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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, 2004
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
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
9.375% SERIES C CUMULATIVE REDEEMABLE NEW YORK STOCK EXCHANGE
PREFERRED STOCK, $.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 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 an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes |X| No /_/
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 $11.98 as reported on the New York Stock Exchange on June 30,
2004, was $630,821,384 (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, 2005 was 53,296,678 shares.
Documents Incorporated by Reference: The registrant's Definitive Proxy
Statement for the 2005 Annual Meeting of Stockholders is incorporated by
reference into Part III.
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ANTHRACITE CAPITAL, INC. AND SUBSIDIARIES
2004 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PAGE
PART I
Item 1. Business...........................................................4
Item 2. Properties ......................................................26
Item 3. Legal Proceedings ................................................26
Item 4. Submission of Matters to a Vote of
Security Holders .................................................26
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters ..................................27
Item 6. Selected Financial Data ..........................................28
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ....................29
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk ......................................................53
Item 8. Financial Statements and Supplementary Data ......................57
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ..........................106
Item 9A. Controls and Procedures..........................................106
PART III
Item 10. Directors and Executive Officers of the Registrant ..............107
Item 11. Executive Compensation ..........................................107
Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Shareholder Matters ...........107
Item 13. Certain Relationships and Related Transactions ..................107
Item 14. Principal Accountant Fees and Services...........................107
PART IV
Item 15. Exhibits and Financial Statement Schedules ......................108
Signatures ..............................................................110
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
the Company's manager, 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 and 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 or The PNC Financial
Services Group, Inc. ("PNC Bank");
(11) terrorist activities, which may adversely affect the general
economy, real estate, financial and capital markets, specific
industries, and 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; and
(14) the impact of changes to tax legislation and, generally, the tax
position of the Company.
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.
PART I
ITEM 1. BUSINESS
All dollar figures expressed herein are expressed in thousands, except share or
per share amounts.
General
The Company, a Maryland corporation, is a real estate finance company that
generates income based on the spread between the interest income on its
mortgage loans and securities investments and the interest expense from
borrowings to finance its investments. The Company's primary activity is
investing in high yielding commercial real estate debt. The Company combines
traditional real estate underwriting and capital markets expertise to exploit
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 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
consistent 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 over $341,800,000 of assets under management as of December 31,
2004. The Manager provides an operating platform that incorporates significant
asset origination, risk management, and operational capabilities.
The Company's ongoing investment activities encompass two core investment
activities:
1) Commercial Real Estate Securities
2) Commercial Real Estate Loans
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 provide attractive risk adjusted returns over shorter periods
of time through strategic investments in specific property types or regions.
The Company believes these portfolios can serve to provide stable earnings over
time.
During the third quarter of 2004, the Company completed its repositioning into
commercial real estate assets. As of December 31, 2004, CMBS and commercial
real estate loans represented 90% of portfolio assets while residential
mortgage-backed securities ("RMBS") represented 10%.
Commercial Real Estate Securities
The Company's principal activity is to underwrite and acquire high yielding
CMBS that are rated below investment grade. The Company's CMBS are securities
backed by pools of loans secured by first mortgages on commercial real estate
throughout the United States. The commercial real estate securing the first
mortgages consist 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 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.
Each trust has a designated special servicer. Special servicers are responsible
for carrying out loan loss mitigation strategies. A servicer will also 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 servicer is paid
interest on advanced funds and a fee for its efforts in carrying out loss
mitigation strategies.
The Company focuses on acquiring the securities rated below investment grade
(BB+ or lower). 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 control the workout process and therefore
designate the trust's special servicer. The Company will generally seek to
control 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 all securities that are rated
below investment grade represents 2.75% - 6.0% of the par of the underlying
loans of newly issued CMBS transactions. This is known as the subordination
level because 2.75% - 6.0% of the loan balance is subordinated to the senior,
investment grade rated securities.
The Company does not typically purchase a BB- 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 we 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 control of 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 2.5% - 4.0% subordination levels of these
securities provide additional credit protection and diversification with an
attractive risk return profile.
As of December 31, 2004, the Company owns 16 different trusts ("Controlling
Class") where 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 controls the workout process on $18,580,729 of underlying loans.
The total par amount owned of these subordinated Controlling Class securities
is $631,649. The Company does not own the senior securities that represent the
remaining par amount of the underlying mortgage loans. The special servicer on
11 of the 16 trusts is Midland Loan Services, Inc., the special servicer on two
trusts is GMAC Commercial Mortgage Management, Inc., and the special servicer
on the remaining three trusts is Lennar Partners, Inc.
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 portfolios as a
whole and to provide greater diversification to optimize secured financing
alternatives. The Company generally seeks to assemble a portfolio of high
quality issues that will maintain consistent performance over the life of the
security.
The Company also acquires CMBS interest only securities ("IOs"). These
securities represent a portion of the interest coupons paid by the underlying
loans. The Company views this portfolio as an 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.
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.
