Commercial real estate
loans(2) 554,148 11.8 425,453 10.6 329,930 9.1 97,984 4.4 88,926 3.6
Commercial real estate
equity 109,744 2.3 51,003 1.3 -- -- -- -- -- --
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Commercial real estate
assets 4,429,005 94.1 3,774,246 93.6 3,265,914 89.8 1,490,994 67.2 983,271 39.5
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Residential
mortgage-backed
securities ("RMBS") 276,344 5.9 259,026 6.4 372,071 10.2 726,717 32.8 1,506,450 60.5
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
Total $4,705,349 100.0% $4,033,272 100.0% $3,637,985 100.0% $2,217,711 100.0% $2,489,721 100.0%
========== ===== ========== ===== ========== ===== ========== ===== ========== =====
(1) Represents a Controlling Class CMBS that is consolidated for accounting
purposes. See Note 5 of the consolidated financial statements.
(2) Includes equity investments and real estate joint ventures.
33
SUMMARY OF COMMERCIAL REAL ESTATE ASSETS
A summary of the Company's commercial real estate assets with estimated fair
values in local currencies at December 31, 2006 is as follows:
Total Total
Commercial Commercial Commercial Commercial Commercial Commercial
Real Estate Real Estate Real Estate Mortgage Real Estate Real Estate
Securities Loans (1) Equity Loan Pools Assets Assets (USD)
----------- ----------- ----------- ---------- ----------- ------------
USD $2,312,503 $310,771 $ 105,894 $1,271,014 $ 4,000,182 $4,000,182
GBP L 27,532 L 28,977 -- -- L 56,509 110,681
Euro E 80,923 E141,422 -- -- E 222,345 293,408
Canadian --
Dollars $ 24,339 -- -- -- $ 24,339 20,885
Indian Rupees -- -- Rs169,823 -- Rs 169,823 3,850
---------- -------- --------- ---------- ----------- ----------
Total USD
Equivalent $2,494,100 $554,148 $ 109,744 $1,271,014 $ 4,429,006 $4,429,006
---------- -------- --------- ---------- ----------- ----------
(1) Includes the Company's investments in the Carbon Capital Funds at December
31, 2006.
A summary of the Company's commercial real estate assets with estimated fair
values in local currencies at December 31, 2005 is as follows:
Total Total
Commercial Commercial Commercial Commercial Commercial Commercial
Real Estate Real Estate Real Estate Mortgage Real Estate Real Estate
Securities Loans (1) Equity Loan Pools Assets Assets (USD)
----------- ----------- ----------- ---------- ----------- ------------
USD $1,968,063 $295,499 $51,003 $1,292,407 $3,606,972 $3,606,972
GBP L 16,334 L 33,139 -- -- L 49,473 $ 85,027
Euro E 7,809 E 61,642 -- -- E 69,451 $ 82,247
---------- -------- ------- ---------- ---------- ----------
Total USD
Equivalent $2,005,383 $425,453 $51,003 $1,292,407 $3,774,246 $3,774,246
---------- -------- ------- ---------- ---------- ----------
(1) Includes the Company's investments in the Carbon Capital Funds at December
31, 2005.
The Company has foreign currency rate exposure related to its non-U.S. dollar
denominated assets. The Company's primary currency exposures are Euro and
British pound. Changes in currency rates can adversely impact the estimated fair
value and earnings of the Company's non-U.S. holdings. Outside its
collateralized debt obligations ("CDOs"), the Company mitigates this impact by
utilizing local currency-denominated financing on its foreign investments and
foreign currency forward commitments to hedge the net exposure. In its Euro CDO,
the Company mitigates the exposure to foreign exchange rates with currency swaps
agreements. Net foreign currency gain (loss) was $2,161 and $(134) for the years
ended December 31, 2006 and 2005, respectively.
34
COMMERCIAL REAL ESTATE ASSETS PORTFOLIO ACTIVITY
The following table details the par, estimated fair value, adjusted purchase
price, and loss adjusted yield of the Company's commercial real estate
securities included in as well as outside of the Company's CDOs at December 31,
2006. The dollar price ("Dollar Price") represents the estimated fair value or
adjusted purchase price of a security, respectively, relative to its par value.
Adjusted
Carrying Dollar Purchase Dollar Expected
Par Value Price Price Price Yield
---------- ---------- ------ ---------- ------ --------
Commercial real estate securities outside CDOs
Investment grade CMBS $ 23,060 $ 21,426 92.92 $ 21,753 102.58 5.51%
Investment grade REIT debt 23,121 21,566 93.28 22.973 99.36 5.49%
CMBS rated BB+ to B 108,176 86,677 80.13 87,486 81.59 8.01%
CMBS rated B- or lower 148,310 50,165 33.82 46,043 31.27 9.06%
CDO Investments 406,605 117,246 28.84 114,482 28.16 14.19%
CMBS Interest Only securities
("IOs") 2,980,467 69,352 2.33 69,183 2.32 7.36%
Multifamily agency securities 447,191 449,827 100.59 452,781 101.25 5.07%
Commercial mortgage loan pools 1,207,212 1,271,014 105.29 1,271,014 105.29 4.14%
---------- ---------- ------ ---------- ------ -----
Total commercial real estate assets
outside CDOs 5,344,142 2,087,273 39.06 2,085,715 39.08 5.30%
---------- ---------- ------ ---------- ------ -----
Commercial real estate loans and equity outside CDOs
Commercial real estate loans 63,439 140,985 141,951
Commercial real estate 96,453 109,744 96,453
---------- ---------- ----------
Total commercial real estate loans
and equity outside CDOs 159,892 250,729 238,404
---------- ---------- ----------
Commercial real estate assets included in CDOs
Investment grade CMBS 779,653 794,622 101.92 750,662 94.34 7.00%
Investment grade REIT debt 223,324 227,678 101.95 224,964 100.73 5.92%
CMBS rated BB+ to B 614,780 554,185 90.14 508,908 78.28 9.31%
CMBS rated B- or lower 193,236 77,038 39.87 70,727 36.60 14.87%
Credit tenant lease 23,793 24,318 102.20 24,439 102.71 5.67%
Commercial real estate loans 357,111 413,163 115.70 400,559 96.95 8.36%
---------- ---------- ------ ---------- ------ -----
Total commercial real estate assets
included in CDOs 2,191,897 2,091,004 95.40 1,980,259 85.91 8.01%
---------- ---------- ------ ---------- ------ -----
Total commercial real estate assets $7,695,931 $4,429,006 $4,304,378
========== ========== ==========
During the year ended December 31, 2006, the Company increased its commercial
real estate assets by 17% from $3,774,246 to $4,429,006. This increase was
primarily attributable to the purchase of subordinated CMBS, multifamily agency
securities, and investment grade CMBS that have an estimated fair value at
December 31, 2006 of $336,176, $193,395, and $75,841, respectively. The purchase
of the aforementioned securities was offset by the sale of assets with an
estimated fair value of $182,211.
35
The following table details the par, carrying value, adjusted purchase price and
expected yield of the Company's commercial real estate assets included in as
well as outside its CDOs at December 31, 2005:
Adjusted
Carrying Dollar Purchase Dollar Expected
Par Value Price Price Price Yield
---------- ---------- ------ ---------- ------ --------
Commercial real estate securities outside CDOs
Investment grade CMBS $ 150,128 $ 151,889 96.22 $ 161,314 102.17 4.00%
Investment grade REIT debt 23,000 21,828 94.90 22,828 99.25 5.49%
CMBS rated BB+ to B 104,784 90,289 78.38 92,931 80.69 7.77%
CMBS rated B- or lower 132,242 47,854 34.05 45,070 31.59 9.17%
CDO Investments 423,349 124,549 29.42 112,577 26.59 17.29%
CMBS IOs 3,505,646 103,363 2.95 103,120 2.94 6.58%
Multifamily agency securities 256,398 263,362 102.72 268,319 104.65 4.77%
Commercial mortgage loan pools 1,221,302 1,292,407 105.82 1,292,407 105.82 4.14%
---------- ---------- ------ ---------- ------ -----
Total commercial real estate
securities outside CDOs 5,816,849 2,095,541 17.19 2,098,566 17.24 5.43%
---------- ---------- ------ ---------- ------ -----
Commercial real estate loans and equity outside CDOs
Commercial real estate loans 368,433 405,782 404,217
Commercial real estate 50,704 51,004 50,704
---------- ---------- ----------
Total commercial real estate loans
and equity outside CDOs 419,137 456,786 454,921
---------- ---------- ----------
Commercial real estate securities included in CDOs
Investment grade CMBS 375,502 377,291 100.48 354,561 94.42 7.37%
Investment grade REIT debt 223,445 233,939 104.70 226,583 101.40 6.15%
CMBS rated BB+ to B 656,207 566,181 86.28 513,446 78.24 9.16%
Credit tenant lease 24,317 24,837 102.14 24,995 102.79 5.68%
Commercial real estate loans 20,175 19,671 97.49 20,160 99.93 6.96%
---------- ---------- ------ ---------- ------ -----
Total commercial real estate assets
included in CDOs 1,299,647 1,221,919 94.02 1,139,745 87.70 8.17%
---------- ---------- ------ ---------- ------ -----
Total commercial real estate assets $7,535,633 $3,774,246 $3,693,232
========== ========== ==========
The Company's CDO offerings allow the Company to match fund its commercial real
estate portfolio by issuing long-term debt to finance long-term assets. The CDO
debt is non-recourse to the Company; therefore, the Company's losses are limited
to its equity investment in the CDO. The CDO debt is also hedged to protect the
Company from an increase in short-term interest rates. At December 31, 2005,
over 82% of the estimated fair value of the Company's subordinated CMBS was
match funded in the Company's CDOs in this manner. The Company retained 100% of
the equity of CDOs I, II, III, HY3 and Euro (each as defined below) and recorded
the transactions on its consolidated financial statements as secured financing.
36
The table below summarizes the Company's CDO collateral and debt at December 31,
2006.
Debt at December 31, 2006
Collateral at December 31, 2006 --------------------------
------------------------------- Weighted
Adjusted Loss Adjusted Adjusted Average Cost
Purchase Price Yield Issue Price of Funds * Net Spread
--------------- ------------- ----------- ------------ ----------
CDO I $ 467,786 8.08% $ 405,490 7.33% .75%
CDO II 335,293 7.56% 291,261** 6.02% 1.54%
CDO III 378,932 7.08% 366,019** 5.00% 2.08%
CDO HY3 444,615 9.69% 402,089 6.42% 3.27%
Euro CDO 359,084 7.29% 347,715 5.10% 2.19%
---------- ---- ---------- ---- ----
Total ** $1,985,710 8.02% $1,812,574 6.02% 2.00%
========== ==== ========== ==== ====
* Weighted Average Cost of Funds is the current cost of funds plus hedging
expenses.
** The Company chose not to sell $10,000 of par of CDO II debt rated BB,
$13,069 of par of CDO III debt rated BB and $12,500 of par of Euro CDO debt
rated BB.
The Company's first CDO transaction ("CDO I") was issued as Anthracite CDO 2002
CIBC-1 and closed on May 15, 2002. The Company issued $403,633 of debt secured
by a portfolio of commercial real estate securities with a total par of $515,880
and an adjusted purchase price of $431,995.
On December 10, 2002, the Company issued $280,607 of debt through Anthracite CDO
2002-2 ("CDO II") secured by a separate portfolio of commercial real estate
securities with a par of $313,444 and an average adjusted purchase price of
$289,197. Included in the Company's second CDO was a ramp facility that was
utilized to fund the purchase of an additional $50,000 of par of below
investment grade CMBS. The Company utilized the ramp in February 2003 and July
2003, to contribute $30,000 of par of CSFB 03-CPN1 and $20,000 of par of GECMC
03-C2, respectively. In July 2004, the Company issued a bond with a par of
$12,850 from CDO II. Before issuing this security, the Company amended the
indenture to reduce the coupon from 9.0% to 7.6%.
On March 30, 2004, the Company issued its third CDO ("CDO III") through
Anthracite CDO 2004-1. The total par value of bonds sold was $372,456. The total
cost of funds on a fully hedged basis was 5.0%. Included in CDO III was a
$50,000 ramp facility that was fully utilized at December 31, 2004.
On May 23, 2006, the Company closed its sixth CDO issuance ("CDO HY3") resulting
in the issuance of $417,000 of non-recourse debt to investors. The debt is
secured by a portfolio of CMBS and subordinated commercial real estate loans.
This debt was rated AAA through BBB- and the Company retained additional debt
rated BB and 100% of the preferred shares issued by the CDO HY3.
On December 14, 2006, the Company closed its seventh CDO ("Euro CDO"). The Euro
CDO sold E263,500 of non-recourse debt at a weighted average spread to Euro
Libor of 60 basis points. The E263,500 consists of E251,000 of investment grade
debt at a weighted average spread to Euro Libor of 50 basis points and E12,500
of below investment grade debt. The Company retained an additional E12,500 of
below investment grade debt and all of the CDO's preferred shares. This
transaction represents the Company's first CDO that was not U.S. dollar
denominated.
37
SECURITIZATIONS
On November 9, 2004, the Company closed its fourth CDO ("CDO HY1") secured by a
portfolio of below investment grade CMBS with an average rating of CCC. The CMBS
portfolio was carried at its estimated fair value of $109,933 on the Company's
consolidated statement of financial condition based on price quotes received
from third parties. The transaction was accounted for as a sale under SFAS No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities ("SFAS No. 140.") The Company received cash
proceeds of $140,425 as well as all of the CDO HY1 preferred shares that had an
estimated fair value of $15,885 at December 31, 2004. The transaction raised
investable proceeds of $95,799.
On July 26, 2005, the Company closed its fifth CDO ("CDO HY2") and issued
non-recourse debt with a face amount of $365,010. Senior investment grade notes
with a face amount of $240,134 were issued. The Company retained the floating
rate BBB- note, the below investment grade notes and the preferred shares. The
Company recorded CDO HY2 as a secured financing for accounting purposes and
consolidated the assets, liabilities, income and expenses of CDO HY2 until the
sale of the floating rate BBB- note in December 2005, at which point CDO HY2
qualified as a sale under SFAS No. 140.
REAL ESTATE CREDIT PROFILE OF BELOW INVESTMENT GRADE CMBS
The Company views its below investment grade CMBS investment activity as two
portfolios: Controlling Class CMBS and other below investment grade CMBS. The
Company considers the CMBS securities where it maintains the right to influence
the foreclosure/workout process on the underlying loans its controlling class
CMBS ("Controlling Class"). The distinction between the two is in the rights the
Company obtains with its investment in Controlling Class CMBS. Controlling Class
rights allow the Company to influence the workout and/or disposition of defaults
that occur in the underlying loans. These securities absorb the first losses
realized in the underlying loan pools. The coupon payment on the non-rated
security also can be reduced for special servicer fees charged to the trust. The
next highest rated security in the structure then generally will be downgraded
to non-rated and become the first to absorb losses and expenses from that point
on. At December 31, 2006, the Company owns 29 trusts where it is in the first
loss position and is designated as the controlling class representative by
owning the lowest rated or non-rated CMBS class. The total par of the loans
underlying these securities was $42,398,701. At December 31, 2006, subordinated
Controlling Class CMBS with a par of $909,977 were included on the Company's
consolidated statement of financial condition and subordinated Controlling Class
CMBS with a par of $696,883 were held as collateral for CDO HY1 and CDO HY2.
The Company's other below investment grade CMBS have more limited rights
associated with its ownership to influence the workout and/or disposition of
underlying loan defaults. The total par of the Company's other below investment
grade CMBS at December 31, 2006 was $154,524; the average credit protection, or
subordination level, of this portfolio is 1.9%.
38
The Company's investment in its subordinated Controlling Class CMBS securities
by credit rating category at December 31, 2006 is as follows:
Estimated Fair Adjusted Purchase Weighted Average
Par Value Dollar Price Price Dollar Price Subordination Level
-------- -------------- ------------ ----------------- ------------ -------------------
BB+ $158,220 $142,415 90.01 $130,966 82.77 3.51%
BB 135,874 116,085 85.44 111,000 81.69 2.81%
BB- 120,226 94,256 78.40 86,317 71.80 3.13%
B+ 71,277 51,030 71.59 47,861 67.15 2.05%
B 88,217 60,237 68.28 52,988 60.07 1.88%
B- 66,160 37,680 56.95 35,001 52.90 1.28%
CCC 9,671 3,823 39.53 3,596 37.19 0.88%
NR 260,332 81,480 31.30 73,842 28.36 n/a
-------- -------- ----- -------- -----
Total $909,977 $587,006 64.51 $541,571 59.54
======== ======== ===== ======== =====
The Company's investment in its subordinated Controlling Class CMBS securities
by credit rating category at December 31, 2005 is as follows:
Estimated Fair Adjusted Purchase Weighted Average
Par Value Dollar Price Price Dollar Price Subordination Level
-------- -------------- ------------ ----------------- ------------ -------------------
BB+ $139,541 $131,676 94.36 $120,541 86.38 5.64%
BB 92,583 81,469 88.00 76,527 82.66 4.43%
BB- 110,514 92,116 83.35 85,829 77.66 4.15%
B+ 79,564 56,651 71.20 52,828 66.40 2.60%
B 132,247 84,201 63.37 77,784 58.82 2.81%
B- 23,775 13,216 55.59 12,303 51.75 1.24%
NR 96,626 27,777 28.75 25,727 26.63 n/a
-------- -------- ----- -------- -----
Total $674,850 $487,106 72.18 $451,539 66.91
======== ======== ===== ======== =====
During 2006, the par amount of the Company's Controlling Class CMBS was reduced
by $10,874; of this amount, $9,174 of the par reductions were related to
Controlling Class CMBS held in CDO HY1 and CDO HY2. Further delinquencies and
losses may cause the par reductions to continue and cause the Company to
conclude that a change in loss adjusted yield is required along with a
write-down of the adjusted purchase price through the income statement according
to Emerging Issues Task Force ("EITF") Issue 99-20, Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets ("EITF 99-20"). Also during 2006, the loan pools
were paid down by $682,017. Pay down proceeds are distributed to the highest
rated CMBS class first and reduce the percent of total underlying collateral
represented by each rating category.
As the portfolio matures and expected losses occur, subordination levels of the
lower rated classes of a CMBS investment will be reduced. This may cause the
lower rated classes to be downgraded, which would negatively affect their
estimated fair value and therefore the Company's net asset value. Reduced
estimated fair value would negatively affect the Company's ability to finance
any such securities that are not financed through a CDO or similar matched
funding vehicle. In some cases, securities held by the Company may be upgraded
to reflect seasoning of the underlying collateral and thus would increase the
39
estimated fair value of the securities. During the twelve months ended December
21, 2006, 21 securities in nine of the Company's Controlling Class CMBS were
upgraded by at least one rating agency and none were downgraded. Additionally,
at least one rating agency upgraded 69 of the Company's non-Controlling Class
commercial real estate securities. Three of the Company's investment grade REIT
debt securities were downgraded during the twelve months ended December 31,
2006.
The Company considers delinquency information from the Lehman Brothers Conduit
Guide to be the most relevant benchmark to measure credit performance and market
conditions applicable to its Controlling Class CMBS holdings. The year of
issuance, or vintage year, is important, as older loan pools will tend to have
more delinquencies than newly underwritten loans. The Company owns Controlling
Class CMBS issued in 1998, 1999, 2001, 2002, 2003, 2004, 2005 and 2006.
Comparable delinquency statistics referenced by vintage year as a percentage of
par outstanding at December 31, 2006 are shown in the table below:
Underlying Delinquencies Lehman Brothers
Vintage Year Collateral Outstanding Conduit Guide
------------ ----------- ------------- ---------------
1998 $ 5,284,446 1.29% 1.22%
1999 592,717 2.22% 1.13%
2001 829,692 -- 1.11%
2002 1,147,467 0.37% 0.70%
2003 2,086,852 1.22% 0.45%
2004 6,616,657 0.22% 0.26%
2005 12,110,707 0.33% 0.20%
2006 13,730,163 -- 0.07%
----------- ----- -----
Total $42,398,701 0.39%* 0.35%*
* Weighted average based on current principal balance.
Delinquencies on the Company's CMBS collateral as a percent of principal are in
line with expectations and are consistent with comparable data provided in the
Lehman Brothers Conduit Guide. These seasoning criteria generally will adjust
for the lower delinquencies that occur in newly originated collateral. See Item
7A - "Quantitative and Qualitative Disclosures About Market Risks" for a
detailed discussion of how delinquencies and loan losses affect the Company.
40
The following table sets forth certain information relating to the aggregate
principal balance and payment status of delinquent commercial mortgage loans
underlying the Controlling Class CMBS held by the Company at December 31, 2006
and 2005:
December 31, 2006 December 31, 2005
------------------------------------ ------------------------------------
Number of % of Number of % of
Principal Loans Collateral Principal Loans Collateral
----------- --------- ---------- ----------- --------- ----------
Past due 30 days to 60 days $ 70,123 10 0.17% $ 50,751 7 0.17%
Past due 60 days to 90 days 19,767 5 0.05 37,155 5 0.13
Past due 90 days or more 11,365 7 0.03 79,758 20 0.27
Real Estate owned 56,486 10 0.13 19,666 4 0.07
Foreclosure 7,164 2 0.02 3,625 1 0.01
----------- ----- ---- ----------- ----- ----
Total Delinquent $164,905 34 0.39% $ 190,954 37 0.64%
=========== ===== ==== =========== ===== ====
Total Collateral Balance $42,398,701 4,667 $29,668,349 3,596
Of the 34 delinquent loans at December 31, 2006, 10 loans were real estate owned
and being marketed for sale, 2 loans were in foreclosure and the remaining 22
loans were in some form of workout negotiations. The Controlling Class CMBS
owned by the Company have a delinquency rate of 0.39%, which is consistent with
industry averages. During 2006, the underlying collateral experienced early
payoffs of $682,017 representing 1.6% of the year-end pool balance. These loans
were paid off at par with no loss. Aggregate losses related to the underlying
collateral of $19,279 were realized during year ended December 31, 2006. This
brings cumulative realized losses to $109,449, which is 21.3% of total estimated
losses. These losses include special servicer and other workout expenses. This
experience to date is in line with the Company's loss expectations. Realized
losses and special servicer expenses are expected to increase on the underlying
loans as the portfolio matures. Special servicer expenses are also expected to
increase as portfolios mature.
To the extent that realized losses differ from the Company's original loss
estimates, it may be necessary to reduce or increase the projected yield on the
applicable CMBS investment to better reflect such investment's expected earnings
net of expected losses, from the date of purchase. While realized losses on
individual assets may be higher or lower than original estimates, the Company
currently believes its aggregate loss estimates and yields remain appropriate.
41
The Company manages its credit risk through disciplined underwriting,
diversification, active monitoring of loan performance and exercise of its right
to influence the workout process for delinquent loans as early as possible. The
Company maintains diversification of credit exposures through its underwriting
process and can shift its focus in future investments by adjusting the mix of
loans in subsequent acquisitions. The comparative profiles of the loans
underlying the Company's CMBS by property type at December 31, 2006 and 2005 are
as follows:
12/31/06 Exposure 12/31/05 Exposure
------------------------------- -------------------------------
Property Type Collateral Balance % of Total Collateral Balance % of Total
------------- ------------------ ---------- ------------------ ----------
Office $13,415,671 31.6% $9,406,148 31.7%
Retail 13,217,676 31.2 9,195,747 31.0
Multifamily 8,978,823 21.2 6,874,450 23.2
Industrial 3,332,194 7.9 2,060,953 7.0
Lodging 2,726,441 6.4 1,670,436 5.6
Healthcare 305,612 0.7 299,692 1.0
Other 422,284 1.0 160,923 0.5
----------- ---- ----------- ----
Total $42,398,701 100% $29,668,349 100%
=========== ==== =========== ====
At December 31, 2006 and 2005, the commercial mortgage loans underlying the
Controlling Class CMBS held by the Company were secured by properties at the
locations identified below:
Percentage (1)
--------------
Geographic Location 2006 2005
------------------- ------ -----
California 16.1% 16.7%
New York 12.5 14.5
Texas 8.8 8.7
Florida 7.2 8.1
Other (2) 55.4 52.0
---- -----
Total 100% 100.0%
==== =====
(1) Based on a percentage of the total unpaid principal balance of the
underlying loans.
(2) No other individual category comprises more than 5% of the total.
As the portfolio matures and expected losses occur, subordination levels of the
lower rated classes of a CMBS investment will be reduced. This may cause the
lower rated classes to be downgraded, which would negatively affect their
estimated fair value and therefore the Company's net asset value. Reduced
estimated fair value will negatively affect the Company's ability to finance any
such securities that are not financed through a CDO or similar matched funding
vehicle. In some cases, securities held by the Company may be upgraded to
reflect seasoning of the underlying collateral and thus would increase the
estimated fair value of the securities.
The Company's interest income calculated in accordance with EITF 99-20 for its
CMBS is computed based upon a yield, which assumes credit losses will occur. The
yield to compute the Company's taxable income does not assume there would be
credit losses, as a loss can only be deducted for tax purposes when it has
occurred. This is the primary difference between the Company's income in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and taxable income. As a result, for the years 1998 through
2006, the Company's GAAP income was approximately $44,856 lower than its taxable
income.
42
COMMERCIAL REAL ESTATE LOAN ACTIVITY
The Company's commercial real estate loan portfolio generally emphasizes larger
transactions located in metropolitan markets located in the United States and
Europe, as compared to the typical loan in the CMBS portfolio.
The following table summarizes the Company's commercial real estate loan
portfolio by property type at December 31, 2006, 2005, and 2004:
Loans Outstanding Weighted Average
December 31, 2006 December 31, 2005 December 31, 2004 Yield
----------------- ----------------- ----------------- ------------------
Property Type Amount % Amount % Amount % 2006 2005 2004
------------- -------- ------ -------- ------ -------- ------ ---- ---- ----
Office $130,016 27.0% $ 94,432 25.8% $ 88,311 33.5% 8.2% 8.9% 9.2%
Residential 57,917 12.0 57,466 15.7 13,480 5.1 10.7 8.6 12.2
Retail 194,938 40.5 76,502 20.9 59,070 22.4 7.7 7.3 6.6
Hotel 38,899 8.1 79,840 21.8 102,645 39.0 10.0 8.6 7.2
Storage 34,009 7.1 32,913 9.0 -- -- 9.0 9.1 --
Communication
Tower -- -- 20,000 5.5 -- -- -- 9.4 --
Industrial 19,317 4.0 2,423 0.7 -- -- 9.1 8.1 --
Other Mixed Use 6,649 1.3 2,230 0.6 -- -- 8.7 8.1 --
-------- ----- -------- ----- -------- ----- ---- --- ----
Total $481,745 100.0% $365,806 100.0% $263,506 100.0% 8.6% 8.5% 8.0%
======== ===== ======== ===== ======== ===== ==== === ====
Included in the table above are non-U.S. dollar denominated commercial real
estate loans with a carrying value of $243,377, $129,951, and $21,119 at
December 31, 2006, 2005, and 2004, respectively. The Company finances its
non-U.S. dollar denominated loans by borrowing in the applicable local currency
and hedging the un-financed portion.
For the year ended December 31, 2006, the Company purchased $328,439 of
commercial real estate loans. These acquisitions include commercial real estate
loans denominated in British pounds of (pound)33,715 ($61,008) and loans
denominated in Euros of (euro)133,563 ($171,464). For the year ended December
31, 2006, the Company experienced repayments of $197,094 related to its
commercial real estate loan portfolio.
Also included in commercial real estate loans are the Company's investments in
Carbon Capital, Inc. ("Carbon I") and Carbon Capital II, Inc. ("Carbon II", and
collectively with Carbon I, the "Carbon Capital Funds.") For the year ended
December 31, 2006, the Company recorded $11,668 of income for the Carbon Capital
Funds. Carbon II increased its investment in U.S. commercial real estate loans
by originating 17 loans for a total investment of $452,541 during 2006. Paydowns
in Carbon II during 2006 totaled $217,911. As loans are repaid, Carbon II has
redeployed capital into acquisitions of additional loans for the portfolio. The
Carbon I investment period has expired and as repayments continue to occur,
capital will be returned to investors.
The Company's investments in the Carbon Capital Funds are as follows:
December 31, 2006 December 31, 2005
----------------- -----------------
Carbon I $ 3,144 $18,458
Carbon II 69,259 41,185
------- -------
$72,403 $59,643
======= =======
43
At December 31, 2006, all commercial real estate loans owned directly by the
Company were performing in line with expectations. As previously reported,
investments held by Carbon II include a $24,546 commercial real estate mezzanine
loan which defaulted during July 2006. The default was subsequently cured. On
March 9, 2007, the loan matured. The borrower did not repay the loan on the due
date. In addition, the senior mortgage holder did not grant the borrower's
request for extension of time to accommodate a sale of the property or
refinancing of the loan. As a result, the loan is in default. The Company
believes the underlying asset is sufficient collateral to repay the Company's
loan in full. The underlying property is a hotel located in the South Beach area
of Miami, Florida.
During February 2007, two other loans held by Carbon II defaulted. The aggregate
carrying value of the two loans on Carbon II's consolidated financial statements
is $24,000 ($12,000 per loan). The underlying properties for both loans are
multi-family assets being converted to condominiums that are located in Florida.
Carbon II is negotiating a workout arrangement with the borrower for one loan,
whereby the borrower will cure its default and make additional capital
contributions to sustain the property while the borrower continues its sales
program. Based on credit analysis performed for this property, Carbon II
believes a loan loss reserve is not necessary at this time.
For the second loan, the borrower was not able to achieve sufficient condominium
sales to complete the condominium conversion. The borrower has indicated it will
not contribute additional capital to sustain the rental property until such time
as the condominium market recovers. As a result, Carbon II is expected to take
title to the property and currently intends to operate it as a rental property
while preparing the property for sale. Based on the credit analysis performed
for this property, Carbon II has established a loan loss reserve of $5,180 for
the loan, of which the Company's share is $1,361. All other commercial real
estate loans in the Carbon Capital Funds are performing as expected.
COMMERCIAL REAL ESTATE
At December 31, 2006, the Company had invested an aggregate of $92,603 in
BlackRock Diamond Property Fund, Inc. ("BlackRock Diamond"). BlackRock Diamond
is a private real estate investment trust ("REIT") managed by BlackRock Realty
Advisors, Inc., a subsidiary of the Company's Manager. BlackRock Diamond's
investment objective is to seek a high risk adjusted return through
"value-added" capital appreciation and current income on properties through out
the United States. This means the BlackRock Diamond's focuses on operating
properties that will be repositioned, renovated, or expanded to achieve maximum
returns. Part of the investment strategy includes a budgeted amount of capital
expenditures that are used to improve the value of the investment and realize
the full value potential of a given property. BlackRock Diamond relies on the
Manager's extensive relationships in the real estate markets to source
opportunities. BlackRock Diamond focuses on large urban locations where it
believes the real estate equity markets will outperform.
BlackRock Diamond is an open-end fund. As such, it allows shares to be redeemed
at a price equal to its quarter-end net asset value upon 60 days notice. The
assets are subject to quarterly appraisals with one independent appraisal done
annually. The Company does not pay a separate management fee to the Manager for
management services associated with its investment in BlackRock Diamond.
The Company had a 21% ownership in BlackRock Diamond at December 31, 2006 and
recorded $15,763 of income during 2006 with respect to this investment under the
equity method. At December 31, 2006, the Company had $7,397 of remaining capital
commitments to BlackRock Diamond, all of which was called in January 2007.
44
For the year ended December 31, 2006, the Company recorded $15,763 of income,
consisting of $1,463 of current income and $14,300 of unrealized gains on the
underlying portfolio assets. At December 31, 2006, BlackRock Diamond's portfolio
consisted of 26 assets with a total estimated market value of approximately
$680,134. All financial information was reported by BlackRock Diamond.
The Company purchased a defaulted loan from a Controlling Class CMBS trust
during the first quarter of 2006. The loan was secured by a first mortgage on a
multi-family property in Texas. Subsequent to the loan purchase, the Company
foreclosed on the loan and acquired title to the property in the process. The
Company sold the property during the second quarter of 2006 and recorded a gain
from discontinued operations of $1,366 on the consolidated statement of
operations.
The Company has an indirect investment in a commercial real estate development
fund located in India. At December 31, 2006, the Company's capital committed was
$11,000, of which $3,850 had been drawn. The entity conducts its operations in
the local currency, Indian Rupees.
CRITICAL ACCOUNTING ESTIMATES
Management's discussion and analysis of financial condition and results of
operations are based on the amounts reported in the Company's consolidated
financial statements. These financial statements are prepared in accordance with
GAAP. In preparing the financial statements, management is required to make
various judgments, estimates and assumptions that affect the reported amounts.
Changes in these estimates and assumptions could have a material effect on the
Company's consolidated financial statements. The following is a summary of the
Company's accounting policies that are the most affected by management
judgments, estimates and assumptions:
Securities Available-for-sale
The Company has designated certain investments in mortgage-backed securities,
mortgage-related securities and certain other securities as available-for-sale.
Securities available-for-sale are carried at estimated fair value with the net
unrealized gains or losses reported as a component of accumulated other
comprehensive income in stockholders' equity. Many of these investments are
relatively illiquid, and management must estimate their values. In making these
estimates, management generally utilizes market prices provided by dealers who
make markets in these securities, but may, under certain circumstances, adjust
these valuations based on management's judgment. Changes in the valuations do
not affect the Company's reported net income or cash flows, but impact
stockholders' equity and, accordingly, book value per share.
Management must also assess whether unrealized losses on securities reflect a
decline in value that is other than temporary, and, accordingly, write the
impaired security down to its fair value, through earnings. Significant judgment
by management is required in this analysis, which includes, but is not limited
to, making assumptions regarding the collectability of the principal and
interest, net of related expenses, on the underlying loans.
Income on these securities is recognized based upon a number of assumptions that
are subject to uncertainties and contingencies. Examples include, among other
things, the rate and timing of principal payments (including prepayments,
repurchases, defaults and liquidations), the pass-through or coupon rate and
interest rate fluctuations. Additional factors that may affect the Company's
reported interest income on its commercial real estate securities include
interest payment shortfalls due to delinquencies on the underlying commercial
mortgage loans, the timing and magnitude of credit losses on the commercial
mortgage loans underlying the securities that are a result of the general
45
condition of the real estate market (including competition for tenants and their
related credit quality) and changes in market rental rates. These uncertainties
and contingencies are difficult to predict and are subject to future events that
may alter the assumptions.
The Company recognizes interest income from its purchased beneficial interests
in securitized financial interests ("beneficial interests") (other than
beneficial interests of high credit quality, sufficiently collateralized to
ensure that the possibility of credit loss is remote, or that cannot
contractually be prepaid or otherwise settled in such a way that the Company
would not recover substantially all of its recorded investment) in accordance
with EITF 99-20. Accordingly, on a quarterly basis, when changes in estimated
cash flows from the cash flows previously estimated occur due to actual
prepayment and credit loss experience, the Company calculates a revised yield
based on the current amortized cost of the investment (including any
other-than-temporary impairments recognized to date) and the revised cash flows.
The revised yield is then applied prospectively to recognize interest income.
For other mortgage-backed and related mortgage securities, the Company accounts
for interest income under SFAS No. 91, Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases ("SFAS No. 91"), using the effective yield method which includes the
amortization of discount or premium arising at the time of purchase and the
stated or coupon interest payments.
Impairment - Securities
In accordance with SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities ("SFAS No. 115"), when the estimated fair value of the
security classified as available-for-sale has been below amortized cost for a
significant period of time and the Company concludes that it no longer has the
ability or intent to hold the security for the period of time over which the
Company expects the values to recover to amortized cost, the investment is
written down to its fair value. The resulting charge is included in income, and
a new cost basis is established. Additionally, under EITF 99-20, when changes in
estimated cash flows from the cash flows previously estimated occur due to
actual prepayment and credit loss experience, and the present value of the
revised cash flows using the current expected yield is less than the present
value of the previously estimated remaining cash flows (adjusted for cash
receipts during the intervening period), an other-than-temporary impairment is
deemed to have occurred. Accordingly, the security is written down to fair value
with the resulting change being included in income, and a new cost basis
established. In both instances, the original discount or premium is written off
when the new cost basis is established.
After taking into account the effect of an impairment charge, income is
recognized under EITF 99-20 or SFAS No. 91, as applicable, using the revised
market yield for the security used in establishing the write-down.
Variable Interest Entities
The consolidated financial statements include the financial statements of
Anthracite Capital, Inc. and its subsidiaries, which are wholly owned or
controlled by the Company or entities which are variable interest entities
("VIEs") in which the Company is the primary beneficiary under Financial
Accounting Standards Board ("FASB") Interpretation No. 46, Consolidation of
Variable Interest Entities (revised December 2003) ("FIN 46R"). FIN 46R requires
a VIE to be consolidated by its primary beneficiary. The primary beneficiary is
the party that absorbs the majority of the VIE's expected losses and/or the
majority of the expected returns. The Company has evaluated its investments for
potential variable interests by evaluating the sufficiency of the entity's
equity investment at risk to absorb losses. All significant inter-company
balances and transactions have been eliminated in consolidation.
46
The Company has analyzed the governing pooling and servicing agreements for each
of its Controlling Class CMBS and believes that the terms are industry standard
and are consistent with the qualifying special-purpose entity ("QSPE") criteria.
However, there is uncertainty with respect to QSPE treatment due to ongoing
review by accounting standard setters, potential actions by various parties
involved with the QSPE, as well as varying and evolving interpretations of the
QSPE criteria under SFAS No. 140. Additionally, the standard setters continue to
review the FIN 46R provisions related to the computations used to determine the
primary beneficiary of a VIE. Future guidance from the standard setters may
require the Company to consolidate CMBS trusts in which the Company has
invested.
Commercial Mortgage Loans
The Company purchases and originates commercial mortgage loans to be held as
long-term investments. The Company also has investments in private opportunity
funds that invest in commercial mortgage loans that are managed by the Manager.
Management periodically must evaluate each loan for possible impairment.
Impairment is indicated when it is deemed probable that the Company will not be
able to collect all amounts due according to the contractual terms of the loan.
If a loan were determined to be impaired, the Company would establish a reserve
for probable losses and a corresponding charge to earnings. Given the nature of
the Company's loan portfolio and the underlying commercial real estate
collateral, significant judgment of management is required in determining
impairment and the resulting loan loss allowance, which includes but is not
limited to making assumptions regarding the value of the real estate that
secures the commercial mortgage loan.
Equity Investments
For those investments in real estate entities where the Company does not control
the investee, or is not the primary beneficiary of a VIE, but can exert
significant influence over the financial and operating policies of the investee,
the Company uses the equity method of accounting. The Company recognizes its
share of each investee's income or loss, and reduces its investment balance by
distributions received. The Company owns an equity method investment in
BlackRock Diamond, a privately held REIT that maintains its financial records on
a fair value basis. The Company has retained such accounting relative to its
investment in this REIT pursuant to EITF Issue 85-12, Retention of Specialized
Accounting for Investments in Consolidation.
Derivative Instruments
The Company utilizes various hedging instruments (derivatives) to hedge interest
rate and foreign currency exposures or to modify the interest rate or foreign
currency characteristics of related Company investments. All derivatives are
carried at fair value, generally estimated by management based on valuations
provided by the counterparty to the derivative contract. For accounting
purposes, the Company's management must decide whether to designate these
derivatives as either a hedge of an asset or liability, securities
available-for-sale, securities held-for-trading, or foreign currency exposure.
This designation decision affects the manner in which the changes in the fair
value of the derivatives are reported.
Securitizations
When the Company sells assets in securitizations, it can retain certain tranches
which are considered retained interests in the securitization. Gain or loss on
the sale of assets depends in part on the previous carrying amount of the
financial assets securitized, allocated between the assets sold and the retained
47
interests based on their relative fair value at the date of securitization. To
obtain fair values, quoted market prices are used. Gain or loss on
securitizations of financial assets is reported as a component of sale of
securities available-for-sale on the consolidated statement of operations.
Retained interests are carried at estimated fair value on the consolidated
statement of financial condition. Adjustments to estimated fair value for
retained interests classified as securities available-for-sale are included in
accumulated other comprehensive income on the consolidated statement of
financial condition.
RECENT ACCOUNTING PRONOUNCEMENTS
Reverse Repurchase Agreements
Accounting standard setters are currently reviewing the treatment of
transactions where mortgage-backed securities purchased from a particular
counterparty are financed via a repurchase agreement with the same counterparty.
Currently, the Company records such assets and the related financing gross on
the consolidated statement of financial condition, and the corresponding
interest income and interest expense gross on the consolidated statement of
operations. Any change in fair value of the security is reported through other
comprehensive income pursuant to SFAS No. 115, because the security is
classified as available-for-sale. However, in a transaction where the
mortgage-backed securities are acquired from and financed under a repurchase
agreement with the same counterparty, the acquisition may not qualify as a sale
from the seller's perspective under the provisions of SFAS No. 140. In such
cases, the seller may be required to continue to consolidate the assets sold to
the Company, based on their continuing involvement with such investments.
Depending on the ultimate outcome of the accounting standard setters'
deliberations, the Company may be precluded from presenting the assets gross on
the Company's consolidated statement of financial condition and should instead
be treating the Company's net investment in such assets as a derivative. If it
is determined that these transactions should be treated as investments in
derivatives, the derivative instruments entered into by the Company to hedge the
Company's interest rate exposure with respect to the borrowings under the
associated repurchase agreements may no longer qualify for hedge accounting, and
would then, as with the underlying asset transactions, also be marked to market
through the consolidated statement of operations. This potential change in
accounting treatment does not affect the economics of the transactions but does
affect how the transactions would be reported on the consolidated financial
statements. The Company's cash flows, liquidity and ability to pay a dividend
would be unchanged, and the Company does not believe its REIT taxable income or
REIT status would be affected. The Company's net equity would not be materially
affected. At December 31, 2006, the Company has identified available-for-sale
securities with a fair value of approximately $36,649 which had been purchased
from and financed with reverse repurchase agreements totaling approximately
$31,375 with the same counterparty since their purchase. If the Company were to
change the current accounting treatment for these transactions at December 31,
2006, total assets and total liabilities would be reduced by approximately
$31,375.
Variable Interest Entities
The consolidated financial statements include the financial statements of
Anthracite Capital, Inc. and its subsidiaries, which are wholly owned or
controlled by the Company or entities which are VIEs in which the Company is the
primary beneficiary under FIN 46R. FIN 46R requires a VIE to be consolidated by
its primary beneficiary. The primary beneficiary is the party that absorbs the
majority of the VIE's anticipated losses and/or the majority of the expected
returns. All significant inter-company balances and transactions have been
eliminated in consolidation.
The Company has analyzed the governing pooling and servicing agreements for each
of its Controlling Class CMBS and believes that the terms are industry standard
and are consistent with the QSPE criteria.
48
However, there is uncertainty with respect to QSPE treatment due to ongoing
review by accounting standard setters, potential actions by various parties
involved with the QSPE, as well as varying and evolving interpretations of the
QSPE criteria under SFAS No. 140. Future guidance from the accounting standard
setters may require the Company to consolidate CMBS trusts in which the Company
has invested.
Impairment of Investments
In November 2005, the FASB issued FASB Staff Position ("FSP") FAS 115-1/124-1,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments, which provides guidance for determining when impairment charges
should be taken on certain debt and equity securities. FSP FAS 115-1/124-1
requires that debt and equity securities subject to the provisions of SFAS No.
115, and equity securities subject to the provisions of APB Opinion No. 18, The
Equity Method of Accounting for Investments in Common Stock ("APB Opinion No.
18"), but which are not accounted for under the equity method (i.e., securities
accounted for under the cost method) shall be reviewed for impairment when
circumstances warrant. For securities subject to SFAS No. 115, a review for
other-than-temporary impairments shall occur in each accounting period where the
fair value of the security is less than its cost. For securities subject to APB
Opinion No. 18, a review for other-than-temporary impairments shall occur in
each accounting period where a) circumstances indicate that impairment may exist
and b) the fair value of the security is less than its carrying value. The
provisions of the FSP were required to be applied to reporting periods beginning
after December 15, 2005. The adoption of FSP FAS 115-1/124-1 on January 1, 2006
had no material impact on the Company's consolidated financial statements.
Certain Hybrid Financial Instruments
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments ("SFAS No. 155"), which amends SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities ("SFAS No. 133"), and SFAS No.
140. SFAS No. 155 provides, among other things, that:
- For embedded derivatives which would otherwise be required to be
bifurcated from their host contracts and accounted for at fair value
in accordance with SFAS No. 133, an irrevocable election may be made
on an instrument-by-instrument basis, to be measured as hybrid
financial instrument at fair value in its entirety, with changes in
fair value recognized in earnings.
- Concentrations of credit risk in the form of subordination are not
considered embedded derivatives.
- Clarification regarding which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133.
SFAS No. 155 is effective for all financial instruments acquired, issued or
subject to remeasurement after the beginning of an entity's first fiscal year
that begins after September 15, 2006. Upon adoption, differences between the
total carrying amount of the individual components of an existing bifurcated
hybrid financial instrument and the fair value of the combined hybrid financial
instrument should be recognized as a cumulative effect adjustment to beginning
retained earnings. Prior periods should not be restated. The Company is
currently evaluating the impact of adopting SFAS No. 155.
Determining the Variability in a Potential VIE
The FASB issued FASB Staff Position FIN 46(R)-6, Determining the Variability to
be Considered in Applying FASB Interpretation No. 46(R) ("FSP FIN 46(R)-6") in
April 2006. FSP FIN 46(R)-6 addresses the application of FIN 46(R),
Consolidation of Variable Interest Entities ("FIN 46(R)"), in
49
determining whether certain contracts or arrangements with a VIE are variable
interests by requiring companies to base such evaluations on an analysis of the
VIE's purpose and design, rather than its legal form or accounting
classification.
FSP FIN 46(R)-6 is required to be applied for all reporting periods beginning
after June 15, 2006. The adoption of this FSP did not result in material
differences from the Company's existing accounting policies regarding the
consolidation of VIEs.
Accounting for Uncertainty in Income Taxes
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes and Related Implementation Issues ("FIN No. 48").
FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized
in a company's financial statements in accordance with SFAS No. 109, Accounting
for Income Taxes. FIN 48 prescribes a threshold and measurement attribute for
recognition in the financial statements of an asset or liability resulting from
a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. FIN 48 is effective as
of the beginning of fiscal years that begin after December 15, 2006. The Company
is currently evaluating the impact of implementing this new standard but does
not expect its implementation to have a material impact on the consolidated
financial statements.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS
No. 157"). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value and requires enhanced disclosures about fair value
measurements. SFAS No. 157 requires companies to disclose the fair value of its
financial instruments according to a fair value hierarchy (i.e., levels 1, 2,
and 3, as defined). Additionally, companies are required to provide enhanced
disclosure regarding instruments in the level 3 category (which require
significant management judgment), including a reconciliation of the beginning
and ending balances separately for each major category of assets and
liabilities. SFAS No. 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007 and all interim periods within
those fiscal years. The Company is currently evaluating the impact of adopting
SFAS No. 157.
Effects of Prior Year Misstatements
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108,
Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements ("SAB No. 108"). SAB No. 108
provides guidance on the consideration of effects of the prior year
misstatements in quantifying current year misstatements for the purpose of a
materiality assessment. The SEC staff believes registrants must quantify errors
using both a balance sheet and income statement approach and evaluate whether
either approach results in quantifying a misstatement that, when all relevant
quantitative and qualitative factors are considered, is material. SAB No. 108 is
effective for the first annual period ending after November 15, 2006 with early
application encouraged. The adoption of SAB No. 108 on December 31, 2006 had no
effect on the Company's consolidated financial statements.
Valuation of Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities ("SFAS No. 159"). SFAS No. 159
permits entities to choose to measure eligible financial instruments at fair
value. The unrealized gains and losses on items for which the fair value
50
option has been elected should be reported in earnings. The decision to elect
the fair value options is determined on an instrument by instrument basis, it
should be applied to an entire instrument, and it is irrevocable. Assets and
liabilities measured at fair value pursuant to the fair value option should be
reported separately in the balance sheet from those instruments measured using
another measurement attribute. SFAS No. 159 is effective as of the beginning of
the first fiscal year that begins after November 15, 2007. The Company is
currently analyzing the potential impact of adoption of SFAS No. 159.
INTEREST INCOME: The following tables set forth information regarding interest
income from certain of the Company's interest-earning assets.
Variance
-----------------------------------
Year Ended December 31, 2006 vs. 2005 2005 vs. 2004
------------------------------ --------------- ----------------
2006 2005 2004 Variance % Variance %
-------- -------- -------- -------- ---- -------- -----
Commercial real estate securities $168,271 $142,634 $123,860 $25,637 18.0% $18,774 15.2%
Commercial mortgage loan pools 52,917 54,025 39,672 (1,108) (2.1)% 14,353 36.2%
Commercial real estate loans 40,537 23,181 11,896 17,356 74.9% 11,285 94.9%
RMBS 11,858 9,851 18,901 2,007 20.4% (9,050) (47.9)%
Cash and cash equivalents 2,403 2,077 638 326 15.7% 1,439 225.5%
-------- -------- -------- ------- ---- ------- -----
Total $275,986 $231,768 $194,967 $44,218 19.1% $36,801 18.9%
======== ======== ======== ======= ==== ======= =====
The following table reconciles interest income and total income for the years
ended December 31, 2006, 2005 and 2004.
Variance
----------------------------------------
Year Ended December 31, 2006 vs.2005 2005 vs. 2004
------------------------------ ------------------ ------------------
2006 2005 2004 Variance % Variance %
-------- -------- -------- -------- ------- -------- -------
Interest income $275,986 $231,768 $194,967 $44,218 19.1% $36,801 18.9%
Earnings from BlackRock Diamond 15,763 299 -- 15,464 5,171.9% 299 n/a
Earnings from Carbon I 924 4,983 6,763 (4,059) (81.5)% (1,780) (26.3)%
Earnings from Carbon II 10,744 6,805 297 3,939 57.9% 6,508 2,191.3%
Earnings from real estate joint
ventures -- 59 1,097 (59) n/a (1,038) (94.6)%
Other income -- -- 742 -- n/a (742) n/a
-------- -------- -------- ------- ------- ------- -------
Total Income $303,417 $243,914 $203,866 $59,503 24.4% $40,048 19.6%
======== ======== ======== ======= ======= ======= =======
For the year ended December 31, 2006 versus 2005, interest income increased
$44,218, or 19.1%. For the year ended December 31, 2005 versus 2004, interest
income increased $36,801, or 18.9%. The Company continued to increase its
investments in commercial real estate securities and loans, resulting
51
in an increase of $42,993, or 25.9%, during 2006 and $30,059, or 22.1%, during
2005. Income from BlackRock Diamond was $15,763 and $299 for the year ended
December 31, 2006 and 2005, respectively. The Company began investing in
BlackRock Diamond in the fourth quarter of 2005. BlackRock Diamond maintains its
financial records on a fair value basis. The Company has retained such
accounting in its consolidated financial statements pursuant to EITF Issue
85-12, Retention of Specialized Accounting for Investments in Consolidation. For
the year ended December 31, 2006 end 2005, respectively, income from Carbon I
decreased $(4,059), or (81.5)%, and $(1,780), or (26.3)%. The decrease in Carbon
I income is attributable to Carbon I's investment period expiring on July 12,
2004 and the subsequent pay down of its assets. For the year ended December 31,
2006 and 2005, respectively, income from Carbon II increased $3,939, or 57.9%,
and $6,508, or 2,191.3%. The increase in Carbon II income during 2006 is
attributable to the investment of additional capital in 2006 and prepayment
penalties received on its underlying commercial real estate loans primarily
during the second quarter of 2006. The increase in Carbon II income during 2005
is attributable to the investment of additional capital subsequent to the
Company's initial investment in Carbon II in the fourth quarter of 2004. The
consolidation of a VIE (see Note 5 of the consolidated financial statements)
that included commercial mortgage loan pools decreased interest income by
$(1,108) during 2006 and increased interest income by $14,353 during 2005. The
VIE was consolidated for year ended December 31, 2006 and 2005 and for nine
months of 2004, as the entity was acquired in April 2004.
INTEREST EXPENSE: The following table sets forth information regarding the total
amount of interest expense from certain of the Company's borrowings and cash
flow hedges.
Variance
---------------------------------------
Year Ended December 31, 2006 vs. 2005 2005 vs. 2004
------------------------------ ------------------ ------------------
2006 2005 2004 Variance % Variance %
-------- -------- -------- -------- ------- -------- -------
Collateralized debt obligations $ 81,337 $ 69,794 $ 58,986 $11,543 16.5% $10,808 18.3%
Commercial mortgage loan pools 50,213 50,864 37,408 (651) (1.3%) 13,456 36.0%
Commercial real estate
securities* 39,322 17,231 7,517 22,091 128.2% 9,714 129.2%
Commercial real estate loans 10,626 5,907 1,790 4,719 79.9% 4,117 230.0%
RMBS 14,916 9,821 7,016 5,095 51.9% 2,805 40.0%
Senior unsecured notes 1,299 -- -- 1,299 n/a -- --
Junior subordinated notes - net 12,447 1,543 -- 10,904 706.7% 1,543 n/a
Cash flow hedges 1,966 7,110 14,434 (5,144) (72.3)% (7,324) (50.7)%
Hedge ineffectiveness** 262 1,188 1,015 (926) (77.9)% 173 17.0%
-------- -------- -------- ------- ----- ------- -----
Total Interest Expense $212,388 $163,458 $128,166 $48,930 29.9% $35,292 27.5%
======== ======== ======== ======= ===== ======= =====
* Includes $227, $124, and $119 of interest expense for the years ended
December 31, 2006, 2005, and 2004, respectively, from short-term financings
of securities related to the consolidation of commercial mortgage loan
pools.
** See Note 16 of the consolidated financial statements, Derivative
Instruments and Hedging Activities, for a further description of the
Company's hedge ineffectiveness.