On November 9, 2004, the Company closed its fourth collateralized debt
obligation ("CDO") secured by a portfolio of below investment grade CMBS ("CDO
HY1"). The transaction was accounted for as a sale in accordance with Statement
of Financial Accounting Standard ("SFAS") No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities." The
Company received cash proceeds of $140,425 as well as all of the CDO HY1
preferred shares that had a fair market value of $15,885 as of December 31,
2004 in exchange for the collateral. The collateral was carried at a fair
market value of $109,933 on the Company's September 30, 2004 consolidated
statement of financial condition based on price quotes received from third
parties. The transaction raised reinvestable proceeds of $95,799. The following
table summarizes the impact of this transaction on fourth quarter 2004 results
and per share amounts:
Realized gain at closing of CDO HY1 $14,769 $0.28
Realized gain from subsequent sale of A- tranche 1,825 0.03
Increase in accumulated other comprehensive income 29,782 0.56
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Total book value impact $46,376 $0.87
=========================
The following table indicates the amounts of each category of commercial real
estate securities the Company owns as of December 31, 2004. 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
Fair Dollar Purchase Dollar Adjusted
Assets Par Value Price Price* Price Yield
- ------------------------------------------------------------------------------------------------------------
Investment Grade
Commercial Real
Estate Related Securities $ 668,101 $692,054 103.59 $674,167 100.91 5.83%
CMBS IOs 3,712,604 125,246 3.37 122,379 3.30 7.31%
Other Below Investment
Grade CMBS 332,225 313,282 94.30 290,771 87.52 8.51%
Controlling Class CMBS 661,483 473,521 71.58 452,086 68.34 9.48%
CDO Investments 203,182 19,836 9.76 19,450 9.57 56.65%
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Total $5,577,595 $1,623,939 29.12 $1,558,854 27.95 8.14%
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* The adjusted purchase price represents the amortized cost of the Company's investments.
The Company finances the majority of these portfolios with match funded,
secured term debt through CDO offerings. To accomplish this, the Company forms
a special purpose entity ("SPE") and contributes a portfolio of mostly below
investment grade CMBS, investment grade CMBS, and unsecured debt of commercial
real estate companies in exchange for the preferred equity interest in the SPE.
With the exception of CDO HY1, these transactions are considered financings and
the SPEs are fully consolidated on the Company's consolidated financial
statements. The SPE will then 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. The structure of the CDO debt also eliminates the mark to market
requirement of 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 is generally 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. The CDO provides an optimal 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
30-day reverse repurchase agreements.
The following table indicates the market values of each category of commercial
real estate securities collateralizing different types of borrowings as of
December 31, 2004:
Market Value Securing
--------------------------------------------------------------------------
Reverse Committed Not
CDO Debt Repo Facilities Financed Total
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Investment Grade Commercial Real Estate
Related Securities $478,645 $182,165 $ - $31,243 $692,053
CMBS IOs - 115,214 - 10,032 125,246
Other Below Investment
Grade CMBS 286,748 1,483 - 25,051 313,282
Controlling Class CMBS 412,064 30,979 9,217 21,261 473,521
CDO Investments - - - 19,837 19,837
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Total $1,177,457 $329,841 $9,217 $107,424 $1,623,939
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Prior to acquiring Controlling Class securities, the Company performs a
significant amount of due diligence on the underlying loans to ensure their
risk profiles fit the Company's criteria. Loans that do not fit the Company's
criteria are either removed from the pool or price adjustments occur. The debt
service coverage ratios are evaluated to determine if they are appropriate for
each asset class. The average loan to value ratio ("LTV") of the underlying
loans is generally 70% at origination. Due to its greater levels of credit
protection, other below investment grade CMBS are subject to less comprehensive
due diligence than Controlling Class securities.
As part of the underwriting process, the Company assumes a certain amount of
loans will incur losses over time. In performing continuing credit reviews on
the 16 Controlling Class trusts, the Company estimates that $418,995 of
principal of the underlying loans will not be recoverable. This amount
represents 2.02% of the underlying loan pools and 66.3% of the par amount of
the subordinated Controlling Class securities owned by the Company. This loss
assumption is used to compute a loss adjusted yield, which is then used to
report income on the Company's consolidated financial statements. The weighted
average loss adjusted yield for all subordinated Controlling Class securities
is 9.56%. For all Controlling Class securities with a rating of BB- and below,
the weighted average loss adjusted yield is 10.3%. 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. A write down of the adjusted purchase price or write up of loss
adjusted yields of the security may also 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 closely monitors any
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.
Commercial Real Estate Loans
The Company's loan activity is focused on providing mezzanine capital to the
commercial real estate industry. The Company targets well capitalized real
estate operators with strong track records and compelling business plans
designed to enhance the value of their real estate. These loans are generally
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 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 average leverage is 1:1 debt to equity generally funded with
committed financing facilities. These investments have fixed or floating rate
coupons and some provide additional earnings through an internal rate of return
("IRR") look back or gross revenue participation.
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 control over the underlying
asset.
Since 2001, the Company's activity in this sector has generally been conducted
through Carbon Capital, Inc. ("Carbon I") and Carbon Capital II, Inc. ("Carbon
II"and collectively with Carbon I, the "Carbon Capital Funds"), private
commercial real estate income opportunity funds. As of December 31, 2004, the
Company owned approximately 20% of Carbon I as well as approximately 20% of
Carbon II. Various institutional investors, an affiliate of the Manager and PNC
Bank own the remainder. The Manager also manages the Carbon Capital Funds. The
Company does not incur any additional management or incentive fees to the
Manager as a result of its investment in the Carbon Capital Funds. In certain
cases the Manager may be paid up to 1.0% of an investment's par as an
origination fee. 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.
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. No
additional capital will be called. The Company's investment in Carbon I as of
December 31, 2004 was $39,563.