52
For the year ended December 31, 2006 and 2005, respectively, interest expense
increased $48,930, or 29.9%, and $35,292, or 27.5%. The increase in interest
expense related to CDOs of $11,543, or 16.5%, during 2006 is primarily
attributable to the issuance of CDO HY3 and the Euro CDO in 2006. The increase
in interest expense related to CDOs of $10,808, or 18.3%, during 2005 is
primarily attributable to the issuance of CDO III and CDO HY2 which was
accounted for as a secured financing from July 2005 through December 2006. The
financing of additional commercial real estate securities and commercial real
estate loans along with higher short-term borrowing rates increased interest
expense $26,810, or 115.9%, and $13,826, or 148.6%, respectively, for year ended
December 31, 2006 and 2005, respectively. Interest expense related to the senior
unsecured notes was $1,299 for the year ended December 31, 2006. The Company
issued $75,000 of senior unsecured notes during the fourth quarter of 2006. For
year ended December 31, 2006 and 2005, respectively, the issuance of $175,000 of
junior subordinated notes since the third quarter of 2005 increased interest
expense $10,904 and $1,543. Cash flow hedge expense decreased $5,144, or 72.5%,
and $7,324, or 50.7%, for the year ended December 31, 2006 and 2005,
respectively. This decrease is due to the cash flow hedges offsetting higher
short-term interest rates on floating rate liabilities. The consolidation of a
VIE (see Note 5 of the consolidated financial statements) that included
commercial mortgage loan pools decreased interest expense by $(548), or (1.1)%,
during 2006 and increased interest expense by 13,461, or 35.9%, in 2005. The VIE
was consolidated for years ended December 31, 2006 and 2005 and for nine months
of 2004 as the entity was acquired in April 2004.
NET INTEREST MARGIN AND NET INTEREST SPREAD FROM THE PORTFOLIO: The Company
considers its interest generating portfolio to consist of its securities
available-for-sale, securities held-for-trading, commercial mortgage loans, and
cash and cash equivalents because these assets relate to its core strategy of
acquiring and originating high yield loans and securities backed by commercial
real estate, while at the same time maintaining a portfolio of investment grade
securities to enhance the Company's liquidity. The Company's equity investments,
which include the Carbon Capital Funds and BlackRock Diamond, also generate a
significant portion of the Company's income.
The Company believes interest income and expense related to these assets
excluding the effects of hedge ineffectiveness and the consolidation of a VIE
better reflect the Company's net interest margin and net interest spread from
its portfolio. Adjusted interest income and adjusted interest expense are better
indicators for both management and investors of the Company's financial
performance over time.
The following charts reconcile interest income and expense to adjusted interest
income and adjusted interest expense.
For the Year Ended December 31
2006 2005 2004
---------- ---------- ----------
Interest income $ 275,986 $ 231,768 $ 194,967
Interest expense related to the consolidation of
commercial mortgage loan pools* (50,213) (50,864) (37,408)
---------- ---------- ----------
Adjusted interest income $ 225,773 $ 180,904 $ 157,559
---------- ---------- ----------
* Includes short-term interest expense of $227, $124, and $119 for the year
ended December 31, 2006, 2005, and 2004, respectively.
For the Year Ended December 31
2006 2005 2004
------------ ------------ ------------
Interest expense $ 212,388 $ 163,458 $ 128,166
Interest expense related to the consolidation of
commercial mortgage loan pools (50,213) (50,864) (37,408)
Hedge ineffectiveness (262) (1,188) (1,015)
------------ ------------ ------------
Adjusted interest expense $ 161,913 $ 111,406 $ 89,743
------------ ------------ ------------
Net interest margin from the portfolio is annualized net interest income divided
by the average estimated fair value of interest-earning assets. Net interest
income is total interest income less interest expense related to collateralized
borrowings. Net interest spread equals the yield on average assets for the
period less the average cost of funds for the period. The yield on average
assets is interest income divided by average amortized cost of interest earning
assets. The average cost of funds is interest expense from the portfolio divided
by average outstanding collateralized borrowings.
The ratios below are also presented including the income from equity
investments. The Company believes the ratios including income from equity
investments are indicative of the performance of the Company's entire portfolio.
The following chart describes the adjusted interest income, adjusted interest
expense, net interest margin and net interest spread for the Company's
portfolio. The following interest income and interest expense amounts exclude
income and expense related to hedge ineffectiveness, and the gross-up effect of
the consolidation of a VIE that includes commercial mortgage loan pools. The
Company believes interest income and expense excluding the effects of these
items better reflects the Company's net interest margin and net interest spread
from the portfolio.
For the Year Ended December 31,
2006 2005 2004
------------ ------------ ------------
Adjusted interest income $ 225,773 $ 180,904 $ 157,559
Adjusted interest expense $ 161,913 $ 111,406 $ 89,743
Adjusted net interest income ratios
Net interest margin 2.1% 3.0% 3.1%
Average yield 7.4% 7.8% 7.1%
Cost of funds 6.1% 5.5% 4.8%
Net interest spread 1.3% 2.3% 2.3%
Ratios including income from equity investments
Net interest margin 2.9% 3.4% 3.4%
Average yield 7.9% 8.1% 7.3%
Cost of funds 6.1% 5.5% 4.8%
Net interest spread 1.8% 2.6% 2.5%
Net interest margin and net interest spread have declined due to CMBS spread
tightening and the yield curve having been flat to inverted in recent periods.
OTHER EXPENSES: Expenses other than interest expense consist primarily of
management fees, incentive fees and general and administrative expenses. The
table below summarizes those expenses for the years ended December 31, 2006,
2005, and 2004, respectively.
Variance
----------------------------------
For the Year Ended December 31, 2006 vs. 2005 2005 vs. 2004
------------------------------- ---------------- ---------------
2006 2005 2004 Variance % Variance %
------- ------- ------- -------- ----- -------- ----
Management fee $12,617 $10,974 $ 8,956 $1,643 15.0% $2,018 22.5%
Incentive fee 5,919 4,290 -- 1,629 38.0% 4,290 n/a
Incentive fee- stock based 2,761 -- -- 2,761 -- n/a n/a
General and administrative
expense 4,533 3,917 3,427 616 15.8% 490 14.3%
------- ------- ------- ------ ---- ------ ----
Total other expenses $25,830 $19,181 $12,383 $6,649 34.7% $6,798 54.9%
======= ======= ======= ====== ==== ====== ====
Commencing in March 2004, management fees are based on 2% of average quarterly
stockholders' equity. The increase of $1,643, or 15.0%, from 2005 and $6,308, or
70.4%, from 2004 is primarily due to the increase in the Company's stockholders'
equity. The Manager earned an incentive fee of $5,919 and $4,290 in 2006 and
2005, respectively, as the Company achieved the necessary performance goals
specified in the Management Agreement. The expense of $2,761 for 2006 is the
related to the stock based incentive fee that was approved by the Company's
Board of Directors in February 2006. See Note 14 of the consolidated financial
statements, Transactions with Affiliates, for further discussion of the
Company's Management Agreement.
General and administrative expense is comprised of accounting agent fees,
custodial agent fees, directors' fees, fees for professional services, insurance
premiums, broken deal expenses, and due diligence costs. The increase in general
and administrative expense for the year ended December 31, 2006 and 2005 is
primarily attributable to costs associated with the Company's global expansion.
53
OTHER GAINS (LOSSES): During the year ended December 31, 2006, the Company sold
seven CMBS held as collateral for three of its CDOs, resulting in a realized
gain of $28,520. The gain from these seasoned CMBS was a result of increased
value of the securities due to multiple credit upgrades and spread tightening of
approximately 475 basis points. Investment grade CMBS owned by the Company
outside of its CDOs were used to replace this collateral.
During the year ended December 31, 2006, the Company changed its financing
strategy and de-designated a portion of it cash flows hedges and incurred a loss
of $12,661. The Company changed its financing strategy to emphasize the use of
90-day reverse repurchase agreements and concurrently reduced the use of 30-day
reverse repurchase agreements. The Company expects 90-day repurchase agreements
to be its primary source for short-term financings in future periods. As a
result of the reduction in the balance of 30-day reverse repurchase agreements,
certain interest swaps that were hedging the 30-day reverse repurchase
agreements were de-designated as hedges.
During the years ended December 31, 2006, 2005, and 2004, respectively, the
Company sold a portion of its securities available-for-sale resulting in
realized gains of $512, $16,543, and $17,544. The gain on sales of securities
available-for-sale during 2004 and 2005, respectively, primarily are
attributable to CDO HY1 and CDO HY2. The gain (loss) on securities
held-for-trading of $3,254, $(1,999), and $11,464 for the years ended December
31, 2006, 2005, and 2004, respectively, consisted primarily of realized and
unrealized gains and losses on U.S. Treasury and Agency securities, forward
commitments to purchase or sell agency RMBS and hedges. The net foreign currency
gain of $2,161 and $134 for the years ended December 31, 2006 and 2005,
respectively, relates to the Company's hedging of its net investment in
commercial mortgage loans denominated in pounds sterling and euros. The losses
on impairment of assets of $7,880, $5,088, and $26,018 for the years ended
December 31, 2006, 2005, and 2004, respectively, were related to the impairment
charges of Controlling Class CMBS and franchise loan backed securities under
EITF 99-20. (See Note 3 of the consolidated financial statements.)
INCOME FROM DISCONTINUED OPERATIONS: The Company purchased a defaulted loan from
a Controlling Class CMBS trust during the first quarter of 2006. The Company
sold the property during the second quarter of 2006 and recorded a gain from
discontinued operations of $1,366 on the consolidated statement of operations.
DIVIDENDS DECLARED: During the year ended December 31, 2006, the Company
declared dividends to common stockholders totaling $66,017, or $1.15 per share,
of which $49,246 was paid during the year and $16,771 was paid on February 1,
2007. During the year ended December 31, 2005, the Company declared dividends to
common stockholders totaling $61,168, or $1.12 per share, of which $45,394 was
paid during the 2005 calendar year and $15,774 was paid on February 1, 2006.
During the year ended December 31, 2004, the Company declared dividends to
common stockholders totaling $58,208, or $1.12 per share, of which $43,287 was
paid during the year and $14,920 was paid on February 1, 2005. For U.S. Federal
income tax purposes, the dividends are ordinary income to the Company's
stockholders.
54
CHANGES IN FINANCIAL CONDITION
Securities available-for-sale: The Company's securities available-for-sale,
which are carried at estimated fair value, included the following at December
31, 2006 and December 31, 2005:
December December
31, 2006 31, 2005
Estimated Estimated
Fair Fair
Security Description Value Percentage Value Percentage
-------------------- ---------- ---------- ---------- ----------
Commercial mortgage-backed securities:
CMBS IOs $ 69,352 2.7% $ 103,363 5.0%
Investment grade CMBS 795,543 30.4 509,835 24.5
Non-investment grade rated subordinated securities 686,019 26.2 675,995 32.5
Non-rated subordinated securities 80,167 3.1 26,411 1.3
Credit tenant lease 24,318 0.9 24,837 1.2
Investment grade REIT debt 249,244 9.5 255,767 12.3
Multifamily agency securities 449,827 17.2 263,362 12.7
CDO investments 117,246 4.5 124,549 6.0
---------- ----- ---------- -----
Total CMBS 2,471,716 94.5 1,984,119 95.5
---------- ----- ---------- -----
Residential mortgage-backed securities:
Agency adjustable rate securities 1,774 0.1 76,491 3.7
Residential CMOs 130,850 5.0 725 0.1
Hybrid adjustable rate mortgages ("ARMs") 11,516 0.4 15,601 0.7
---------- ----- ---------- -----
Total RMBS 144,140 5.5 92,817 4.5
---------- ----- ---------- -----
Total securities available-for-sale $2,615,856 100.0% $2,076,936 100.0%
========== ===== ========== =====
Borrowings: At December 31, 2006 and 2005, the Company's debt consisted of
credit facilities, CDOs, senior unsecured notes, trust preferred securities,
reverse repurchase agreements, and commercial mortgage loans pools
collateralized by a pledge of most of the Company's securities
available-for-sale, securities held-for-trading, and its commercial mortgage
loans. The Company's financial flexibility is affected by its ability to renew
or replace on a continuous basis its maturing short-term borrowings. At December
31, 2006 and 2005, the Company obtained financing in amounts and at interest
rates consistent with the Company's short-term financing objectives.
Under the credit facilities and reverse repurchase agreements the lender retains
the right to mark the underlying collateral to its estimated fair value. A
reduction in the value of its pledged assets would require the Company to
provide additional collateral or fund margin calls. From time to time, the
Company expects that it will be required to provide such additional collateral
or fund margin calls.
55
The following table sets forth information regarding the Company's borrowings:
For the Year Ended
December 31, 2006
-----------------------------------------------
December 31, Maximum Range of
2006 Balance Balance Maturities
------------ ---------- -------------------
CDO debt* $1,812,574 $1,812,574 5.3 to 9.7 years
Commercial mortgage loan pools 1,250,503 1,278,908 2.0 to 12.0 years
Reverse repurchase agreements 799,669 1,079,980 8 to 81 days
Credit facilities 75,447 403,188 8 days to 1.1 years
Senior unsecured notes 75,000 75,000 10.0 years
Junior subordinated notes 180.477 180,407 29.1 years**
For the Year Ended
December 31, 2005
-------------------------------------------------
December 31, Maximum Range of
2005 Balance Balance Maturities
------------ ---------- ---------------------
CDO debt* $1,066,930 $1,306,963 5.9 to 8.1 years
Commercial mortgage loan pools 1,278,908 1,294,058 3.0 to 13.0 years
Reverse repurchase agreements 816,641 888,712 16 days to 20.0 years
Credit facilities 284,675 350,554 130 days to 2.0 years
Junior subordinated notes 77,380 77,380 29.7 years**
* Disclosed as adjusted issue price. Total par of the Company's CDO debt at
December 31, 2006 and 2005 was $1,824,063 and $1,079,463, respectively.
** The junior subordinated notes can be redeemed at par by the Company
beginning in October 2010.
The table above does not include interest payments on the Company's borrowings.
Such disclosure of interest payments has been omitted because certain borrowings
require variable rate interest payments. The Company's total interest payments
for the year ended December 31, 2006 were $208,879.
At December 31, 2006, the Company's borrowings had the following weighted
average yields and range of interest rates and yields:
Reverse Commercial Collateralized Senior Junior
Repurchase Lines of Mortgage Debt Unsecured Subordinated Total
Agreements Credit Loan Pools Obligations Notes Notes Borrowings
---------- -------- ---------- -------------- --------- ------------ ----------
Weighted average yield 5.37% 6.69% 3.99% 6.02% 7.21% 7.64% 5.39%
Interest Rate
Fixed --% --% 3.99% 6.68% 7.21% 7.64% 5.73%
Floating 5.37% 6.69% --% 5.58% --% --% 5.55%
Effective Yield
Fixed --% --% 3.99% 7.27% 7.21% 7.64% 5.89%
Floating 5.37% 6.69% --% 5.58% --% --% 5.55%
56
HEDGING INSTRUMENTS: The Company may modify its exposure to market interest
rates by entering into various financial instruments that adjust portfolio
duration. These financial instruments are intended to mitigate the effect of
changes in interest rates on the value of the Company's assets and the cost of
borrowing.
Interest rate hedging instruments at December 31, 2006 and 2005 consisted of the
following:
At December 31, 2006
-------------------------------------------------------
Notional Estimated Unamortized Average Remaining
Value Fair Value Cost Term (years)
-------- ---------- ----------- -----------------
Cash flow hedges $644,200 $5,048 -- 7.91
CDO cash flow hedges 895,499 8,230 -- 7.19
Trading swaps 80,000 2,033 -- 3.27
CDO timing swaps 223,445 212 -- 6.08
CDO LIBOR cap 85,000 (38) 1,407 6.40
At December 31, 2005
-------------------------------------------------------
Notional Estimated Unamortized Average Remaining
Value Fair Value Cost Term (years)
-------- ---------- ----------- -----------------
Cash flow hedges $500,350 $ 6,234 -- 8.42
CDO cash flow hedges 701,603 10,616 -- 7.51
Trading swaps 133,000 4,032 -- 6.83
CDO timing swaps 223,445 (37) -- 7.08
CDO LIBOR cap 85,000 1,419 1,407 7.40
Foreign currency agreements at December 31, 2006 consisted of the following:
At December 31, 2006
----------------------------------------
Average
Estimated Unamortized Remaining
Fair Value Cost Term
----------- ----------- -----------
Currency swaps $ 1,179 $ -- 12.53 years
CDO currency swaps (1,418) -- 12.53 years
Forwards (2,659) -- 10 days
At December 31, 2005
----------------------------------------
Average
Estimated Unamortized Remaining
Fair Value Cost Term
----------- ----------- -----------
Forwards $ 1,108 -- 10 days
The Company did not have any currency swaps at December 31, 2005.
CAPITAL RESOURCES AND LIQUIDITY
The Company requires capital to fund its investment activities and operating
expenses. The Company believes it currently has sufficient access to capital
resources to fund its existing business plan. The Company's capital sources
include cash flow from operations, borrowings under reverse repurchase
agreements, credit facilities, CDOs, and the issuance of preferred and common
equity securities.
57
The distribution requirements under the REIT provisions of the Code limit the
Company's ability to retain earnings and thereby replenish or increase capital
committed to its operations. However, the Company believes that its access to
significant capital resources and financing will enable the Company to meet
current and anticipated capital requirements.
The Company believes that its existing sources of funds will be adequate for
purposes of meeting its short- and long-term liquidity needs. The Company's
ability to meet its long-term (i.e., beyond one year) liquidity requirements is
subject to obtaining additional debt and equity financing. Any decision by the
Company's lenders and investors to provide the Company with financing will
depend upon a number of factors, such as the Company's compliance with the terms
of its existing credit arrangements, the Company's financial performance,
industry or market trends, the general availability of and rates applicable to
financing transactions, such lenders' and investors' resources and policies
concerning the terms under which they make capital commitments and the relative
attractiveness of alternative investment or lending opportunities.
Certain information with respect to the Company's borrowings at December 31,
2006 is summarized as follows:
Reverse Commercial Senior Trust
Repurchase Credit Mortgage Unsecured Preferred Total
CDOs Agreements Facilities Loan Pools Notes Securities Borrowings
---------- ---------- ---------- ---------- ----------- ----------- ----------
Outstanding borrowings $1,812,574 $799,669 $ 75,447 $1,250,503 $ 75,000 $ 180,477 $4,193,670
Weighted average
borrowing rate 6.02% 5.37% 6.69% 3.99% 7.20% 7.64% 5.39%
Weighted average
remaining maturity 7.0 years 78 days 193 days 5.8 years 10.0 years 29.1 years 6.3 years
Estimated fair value
of assets pledged $2,096,455 $854,074 $ 88,876 $1,271,014 -- -- $4,310,419
At December 31, 2006, the Company's borrowings had the following remaining
maturities:
Reverse Commercial Senior Trust
Repurchase Credit Mortgage Unsecured Preferred Total
CDOs* Agreements Facilities Loan Pools Notes Securities Borrowings
---------- ---------- ---------- ---------- ----------- ----------- ----------
Within 30 days $ -- $ 18,700 $27,569 $ -- $ -- $ -- $ 46,269
31 to 59 days -- -- -- -- -- -- --
60 days to less than 1
year -- 780,969 33,893 -- -- -- 814,863
1 year to 3 years -- -- 13,985 -- -- -- 13,985
3 years to 5 years -- -- -- -- -- -- --
Over 5 years 1,812,574 -- -- 1,250,503 75,000 180,477 3,318,554
---------- -------- ------- ---------- ------- -------- ----------
$1,812,574 $799,669 $75,447 $1,250,503 $75,000 $180,477 $4,193,670
========== ======== ======= ========== ======= ======== ==========
* At December 31, 2006, CDOs are comprised of $405,490 of CDO debt with a
weighted average remaining maturity of 5.29 years, $291,261 of CDO debt
with a weighted average remaining maturity of 5.63 years, $366,019 of CDO
debt with a weighted average remaining maturity of 6.39 years, $402,089 of
CDO debt with a weighted average remaining maturity of 9.68 years and
$347,715 of CDO debt with a weighted average remaining maturity of 7.75
years.
Reverse Repurchase Agreements and Credit Facilities
Reverse repurchase agreements are secured loans generally with a term of 90
days. The interest rate is based on 90-day LIBOR plus a spread that is
determined based on the asset pledged as security. The terms include a daily
mark to market provision that requires the posting of additional collateral if
the value of the pledged asset declines. After the 90-day period expires, there
is no obligation for the lender
58
to extend credit for an additional period. This type of financing generally is
available only for more liquid securities. The interest rate charged on reverse
repurchase agreements is usually the lowest relative to the alternatives due to
the lower risk inherent in these transactions.
Committed financing facilities represent multi-year agreements to provide
secured financing for a specific asset class. These facilities include a mark to
market provision requiring the Company to repay borrowings if the value of the
pledged asset declines in excess of a threshold amount. A significant difference
between committed financing facilities and reverse repurchase agreements is the
term of the financing. A committed facility provider generally is required to
provide financing for the full term of the agreement, usually two to three
years, rather than ninety days as generally used in the reverse repurchase
market. This longer term makes the financing of less liquid assets viable.
CDOs
Issuance of secured term debt is generally done through a CDO offering in a
private placement. This entails creating a special purpose entity that holds
assets used to secure the payments required of the debt issued. Asset cash flows
generally are matched with the debt service requirements over their respective
lives and an interest rate swap is used to match the fixed or floating rate
nature of the coupon payments where necessary. This type of transaction is
usually referred to as "match funding" or "term financing" the assets. There is
no mark to market requirement in this structure and the debt cannot be called or
terminated by the bondholders. Furthermore, the debt issued is non-recourse to
the issuer; and therefore permanent reductions in asset value do not affect the
liquidity of the Company. However, since the Company expects to earn a positive
spread between the income generated by the assets and the expense of the debt
issued, a permanent impairment of any of the assets would negatively affect the
spread over time.
Senior Unsecured Notes
During October 2006, the Company issued $75,000 of unsecured senior notes due in
2016 with a weighted average cost of funds of 7.21%. The unsecured senior notes
can be redeemed in whole by the Company subject to certain provisions, which
could include the payment of fees.
Trust Preferred
On September 26, 2005, the Company issued $75,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust I, a Delaware
statutory trust ("Trust I"). The trust preferred securities have a thirty-year
term ending October 30, 2035 with interest at a fixed rate of 7.497% for the
first ten years and at a floating rate of three-month LIBOR plus 2.9%
thereafter. The trust preferred securities can be redeemed at par by the Company
beginning in October 2010. Trust I issued $2,380 aggregate liquidation amount of
common securities, representing 100% of the voting common stock of Trust I to
the Company for a purchase price of $2,380. The Company realized net proceeds
from this offering of approximately $72,618.
On January 31, 2006, the Company issued $50,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust II, a Delaware
statutory trust ("Trust II"). The trust preferred securities have a thirty-year
term ending April 30, 2036 with interest at a fixed rate of 7.73% for the first
ten years and at a floating rate of three-month LIBOR plus 2.7% thereafter. The
trust preferred securities can be redeemed at par by the Company beginning in
April 2011. Trust II issued $1,550 aggregate liquidation amount of common
securities, representing 100% of the voting common stock of Trust II to the
Company for a purchase price of $1,550. The Company realized net proceeds from
this offering of approximately $48,491.
59
On March 16, 2006, the Company issued $50,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust III, a Delaware
statutory trust ("Trust III"). The trust preferred securities have a thirty-year
term ending March 15, 2036 with interest at a fixed rate of 7.77% for the first
ten years and at a floating rate of three-month LIBOR plus 2.7% thereafter. The
trust preferred securities can be redeemed at par by the Company beginning in
March 2011. Trust III issued $1,547 aggregate liquidation amount of common
securities, representing 100% of the voting common stock of Trust III to the
Company for a purchase price of $1,547. The Company realized net proceeds from
this offering of approximately $48,435.
Preferred Equity Issuances
The Company may issue preferred stock from time to time as a source of long-term
or permanent capital. Preferred stock generally has a fixed coupon and may have
a fixed term in the form of a maturity date or other redemption or conversion
features. The preferred stockholder typically has the right to a preferential
distribution for dividends and any liquidity proceeds.
On February 12, 2007, the Company issued $86,250 of Series D Cumulative
Redeemable Preferred Stock ("Series D Preferred Stock"), including $11,250 of
Series D Preferred Stock sold to underwriters pursuant to an over-allotment
option. The Series D Preferred Stock will pay an annual dividend of 8.25%.
Common Equity Issuances
Another source of permanent capital is the issuance of common stock through a
follow-on offering. This allows investors to purchase a large block of common
stock in one transaction. A common stock issuance can be accretive to the
Company's book value per share if the issue price per share exceeds the
Company's book value per share. It also can be accretive to earnings per share
if the Company deploys the new capital into assets that generate a risk adjusted
return that exceeds the return of the Company's existing assets. Furthermore,
earnings accretion also can be achieved at reinvestment rates that are lower
than the return on existing assets if common stock is issued at a premium to
book value.
The Company continuously evaluates the market for follow-on Common Stock
offerings as well as the available opportunities to deploy new capital on an
accretive basis. In 2005, the Company issued 1,725,000 shares of Common Stock in
a follow-on offering at $11.59 per share. Additionally, for the years ended
December 31, 2006 and 2005, respectively, the Company issued 608,747 and
1,318,568 shares of Common Stock under its Dividend Reinvestment Plan. Net
proceeds to the Company under the Dividend Reinvestment Plan were approximately
$6,517 and $14,327, respectively.
For the year ended December 31, 2006, the Company issued 664,900 shares of
Common Stock under a sales agency agreement with Brinson Patrick Securities
Corporation. Net proceeds to the Company were approximately $8,625.
Off Balance Sheet Arrangements
The Company's ownership of the subordinated classes of CMBS from a single issuer
gives it the right to influence the foreclosure/workout process on the
underlying loans ("Controlling Class CMBS"). FASB Staff Position FIN 46(R)-5,
Implicit Variable Interests under FASB Interpretation No. 46 ("FIN 46(R)-5") has
certain scope exceptions, one of which provides that an enterprise that holds a
variable interest in a QSPE does not consolidate that entity unless that
enterprise has the unilateral ability to cause the entity to liquidate. SFAS No.
140 provides the requirements for an entity to be considered a QSPE. To
60
maintain the QSPE exception, the trust must continue to meet the QSPE criteria
both initially and in subsequent periods. A trust's QSPE status can be impacted
in future periods by activities by its transferors or other involved parties,
including the manner in which certain servicing activities are performed. To the
extent its CMBS investments were issued by a trust that meets the requirements
to be considered a QSPE, the Company records the investments at the purchase
price paid. To the extent the underlying trusts are not QSPEs the Company
follows the guidance set forth in FIN 46(R)-5 as the trusts would be considered
VIEs.
The Company has analyzed the governing pooling and servicing agreements for each
of its Controlling Class CMBS and believes that the terms are consistent with
the QSPE criteria and are industry standard. However, there is uncertainty with
respect to QSPE treatment due to ongoing review by accounting standard setters,
potential actions by various parties involved with the QSPE, as discussed above,
as well as varying and evolving interpretations of the QSPE criteria under SFAS
No. 140. Additionally, the standard setters continue to review the FIN 46(R)-5
provisions related to the computations used to determine the primary beneficiary
of a VIE. Future guidance from the standard setters may require the Company to
consolidate CMBS trusts in which the Company has invested.
At December 31, 2006, the Company owned securities of 29 Controlling Class CMBS
trusts with a par of $1,171,054. The total par amount of CMBS issued by the 29
trusts was $42,398,701. One of the Company's 29 Controlling Class trusts does
not qualify as a QSPE and has been consolidated by the Company (see Note 5 of
the consolidated financial statements).
The Company's maximum exposure to loss as a result of its investment in these
VIEs totaled $762,567 and $565,231 at December 31, 2006 and 2005, respectively.
In addition, the Company has completed two securitizations that qualify as
QSPE's under SFAS No. 140. Through CDO HY1 and CDO HY2 the Company issued
non-recourse liabilities secured by commercial related assets including portions
of 17 Controlling Class CMBS. Should future guidance from the standard setters
determine that Controlling Class CMBS are not QSPE's, the Company would be
required to consolidate the assets, liabilities, income and expense of CDO HY1
and CDO HY2.
The Company's total maximum exposure to loss as a result of its investment in
CDO HY1 and CDO HY2 at December 31, 2006 and 2005, respectively, was $111,076
and $109,003.
The Company also owns non-investment debt and preferred securities in LEAFs CMBS
I Ltd ("Leaf"), a QSPE under SFAS No. 140. Leaf issued non-recourse liabilities
secured by investment grade commercial real estate securities. At December 31,
2006 and 2005, the Company's total maximum exposure to loss as a result of its
investment in Leaf was $6,796 and $6,936, respectively.
Cash Flows
Cash provided by operating activities is net income adjusted for certain
non-cash items and changes in assets and liabilities including the Company's
trading securities. Operating activities provided cash flows of $117,655,
107,373, and 125,756 for the year ended December 31, 2006, 2005, and 2004,
respectively. Operating cash flow is affected by the purchase and sale of fixed
income securities classified as trading securities. Proceeds received from
repayment of trading securities also increases operating cash flows. The Company
received $36,140, $43,477, and $69,345 from trading securities for the year
ended December 31, 2006, 2005, and 2004, respectively. In addition, in 2006 the
Company closed interest rate swaps classified as a cash flow hedges and received
cash of $11,634.
61
The Company's investing cash flow consists primarily of the purchase, sale, and
repayments on securities activities available for sale, commercial loan pools,
commercial mortgage loans and equity investments. The Company's investing
activities used cash flows of $703,451, $419,992, and $95,022 during the year
ended December 31, 2006, 2005, and 2006, respectively. The variance in investing
cash flows is primarily attributable to significant purchases of securities and
commercial mortgage loans.
Net cash flow provided by (used in) financing activities was $611,628, $329,420,
and $(27,784) for the years ended December 31, 2006, 2005, and 2004,
respectively, primarily due to borrowings and repayments under reverse
repurchase agreements and credit facilities and dividends payments, offset by
common stock issuances, and CDO issuances. In addition, at the end of the first
quarter of 2004, the Board of Directors approved the Company's decision to
redeem its Series B Preferred Stock, $0.001 par value per share ("Series B
Preferred Stock") for $43,930. The Series B Preferred Stock was redeemed on May
6, 2004.
TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement, an administrative services agreement and
an accounting services agreement with the Manager, the employer of certain
directors and all of the officers of the Company, under which the Manager and
the Company's officers manage the Company's day-to-day investment operations,
subject to the direction and oversight of the Company's Board of Directors.
Pursuant to the Management Agreement and these other agreements, the Manager and
the Company's officers formulate investment strategies, arrange for the
acquisition of assets, arrange for financing, monitor the performance of the
Company's assets and provide certain other advisory, administrative and
managerial services in connection with the operations of the Company. For
performing certain of these services, the Company pays the Manager under the
Management Agreement a base management fee equal to 2.0% of the quarterly
average total stockholders' equity for the applicable quarter.
To provide an incentive, the Manager is entitled to receive an incentive fee
under the Management Agreement equal to 25% of the amount by which the rolling
four-quarter GAAP net income before the incentive fee exceeds the greater of
8.5% or 400 basis points over the ten-year Treasury note multiplied by the
adjusted per share issue price of the Company's Common Stock ($11.37 per common
share at December 31, 2006). Additionally, up to 30% of the incentive fees
earned in 2005 or after may be paid in shares of the Company's Common Stock
subject to certain provisions under a compensatory deferred stock plan approved
by the stockholders of the Company in 2006. The Board of Directors also
authorized a stock based incentive plan where one-half of one percent of common
shares outstanding was paid to the Manager in 2006.
The Company's unaffiliated directors approved an extension of the Management
Agreement to March 30, 2008 at the Board's March 2007 meeting.
The following is a summary of management and incentive fees incurred for the
year ended December 31, 2006, 2005 and 2004:
For the Year Ended
December 31,
--------------------------
2006 2005 2004
------- ------- ------
Management fee $12,617 $10,974 $8,956
Incentive fee 5,919 4,290 --
Incentive fee- stock based 2,761 -- --
------- ------- ------
Total management and incentive fees $21,297 $15,264 $8,956
======= ======= ======
62
At December 31, 2006, 2005, and 2004, respectively, management and incentive
fees of $8,989, $5,734, and $2,309 remain payable to the Manager and are
included on the accompanying consolidated statement of financial condition as a
component of other liabilities.
In accordance with the provisions of the Management Agreement, the Company
recorded reimbursements to the Manager of $400, $350, and $120 for certain
expenses incurred on behalf of the Company during 2006, 2005, and 2004,
respectively.
The Company also has administration and accounting services agreements with
the Manager. Under the terms of the administration agreement, the Manager
provides financial reporting, audit coordination and accounting oversight
services to the Company. Under the terms of the accounting services agreement,
the Manager provides investment accounting services to the Company. For the
years ended December 31, 2006, 2005, and 2004, the Company paid administration
fees of $234, $209, and $174, respectively, which are included in general and
administrative expense on the accompanying statement of operations. No payments
were made in each of the three years in the period ended December 31, 2006 under
the accounting services agreement.
The special servicer on 25 of the Company's 29 Controlling Class trusts is
Midland Loan Services, Inc. ("Midland"), a wholly owned indirect subsidiary of
PNC Bank, and therefore a related party of the Manager. The Company's fees for
Midland's services are at market rates.
On December 13, 2005, the Company entered into a $75,000 commitment to acquire
shares of BlackRock Diamond. BlackRock Diamond is a private REIT managed by
BlackRock Realty Advisors, Inc., a subsidiary of the Manager. On February 21,
2006, the Company increased its capital commitment by an additional $25,000,
resulting in a total capital commitment of $100,000. At December 31, 2006, 93%
of the commitment had been called and the Company owned approximately 21% of
BlackRock Diamond. The Company does not incur any additional management or
incentive fees to the Manager related to its investment in BlackRock Diamond.
The Company's investment in BlackRock Diamond at December 31, 2006 was $105,894.
At December 31, 2006, the Company had $7,397 of remaining capital commitments to
BlackRock Diamond, all of which was called in January 2007.
During 2001, the Company entered into a $50,000 commitment to acquire shares in
Carbon I, a private commercial real estate income opportunity fund managed by
the Manager. The Carbon I investment period ended on July 12, 2004 and the
Company's investment in Carbon I at December 31, 2006 was $3,144. The Company
does not incur any additional management or incentive fees to the Manager
related to its investment in Carbon I. On December 31, 2006, the Company owned
approximately 20% of the outstanding shares in Carbon I.
The Company entered into an aggregate commitment of $100,000 to acquire shares
in Carbon II, a private commercial real estate income opportunity fund managed
by the Manager. At December 31, 2006, the Company's investment in Carbon II was
$69,259 and the Company's remaining commitment to Carbon II is $28,958. The
Company does not incur any additional management or incentive fees to the
Manager related to its investment in Carbon II. On December 31, 2006, the
Company owned approximately 26% of the outstanding shares in Carbon II.
The Company's unaffiliated directors approved the investments in BlackRock
Diamond and the Carbon Capital Funds prior to the investments being made.
63
REIT STATUS: The Company has elected to be taxed as a REIT and therefore must
comply with the provisions of the Code with respect thereto. Accordingly, the
Company generally will not be subject to Federal income tax to the extent of its
distributions to stockholders and as long as certain asset, income, and stock
ownership tests are met. The Company may, however, be subject to tax at
corporate rates or at excise tax rates on net income or capital gains not
distributed.
64
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK: Market risk includes the exposure to loss resulting from changes in
interest rates, credit curve spreads, foreign currency exchange rates, commodity
prices and equity prices. The primary market risks to which the Company is
exposed are interest rate risk, credit curve risk and foreign currency risk.
Interest rate risk is highly sensitive to many factors, including governmental,
monetary and tax policies, domestic and international economic and political
considerations and other factors beyond the control of the Company. Credit curve
risk is highly sensitive to the dynamics of the markets for commercial real
estate securities and other loans and securities held by the Company. Excessive
supply of these assets combined with reduced demand will cause the market to
require a higher yield. This demand for higher yield will cause the market to
use a higher spread over the U.S. Treasury securities yield curve, or other
benchmark interest rates, to value these assets. Changes in the general level of
the U.S. Treasury yield curve can have significant effects on the estimated fair
value of the Company's portfolio.
The majority of the Company's assets are fixed rate securities valued based on a
market credit spread to U.S. Treasuries. As U.S. Treasury securities are priced
to a higher yield and/or the spread to U.S. Treasuries used to price the
Company's assets is increased, the estimated fair value of the Company's
portfolio may decline. Conversely, as U.S. Treasury securities are priced to a
lower yield and/or the spread to U.S. Treasuries used to price the Company's
assets is decreased, the estimated fair value of the Company's portfolio may
increase. Changes in the estimated fair value of the Company's portfolio may
affect the Company's net income or cash flow directly through their impact on
unrealized gains or losses on securities held-for-trading or indirectly through
their impact on the Company's ability to borrow. Changes in the level of the
U.S. Treasury yield curve can also affect, among other things, the prepayment
assumptions used to value certain of the Company's securities and the Company's
ability to realize gains from the sale of such assets. In addition, changes in
the general level of the LIBOR money market rates can affect the Company's net
interest income. At December 31, 2006, all of the Company's collateralized
liabilities outside of the CDOs are floating rate based on a market spread to
LIBOR. As the level of LIBOR increases or decreases, the Company's interest
expense will move in the same direction.
The Company may utilize a variety of financial instruments, including interest
rate swaps, caps, floors and other interest rate exchange contracts, in order to
limit the effects of fluctuations in interest rates on its operations. The use
of these types of derivatives to hedge interest-earning assets and/or
interest-bearing liabilities carries certain risks, including the risk that
losses on a hedge position will reduce the funds available for payments to
holders of securities and that such losses may exceed the amount invested in
such instruments. A hedge may not perform its intended purpose of offsetting
losses or rising interest rates. Moreover, with respect to certain of the
instruments used as hedges, the Company is exposed to the risk that the
counterparties with which the Company trades may cease making markets and
quoting prices in such instruments, which may render the Company unable to enter
into an offsetting transaction with respect to an open position. If the Company
anticipates that the income from any such hedging transaction will not be
qualifying income for REIT income purposes, the Company may conduct part or all
of its hedging activities through a to-be-formed corporate subsidiary that is
fully subject to Federal corporate income taxation. The profitability of the
Company may be adversely affected during any period as a result of changing
interest rates.
The Company monitors and manages interest rate risk based on a method that takes
into consideration the interest rate sensitivity of the Company's assets and
liabilities, including preferred stock. The Company's objective is to acquire
assets and match fund the purchase so that interest rate risk associated with
financing these assets is reduced or eliminated. The primary risks
65
associated with acquiring and financing these assets under 90-day repurchase
agreements and committed borrowing facilities are mark-to-market risk and
short-term rate risk. Certain secured financing arrangements provide for an
advance rate based upon a percentage of the estimated fair value of the asset
being financed. Market movements that cause asset values to decline would
require a margin call or a cash payment to maintain the relationship between
asset value and amount borrowed. A cash flow based CDO is an example of a
secured financing vehicle that does not require a mark-to-market to establish or
maintain a level of financing. When financed assets are subject to a
mark-to-market margin call, the Company carefully monitors the interest rate
sensitivity of those assets. The duration of the assets financed which are
subject to a mark-to-market margin call was 2.0 years based on net asset value
at December 31, 2006. This means that a 100 basis point increase in interest
rates would cause a margin call of approximately $13,000.
Net interest income sensitivity to changes in interest rates is analyzed using
the assumptions that interest rates, as defined by the LIBOR curve, increase or
decrease and that the yield curves of the LIBOR rate shocks will be parallel to
each other.
Regarding the table below, all changes in net interest income are measured as
percentage changes from the respective values calculated in the scenario labeled
as "Base Case." The base interest rate scenario assumes interest rates at
December 31, 2006. Actual results could differ significantly from these
estimates.
PROJECTED PERCENTAGE CHANGE IN EARNINGS
PER SHARE GIVEN LIBOR MOVEMENTS
----------------------------------------
Change in LIBOR, Projected Change
+/- Basis Points in Earnings per Share
---------------- ---------------------
-200 $ 0.03
-100 $ 0.01
-50 $ 0.01
Base Case
+50 $(0.01)
+100 $(0.01)
+200 $(0.03)
The Company's GAAP book value incorporates the estimated fair value of the
Company's interest bearing assets but it does not incorporate the estimated fair
value of the Company's interest bearing fixed rate liabilities and preferred
stock. The fixed rate liabilities and preferred stock generally will reduce the
actual interest rate risk of the Company from an economic perspective even
though changes in the estimated fair value of these liabilities are not
reflected in the Company's reported book value. The Company focuses on economic
risk in managing its sensitivity to interest rates and maintains an economic
duration within a band of 2.0 to 5.0 years. At December 31, 2006, economic
duration for the Company's entire portfolio was 2.3 years. This implies that for
each 100 basis points of change in interest rates the Company's economic value
will change by approximately 2.3%. At December 31, 2006 the Company estimates
its economic value, or net asset value of its common stock to be $572,947.
66
A reconciliation of the economic duration of the Company to the duration of the
reported book value of the Company's common stock is as follows:
Duration - GAAP book value at December 31, 2006 8.3
Less:
Duration contribution of CDO I liabilities (1.2)
Duration contribution of CDO II liabilities (1.0)
Duration contribution of CDO III liabilities (1.0)
Duration contribution of CDO HY3 liabilities (0.8)
Duration contribution of Euro CDO liabilities (0.1)
Duration contribution of Series C Preferred Stock (0.1)
Duration contribution of junior subordinated notes (1.1)
Duration contribution of senior unsecured notes (0.7)
----
Economic duration at December 31, 2006 2.3
====
The GAAP book value of the Company's common stock is $10.35 per share. As
indicated in the table above a 100 basis point change in interest rates will
change reported book value by approximately 8.3%, or $54,000. As indicated
above, approximately $13,000 of that change would be required to meet margin
calls in the event rates rise by 100 basis points.
CREDIT RISK: The Company's portfolios of commercial real estate assets are
subject to a high degree of credit risk. Credit risk is the exposure to loss
from loan defaults. Default rates are subject to a wide variety of factors,
including, but not limited to, property performance, property management,
supply/demand factors, construction trends, consumer behavior, regional
economics, interest rates, the strength of the U.S. economy, and other factors
beyond the control of the Company.
All loans are subject to a certain probability of default. Before acquiring a
Controlling Class security, the Company will perform an analysis of the quality
of all of the loans proposed. As a result of this analysis, loans with
unacceptable risk profiles are either removed from the proposed pool or the
Company receives a price adjustment. The Company underwrites its Controlling
Class CMBS investments assuming the underlying loans will suffer a certain
dollar amount of defaults and these defaults will lead to some level of realized
losses. Loss adjusted yields are computed based on these assumptions and applied
to each class of security supported by the cash flow on the underlying loans.
The most significant variables affecting loss adjusted yields include, but are
not limited to, the number of defaults, the severity of loss that occurs
subsequent to a default and the timing of the actual loss. The different rating
levels of CMBS will react differently to changes in these assumptions. The
lowest rated securities (B- or lower) are generally more sensitive to changes in
timing of actual losses. The higher rated securities (B or higher) are more
sensitive to the severity of losses and timing of cash flows.
The Company generally assumes that all of the principal of a non-rated security
and a significant portion, if not all, of CCC and a portion of B- rated
securities will not be recoverable over time. The loss adjusted yields of these
classes reflect that assumption; therefore, the timing of when the total loss of
principal occurs is the most important assumption in determining value. The
interest coupon generated by a security will cease when there is a total loss of
its principal regardless of whether that principal is paid. Therefore, timing is
of paramount importance because the longer the principal balance remains
outstanding, the more interest coupon the holder receives; which results in a
larger economic return. Alternatively, if principal is lost faster than
originally assumed, there is less opportunity to receive interest coupon; which
results in a lower or possibly negative return.
67
If actual principal losses on the underlying loans exceed estimated loss
assumptions, the higher rated securities will be affected more significantly as
a loss of principal may not have been assumed. The Company generally assumes
that all principal will be recovered by classes rated B or higher. The Company
manages credit risk through the underwriting process, establishing loss
assumptions and careful monitoring of loan performance. After the securities
have been acquired, the Company monitors the performance of the loans, as well
as external factors that may affect their value.
Factors that indicate a higher loss severity or acceleration of the timing of an
expected loss will cause a reduction in the expected yield and therefore reduce
the earnings of the Company. Furthermore, the Company may be required to
write-down a portion of the adjusted purchase price of the affected assets
through its consolidated statements of operations.
For purposes of illustration, a doubling of the losses in the Company's
Controlling Class CMBS, without a significant acceleration of those losses,
would reduce GAAP income by approximately $0.87 per share of Common Stock per
year and cause a significant write-down at the time the loss assumption is
changed. The amount of the write-down depends on several factors, including
which securities are most affected at the time of the write-down, but is
estimated to be in the range of $0.01 to $0.19 per share based on a doubling of
expected losses. A significant acceleration of the timing of these losses would
cause the Company's net income to decrease. The Company's exposure to a
write-down is mitigated by the fact that most of these assets are financed on a
non-recourse basis in the Company's CDOs, where a significant portion of the
risk of loss is transferred to the CDO bondholders. At December 31, 2006,
securities with a total estimated fair value of $2,103,441 are collateralizing
the CDO borrowings of $1,828,078; therefore, the Company's preferred equity
interest in the five CDOs is $275,363 ($4.76 per share).
ASSET AND LIABILITY MANAGEMENT: Asset and liability management is concerned with
the timing and magnitude of the re-pricing and/or maturing of assets and
liabilities. It is the Company's objective to attempt to control risks
associated with interest rate movements. In general, management's strategy is to
match the term of the Company's liabilities as closely as possible with the
expected holding period of the Company's assets. This is less important for
those assets in the Company's portfolio considered liquid, as there is a very
stable market for the financing of these securities.
Other methods for evaluating interest rate risk, such as interest rate
sensitivity "gap" (defined as the difference between interest-earning assets and
interest-bearing liabilities maturing or re-pricing within a given time period),
are used but are considered of lesser significance in the daily management of
the Company's portfolio. Management considers this relationship when reviewing
the Company's hedging strategies. Because different types of assets and
liabilities with the same or similar maturities react differently to changes in
overall market rates or conditions, changes in interest rates may affect the
Company's net interest income positively or negatively even if the Company were
to be perfectly matched in each maturity category.
CURRENCY RISK: The Company has foreign currency rate exposures related to
certain CMBS and commercial real estate loans. The Company's principal currency
exposures are to the Euro and British pound. Changes in currency rates can
adversely impact the fair values and earnings of the Company's non-U.S.
holdings. The Company mitigates this impact by utilizing local
currency-denominated financings on its foreign investments and foreign currency
forward commitments and swaps to hedge the net exposure.
68
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
Management's Report on Internal Control Over Financial Reporting.............. 70
Report of Independent Registered Public Accounting Firm on
Internal Control Over Financial Reporting..................................... 71
Report of Independent Registered Public Accounting Firm....................... 73
Consolidated Financial Statements:
Consolidated Statements of Financial Condition at December 31, 2006 and 2005.. 74
Consolidated Statements of Operations
For the Years Ended December 31, 2006, 2005, and 2004......................... 75
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31 2006, 2005, and 2004.......................... 76
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2006, 2005, and 2004......................... 78
Notes to Consolidated Financial Statements.................................... 80
All schedules have been omitted because either the required information is not
applicable or the information is shown in the financial statements or notes
thereto.
69
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Anthracite Capital, Inc. is responsible for establishing and
maintaining adequate internal control over financial reporting. Internal control
over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended, as a process designed by, or under
the supervision of, the Company's principal executive and principal financial
officers and effected by the Company's Board of Directors, management and other
personnel to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles and includes those
policies and procedures that:
- pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the
assets of the Company;
- provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and
- provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the Company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
can provide only reasonable assurance with respect to financial statement
preparation and presentation. Projections of any evaluation of effectiveness to
future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control over
financial reporting at December 31, 2006. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on its assessment, management concluded that, at December 31, 2006, the
Company's internal control over financial reporting is effective.
The Company's independent registered public accounting firm has issued a report
on management's assessment of the Company's internal control over financial
reporting. This report begins on the following page.
70
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Anthracite Capital, Inc.
New York, New York
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that
Anthracite Capital, Inc. and subsidiaries (the "Company") maintained effective
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on
71
the criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statement of
financial condition as of December 31, 2006, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2006 of the Company and
our report dated March 14, 2007 expressed an unqualified opinion on those
financial statements.
/s/ Deloitte & Touche LLP
New York, New York
March 14, 2007
72
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Anthracite Capital, Inc.