On October 6, 2004, the Company entered into a $30,000 commitment to acquire
shares in Carbon Capital II. On November 19, 2004 the Company entered into an
additional $32,067 commitment to acquire shares in Carbon II. During 2004, the
Company received capital call notices of $16,953. The proceeds were used by
Carbon II to purchase nine commercial mortgage loans. As of December 31, 2004,
the Company's investment in Carbon II was $17,249 and the Company's remaining
commitment to Carbon II is $45,114.
On December 31, 2004, the Company owned commercial real estate loans with a
carrying value of $375,811. The average yield of this portfolio at December 31,
2004 was 9.1%. The majority of these loans pay interest based on the one-month
London Interbank Offered Rate ("LIBOR"). Commercial real estate loans with a
carrying value of $102,694 were held in the Carbon Capital Funds and $273,117
were held directly. The Company and the Carbon Capital Funds each have
committed financing facilities used to finance these assets.
During the year ended December 31, 2004, the Company invested $226,997 in new
loans and received par payoffs of $23,285. In addition, during 2004, the Company
invested $29,453 in the Carbon Capital Funds and received a return of capital
of $6,719.
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. 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 counter parties with long-term debt rated A or better by at least one
nationally recognized credit rating organization. The business failure of a
counter party with which the Company has entered into a hedging transaction
will most likely 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 counter party, 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 market 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.
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.
At December 31, 2004, the Company had no outstanding futures contracts. At
December 31, 2003, the Company had outstanding short positions of 30 five-year
and 73 ten-year U.S. Treasury Note future contracts. At December 31, 2004 and
2003, the Company had a forward LIBOR cap with a notional amount of $85,000 and
a fair value of $694 and $1,114, respectively.
Swap agreements as of December 31, 2004 and 2003 consisted of the following:
As of December 31, 2004
-------------------------------------------------------------------------
Estimated Fair Unamortized Average Remaining
Notional Value Value Cost Term (years)
-------------------------------------------------------------------------
Cash flow hedges $452,600 $253 - 5.44
Trading swaps 16,000 (5) - 1.94
CDO cash flow hedges 718,120 (11,262) - 8.50
CDO timing swaps 223,445 145 - 8.08
As of December 31, 2003
-------------------------------------------------------------------------
Estimated Fair Unamortized Average Remaining
Notional Value Value Cost Term (years)
-------------------------------------------------------------------------
Cash flow hedges $611,300 $(4,442) - 6.53
Trading swaps 308,000 1,513 - 3.34
CDO cash flow hedges 454,778 (23,651) - 8.51
CDO timing swaps 171,545 29 - 8.61
The counterparties for the Company's swaps are Deutsche Bank, AG, Merrill Lynch
Capital Services, Inc., Goldman Sachs Capital Markets, L.P., Lehman Special
Financing Inc., and Societe Generale with ratings of AA-, A+, A+, A, and AA-,
respectively. The Company continually monitors the rating and overall credit
quality of its swap counterparties.
Financing and Leverage
The Company has financed its assets with the net proceeds of its 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 borrowings, short-term
borrowings under repurchase agreements, and the lines of credit discussed
below. In the future, operations may be financed by future 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 total leverage to a maximum 6.0
to 1 debt to equity ratio. Subsequent to December 31, 2004, the Board of
Directors adopted a new indebtedness policy for the Company that limits
recourse debt to a maximum of 3.0 to 1. The Company's recourse debt-to-equity
ratio of 1.6 to 1 was in compliance with the revised policy as of December 31,
2004. 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 in the future.
On May 29, 2002, the Company issued ten tranches of secured debt through a
collateralized debt obligation ("CDO I"). In this transaction, a wholly owned
subsidiary of the Company issued secured debt in the par amount of $419,185
secured by the subsidiary's assets. The adjusted issue price of the CDO I debt,
as of December 31, 2004, was $405,377. 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 7.29 years as of December 31,
2004. All floating rate coupons were swapped to fixed rate coupons resulting in
a total fixed rate cost of funds for CDO I of approximately 7.21%.
On December 10, 2002, the Company issued seven tranches of secured debt through
a second collateralized debt obligation ("CDO II"). In this transaction, a
wholly owned subsidiary of the Company issued secured debt in the par amount of
$280,783 secured by the subsidiary's assets. In July 2004, the Company issued a
bond with a par of $12,850 from CDO II that it had previously retained. Before
issuing 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 as of December
31, 2004 was $293,167. 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 7.72 years as of December 31, 2004. All floating
rate coupons were swapped to fixed rate coupons, resulting in a total fixed
rate cost of funds for CDO II of approximately 5.79%.
Included in CDO II 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.
On March 30, 2004 the Company issued its third collateralized debt obligation
("CDO III") through Anthracite CDO 2004-1. The total par value of bonds sold
was $372,456. The adjusted issue price of the CDO III debt as of December 31,
2004 was $369,422. 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 8.39 years as of December 31, 2004. All floating rate
coupons were swapped to fixed rate coupons resulting in a total fixed rate cost
of funds for CDO I of approximately 5.03%. Included in CDO III was a $50,000
ramp facility that was fully utilized as of December 31, 2004.
The Company has a $200,000 committed credit facility with Deutsche Bank, AG
(the "Deutsche Bank Facility"), which matures on December 20, 2007. The
Deutsche Bank Facility can be used to replace existing reverse repurchase
agreement borrowings and to finance the acquisition of mortgage-backed
securities, loan investments, and investments in real estate joint ventures. As
of December 31, 2004 and 2003, the outstanding borrowings under this facility
were $126,349 and $82,406, respectively. Outstanding borrowings under the
Deutsche Bank Facility bear interest at a LIBOR based variable rate.