New York, New York
We have audited the accompanying consolidated statements of financial condition
of Anthracite Capital, Inc. and subsidiaries (the "Company") as of December 31,
2006 and 2005, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2006. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Anthracite Capital, Inc. and
subsidiaries as of December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2006, in conformity with accounting principles generally accepted
in the United States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006, based on the
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 14, 2007 expressed an unqualified opinion on management's assessment
of the effectiveness of the Company's internal control over financial reporting
and an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
/s/ Deloitte & Touche LLP
New York, New York
March 14, 2007
73
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT SHARE DATA)
December 31, 2006 December 31, 2005
----------------------- -----------------------
ASSETS
Cash and cash equivalents $ 66,388 $ 40,556
Restricted cash equivalents 59,801 1,246
Securities available-for-sale, at fair value
CMBS $ 883,432 $ 826,955
Investment grade CMBS 1,588,284 1,157,164
RMBS 144,140 92,817
---------- ----------
Total securities available-for-sale 2,615,856 2,076,936
Commercial mortgage loan pools, at amortized cost 1,271,014 1,292,407
Securities held-for-trading, at estimated fair value
CMBS 22,383 21,264
RMBS 132,204 166,209
---------- ----------
Total securities held-for-trading 154,587 187,473
Commercial mortgage loans, net 481,745 365,806
Equity investments 182,147 110,650
Derivative instruments, at fair value 317,574 102,845
Other assets 69,151 56,906
---------- ----------
Total Assets $5,218,263 $4,234,825
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Borrowings:
CDOs $1,812,574 $1,066,930
Secured by pledge of subordinated CMBS 48,628 83,213
Secured by pledge of other securities available-for-sale 666,275 606,209
Secured by pledge of commercial mortgage loan pools 1,256,897 1,278,908
Secured by pledge of securities held-for-trading 127,249 176,361
Secured by pledge of commercial mortgage loans 26,570 229,556
Senior unsecured notes 75,000 --
Junior subordinated notes to subsidiary trust issuing preferred
securities 180,477 77,380
---------- ----------
Total borrowings 4,193,670 3,518,557
Payable for investments purchased 23,796 --
Distributions payable 17,669 16,673
Derivative instruments, at fair value 304,987 79,473
Other liabilities 22,032 22,104
---------- ----------
Total Liabilities $4,562,154 $3,636,807
---------- ----------
Commitments and Contingencies
Stockholders' Equity:
Common Stock, par value $0.001 per share; 400,000,000 shares
authorized;
57,830,964 shares issued and outstanding in 2006;
56,338,540 shares issued and outstanding in 2005
58 56
9.375% Series C Preferred stock, liquidation preference $57,500 55,435 55,435
Additional paid-in capital 629,785 612,368
Distributions in excess of earnings (120,976) (130,038)
Accumulated other comprehensive income 91,807 60,197
---------- ----------
Total Stockholders' Equity 656,109 598,018
---------- ----------
Total Liabilities and Stockholders' Equity $5,218,263 $4,234,825
========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
74
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
Year ended December 31,
---------------------------------------
2006 2005 2004
----------- ----------- -----------
Income:
Interest from securities available-for-sale $ 171,686 $ 141,113 $ 131,342
Interest from commercial mortgage loans 41,773 23,183 11,896
Interest from commercial mortgage loan pools 52,917 54,025 39,672
Interest from securities held-for-trading 7,207 11,370 11,419
Earnings from equity investments 27,431 12,087 7,060
Earnings from real estate joint ventures -- 59 1,097
Interest from cash and cash equivalents 2,403 2,077 638
Other income -- -- 742
----------- ----------- -----------
Total Income 303,417 243,914 203,866
----------- ----------- -----------
Expenses:
Interest 205,023 156,865 124,289
Interest - securities held-for-trading 7,365 6,593 3,877
Management and incentive fees 21,297 15,264 8,956
General and administrative expense 4,533 3,917 3,427
----------- ----------- -----------
Total Expenses 238,218 182,639 140,549
----------- ----------- -----------
Other gain (loss):
Sale of securities available-for-sale 29,032 16,543 17,544
Dedesignation of derivative instruments (12,661) -- --
Securities held-for-trading 3,254 (1,999) (11,464)
Foreign currency gain (loss) 2,161 (134) (187)
Loss on impairment of assets (7,880) (5,088) (26,018)
----------- ----------- -----------
Total Other gain (loss) 13,906 9,322 (20,125)
----------- ----------- -----------
Income from continuing operations 79,105 70,597 43,192
----------- ----------- -----------
Income from discontinued operations 1,366 -- --
----------- ----------- -----------
Net income 80,471 70,597 43,192
----------- ----------- -----------
Dividends on Preferred Stock 5,392 5,392 6,916
Cost to retire preferred stock in excess of carrying value -- -- 10,508
----------- ----------- -----------
Net income available to Common Stockholders $ 75,079 $ 65,205 $ 25,768
=========== =========== ===========
Net income per common share, basic $ 1.31 $ 1.20 $ 0.50
Net income per common share, diluted $ 1.31 $ 1.20 $ 0.50
Weighted average number of shares outstanding:
Basic 57,182,434 54,144,243 51,766,877
Diluted 57,401,664 54,152,820 51,775,780
Dividend declared per share of Common Stock $ 1.15 $ 1.12 $ 1.12
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
75
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2006, 2005 AND 2004 (IN THOUSANDS)
Common Series Series Accumulated
Stock, B C Additional Distributions Other Total
Par Preferred Preferred Paid-In In Excess Comprehensive Comprehensive Stockholders'
Value Stock Stock Capital Of Earnings Income (Loss) Income Equity
------ --------- --------- ---------- ------------- ------------- ------------- -------------
Balance at December 31, 2003 $49 $ 33,431 $55,435 $536,333 $(101,635) $(106,183) $417,430
Net Income 43,192 $ 43,192 43,192
Unrealized gain on cash flow
hedges 1,078 1,078 1,078
Reclassification adjustments
from cash flow hedges
included in net income 6,133 6,133 6,133
Change in net unrealized gain
on securities
available-for-sale, net of
reclassification
adjustment 112,378 112,378 112,378
--------
Other comprehensive income 119,589
--------
Comprehensive income $162,781
========
Dividends declared-common
stock (58,208) (58,208)
Dividends on preferred stock (6,916) (6,916)
Issuance of common stock 4 42,577 42,581
Conversion of Series B
preferred stock to common
stock (9) 9 --
Redemption of Series B
preferred stock (33,422) (10,508) (43,930)
--- -------- ------- -------- --------- --------- --------
Balance at December 31, 2004 $53 $ -- $55,435 $578,919 $(134,075) $ 13,406 $513,738
Net Income 70,597 $ 70,597 70,597
Unrealized gain on cash flow
hedges 26,626 26,626 26,626
Reclassification adjustments
from cash flow hedges
included in net income 6,129 6,129 6,129
Change in net unrealized gain
on securities
available-for-sale, net of
reclassification
adjustment 14,036 14,036 14,036
--------
Other comprehensive income 46,791
--------
Comprehensive income $117,388
========
Dividends declared-common
stock (61,168) (61,168)
Dividends on preferred stock (5,392) (5,392)
Issuance of common stock 3 33,449 33,452
--- -------- ------- -------- --------- --------- --------
Balance at December 31, 2005 $56 $ -- $55,435 $612,368 $(130,038) $ 60,197 $598,018
Net Income 80,471 $ 80,471 80,471
Unrealized gain on cash flow
hedges 2,961 2,961 2,961
Reclassification adjustments
from cash flow hedges
included in net loss 5,029 5,029 5,029
Foreign currency translation 204 204 204
Dedesignation of cash flow
hedges 12,661 12,661 12,661
Change in net unrealized gain
on securities
available-for-sale, net of
reclassification
adjustment 10,755 10,755 10,755
--------
Other comprehensive income 31,610
--------
Comprehensive income $112,081
========
Dividends declared-common
stock (66,017) (66,017)
Dividends on preferred stock (5,392) (5,392)
Issuance of common stock 2 17,417 17,419
--- -------- ------- -------- --------- --------- --------
Balance at December 31, 2006 $58 $ -- $55,435 $629,785 $(120,976) $ 91,807 $656,109
76
DISCLOSURE OF RECLASSIFICATION ADJUSTMENT:
Year ended December 31,
-----------------------------
2006 2005 2004
------- -------- --------
Unrealized holding gain (loss) on securities $ 7,249 $(2,507) $ 94,834
available-for-sale
Reclassification for realized gains
previously recorded as unrealized 16,371 16,543 17,544
------- ------- --------
$23,620 $14,036 $112,378
======= ======= ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
77
ANTHRACITE CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW (IN THOUSANDS)
Year Ended December 31,
---------------------------------
2006 2005 2004
--------- --------- ---------
Cash flows from operating activities:
Net income $ 80,471 $ 70,597 $ 43,192
Adjustments to reconcile net income to net cash provided by
operating activities:
Decrease in trading securities 36,140 43,447 69,345
Net gain on sale of securities (19,625) (14,544) (6,080)
Gain on sale of real estate held for sale (1,366) -- --
Earnings from subsidiary trust (388) (47) --
Distributions from subsidiary trust 363 45 --
Earnings from equity investments and real estate joint ventures (27,431) (12,146) (8,157)
Distributions of earnings from equity investments and
real estate joint ventures 19,725 8,483 9,290
Amortization of collateralized debt obligation issuance costs 2,677 2,214 2,083
Amortization of junior subordinated note issuance costs 197 34 --
Amortization of senior unsecured notes issuance costs 32 -- --
(Discount accretion) premium amortization, net (469) 5,426 (3,202)
Loss on impairment of assets 7,880 5,088 26,018
Unrealized net foreign currency (gain) loss (19,200) 632 6
Non-cash management and incentive fees 4,537 1,287 --
Non-cash directors compensation 64 65 --
Proceeds (disbursements) from sale of interest rate swap agreements 11,634 (2,108) (20,623)
Decrease (increase) in other assets 33,832 (251) 24,726
(Decrease) increase in other liabilities (11,418) (849) (10,842)
--------- --------- ---------
Net cash provided by operating activities 117,655 107,373 125,756
--------- --------- ---------
Cash flows from investing activities:
Purchase of securities available-for-sale (806,452) (517,022) (411,920)
Proceeds from sale of securities available-for-sale 236,945 172,737 486,942
Principal payments received on securities available-for-sale 51,193 53,779 79,157
Purchase of securities related to consolidated variable interest entity -- -- (22,669)
Sale of securities related to consolidated variable interest entity -- -- 5,847
Repayments received from commercial mortgage loan pools 9,004 7,876 4,829
Purchase of real estate held-for-sale (5,435) -- --
Proceeds from sale of real estate held-for-sale 6,801 -- --
Funding of commercial mortgage loans (270,362) (243,557) (226,997)
Repayments received from commercial mortgage loans 197,094 112,830 23,285
Sale of commercial mortgage loans -- 20,072 --
(Increase) decrease in restricted cash equivalents (58,448) 18,434 (6,835)
Return of capital from equity investments and joint ventures 14,742 26,868 9,510
Investment in equity investments (78,533) (72,009) (36,171)
--------- --------- ---------
Net cash used in investing activities (703,451) (419,992) (95,022)
--------- --------- ---------
Cash flows from financing activities:
Net (decrease) increase in borrowings under reverse repurchase
agreements and credit facilities (228,633) 293,683 (334,219)
Repayments of borrowings secured by commercial mortgage loan pools (8,587) (2,672) (4,829)
Issuance of collateralized debt obligations 765,388 -- 385,579
Repayments of collateralized debt obligations (20,115) (1,955) (3,440)
Issuance costs for collateralized debt obligations (11,662) -- (5,472)
Issuance of junior subordinated notes to subsidiary trust 100,000 75,000 --
Issuance costs of junior subordinated notes (3,208) (2,382) --
78
Issuance of senior unsecured notes 75,000 -- --
Issuance costs of senior unsecured notes (1,396) -- --
Redemption of Series B preferred stock -- -- (43,930)
Dividends paid on preferred stock (5,392) (5,392) (6,916)
Proceeds from issuance of common stock, net of offering costs 15,256 33,452 42,581
Dividends paid on common stock (65,023) (60,314) (57,138)
--------- --------- ---------
Net cash provided by (used in) financing activities 611,628 329,420 (27,784)
--------- --------- ---------
Net increase in cash and cash equivalents 25,832 16,801 2,950
Cash and cash equivalents, beginning of year 40,556 23,755 20,805
--------- --------- ---------
Cash and cash equivalents, end of year $ 66,388 $ 40,556 $ 23,755
========= ========= =========
Year Ended December 31,
--------------------------------
2006 2005 2004
-------- -------- ----------
Supplemental disclosure of cash flow information:
Interest paid $208,879 $156,480 $ 127,142
======== ======== ==========
Commercial mortgage loans purchased not settled $ 23,796 $ -- $ --
======== ======== ==========
Supplemental disclosure of non-cash investing and financing activities:
Securitizations:
Available-for-sale securities retained $ -- $ 75,844 $ --
======== ======== ==========
Residual interests $ -- $ 20,317 $ 16,956
======== ======== ==========
Investment in subsidiary trust $ 3,097 $ 2,380 $ --
======== ======== ==========
Consolidated variable interest entity:
Carrying value of assets acquired $ - $ -- $1,329,777
======== ======== ==========
Liabilities assumed $ - $ -- $1,306,724
======== ======== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
79
ANTHRACITE CAPITAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1 ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company was incorporated in Maryland in November 1997 and commenced
operations on March 24, 1998. The Company's principal business activity is to
invest in a diversified portfolio of CMBS, multifamily and commercial mortgage
loans, and other real estate related assets in the U.S. and non-U.S. markets.
The Company is organized and managed as a single business segment.
A summary of the Company's significant accounting policies follows:
USE OF ESTIMATES
In preparing the consolidated financial statements in accordance with GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the consolidated statements of financial
condition and the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates and assumptions.
Significant estimates in the consolidated financial statements include the
valuation of the Company's securities and estimates pertaining to credit
performance related to CMBS and commercial real estate loans.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial statements of
Anthracite Capital, Inc. and its majority owned subsidiaries, and those VIEs in
which the Company is the primary beneficiary under FIN 46R. All inter-company
balances and transactions have been eliminated in consolidation.
VARIABLE INTEREST ENTITIES
The Company's ownership of the subordinated classes of CMBS from a single issuer
gives it the right to control the foreclosure/workout process on the underlying
loans ("Controlling Class CMBS"). FIN 46R has certain scope exceptions, one of
which provides that an enterprise that holds a variable interest in a QSPE does
not consolidate that entity unless that enterprise has the unilateral ability to
cause the entity to liquidate. SFAS No. 140 provides the requirements for an
entity to be considered a QSPE. To maintain the QSPE exception, the trust must
continue to meet the QSPE criteria both initially and in subsequent periods. A
trust's QSPE status can be impacted in future periods by activities by its
transferors or other involved parties, including the manner in which certain
servicing activities are performed. To the extent its CMBS investments were
issued by a trust that meets the requirements to be considered a QSPE, the
Company records the investments at the purchase price paid. To the extent the
underlying trusts are not QSPEs the Company follows the guidance set forth in
FIN 46R as the trusts would be considered VIEs.
The Company has analyzed the governing pooling and servicing agreements for each
of its Controlling Class CMBS and believes that the terms are industry standard
and are consistent with the QSPE criteria. However, there is uncertainty with
respect to QSPE treatment due to ongoing review by accounting standard setters,
potential actions by various parties involved with the QSPE, as discussed above,
as well as varying and evolving interpretations of the QSPE criteria under SFAS
No. 140. Additionally, the standard setters continue to review the FIN 46R
provisions related to the computations used to
80
determine the primary beneficiary of a VIE. Future guidance from the standard
setters may require the Company to consolidate CMBS trusts in which the Company
has invested.
At December 31, 2006, the Company owned securities of 29 Controlling Class CMBS
trusts with a par of $1,171,054. However, portions of the non-rated securities
of 17 of the 29 Controlling Class CMBS transactions are included in CDO HY1 and
CDO HY2. The total par amount of CMBS issued by the 29 trusts was $42,398,701.
One of the Company's 29 Controlling Class trusts does not qualify as a QSPE and
has been consolidated by the Company (see Note 5 of the consolidated financial
statements). The Company's maximum exposure to loss as a result of its
investment in these VIEs totaled $762,567 and $565,231 at December 31, 2006 and
2005, respectively.
In addition, the Company has completed two securitizations that qualify as
QSPE's under SFAS No. 140. Through CDO HY1 and CDO HY2 the Company issued
non-recourse liabilities primarily secured by non-investment grade commercial
real estate assets including portions of 17 Controlling Class CMBS. Should
future guidance from the standard setters determine that Controlling Class CMBS
are not QSPE's, the Company would be required to consolidate the assets,
liabilities, income and expenses of CDO HY1 and CDO HY2. The Company's total
maximum exposure to loss as a result of its investment in CDO HY1 and CDO HY2 at
December 31, 2006 and 2005, respectively, is $111,076 and $109,003.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities denominated in foreign currencies are translated into
U.S. dollars using foreign exchange rates at the end of the reporting period.
Income and expenses are translated at the approximate weighted average exchange
rates for each reporting period. The effects of translating income with a
functional currency other than the U.S. dollar are included in stockholders'
equity along with the related hedge effects. The effects of translating
operations with the U.S. dollar as the functional currency are included in
foreign currency gain (loss) along with the related hedge effects.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and short-term, highly liquid
investments with original maturities of three months or less. Cash and cash
equivalents are held at major financial institutions, to which the Company is
exposed to credit risk.
RESTRICTED CASH
On December 31, 2006, the Company had restricted cash of $59,801, consisting of
$56,266 on deposit with the trustees for the Company's collateralized debt
obligations ("CDOs") and $3,535 pledged as collateral for interest rate swap
agreements. The balance $1,246 at December 31, 2005 primarily represents cash
held as collateral for the Company's interest rate swap agreements.
DEFERRED FINANCING COSTS
Deferred financing costs, which are included in other assets on the Company's
consolidated statements of financial condition, includes issuance costs related
to the Company's debt. These costs are amortized by applying the effective
interest rate method and the amortization is reflected in interest expense.
81
SECURITIES AVAILABLE-FOR-SALE
The Company has designated certain investments in mortgage-backed securities,
mortgage-related securities and certain other securities as assets
available-for-sale because the Company may dispose of them prior to maturity and
does not hold them principally for the purpose of selling them in the near term.
Securities available-for-sale are carried at estimated fair value with the net
unrealized gains or losses reported as a component of accumulated other
comprehensive income (loss) in stockholders' equity. Unrealized losses on
securities that reflect a decline in value that is judged by management to be
other than temporary, if any, are charged to earnings. At disposition, the
realized net gain or loss is included in income on a specific identification
basis.
In accordance with SFAS No. 115, when the estimated fair value of the security
classified as available-for-sale has been below amortized cost for a significant
period of time and the Company concludes that it no longer has the ability or
intent to hold the security for the period of time over which the Company
expects the values to recover to amortized cost, the investment is written down
to its fair value. The resulting charge is included in income, and a new cost
basis established. Additionally, under EITF 99-20, when changes in estimated
cash flows from the cash flows previously estimated occur due to actual
prepayment and credit loss experience, and the present value of the revised cash
flows using the current expected yield is less than the present value of the
previously estimated remaining cash flows (adjusted for cash receipts during the
intervening period), an other-than-temporary impairment is deemed to have
occurred. Accordingly, the security is written down to fair value with the
resulting change being included in income, and a new cost basis established. In
both instances, the original discount or premium is written off when the new
cost basis is established.
REVENUE RECOGNITION
The Company recognizes interest income from its purchased beneficial interests
in securitized financial interests ("beneficial interests") (other than
beneficial interests of high credit quality, sufficiently collateralized to
ensure that the possibility of credit loss is remote, or that cannot
contractually be prepaid or otherwise settled in such a way that the Company
would not recover substantially all of its recorded investment) in accordance
with EITF 99-20. Accordingly, on a quarterly basis, when changes in estimated
cash flows from the cash flows previously estimated occur due to actual
prepayment and credit loss experience, the Company calculates a revised yield
based on the current amortized cost of the investment (including any
other-than-temporary impairments recognized to date.) The revised yield is then
applied prospectively to recognize interest income.
For other mortgage-backed and related mortgage securities, the Company accounts
for interest income under SFAS No. 91, by applying the effective yield method
which includes the amortization of discount or premium arising at the time of
purchase and the stated or coupon interest payments. Actual prepayment and
credit loss experience is reviewed quarterly and effective yields are
recalculated when differences arise between prepayments and credit losses
originally anticipated and amounts actually received plus anticipated future
prepayments and credit losses.
After taking into account the effect of the impairment charge, income is
recognized under EITF 99-20 or SFAS No. 91, as applicable, by applying the yield
used in establishing the write-down.
SECURITIES HELD-FOR-TRADING
Securities held-for-trading are carried at estimated fair value with net
realized and unrealized gains or losses included in the consolidated statements
of operations.
82
SECURITIZATIONS
When the Company sells assets in securitizations, it can retain certain tranches
which are considered retained interests in the securitization. Gain or loss on
the sale of assets depends in part on the previous carrying amount of the
financial assets securitized, allocated between the assets sold and the retained
interests based on their relative fair value at the date of securitization. To
obtain fair values, quoted market prices are used. Gain or loss on
securitizations of financial assets is reported as a component of sale of
securities available-for-sale on the consolidated statement of operations.
Retained interests are carried at estimated fair value on the consolidated
statement of financial condition. Adjustments to estimated fair value for
retained interests classified as securities available-for-sale are included in
accumulated other comprehensive income on the consolidated statement of
financial condition.
COMMERCIAL MORTGAGE LOANS AND LOAN POOLS
The Company purchases and originates certain commercial mortgage loans to be
held as long-term investments. In accordance with SFAS No. 65, Accounting for
Certain Mortgage Banking Activities, commercial mortgage loans and loan pools
are classified as long term investments because the Company has the ability and
the intent to hold these loans to maturity. Loans are recorded at cost at the
date of purchase. Premiums and discounts related to these loans are amortized
over their estimated lives using the effective interest method. Any origination
fee income and application fee income, net of direct costs, associated with
originating or purchasing commercial mortgage loans are deferred and included in
the basis of the loans on the consolidated statements of financial condition.
The net fees are amortized over the life of the loans using the effective
interest method. The Company recognizes impairment on the loans when it is
probable that the Company will not be able to collect all amounts due according
to the contractual terms of the loan agreement. The Company measures impairment
(both interest and principal) based on the present value of expected future cash
flows discounted at the loan's effective interest rate or the fair value of the
collateral if the loan is collateral dependent.
EQUITY INVESTMENTS
For those investments in real estate entities where the Company does not control
the investee, or is not the primary beneficiary of a VIE, but can exert
significant influence over the financial and operating policies of the investee,
the Company uses the equity method of accounting. The Company recognizes its
share of each investee's income or loss, and reduces its investment balance by
distributions received. The Company owns an equity method investment in a
privately held REIT that maintains its financial records on a fair value basis.
The Company has retained such accounting relative to its investment in this REIT
pursuant to EITF Issue 85-12, Retention of Specialized Accounting for
Investments in Consolidation.
DERIVATIVE INSTRUMENTS
As part of its asset/liability risk management activities, the Company may enter
into interest rate swap agreements, forward currency exchange contracts and
other financial instruments in order to hedge interest rate and foreign currency
exposures or to modify the interest rate or foreign currency characteristics of
related items in its consolidated statement of financial condition.
Income and expense from interest rate swap agreements that are, for accounting
purposes, designated as cash flow hedges are recognized as a net adjustment to
the interest expense of the hedged item and changes in fair value are recognized
as a component of accumulated other comprehensive income in stockholders'
equity. Changes in fair value are included as a component of accumulated other
83
comprehensive income in stockholders' equity, to the extent effective.
Ineffective portions of changes in the fair value of cash flow hedges are
recognized in earnings. If the underlying hedged securities are sold, the amount
of unrealized gain or loss in accumulated other comprehensive income relating to
the corresponding interest rate swap agreement is included in the determination
of gain or loss on the sale of the securities. If interest rate swap agreements
are terminated, the associated gain or loss is deferred and amortized over the
shorter of the remaining term of the original swap agreement, or the underlying
hedged item, provided that the underlying hedged item has not been sold.
Income and expense from interest rate swap agreements that are, for accounting
purposes, designated as trading derivatives are recognized as a net adjustment
to securities held-for-trading in the accompanying consolidated statement of
operations. During the term of the interest rate swap agreement, changes in fair
value are recognized in the consolidated statements of operations. A
corresponding amount is included as loss on securities held-for-trading in the
consolidated statement of operations.
Gains and losses from forward currency exchange contracts are recognized as a
net adjustment to foreign currency gain or loss in the consolidated statement of
operations. During the term of the forward currency exchange contracts, changes
in fair value are recognized in the consolidated statement of financial
condition and included in other assets (if there is an unrealized gain) or in
other liabilities (if there is an unrealized loss). A corresponding amount is
included as a component of net foreign currency gain or loss in the consolidated
statement of operations.
The Company monitors its hedging instruments throughout their terms to ensure
that they remain effective for their intended purpose. The Company is exposed to
interest rate and/or currency risk on these hedging instruments, as well as to
credit loss in the event of nonperformance by any other party to the Company's
hedging instruments. The Company's policy is to enter into hedging agreements
with counterparties rated A or better.
SHARE-BASED COMPENSATION
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. This
statement is a revision to SFAS No. 123, Accounting for Stock-Based
Compensation, and superseded APB Opinion No. 25, Accounting for Stock Issued to
Employees. This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services, primarily focusing on the accounting for transactions in which an
entity obtains employee services in share-based payment transactions. Entities
will be required to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period
during which an employee is required to provide service (usually the vesting
period) in exchange for the award. The grant-date fair value of employee share
options and similar instruments will be estimated using option-pricing models.
If an equity award is modified after the grant date, incremental compensation
cost will be recognized in an amount equal to the excess of the fair value of
the modified award over the fair value of the original award immediately before
the modification. As amended by Rule 4-01(a) of Regulation S-X promulgated by
the SEC, this statement is effective as of the beginning of the first interim or
annual reporting period of the Company's first fiscal year beginning on or after
December 15, 2005. The Company adopted SFAS No. 123R, as amended, effective
January 1, 2006 with no impact on the consolidated financial statements as there
are no unvested options as of December 31, 2005 and the Company applied the fair
value method to all options issued after January 1, 2003.
84
INCOME TAXES
The Company has elected to be taxed as a REIT and to comply with the provisions
of the Code with respect thereto. Accordingly, the Company generally will not be
subject to Federal income tax to the extent of its distributions to stockholders
and as long as certain asset, income and stock ownership tests are met. At
December 31, 2006, the Company had a Federal capital loss carryover of
approximately $34,637 available to offset future capital gains.
RECENT ACCOUNTING PRONOUNCEMENTS
Reverse Repurchase Agreements
Accounting standard setters are currently reviewing treatment of transactions
where mortgage-backed securities purchased from a particular counterparty are
financed via a repurchase agreement with the same counterparty. Currently, the
Company records such assets and the related financing gross on the consolidated
statement of financial condition, and the corresponding interest income and
interest expense gross on the consolidated statement of operations. Any change
in fair value of the security is reported through other comprehensive income
pursuant to SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities, because the security is classified as available-for-sale. However,
in a transaction where the mortgage-backed securities are acquired from and
financed under a repurchase agreement with the same counterparty, the
acquisition may not qualify as a sale from the seller's perspective under the
provisions of SFAS No. 140. In such cases, the seller may be required to
continue to consolidate the assets sold to the Company, based on their
continuing involvement with such investments. Depending on the ultimate outcome
of the accounting standard setters' deliberations, the Company may be precluded
from presenting the assets gross on the Company's consolidated statement of
financial condition and should instead be treating the Company's net investment
in such assets as a derivative. If it is determined that these transactions
should be treated as investments in derivatives, the derivative instruments
entered into by the Company to hedge the Company's interest rate exposure with
respect to the borrowings under the associated repurchase agreements may no
longer qualify for hedge accounting, and would then, as with the underlying
asset transactions, also be marked to market through the consolidated statement
of operations. This potential change in accounting treatment does not affect the
economics of the transactions but does affect how the transactions would be
reported on the consolidated financial statements. The Company's cash flows,
liquidity and ability to pay a dividend would be unchanged, and the Company does
not believe its REIT taxable income or REIT status would be affected. The
Company's net equity would not be materially affected. At December 31, 2006, the
Company has identified available-for-sale securities with a fair value of
approximately $36,649 which had been purchased from and financed with reverse
repurchase agreements totaling approximately $31,375 with the same counterparty
since their purchase. If the Company were to change the current accounting
treatment for these transactions at December 31, 2006, total assets and total
liabilities would be reduced by approximately $31,375.
Variable Interest Entities
The consolidated financial statements include the financial statements of
Anthracite Capital, Inc. and its subsidiaries, which are wholly owned or
controlled by the Company or entities which are VIEs in which the Company is the
primary beneficiary under FIN 46R. FIN 46R requires a VIE to be consolidated by
its primary beneficiary. The primary beneficiary is the party that absorbs the
majority of the VIE's anticipated losses and/or the majority of the expected
returns. All significant inter-company balances and transactions have been
eliminated in consolidation.
85
The Company has analyzed the governing pooling and servicing agreements for each
of its Controlling Class CMBS and believes that the terms are industry standard
and are consistent with the QSPE criteria. However, there is uncertainty with
respect to QSPE treatment due to ongoing review by accounting standard setters,
potential actions by various parties involved with the QSPE, as well as varying
and evolving interpretations of the QSPE criteria under SFAS No. 140. Future
guidance from the accounting standard setters may require the Company to
consolidate CMBS trusts in which the Company has invested.
Impairment of Investments
In November 2005, the FASB issued FASB Staff Position ("FSP") FAS 115-1/124-1,
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments, which provides guidance for determining when impairment charges
should be taken on certain debt and equity securities. FSP FAS 115-1/124-1
requires that debt and equity securities subject to the provisions of SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securities, and
equity securities subject to the provisions of APB Opinion No. 18, The Equity
Method of Accounting for Investments in Common Stock, but which are not
accounted for under the equity method (i.e., securities accounted for under the
cost method) shall be reviewed for impairment when circumstances warrant. For
securities subject to SFAS No. 115, a review for other-than-temporary
impairments shall occur in each accounting period where the fair value of the
security is less than its cost. For securities subject to APB Opinion No. 18, a
review for other-than-temporary impairments shall occur in each accounting
period where a) circumstances indicate that impairment may exist and b) the fair
value of the security is less than its carrying value. The provisions of the FSP
were required to be applied to reporting periods beginning after December 15,
2005. The adoption of FSP FAS 115-1/124-1 on January 1, 2006 had no material
impact on the Company's consolidated financial statements.
Certain Hybrid Financial Instruments
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Financial Instruments, which amends SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, and SFAS No. 140. The Statement provides,
among other things, that:
- For embedded derivatives which would otherwise be required to be
bifurcated from their host contracts and accounted for at fair value
in accordance with SFAS No. 133, an irrevocable election may be made
on an instrument-by-instrument basis, to be measured as hybrid
financial instrument at fair value in its entirety, with changes in
fair value recognized in earnings.
- Concentrations of credit risk in the form of subordination are not
considered embedded derivatives.
- Clarification regarding interest-only strips and principal-only strips
are not subject to the requirements of SFAS No. 133.
SFAS No. 155 is effective for all financial instruments acquired, issued or
subject to remeasurement after the beginning of an entity's first fiscal year
that begins after September 15, 2006. Upon adoption, differences between the
total carrying amount of the individual components of an existing bifurcated
hybrid financial instrument and the fair value of the combined hybrid financial
instrument should be recognized as a cumulative effect adjustment to beginning
retained earnings. Prior periods should not be restated. The Company is
currently evaluating the impact of adopting SFAS No. 155.
Determining the Variability in a Potential VIE
86
The FASB issued FASB Staff Position FIN 46(R)-6, Determining the Variability to
be Considered in Applying FASB Interpretation No. 46(R) ("FSP FIN 46(R)-6") in
April 2006. FSP FIN 46(R)-6 addresses the application of FIN 46(R),
Consolidation of Variable Interest Entities, in determining whether certain
contracts or arrangements with a VIE are variable interests by requiring
companies to base such evaluations on an analysis of the VIE's purpose and
design, rather than its legal form or accounting classification.
FSP FIN 46(R)-6 is required to be applied for all reporting periods beginning
after June 15, 2006. The adoption of this FSP did not result in material
differences from the Company's existing accounting policies regarding the
consolidation of VIEs.
Accounting for Uncertainty in Income Taxes
In July 2006, the FASB issued FIN 48. FIN No. 48 clarifies the accounting for
uncertainty in income taxes recognized in a company's financial statements in
accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a
threshold and measurement attribute for recognition in the financial statements
of an asset or liability resulting from a tax position taken or expected to be
taken in a tax return. FIN 48 also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective as of the beginning of fiscal
years that begin after December 15, 2006. The Company is currently evaluating
the effect of implementing this new standard but does not expect its
implementation to have a material impact on the consolidated financial
statements.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157. SFAS No. 157 defines fair
value, establishes a framework for measuring fair value and requires enhanced
disclosures about fair value measurements. SFAS No. 157 requires companies to
disclose the fair value of its financial instruments according to a fair value
hierarchy (i.e., levels 1, 2, and 3, as defined). Additionally, companies are
required to provide enhanced disclosure regarding instruments in the level 3
category (which require significant management judgment), including a
reconciliation of the beginning and ending balances separately for each major
category of assets and liabilities. SFAS No. 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007 and all
interim periods within those fiscal years. The Company is currently evaluating
the impact of adopting SFAS No. 157.
Effects of Prior Year Misstatements
In September 2006, the SEC issued SAB No. 108. SAB No. 108 provides guidance on
the consideration of effects of the prior year misstatements in quantifying
current year misstatements for the purpose of a materiality assessment. The SEC
staff believes registrants must quantify errors using both a balance sheet and
income statement approach and evaluate whether either approach results in
quantifying a misstatement that, when all relevant quantitative and qualitative
factors are considered, is material. SAB No. 108 is effective for the first
annual period ending after November 15, 2006 with early application encouraged.
The adoption of SAB No. 108 on December 31, 2006 has no effect on the Company's
consolidated financial statements.
Valuation of Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159. SFAS No. 159 permits entities to
choose to measure eligible financial instruments at fair value. The unrealized
gains and losses on items for which the fair value option has been elected
should be reported in earnings. The decision to elect the fair value options
87
is determined on an instrument by instrument basis, it should be applied to an
entire instrument, and it is irrevocable. Assets and liabilities measured at
fair value pursuant to the fair value option should be reported separately in
the balance sheet from those instruments measured using another measurement
attribute. SFAS No. 159 is effective as of the beginning of the first fiscal
year that begins after November 15, 2007. The Company is currently analyzing the
potential impact of adoption of SFAS No. 159 to its consolidated financial
statements.
RECLASSIFICATIONS
Certain items previously reported have been reclassified to conform to the
current year's presentation.
NOTE 2 SECURITIES AVAILABLE-FOR-SALE
The Company's securities available-for-sale are carried at estimated fair value.
The amortized cost and estimated fair value of securities available-for-sale at
December 31, 2006 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
-------------------- ---------- ---------- ---------- ----------
CMBS:
CMBS IOs $ 69,183 $ 1,450 $ (1,280) $ 69,352
Investment grade CMBS 751,945 51,386 (7,788) 795,543
Non-investment grade rated subordinated securities 638,709 52,304 (4,994) 686,019
Non-rated subordinated securities 72,751 7,483 (67) 80,167
Credit tenant leases 24,439 391 (512) 24,318
Investment grade REIT debt 247,937 4,627 (3,320) 249,244
Multifamily agency securities 452,781 3,048 (6,003) 449,827
CDO investments 114,482 5,806 (3,042) 117,246
---------- -------- --------- ----------
Total CMBS 2,372,227 126,495 (27,006) 2,471,716
---------- -------- --------- ----------
RMBS:
Agency adjustable rate securities 1,768 5 -- 1,774
Residential CMOs 131,563 265 (978) 130,850
Hybrid ARMs 11,798 -- (283) 11,516
---------- -------- --------- ----------
Total RMBS 145,129 270 (1,261) 144,140
---------- -------- --------- ----------
Total securities available-for-sale $2,517,356 $126,765 $(28,267) $2,615,856
========== ======== ========= ==========
At December 31, 2006, the Company's securities available-for-sale included
non-U.S. dollar denominated assets with an estimated fair value of $181,597.
At December 31, 2006, an aggregate of $2,415,765 in estimated fair value of the
Company's securities available-for-sale was pledged to secure its collateralized
borrowings.
88
The amortized cost and estimated fair value of securities available-for-sale at
December 31, 2005 are summarized as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Security Description Cost Gain Loss Value
-------------------- ---------- ---------- ---------- ----------
CMBS:
CMBS IOs $ 103,120 $ 1,784 $ (1,541) $ 103,363
Investment grade CMBS 495,555 24,757 (10,477) 509,835
Non-investment grade rated subordinated securities 625,132 55,693 (4,830) 675,995
Non-rated subordinated securities 24,436 2,303 (328) 26,411
Credit tenant leases 24,995 526 (684) 24,837
Investment grade REIT debt 249,412 8,887 (2,532) 255,767
Multifamily agency securities 268,319 490 (5,447) 263,362
CDO investments 112,571 12,155 (183) 124,549
---------- -------- --------- ----------
Total CMBS 1,903,546 106,595 (26,022) 1,984,119
---------- -------- --------- ----------
RMBS:
Agency adjustable rate securities 77,629 -- (1,138) 76,491
Residential CMOs 667 58 -- 725
Hybrid ARMs 16,012 -- (411) 15,601
---------- -------- --------- ----------
Total RMBS 94,308 58 (1,549) 92,817
---------- -------- --------- ----------
Total securities available-for-sale $1,997,854 $106,653 $(27,571) $2,076,936
========== ======== ========= ==========
At December 31, 2005, the Company's securities available-for-sale included
non-U.S. dollar denominated assets with an estimated fair value of $37,320.
At December 31, 2005, an aggregate of $1,940,734 in estimated fair value of the
Company's securities available-for-sale was pledged to secure its collateralized
borrowings.
89
At December 31, 2006 and 2005, the aggregate estimated fair values by underlying
credit rating of the Company's securities available-for-sale are as follows:
December 31, 2006 December 31, 2005
----------------------- -----------------------
Estimated Estimated
Security Rating Fair Value Percentage Fair Value Percentage
--------------- ---------- ---------- ---------- ----------
Agency and agency insured
securities $ 593,170 23% $ 359,044 17%
AAA 207,482 8 192,482 9
AA+ 10,719 -- -- --
AA 5,810 -- -- --
AA- 14,859 1 2,580 --
A+ 41,090 2 11,612 1
A 141,544 5 26,725 1
A- 112,906 4 57,733 3
BBB+ 226,512 9 145,066 7
BBB 207,382 8 209,763 10
BBB- 154,776 6 228,406 11
---------- --- ---------- ---
Total investment grade securities
available-for -sale 1,716,250 66 1,233,411 59
---------- --- ---------- ---
BB+ 178,378 7 287,308 14
BB 276,044 10 173,110 8
BB- 99,892 4 97,883 5
B+ 51,271 2 56,934 3
B 113,509 4 126,711 6
B- 41,334 2 16,884 1
CCC 3,823 -- -- --
Not rated 135,355 5 84,695 4
---------- --- ---------- ---
Total below investment grade
securities available-for -sale 899,606 34 843,525 41
---------- --- ---------- ---
Total securities
available-for-sale $2,615,856 100% $2,076,936 100%
========== === ========== ===
The following table shows the Company's fair value and gross unrealized losses,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2006.
Less than 12 Months 12 Months or More Total
---------------------- ---------------------- ----------------------
Estimated Gross Estimated Gross Estimated Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
--------- ---------- --------- ---------- --------- ----------
CMBS IOs $ 5,524 $ (378) $ 22,181 $ (902) $ 27,705 $ (1,280)
Investment grade CMBS 32,051 (151) 139,776 (7,637) 171,827 (7,788)
Non-investment grade rated
subordinated securities 125,396 (2,457) 74,852 (2,537) 200,248 (4,994)
Non-rated subordinated securities 1,548 (6) 2,468 (61) 4,016 (67)
Credit tenant leases -- -- 15,803 (512) 15,803 (512)
Investment grade REIT debt 10,450 (152) 72,524 (3,168) 82,974 (3,320)
Multifamily agency securities 153,266 (600) 181,102 (5,403) 334,368 (6,003)
CDO investments 35,417 (3,042) -- -- 35,417 (3,042)
Residential CMOs 111,859 (978) -- -- 111,859 (978)
Hybrid ARMs -- -- 11,516 (283) 11,516 (283)
-------- ------- -------- -------- -------- --------
Total temporarily impaired
securities $475,511 $(7,764) $520,222 $(20,503) $955,733 $(28,267)
======== ======= ======== ======== ======== ========
90
The following table shows the Company's fair value and gross unrealized losses,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2005.
Less than 12 Months 12 Months or More Total
--------------------- --------------------- ---------------------
Gross Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
-------- ---------- -------- ---------- -------- ----------
CMBS IOs $ 35,719 $ (1,012) $ 11,506 $ (529) $ 47,225 $ (1,541)
Investment grade CMBS 107,478 (2,950) 118,941 (7,527) 226,419 (10,477)
Investment grade REIT debt 19,757 (244) 58,830 (2,288) 78,587 (2,532)
Non-investment grade rated
subordinated securities 99,207 (2,941) 22,269 (1,889) 121,476 (4,830)
Non-rated subordinated securities 9,233 (328) -- -- 9,233 (328)
Credit tenant leases -- -- 15,923 (684) 15,923 (684)
Multifamily agency securities 181,072 (5,084) 22,320 (363) 203,392 (5,447)
CDO investments 3,391 (183) -- 3,391 (183)
Agency adjustable rate securities 76,491 (1,138) -- -- 76,491 (1,138)
Hybrid ARMS -- -- 15,601 (411) 15,601 (411)
-------- -------- -------- -------- -------- --------
Total temporarily impaired
securities $532,348 $(13,880) $265,390 $(13,691) $797,738 $(27,571)
======== ======== ======== ======== ======== ========
The temporary impairment of the available-for-sale securities results from the
fair value of the securities falling below the amortized cost basis. These
unrealized losses are primarily the result of market factors other than credit
impairment and the Company believes the carrying value of the securities are
fully recoverable over their expected holding period. Management possesses both
the intent and the ability to hold the securities until the Company has
recovered the amortized cost. As such, management does not believe any of the
securities are other than temporarily impaired.
The CMBS held by the Company consist of subordinated securities collateralized
by adjustable and fixed rate commercial and multifamily mortgage loans. The CMBS
provide credit support to the more senior classes of the related commercial
securitization. The Company generally does not own the senior classes of its
below investment grade CMBS. Cash flow from the mortgages underlying the CMBS
generally is allocated first to the senior classes, with the most senior class
having a priority entitlement to cash flow. Then, any remaining cash flow is
allocated generally among the other CMBS classes in order of their relative
seniority. To the extent there are defaults and unrecoverable losses on the
underlying mortgages, resulting in reduced cash flows, the most subordinated
CMBS class will bear this loss first. To the extent there are losses in excess
of the most subordinated class' stated entitlement to principal and interest,
the remaining CMBS classes will bear such losses in order of their relative
subordination.
At December 31, 2006 and 2005, the anticipated weighted average unleverged yield
based upon the adjusted cost of the Company's entire subordinated CMBS portfolio
was 10.3% and 10.2% per annum, respectively, and of the Company's other
securities available-for-sale was 6.1% and 5.8% per annum, respectively. The
Company's anticipated yields to maturity on its subordinated CMBS and other
91
securities available-for-sale are based upon a number of assumptions that are
subject to certain business and economic uncertainties and contingencies.
Examples of these include, among other things, the rate and timing of principal
payments (including prepayments, repurchases, defaults, liquidations, and
related expenses), the pass-through or coupon rate, and interest rate
fluctuations. Additional factors that may affect the Company's anticipated
yields to maturity on its Controlling Class CMBS include interest payment
shortfalls due to delinquencies on the underlying mortgage loans, and the timing
and magnitude of credit losses on the mortgage loans underlying the Controlling
Class CMBS that are a result of the general condition of the real estate market
(including competition for tenants and their related credit quality), and
changes in market rental rates. As these uncertainties and contingencies are
difficult to predict and are subject to future events that may alter these
assumptions, no assurance can be given that the anticipated yields to maturity,
discussed above and elsewhere, will be achieved.
The RMBS held by the Company consist of adjustable rate and fixed rate
residential pass-through or mortgage-backed securities collateralized by
adjustable and fixed rate single-family residential mortgage loans. All of the
Company's RMBS were issued by FHLMC, FNMA or GNMA. The Company does not have any
subprime exposure. The Company's securities available-for-sale are subject to
credit, interest rate, and/or prepayment risks. The agency adjustable rate RMBS
held by the Company are subject to periodic and lifetime caps that limit the
amount the interest rates of such securities can change during any given period
and over the life of the loan. At December 31, 2006 and 2005, adjustable rate
RMBS with an estimated fair value of $144,140 and $92,817, respectively, is
included in securities available-for-sale on the consolidated statements of
financial condition.
During 2006, the Company sold securities available-for-sale for total proceeds
of $236,945, resulting in a gross realized gain of $30,884 and a gross realized
loss of $1,852. The Company sold the securities with unrealized losses prior to
maturity due to changes in the underlying collateral which were expected to
significantly impact the market value of the securities. During 2005, the
Company sold securities available-for-sale for total proceeds of $172,737,
resulting in a realized gain of $16,543. During 2004, the Company sold
securities available-for-sale for total proceeds of $486,942, resulting in a
realized gain of $17,544.
NOTE 3 IMPAIRMENTS - CMBS
In 2001, the Company adopted EITF 99-20. The Company updates its estimated cash
flows for securities subject to EITF 99-20 on a quarterly basis. The Company
compares the yields resulting from the updated cash flows to the current accrual
yields. An impairment charge is required under EITF 99-20 if the updated yield
is lower than the current accrual yield and the security has an estimated fair
value less than its adjusted purchase price. The Company carries all these
securities at their estimated fair value on its consolidated statement of
financial condition.
2006
During 2006, the Company had sixteen CMBS that required an impairment charge of
$7,880, of which $6,133 was attributed to higher prepayment rates on a pool of
Small Business Administration commercial mortgages. The decline in the updated
yields that caused the remaining impairment charge of $1,747 is not related to
increases in losses but rather accelerated prepayments and changes in the timing
of credit losses.
2005
92
During 2005, the Company had six CMBS that required impairment charges of
$5,088. For one below investment grade CMBS, the Company increased its
underlying loan loss expectations on a 1998 vintage CMBS transaction resulting
in a charge of $3,072. This CMBS transaction has two underlying mortgage loans
secured by assisted living facilities located in Texas that were performing
below management's original expectations. The two underlying mortgage loans were
resolved in the fourth quarter of 2005 with lower than expected loss severities.
The effect of the improved loss severity will be recognized over the remaining
life of the security in the form of an increased yield. For the remaining five
securities, changes in the timing of credit losses and prepayments caused yields
to decline.
2004
During 2004, six 1998 vintage CMBS securities in four separate CMBS transactions
required impairment charges of $26,018. A variety of factors influenced updated
yields for these securities including magnitude of credit loss, timing of credit
loss, prepayments and servicer advances. The Company completed a re-evaluation
of credit assumptions of its 1998 vintage CMBS portfolio in the fourth quarter
of 2004. The magnitude of credit losses did not significantly change as a result
of this process, as total loss expectations on the underlying loans moved from
2.06% to 2.04%. Changes in the timing of credit losses and prepayments caused
updated yields on these securities to decline by a weighted average of 66 basis
points. Market dislocations in 1998 caused disproportionate unrealized losses in
the estimated fair value of these securities based on price quotes received from
third parties. The Company had recorded these unrealized losses as other
comprehensive loss on its consolidated statement of financial condition since
that time. In addition, the Company increased underlying loan loss expectations
on one non-rated security resulting in an impairment charge of $663.
NOTE 4 SECURITIZATION TRANSACTIONS
During 2005, the Company closed CDO HY2 and issued non-recourse liabilities with
a face amount of $365,010. Senior investment grade notes with a face amount of
$240,134 were issued and sold in a private placement. The Company retained the
floating rate BBB- note, the below investment grade notes and the preferred
shares. The Company recorded CDO HY2 as a secured financing for accounting
purposes and consolidated the assets, liabilities, income and expenses of CDO
HY2 until the sale of the floating rate BBB- note in the fourth quarter of 2005,
at which point CDO HY2 qualified as a sale under SFAS No. 140. In exchange for a
portfolio of CMBS and investment grade REIT debt with an estimated fair value of
$323,103, the Company received cash proceeds of $244,212 as well as all of the
retained interests that had an estimated fair value of $105,025 at December 31,
2005. The total gain from CDO HY2 of $16,523 is included in sale of securities
available-for-sale on the consolidated statement of operations.
During 2004, the Company sold non-investment grade CMBS with an estimated fair
value of $109,933 to a qualifying special purpose entity ("CDO HY1"). These CMBS
were securitized into various classes of non-recourse bonds and preferred
equity. CDO HY1 sold the investment grade rated bonds to unrelated third parties
for net proceeds of $121,547. In accordance with SFAS No. 140, a gain of $14,769
was recognized on the sale of the CMBS collateral to CDO HY1. At closing, the
Company retained the A- rated bond and the preferred equity in CDO HY1.
Subsequently, the A- rated bond was sold at a gain of $1,825 during the fourth
quarter of 2004.
93
The table below summarizes the cash flows received from securitizations during
the year ended December 31, 2006, 2005 and 2004, respectively.
2006 2005 2004
------- -------- --------
Proceeds from securitizations $ -- $235,197 $121,547
Sale of retained interest $ -- $ 9,015 $ 18,879
Cash flow on retained interests $17,951 $ 11,347 $ 0(1)
(1) For 2004, the retained interest's first scheduled quarterly payment was in
January 2005.
Key economic assumptions used in measuring the fair value of the retained
interests at the date of the securitization was as follows:
Subordinated Debt
2005 2004
--------- ----
Weighted average life 9.9 years n/a
Subordinated discount rate 12.1% n/a
Preferred Equity
2005 2004
---------- ----------
Expected life 18.2 years 11.5 years
Preferred equity discount rate 4.93% 67.4%
When subsequently measuring the fair value of the retained interests, the
Company applies certain loss assumptions to after-loss cash flows. The Company
estimated credit losses and the timing of losses for each loan underlying the
CMBS collateral, and accordingly does not apply a constant default rate to the
portfolio. At December 31, 2006, 2005, and 2004, respectively, the amortized
costs of the retained interests were $111,076, $119,003, and $15,851, with an
estimated fair value of $114,142, $121,159, and $15,885, based on key economic
assumptions. The sensitivity of the retained interest to immediate adverse
changes in those assumptions follows:
2006 2005 2004
----- ----- -----
Reduction of income per share:
50% adverse change in credit losses $0.12 $0.09 $0.02
100% adverse change in credit losses $0.24 $0.18 $0.04
EITF 99-20 impairment per share:
50% adverse change in credit losses $0.05 $0.03 $0.04
100% adverse change in credit losses $0.05 $0.03 $0.07
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a variation in key assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in fair value may not be linear. This non-linear
relationship exists because the Company applies its key assumptions on a
loan-by-loan basis to the assets underlying the CMBS collateral. Also, in this
table, the effect of a variation in a particular assumption on the fair value of
the retained interest was calculated without changing any other assumption; in
reality, changes in one factor may result in changes to another, which might
magnify or counteract the sensitivities. The Company reviews all major
assumptions periodically using the most recent empirical and market data
available, and makes adjustments where warranted.
94
NOTE 5 COMMERCIAL MORTGAGE LOAN POOLS
During the second quarter of 2004, the Company acquired subordinated CMBS in a
trust establishing a Controlling Class interest. The Company obtained a greater
degree of influence over the disposition of the commercial mortgage loans than
is typically granted to the special servicer. As a result of this expanded
influence, the trust was not a QSPE and FIN 46R required the Company to
consolidate the net assets and results of operations of the trust.
Approximately 45% of the par amount of the commercial mortgage loan pool is
comprised of investment grade loans and the remaining 55% are unrated. For
income recognition purposes, the Company considers the investment grade and
unrated commercial mortgage loans in the pool as single assets reflecting the
credit assumptions made in establishing loss adjusted yields for Controlling
Class securities. The Company has taken into account the credit quality of the
underlying loans in formulating its loss assumptions. Credit losses assumed on
the entire pool are 1.40% of the principal balance, or 2.53% of the unrated
principal balance.
Over the life of the commercial mortgage loan pools, the Company reviews and
updates its loss assumptions to determine the impact on expected cash flows to
be collected. A decrease in estimated cash flows will reduce the amount of
interest income recognized in future periods and may result in a loan loss
reserve depending upon the severity of the cash flow reductions. An increase in
estimated cash flows will first reduce the loan loss reserve and any additional
cash will increase the amount of interest income recorded in future periods.
NOTE 6 SECURITIES HELD-FOR-TRADING
The Company's securities held-for-trading are carried at estimated fair value.
At December 31, 2006, the Company's securities held-for-trading consisted of
FNMA Mortgage Pools with an estimated fair value of $132,204 and CMBS with an
estimated fair value of $22,383. At December 31, 2005, the Company's securities
held-for-trading consisted of FNMA Mortgage Pools with an estimated fair value
of $166,209 and CMBS with an estimated fair value of $21,264. The FNMA Mortgage
Pools, and the underlying mortgages, bear interest at fixed rates for specified
periods, generally three to seven years, after which the rates are periodically
reset to market.
95
NOTE 7 COMMERCIAL MORTGAGE LOANS
The following table summarizes the Company's commercial real estate loan
portfolio by property type at December 31, 2006 and 2005:
Loan Outstanding Weighted
------------------------------------- Average
December 31, 2006 December 31, 2005 Yield
----------------- ----------------- -----------
Property Type Amount % Amount % 2006 2005
------------- --------- ----- --------- ----- ---- ----
Office $130,016 27.0% $ 94,432 25.8% 8.2% 8.9%
Residential 57,917 12.0 57,466 15.7 10.7 8.6
Retail 194,938 40.5 76,502 20.9 7.7 7.3
Hotel 38,899 8.1 79,840 21.8 10.0 8.6
Storage 34,009 7.1 32,913 9.0 9.0 9.1
Communication Tower -- -- 20,000 5.5 -- 9.4
Industrial 19,317 4.0 2,423 0.7 9.1 8.1
Other Mixed Use 6,649 1.3 2,230 0.6 8.7 8.1
-------- ----- -------- ----- ---- ---
Total $481,745 100.0% $365,806 100.0% 8.6% 8.5%
-------- ----- -------- ----- ---- ---
Included in the table above are non-U.S. dollar denominated commercial real
estate loans with a carrying value of $243,377 and $129,951 at December 31, 2006
and 2005, respectively. The Company finances its non-U.S. dollar denominated
loans by borrowing in the applicable local currency and hedging the un-financed
portion.
Reconciliation of commercial mortgage loans:
Par Book Value
--------- ----------
Balance at December 31, 2004 $ 272,686 $ 263,506
Adjustment for discount accretion and
foreign currency -- (4,456)
Proceeds from repayment of mortgage loans (112,830) (112,830)
Principal receivable (3,899) (3,899)
Reduction in notional par value (2,479) --
Sale of commercial mortgage loans (22,425) (20,072)
Investments in commercial mortgage loans 242,572 243,557
--------- ---------
Balance at December 31, 2005 $ 373,625 $ 365,806
Adjustment for discount accretion and
foreign currency -- 18,875
Proceeds from repayment of mortgage loans (189,720) (197,094)
Investments in commercial mortgage loans 236,545 294,158
--------- ---------
Balance at December 31, 2006 $ 420,450 $ 481,745
There were no loans subject to delinquent principal or interest at December 31,
2006 or 2005.
96
NOTE 8 EQUITY INVESTMENTS
The following table is a summary of the Company's equity investments for the
year ended December 31, 2006:
Dynamic
BlackRock India
Diamond Carbon I Carbon II Fund IV Total
--------- -------- --------- ------- --------
Balance at
December 31, 2005 $ 51,004 $ 18,458 $ 41,188 $ -- $110,650
Contributions to
Investments 41,901 -- 32,782 3,850 78,533
Distributions from
Investments (2,774) (16,238) (15,455) -- (34,467)
Equity earnings 15,763 924 10,744 -- 27,431
-------- -------- -------- ------ ---------
Balance at
December 31, 2006 $105,894 $ 3,144 $ 69,259 $3,850 $182,147
======== ======== ======== ====== =========
At December 31, 2006, the Company owned approximately 20% of Carbon I. The
Company also owned approximately 26% of Carbon II at December 31, 2006.
Collectively, the Carbon Capital Funds are private commercial real estate income
opportunity funds managed by the Manager (see Note 14 of the consolidated
financial statements).
The Company entered into a $50,000 commitment on July 20, 2001 to acquire shares
in Carbon I. On July 12, 2004, the investment period expired and as repayments
occur, capital will be returned to investors. The Company's investment in Carbon
I at December 31, 2006 and 2005 was $3,144 and $18,458, respectively.
The Company entered into an aggregate commitment of $100,000 to acquire shares
in Carbon II. The Company's investment in Carbon II at December 31, 2006 and
2005 was $69,259 and $41,188, respectively. The Company's remaining commitment
to Carbon II at December 31, 2006 was $28,958.
The following table summarizes the loan investments held by the Carbon Capital
Funds at December 31, 2006 and 2005.
Loan Outstanding Weighted
------------------------------------- Average
December 31, 2006 December 31, 2005 Yield
----------------- ----------------- -----------
Property Type Amount % Amount % 2006 2005
------------- -------- ----- -------- ----- ---- ----
Office $162,759 23.1% $128,802 23.0% 10.5% 10.1%
Residential 138,713 19.7 192,604 34.3 12.3 10.3
Retail 73,184 10.4 57,791 10.3 9.7 13.2
Hotel 241,086 34.2 146,710 26.1 12.1 12.8
Storage -- -- 10,171 1.8 -- 16.4
Land 53,500 7.6 25,000 4.5 12.6 15.2
Other Mixed Use 35,384 5.0 -- -- 8.8 --
-------- ----- -------- ----- ---- ----
Total $704,626 100.0% $561,078 100.0% 11.4% 11.5%
-------- ----- -------- ----- ---- ----
97
At December 31, 2006, all commercial real estate loans owned directly by the
Company were performing in line with expectations. As previously reported,
investments held by Carbon II include a $24,546 commercial real estate mezzanine
loan which defaulted during July 2006. The default was subsequently cured. On
March 9, 2007, the loan matured. The borrower did not repay the loan on the due
date. In addition, the senior mortgage holder did not grant the borrower's
request for extension of time to accommodate a sale of the property or
refinancing of the loan. As a result, the loan is in default. The Company
believes the underlying asset is sufficient collateral to repay the Company's
loan in full. The underlying property is a hotel located in the South Beach area
of Miami, Florida.
During February 2007, two other loans held by Carbon II defaulted. The aggregate
carrying value of the two loans on Carbon II's consolidated financial statements
is $24,000 ($12,000 per loan). The underlying properties for both loans are
multi-family assets being converted to condominiums that are located in Florida.
Carbon II is negotiating a workout arrangement with the borrower for one loan,
whereby the borrower will cure its default and make additional capital
contributions to sustain the property while the borrower continues its sales
program. Based on credit analysis performed for this property, Carbon II
believes a loan loss reserve is not necessary at this time.