On July 18, 2002, the Company entered into a $75,000 committed credit facility
with Greenwich Capital, Inc. Outstanding borrowings under this credit facility
bear interest at a LIBOR based variable rate. As of December 31, 2004,
outstanding borrowings under this facility were $24,527. As of December 31,
2003, outstanding borrowings under this facility were $7,530.
At December 31, 2004, the Company had outstanding borrowings of $12,800 under a
$13,000 committed credit facility with Morgan Stanley Mortgage Capital, Inc.
The Morgan Stanley Mortgage Capital, Inc. facility matures May 11, 2006.
The Company is subject to various covenants in its lines of credit, including
maintaining a minimum net worth of $305,000 as determined under generally
accepted accounting principles in the United States of America ("GAAP"), a
debt-to-equity ratio not to exceed 5.5 to 1, a recourse debt-to-equity of 3.0
to 1, a minimum cash requirement based upon certain debt-to-equity ratios, a
minimum debt service coverage ratio of 1.5 and a minimum liquidity reserve of
$10,000. The Company received authorization from its lenders to permit debt to
equity ratios in excess of existing covenants and a debt service coverage ratio
less than 1.5. As of December 31, 2004 and 2003, the Company was in compliance
with all other covenants.
As part of the CORE Cap Inc. merger ("CORE Cap"), the Company authorized and
issued 2,261,000 shares of Series B Preferred Stock, $0.001 par value per share
("Series B Preferred Stock"), to CORE Cap stockholders. The Series B Preferred
Stock was perpetual, carried a 10% coupon, had a preference in liquidation as
of December 31, 2003 of $43,942, and was convertible into the Company's Common
Stock at a price of $17.09 per share, subject to adjustment.
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"). The second quarter of 2004 earnings
includes a charge of $0.21 per share for the redemption of the Company's Series
B Preferred. All the Series B Preferred Stock was redeemed on May 6, 2004.
On May 29, 2003, the Company authorized and issued 2,300,000 shares of 9.375%
Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Stock"),
par value $0.001 per share. The Series C Preferred Stock is perpetual, carries
a 9.375% coupon, and has a preference in liquidation of $57,500. The aggregate
net proceeds to the Company (after deducting underwriting fees and expenses)
were approximately $55,435.
For the year ended December 31, 2004, the Company issued 1,084,619 shares of
Common Stock under its Dividend Reinvestment Plan. Net proceeds to the Company
were approximately $12,691. For the year ended December 31, 2003, the Company
issued 1,955,919 shares of Common Stock under its Dividend Reinvestment Plan.
Net proceeds to the Company were approximately $21,134.
For the years ended December 31, 2004 and 2003, the Company issued 294,400 and
45,000 shares of Common Stock under a sale agency agreement with Brinson
Patrick Securities Corporation. Net proceeds to the Company were approximately
$3,210 and $497, respectively.
The Company has entered into reverse repurchase agreements to finance its
securities that are not financed under its lines of credit or CDOs. The reverse
repurchase agreements collateralized by most of these securities bear interest
at rates that have historically moved in close relationship to LIBOR.
Further information with respect to the Company's collateralized borrowings at
December 31, 2004 is summarized as follows:
Commercial Total
Lines of Reverse Repurchase Mortgage Collateralized Collateralized
Credit Agreements Loan Pools Debt Obligations Borrowings
-------------- ------------------- -------------- ----------------- ----------------
Commercial Real Estate Securities
Outstanding Borrowings $5,798 $284,224 $- $1,083,471* $1,373,493
Weighted average borrowing rate 3.76% 2.62% - 6.04% 5.32%
Weighted average remaining
maturity days 192 30 - 2,942 2,328
Estimated fair value of assets
pledged $9,217 $339,073 $- $1,202,760 $1,551,050
Residential Mortgage-Backed Securities
Outstanding Borrowings - $356,451 $- - $356,451
Weighted average borrowing rate - 2.36% - - 2.36%
Weighted average remaining -
maturity days - 23 - 23
Estimated fair value of assets -
pledged - $372,071 $- $372,071
Commercial Mortgage Loan Pools
Outstanding Borrowings $773 - $1,294,058 - $1,294,830
Weighted average borrowing rate 3.61% - 3.76% - 3.76%
Weighted average remaining -
maturity days 189 - 2,587 2,585
Estimated fair value of assets -
pledged $1,339 - $1,312,045 $1,313,384
Commercial Real Estate Loans
Outstanding Borrowings $141,601 - - - $141,601
Weighted average borrowing rate 3.47% - - - 3.47%
Weighted average remaining - - -
maturity days 222 222
Estimated fair value of assets - - -
pledged $211,566 $211,566
* $15.054 of the Company's CDO debt is the financing of CDO bonds that the Company has chosen not to sell and
financed under its lines of credit.
At December 31, 2004, the Company's collateralized borrowings had the following remaining maturities:
Reverse Commercial Total
Lines of Repurchase Mortgage Loan Collateralized Collateralized
Credit Agreements Pools Debt Obligations Borrowings
---------------- ------------------- ------------------- ------------------- ------------------
Within 30 days $ - $605,944 $- $ - $605,944
31 to 59 days - 7,925 - - 7,925
Over 60 days 163,676 26,806 1,294,058 1,067,967 2,552,507
---------------- ------------------- ------------------- ------------------- ------------------
$163,676 $640,675 $1,294,058 $1,067,967 $3,166,376
================ =================== =================== =================== ==================
As of December 31, 2004, $73,651 of the Company's $200,000 Deutsche Bank
Facility was available for future borrowings and $50,473 of the Company's
$75,000 committed credit facility with Greenwich Capital, Inc. was available.