For the second loan, the borrower was not able to achieve sufficient condominium
sales to complete the condominium conversion. The borrower has indicated it will
not contribute additional capital to sustain the rental property until such time
as the condominium market recovers. As a result, Carbon II is expected to take
title to the property and currently intends to operate it as a rental property
while preparing the property for sale. Based on the credit analysis performed
for this property, Carbon II has established a loan loss reserve of $5,180 for
the loan, of which the Company's share is $1,361. All other commercial real
estate loans in the Carbon Capital Funds are performing as expected.
On December 13, 2005, the Company entered into a $75,000 commitment to acquire
shares of BlackRock Diamond. On February 21, 2006, the Company increased its
capital commitment by an additional $25,000, resulting in a total capital
commitment of $100,000. At December 31, 2006, 93% of the commitment has been
called and the Company owned approximately 21% of BlackRock Diamond. The
Company's investment in BlackRock Diamond at December 31, 2006 was $105,894. At
December 31, 2006, the Company had $7,397 of remaining capital commitments to
BlackRock Diamond, all of which was called in January 2007.
On December 22, 2005, the Company entered into an $11,000 commitment to acquire
shares of Dynamic India Fund IV. On February 13, 2006, the Company received a
notice calling 35% of its commitment.
98
Combined summarized financial information of the unconsolidated equity
investments of the Company is as follows:
December 31,
---------------------
2006 2005
---------- --------
Combined Balance Sheets:
Real estate property, at fair value $ 680,134 $273,432
Commercial mortgage loans, net 699,444 561,078
Other assets 138,060 101,947
---------- --------
Total Assets $1,517,638 $936,457
========== ========
Secured borrowings $ 654,385 $402,876
Other liabilities 90,581 105,507
Partners', members' and stockholders' equity 772,672 428,074
---------- --------
Total liabilities, partners', members', and
stockholders' equity $1,157,638 $936,457
========== ========
The Company's share of equity $ 182,147 $110,650
========== ========
For the year ended December 31,
-------------------------------
2006 2005 2004
------- ------- -------
Combined Statements of Operations:
Income $95,470 $82,973 $49,107
------- ------- -------
Expenses
Interest expense 42,483 21,834 7,731
Depreciation and amortization -- -- 1,274
Operating expenses 22,506 16,250 6,752
------- ------- -------
Total expenses 64,989 38,084 15,757
------- ------- -------
Realized/Unrealized gain 57,677 17,124 --
------- ------- -------
Net Income $88,158 $62,013 $33,350
======= ======= =======
The Company's share of net income $27,431 $12,146 $ 8,157
======= ======= =======
NOTE 9 REAL ESTATE, HELD-FOR-SALE
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
specifies that long-lived assets to be disposed by sale, which meet certain
criteria, should be classified as real estate held-for-sale and measured at the
lower of its carrying amount or fair value less costs of sale. In addition,
depreciation is not recorded for real estate held-for-sale.
On March 6, 2006, the Company purchased a defaulted loan from a Controlling
Class CMBS trust. The loan was secured by a first mortgage on a multi-family
property in Texas. Subsequent to the loan purchase, the property was acquired by
the Company at foreclosure. The Company sold the property
99
during the second quarter of 2006 and recorded a gain from discontinued
operations of $1,366 on the consolidated statement of operations.
NOTE 10 BORROWINGS
The Company's borrowings consist of credit facilities, CDOs, senior unsecured
notes, trust preferred securities, reverse repurchase agreements, and commercial
mortgage loan pools.
Certain information with respect to the Company's borrowings at December 31,
2006 is summarized as follows:
Reverse Commercial Senior Trust
Repurchase Credit Mortgage Loan Unsecured Preferred Total
Agreements Facilities Pools CDOs Notes Securities Borrowings
---------- ---------- ------------- ---------- ----------- ----------- ----------
Outstanding borrowings $799,669 $75,447 $1,250,503 $1,812,574 $ 75,000 $ 180,477 $4,193,670
Weighted average borrowing rate 5.37% 6.69% 3.99% 6.02% 7.20% 7.64% 5.39%
Weighted average remaining maturity 78 days 193 days 5.8 years 7.0 years 10.0 years 29.1 years 6.3 years
Estimated fair value of assets
pledged $854,074 $88,876 $1,271,014 $2,096,455 -- -- $4,310,419
At December 31, 2006, the Company's borrowings had the following remaining
maturities:
Reverse Commercial Senior Trust
Repurchase Credit Mortgage Unsecured Preferred Total
Agreements Facilities Loan Pools CDOs* Notes Securities Borrowings
---------- ---------- ---------- ---------- --------- ---------- ----------
Within 30 days $ 18,700 $27,569 $ -- $ -- $ -- $ -- $ 46,269
31 to 59 days -- -- -- -- -- -- --
60 days to less than 1
year 780,969 33,893 -- -- -- -- 814,862
1 year to 3 years -- 13,985 -- -- -- -- 13,985
3 years to 5 years -- -- -- -- -- -- --
Over 5 years -- -- 1,250,503 1,812,574 75,000 180,477 3,318,554
-------- ------- ---------- ---------- ------- -------- ----------
$799,669 $75,447 $1,250,503 $1,812,574 $75,000 $180,477 $4,193,670
======== ======= ========== ========== ======= ======== ==========
* At December 31, 2006, CDOs are comprised of $405,490 of CDO debt with a
weighted average remaining maturity of 5.29 years, $291,261 of CDO debt
with a weighted average remaining maturity of 5.63 years, $366,019 of CDO
debt with a weighted average remaining maturity of 6.39 years, $402,089 of
CDO debt with a weighted average remaining maturity of 9.68 years and
$347,715 of CDO debt with a weighted average remaining maturity of 7.75
years.
100
Information with respect to the Company's borrowings at December 31, 2005 is
summarized as follows:
Reverse Commercial Trust
Repurchase Credit Mortgage Preferred Total
Agreements Facilities Loan Pools CDOs Securities Borrowings
---------- ----------- ----------- ----------- ----------- ------------
Outstanding borrowings $816,641 $ 284,675 $ 1,272,931 $ 1,066,930 $ 77,380 $ 3,518,557
Weighted average borrowing
rate 4.47% 5.27% 3.97% 5.96% 7.64% 4.88%
Weighted average remaining
maturity 27 days 1.37 years 6.80 years 6.78 years 30.1 years 45.37 years
Estimated fair value of
assets pledged $897,886 $ 415,501 $ 1,292,407 $ 1,227,222 -- $ 3,833,016
At December 31, 2005, the Company's borrowings had the following remaining
maturities:
Reverse Commercial Trust
Repurchase Credit Mortgage Preferred Total
Agreements Facilities Loan Pools CDOs* Securities Borrowings
---------- ---------- ---------- ---------- ---------- ----------
Within 30 days $796,365 $ -- $ -- $ -- $ -- $ 796,365
31 to 59 days 20,276 -- -- -- -- 20,276
60 days to less than 1
year -- 113,009 -- -- -- 113,009
1 year to 3 years -- 171,666 -- -- -- 171,666
3 years to 5 years -- -- -- -- -- --
Over 5 years -- -- 1,272,931 1,066,930 77,380 2,417,241
-------- -------- ---------- ---------- ------- ----------
$816,641 $284,675 $1,272,931 $1,066,930 $77,380 $3,518,557
======== ======== ========== ========== ======= ==========
* Comprised of $406,208 of CDO debt with a weighted average remaining
maturity of 6.29 years at December 31, 2005 and $292,807 of CDO debt with a
weighted average remaining maturity of 6.68 years at December 31, 2005, and
$367,915 of CDO debt with a weighted average remaining maturity of 7.39
years at December 31, 2005.
Reverse Repurchase Agreements and Credit Facilities
The Company has entered into reverse repurchase agreements to finance most of
its securities available-for-sale that are not financed under its credit
facilities or CDOs. The reverse repurchase agreements bear interest at a
LIBOR-based variable rate.
Under the credit facilities and the reverse repurchase agreements, the
respective lender retains the right to mark the underlying collateral to
estimated fair value. A reduction in the value of pledged assets would require
the Company to provide additional collateral or fund margin calls. From time to
time, the Company may be required to provide additional collateral or fund
margin calls. At December 31, 2006, more than ten percent of the Company's net
assets were held as collateral for reverse repurchase agreements with Citigroup
Global Markets, Inc. and Lehman Brothers, Inc.
101
The Company's credit facilities can be used to replace existing reverse
repurchase agreement borrowings and to finance the acquisition of
mortgage-backed securities and commercial real estate loans. Outstanding
borrowings bear interest at a variable rate. The following table summarizes the
Company's credit facilities at December 31, 2006 and 2005.
December 31, 2006 December 31, 2005
--------------------------------- ---------------------------------
Unused Unused
Maturity Facility Total Borrowing Facility Total Borrowing
Date Amount Borrowings Capacity Amount Borrowings Capacity
-------- -------- ---------- --------- -------- ---------- ---------
Greenwich Capital, Inc. (1) 7/7/07 $ 75,000* $12,064 $ -- $ 75,000 $ 75,000 $ --
Deutsche Bank, AG (2) 12/20/07 200,000 $49,398 $150,602 200,000 $181,875 $18,125
Bank of America, N.A.(3) 9/17/08 $100,000 $ -- $100,000 n/a n/a n/a
Morgan Stanley Bank (3)(4) 2/16/08 $200,000 $13,985 $186,015 $ 27,800 $ 27,800 --
-------- ------- -------- -------- -------- -------
$575,000 $75,447 $436,617 $302,800 $284,675 $18,125
======== ======= ======== ======== ======== =======
* Commitment expired December 23, 2006. No new borrowings permitted.
(1) USD only
(2) Multicurrency
(3) Non-USD only
(4) Can be increased up to $15,000 based on the change in exchange rates of the
non-U.S. dollar loans. However, any amounts drawn under this provision must
be repaid in ninety days.
The Company is subject to various covenants in its credit facilities, including
maintaining a minimum net worth measured on a book value of $305,000 in
accordance with generally accepted accounting principles in the United States of
America ("GAAP"), a maximum recourse debt-to-equity of 3.0 to 1, a minimum cash
requirement based upon certain debt-to-equity ratios. During the first quarter
of 2007, the Company amended the debt service coverage ratio covenant on its
committed debt facilities. The terms of the calculation were revised and the
debt service coverage ratio was reduced from 1.75 to 1.20. The revised
calculation better reflects the Company's ability to service debt on a cash
basis. At December 31, 2006 and 2005, the Company was in compliance with all
other covenants.
CDOs
On May 29, 2002, the Company issued ten tranches of secured debt through CDO I.
In this transaction, a wholly owned subsidiary of the Company issued debt in the
par amount of $419,185 secured by the subsidiary's assets. The adjusted issue
price of the CDO I debt, at December 31, 2006, is $405,490. Five tranches were
issued at a fixed rate coupon and five tranches were issued at a floating rate
coupon with a combined weighted average remaining maturity of 5.3 years at
December 31, 2006. All floating rate coupons were swapped to fixed rate coupons
resulting in a total fixed rate cost of funds for CDO I of approximately 7.3%.
The Company incurred $9,890 of issuance costs that will be amortized over the
weighted average life of CDO I. CDO I was structured to match fund the cash
flows from a significant portion of the Company's CMBS and investment grade REIT
debt. The par amount at December 31, 2006 of the collateral securing CDO I
consisted of 78.2% CMBS rated B or higher and 21.8% REIT debt rated BBB or
higher. At December 31, 2006, the collateral securing CDO I had a fair value of
$516,347.
On December 10, 2002, the Company issued seven tranches of secured debt through
CDO II. In this transaction, a wholly owned subsidiary of the Company issued
debt in the par amount of $280,783 secured by the subsidiary's assets. In July
2004, the Company sold a CDO II bond with a par of
102
$12,850 that it had previously retained. Before the sale of this security, the
Company amended the indenture to reduce the coupon from 9.0% to 7.6%. The
adjusted issue price of the CDO II debt at December 31, 2006 is $291,261. Five
tranches were issued at a fixed rate coupon and three tranches were issued at a
floating rate coupon with a combined weighted average remaining maturity of 5.6
years at December 31, 2006. All floating rate coupons were swapped to fixed rate
coupons resulting in a total fixed rate cost of funds for CDO II of
approximately 6.0%. The Company incurred $6,004 of issuance costs that will be
amortized over the weighted average life of CDO II. CDO II was structured to
match fund the cash flows from a significant portion of the Company's CMBS and
investment grade REIT debt. The par amount at December 31, 2006 of the
collateral securing CDO II consisted of 81.4% CMBS rated B or higher and 18.6%
REIT debt rated BBB or higher. At December 31, 2006, the collateral securing CDO
II had a fair value of $358,447.
On March 30, 2004, the Company issued eleven tranches of secured debt through
CDO III. In this transaction, a wholly owned subsidiary of the Company issued
secured debt in the par amount of $372,456 secured by the subsidiary's assets.
The adjusted issue price of the CDO III debt, at December 31, 2006, is $366,019.
Five tranches were issued at a fixed rate coupon and six tranches were issued at
a floating rate coupon with a combined weighted average remaining maturity of
6.4 years at December 31, 2006. All floating rate coupons were swapped to fixed
rate coupons resulting in a total fixed rate cost of funds for CDO III of
approximately 5.0%. The Company incurred $2,006 of issuance costs that will be
amortized over the weighted average life of CDO III. CDO III was structured to
match fund the cash flows from a significant portion of the Company's CMBS and
investment grade REIT. The par amount at December 31, 2006 of the collateral
securing CDO III consisted of 84.3% CMBS rated B or higher and 15.7% REIT debt
rated BBB or higher. At December 31, 2006, the collateral securing CDO III had a
fair value of $391,061.
On May 23, 2006, the Company issued nine tranches of secured debt through CDO
HY3. In this transaction, a wholly owned subsidiary of the Company issued
secured debt in the par amount of $417,000 secured by the subsidiary's assets.
The adjusted issue price of the CDO HY3 debt at December 31, 2006 is $402,089.
Three tranches were issued at a fixed rate coupon and six tranches were issued
at a floating rate coupon with a combined weighted average remaining maturity of
9.7 years at December 31, 2006. All floating rate coupons were swapped to fixed
rate coupons resulting in a total fixed rate cost of funds for CDO HY3 of
approximately 6.4%. The Company incurred $7,057 of issuance costs that will be
amortized over the weighted average life of CDO HY3. CDO HY3was structured to
match fund the cash flows from a significant portion of the Company's CMBS and
commercial real estate loans. The par amount at December 31, 2006 of the
collateral securing CDO HY3 consisted of 75.6% CMBS rated B or higher and 24.4%
commercial real estate loans. At December 31, 2006, the collateral securing CDO
HY3 had a fair value of $449,649.
On December 14, 2006, the Company closed its seventh CDO ("Euro CDO"). The Euro
CDO sold E263,500 of non-recourse debt at a weighted average spread to Euro
Libor of 60 basis points. The E263,500 consists of E251,000 of
investment grade debt at a weighted average spread to Euro Libor of 50 basis
points and E12,500 of below investment grade debt. The Company retained an
additional E12,500 of below investment grade debt and all of Euro CDO's
preferred shares. The Company incurred E3,489 of issuance costs that will
be amortized over the weighted average life of Euro CDO. This transaction
represents the Company's seventh CDO. The previous six were U.S. dollar
denominated.
103
Senior Unsecured Notes
During October 2006, the Company issued $75,000 of unsecured senior notes due in
2016 with a weighted average cost of funds of 7.21%. The unsecured senior notes
can be redeemed in whole by the Company subject to certain provisions, which
could include the payment of fees.
Trust Preferred Securities
On September 26, 2005, the Company issued $75,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust I, a Delaware
statutory trust ("Trust I"). The trust preferred securities have a thirty-year
term ending October 30, 2035 with interest at a fixed rate of 7.497% for the
first ten years and at a floating rate of three-month LIBOR plus 2.9%
thereafter. The trust preferred securities can be redeemed at par by the Company
beginning in October 2010. Trust I issued $2,380 aggregate liquidation amount of
common securities, representing 100% of the voting common stock of Trust I to
the Company for a purchase price of $2,380. The Company realized net proceeds
from this offering of approximately $72,618.
On January 31, 2006, the Company issued $50,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust II, a Delaware
statutory trust ("Trust II"). The trust preferred securities have a thirty-year
term ending April 30, 2036 with interest at a fixed rate of 7.73% for the first
ten years and at a floating rate of three-month LIBOR plus 2.7% thereafter. The
trust preferred securities can be redeemed at par by the Company beginning in
April 2011. Trust II issued $1,550 aggregate liquidation amount of common
securities, representing 100% of the voting common stock of Trust II to the
Company for a purchase price of $1,550. The Company realized net proceeds from
this offering of approximately $48,491.
On March 16, 2006, the Company issued $50,000 of trust preferred securities
through its wholly owned subsidiary, Anthracite Capital Trust III, a Delaware
statutory trust ("Trust III" and collectively with Trust I and Trust II, the
"Trusts"). The trust preferred securities have a thirty-year term ending March
15, 2036 with interest at a fixed rate of 7.77% for the first ten years and at a
floating rate of three-month LIBOR plus 2.7% thereafter. The trust preferred
securities can be redeemed at par by the Company beginning in March 2011. Trust
III issued $1,547 aggregate liquidation amount of common securities,
representing 100% of the voting common stock of Trust III to the Company for a
purchase price of $1,547. The Company realized net proceeds from this offering
of approximately $48,435.
The Trusts used the proceeds from the sale of the trust preferred securities and
the common securities to purchase the Company's junior subordinated notes. The
terms of the junior subordinated notes match the terms of the trust preferred
securities. The notes are subordinate and junior in right of payment to all
present and future senior indebtedness and certain other of our financial
obligations.
The Company's interests in the Trusts are accounted for using the equity method
and the assets and liabilities of the Trusts are not consolidated into the
Company's financial statements. Interest on the junior subordinated notes is
included in interest expense on the consolidated statements of operation while
the common securities are included as a component of other assets on the
Company's consolidated statement of financial condition.
104
NOTE 11 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the notional amount, carrying value and estimated
fair value of financial instruments at December 31, 2006 and 2005:
December 31, 2006 December 31, 2005
------------------------------------ --------------------------------------
Notional Carrying Estimated Notional Carrying Estimated
Amount Value Fair Value Amount Value Fair Value
---------- ---------- ---------- ---------- ----------- -----------
Securities available-for-sale $ -- $2,615,856 $2,615,856 $ -- $ 2,076,936 $ 2,076,936
Securities held-for-trading -- 154,587 154,587 -- 187,473 187,473
Commercial mortgage loans -- 481,745 481,745 -- 365,806 365,806
Secured borrowings -- 875,116 875,116 -- 1,101,316 1,101,316
CDO borrowings -- 1,812,574 1,834,787 -- 1,066,930 1,090,927
Commercial mortgage loan pool
borrowings -- 1,250,503 1,250,503 -- 1,272,931 1,272,931
Senior unsecured notes -- 75,000 75,000
Junior subordinated notes -- 180,477 180,477 -- 77,380 77,380
Currency forward contracts -- (2,659) (2,659) -- 1,108 1,108
Currency swap agreements -- (240) (240) -- -- --
Interest rate swap agreements 1,843,144 15,274 15,274 1,558,398 20,845 20,845
Notional amounts are a unit of measure specified in a derivative instrument. The
estimated fair values of the Company's securities available-for-sale, securities
held-for-trading, currency forward contracts and interest rate swap agreements
are based on market prices provided by certain dealers who make markets in these
financial instruments. The estimated fair values reported reflect estimates and
may not necessarily be indicative of the amounts the Company could realize in a
current market exchange. Commercial mortgage loans and secured borrowings are
floating rate instruments, and based on these terms, their carrying value
approximates fair value.
NOTE 12 PREFERRED STOCK
The Series B Preferred Stock was redeemed on May 6, 2004. The consolidated
statement of operations for 2004 includes a charge of $10,508 for the redemption
of the Company's Series B Preferred Stock.
On February 12, 2007, the Company issued $86,250 of Series D Cumulative
Redeemable Preferred Stock ("Series D Preferred Stock"), including $11,250 of
Series D Preferred Stock sold to underwriters pursuant to an over-allotment
option. The Series D Preferred Stock will pay an annual dividend of 8.25%.
At December 31, 2006, the Company had 94,394,003 authorized and un-issued shares
of preferred stock. Following the issuance of the Series D Preferred Stock on
February 12, 2007, the Company had 90,944,003 authorized and un-issued shares of
preferred stock.
NOTE 13 COMMON STOCK
On August 18, 2005, the Company completed a follow-on offering of 1,725,000
shares of its Common Stock, at a price of $11.59 per share, which included a 15%
over-allotment option exercised by the underwriter. Net proceeds (after
deducting underwriting fees and expenses) were $19,125.
105
The following table summarizes Common Stock issued by the Company for the years
ended December 31, 2006 and 2005:
2006 2005
------------------------ ------------------------
Shares Net Proceeds Shares Net Proceeds
--------- ------------ --------- ------------
Dividend Reinvestment Plan 608,747 $ 6,517 1,318,568 $14,327
Follow-on offerings -- -- 1,725,000 19,125
Sales agency agreement 664,900 8,625 -- --
Director compensation 5,000 64 6,000 70
Incentive fees 189,077 2,100 -- --
Stock options 24,700 209 -- --
--------- ------- --------- -------
Total 1,492,424 $17,515 3,049,568 $33,522
========= ======= ========= =======
The following table summarizes dividends declared and paid by the Company for
the years ended December 31, 2006, 2005, and 2004:
Dividend Paid in
Dividend Declared per Paid in Subsequent
Year Declared Share Current Year Year (1)
---- -------- ------------ ------------ ----------
2006 $66,017 $1.15 $49,246 $16,771
2005 $61,168 $1.12 $45,394 $15,774
2004 $58,208 $1.12 $43,287 $14,920
(1) Paid on February 1
Dividends related to 2006, 2005 and 2004 were 100% ordinary income.
NOTE 14 TRANSACTIONS WITH AFFILIATES
The Company has a Management Agreement, an administrative services agreement and
an accounting services agreement with the Manager, the employer of certain
directors and all of the officers of the Company, under which the Manager and
the Company's officers manage the Company's day-to-day investment operations,
subject to the direction and oversight of the Company's Board of Directors.
Pursuant to the Management Agreement and these other agreements, the Manager and
the Company's officers formulate investment strategies, arrange for the
acquisition of assets, arrange for financing, monitor the performance of the
Company's assets and provide certain other advisory, administrative and
managerial services in connection with the operations of the Company. For
performing certain of these services, the Company pays the Manager under the
Management Agreement a base management fee equal to 2.0% of the quarterly
average total stockholders' equity for the applicable quarter.
To provide an incentive, the Manager is entitled to receive an incentive fee
under the Management Agreement equal to 25% of the amount by which the rolling
four-quarter GAAP net income before the incentive fee exceeds the greater of
8.5% or 400 basis points over the ten-year Treasury note multiplied by the
adjusted per share issue price of the Company's Common Stock ($11.37 per common
share at December 31, 2006). Additionally, up to 30% of the incentive fees
earned in 2005 or after may be paid in shares of the Company's Common Stock
subject to certain provisions under a compensatory deferred stock plan approved
by the stockholders of the Company in 2006. The Board of Directors also
authorized a stock based incentive plan where one-half of one percent of common
shares outstanding was paid to the Manager in 2006.
106
The Company's unaffiliated directors approved an extension of the Management
Agreement to March 30, 2008 at the Board's March 2007 meeting.
The following is a summary of management and incentive fees incurred for the
years ended December 31, 2006, 2005, and 2004:
For the Year Ended December 31,
-------------------------------
2006 2005 2004
------- ------- ------
Management fee $12,617 $10,974 $8,956
Incentive fee 5,919 4,290 --
Incentive fee- stock based 2,761 -- --
------- ------- ------
Total management and incentive fees $21,297 $15,264 $8,956
======= ======= ======
The Company has administration and accounting services agreements with the
Manager. Under the terms of the administration agreement, the Manager provides
financial reporting, audit coordination and accounting oversight
services to the Company. Under the terms of the accounting services agreement,
the Manager provides investment accounting services to the Company. For the
years ended December 31, 2006, 2005, and 2004, the Company paid administration
fees of $234, $209, and $174, respectively, which are included in general and
administrative expense on the accompanying statement of operations. No payments
were made in each of the three years in the period ended December 31, 2006 under
the accounting services agreement.
The special servicer on 25 of the Company's 29 Controlling Class trusts is
Midland, a wholly owned indirect subsidiary of PNC Bank, and therefore a related
party to the Manager. The Company's fees for Midland's services are at market
rates.
On December 13, 2005, the Company entered into a $75,000 commitment to acquire
shares of BlackRock Diamond. BlackRock Diamond is a private REIT managed by
BlackRock Realty Advisors, Inc., a subsidiary of the Manager. During February
2006, the Company increased its capital commitments by an additional $25,000. At
December 31, 2006, 93% of the commitment has been called and the Company owned
approximately 21% of BlackRock Diamond. The Company does not incur any
additional management or incentive fees to the Manager related to its investment
in BlackRock Diamond. The Company's investment in BlackRock Diamond at December
31, 2006 was $105,894. At December 31, 2006, the Company had $7,397 of remaining
capital commitments to BlackRock Diamond, all of which was called in January
2007.
During 2001, the Company entered into a $50,000 commitment to acquire shares in
Carbon I, a private commercial real estate income opportunity fund managed by
the Manager. The Carbon I investment period ended on July 12, 2004 and the
Company's investment in Carbon I at December 31, 2006 was $3,144. The Company
does not incur any additional management or incentive fees to the Manager
related to its investment in Carbon I. On December 31, 2006, the Company owned
approximately 20% of the outstanding shares in Carbon I. The Company's
unaffiliated directors approved this transaction in July 2001.
The Company entered into an aggregate commitment of $100,000 to acquire shares
in Carbon II, a private commercial real estate income opportunity fund managed
by the Manager. At December 31, 2006, the Company's investment in Carbon II was
$69,259 and the Company's remaining commitment to Carbon II is $28,958. The
Company does not incur any additional management or incentive fees to the
Manager related to its investment in Carbon II. On December 31, 2006, the
107
Company owned approximately 26% of the outstanding shares in Carbon II. The
Company's unaffiliated directors approved this transaction in September 2004.
During 2000, the Company completed the acquisition of CORE Cap, Inc. At the time
of the CORE Cap, Inc. acquisition, the Manager agreed to pay GMAC (CORE Cap,
Inc.'s external advisor) $12,500 over a ten-year period ("Installment Payment")
to purchase the right to manage the Core Cap, Inc. assets under the existing
management contract ("GMAC Contract"). The GMAC Contract had to be terminated in
order to allow the Company to complete the merger, as the Company's management
agreement with the Manager did not provide for multiple managers. As a result
the Manager offered to buy-out the GMAC Contract as the Manager estimated it
would receive incremental fees above and beyond the Installment Payment, and
thus was willing to pay for, and separately negotiate, the termination of the
GMAC Contract. Accordingly, the value of the Installment Payment was not
considered in the Company's allocation of its purchase price to the net assets
acquired in the acquisition of CORE Cap, Inc. The Company agreed that should the
Management Agreement with its Manager be terminated, not renewed or not extended
for any reason other than for cause, the Company would pay to the Manager an
amount equal to the Installment Payment less the sum of all payments made by the
Manager to GMAC. At December 31, 2006, the Installment Payment would be $4,000
payable over four years. The Company does not accrue for this contingent
liability.