Certain information with respect to the Company's collateralized borrowings at
December 31, 2003 is summarized as follows:
Reverse Total
Lines of Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
------------ ---------------- ----------------- ----------------
Commercial Real Estate Securities
Outstanding Borrowings $67,226 $360,629 $684,970 $1,112,825
Weighted average borrowing rate 2.26% 1.46% 6.60% 4.68%
Weighted average remaining maturity days 562 17 3,033 1,906
Estimated fair value of assets pledged $110,652 $423,244 $770,575 $1,304,471
Residential Mortgage-Backed Securities
Outstanding Borrowings - $688,006 - $688,006
Weighted average borrowing rate - 1.12% - 1.12%
Weighted average remaining maturity days - 24 - 24
Estimated fair value of assets pledged - $714,296 - $714,296
Real Estate Joint Ventures
Outstanding Borrowings $513 - - $513
Weighted average borrowing rate 3.12% - - 3.12%
Weighted average remaining maturity days 212 - - 212
Estimated fair value of assets pledged $2,750 - - $2,750
Commercial Real Estate Loans
Outstanding Borrowings $22,197 - - $22,197
Weighted average borrowing rate 2.79% - - 2.79%
Weighted average remaining maturity days 254 - - 254
Estimated fair value of assets pledged $33,206 - - $33,206
At December 31, 2003, the Company's collateralized borrowings had the following remaining maturities:
Total
Lines of Reverse Repurchase Collateralized Collateralized
Credit Agreements Debt Obligations Borrowings
-------------- --------------------- ------------------- ----------------
Within 30 days $ - $1,048,635 $ - $1,048,635
31 to 59 days - - - -
Over 60 days 89,936 - 684,970 774,906
-------------- --------------------- ------------------- ----------------
$89,936 $1,048,635 $684,970 $1,823,541
============== ===================== =================== ================
As of December 31, 2003, $102,594 of the Company's $185,000 Deutsche Bank
Facility was available for future borrowings and $67,470 of the Company's
$75,000 committed credit facility with Greenwich Capital, Inc. was available.
Under the lines of credit and the reverse repurchase agreements, the respective
lender retains the right to mark the underlying collateral to estimated market
value. A reduction in the value of pledged assets would 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.
Risks
Risk is an inherent part of investing in high yielding commercial real estate
debt. 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 our 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. For example, the Company may purchase
certain mortgage assets from PNC Bank, an affiliate of PNC Bancorp,
Inc. which owns approximately 71% of the outstanding capital stock of
the Manager's parent company, BlackRock, Inc as of December 31, 2004.
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 real estate investment
trusts ("REITs") not affiliated with us. 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 mortgage assets. In
addition, the Manager and its affiliates may from time to time
purchase mortgage 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 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 investors. Such conflicts may result in
decisions and allocations of mortgage 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 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 our business
Interest rate fluctuations will affect the value of the Company's
mortgage 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 beyond the
Company's control. 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 and
changing prepayment rates.
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 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 significantly influence the Company's net income.
Increases in these rates tend to decrease the Company's net income and
market 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 is
often referred to as the "yield curve." Ordinarily, short-term
interest rates are lower than long-term interest rates. If short-term
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 will primarily bear
interest at short-term rates and the Company's assets will primarily
bear interest at medium-term to long-term rates, a flattening of the
yield curve tends to decrease the Company's net income and market
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 market 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.
Interest rate caps on the Company's mortgage-backed securities may
adversely affect the Company's profitability.
The Company's adjustable-rate mortgage-backed securities are typically
subject to periodic and lifetime interest rate caps. Periodic interest
rate caps limit the amount an interest rate can increase during any
given period. Lifetime interest rate caps limit the amount an interest
rate can increase through maturity of 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, market values of these subordinated interests tend to be
more 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 income derived
from the Company's investments.
The Company's ownership of non-investment grade mortgage assets
subjects the Company to an increased risk of loss.
The Company acquires mortgage 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 mortgage loans are subject to certain risks.
The Company acquires, accumulates and securitizes mortgage loans as
part of its investment strategy. While holding mortgage loans, the
Company is subject to risks of borrower defaults, bankruptcies, fraud
and special hazard losses that are not covered by standard hazard
insurance. Also, the costs of financing and hedging the mortgage loans
can exceed the interest income on the mortgage loans. In the event of
any default under 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 mortgage collateral and the principal amount
of the mortgage loan. In addition, delinquency and loss ratios on the
Company's mortgage loans are affected by the performance of
third-party servicers and special servicers.
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 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 mortgage loan. As to those
mortgage loans that provide for recourse against the borrower and
their assets generally, there can be no assurance that such recourse
will provide a recovery in respect of a defaulted mortgage loan
greater than the liquidation value of the mortgaged property securing
that mortgage loan.
The volatility of certain mortgaged property values may adversely
affect the Company's mortgage loans.
Commercial and multifamily property values and net operating income
derived from 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
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. No assurances can be given that the fair market
value of any of the Company's assets will not 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. 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.