NOTE 15 STOCK OPTIONS
The Company has adopted a stock option plan (the "1998 Stock Option Plan") that
provides for the grant of both qualified incentive stock options that meet the
requirements of Section 422 of the Code and non-qualified stock options, stock
appreciation rights and dividend equivalent rights. Stock options may be granted
to the Manager, directors and officers of the Company and directors, officers
and key employees of the Manager and to any other individual or entity
performing services for the Company.
The exercise price for any stock option granted under the 1998 Stock Option Plan
may not be less than 100% of the fair market value of the shares of Common Stock
at the time the option is granted. Each option must terminate no more than ten
years from the date it is granted and have vested over either a two or
three-year period. Subject to anti-dilution provisions for stock splits, stock
dividends and similar events, the 1998 Stock Option Plan authorizes the grant of
options to purchase up to an aggregate of 2,470,453 shares of Common Stock.
The following table summarizes information about options outstanding under the
1998 Stock Option Plan:
2006 2005 2004
---------------------------- ---------------------------- ----------------------------
Weighted-Average Weighted-Average Weighted-Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
--------- ---------------- --------- ---------------- --------- ----------------
Outstanding at January 1 1,417,851 $14.87 1,417,851 $14.87 1,468,351 $14.75
Granted -- -- -- -- 5,000 11.81
Exercised (24,700) 8.45 -- -- (30,000) 8.44
Cancelled (1,000) 11.81 -- -- (25,500) 15.00
Outstanding at December 31 1,392,151 $14.98 1,417,851 $14.87 1,417,851 $14.87
========= ====== ========= ====== ========= ======
Options exercisable at December 31 1,392,151 $14.98 1,417,851 $14.87 1,417,851 $14.87
========= ====== ========= ====== ========= ======
108
The following table summarizes information about options outstanding under the
1998 Stock Option Plan at December 31, 2006:
Remaining
Exercise Options Contractual Options
Price Outstanding Life (Years) Exercisable
-------- ----------- ------------ -----------
$ 8.44 8,000 2.2 8,000
11.81 4,000 7.4 4,000
15.00 1,310,851 1.2 1,310,851
15.58 57,750 0.7 57,750
15.83 11,550 1.2 11,550
------------ --------- --- ---------
$7.82-$15.83 1,392,151 1.2 1,392,151
============ ========= === =========
On May 25, 2004, the Company granted stock options to each of its unaffiliated
directors with an exercise price equal to the closing price of the Common Stock
on the New York Stock Exchange on such date (or $11.81). The options vested
immediately upon grant. The fair value of the options granted is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following assumptions.
2004
-------
Estimated volatility 22.6%
Expected term 7 years
Risk-free interest rate 1.2%
Expected dividend yield 9.5%
There were no options granted in 2006 or 2005. Shares of Common Stock available
for future grant under the 1998 Stock Option Plan at December 31, 2006 were
775,502.
NOTE 16 DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company accounts for its derivative investments under SFAS No. 133, as
amended, which establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. All derivatives, whether designated in
hedging relationships or not, are required to be recorded on the consolidated
statement of financial condition at estimated fair value. If the derivative is
designated as a cash flow hedge, the effective portions of change in the
estimated fair value of the derivative are recorded in other comprehensive
income ("OCI") and are recognized in the consolidated statement of operations
when the hedged item affects earnings. Ineffective portions of changes in the
estimated fair value of cash flow hedges are recognized in earnings. If the
derivative is designated as a fair value hedge, the changes in the estimated
fair value of the derivative and of the hedged item attributable to the hedged
risk are recognized in earnings.
The Company uses interest rate swaps to manage exposure to variable cash flows
on portions of its borrowings under reverse repurchase agreements and the
floating rate debt of its CDOs and as trading derivatives intended to offset
changes in estimated fair value related to securities held as trading assets. On
the date in which the derivative contract is entered, the Company designates the
derivative as either a cash flow hedge or a trading derivative.
109
The reverse repurchase agreements bear interest at a LIBOR-based variable rate.
Increases in the LIBOR rate could negatively impact earnings. The interest rate
swap agreements allow the Company to receive a variable rate cash flow based on
LIBOR and pay a fixed rate cash flow, mitigating the impact of this exposure.
Interest rate swap agreements contain an element of risk in the event that the
counterparties to the agreements do not perform their obligations under the
agreements. The Company minimizes its risk exposure by entering into agreements
with parties rated at least A or better by nationally recognized credit rating
organizations. Furthermore, the Company has interest rate swap agreements
established with several different counterparties in order to reduce the risk of
credit exposure to any one counterparty. Management does not expect any
counterparty to default on their obligations.
Where the Company elects to apply hedge accounting, it formally documents all
relationships between hedging instruments and hedged items, as well as its
risk-management objectives and strategies for undertaking various hedge
transactions. The Company assesses, both at the inception of the hedge and on an
on-going basis, whether the derivatives that are used in hedging transactions
are highly effective in offsetting changes in fair values or cash flows of
hedged items. When it is determined that a derivative is not highly effective as
a hedge, the Company discontinues hedge accounting prospectively.
Occasionally, counterparties will require the Company or the Company will
require counterparties to provide collateral for the interest rate swap
agreements in the form of margin deposits. Such deposits are recorded as a
component of other assets, other liabilities or restricted cash. Should the
counterparty fail to return deposits paid, the Company would be at risk for the
value of that asset. At December 31, 2006, the balance of such net deposits
pledged to counterparties as collateral under these agreements totaled $520. At
December 31, 2005, the balance of such net deposits held by the Company as
collateral under these agreements totaled $1,246.
2006
During the fourth quarter, the Company changed its financing strategy to
emphasize the use of 90-day reverse repurchase agreements and concurrently
reduced the use of 30-day reverse repurchase agreements. The Company expects
90-day repurchase agreements to be its primary source for short-term financings
in future periods. As a result of the reduction in the balance of 30-day reverse
repurchase agreements, certain interest swaps that were hedging the 30-day
reverse repurchase agreements were de-designated as hedges. As a result of the
de-designation, the Company incurred a loss of $12,661. Of this amount, $9,433
were previously recorded in OCI and was being reclassified to interest expense
over the weighted average remaining term of the swaps at the time the swaps were
closed. The balance of $3,228 relates to costs associated with interest rate
swaps that were closed or redesignated in the fourth quarter of 2006. At
December 31, 2006, a loss of $8,210 remained in OCI and $1,637 will be
reclassified as an increase to interest expense over the next twelve months.
At December 31, 2006, the Company had interest rate swaps with notional amounts
aggregating $1,539,699 designated as cash flow hedges of borrowings under
reverse repurchase agreements and the floating rate debt of its CDOs. Cash flow
hedges with an estimated fair value of $24,290 are included in other assets on
the consolidated statement of financial condition and cash flow hedges with an
estimated fair value of $11,012 are included in other liabilities on the
consolidated statement of financial condition. This liability was collateralized
with the restricted cash equivalents recorded on the
110
Company's consolidated statement of financial condition. For the year ended
December 31, 2006, the net change in the estimated fair value of the interest
rate swaps was an increase of $2,699, of which $262 was deemed ineffective and
is included as an increase of interest expense and $2,961 was recorded as an
increase of OCI. At December 31, 2006, the $1,539,699 notional of swaps that
were designated as cash flow hedges had a weighted average remaining term of 7.5
years.
At December 31, 2006, the Company had interest rate swaps with notional amounts
aggregating $446,599 designated as trading derivatives. Trading derivatives with
an estimated fair value of $3,294 are included in other assets on the
consolidated statement of financial condition and trading derivatives with a
fair value of $1,537 are included in other liabilities on the consolidated
statement of financial condition. For the year ended December 31, 2006, the
change in fair value for these trading derivatives was an increase of $717 and
is included as an addition to gain on securities held-for-trading in the
consolidated statement of operations. At December 31, 2006, the $446,599
notional of swaps, which were designated as trading derivatives, had a weighted
average remaining term of 7.6 years.
At December 31, 2006, the Company had a forward LIBOR cap with a notional amount
of $85,000 and a fair value of $211 that is included in interest rate swap
agreement on the consolidated statement of financial condition. The change in
estimated fair value related to this derivative is included as a component of
gain (loss) on securities held-for-trading in the consolidated statements of
operations.
2005
On June 9, 2005, interest rate swaps with notional amounts of $43,000 that were
classified as trading derivatives were re-designated as cash flow hedges of
borrowings under reverse repurchase agreements. The reclassification was based
on the Company's intent with respect to these derivatives with the principle
objective of generating returns from other than short-term pricing differences.
At December 31, 2005, the Company had interest rate swaps with notional amounts
aggregating $1,201,953 designated as cash flow hedges of borrowings under
reverse repurchase agreements and the floating rate debt of its CDOs. Cash flow
hedges with an estimated fair value of $25,632 are included in other assets on
the consolidated statement of financial condition and cash flow hedges with an
estimated fair value of $8,782 are included in other liabilities on the
consolidated statement of financial condition. For the year ended December 31,
2005, the net change in the estimated fair value of the interest rate swaps was
an increase of $25,436, of which $1,190 was deemed ineffective and is included
as an increase of interest expense and $26,626 was recorded as an addition to
OCI. At December 31, 2005, the $1,201,953 notional of swaps designated as cash
flow hedges had a weighted average remaining term of 7.89 years.
During the year ended December 31, 2005, the Company terminated nine of its
interest rate swaps with a notional amount of $204,300 that were designated as
cash flow hedges of borrowings under reverse repurchase agreements. The Company
will reclassify the $2,034 loss in value incurred from OCI to interest expense
over 8.86 years, which was the weighted average remaining term of the swaps at
the time they were closed out. For the year ended December 31, 2005, $103 was
reclassified as an increase to interest expense and $252 will be reclassified as
an increase to interest expense for the next 12 months. As of December 31, 2005
the Company has, in aggregate, $35,530 of losses related to terminated swaps in
OCI. For the year ended December 31, 2005, $6,129 was reclassified as an
increase to interest expense and $6,029 will be reclassified as an increase to
interest expense for the next twelve months.
At December 31, 2005, the Company had interest rate swaps with notional amounts
aggregating $356,445 designated as trading derivatives. Trading derivatives with
an estimated fair value of $4,119 are included in
111
other assets on the consolidated statement of financial condition and trading
derivatives with an estimated fair value of $125 are included in other
liabilities on the consolidated statement of financial condition. For the year
ended December 31, 2005, the change in estimated fair value for these trading
derivatives was an increase of $3,030 and is included as a reduction of loss on
securities held-for-trading in the consolidated statements of operations. At
December 31, 2005, the $356,445 notional of swaps designated as trading
derivatives had a weighted average remaining term of 6.99 years.
At December 31, 2005, the Company had a forward LIBOR cap with a notional amount
of $85,000 and a fair value of $1,491 that is included in interest rate swap
agreement on the consolidated statement of financial condition. The change in
estimated fair value related to this derivative is included as a component of
gain (loss) on securities held-for-trading in the consolidated statements of
operations.
FOREIGN CURRENCY
The U.S. dollar is considered the functional currency for certain of the
Company's international subsidiaries. Foreign currency transaction gains or
losses are recognized in the period incurred and are included in foreign
currency gain (loss) in the consolidated statement of operations. Gains and
losses on foreign currency forward commitments are included in foreign currency
gain (loss) in the consolidated statement of operations. The Company recorded
foreign currency gain (loss) of $2,161, $(134), and $(187) for the years ended
December 31, 2006, 2005 and 2004, respectively. At December 31,2006, the Company
had foreign currency forward commitments with an estimated fair value of
$289,779 included in other assets and $(292,438) included in other liabilities
on the consolidated statement of financial condition. At December 31,2005, the
Company had foreign currency forward commitments with an estimated fair value of
$71,673 included in other assets and $(70,565) included in other liabilities on
the consolidated statement of financial condition.
NOTE 17 NET INTEREST INCOME
The following is a presentation of the Company net interest income for the year
ended December 31, 2006, 2005 and 2004:
Year ended December 31,
------------------------------
2006 2005 2004
-------- -------- --------
Interest Income:
Interest from securities available-for-sale $171,686 $141,113 $131,342
Interest from commercial mortgage loans 41,773 23,183 11,896
Interest from commercial mortgage loan pools 52,917 54,025 39,672
Interest from securities held-for-trading 7,207 11,370 11,419
Interest from cash and cash equivalents 2,403 2,077 638
-------- -------- --------
Total interest income 275,986 231,768 194,967
-------- -------- --------
Interest Expense:
Interest 205,023 156,865 124,289
Interest - securities held-for-trading 7,365 6,593 3,877
-------- -------- --------
Total interest expense 212,388 163,458 128,166
-------- -------- --------
Net interest income $ 63,598 $ 68,310 $ 66,801
======== ======== ========
112
NOTE 18 NET INCOME PER SHARE
Net income per share is computed in accordance with SFAS No. 128, Earnings Per
Share ("SFAS No. 128"). Basic income per share is calculated by dividing net
income available to common stockholders by the weighted average number of shares
of Common Stock outstanding during the period. Diluted income per share is
calculated using the weighted average number of shares of Common Stock
outstanding during the period plus the additional dilutive effect of common
stock equivalents. The dilutive effect of outstanding stock options is
calculated using the treasury stock method, and the dilutive effect of preferred
stock is calculated using the "if converted" method.
For the year ended December 31,
---------------------------------------
2006 2005 2004
----------- ----------- -----------
Numerator:
Net income available to common stockholders $ 75,079 $ 65,205 $ 25,768
----------- ----------- -----------
Numerator for basic and diluted earnings per share $ 75,079 $ 65,205 $ 25,768
=========== =========== ===========
Denominator:
Denominator for basic earnings per share--weighted
average common shares outstanding 57,182,434 54,144,243 51,766,877
Dilutive effect of stock options 2,364 8,577 8,903
Dilutive effect of stock based incentive fee 216,866 -- --
----------- ----------- -----------
Denominator for diluted earnings per
share--weighted average common shares
outstanding and common stock equivalents
outstanding 57,401,664 54,152,820 51,775,780
=========== =========== ===========
Basic net income per weighted average common share: $ 1.31 $ 1.20 $ 0.50
----------- ----------- -----------
Diluted net income per weighted average common stock
and common stock equivalents: $ 1.31 $ 1.20 $ 0.50
----------- ----------- -----------
Total anti-dilutive stock options and warrants excluded from the calculation of
net income per share were $1,380,151, 1,375,151, and 1,385,151 for the years
ended December 31, 2006, 2005, and 2004, respectively.
113
NOTE 19 SUMMARIZED QUARTERLY RESULTS (UNAUDITED)
The following is a presentation of quarterly results of operations:
Quarters Ending
------------------------------------------------------------------------------
March 31 June 30 September 30 December 31
----------------- ----------------- ----------------- ------------------
2006 2005 2006 2005 2006 2005 2006 2005
------- ------- ------- ------- ------- ------- ------- --------
Total Income $71,743 $57,308 $77,441 $58,125 $74,553 $61,938 $79,680 $ 66,543
------- ------- ------- ------- ------- ------- ------- --------
Expenses:
Interest 46,524 36,504 51,358 38,970 56,060 42,804 58,446 45,180
Management fee and Other 5,323 3,399 6,638 3,599 5,320 3,732 8,549 8,451
------- ------- ------- ------- ------- ------- ------- --------
Total Expenses 51,847 39,903 57,996 42,569 61,380 46,536 66,995 53,631
------- ------- ------- ------- ------- ------- ------- --------
Gain (loss) on sale of securities 32 10 (93) 47 446 31 28,647 16,455
available-for-sale
Dedesignation of derivative
instruments -- -- -- -- -- -- (12,661)
Gain (loss) on securities
held-for-trading 950 (1,372) 1,365 (1,306) (18) 897 957 (218)
Foreign currency gain (loss) 43 (168) 271 (176) 682 87 1,165 123
Loss on impairment of assets (781) (159) (4,653) (3,072) (361) -- (2,085) (1,857)
------- ------- ------- ------- ------- ------- ------- --------
Income from continuing operations 20,140 15,716 16,335 11,049 13,922 16,417 28,708 27,415
------- ------- ------- ------- ------- ------- ------- --------
Income from discontinued operations -- -- 1,366 -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- --------
Net income $20,140 $15,716 $17,701 $11,049 $13,922 $16,417 $28,708 $ 27,415
------- ------- ------- ------- ------- ------- ------- --------
Dividends on convertible preferred
stock 1,348 1,348 1,348 1,348 1,348 1,348 1,348 1,348
------- ------- ------- ------- ------- ------- ------- --------
Net income available to common
stockholders $18,792 $14,368 $16,353 $ 9,701 $12,574 $15,069 $27,360 $ 26,067
======= ======= ======= ======= ======= ======= ======= ========
Net income per share, basic: $ 0.33 $ 0.27 $ 0.29 $ 0.18 $ 0.22 $ 0.28 $ 0.47 $ 0.47
======= ======= ======= ======= ======= ======= ======= ========
Net income per share, diluted: $ 0.33 $ 0.27 $ 0.29 $ 0.18 $ 0.22 $ 0.28 $ 0.47 $ 0.47
======= ======= ======= ======= ======= ======= ======= ========
114
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company, under the direction and with the participation of its management,
including the Chief Executive Officer and the Chief Financial Officer, evaluated
the effectiveness of the Company's disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of the end of the period covered by this report. Based
on that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that the Company's disclosure controls and procedures were effective
at December 31, 2006.
No change in internal control over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) occurred during the quarter ended December 31,
2006 that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
Management's Report on Internal Control over Financial Reporting and the Report
of Independent Registered Public Accounting Firm thereon are set forth in Part
II, Item 8 of this Annual Report on Form 10-K.
ITEM 9B. OTHER INFORMATION
None.
115
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE
REGISTRANT
Information regarding directors of the Company, including its audit committee
and audit committee financial experts, and its executive officers and compliance
with Section 16(a) of the Exchange Act will be in the Company's Proxy Statement
and is incorporated herein by reference.
The Company has adopted Codes of Business Conduct and Ethics that govern both
the Company's senior officers, including the Company's chief executive officer
and chief financial officer, and employees. Copies of the Company's Codes of
Business Conduct and Ethics are available on the Company's website at
www.anthracitecapital.com and may also be obtained upon request without charge
by writing to the Secretary of the Company, Anthracite Capital, Inc., 40 East
52nd Street, New York, NY 10022. The Company will post to its website any
amendments to the Codes of Business Conduct and Ethics, and any waivers that are
required to be disclosed by the rules of either the SEC or the NYSE.
Copies of the Company's Corporate Governance Guidelines and the charters of the
Company's Audit Committee, Compensation Committee and Nominating and Corporate
Governance Committee are available on the Company's website and may also be
obtained upon request without charge as described in the preceding paragraph.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the captions "Executive Officers" and
"Compensation of Directors" in the Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information set forth under the captions "Security Ownership of Certain
Beneficial Owners and Management" and "Executive Officers" and other information
relating to security ownership of certain beneficial owners of the Company's
Common Stock and of the Company's management in the Proxy Statement are
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information set forth under the caption "Certain Relationships and Related
Transactions" and the information regarding director independence under the
caption "Corporate Governance" in the Proxy Statement are incorporated herein by
reference.
116
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information set forth under the caption "Independent Registered Public
Accounting Firm" and other information regarding principal accountant fees and
services in the Proxy Statement are incorporated herein by reference.
117
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) List of documents filed as part of this report:
(1) Consolidated Financial Statements and Report of Independent
Registered Public Accounting Firm
See the Index to Financial Statements at Item 8 of this report.
(2) Financial Statement Schedules
All financial statement schedules have been omitted because
either the required information is not applicable or the
information is shown in the financial statements or notes
thereto.
(3) List of Exhibits
EXHIBIT NO. DESCRIPTION
----------- -----------
3.1 Articles of Amendment and Restatement of the Company (incorporated
by reference to Exhibit 3.1 to the Company's Annual Report on Form
10-K for the year ended December 31, 1999, filed on March 29,
2000)
3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to
the Company's Registration Statement on Form S-11 (File No.
333-40813) filed on March 18, 1998)
3.3 Articles Supplementary of the Company establishing 9.375% Series C
Cumulative Redeemable Preferred Stock (incorporated by reference
to Exhibit 3.1 to the Company's Current Report on Form 8-K, filed
on May 30, 2003)
3.4 Articles Supplementary of the Company establishing 8.25% Series D
Cumulative Redeemable Preferred Stock (incorporated by reference
to Exhibit 3.2 to the Company's Registration Statement on Form
8-A, filed on February 12, 2007)
4.1 Junior Subordinated Indenture, dated as of September 26, 2005,
between the Company and Wells Fargo Bank, National Association, as
trustee (incorporated by reference to Exhibit 4.1 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2005,
filed on March 16, 2006)
4.2 Junior Subordinated Indenture, dated as of January 31, 2006,
between the Company and JPMorgan Chase Bank, National Association,
as trustee (incorporated by reference to Exhibit 4.2 to the
Company's Annual Report on Form 10-K for the year ended December
31, 2005, filed on March 16, 2006)
4.3 Junior Subordinated Indenture, dated as of March 16, 2006, between
the Company and Wilmington Trust Company, as trustee
(incorporated by reference to Exhibit 4.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2006, filed on May 10, 2006)
4.4 Amended and Restated Trust Agreement, dated as of September 26,
2005, among the Company, as depositor, Wells Fargo Bank, National
Association, as property trustee, Wells Fargo Delaware Trust
Company, as Delaware trustee, and three administrative trustees,
each of whom is an officer of the Company (incorporated by
reference to Exhibit 4.4 to the Company's Annual Report on Form
10-K for the year ended December 31, 2005, filed on March 16,
2006)
118
4.5 Amended and Restated Trust Agreement, dated as of January 31,
2006, among the Company, as depositor, JPMorgan Chase Bank,
National Association, as property trustee, Chase Bank USA,
National Association, as Delaware trustee, and three
administrative trustees, each of whom is an officer of the Company
(incorporated by reference to Exhibit 4.5 to the Company's Annual
Report on Form 10-K for the year ended December 31, 2005, filed on
March 16, 2006)
4.6 Amended and Restated Trust Agreement, dated as of March 16, 2006,
among the Company, as depositor, Wilmington Trust Company, as
property trustee, Wilmington Trust Company, as Delaware trustee,
and the three administrative trustees, each of whom is an officer
of the Company (incorporated by reference to Exhibit 4.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2006, filed on May 10, 2006)
10.1* Amended and Restated Investment Advisory Agreement, dated as of
March 15, 2007, between the Company and BlackRock Financial
Management, Inc.
10.2* Amended and Restated Accounting Services Agreement, dated as of
March 15, 2007, between the Company and BlackRock Financial
Management, Inc.
10.3* Amended and Restated Administration Agreement, dated as of March
15, 2007, between the Company and BlackRock Financial Management,
Inc.
10.4 Form of 1998 Stock Option Incentive Plan (incorporated by
reference to Exhibit 10.6 to the Company's Registration Statement
on Form S-11 (File No. 333-40813) filed on March 18, 1998)
10.5* Form of 2006 Stock Award and Incentive Plan
10.6 Multicurrency Revolving Facility Agreement, dated as of February
14, 2006, among AHR Capital MS Limited, as borrower, Morgan
Stanley Mortgage Servicing Inc., as security trustee and Morgan
Stanley Bank, as initial lender and agent (incorporated by
reference to Exhibit 10.9 to the Company's Annual Report on Form
10-K for the year ended December 31, 2005, filed on March 16,
2006)
10.7 Multicurrency Revolving Facility Agreement, dated as of March 17,
2006, among AHR Capital BofA Limited, as borrower, the Company, as
borrower agent, and Bank of America, N.A., as lender (incorporated
by reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2006, filed on May 10,
2006)
10.8a Parent Guaranty, dated as of March 17, 2006, executed by the
Company, as guarantor, in favor of Bank of America, N.A., as
lender (incorporated by reference to Exhibit 10.1a to the
Company's Current Report on Form 8-K, filed on March 1, 2007)
10.8b Amendment No. 1, dated as of February 23, 2007, to Parent
Guaranty, dated as of March 17, 2006 (incorporated by reference to
Exhibit 10.1b to the Company's Current Report on Form 8-K, filed
on March 1, 2007)
119
10.9 Master Repurchase Agreement, dated as of December 23, 2004,
between Anthracite Funding, LLC, as seller, and Deutsche Bank AG,
Cayman Islands Branch, as buyer
10.10a Guaranty, dated as of December 23, 2004, executed by the Company,
as guarantor
10.10b Amendment, dated as of February 27, 2007, to Guaranty, dated as of
December 23, 2004 (incorporated by reference to Exhibit 10.2 to
the Company's Current Report on Form 8-K, filed on March 1, 2007)
10.11 Annex I to Master Repurchase Agreement, dated as of July 8, 2002,
between Anthracite Funding LLC and Deutsche Bank AG, Cayman
Islands
10.12 Letter agreement, dated as of July 1, 2006 to Master Repurchase
Agreement, dated as of July 8, 2002 between the Company, as
seller, and Greenwich Capital Financial Products, Inc., as buyer
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2006,
filed on August 9, 2006)
12.1* Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends
21.1* List of subsidiaries of the Company as of December 31, 2006
23.1* Consent of Deloitte & Touche LLP, Independent Registered Public
Accounting Firm
24.1* Powers of Attorney (included on signature page hereto)
31.1* Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2* Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1* Certification of Chief Executive Officer and Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
* Filed herewith.
120
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ANTHRACITE CAPITAL, INC.
Date: March 16, 2007 By: /s/ Christopher A. Milner
------------------------------------
Christopher A. Milner
Chief Executive Officer
(duly authorized representative)
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature
appears below constitutes and appoints Richard M. Shea his true and lawful
attorney-in-fact and agent with full power of substitution and re-substitution,
for his name, place and stead, in any and all capacities, to sign any and all
amendments (including post-effective amendments) to this Form 10-K and to file
the same with all exhibits thereto, and all documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done, as
fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorney-in-fact and agent, or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
This power of attorney may be executed in counterparts.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 16, 2007 By: /s/ Christopher A. Milner
------------------------------------
Christopher A. Milner
Chief Executive Officer
(Principal Executive Officer)
Date: March 16, 2007 By: /s/ James J. Lillis
------------------------------------
James J. Lillis
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
Date: March 16, 2007 By: /s/ Ralph L. Schlosstein
------------------------------------
Ralph L. Schlosstein
Chairman of the Board of Directors
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Date: March 16, 2007 By: /s/ Scott M. Amero
------------------------------------
Scott M. Amero
Director
Date: March 16, 2007 By: /s/ Hugh R. Frater
------------------------------------
Hugh R. Frater
Director
Date: March 16, 2007 By: /s/ Donald G. Drapkin
------------------------------------
Donald G. Drapkin
Director
Date: March 16, 2007 By: /s/ Carl F. Geuther
------------------------------------
Carl F. Geuther
Director
Date: March 16, 2007 By: /s/ Jeffrey C. Keil
------------------------------------
Jeffrey C. Keil
Director
Date: March 16, 2007 By: /s/ Leon T. Kendall
------------------------------------
Leon T. Kendall
Director
Date: March 16, 2007 By: /s/ Deborah J. Lucas
------------------------------------
Deborah J. Lucas
Director
122