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:
o the Company would be subject to federal and state income tax on
its taxable income at regular corporate rates;
o the Company would not be allowed to deduct distributions to
stockholders in computing its taxable income; and
o unless the Company were entitled to relief under the United States
Internal Revenue Code of 1986, as amended (the "Code"), the
Company would also 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, there cannot be any assurance that the Company is or will
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. The Company cannot predict with certainty
whether, when, in what forms, or with what effective dates, the tax
laws applicable to the Company or its stockholders may be changed.
Competition may adversely affect the Company's ability to acquire
assets.
Because of competition, the Company may not be able to acquire
mortgage-backed securities at favorable yields.
Failure to maintain an exemption from the Investment Company Act of
1940 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 of 1940, as
amended (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.
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 Code and is excluded from
regulation as an investment company. Before acquiring any asset, the Manager
determines whether such asset would constitute a "Real Estate Asset" under the
REIT provisions of the Code, as amended. The Company regularly monitors
purchases of mortgage 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.
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.
The Company's unaffiliated directors review all transactions on a quarterly
basis to ensure compliance with the Company's operating policies and to ratify
all transactions with PNC Bank (an affiliate of the Manager) and its
affiliates, except that the purchase of securities from PNC Bank and its
affiliates require prior approval. The unaffiliated directors rely
substantially on information and analysis provided by the Manager to evaluate
the Company's operating policies, compliance therewith, and other matters
relating to the Company's investments.
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 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 and servicing rights and when
the Company has appropriate 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
comply with the Investment Company Act and be able to register as an investment
company. In such event, modification of (i) the Company's business plan so that
it would not be required to register as an investment company would likely
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 mortgage-backed securities, which are Qualifying Interests or
(ii) the Company's business plan to register as an investment company would
result in significantly increased operating expenses and would likely entail
significantly reducing the Company's indebtedness (including the possible
prepayment of the Company's short-term borrowings), which could also 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 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 recession 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 mortgage assets at favorable spreads over the Company's borrowing
costs. In acquiring mortgage 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 mortgage assets suitable for purchase by the
Company. Some of the Company's anticipated 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 mortgage 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 Agreement
The Company is managed pursuant to a management agreement, dated March 27,
1998, between the Company and the Manager (the "Management Agreement"), and
pursuant to which the Manager is responsible for the day-to-day operations of
the Company and performs such services and activities relating to the assets
and operations of the Company as may be appropriate. On March 25, 2002, the
Management Agreement was extended for one year through March 27, 2003, with the
approval of the unaffiliated directors, on terms similar to the prior agreement
with the following changes: (i) the incentive fee calculation would be based
upon GAAP earnings instead of funds from operations, (ii) the removal of the
four-year period to value the Management Agreement in the event of termination
and (iii) subsequent renewal periods of the Management Agreement would be for
one year instead of two years. Houlihan Lokey Howard & Zukin Financial
Advisors, Inc., a national investment banking and financial advisory firm,
advised the Board of Directors in the 2002 renewal process.
On March 6, 2003, the unaffiliated directors approved an extension of the
Management Agreement from its expiration of March 27, 2003 for one year through
March 31, 2004. The terms of the renewed agreement were similar to the prior
agreement except for the incentive fee calculation that would provide for a
rolling four-quarter high watermark rather than a quarterly calculation. In
determining the rolling four-quarter high watermark, the Company would
calculate the incentive fee based upon the current and prior three quarters'
net income. The Manager would be paid an incentive fee in the current quarter
if the Yearly Incentive Fee, as defined, was greater than what was paid to the
Manager in the prior three quarters cumulatively. The Company phased in the
rolling four-quarter high watermark commencing with the second quarter of 2003.
Calculation of the incentive fee was based on GAAP earnings and adjusted to
exclude special one-time events pursuant to changes in GAAP accounting
pronouncements after discussion between the Manager and the unaffiliated
directors. The incentive fee threshold did not change. The high watermark
provided for the Manager to be paid 25% of the amount of earnings (calculated
in accordance with GAAP) per share that exceeds the product of the adjusted
issue price of the Company's Common Stock per share and the greater of 9.5% or
350 basis points over the ten-year Treasury note.
The Management Agreement was further extended for one year from March 31, 2004
through March 31, 2005. The base management fee was revised to equal 2% of the
quarterly average total stockholders' equity for the applicable quarter. The
incentive fee was revised to be 25% of the amount of earnings (calculated in
accordance with GAAP) per share that exceeds the product of the adjusted issue
price of the Company's common stock per share ($11.37 as of December 31, 2004)
and the greater of 8.5% or 400 basis points over the ten-year Treasury note. On
March 10, 2004, the members of the Company's Board of Directors who are not
affiliated with the Manager approved an extension of the Company's management
agreement with the Manager for one additional year through March 31, 2006. The
terms of the extended agreement did not change.
During the third quarter of 2003, the Manager agreed to reduce its management
fees by 20% from its calculated amount for the third and fourth quarter of 2003
and the first quarter of 2004. This revision resulted in $1,046 in savings to
the Company during 2003 and $532 during 2004, respectively.
The Manager primarily engages in four activities on behalf of the Company: (i)
acquiring and originating mortgage 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
investor relations activities. In conducting these activities, the Manager
formulates operating strategies for the Company, arranges for the acquisition
of assets by the Company, arranges for various types of financing and hedging
strategies for the Company, monitors the performance of the Company's assets,
and provides certain administrative and managerial services in connection with
the operation of the Company. At all times, the Manager is 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.
During 2000, the Company completed the acquisition of CORE Cap, Inc. The merger
was a stock for stock acquisition where the Company issued 4,180,552 shares of
its Common Stock and 2,261,000 shares of its Series B Preferred Stock. At the
time of the CORE Cap 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 assets under the existing management
contract ("GMAC Contract"). The GMAC Contract had to be terminated in order to
allow for 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 the 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. As of December 31, 2004, the Installment Payment
would be $6,500 payable over six years. The Company does not accrue for this
contingent liability.
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 designated 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.
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 and all amendments
to those reports 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, Nominating and Corporate Governance
Committees of the Board of Directors and its Codes of 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.
ITEM 2. PROPERTIES
The Company does not maintain an office and owns no real property. 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, 2004 there were no pending legal proceedings of 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 2004 through the solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been listed and traded on the New York Stock
Exchange under the symbol "AHR" since the 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
2003 High Low Last Sale Declared
First Quarter................... 12.04 10.27 11.44 .35
Second Quarter.................. 12.89 11.00 12.06 .35
Third Quarter................... 12.55 9.26 9.65 .28
Fourth Quarter.................. 11.30 9.50 11.07 .28
2004
First Quarter................... 13.01 10.52 12.73 .28
Second Quarter.................. 13.00 10.51 11.98 .28
Third Quarter................... 12.14 10.50 11.12 .28
Fourth Quarter.................. 12.69 11.05 12.36 .28
On March 4, 2005, the closing sale price for the Company's Common Stock, as
reported on the New York Stock Exchange, was $11.95. As of March 4, 2005, there
were approximately 1,114 record holders of the Common Stock. This figure does
not reflect beneficial ownership of shares held in nominee name.
The following table summarizes information about options outstanding under the
1998 Stock Option Plan:
Weighted
Average
Shares Exercise Price
-------------- ---------------
Outstanding at January 1, 2004 1,468,351 $14.75
Granted 5,000 11.81
Exercised (30,000) 8.44
Cancelled (25,500) 15.00
--------------
Outstanding at December 31, 2004 1,417,851 $14.87
==============
Options exercisable at December 31, 2004 1,417,851 $14.87
==============
Weighted-average fair value of
options granted during the
year ended December 31, 2004
(per option) $ 0.36
==============
Shares of Common Stock available for future grant under the 1998 Stock Option
Plan at December 31, 2004 were 774,502.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended
December 31, 2004, 2003, 2002, 2001, and 2000 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 For the Year For the Year For the Year For the Year
Ended Ended Ended Ended Ended
December 31, December 31, December 31, December 31, December 31,
2004 2003 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
(In thousands, except per share data)
Operating Data:
Total income $203,866 $163,778 $162,445 $131,220 $97,642
Interest expense 128,166 83,249 65,018 59,400 51,112
Other operating expenses 12,383 11,707 14,850 12,736 9,727
Other gains (losses) (1) (20,125) (77,464) (28,949) (910) 2,523
Cumulative transition adjustment (2) - - 6,327 (1,903) -
Net income (loss) 43,192 (8,642) 59,955 56,271 39,326
Net income (loss) available to common
stockholders 25,768 (16,386) 54,793 47,307 32,261
Per Share Data:
Net income (loss):
Basic 0.50 (0.34) 1.18 1.41 1.37
Diluted 0.50 (0.34) 1.18 1.35 1.28
Dividends declared per common share 1.12 1.26 1.40 1.29 1.17
Balance Sheet Data:
Total assets 3,729,134 2,398,846 2,640,558 2,627,203 1,033,651
Long-term obligations 3,215,396 1,981,416 2,234,342 2,244,088 791,397
Total stockholders' equity 513,738 417,430 406,216 383,115 242,254
(1) Other gains (losses) for the year ended December 31, 2004 of $(20,125)
consist primarily 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. Other gains (losses) for the year ended December
31, 2001 of $(910) consist primarily of a loss of $(5,702) related to
impairments on assets, a loss of $(2,604) related to securities
held-for-trading, and a gain of $7,401 related to the sale of
securities available-for-sale.
(2) The cumulative transition adjustment represents the Company's
adoption of SFAS No. 142 and SFAS 133 for the years ended December
31, 2002 and 2001, respectively.
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. (the "Company"), a Maryland corporation, is a real
estate finance company that invests in high yielding commercial real estate
debt. The Company commenced operations on March 24, 1998.
The Company's primary focus is to invest in a diverse portfolio of commercial
real estate loans and commercial mortgage-backed securities ("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 are usually 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 loans with principal amounts of as little as
$1,000 to over $100,000. The pooling concept also 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. The principal amount of these below investment grade classes generally
represents 3.0-5.0% 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 control over 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 is 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 this case 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 control
workouts or foreclosures. The Company invests in B notes as they provide higher
yields with a degree of control over dispositions.
The Company also invests in mezzanine loans on commercial real estate. The
ownership interests in an entity that owns real estate secure mezzanine loans.
These loans are generally subordinated 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 approximately $341,800,000 of assets under management as of
December 31, 2004. 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 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
consistent 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.
During the third quarter of 2004, the Company completed its repositioning into
commercial real estate assets. As of December 31, 2004, CMBS and commercial
real estate loans represent 90% of portfolio assets while residential
mortgage-backed securities ("RMBS") represent 10%. During 2004, exclusive of
its investment in the Carbon Capital, Inc. ("Carbon I") and Carbon Capital II,
Inc. ("Carbon II"and collectively with Carbon I, the "Carbon Capital Funds")
and the commercial mortgage loan pools, the Company acquired commercial real
estate assets with a market value of $638,632, comprised primarily of $151,094
of below investment grade CMBS, $120,423 of investment grade CMBS, $67,507 of
investment grade REIT debt, and $227,773 of high yield commercial real estate
loans.
The table below is a summary of the Company's investments by asset class for
the last five years:
Carrying Value as of December 31,
2004 2003 2002 2001 2000
Amount % Amount % Amount % Amount % Amount %
-------------------------------------------------------------------------------------------------------------
Commercial real
estate securities $ 1,623,939 44.6% $1,393,010 62.8% $ 894,345 35.9% $453,953 20.8% $412,435 42.6%
Commercial mortgage
loan pools 1,312,045 36.1 - - - - - - - -
Commercial real
estate loans(1) 329,930 9.1 97,984 4.4 88,926 3.6 159,738 7.3 163,541 16.9
RMBS 372,071 10.2 726,717 32.8 1,506,450 60.5 1,570,009 71.9 337,222 34.9
U.S. Treasury
securities - - - - - - - - 54,043 5.6
-------------------------------------------------------------------------------------------------------------
Total $ 3,637,985 100.0% $2,217,711 100.0% $2,489,721 100.0% $2,183,700 100.0% $967,241 100.0%
=============================================================================================================
(1) Includes real estate joint ventures and an equity investment.
As of December 31, 2004, the Company owns 16 different trusts where it is in
the first loss position and is designated as the controlling class
representative by owning the lowest rate or non-rated CMBS class. The Company
considers the CMBS securities where it maintains the right to control the
foreclosure/workout process on the underlying loans its controlling class CMBS
("Controlling Class"). The Company divides its below investment grade CMBS
investment activity into two portfolios: Controlling Class CMBS and other below
investment grade CMBS.
Commercial Mortgage Loan Pools and Commercial Real Estate Securities Portfolio
Activity
The Company continues to increase its investments in commercial real estate
securities. Commercial real estate securities include CMBS, investment grade
real estate investment trusts ("REIT") debt and collateralized debt obligation
("CDO") investments. During the year ended December 31, 2004, the Company
increased its commercial real estate securities portfolio by 19% from
$1,366,508 to $1,623,939. This increase was primarily attributable to the
purchase of subordinated CMBS and investment grade CMBS that have a market
value as of December 31, 2004 of $133,760 and $84,702, respectively.
During the second quarter of 2004, the Company acquired subordinated CMBS in a
trust establishing a Controlling Class interest. As the Controlling Class
holder, the Company has the ability to control dispositions or workouts of any
defaulted loans in this trust. The Company negotiated for and obtained a
greater degree of discretion over the disposition of the commercial mortgage
loans than is typically granted to the special servicer. As a result of this
expanded discretion, Financial Accounting Standards Board ("FASB")
interpretation No. 46, "Consolidation of Variable Interest Entities" (revised
December 2003) ("FIN 46R") requires the Company to consolidate the net assets
and results of operations of the trust.
The CMBS securities acquired by the Company had a par value of $41,495 with
$13,890 not rated and the balance rated BBB- to B-. During the third quarter of
2004 the Company sold the BBB- rated security, which had the impact of
increasing the borrowings for the commercial loan pool by $5,848. As of
December 31, 2004, the CMBS securities owned by the Company have a par value of
$35,495.
The debt associated with the real estate mortgage investment conduit ("REMIC")
trust is non-recourse to the Company, and is secured only by the commercial
mortgage loan pools. As of December 31, 2004, the consolidation of the REMIC
trust results in an increase in the Company's total debt to capital ratio from
3.7:1 to 6.2:1, but has no effect on the Company's recourse debt to capital
ratio. The Company received authorization from its lenders to permit debt to
capital ratios in excess of existing covenants.
Approximately 45% of the par amount of the commercial mortgage loan pool is
comprised of loans that are shadow rated A2 or better by Moody's Investors
Service, Inc. and AA by Standard & Poor's Rating Group, a division of The
McGraw-Hill Companies, Inc. 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. For income recognition purposes, the Company
accounts for the unrated commercial mortgage loans in the pool as a single
asset based on common credit risk characteristics.
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.
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 fully hedged
to protect the Company from an increase in short-term interest rates. As of
December 31, 2004, over 86% of the market value of the Company's subordinated
CMBS assets are match funded in the Company's CDOs in this manner.
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 another $280,607 of debt through
Anthracite CDO 2002-2 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 collateralized debt obligation ("CDO
II") 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 collateralized debt obligation
("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 as of
December 31, 2004.
The Company retained 100% of the equity of CDOs I, II and III and recorded the
transactions on its consolidated financial statements as secured financing.
Collateral as of December 31, 2004 Debt as of December 31, 2004
--------------------------------------------------------------------------------
Adjusted Purchase Adjusted Issue Weighted Average
Price Loss Adjusted Yield Price Cost of Funds * Net Spread
-----------------------------------------------------------------------------------------------
CDO I $434,661 8.89% $405,377 7.21% 1.68%
CDO II 324,324 7.80% 293,167** 5.79% 2.01%
CDO III 377,154 7.09% 369,422** 5.03% 2.06%
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Total ** $1,136,139 7.98% $1,067,967 6.06% 1.91%
* 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 and
$13,069 of par of CDO III debt rated BB.
The following table details the par, fair market value, adjusted purchase
price, and loss adjusted yield of the Company's commercial real estate
securities outside of the CDOs as of December 31, 2004: