10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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(Mark One) |
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þ
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QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
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For the quarterly period ended
June 30, 2006 |
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OR |
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o
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TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
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For the transition period
from to |
Commission File Number 001-32958
Crystal River Capital, Inc.
(Exact name of registrant as specified in its charter)
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Maryland |
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20-2230150 |
(State or other jurisdiction
of
incorporation or organization) |
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(I.R.S. Employer
Identification No.) |
Three World Financial Center, 200 Vesey Street,
10th Floor, New York, NY 10281-1010
(Address of principal executive
offices) (Zip
Code)
Registrants telephone number, including area code:
(212) 549-8400
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 o No þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated
filer o
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Accelerated
filer o
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Non-accelerated
filer þ
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2 of the
Exchange
Act). Yes o No þ
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of outstanding shares of the registrants common
stock, par value $0.001 per share, as of September 8,
2006 was 25,019,500.
CRYSTAL RIVER CAPITAL, INC.
INDEX
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Financial
Information |
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Item 1:
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Financial
Statements
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1 |
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Consolidated
Balance Sheets June 30, 2006
(unaudited) and December 31, 2005 (audited)
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1 |
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Consolidated
Statements of Income Three and Six Months Ended
June 30, 2006, Three Months Ended June 30, 2005 and
March 15, 2005 (commencement of operations) to
June 30, 2005(unaudited)
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2 |
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Consolidated
Statement of Changes in Stockholders Equity
Six Months Ended June 30, 2006 (unaudited)
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3 |
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Consolidated
Statements of Cash Flows Six Months Ended
June 30, 2006 and March 15, 2005 (commencement of
operations) to June 30, 2005 (unaudited)
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4 |
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Notes to
Consolidated Financial Statements (unaudited)
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5 |
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Item 2:
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Managements
Discussion and Analysis of Financial Condition and Results of
Operations
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28 |
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Item 3:
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Quantitative
and Qualitative Disclosures about Market Risk
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53 |
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Item 4:
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Controls and
Procedures
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53 |
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Other
Information |
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Item 1:
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Legal
Proceedings
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54 |
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Item 1A:
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Risk
Factors
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54 |
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Item 2:
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Unregistered
Sales of Equity Securities and Use of Proceeds
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54 |
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Item 3:
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Defaults Upon
Senior Securities
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54 |
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Item 4:
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Submission of
Matters to a Vote of Security Holders
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54 |
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Item 5:
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Other
Information
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55 |
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Item 6:
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Exhibits
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55 |
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Signatures
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S-1 |
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EX-31.1: CERTIFICATION |
EX-31.2: CERTIFICATION |
EX-32.1: CERTIFICATION |
EX-32.2: CERTIFICATION |
EX-99.1: RISK FACTORS |
Crystal River Capital, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands)
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June 30, | |
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December 31, | |
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2006 | |
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2005 | |
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| |
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| |
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(Unaudited) | |
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(Audited) | |
Assets
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Available for sale securities, at
fair value:
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Commercial MBS
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$ |
303,064 |
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$ |
206,319 |
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Residential MBS
Non-Agency MBS
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542,287 |
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512,685 |
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Agency ARMS
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1,792,615 |
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1,663,462 |
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ABS
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50,328 |
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54,530 |
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Preferred stock
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4,634 |
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2,232 |
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Real estate loans
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135,361 |
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146,497 |
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Cash and cash equivalents
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56,200 |
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21,463 |
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Restricted cash
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82,465 |
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18,499 |
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Receivables:
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Principal paydown
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7,824 |
|
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|
11,773 |
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Interest
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15,089 |
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|
12,091 |
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Interest purchased
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|
663 |
|
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|
612 |
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Due from broker
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114,429 |
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Prepaid expenses and other assets
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2,245 |
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961 |
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Deferred financing costs, net
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5,887 |
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6,662 |
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Derivative assets
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35,854 |
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11,983 |
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Total assets
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$ |
3,148,945 |
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$ |
2,669,769 |
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Liabilities and
Stockholders Equity |
Liabilities:
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Accounts payable, accrued expenses
and cash collateral payable
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$ |
27,278 |
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$ |
4,173 |
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Due to Manager
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2,820 |
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|
486 |
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Dividends payable
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12,705 |
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Repurchase agreements
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2,439,496 |
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1,977,858 |
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Repurchase agreements, related party
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57,234 |
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|
16,429 |
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Collateralized debt obligations
(CDOs)
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210,903 |
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227,500 |
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Note payable, related party
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35,000 |
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Delayed funding of real estate loan
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4,339 |
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Interest payable
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18,332 |
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12,895 |
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Derivative liabilities
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6,575 |
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9,660 |
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Total liabilities
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2,775,343 |
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2,288,340 |
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Commitments and
contingencies
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Stockholders equity:
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Preferred Stock, par value
$0.001 per share; 100,000,000 shares authorized, no
shares issued and outstanding
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Common stock, par value
$0.001 per share, 500,000,000 shares authorized,
17,523,500 and 17,487,500 shares outstanding at
June 30, 2006 and December 31, 2005, respectively
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18 |
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17 |
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Additional paid-in capital
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406,979 |
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406,311 |
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Accumulated other comprehensive loss
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(16,269 |
) |
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(11,742 |
) |
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Declared dividends in excess of
earnings
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(17,126 |
) |
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(13,157 |
) |
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Total stockholders equity
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|
373,602 |
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381,429 |
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Total liabilities and
stockholders equity
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$ |
3,148,945 |
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|
$ |
2,669,769 |
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|
See accompanying notes to unaudited consolidated financial
statements.
1
Crystal River Capital, Inc. and Subsidiaries
Consolidated Statements of Income
(In thousands, except share and per share data)
(Unaudited)
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March 15, 2005 | |
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Three Months Ended June 30, | |
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(commencement | |
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Six Months Ended | |
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of operations) to | |
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2006 | |
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2005 | |
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June 30, 2006 | |
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June 30, 2005 | |
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| |
Revenues:
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Net interest income:
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Interest income
available for sale securities
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|
$ |
42,815 |
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$ |
14,794 |
|
|
$ |
81,174 |
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|
$ |
15,507 |
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|
Interest income real
estate loans
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|
2,478 |
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|
301 |
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5,089 |
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301 |
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Total interest income
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45,293 |
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|
15,095 |
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86,263 |
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15,808 |
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Less interest expense
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(31,425 |
) |
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(7,542 |
) |
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(60,276 |
) |
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(7,645 |
) |
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Net interest income
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|
13,868 |
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|
7,553 |
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25,987 |
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8,163 |
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Expenses:
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Management fees, related party
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1,635 |
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|
1,749 |
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|
3,312 |
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|
2,069 |
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Professional fees
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|
753 |
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|
682 |
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1,514 |
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|
723 |
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Insurance expense
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|
99 |
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|
77 |
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|
190 |
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|
90 |
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Directors fees
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|
92 |
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|
27 |
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|
|
236 |
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|
35 |
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Start up costs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
292 |
|
|
Miscellaneous expenses
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|
157 |
|
|
|
121 |
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|
249 |
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|
130 |
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Total expenses
|
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|
2,736 |
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|
|
2,656 |
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5,501 |
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3,339 |
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|
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Income before other revenues
(expenses)
|
|
|
11,132 |
|
|
|
4,897 |
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|
20,486 |
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|
4,824 |
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|
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|
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|
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Other revenues
(expenses):
|
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|
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|
|
|
|
|
|
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Realized net loss on sale of
securities available for sale
|
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|
(1,100 |
) |
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|
|
|
|
|
(1,668 |
) |
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|
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|
Realized and unrealized gain (loss)
on derivatives
|
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|
(481 |
) |
|
|
(4,565 |
) |
|
|
7,449 |
|
|
|
(4,370 |
) |
|
Loss on impairment of available for
sale securities
|
|
|
(5,666 |
) |
|
|
|
|
|
|
(6,924 |
) |
|
|
|
|
|
Foreign currency exchange gain
|
|
|
2,066 |
|
|
|
|
|
|
|
1,875 |
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|
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Other
|
|
|
57 |
|
|
|
(17 |
) |
|
|
234 |
|
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|
(17 |
) |
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Total other revenues
(expenses)
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|
(5,124 |
) |
|
|
(4,582 |
) |
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|
966 |
|
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|
(4,387 |
) |
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Net income
|
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$ |
6,008 |
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|
$ |
315 |
|
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$ |
21,452 |
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$ |
437 |
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Per share information:
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Net income per share of common
stock:
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Basic
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$ |
0.34 |
|
|
$ |
0.02 |
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|
$ |
1.22 |
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|
$ |
0.02 |
|
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|
|
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|
Diluted
|
|
$ |
0.34 |
|
|
$ |
0.02 |
|
|
$ |
1.22 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Weighted average number of shares
outstanding:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
17,528,607 |
|
|
|
17,487,500 |
|
|
|
17,511,937 |
|
|
|
17,487,500 |
|
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|
|
|
|
|
|
|
|
|
|
|
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|
Diluted
|
|
|
17,528,607 |
|
|
|
17,487,500 |
|
|
|
17,511,937 |
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|
|
17,487,500 |
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|
|
|
|
|
|
|
|
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|
|
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|
Dividends declared per common share
|
|
$ |
0.725 |
|
|
$ |
0.25 |
|
|
$ |
1.45 |
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|
$ |
0.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to unaudited consolidated financial
statements.
2
Crystal River Capital, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders
Equity
For the Six Months Ended June 30, 2006
(In thousands)
(Unaudited)
|
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|
|
|
|
|
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|
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Declared | |
|
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|
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|
|
Common Stock | |
|
|
|
Accumulated | |
|
Dividends | |
|
|
|
|
|
|
| |
|
Additional | |
|
Other | |
|
In Excess | |
|
|
|
|
|
|
|
|
Par | |
|
Paid-In | |
|
Comprehensive | |
|
of | |
|
|
|
Comprehensive | |
|
|
Shares | |
|
Value | |
|
Capital | |
|
Loss | |
|
Earnings | |
|
Total | |
|
Income | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Balance at January 1, 2006
|
|
|
17,487,500 |
|
|
$ |
17 |
|
|
$ |
406,311 |
|
|
$ |
(11,742 |
) |
|
$ |
(13,157 |
) |
|
$ |
381,429 |
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
21,452 |
|
|
|
21,452 |
|
|
$ |
21,452 |
|
Net unrealized holdings loss on
securities available for sale
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(24,064 |
) |
|
|
|
|
|
|
(24,064 |
) |
|
|
(24,064 |
) |
Unrealized gain on cash flow hedges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,604 |
|
|
|
|
|
|
|
19,604 |
|
|
|
19,604 |
|
Amortization of realized cash flow
hedge gain
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(67 |
) |
|
|
|
|
|
|
(67 |
) |
|
|
(67 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
16,925 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends declared on common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(25,421 |
) |
|
|
(25,421 |
) |
|
|
|
|
Issuance of stock based
compensation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Manager and managers employees
|
|
|
34,000 |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Board of directors
|
|
|
2,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of stock based
compensation
|
|
|
|
|
|
|
|
|
|
|
669 |
|
|
|
|
|
|
|
|
|
|
|
669 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at June 30, 2006
|
|
|
17,523,500 |
|
|
$ |
18 |
|
|
$ |
406,979 |
|
|
$ |
(16,269 |
) |
|
$ |
(17,126 |
) |
|
$ |
373,602 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to unaudited consolidated financial
statements.
3
Crystal River Capital, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 15, 2005 | |
|
|
Six Months | |
|
(commencement | |
|
|
Ended | |
|
of operations) to | |
|
|
June 30, 2006 | |
|
June 30, 2005 | |
|
|
| |
|
| |
CASH FLOWS FROM OPERATING
ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
21,452 |
|
|
$ |
437 |
|
|
Adjustments to reconcile net income
to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
Dividend declared and expensed to
directors and manager
|
|
|
|
|
|
|
22 |
|
|
|
Amortization of stock based
compensation
|
|
|
660 |
|
|
|
266 |
|
|
|
Amortization of underwriting costs
on available for sale securities and real estate loans
|
|
|
64 |
|
|
|
|
|
|
|
Amortization of realized cash flow
hedge gain
|
|
|
(67 |
) |
|
|
|
|
|
|
Accretion of net discount on
available for sale securities and real estate loans
|
|
|
(4,093 |
) |
|
|
(941 |
) |
|
|
Realized net loss on sale of
available for sale securities
|
|
|
1,668 |
|
|
|
|
|
|
|
Loss on impairment of available for
sale securities
|
|
|
6,924 |
|
|
|
|
|
|
|
Accretion of interest on real
estate loan
|
|
|
(538 |
) |
|
|
|
|
|
|
Unrealized (gain) loss on
derivatives
|
|
|
(7,840 |
) |
|
|
4,290 |
|
|
|
Amortization of deferred financing
costs
|
|
|
985 |
|
|
|
|
|
|
|
Gain on foreign currency exchange
|
|
|
(1,762 |
) |
|
|
|
|
|
Changes in operating assets and
liabilities:
|
|
|
|
|
|
|
|
|
|
|
Interest receivable
|
|
|
(3,348 |
) |
|
|
(7,844 |
) |
|
|
Swap interest receivable
|
|
|
|
|
|
|
(841 |
) |
|
|
Prepaid expenses and other assets
|
|
|
(1,284 |
) |
|
|
(262 |
) |
|
|
Accounts payable and accrued
liabilities
|
|
|
(2,413 |
) |
|
|
1,037 |
|
|
|
Due to Manager
|
|
|
2,334 |
|
|
|
511 |
|
|
|
Interest payable
|
|
|
5,437 |
|
|
|
4,809 |
|
|
|
Interest payable, derivative
|
|
|
488 |
|
|
|
3,360 |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
18,667 |
|
|
|
4,844 |
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING
ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Purchase of securities available
for sale
|
|
|
(828,504 |
) |
|
|
(1,824,502 |
) |
|
Interest purchased
|
|
|
(51 |
) |
|
|
(1,938 |
) |
|
Underwriting costs on available for
sale securities
|
|
|
(339 |
) |
|
|
|
|
|
Principal paydown on available for
sale securities
|
|
|
253,927 |
|
|
|
41,555 |
|
|
Principal payments on real estate
loans
|
|
|
155 |
|
|
|
|
|
|
Proceeds from the sale of available
for sale securities
|
|
|
182,482 |
|
|
|
|
|
|
Proceeds from the repayment of real
estate loans
|
|
|
15,845 |
|
|
|
|
|
|
Funding of real estate loans
|
|
|
(6,926 |
) |
|
|
(38,224 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash used in investing
activities
|
|
|
(383,411 |
) |
|
|
(1,823,109 |
) |
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING
ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Proceeds from issuance of common
stock, net of issuance costs
|
|
|
|
|
|
|
405,614 |
|
|
Cash collateral payable
|
|
|
25,518 |
|
|
|
|
|
|
Principal repayments on
collateralized debt obligations
|
|
|
(16,597 |
) |
|
|
|
|
|
Net deposits into restricted cash
|
|
|
(63,966 |
) |
|
|
(3,650 |
) |
|
Payment of deferred financing costs
|
|
|
(210 |
) |
|
|
|
|
|
Repayment of note payable, related
party
|
|
|
(35,000 |
) |
|
|
|
|
|
Dividends paid
|
|
|
(12,707 |
) |
|
|
|
|
|
Net proceeds from repurchase
agreements
|
|
|
461,638 |
|
|
|
1,436,547 |
|
|
Net proceeds from repurchase
agreement, related party
|
|
|
40,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing
activities
|
|
|
399,481 |
|
|
|
1,838,511 |
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash
equivalents
|
|
|
34,737 |
|
|
|
20,246 |
|
|
|
|
Cash and cash equivalents at
beginning of period
|
|
|
21,463 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
period
|
|
$ |
56,200 |
|
|
$ |
20,246 |
|
Supplemental disclosure of
noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid stock compensation issued
to directors
|
|
$ |
|
|
|
$ |
54 |
|
|
|
|
Dividends declared, not yet paid
|
|
|
12,714 |
|
|
|
4,350 |
|
|
|
|
Principal paydown receivable
|
|
|
7,824 |
|
|
|
11,874 |
|
|
|
|
Purchase of available for sale
securities not yet settled
|
|
|
|
|
|
|
108,087 |
|
|
|
|
Sale of available for sale
securities not yet settled
|
|
|
114,079 |
|
|
|
|
|
See accompanying notes to unaudited consolidated financial
statements
4
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
References herein to we, us or
our refer to Crystal River Capital, Inc. and its
subsidiaries unless the context specifically requires otherwise.
We are a Maryland corporation that was formed in January 2005
for the purpose of acquiring and originating a diversified
portfolio of commercial and residential real estate structured
finance investments. We commenced operations on March 15,
2005 when we completed an offering of 17,400,000 shares of
common stock, which we refer to as the Private Offering, as more
fully explained in Note 8. We are externally managed and
are advised by Hyperion Brookfield Crystal River Capital
Advisors, LLC (the Manager) as more fully explained
in Note 10.
We intend to elect to be taxed as a Real Estate Investment Trust
(REIT) under the Internal Revenue Code beginning
with the 2005 tax year. To maintain our tax status as a REIT, we
plan to distribute at least 90% of our taxable income. In view
of our election to be taxed as a REIT, we have tailored our
balance sheet investment program to originate or acquire loans
and investments to produce a portfolio that meets the asset and
income tests necessary to maintain qualification as a REIT.
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
|
|
|
Basis of Quarterly Presentation |
The accompanying unaudited consolidated financial statements
have been prepared in conformity with the instructions to
Form 10-Q and
Article 10, Rule 10-01 of
Regulation S-X for
interim financial statements. Accordingly, they do not include
all of the information and footnotes required by accounting
principles generally accepted in the United States
(GAAP) for complete financial statements. In the
opinion of management, all adjustments (which includes only
normal recurring adjustments) necessary to present fairly the
financial position, results of operations and changes in cash
flows have been made. These consolidated financial statements
should be read in conjunction with the annual financial
statements and notes thereto for the period ended
December 31, 2005 included in the Companys
Registration Statement on
Form S-11 filed
with the Securities and Exchange Commission (the
SEC).
|
|
|
Principles of Consolidation |
Our consolidated financial statements include our accounts and
the accounts of our wholly-owned subsidiaries, Crystal River CDO
2005-1, Ltd., Crystal River CDO 2005-1 LLC, CRC SPV1, LLC, CRC
SPV2, LLC and Crystal River Capital TRS Holdings, Inc. All
significant intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date
of the consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period.
Actual results may ultimately differ from those estimates.
5
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) |
|
|
|
Cash and Cash Equivalents |
We classify highly liquid investments with original maturities
of three months or less from the date of purchase as cash
equivalents. Cash and cash equivalents may include cash and
short term investments. Short term investments are stated at
cost, which approximates their fair value, and may consist of
investments in money market accounts.
We invest in U.S. Agency and Non-Agency securities,
residential and commercial MBS and other real estate debt and
equity instruments. We account for our available for sale
securities (Agency ARMS, CMBS, RMBS, ABS and other real estate
and equity instruments) in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115,
Accounting for Certain Investments in Debt and Equity
Securities (SFAS 115). We classify our
securities as available for sale because we may dispose of them
prior to maturity in response to changes in the market,
liquidity needs or other events, even though we do not hold the
securities for the purpose of selling them in the near future.
All investments classified as available for sale are reported at
fair value, based on quoted market prices provided by
independent pricing sources, when available, or from quotes
provided by dealers who make markets in certain securities, or
from our managements estimates in cases where the
investments are illiquid. In making these estimates, our
management utilizes pricing information obtained from dealers
who make markets in these securities. However, under certain
circumstances we may adjust these values based on our knowledge
of the securities and the underlying collateral. Our management
also uses a discounted cash flow model, which utilizes
prepayment and loss assumptions based upon historical
experience, economic factors and the characteristics of the
underlying cash flow in order to substantiate the fair value of
the securities. The assumed discount rate is based upon the
yield of comparable securities. The determination of future cash
flows and the appropriate discount rates are inherently
subjective and, as a result, actual results may vary from our
managements estimates.
Unrealized gains and losses are recorded as a component of
accumulated other comprehensive loss in stockholders
equity.
Periodically, all available for sale securities are evaluated
for other than temporary impairment in accordance with
SFAS 115 and Emerging Issues Task Force (EITF)
No. 99-20, Recognition of Interest Income and Impairment
on Purchased and Retained Beneficial Interest in Securitized
Financials Assets (EITF 99-20). An
impairment that is an other than temporary
impairment is a decline in the fair value of an investment
below its amortized cost attributable to factors that indicate
the decline will not be recovered over the remaining life of the
investment. Other than temporary impairments result in reducing
the carrying value of the security to its fair value through the
statement of income, which also creates a new carrying value for
the investment. We compute a revised yield based on the future
estimated cash flows as described in the section titled
Revenue Recognition below. Significant judgments,
including making assumptions regarding the estimated
prepayments, loss assumptions and the changes in interest rates,
are required in determining impairment.
6
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) |
Real estate loans are carried at cost, net of unamortized loan
origination costs and fees, discounts, repayments, sales of
partial interests in loans and unfunded commitments, unless the
loan is deemed to be impaired. We account for our real estate
loans in accordance with SFAS No. 91, Accounting
for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases
(SFAS 91).
Real estate loans are evaluated for possible impairment on a
periodic basis in accordance with SFAS No. 114,
Accounting by Creditors For Impairment of a Loan, an
Amendment of FASB Statement No. 5 and 15
(SFAS 114). Impairment occurs when we
determine it is probable that we will not be able to collect all
amounts due according to the contractual terms of the loan. Upon
determination of impairment, we establish a reserve for loan
losses and recognize a corresponding charge to the statement of
income through a provision for loan losses. Significant
judgments are required in determining impairment, including
making assumptions regarding the value of the loan and the value
of the real estate, partnership interest or other collateral
that secures the loan.
|
|
|
Accounting For Derivative Financial Instruments and
Hedging Activities |
We account for our derivative and hedging activities in
accordance with SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended
(SFAS 133). SFAS 133 requires us to
recognize all derivative instruments at their fair value as
either assets or liabilities on our balance sheet. The
accounting for changes in fair value (i.e., gains or
losses) of a derivative instrument depends on whether we have
designated it, and whether it qualifies, as part of a hedging
relationship and on the type of hedging relationship. For those
derivative instruments that are designated and qualify as
hedging instruments, we must designate the hedging instrument,
based upon the exposure being hedged, as a fair value hedge, a
cash flow hedge or a hedge of a net investment in a foreign
operation. We have no fair value hedges or hedges of a net
investment in foreign operations as of June 30, 2006.
For derivative instruments that are designated and qualify as a
cash flow hedge (i.e., hedging the exposure to
variability in expected future cash flows that are attributable
to a particular risk), the effective portion of the gain or loss
on the derivative instrument is reported as a component of other
comprehensive income and reclassified into earnings in the same
line item associated with the forecasted transaction in the same
period or periods during which the hedged transaction affects
earnings (i.e., in interest expense when the
hedged transactions are interest cash flows associated with
floating-rate debt). The remaining gain or loss on the
derivative instrument in excess of the cumulative changes in the
present value of future cash flows of the hedged item, if any,
is recognized in the realized and unrealized gain (loss) on
derivatives in current earnings during the period of change. For
derivative instruments not designated as hedging instruments
(including foreign currency swaps), the gain or loss is
recognized in realized and unrealized gain (loss) on derivatives
in the current earnings during the period of change. Income
and/or expense from interest rate swaps are recognized as an
adjustment to interest expense. We account for income and
expense from interest rate swaps on an accrual basis over the
period to which the payments and/or receipts relate.
7
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) |
|
|
|
Dividends to Stockholders |
We record dividends to stockholders on the declaration date. The
actual dividend and its timing are at the discretion of our
board of directors. We intend to pay sufficient dividends to
avoid incurring any income or excise tax. During the six months
ended June 30, 2006, we declared dividends in the amount of
$25,421, of which $12,707 was distributed on April 17, 2006
and $12,714 was distributed on July 21, 2006.
Offering costs that were incurred in connection with the Private
Offering are reflected as a reduction of additional
paid-in-capital.
Offering costs in connection with our initial public offering,
which closed on August 2, 2006, are currently reflected in
prepaid expenses and other assets and will be reflected as a
reduction of additional
paid-in-capital
commencing in the third quarter of 2006.
Interest income for our available for sale securities and real
estate loans is recognized over the life of the investment using
the effective interest method and recorded on the accrual basis.
Interest income on mortgage-backed securities (MBS)
is recognized using the effective interest method as required by
EITF 99-20. Real estate loans are generally originated or
purchased at or near par value, and interest income is
recognized based on the contractual terms of the loan
instruments. Any loan fees or acquisition costs on originated
loans or securities are capitalized and recognized as a
component of interest income over the life of the investment
utilizing the straight-line method, which approximates the
effective interest method.
Under EITF 99-20, at the time of purchase, our management
estimates the future expected cash flows and determines the
effective interest rate based on these estimated cash flows and
the purchase price. As needed, we update these estimated cash
flows and compute a revised yield based on the current amortized
cost of the investment. In estimating these cash flows, there
are a number of assumptions that are subject to uncertainties
and contingencies, including the rate and timing of principal
payments (including prepayments, repurchases, defaults and
liquidations), the pass-through or coupon rate and interest rate
fluctuations. In addition, interest payment shortfalls due to
delinquencies on the underlying mortgage loans and the timing
and the magnitude of credit losses on the mortgage loans
underlying the securities have to be judgmentally estimated.
These uncertainties and contingencies are difficult to predict
and are subject to future events that may impact our
managements estimates and our interest income.
We record security transactions on the trade date. Realized
gains and losses from security transactions are determined based
upon the specific identification method and recorded as gain
(loss) on sale of available for sale securities in the statement
of income.
We account for accretion of discounts or premiums on available
for sale securities and real estate loans using the effective
interest yield method. Such amounts have been included as a
component of interest income in the statements of income.
8
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) |
We may sell all or a portion of our real estate investments to a
third party. To the extent the fair value received for an
investment differs from the amortized cost of that investment
and control of the asset that is sold is surrendered making it a
true sale, as defined under SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities
(SFAS 140), a gain or loss on the sale will
be recorded in the statement of income as realized net gain
(loss) on sale of real estate loans. To the extent a real estate
investment is sold that has any fees which were capitalized at
the time the investment was made and were being recognized over
the term of the investment, the unamortized fees are recognized
at the time of sale and included in any gain or loss on sale of
real estate loans.
Dividend income on preferred stock is recorded on the dividend
declaration date.
We intend to elect to be taxed as a REIT and to comply with the
corresponding federal income tax provisions. Accordingly, we
generally will not be subject to federal or state income tax to
the extent that we make qualifying distributions to our
stockholders and provided we satisfy the REIT requirements,
including certain asset, income, distribution and stock
ownership tests. If we were to fail to meet these requirements,
we would be subject to federal, state and local income taxes,
which could have a material adverse impact on our results of
operations and amounts available for distribution to our
stockholders.
The dividends paid deduction of a REIT for qualifying dividends
to our stockholders is computed using our taxable income as
opposed to using our financial statement net income. Some of the
significant differences between financial statement net income
and taxable income include the timing of recording unrealized
gains/realized gains associated with certain assets, the
book/tax basis of assets, interest income, impairment, credit
loss recognition related to certain assets (asset-backed
mortgages), accounting for derivative instruments and stock
compensation and amortization of various costs (including start
up costs).
We have a taxable REIT subsidiary (TRS) that has
made a joint election with us to be treated as our TRS. The TRS
is a separate entity subject to federal income tax under the
Internal Revenue Code. During the quarter ended June 30,
2006, the TRS recorded a $28 current income tax accrual
which is included in other expenses.
We compute basic and diluted earnings per share in accordance
with SFAS No. 128, Earnings Per Share
(SFAS 128). Basic earnings per share
(EPS) is computed based on the income available to
common stockholders divided by the weighted average number of
shares of common stock and other participating securities
outstanding during the period. Diluted EPS is based on the
income available to common stockholders divided by the weighted
average number of shares of common stock plus any additional
shares of common stock attributable to stock options, provided
that the options have a dilutive effect. At June 30, 2006
and June 30, 2005, options to purchase a total of
130,000 shares of common stock and 126,000 shares of
common stock, respectively, have been excluded from the
computation of diluted EPS as there would be no dilutive effect.
9
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) |
|
|
|
Variable Interest Entities |
In January 2003, the Financial Accounting Standards Board
(FASB) issued Interpretation No. 46,
Consolidation of Variable Interest Entities An
Interpretation of ARB No. 51 (FIN 46).
FIN 46 provides guidance on identifying entities for which
control is achieved through means other than through voting
rights and on determining when and which business enterprise
should consolidate a variable interest entity (VIE)
when such enterprise would be determined to be the primary
beneficiary. In addition, FIN 46 requires that both the
primary beneficiary and all other enterprises with a significant
variable interest in a VIE make additional disclosures. In
December 2003, the FASB issued a revision of FIN 46,
Interpretation No. 46R (FIN 46R), to
clarify the provisions of FIN 46. FIN 46R states that
a VIE is subject to consolidation if the investors in the entity
being evaluated under FIN 46R either do not have sufficient
equity at risk for the entity to finance its activities without
additional subordinated financial support, are unable to direct
the entitys activities, or are not exposed to the
entitys losses or entitled to its residual returns. VIEs
within the scope of FIN 46R are required to be consolidated
by their primary beneficiary. The primary beneficiary of a VIE
is determined to be the party that absorbs a majority of the
VIEs expected losses, receives the majority of the
VIEs expected returns, or both.
Our ownership of the subordinated classes of commercial mortgage
backed securities (CMBS) and residential mortgage
backed securities (RMBS) from a single issuer may
provide us with the right to control the foreclosure/ workout
process on the underlying loans, which we refer to as the
Controlling Class CMBS and RMBS. There are certain exceptions to
the scope of FIN 46R, one of which provides that an
investor that holds a variable interest in a qualifying
special-purpose entity (QSPE) is not required to
consolidate that entity unless the investor has the unilateral
ability to cause the entity to liquidate. SFAS 140 sets
forth the requirements for an entity to qualify as a QSPE. To
maintain the QSPE exception, the special-purpose entity must
initially meet the QSPE criteria and must continue to satisfy
such criteria in subsequent periods. A special-purpose
entitys QSPE status can be impacted in future periods by
activities undertaken by its transferor(s) or other involved
parties, including the manner in which certain servicing
activities are performed. To the extent that our CMBS or RMBS
investments were issued by a special-purpose entity that meets
the QSPE requirements, we record those investments at the
purchase price paid. To the extent the underlying
special-purpose entities do not satisfy the QSPE requirements,
we follow the guidance set forth in FIN 46R as the special
purpose entities would be determined to be VIEs.
We have analyzed the pooling and servicing agreements governing
each of our Controlling Class CMBS and RMBS investments and we
believe that the terms of those agreements are industry standard
and are consistent with the QSPE criteria. However, there is
uncertainty with respect to QSPE treatment for those
special-purpose entities due to ongoing review by regulators and
accounting standard setters (including the FASBs project
to amend SFAS 140 and the recently added FASB project on
servicer discretion in a QSPE), potential actions by various
parties involved with the QSPE (discussed in the paragraph
above) and varying and evolving interpretations of the QSPE
criteria under SFAS 140. We also have evaluated each of our
Controlling Class CMBS and RMBS investments as if the
special-purpose entities that issued such securities are not
QSPEs. Using the fair value approach to calculate expected
losses or
10
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
residual returns, we have concluded that we would not be the
primary beneficiary of any of the underlying special-purpose
entities. Additionally, the standard setters continue to review
the FIN 46R provisions related to the computations used to
determine the primary beneficiary of VIEs. Future guidance from
regulators and standard setters may require us to consolidate
the special-purpose entities that issued the CMBS and RMBS in
which we have invested as described in the section titled
Recently Issued Accounting Pronouncements.
Our maximum exposure to loss as a result of our investment in
these QSPEs totaled $325,196 as of June 30, 2006.
The financing structures that we offer to the borrowers on
certain of our real estate loans involve the creation of
entities that could be deemed VIEs and therefore, could be
subject to FIN 46R. Our management has evaluated these
entities and has concluded that none of them are VIEs that are
subject to the consolidation rules of FIN 46R.
We account for stock-based compensation in accordance with the
provisions of SFAS No. 123R, Accounting for
Stock-Based Compensation (SFAS 123R), which
establishes accounting and disclosure requirements using fair
value based methods of accounting for stock-based compensation
plans. Compensation expense related to grants of stock and stock
options are recognized over the vesting period of such grants
based on the estimated fair value on the grant date.
Stock compensation awards granted to Hyperion Brookfield Crystal
River Capital Advisors, LLC, our external manager, and certain
employees of the managers affiliates are accounted for in
accordance with
EITF 96-18,
Accounting For Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling,
Goods and Services, which requires us to measure the fair
value of the equity instrument using the stock prices and other
measurement assumptions as of the earlier of either the date at
which a performance commitment by the counterparty is reached or
the date at which the counterpartys performance is
complete.
|
|
|
Concentration of Credit Risk and Other Risks and
Uncertainties |
Our investments are primarily concentrated in mortgage backed
securities that pass through collections of principal and
interest from the underlying mortgages and there is a risk that
some borrowers on the underlying mortgages will default.
Therefore, mortgage backed securities may bear some exposure to
credit losses. Our maximum exposure to loss due to credit risk
if all parties to the investments failed completely to perform
according to the terms of the contracts as of June 30, 2006
is $2,692,928. Our real estate loans may bear some exposure to
credit losses. Our maximum exposure to loss due to credit risk
if parties to the real estate loans, related and unrelated,
failed completely to perform according to the terms of the loans
as of June 30, 2006 is $135,361.
We bear certain other risks typical in investing in a portfolio
of mortgage backed securities. Principal risks potentially
affecting our financial position, income and cash flows include
the risk that: (i) interest rate changes can negatively
affect the market values of our mortgage backed securities,
(ii) interest rate changes can influence decisions made by
borrowers in the
11
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
mortgages underlying the securities to prepay those mortgages,
which can negatively affect both the cash flows from, and the
market value of, our mortgage backed securities, and
(iii) adverse changes in the market value of our mortgage
backed securities and/or our inability to renew short term
borrowings would result in the need to sell securities at
inopportune times and cause us to realize losses.
Other financial instruments that potentially subject us to
concentrations of credit risk consist primarily of cash and cash
equivalents and real estate loans. We place our cash and cash
equivalents in excess of insured amounts with high quality
financial institutions. The collateral securing our real estate
loans are located in the United States and Canada.
|
|
|
Other Comprehensive Income |
Comprehensive income consists of net income and other
comprehensive income. Our other comprehensive income is
comprised primarily of unrealized gains and losses on securities
available for sale and net unrealized and deferred gains and
losses on certain derivative investments accounted for as cash
flow hedges.
|
|
|
Foreign Currency Transactions |
We conform to the requirements of SFAS No. 52, Foreign
Currency Translation (SFAS 52).
SFAS 52 requires us to record realized and unrealized gains
and losses from transactions denominated in a currency other
than our functional currency (US dollar) in determining net
income.
|
|
|
Recently Adopted Accounting Pronouncements |
In December 2004, the FASB issued SFAS No. 153,
Exchanges of Non-Monetary Assets, an amendment of APB Opinion
No. 29 (SFAS 153). SFAS 153
eliminates the exception from fair value measurement for
non-monetary exchanges of similar productive assets provided by
APB Opinion No. 29, Accounting for Non-monetary
Transactions (APB 29), and replaces it with
an exception for exchanges that do not have commercial
substance. SFAS 153 specifies that a non-monetary exchange
has commercial substance if the future cash flows of the entity
are expected to change significantly as a result of the
exchange. SFAS 153 is effective for fiscal periods
beginning after June 15, 2005 and we adopted SFAS 153
in the first quarter of 2006. The adoption of SFAS 153 did
not materially affect our consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections A
Replacement of APB Opinion No. 20 and FASB Statement
No. 3(SFAS 154). SFAS 154
requires the retrospective application to prior periods
financial statements of changes in accounting principles, unless
it is impractical to determine either the period-specific
effects or the cumulative effect of the accounting change.
SFAS 154 also requires that a change in the depreciation,
amortization, or depletion method for long-lived non-financial
assets be accounted for as a change in accounting estimate
affected by a change in accounting principle. SFAS 154 is
effective for accounting changes and corrections of errors made
in fiscal years beginning after December 15, 2005. We
adopted SFAS 154 in the first quarter of 2006. The adoption
of SFAS 154 did not materially affect our consolidated
financial statements.
12
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(Continued) |
In November 2005, the FASB issued FASB Staff Position
(FSP)
FAS 115-1, The
Meaning of Other than Temporary Impairment and its Application
to Certain Investments. This FSP, which is effective for
reporting periods beginning after December 15, 2005,
addresses the determination of when an investment is considered
impaired, whether that impairment is other than temporary, and
the measurement of an impairment loss. We adopted FSP
FAS 115-1 in the
first quarter of 2006. The adoption of FSP
FAS 115-1 did not
materially affect our consolidated financial statements.
|
|
|
Recently Issued Accounting Pronouncements Not Yet
Adopted |
In February 2006, the FASB issued SFAS No. 155,
Accounting for Certain Hybrid Instruments
(SFAS 155). SFAS 155 is an amendment
of SFAS 133 and SFAS 140 that allows financial
instruments that have embedded derivatives to be accounted for
as a whole (eliminating the need to bifurcate the derivative
from its host) if the holder elects to account for the whole
instrument on a fair value basis. SFAS 155 also clarifies
which interest-only strips and principal-only strips are not
subject to the requirements of SFAS 133 and establishes a
requirement to evaluate interests in securitized financial
assets to identify interests that are freestanding derivatives
or that are hybrid financial instruments that contain an
embedded derivative requiring bifurcation. Finally,
SFAS 155 amends SFAS 140 to eliminate the prohibition
on a qualifying special-purpose entity from holding a derivative
financial instrument that pertains to a beneficial interest
other than another derivative financial instrument.
SFAS 155 is effective for fiscal periods beginning after
September 15, 2006 and we will adopt SFAS 155 in the
first quarter of 2007. We currently do not anticipate that the
effects of SFAS 155 will materially affect our consolidated
financial statements upon adoption.
In March 2006, the FASB issued SFAS No. 156,
Accounting for Servicing of Financial Assets an
amendment of FASB Statement No. 140
(SFAS 156). SFAS 156 requires:
1) an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract under
certain conditions, 2) all separately recognized servicing
assets and servicing liabilities to be initially measured at
fair value, if practicable, and 3) permits an entity to
choose either the amortization method or the fair value
measurement method for subsequent measurement of each class of
separately recognized servicing assets and servicing
liabilities. SFAS 156 is effective for fiscal periods
beginning after September 15, 2006 and we will adopt
SFAS 156 in the first quarter 2007. We currently do not
anticipate that the effects of SFAS 156 will materially
affect our consolidated financial statements upon adoption.
In April 2006, the FASB issued FSP
FIN 46(R)-6,
Determining the Variability to be Considered When Applying
FASB Interpretation No. 46(R)
(FIN 46(R)-6).
FIN 46(R)-6
addresses the approach to determine the variability to consider
when applying FIN 46(R). The variability that is considered
in applying Interpretation 46(R) may affect (i) the
determination as to whether an entity is a VIE, (ii) the
determination of which interests are variable in the entity,
(iii) if necessary, the calculation of expected losses and
residual returns on the entity, and (iv) the determination
of which party is the primary beneficiary of the VIE. Thus,
determining the variability to be considered is necessary to
apply the provisions of Interpretation 46(R).
FIN 46(R)-6 is
required to be prospectively applied to entities in which we
first
13
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
become involved after July 1, 2006 and would be applied to
all existing entities with which we are involved if and when a
reconsideration event (as described in FIN 46)
occurs. We are currently evaluating the effects of adopting
FIN 46(R)-6 on our
consolidated financial statements.
The FASB has placed on its agenda the accounting treatment of
transactions whereby securities purchased from a particular
counterparty are financed with same counterparty through a
repurchase agreement pursuant to which we pledge the purchased
securities. Currently, we record the acquisition of these
securities and the related borrowing under repurchase agreements
as assets and liabilities on the consolidated balance sheet, and
the corresponding interest income and interest expense on the
consolidated income statement. Any changes in the fair value of
the securities are reported through other comprehensive income
pursuant to FASB No. 115, Accounting for Certain
Investments in Debt and Equity Securities, because the
securities are classified as available for sale. However, in a
transaction where the securities are acquired from and financed
under a repurchase agreement with the same counterparty, the
acquisition may not qualify as a sale from the sellers
perspective under SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. In such cases, the sellers may be required
to continue to consolidate the assets sold to us, based on their
continuing involvement with such investments. Depending on the
ultimate outcome of the FASBs deliberations, we may be
precluded from presenting the assets gross on our balance sheet
and instead should be treating our net investment in such assets
as a derivative. If it is determined that these transactions
should be treated as an investment in derivatives, the
derivative instruments entered into by us to hedge our interest
rate exposure with respect to the borrowings under the
associated repurchase agreements may no longer qualify for hedge
accounting, and would then, as with the underlying asset
transaction, also be marked to market through the income
statement. This potential change in accounting treatment does
not affect the economics of the transactions but does affect how
the transactions would be reported on our consolidated financial
statements. Our cash flows, liquidity and ability to pay a
dividend would be unchanged, and we do not believe our REIT
taxable income or REIT tax status would be affected. Our net
equity would not be materially affected. As of June 30,
2006, we have identified available for sale securities with a
fair value of approximately $13,097 that had been purchased from
and financed with reverse repurchase agreements totaling $10,726
with the same counterparties since their purchase. If we were to
change the current accounting treatment for these transactions
as of June 30, 2006, our total assets and total liabilities
would be reduced by approximately $10,726.
In July 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes
(FIN 48). This interpretation, among other
things, creates a two-step approach for evaluating uncertain tax
positions. Recognition (step one) occurs when an enterprise
concludes that a tax position, based solely on its technical
merits, is more-likely-than-not to be sustained upon
examination. Measurement (step two) determines the amount of
benefit that more-likely-than-not will be realized upon
settlement. Derecognition of a tax position that was previously
recognized would occur when a company subsequently determines
that a tax position no longer meets the more-likely-than-not
threshold of being sustained. FIN 48 specifically prohibits
the use of a valuation allowance as a substitute for
derecognition of tax positions, and it has expanded disclosure
requirements. FIN 48 is effective for fiscal years
beginning after
14
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
December 15, 2006, in which the impact of adoption should
be accounted for as a cumulative-effect adjustment to the
beginning balance of retained earnings. We currently are
evaluating the effect, if any, that this pronouncement will have
on our future financial results.
Certain reclassifications have been made in the presentation of
the prior periods consolidated financial statements to conform
to the June 2006 presentation.
|
|
3. |
AVAILABLE FOR SALE SECURITIES |
Our available for sale securities are carried at their estimated
fair values. The amortized cost and estimated fair values of our
available for sale securities as of June 30, 2006 are
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross | |
|
Gross | |
|
|
|
|
Amortized | |
|
Unrealized | |
|
Unrealized | |
|
Estimated | |
Security Description |
|
Cost | |
|
Gains | |
|
Losses | |
|
Fair Value | |
|
|
| |
|
| |
|
| |
|
| |
CMBS
|
|
$ |
312,594 |
|
|
$ |
1,219 |
|
|
$ |
(10,749 |
) |
|
$ |
303,064 |
|
Residential MBS-Non-Agency ARMs
|
|
|
549,360 |
|
|
|
3,835 |
|
|
|
(10,908 |
) |
|
|
542,287 |
|
Residential MBS-Agency ARMs
|
|
|
1,824,847 |
|
|
|
24 |
|
|
|
(32,256 |
) |
|
|
1,792,615 |
|
ABS
|
|
|
48,786 |
|
|
|
2,028 |
|
|
|
(486 |
) |
|
|
50,328 |
|
Preferred stock
|
|
|
4,852 |
|
|
|
|
|
|
|
(218 |
) |
|
|
4,634 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,740,439 |
|
|
$ |
7,106 |
|
|
$ |
(54,617 |
) |
|
$ |
2,692,928 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2006, we pledged an aggregate of $2,380,048
and $248,007 in estimated fair value of our available for sale
securities to secure our repurchase agreements and
collateralized debt obligations, respectively.
As of June 30, 2006, the aggregate estimated fair values by
underlying credit rating of our available for sale securities
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Estimated Fair | |
|
|
Security Rating |
|
Value | |
|
Percentage | |
|
|
| |
|
| |
AAA
|
|
$ |
2,015,604 |
|
|
|
74.85 |
% |
AA
|
|
|
|
|
|
|
|
|
A
|
|
|
60,945 |
|
|
|
2.26 |
|
BBB
|
|
|
248,884 |
|
|
|
9.24 |
|
BB
|
|
|
194,494 |
|
|
|
7.22 |
|
B
|
|
|
114,204 |
|
|
|
4.25 |
|
Not rated
|
|
|
58,797 |
|
|
|
2.18 |
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,692,928 |
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
15
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
3. |
AVAILABLE FOR SALE SECURITIES (Continued) |
As of June 30, 2006, the face amount and net unearned
discount on our investments was as follows:
|
|
|
|
|
Description: |
|
|
|
|
|
Face amount
|
|
$ |
2,985,231 |
|
Net unearned discount
|
|
|
244,792 |
|
|
|
|
|
Amortized cost
|
|
$ |
2,740,439 |
|
|
|
|
|
For the six months ended June 30, 2006 and the period ended
June 30, 2005, $4,093 and $941, respectively, of net
discount on available for sale securities was accreted into
interest income.
The following table sets forth the amortized cost, fair value
and unrealized loss for securities we owned as of June 30,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of | |
|
Amortized | |
|
|
|
Unrealized | |
Security Rating |
|
Securities | |
|
Cost | |
|
Fair Value | |
|
Loss | |
|
|
| |
|
| |
|
| |
|
| |
AAA
|
|
|
95 |
|
|
$ |
1,993,965 |
|
|
$ |
1,956,687 |
|
|
$ |
37,278 |
|
AA
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A
|
|
|
1 |
|
|
|
2,550 |
|
|
|
2,543 |
|
|
|
7 |
|
BBB
|
|
|
38 |
|
|
|
197,854 |
|
|
|
192,986 |
|
|
|
4,868 |
|
BB
|
|
|
45 |
|
|
|
172,037 |
|
|
|
165,224 |
|
|
|
6,813 |
|
B
|
|
|
37 |
|
|
|
64,851 |
|
|
|
61,359 |
|
|
|
3,492 |
|
Not rated
|
|
|
24 |
|
|
|
35,914 |
|
|
|
33,755 |
|
|
|
2,159 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
240 |
|
|
$ |
2,467,171 |
|
|
$ |
2,412,554 |
|
|
$ |
54,617 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2006, we held 137 securities, with
unrealized losses totaling $25,628, that we acquired within
12 months of June 30, 2006. The remaining 103
securities, with unrealized losses totaling $28,989, were
acquired more than 12 months prior to June 30, 2006.
The unrealized losses on all securities were the result of
changes in market interest rates subsequent to their purchase.
The unrealized losses on non-rated bonds were also due to market
conditions and price volatility. Because we have the ability and
intent to hold these investments until a recovery of fair value,
which may be maturity, we do not consider these investments to
be other than temporarily impaired at June 30, 2006.
|
|
|
Other Than Temporary Impairments |
As of June 30, 2006, we held six Agency ARMS and two CMBS
securities that we determined to be other than temporarily
impaired. In connection with the impairment of these Agency ARMS
and CMBS, we recorded impairment charges of $5,666 and $6,924 in
our statement of income for the three months ended June 30,
2006 and the six months ended June 30, 2006,
respectively, that has been reclassified out of other
comprehensive income. We have determined that the impairment
with respect to the six Agency ARMS and one of the
16
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
3. |
AVAILABLE FOR SALE SECURITIES (Continued) |
CMBS securities in the amount of $4,746 and $6,004 for the three
months and six months ended June 30, 2006, respectively,
was other than temporary as we expect to sell these securities
in the near future at a loss. Subsequent to June 30, 2006,
we have sold four of the six Agency ARMS and the two CMBS
securities that were so impaired. As of June 30, 2006, as
part of our periodic surveillance of the underlying value of the
collateral securing our CMBS investments, we revalued two of the
underlying loans in the collateral securing a CMBS security that
resulted in a credit impairment charge for the three months and
six months ended June 30, 2006 in the amount of $920 and
$920, respectively.
|
|
|
Sale of Available for Sale Securities |
During the six months ended June 30, 2006, we sold one
security for proceeds of $3,263 realizing a gain of $327 and we
sold eight securities for proceeds of $293,647 (of which
$114,429 is due from broker as of June 30, 2006) realizing
a loss of $1,995.
During the first six months of 2006, we received payments in
respect of real estate loan redemptions and principal repayments
totaling $16,000, including the redemption in full in February
2006 of one of our B Notes that had a carrying value of $15,910
at December 31, 2005. In addition, during the first six
months of 2006, we provided additional advances under
construction loans of $2,587 and made a delayed funding on a
real estate loan of $4,339.
As of June 30, 2006, our real estate loan portfolio had a
total face value of $135,343 and a total carrying value of
$135,361. The carrying value of our real estate loans at
June 30, 2006 includes unamortized underwriting fees of
$18. As of June 30, 2006, we pledged an aggregate of
$62,085 and $33,000 in face value of our real estate loans to
secure our repurchase agreements and collateralized debt
obligations, respectively. At such date, our real estate loans
included non-US dollar denominated assets with a carrying value
of $44,791.
|
|
5. |
DEBT AND OTHER FINANCING ARRANGEMENTS |
The following is a summary of our debt as of June 30, 2006:
|
|
|
|
|
|
Type of Debt: |
|
|
|
|
|
Repurchase agreements
|
|
$ |
2,439,496 |
|
Repurchase agreements, related party
|
|
|
57,234 |
|
Revolving credit facility
|
|
|
|
|
Collateralized debt obligations
|
|
|
210,903 |
|
|
|
|
|
|
Total Debt
|
|
$ |
2,707,633 |
|
|
|
|
|
As of June 30, 2006, we had entered into 17 master
repurchase agreements with various counterparties to finance our
asset purchases on a short term basis. Under these agreements,
we sell our assets to the counterparties and agree to repurchase
those assets on a date certain
17
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
5. |
DEBT AND OTHER FINANCING ARRANGEMENTS
(Continued) |
at a repurchase price generally equal to the original sales
price plus accrued but unpaid interest. The counterparties will
purchase each asset financed under the facility at a percentage
of the assets value on the date of origination, which is
the purchase rate, and we will pay interest to the counterparty
at short term interest rates (usually based on one-month LIBOR)
plus a pricing spread. We have agreed to a schedule of purchase
rates and pricing spreads with these counterparties that
generally are based upon the class and credit rating of the
asset being financed. The facilities are recourse to us. For
financial reporting purposes, we characterize all of the
borrowings under these facilities as balance sheet financing
transactions.
Under the repurchase agreements, we are required to maintain
adequate collateral with these counterparties. If the market
value of the collateral we have pledged declines, then the
counterparty may require us to provide additional collateral to
secure our obligations under the repurchase agreement. As of
June 30, 2006, we were required to provide additional
collateral in the amount of $78,490, which is classified as
restricted cash on the balance sheet.
As of June 30, 2006, we had repurchase agreements
outstanding in the amount of $2,496,730 with a weighted-average
borrowing rate of 5.24%. As of June 30, 2006, the
18
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
5. DEBT
AND OTHER FINANCING ARRANGEMENTS (Continued)
repurchase agreements had remaining weighted-average maturities
of 55 days and are summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- | |
|
|
|
|
Outstanding | |
|
Fair Value of | |
|
Average | |
|
Maturity | |
Repurchase Counterparty |
|
Balance | |
|
Collateral | |
|
Borrowing Rate | |
|
Range (days) | |
|
|
| |
|
| |
|
| |
|
| |
Related Party
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trilon International,
Inc.
|
|
$ |
57,234 |
|
|
$ |
62,089 |
|
|
|
5.48 |
% |
|
|
26-28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrelated
Parties
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Banc of America Securities LLC
|
|
|
191,815 |
|
|
|
199,170 |
|
|
|
5.15 |
|
|
|
7-47 |
|
Bear, Stearns & Co.
Inc.
|
|
|
310,809 |
|
|
|
328,689 |
|
|
|
5.19 |
|
|
|
7-47 |
|
Citigroup Global Markets
Inc.
|
|
|
171,837 |
|
|
|
177,062 |
|
|
|
5.27 |
|
|
|
40-81 |
|
Credit Suisse First Boston LLC
|
|
|
343,180 |
|
|
|
368,764 |
|
|
|
5.20 |
|
|
|
7-76 |
|
Deutsche Bank Securities
Inc.
|
|
|
318,286 |
|
|
|
328,305 |
|
|
|
5.10 |
|
|
|
24-55 |
|
Greenwich Capital Markets,
Inc.
|
|
|
220,191 |
|
|
|
226,434 |
|
|
|
5.26 |
|
|
|
40-76 |
|
Lehman Brothers Inc.
|
|
|
186,270 |
|
|
|
200,363 |
|
|
|
5.14 |
|
|
|
7-12 |
|
Merrill Lynch, Pierce,
Fenner & Smith Incorporated
|
|
|
243,044 |
|
|
|
253,266 |
|
|
|
5.17 |
|
|
|
24-81 |
|
Morgan Stanley & Co.,
Incorporated
|
|
|
171,139 |
|
|
|
176,986 |
|
|
|
5.15 |
|
|
|
7-40 |
|
Wachovia Bank, National Association
|
|
|
119,207 |
|
|
|
169,073 |
|
|
|
6.23 |
|
|
|
413 |
|
Wachovia Capital Markets, LLC
|
|
|
29,494 |
|
|
|
33,248 |
|
|
|
5.48 |
|
|
|
7-76 |
|
WaMu Capital Corp.
|
|
|
134,224 |
|
|
|
139,363 |
|
|
|
5.24 |
|
|
|
7-69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,439,496 |
|
|
|
2,600,723 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,496,730 |
|
|
$ |
2,662,812 |
|
|
|
5.24 |
% |
|
|
7-413 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2006, the maturity ranges of our outstanding
repurchase agreements segregated by our available for sale
securities and real estate loans are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Up to 30 days | |
|
31 to 90 days | |
|
Over 90 days | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
Agency RMBS
|
|
$ |
936,075 |
|
|
$ |
974,127 |
|
|
$ |
|
|
|
$ |
1,910,202 |
|
Non-agency RMBS
|
|
|
132,356 |
|
|
|
127,908 |
|
|
|
70,389 |
|
|
|
330,653 |
|
CMBS
|
|
|
72,605 |
|
|
|
33,242 |
|
|
|
31,394 |
|
|
|
137,241 |
|
ABS
|
|
|
24,277 |
|
|
|
19,700 |
|
|
|
17,423 |
|
|
|
61,400 |
|
Real estate loans
|
|
|
57,234 |
|
|
|
|
|
|
|
|
|
|
|
57,234 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
1,222,547 |
|
|
$ |
1,154,977 |
|
|
$ |
119,206 |
|
|
$ |
2,496,730 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
5. |
DEBT AND OTHER FINANCING ARRANGEMENTS
(Continued) |
In August 2005, we entered into a $200,000 Master Repurchase
Agreement (the Master Repurchase Agreement) with
Wachovia Bank (the Bank). The Master Repurchase
Agreement is for a two year term (expires August 2007) with a
one year renewal option at the Banks discretion. Subject
to the terms and conditions thereof, the Master Repurchase
Agreement provides for the purchase, sale and repurchase of
commercial and residential mortgage loans, commercial mezzanine
loans, B Notes, participation interests in the foregoing,
commercial mortgage-backed securities and other mutually agreed
upon collateral and bears interest at varying rates over LIBOR
based upon the type of asset included in the repurchase
obligation. In November 2005, the Bank increased the borrowing
capacity to $275,000. As of June 30, 2006, the unused
amount under the Master Repurchase Agreement is $155,793.
|
|
|
Collateralized Debt Obligations (CDOs) |
In November 2005, we issued approximately $377,904 of CDOs
through two newly-formed subsidiaries, Crystal River Capital
CDO 2005-1 Ltd.,
or the Issuer, and Crystal River Capital
CDO 2005-1 LLC, or
the Co-Issuer. The CDO consists of $227,500 of investment grade
notes and $67,750 of non-investment grade notes, which were
co-issued by the Issuer and the Co-Issuer, and $82,654 of
preference shares, which were issued by the Issuer. We retained
all of the non-investment grade securities, the preference
shares and the common shares in the Issuer. The issuer holds
assets, consisting primarily of whole loans, CMBS and RMBS
securities, which serve as collateral for the CDO. Investment
grade notes in the aggregate principal amount of $217,500 were
issued with floating coupons with a combined weighted average
interest rate of three-month LIBOR plus 0.58%. In addition,
$10,000 of investment grade notes were issued with a fixed
coupon rate of 6.02%. The CDO may be replenished, pursuant to
certain rating agency guidelines relating to credit quality and
diversification, with substitute collateral for loans that are
repaid during the first five years of the CDO. Thereafter, the
CDO securities will be retired in sequential order from the
senior-most to junior-most as loans are repaid. We incurred
approximately $5,906 of issuance costs, which is amortized over
the average life of the CDO. The Issuer and Co-Issuer are
consolidated in our financial statements. The investment grade
notes are treated as a secured financing, and are non recourse
to us. Proceeds from the sale of the investment grade notes
issued were used to repay outstanding debt under our repurchase
agreements. The CDO was collateralized by available for sale
securities with fair values of $248,081 and real estate loans
with carrying values of $33,009 as of June 30, 2006.
|
|
|
Note Payable, Related Party |
In August 2005, we borrowed $35,000 from an affiliate of our
Manager for 90 days on an unsecured basis. In November
2005, we extended the loan an additional 90 days. The note bore
interest at the fixed rate of 5.59% per annum and it matured on
February 13, 2006. Interest expense on this note was $239
for the six months ended June 30, 2006. The note was repaid
at maturity.
|
|
|
Revolving Credit Facility |
In March 2006, we entered into an unsecured credit facility with
Signature Bank that provides for borrowings of up to $31,000 in
the aggregate. The credit facility expires in March 2009. The
20
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
5. |
DEBT AND OTHER FINANCING ARRANGEMENTS
(Continued) |
credit facility provides for monthly repayments of all amounts
due. Borrowings under the credit facility bear interest at a
rate equal to the banks prime interest rate or 1.75% over
LIBOR. We had no amounts outstanding under this credit facility
at June 30, 2006.
Certain of our repurchase agreements and our revolving credit
facility contain financial covenants, including maintaining our
REIT status and maintaining a specific net asset value or worth.
As of June 30, 2006, with respect to two debt obligations,
we failed to meet certain financial covenants including an
interest expense coverage ratio. We obtained waivers with
respect to all financial covenants which were not met. As a
result, we were in compliance with or have obtained the
necessary waivers with respect to all our financial covenants as
of June 30, 2006.
|
|
6. |
COMMITMENTS AND CONTINGENCIES |
We invest in real estate construction loans. We had outstanding
commitments to fund real estate construction loans in the
aggregate of $24,050 as of June 30, 2006. At June 30,
2006, we had made advances totaling $21,369 under these
commitments.
|
|
7. |
RISK MANAGEMENT TRANSACTIONS |
As of June 30, 2006, we had interest rate swap open
positions with notional amounts of $1,448,517 (including an
interest rate swap with a notional amount of $53,084 in our CDO)
with a fair value of $34,458, which are reported as derivative
assets on our balance sheet. Also, included in derivative assets
at June 30, 2006 are credit default swaps with a fair value
of $1,396. Included in derivative liabilities as of
June 30, 2006 is a Canadian foreign currency swap with a
fair value of $329 and accrued interest payable on open swap
positions of $6,246. At June 30, 2006, we had not hedged
repurchase agreements totaling $1,144,230.
The change in unrealized gains of interest rate swaps designated
as cash flow hedges are separately disclosed in the statement of
changes in stockholders equity. For the six months ended
June 30, 2006, unrealized gains aggregating $19,604 on cash
flow hedges were recorded in other comprehensive income. The
realized gain on settled swaps in the amount of $67 is being
amortized into income through interest expense for the six
months ended June 30, 2006. As of June 30, 2006, such
cumulative amortized amounts totaled $83. The unamortized
balance of $1,007 is deferred as a component of other
comprehensive income. The unrealized gain (loss) on derivatives
recorded in the statement of income for the three months ended
June 30, 2006, the six months ended June 30, 2006, the
three months ended June 30, 2005 and the period
March 15, 2005 (commencement of operations) to
June 30, 2005 related to hedge ineffectiveness was $190,
$251, $(5) and $(5), respectively. The amount recognized in the
statement of income for the three months ended June 30,
2006, the six months ended June 30, 2006, the three months
ended June 30, 2005 and the period March 15, 2005
(commencement of operations) to June 30, 2005 related to
economic hedges not designated for hedge accounting was an
unrealized gain (loss) of $726, $2,349, $(4,480) and $(4,285),
respectively. Realized losses on the settlement of swaps for the
period March 15, 2005 (commencement of operations) to
June 30, 2005 was $80. The amount recognized in the
statement of income for the three months and six months ended
June 30, 2006 related to foreign currency swaps was a
realized and unrealized loss of $2,112 and $870, respectively.
The amount recognized in the statement of income for the three
months and six months ended
21
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
7. |
RISK MANAGEMENT TRANSACTIONS (Continued) |
June 30, 2006 related to credit default swaps was an
unrealized gain of $347 and $4,989, respectively, and premiums
earned on those credit default swaps for the same periods of
$369 and $731, respectively.
Interest income (expense) on derivative instruments of $3,101,
$3,682, $(1,437) and $(1,437) is included as a component of
interest expense on the statement of income for the three months
ended June 30, 2006, the six months ended June 30,
2006, the three months ended June 30, 2005 and the period
March 15, 2005 (commencement of operations) to
June 30, 2005, respectively.
|
|
8. |
STOCKHOLDERS EQUITY AND LONG-TERM INCENTIVE PLAN |
In March 2005, we completed the Private Offering in which we
sold 17,400,000 shares of common stock, $0.001 par
value, at an offering price of $25 per share, including the
purchase of 400,000 shares of common stock by the initial
purchasers/placement agents pursuant to an over-allotment
option. We received proceeds from these transactions in the
amount of $405,613, net of underwriting commissions, placement
agent fees and other offering costs totaling $29,387. Each share
of common stock entitles its holder to one vote per share.
Officers, directors and entities affiliated with our Manager
owned 977,800 shares of our common stock as of
June 30, 2006.
In March 2005, we adopted a Long-Term Incentive Plan (the
Plan) which provides for awards under the Plan in
the form of stock options, stock appreciation rights, restricted
and unrestricted stock awards, restricted stock units, deferred
stock units and other performance awards. Our Manager and our
officers, employees, directors, advisors and consultants who
provide services to us are eligible to receive awards under the
Plan. The Plan has a term of ten years and, based on awards
since adoption, limits awards through June 30, 2006 to a
maximum of 1,748,750 shares of common stock . For
subsequent periods, the maximum number of shares of common stock
that may be subject to awards granted under the Plan can
increase by ten percent of the difference between the number of
shares of common stock outstanding at the end of the current
calendar year and the prior calendar year. In no event will the
total number of shares that can be issued under the Plan exceed
10,000,000.
In connection with the Plan, a total of 84,000 shares of
restricted common stock and 126,000 stock options (exercise
price of $25 per share) were granted to our Manager in
March 2005. The Manager subsequently transferred these shares
and options to certain of its officers and employees, certain of
our directors and other individuals associated with our Manager
who provide services to us. The restrictions on the restricted
common stock lapse and full rights of ownership vest for
one-third of the restricted shares and options on each of the
first three anniversary dates of issuance. Vesting is predicated
on the continuing involvement of our Manager in providing
services to us. In addition, 3,500 shares of unrestricted
stock were granted to the independent members of our board of
directors in March 2005 in lieu of cash remunerations. The
independent members of our board of directors fully vested in
the shares at the date of grant.
For the six months ending June 30, 2006, we issued a total
of 36,000 shares of restricted common stock. Of this
amount, 30,000 shares were issued to one of our senior
executives.
22
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
8. |
STOCKHOLDERS EQUITY AND LONG-TERM INCENTIVE
PLAN (Continued) |
The restrictions on the restricted common stock lapse and full
rights of ownership vest for one-third of the restricted shares
on each of the first three anniversary dates of issuance. The
remaining 6,000 shares of restricted common stock were
granted to an independent member of our board of directors and
one of our Managers employees. The director vested
one-third immediately and will vest in the remaining shares
ratably on the second and third anniversary dates of issuance
and the Managers employee will vest ratably on the first,
second and third anniversary dates of issuance. In addition, for
the six months ending June 30, 2006, we have issued 9,876
deferred stock units to certain other independent members of our
board of directors. Of this amount, 3,876 deferred stock units
were issued in lieu of cash remunerations. These independent
members of our board of directors fully vested in these units at
the date of grant. The remaining 6,000 deferred stock units
became one-third vested to the members of our board of directors
immediately and will vest in the remaining units ratably on the
second and third anniversary dates of issuance. In August 2006,
one of our Managers employees who owned 4,000 shares
of restricted common stock resigned prior to the vesting of any
of such shares. In accordance with the agreement pursuant to
which those shares were issued, upon his resignation, those
shares of restricted common stock were forfeited back to us.
In March 2006, we granted 4,000 stock options (exercise price of
$25 per share) to one of our directors.
The fair value of the shares of the restricted stock issued to
our Manager, directors and employees of our Managers
affiliates as of June 30, 2006 was $2,880 and the fair
value of the stock options granted as of June 30, 2006 was
$257 ($1.98 per share). The fair value of our stock options
and restricted shares was determined contemporaneously. For the
three months ended June 30, 2006, the six months ended
June 30, 2006, the three months ended June 30, 2005
and the period March 15, 2005 (commencement of operations)
to June 30, 2005, $258, $500, $199 and $232, respectively,
was expensed relating to the amortization of the restricted
stock and the stock options. For the three months ended
June 30, 2006 and the six months ended June 30, 2006,
$57 and $153, respectively, was expensed relating to the
amortization of deferred stock units. The fair value of the
stock options granted was estimated using a Binomial
option-pricing model with the following weighted-average
assumptions as of June 30, 2006: dividend yield of 10.94%,
expected volatility of 22%, risk-free interest rate of 5%; and
the expected life of the options of six years. Option valuation
models require the input of highly subjective assumptions
including the expected stock price volatility. Our stock options
have characteristics that are significantly different from those
of traded options and changes in the subjective input
assumptions could materially affect the fair value estimate.
We are subject to various risks, including credit, interest rate
and market risk. We are subject to interest rate risk to the
extent that our interest-bearing liabilities mature or re-price
at different speeds, or different bases, than our
interest-earning assets. Credit risk is the risk of default on
our investments that result in a counterpartys failure to
make payments according to the terms of the contract.
23
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
9. |
FINANCIAL RISKS (Continued) |
Market risk reflects changes in the value of the securities and
real estate loans due to changes in interest rates or other
market factors, including the rate of prepayments of principal
and the value of the collateral underlying our available for
sale securities and real estate loans.
|
|
10. |
RELATED PARTY TRANSACTIONS |
We have entered into a management agreement (as amended, the
Agreement) with our Manager. The initial term of the
Agreement expires in December 2008. After the initial term, the
Agreement will be automatically renewed for a one-year term each
anniversary date thereafter unless we or our Manager terminates
the Agreement. The Agreement provides that our Manager will
provide us with investment management services and certain
administrative services and will perform our day to day
operations. The monthly base management fee for such services is
equal to 1.5% of one-twelfth of our equity, as defined in the
Agreement, payable in arrears.
In addition, under the Agreement, our Manager earns a quarterly
incentive fee equal to 25% of the amount by which the quarterly
net income per share, as defined in the Agreement (principally
excludes the effect of stock compensation and the unrealized
change in derivatives), exceeds an amount equal to the product
of the weighted average offering price per share multiplied by
the higher of (i) 2.4375% or (ii) 25% of the then
applicable ten-year Treasury note rate plus 0.50%, multiplied by
the then weighted average number of outstanding shares for the
quarter. The incentive fee is paid quarterly. The Agreement
provides that 10% of the incentive management fee is to be paid
in shares of our common stock (providing that such payment does
not result in our Manager owning directly or indirectly more
than 9.8% of our issued and outstanding common stock) and the
balance is to be paid in cash. Our Manager may, at its sole
discretion, elect to receive a greater percentage of its
incentive management fee in shares of our common stock. No
incentive management fees were incurred during the six months
ended June 30, 2006 or the period ended June 30, 2005.
The Agreement may be terminated upon the affirmative vote of at
least two-thirds of the independent members of our board of
directors after the expiration of the initial term and by
providing at least 180 days prior notice based upon either:
(i) unsatisfactory performance by our Manager that is
materially detrimental to us, or (ii) a determination by
the independent members of our board of directors that the
management fees payable to our Manager are not fair (subject to
our Managers right to prevent a compensation termination
by accepting a mutually acceptable reduction of the management
fees). If we terminate the Agreement, then we must pay our
Manager a termination fee equal to twice the sum of the average
annual base and incentive fees earned by our Manager during the
two twelve-month periods immediately preceding the date of
termination, calculated as of the end of the most recently
completed fiscal quarter prior to the date of termination.
We issued to our Manager 84,000 shares of our restricted
common stock and granted options to
purchase 126,000 shares of our common stock for a ten
year period at a price of $25 per share in March 2005. We
issued to one of our executive officers 30,000 shares of
restricted common stock in March 2006 and we issued to one of
our Managers employees 4,000 shares of restricted
stock in June 2006. The restricted stock and the options vest
over a three year period. For the three months ended
June 30, 2006, the six months ended June 30,
24
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
10. |
RELATED PARTY TRANSACTIONS (Continued) |
2006, the three months ended June 30, 2005 and the period
March 15, 2005 (commencement of operations) to
June 30, 2005, the base management expense is $1,382,
$2,837, $1,550 and $1,837, respectively, all of which remained
unpaid as of the end of the respective periods. Included in the
management fee expense for the three months ended June 30,
2006, the six months ended June 30, 2006, the three months
ended June 30, 2005 and the period March 15, 2005
(commencement of operations) to June 30, 2005 is $253,
$475, $199 and $232 of amortization of stock-based compensation
related to restricted stock and options granted. The amount due
to Manager at June 30, 2006 includes $486 in respect of
management fees due at December 31, 2005.
The Agreement provides that we are required to reimburse our
Manager for certain expenses incurred by our Manager on our
behalf provided that such costs and reimbursements are no
greater than that which would be paid to outside professionals
or consultants on an arms length basis. For the six months
ended June 30, 2006 and the period ended June 30,
2005, we did not incur any reimbursable costs due to our Manager.
We and our Manager have entered into sub-advisory agreements
with other affiliated entities and the fees payable under such
agreements will be paid from any management fees earned by our
Manager. In addition, certain of these affiliated sub-advisory
entities have introduced investments to us for purchase in the
amount of $2,500 during the six months ended June 30, 2006.
The purchase price was determined at arms length and the
acquisition was approved in advance by the independent members
of our board of directors.
25
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
The following table sets forth the calculation of Basic and
Diluted EPS for the six months ended June 30, 2006 and the
period ended June 30, 2005 (in thousands, except share and
per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, 2006 | |
|
Period Ended June 30, 2005 | |
|
|
| |
|
| |
|
|
|
|
Weighted | |
|
|
|
|
|
Weighted | |
|
|
|
|
|
|
Average Number | |
|
|
|
|
|
Average Number | |
|
|
|
|
|
|
of Shares | |
|
Per Share | |
|
|
|
of Shares | |
|
Per Share | |
|
|
Net Income | |
|
Outstanding | |
|
Amount | |
|
Net Income | |
|
Outstanding | |
|
Amount | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings per share of common
stock
|
|
$ |
21,452 |
|
|
|
17,511,937 |
|
|
$ |
1.22 |
|
|
$ |
437 |
|
|
|
17,487,500 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding for the
purchase of common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings per share of common
stock and assumed conversions
|
|
$ |
21,452 |
|
|
|
17,511,937 |
|
|
$ |
1.22 |
|
|
$ |
437 |
|
|
|
17,487,500 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26
Crystal River Capital, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(In thousands, except share and per share data)
(unaudited)
|
|
11. |
EARNINGS PER SHARE (Continued) |
The following table sets forth the calculation of Basic and
Diluted EPS for the three months ended June 30, 2006 and
June 30, 2005 (in thousands, except share and per share
amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, 2006 | |
|
Three Months Ended June 30, 2005 | |
|
|
| |
|
| |
|
|
|
|
Weighted | |
|
|
|
|
|
Weighted | |
|
|
|
|
|
|
Average Number | |
|
|
|
|
|
Average Number | |
|
|
|
|
|
|
of Shares | |
|
Per Share | |
|
|
|
of Shares | |
|
Per Share | |
|
|
Net Income | |
|
Outstanding | |
|
Amount | |
|
Net Income | |
|
Outstanding | |
|
Amount | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Basic EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings per share of common
stock
|
|
$ |
6,008 |
|
|
|
17,528,607 |
|
|
$ |
0.34 |
|
|
$ |
315 |
|
|
|
17,487,500 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding for the
purchase of common stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings per share of common
stock and assumed conversions
|
|
$ |
6,008 |
|
|
|
17,528,607 |
|
|
$ |
0.34 |
|
|
$ |
315 |
|
|
|
17,487,500 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12. |
INITIAL PUBLIC OFFERING |
In August 2006, we completed the initial public offering of our
common stock, in which we sold 7,500,000 shares of common
stock, $0.001 par value, at an offering price of
$23 per share. We received proceeds from this transaction
in the amount of $162,409, net of underwriting commissions and
discounts but before other offering costs. Each share of common
stock entitles its holder to one vote per share. An affiliate of
the parent of our Manager purchased 1,000,000 shares of our
common stock in our initial public offering. After the
transaction, our outstanding shares totaled 25,019,500.
On June 23, 2006, we declared a quarterly dividend of
$0.725 per share, which was paid on July 21, 2006 to
our stockholders of record as of June 30, 2006.
27
|
|
Item 2. |
Managements Discussion and Analysis of Financial
Condition and Results of Operations |
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto appearing
elsewhere in this Form 10 Q. Historical results set
forth are not necessarily indicative of our future financial
position and results of operations.
Overview
We are a specialty finance company formed on January 25,
2005 by Hyperion Brookfield Asset Management, Inc., which we
refer to as Hyperion Brookfield, to invest in real
estate-related securities and various other asset classes. We
commenced operations in March 2005. We will elect and intend to
qualify to be taxed as a REIT for federal income tax purposes.
We invest in financial assets and intend to construct an
investment portfolio that is leveraged where appropriate to seek
to achieve attractive risk-adjusted returns and that is
structured to comply with the various federal income tax
requirements for REIT status and to qualify for an exclusion
from regulation under the Investment Company Act. Our current
focus is on the following asset classes:
|
|
|
|
|
Real estate-related securities, principally RMBS and CMBS; |
|
|
|
Whole mortgage loans, bridge loans, B Notes and mezzanine
loans; and |
|
|
|
Other ABS, including CDOs and consumer ABS. |
We completed a private offering of 17,400,000 shares of our
common stock in March 2005 in which we raised net proceeds of
approximately $405.6 million. We have fully invested the
proceeds from the March 2005 private offering and, as of
June 30, 2006, have a portfolio of RMBS and other
alternative investments of approximately $2.8 billion. We
are externally managed by Hyperion Brookfield Crystal River
Capital Advisors, LLC, which we refer to as Hyperion Brookfield
Crystal River or our Manager. Hyperion Brookfield Crystal River
is a wholly-owned subsidiary of Hyperion Brookfield.
We earn revenues and generate cash through our investments. We
use a substantial amount of leverage to seek to enhance our
returns. We finance each of our investments with different
degrees of leverage. The cost of borrowings to finance our
investments comprises a significant portion of our operating
expenses. Our net income will depend, in large part, on our
ability to control this particular operating expense in relation
to our revenues.
A variety of industry and economic factors may impact our
financial condition and operating performance. These factors
include:
|
|
|
|
|
interest rate trends, |
|
|
|
rates of prepayment on mortgages underlying our MBS, |
|
|
|
credit trends in RMBS and our commercial real estate investments; |
|
|
|
competition, and |
|
|
|
other market developments. |
In addition, a variety of factors relating to our business may
also impact our financial condition and operating performance.
These factors include:
|
|
|
|
|
our leverage, |
|
|
|
our access to funding and borrowing capacity, |
|
|
|
our borrowing costs, |
|
|
|
our hedging activities, |
28
|
|
|
|
|
the market value of our investments, and |
|
|
|
REIT requirements and the requirements to qualify for an
exemption from regulation under the Investment Company Act of
1940, which we refer to as the Investment Company Act. |
Trends
We believe the following trends may also affect our business:
Rising interest rate environment interest
rates have recently increased and could continue to do so in the
future. With respect to our existing MBS portfolio, which is
heavily concentrated in 3/1 and 5/1 hybrid adjustable rate RMBS,
we believe that such interest rate increases could result in
decreases in our net interest income, as there is a timing
mismatch between the reset dates on our MBS portfolio and the
financing of these investments. We currently have invested and
intend to continue to invest in hybrid adjustable-rate RMBS
which are based on mortgages with interest rate caps. The
financing of these RMBS is short term in nature and does not
include the benefit of an interest rate cap. This mismatch could
result in a decrease in our net interest income if rates
increase sharply after the initial fixed rate period and our
interest cost increases more than the interest rate earned on
our RMBS due to the related interest rate caps. With respect to
our existing and future floating rate investments, we believe
such interest rate increases could result in increases in our
net interest income because our floating rate assets are greater
in amount than the related liabilities. Similarly, we believe
such an increase in interest rates could generally result in an
increase in our net interest income on future fixed rate
investments made by us because our fixed rate assets would be
greater in amount than our liabilities. However, we would expect
that our fixed rate assets would decline in value in a rising
interest rate environment and our net interest spreads on fixed
rate assets could decline in a rising interest rate environment
to the extent they are financed with floating rate debt. We have
engaged in interest rate swaps to hedge a significant portion of
the risk associated with increases in interest rates. However,
because we do not hedge 100% of the amount of short-term
financing outstanding, increases in interest rates could result
in a decline in the value of our portfolio, net of hedges.
Similarly, decreases in interest rates could result in an
increase in the value of our portfolio.
Flattening yield curve short term interest
rates have been increasing at a greater rate than longer term
interest rates. For example, between June 30, 2005 and
June 30, 2006, the yield on the three-month
U.S. treasury bill increased by 186 basis points,
while the yield on the three-year U.S. treasury note
increased by only 148 basis points. With respect to our MBS
portfolio, we believe that a continued flattening of the shape
of the yield curve could result in decreases in our net interest
income, as the financing of our MBS investments is usually
shorter in term than the fixed rate period of our MBS portfolio,
which is heavily weighted towards 3/1 and 5/1 hybrid adjustable
rate RMBS. Similarly, we believe that a steepening of the shape
of the yield curve could result in increases in our net interest
income. A flattening of the shape of the yield curve results in
a smaller gap between the rate we pay on the swaps and rate we
receive. Furthermore, a continued flattening of the shape of the
yield curve could result in a decrease in our hedging costs,
since we pay a fixed rate and receive a floating rate under the
terms of our swap agreements. Similarly, a steepening of the
shape of the yield curve could result in an increase in our
hedging costs.
Prepayment rates as interest rates increase,
we believe that prepayment rates are likely to fall. Prepayment
rates generally increase when interest rates fall and decrease
when interest rates rise, but changes in prepayment rates are
difficult to predict. Prepayment rates also may be affected by
other factors, including, without limitation, conditions in the
housing and financial markets, general economic conditions and
the relative interest rates on adjustable-rate and fixed-rate
mortgage loans. Because we believe that interest rates are
likely to continue to
29
increase, we believe that MBS prepayment rates are likely to
fall. If interest rates begin to fall, triggering an increase in
prepayment rates, our current portfolio, which is heavily
weighted towards hybrid adjustable-rate mortgages, could cause
decreases in our net interest income relating to our MBS
portfolio.
Competition we expect to face increased
competition for our targeted investments. However, we expect
that the size and growth of the market for these investments
will continue to provide us with a variety of investment
opportunities. In addition, we believe that bank lenders will
continue their historical lending practices, requiring low
loan-to-value ratios
and high debt service coverages, which will provide
opportunities to lenders like us to provide corporate mezzanine
financing.
For a discussion of additional risks relating to our business
see Part II, Item 1A, Risk Factors and Part I,
Item 3, Quantitative and Qualitative Disclosures About
Market Risk.
Critical Accounting Policies
Our financial statements are prepared in accordance with
generally accepted accounting principles in the United States,
or U.S. GAAP. These accounting principles require us to
make some complex and subjective decisions and assessments. Our
most critical accounting policies involve decisions and
assessments that could affect our reported assets and
liabilities, as well as our reported revenues and expenses. We
believe that all of the decisions and assessments upon which our
financial statements are based were reasonable at the time made
based upon information available to us at that time. We rely on
the experience of Hyperion Brookfield Crystal Rivers
management and its analysis of historical and current market
data in order to arrive at what we believe to be reasonable
estimates. See Note 2 to our consolidated financial
statements contained elsewhere in this Quarterly Report on
Form 10-Q for a
complete discussion of our accounting policies. Under different
conditions, we could report materially different amounts arising
under these critical accounting policies. We have identified our
most critical accounting policies to be the following:
For each investment we make, we evaluate the underlying entity
that issued the securities we acquired or to which we made a
loan in order to determine the appropriate accounting. We refer
to guidance in Statement of Financial Accounting Standards
(SFAS) No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS 140), and FASB Interpretation No.
(FIN) 46R, Consolidation of Variable Interest
Entities, in performing our analysis. FIN 46R addresses
the application of Accounting Research
Bulletin No. 51, Consolidated Financial
Statements, to certain entities in which voting rights are
not effective in identifying an investor with a controlling
financial interest. An entity is subject to consolidation under
FIN 46R if the investors either do not have sufficient
equity at risk for the entity to finance its activities without
additional subordinated financial support, are unable to direct
the entitys activities, or are not exposed to the
entitys losses or entitled to its residual returns
(variable interest entities or VIEs).
Variable interest entities within the scope of FIN 46R are
required to be consolidated by their primary beneficiary. The
primary beneficiary of a VIE is determined to be the party that
absorbs a majority of the VIEs expected losses, receives
the majority of the VIEs expected returns, or both.
Our ownership of the subordinated classes of CMBS and RMBS from
a single issuer may provide us with the right to control the
foreclosure/workout process on the underlying loans, which we
refer to as the Controlling Class CMBS and RMBS. There are
certain exceptions to the scope of FIN 46R, one of which
provides that an investor that holds a variable interest in a
qualifying special-purpose entity (QSPE) is not
required to consolidate that entity unless the investor has the
unilateral ability to cause the entity to liquidate.
SFAS 140 sets forth the
30
requirements for an entity to qualify as a QSPE. To maintain the
QSPE exception, the special-purpose entity must initially meet
the QSPE criteria and must continue to satisfy such criteria in
subsequent periods. A special-purpose entitys QSPE status
can be impacted in future periods by activities undertaken by
its transferor(s) or other involved parties, including the
manner in which certain servicing activities are performed. To
the extent that our CMBS or RMBS investments were issued by a
special-purpose entity that meets the QSPE requirements , we
record those investments at the purchase price paid. To the
extent the underlying special-purpose entities do not satisfy
the QSPE requirements, we follow the guidance set forth in
FIN 46R as the special-purpose entities would be determined
to be VIEs.
We have analyzed the pooling and servicing agreements governing
each of our Controlling Class CMBS and RMBS investments and
we believe that the terms of those agreements are industry
standard and are consistent with the QSPE criteria. However,
there is uncertainty with respect to QSPE treatment for those
special-purpose entities due to ongoing review by regulators and
accounting standard setters (including the FASBs project
to amend SFAS 140 and the recently added FASB project on
servicer discretion in a QSPE), potential actions by various
parties involved with the QSPE (discussed in the paragraph
above)and varying and evolving interpretations of the QSPE
criteria under SFAS 140. We also have evaluated each of our
Controlling Class CMBS and RMBS investments as if the
special-purpose entities that issued such securities are not
QSPEs. Using the fair value approach to calculate expected
losses or residual returns, we have concluded that we would not
be the primary beneficiary of any of the underlying
special-purpose entities. Additionally, the standard setters
continue to review the FIN 46R provisions related to the
computations used to determine the primary beneficiary of VIEs.
Future guidance from regulators and standard setters may require
us to consolidate the special-purpose entities that issued the
CMBS and RMBS in which we have invested as described in the
section titled Recently Issued Accounting Pronouncements
Not Yet Adopted.
Our maximum exposure to loss as a result of our investment in
these QSPEs totaled $325,196 as of June 30, 2006.
The most significant source of our revenue comes from interest
income on our securities and loan investments. Interest income
on loans and securities investments is recognized over the life
of the investment using the effective interest method. Mortgage
loans will generally be originated or purchased at or near par
value and interest income will be recognized based on the
contractual terms of the debt instrument. Any loan fees or
acquisition costs on originated loans will be deferred and
recognized over the term of the loan as an adjustment to the
yield. Interest income on MBS is recognized on the effective
interest method as required by EITF 99-20, Recognition
of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets. Under
EITF 99-20, management estimates, at the time of purchase,
the future expected cash flows and determines the effective
interest rate based on these estimated cash flows and our
purchase prices. Subsequent to the purchase and on a quarterly
basis, these estimated cash flows are updated and a revised
yield is calculated based on the current amortized cost of the
investment. In estimating these cash flows, there are a number
of assumptions that are subject to uncertainties and
contingencies. These include the rate and timing of principal
payments (including prepayments, repurchases, defaults and
liquidations), the pass through or coupon rate and interest rate
fluctuations. In addition, interest payment shortfalls have to
be estimated due to delinquencies on the underlying mortgage
loans and the timing and magnitude of credit losses on the
mortgage loans underlying the securities. These uncertainties
and contingencies are difficult to predict and are subject to
future events that may impact managements estimates and
our interest income. When current period cash flow estimates are
lower than the previous period and fair value is less than an
assets carrying
31
value, we will write down the asset to fair market value and
record an impairment charge in current period earnings.
We purchase and originate mezzanine loans and commercial
mortgage loans to be held as long-term investments. We evaluate
each of these loans for possible impairment on a quarterly
basis. Impairment occurs when it is deemed probable that we will
not be able to collect all amounts due according to the
contractual terms of the loan. Upon determination of impairment,
we will establish a reserve for loan losses and a corresponding
charge to earnings through the provision for loan losses.
Significant judgments are required in determining impairment,
which include assumptions regarding the value of the real estate
or partnership interests that secure the mortgage loans.
|
|
|
Valuations of MBS and ABS |
Our MBS and ABS have fair values as determined with reference to
price estimates provided by independent pricing services and
dealers in the securities. Different judgments and assumptions
used in pricing could result in different estimates of value.
When the fair value of an available-for-sale security is less
than its amortized cost for an extended period, we consider
whether there is an other-than-temporary impairment in the value
of the security. If, in our judgment, an other-than-temporary
impairment exists, the cost basis of the security is written
down to the then-current fair value, and the unrealized loss is
transferred from accumulated other comprehensive loss as an
immediate reduction of current earnings (as if the loss had been
realized in the period of other-than-temporary impairment). The
determination of other-than-temporary impairment is a subjective
process, and different judgments and assumptions could affect
the timing of loss realization.
We consider the following factors when determining an
other-than-temporary impairment for a security or investment:
|
|
|
|
|
The length of time and the extent to which the market value has
been less than the amortized cost; |
|
|
|
Whether the security has been downgraded by a rating
agency; and |
|
|
|
Our intent to hold the security for a period of time sufficient
to allow for any anticipated recovery in market value. |
Periodically, all available for sale securities are evaluated
for other than temporary impairment in accordance with
SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities (SFAS 115), and
Emerging Issues Task Force
No. 99-20,
Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interest in Securitized Financial
Assets(EITF 99-20).
An impairment that is an other than temporary
impairment is a decline in the fair value of an investment
below its amortized cost attributable to factors that indicate
the decline will not be recovered over the investments
remaining life. Other than temporary impairments result in
reducing the securitys carrying value to its fair value
through the statement of income, which also creates a new
carrying value for the investment. We compute a revised yield
based on the future estimated cash flows as described in
Revenue Recognition above. Significant
judgments are required in determining impairment, which include
making assumptions regarding the estimated prepayments, loss
assumptions and the changes in interest rates.
The determination of other-than-temporary impairment is made at
least quarterly. If we determine an impairment to be other than
temporary we will need to realize a loss that would have an
impact on future income. At June 30, 2006, our overall
intent was to replace lower-
32
coupon or lower-yielding Agency ARMS with higher yielding
securities. In evaluating which securities were to be sold, we
considered:
|
|
|
|
|
the length of the time to reset; |
|
|
|
securities whose value had declined by more than an immaterial
amount; |
|
|
|
the coupon rate of the security; and |
|
|
|
the book yield of the security. |
In our analysis at June 30, 2006, we established as
thresholds:
|
|
|
|
|
45 or fewer months remaining to rate reset; |
|
|
|
market price declines in excess of 1.50%; |
|
|
|
securities bearing a coupon rate under 4.80%; and |
|
|
|
securities with book yields less than 4.30%. |
These criteria were established based on our Managers
review of our investment portfolio and its determination that
these criteria provided a pool of securities to be sold that
would produce an acceptable proportionate increase in income
yield for our portfolio. Two mitigating factors that we
considered in evaluating the foregoing criteria were whether a
security was subject to a reverse repurchase agreement with a
sufficiently distant settlement date that would preclude such a
sale in the near term, for practical, hedging and economic
reasons, and whether we agreed with the quoted market value for
such securities. With the passage of time, as we periodically
review the performance of our portfolio, our investment strategy
in light of market conditions and our liquidity requirements and
available sources of liquidity, the criteria we utilize to
determine impairment under SFAS 115 may change. At any
measurement date, securities that satisfy all of our impairment
criteria that we do not intend to hold until we recover their
amortized cost or until maturity would be deemed to be other
than temporarily impaired.
Under the guidance provided by SFAS 115, a security is
impaired when its fair value is less than its amortized cost and
we do not intend to hold that security until we recover its
amortized cost or until its maturity. Based on the parameters we
utilized in our June 30, 2006 analysis, we identified eight
individual securities that were determined to be impaired under
the guidance provided by SFAS 115. In connection with the
impairment of these eight securities, we recorded impairment
charges of $4,746 and $6,004 in our statement of income for the
three months ended June 30, 2006 and the six months ended
June 30, 2006, respectively, that was other than temporary
as we expect to sell these securities in the near future at a
loss. Through September 8, 2006, we have sold four of the
six Agency ARMS and the two CMBS securities that were so
impaired. As of June 30, 2006, as part of our periodic
surveillance of the underlying value of the collateral securing
our CMBS investments, we revalued two of the underlying loans in
the collateral securing a CMBS security that resulted in a
credit impairment charge for the three months and six months
ended June 30, 2006 in the amount of $920 and $920,
respectively.
In certain circumstances, we have financed the purchase of
securities from a counterparty through a repurchase agreement
with the same counterparty pursuant to which we pledge the
purchased securities. Currently, we record the acquisition of
these securities as assets and the related borrowing under
repurchase agreements as financing liabilities on our
consolidated balance sheet with changes in the fair value of the
securities being recorded as a component of other comprehensive
income in stockholders equity. Interest income earned on
the securities and interest expense incurred on the repurchase
obligations are reported separately on our consolidated income
statement. As of June 30, 2006 we had three such
transactions that were outstanding, and our June 30, 2006
balance sheet included approximately $13.1 million of such
securities and approximately $10.7 million of such
repurchase agreement liabilities.
33
It has come to our attention and to the attention of other
market participants, as well as our repurchase agreement
counterparties, that SFAS 140 may require a different
accounting treatment for such transactions. Under SFAS 140,
transactions in which we acquire securities from a counterparty
that are financed through a repurchase agreement with the same
counterparty will not qualify as a purchase by us if we are not
able to conclude that the securities purchased have been legally
isolated from the counterparty. If the acquisitions do not
qualify as a purchase of securities under SFAS 140, we
would not be permitted to include the securities purchased and
repurchase agreements on a gross basis on our balance sheet.
Additionally, we would not be able to report on a gross basis on
our income statement the related interest income earned and
interest expense incurred. Instead, we would be required to
present the net investment on our balance sheet together with an
embedded derivative with the corresponding change in fair value
of the derivative being recorded in our income statement. The
value of the derivative would reflect not only changes in the
value of the underlying securities, but also changes in the
value of the underlying credit provided by the counterparty.
Although we believe our accounting for these transactions is
appropriate, we will continue to evaluate our position as the
interpretation of this issue among industry participants and
standard setters evolves.
|
|
|
Accounting For Derivative Financial Instruments and
Hedging Activities |
Our policies permit us to enter into derivative contracts,
including interest rate swaps and interest rate swap forwards,
as a means of mitigating our interest rate risk on forecasted
interest expense associated with the benchmark rate on
forecasted rollover/reissuance of repurchase agreements, or
hedged items, for a specified future time period. We currently
intend to use interest rate derivative instruments to mitigate
interest rate risk rather than to enhance returns.
At June 30, 2006, we were a party to 45 interest rate swaps
with a notional par value of approximately $1,448.5 million
and an intrinsic gain of approximately $34.5 million. We
entered into these interest rate swaps to seek to mitigate our
interest rate risk for the specified future time period, which
is defined as the term of the swap contracts. Based upon the
market value of these interest rate swap contracts, our
counterparties may request additional margin collateral or we
may request additional collateral from our counterparties to
ensure that an appropriate margin account balance is maintained
at all times through the expiration of the contracts.
At June 30, 2006, we were a party to one currency swap with
a notional par value of approximately Can$50.0 million and
an intrinsic loss of approximately $0.3 million. We entered
into this currency swap to seek to mitigate our currency risk
for the specified future time period, which is defined as the
term of the swap contract. Based upon the market value of this
currency swap contract, our counterparty may request additional
margin collateral or we may request additional collateral from
our counterparty to ensure that an appropriate margin account
balance is maintained at all times through the expiration of the
contract.
As of June 30, 2006, we had 11 credit default swaps, or
CDS, with a notional par value of $105.0 million and an
intrinsic gain of approximately $1.4 million. The fair
value of the CDS depends on a number of factors, primarily
premium levels, which are dependent on interest rate spreads.
The CDS contracts are valued using internally developed and
tested market-standard pricing models which calculate the net
present value of differences between future premiums on
currently quoted market CDS and the contractual futures premiums
on our CDS contracts.
We account for derivative and hedging activities in accordance
with SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended, or
SFAS 133. SFAS 133 requires recognizing all derivative
instruments as either asset or liabilities in the balance sheet
at fair value. The accounting for changes in fair value
(i.e., gains or losses) of a derivative instrument
depends on whether it has been designated and qualifies as part
of a
34
hedging relationship and further, on the type of hedging
relationship. For those derivatives instruments that are
designated and qualify as hedging instruments, we must designate
the hedging instrument, based upon the exposure being hedged, as
a fair value hedge, cash flow hedge or a hedge of a net
investment in a foreign operation. We have no fair value hedges
or hedges of a net investment in foreign operations.
For derivative instruments that are designated and qualify as a
cash flow hedge (i.e., hedging the exposure to
variability in expected future cash flows that is attributable
to a particular risk), the effective portion of the gain or loss
on the derivative instrument is reported as a component of other
comprehensive income and reclassified into earnings in the same
line item associated with the forecasted transaction in the same
period or periods during which the hedged transaction affects
earnings (for example, in interest expense when the
hedged transactions are interest cash flows associated with
floating-rate debt). The remaining gain (loss) on the derivative
instrument in excess of the cumulative changes in the present
value of future cash flows of the hedged item, if any, is
recognized in the realized and unrealized gain (loss) on
derivatives in current earnings during the period of change. For
derivative instruments not designated as hedging instruments,
the gain or loss is recognized in realized and unrealized gain
(loss) on derivatives in the current earnings during the period
of change. Income and/or expense from interest rate swaps are
recognized as a net adjustment to interest expense. We account
for income and expense from interest rate swaps on an accrual
basis over the period to which the payment and/or receipt
relates.
We account for share-based compensation issued to members of our
board of directors, our Manager and certain of our senior
executives using the fair value based methodology in accordance
with SFAS No. 123R, Accounting for Stock Based
Compensation. We do not have any employees, although we
believe that members of our Board of Directors are deemed to be
employees for purposes of interpreting and applying accounting
principles relating to share-based compensation. We record as
compensation costs the restricted common stock that we issued to
members of our board of directors at fair value as of the grant
date and we amortize the cost into expense over the three-year
vesting period using the straight-line method. We recorded
compensation costs for restricted common stock and common stock
options that we issued to our Manager and that were reallocated
to employees of our Manager and its affiliates that provide
services to us at fair value as of the grant date and we
remeasure the amount on subsequent reporting dates to the extent
that the restricted common stock and or common stock options are
unvested. Unvested restricted common stock is valued using
appraised value. Unvested common stock options are valued using
a Binomial pricing model and assumptions based on observable
market data for comparable companies. We amortize compensation
expense related to the restricted common stock and common stock
options that we granted to our Manager using the graded vesting
attribution method in accordance with SFAS No. 123R.
Because we remeasure the amount of compensation costs associated
with the unvested restricted common stock and unvested common
stock options that we issued to our Manager and certain of our
senior executives as of each reporting period, our share-based
compensation expense reported in our statements of operations
will change based on the fair value of our common stock and this
may result in earnings volatility.
We operate in a manner that we believe will allow us to be taxed
as a REIT and, as a result, we do not expect to pay substantial
corporate-level income taxes. Many of the requirements for REIT
qualification, however, are highly technical and complex. If we
were to fail to meet these requirements and do not qualify for
certain statutory relief provisions, we would be subject to
federal income tax, which could have a material adverse impact
on our results of operations and
35
amounts available for distributions to our stockholders. In
addition, Crystal River TRS Holdings, Inc., our TRS, is subject
to corporate-level income taxes.
Financial Condition
All of our assets at June 30, 2006 were acquired with the
net proceeds of approximately $405.6 million from our March
2005 private offering of 17,400,000 shares of our common
stock and our use of leverage.
|
|
|
Mortgage-Backed Securities |
Some of our mortgage investment strategy involves buying higher
coupon, higher premium bonds, which takes on more prepayment
risk (particularly call or shortening risk) than lower
dollar-priced strategies. However, we believe that the potential
benefits of this strategy include higher income, wider spreads,
and lower hedging costs due to the shorter option-adjusted
duration of the higher coupon security.
The table below summarizes our MBS investments at June 30,
2006:
|
|
|
|
|
|
|
|
|
|
|
RMBS | |
|
CMBS | |
|
|
| |
|
| |
|
|
(In thousands) | |
Amortized cost
|
|
$ |
2,374,207 |
|
|
$ |
312,594 |
|
Unrealized gains
|
|
|
3,859 |
|
|
|
1,219 |
|
Unrealized losses
|
|
|
(43,164 |
) |
|
|
(10,749 |
) |
|
|
|
|
|
|
|
Fair value
|
|
$ |
2,334,902 |
|
|
$ |
303,064 |
|
|
|
|
|
|
|
|
As of June 30, 2006, the RMBS and CMBS in our portfolio
were purchased at a net discount to their par value and our
portfolio had a weighted-average amortized cost of 97.09% and
65.09% of face amount, respectively. The RMBS and CMBS were
valued below par at June 30, 2006 because we are investing
in lower-rated bonds in the credit structure. Certain of the
securities held at June 30, 2006 are valued below cost. We
do not believe any such securities are other than temporarily
impaired at June 30, 2006.
Our MBS holdings were as follows at June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average | |
|
|
|
|
|
|
|
|
| |
|
|
|
|
Estimated | |
|
Percent of | |
|
|
|
Months | |
|
|
|
Constant | |
|
|
Asset | |
|
Total | |
|
|
|
to | |
|
Yield to | |
|
Prepayment | |
|
|
Value(1) | |
|
Investments | |
|
Coupon | |
|
Reset(2) | |
|
Maturity | |
|
Rate(3) | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
|
|
|
|
|
|
|
|
RMBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Agency:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior prime 5/1 adjustable rate
|
|
$ |
222,988 |
|
|
|
7.9 |
% |
|
|
5.27 |
% |
|
|
45.00 |
|
|
|
6.43 |
% |
|
|
21.66 |
% |
|
|
Junior prime
|
|
|
157,095 |
|
|
|
5.6 |
|
|
|
6.81 |
|
|
|
23.55 |
|
|
|
16.89 |
|
|
|
24.70 |
|
|
|
Subprime
|
|
|
162,204 |
|
|
|
5.7 |
|
|
|
7.34 |
|
|
|
10.51 |
|
|
|
9.30 |
|
|
|
31.28 |
|
|
Agency:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3/1 hybrid adjustable rate
|
|
|
642,086 |
|
|
|
22.7 |
|
|
|
4.99 |
|
|
|
28.83 |
|
|
|
6.23 |
|
|
|
28.19 |
|
|
|
5/1 hybrid adjustable rate
|
|
|
1,150,529 |
|
|
|
40.7 |
|
|
|
5.05 |
|
|
|
48.20 |
|
|
|
6.10 |
|
|
|
24.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total RMBS
|
|
|
2,334,902 |
|
|
|
82.6 |
|
|
|
5.38 |
|
|
|
37.81 |
|
|
|
7.11 |
|
|
|
25.59 |
|
CMBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Below investment grade CMBS
|
|
|
303,064 |
|
|
|
10.7 |
|
|
|
5.06 |
|
|
|
|
|
|
|
9.84 |
|
|
|
|
|
|
|
(1) |
All securities listed in this chart are carried at their
estimated fair value. |
|
(2) |
Represents number of months before conversion to floating rate. |
|
(3) |
Represents the estimated percentage of principal that will be
prepaid over the next 12 months based on historical
principal paydowns. |
36
The table below summarizes the credit ratings of our MBS
investments at June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
RMBS | |
|
CMBS | |
|
|
| |
|
| |
|
|
(In thousands) | |
AAA
|
|
$ |
2,015,604 |
|
|
$ |
|
|
AA
|
|
|
|
|
|
|
|
|
A
|
|
|
49,364 |
|
|
|
|
|
BBB
|
|
|
81,634 |
|
|
|
128,502 |
|
BB
|
|
|
102,301 |
|
|
|
90,009 |
|
B
|
|
|
66,798 |
|
|
|
47,406 |
|
Not rated
|
|
|
19,201 |
|
|
|
37,147 |
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,334,902 |
|
|
$ |
303,064 |
|
|
|
|
|
|
|
|
Actual maturities of RMBS are generally shorter than stated
contractual maturities, as they are affected by the contractual
lives of the underlying mortgages, periodic payments of
principal, and prepayments of principal. The stated contractual
final maturity of the mortgage loans underlying our portfolio of
RMBS ranges up to 30 years, but the expected maturity is
subject to change based on the prepayments of the underlying
loans. As of June 30, 2006, the average final contractual
maturity of the mortgage portfolio is 2035.
The constant prepayment rate, or CPR, attempts to predict the
percentage of principal that will be prepaid over the next
12 months based on historical principal paydowns. As
interest rates rise, the rate of refinancings typically
declines, which we believe may result in lower rates of
prepayment and, as a result, a lower portfolio CPR.
As of June 30, 2006, some of the mortgages underlying our
RMBS had fixed interest rates for the weighted-average lives of
approximately 37.8 months, after which time the interest
rates reset and become adjustable. The average length of time
until contractual maturity of those mortgages as of
June 30, 2006 was 29 years.
After the reset date, interest rates on our hybrid adjustable
rate RMBS securities float based on spreads over various LIBOR
indices. These interest rates are subject to caps that limit the
amount the applicable interest rate can increase during any
year, known as an annual cap, and through the maturity of the
applicable security, known as a lifetime cap. The weighted
average lifetime cap for the portfolio is an increase of 4.32%;
the weighted average maximum increases and decreases are 1.67%.
Additionally, the weighted average maximum increases and
decreases for agency hybrid RMBS in the first year that the
rates are adjustable are 2.60%.
The following table summarizes our RMBS and our CMBS according
to their estimated weighted average life classifications as of
June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RMBS | |
|
CMBS | |
|
|
| |
|
| |
|
|
|
|
Amortized | |
|
|
|
Amortized | |
Weighted Average Life |
|
Fair Value | |
|
Cost | |
|
Fair Value | |
|
Cost | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Less than one year
|
|
$ |
3,656 |
|
|
$ |
3,837 |
|
|
$ |
|
|
|
$ |
|
|
Greater than one year and less than
five years
|
|
|
1,768,742 |
|
|
|
1,799,061 |
|
|
|
|
|
|
|
|
|
Greater than five years
|
|
|
562,504 |
|
|
|
571,309 |
|
|
|
303,064 |
|
|
|
312,594 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
2,334,902 |
|
|
$ |
2,374,207 |
|
|
$ |
303,064 |
|
|
$ |
312,594 |
|
37
The estimated weighted-average lives of the MBS in the tables
above are based upon prepayment models obtained through
subscription-based financial information service providers.
The prepayment model considers current yield, forward yield,
steepness of the yield curve, current mortgage rates, the
mortgage rate of the outstanding loan, loan age, margin and
volatility.
The actual weighted-average lives of the MBS in our investment
portfolio could be longer or shorter than the estimates in the
table above depending on the actual prepayment rates experienced
over the lives of the applicable securities and are sensitive to
changes in both prepayment rates and interest rates.
|
|
|
Other Fixed Income Securities |
At June 30, 2006, we classified certain short-term non-MBS
as available-for-sale. These investments were reported at fair
value. These investments are periodically reviewed for
other-than-temporary impairment, but their contractual lives are
short term in nature.
Our investment policies allow us to acquire equity securities,
including common and preferred shares issued by other real
estate investment trusts. At June 30, 2006, we held two
investments in equity securities.
These investments above are classified as available for sale and
thus carried at fair value on our balance sheet with changes in
fair value recognized in accumulated other comprehensive income
until realized.
At June 30, 2006, our real estate loans are reported at
cost. These investments are periodically reviewed for
impairment. As of June 30, 2006, there was no impairment in
our real estate loans.
|
|
|
Interest and Principal Paydown Receivable |
At June 30, 2006, we had interest and principal paydown
receivables of approximately $138.0 million, none of which
related to interest that had accrued on securities prior to our
purchase of such securities. The total interest and principal
paydown receivable amount consisted of approximately
$135.8 million relating to our MBS, including
$114.4 million due from brokers for securities sold, and
approximately $2.2 million relating to other investments.
|
|
|
Hedging Instruments and Derivative Activities |
There can be no assurance that our hedging activities will have
the desired beneficial impact on our results of operations or
financial condition. Moreover, no hedging activity can
completely insulate us from the risks associated with changes in
interest rates and prepayment rates. We generally intend to
hedge as much of the interest rate risk as Hyperion Brookfield
Crystal River determines is in the best interests of our
stockholders, after considering the cost of such hedging
transactions and our desire to maintain our status as a REIT.
Our policies do not contain specific requirements as to the
percentages or amount of interest rate risk that our manager is
required to hedge.
As of June 30, 2006, we had engaged in interest rate swaps
and interest rate swap forwards as a means of mitigating our
interest rate risk on forecasted interest expense associated
with repurchase agreements for a specified future time period,
which is the term of the swap contract. An interest rate swap is
a contractual agreement entered into by two
38
counterparties under which each agrees to make periodic payments
to the other for an agreed period of time based upon a notional
amount of principal. Under the most common form of interest rate
swap, a series of payments calculated by applying a fixed rate
of interest to a notional amount of principal is exchanged for a
stream of payments similarly calculated but using a floating
rate of interest. This is a fixed-floating interest rate swap.
We hedge our floating rate debt by entering into fixed-floating
interest rate swap agreements whereby we swap the floating rate
of interest on the liability we are hedging for a fixed rate of
interest. An interest rate swap forward is an interest rate swap
based on an interest rate to be set at an agreed future date. As
of June 30, 2006, we were a party to interest rate swaps
with maturities ranging from October 2006 to July 2021 with a
notional par amount of approximately $1,448.5 million.
Under the swap agreements in place at June 30, 2006, we
receive interest at rates that reset periodically, generally
every three months, and pay a rate fixed at the initiation of
and for the life of the swap agreements. The current market
value of interest rate swaps is heavily dependent on the current
market fixed rate, the corresponding term structure of floating
rates (known as the yield curve) as well as the expectation of
changes in future floating rates. As expectations of future
floating rates change, the market value of interest rate swaps
changes. Based on the daily market value of those interest rate
swaps and interest rate swap forward contracts, our
counterparties may request additional margin collateral or we
may request additional collateral from our counterparties to
ensure that an appropriate margin account balance is maintained
at all times through the maturity of the contracts. At
June 30, 2006, the unrealized gain on interest rate swap
contracts was $34.5 million due to an increase in
prevailing market interest rates.
As of June 30, 2006, we had engaged in credit default
swaps, or CDS, which are accounted for as derivatives. CDSs are
similar to insurance on the default risk of a particular
investment as we will enter into a contract with a counterparty
as the protection seller and agree to pay par for
the counterpartys bonds in the event a credit default
occurs in exchange for receiving periodic payments (similar to
an insurance premium) from the protection buyer. As
a result, the economic returns on our CDSs depend substantially
on the performance of the underlying investments held by the
protection buyer and we are subject to the credit risk of the
protection buyer as well as the related investments. We enter
into CDS transactions because they offer a more attractive
leveraged return than the underlying cash instruments, in
exchange for the added credit exposure.
While so far we have only taken synthetic long positions (by
writing protection) we may find it attractive to hedge our
credit exposure by entering into synthetic short positions (by
buying protection) at some point in the future.
As of June 30, 2006, we were a party to 11 credit
default swaps with maturities ranging from February 2035 to July
2043 with a notional par amount of $105.0 million. At
June 30, 2006, the unrealized gain on credit default swap
contracts was $1.4 million due to an increase in the
creditworthiness of the underlying securities.
As of June 30, 2006, we had engaged in currency swaps as a
means of mitigating our currency risk under one of our real
estate loans that was denominated in Canadian dollars. As of
June 30, 2006, we were a party to one currency swap with a
maturity of July 2016 with a notional par amount of
Can$50.0 million. The current market value of currency
swaps is heavily dependent on the current currency exchange rate
and the expectation of changes in future currency exchange
rates. As expectations of future currency exchange rates change,
the market value of currency swaps changes. Based on the daily
market value of those currency swaps, our counterparties may
request additional margin collateral or we may request
additional collateral from our counterparties to ensure that an
appropriate margin account balance is maintained at all times
through the maturity of the contracts. At June 30, 2006,
the unrealized loss on currency swap contracts was
$0.3 million due to a strengthening of the Canadian dollar
versus the United States dollar.
39
We have entered into repurchase agreements to finance some of
our purchases of RMBS. These agreements are secured by our RMBS
and bear interest rates that have historically moved in close
relationship to LIBOR. As of June 30, 2006, we had
established 17 borrowing arrangements with various investment
banking firms and other lenders. As of June 30, 2006, we
were utilizing 14 of those arrangements.
At June 30, 2006, we had outstanding obligations under
repurchase agreements with 13 counterparties totaling
approximately $2,496.7 million with weighted-average
current borrowing rates of 5.24% all of which have maturities of
between seven and 413 days. We intend to seek to renew
these repurchase agreements as they mature under the
then-applicable borrowing terms of the counterparties to the
repurchase agreements. At June 30, 2006, the repurchase
agreements were secured by MBS and real estate loans and cash
with an estimated fair value of approximately
$2,664.0 million and had weighted-average maturities of
55 days. The net amount at risk, defined as fair value of
the collateral, including restricted cash, minus repurchase
agreement liabilities and accrued interest expense, with all
counterparties was approximately $150.0 million at
June 30, 2006. One of the repurchase agreements is a
$275.0 million master repurchase agreement with Wachovia
Bank, that has a two year term with a one year renewal option.
The Wachovia Bank master repurchase agreement provides for the
purchase, sale and repurchase of commercial and residential
mortgage loans, commercial mezzanine loans, B Notes,
participation interests in the foregoing, commercial
mortgage-backed securities and other mutually agreed upon
collateral and bears interest at varying rates over LIBOR based
upon the type of asset included in the repurchase obligation.
Stockholders equity at June 30, 2006 was
approximately $373.6 million and included
$46.8 million of unrealized losses on securities available
for sale and $31.2 million of unrealized and realized gains
on cash flow hedges presented as a component of accumulated
other comprehensive loss.
Results of Operations For the Six Months Ended June 30,
2006
Our net income for the period was $21.5 million or
$1.22 per weighted-average basic and diluted share
outstanding.
Net interest income for the period was $26.0 million. Gross
interest income of $86.3 million primarily consisted of
$76.9 million of interest income from MBS,
$5.1 million of interest income from real estate loans and
$2.0 million of interest income from ABS. Interest expense
of $60.3 million consisted primarily of $56.3 million
related to repurchase agreements, $5.9 million related to
CDOs and amortization of deferred financing costs of
$1.0 million, which was partially offset by
$3.7 million of interest income from interest rate swaps.
Expenses for the period totaled $5.5 million, which
consisted primarily of base management fees of approximately
$2.8 million, amortization of approximately
$0.5 million related to restricted stock and options
granted to our Manager and professional fees of
$1.5 million.
Our Manager has waived its right to request reimbursement from
us of third-party expenses that it incurs through
December 31, 2006, which amount otherwise would have been
required to be reimbursed. The management agreement with
Hyperion Brookfield Crystal River, which was negotiated before
our business model was implemented, provides that we will
reimburse our Manager for certain third party expenses that it
incurs on our behalf, including rent and
40
utilities. Hyperion Brookfield incurs such costs and did not
allocate any such expenses to our Manager in 2005 or in the
first six months of 2006 as our Managers use of such
services were deemed to be immaterial. In 2007, Hyperion
Brookfield will reevaluate whether any such rent and utility
costs will be allocated to our Manager and if so, we will be
responsible for reimbursing such costs allocable to our
operations absent any further waiver of reimbursement by our
Manager. There are no contractual limitations on our obligation
to reimburse our Manager for third party expenses and our
Manager may incur such expenses consistent with the grant of
authority provided to it pursuant to the management agreement
without any additional approval of our board of directors being
required. In addition, our Manager may defer our reimbursement
obligation from any quarter to a future period; provided,
however, that we will record any necessary accrual for any such
reimbursement obligations when required by generally accepted
accounting principles and our Manager has advised us that it
will promptly invoice us for such reimbursements consistent with
sound financial accounting policies.
Other revenues for the period totaled approximately
$1.0 million, which consisted primarily of
$7.4 million of realized and unrealized gains on
derivatives (including a $0.9 million loss related to
foreign currency swaps) and $1.9 million in foreign
currency exchange gain, which was offset in part by
$1.7 million of realized net losses on the sale of
securities available for sale and a $6.9 million loss on
impairment of securities available for sale.
Results of Operations For the Period March 15, 2005
(commencement of operations) to June 30, 2005
Our net income for the period was $0.4 million or
$0.02 per weighted-average basic and diluted share
outstanding.
Net interest income for the period was $8.2 million. Gross
interest income of $15.8 million primarily consisted of
$14.6 million of interest income from MBS,
$0.6 million of interest income from ABS and
$0.3 million of interest income from real estate loans.
Interest expense of $7.6 million consisted primarily of
$6.2 million related to repurchase agreements and
$1.4 million related to interest rate swaps.
Expenses for the period totaled $3.3 million, which
consisted primarily of base management fees of approximately
$1.8 million, amortization of approximately
$0.2 million related to restricted stock and options
granted to our Manager, professional fees of $0.7 million
and start-up costs of
$0.3 million.
Other expenses for the period totaled approximately
$4.4 million, which consisted substantially of realized and
unrealized losses on derivatives.
Results of Operations For the Three Months Ended
June 30, 2006 compared to the Three Months Ended
June 30, 2005
Our net income for the three months ended June 30, 2006
period was $6.0 million, or $0.34 per weighted-average
basic and diluted share outstanding, compared with net income of
$0.3 million, or $0.02 per weighted-average basic and
diluted share outstanding for the same period in 2005.
41
Net interest income for the three months ended June 30,
2006 was $13.9 million, an increase of $6.3 million,
or 83.6%, over net interest income of $7.6 million for the
same period in 2005. Gross interest income for the second
quarter of 2006 of $45.3 million primarily consisted of
$39.9 million of interest income from MBS,
$2.2 million of interest income from real estate loans and
$0.9 million of interest income from ABS. Gross interest
income for the same period in 2005 of $15.1 million
primarily consisted of $14.1 million of interest income
from MBS, $0.3 million of interest income from real estate
loans and $0.6 million of interest income from ABS. This
increase was due to an increase in the size of our investment
portfolio and the diversification of our investment portfolio
from Agency ARMs into higher yielding securities. Interest
expense of $31.4 million for the three months ended
June 30, 2006 consisted primarily of $30.6 million
related to repurchase agreements and $3.0 million related
to CDOs, which was partially offset by $3.1 million of
interest income from interest rate swaps. Interest expense of
$7.5 million for the same period in 2005 consisted
primarily of $6.2 million related to repurchase agreements
and $1.4 million of interest expense on interest rate
swaps. The increase in interest expense was due to an increase
in our leverage and general market increases in financing costs.
Expenses for the second quarter of 2006 totaled
$2.7 million, which consisted primarily of base management
fees of approximately $1.3 million, amortization of
approximately $0.3 million related to restricted stock and
options granted to our Manager and professional fees of
$0.8 million. Expenses for the same period in 2005 totaled
$2.7 million, which consisted primarily of base management
fees of approximately $1.6 million, amortization of
approximately $0.2 million relating to restricted stock and
options granted to our Manager and professional fees of
$0.7 million.
Other expenses for the three months ended June 30, 2006
totaled approximately $5.1 million, which consisted
primarily of $1.1 million of realized losses on the sale of
securities available for sale, a $5.7 million loss on
impairment of securities available for sale and
$0.5 million of realized and unrealized losses on
derivatives (including a loss of $2.1 million related to
foreign currency swaps), which was offset in part by
$2.0 million of foreign currency exchange gain. Other
expenses for the same period in 2005 totaled approximately
$4.6 million, which consisted substantially of realized and
unrealized losses on derivatives.
|
|
|
Liquidity and Capital Resources |
We held cash and cash equivalents of approximately
$56.2 million at June 30, 2006, which excludes
restricted cash of approximately $82.5 million that is used
to collateralize certain of our repurchase facilities and
certain other obligations.
Our operating activities provided net cash of approximately
$18.7 million for the six months ended June 30, 2006
primarily as a result of net income of $21.5 million,
non-cash impairment charges relating to available for sale
securities of $6.9 million, and a net increase in accounts
payable and accrued liabilities, due to Manager and interest
payable of approximately $5.8 million, offset in part by
non-cash unrealized gains on derivatives of $7.8 million,
non-cash accretion of discount on assets of $4.1 million,
non-cash foreign currency exchange gain of $1.8 million and
increases in interest receivable and prepaid expenses and other
assets of $4.6 million.
Our operating activities provided net cash of approximately
$4.8 million during the period March 15, 2005
(commencement of operations) to June 30, 2005 primarily as
a result of net income of $0.4 million, unrealized loss on
derivatives of $4.3 million and the excess of interest
42
expense payments that were recognized but not yet paid over
interest income receipts that were recognized but not yet
received.
Our investing activities used net cash of $383.4 million
for the six months ended June 30, 2006 primarily from the
purchase of securities available for sale of $828.5 million
and the funding or purchase of real estate loans totaling
$6.9 million, partially offset by receipt of principal
paydowns on securities available for sale and real estate loans
of approximately $254.1 million, redemptions of real estate
loans of approximately $15.8 million and
$182.5 million of proceeds from the sale of securities
available for sale and real estate loans.
Our investing activities used net cash of $1,823.1 million
during the period March 15, 2005 (commencement of
operations) to June 30, 2005 primarily from the purchase of
securities available for sale of $1,824.5 million and the
funding or purchase of real estate loans totaling
$38.2 million, partially offset by receipt of principal
paydowns on securities available for sale of approximately
$41.6 million.
Our financing activities provided net cash of
$399.5 million for the six months ended June 30, 2006
primarily from the net proceeds from borrowings under repurchase
agreements, including with related parties, of
$502.4 million and cash collateral received of
approximately $25.5 million, partially offset by principal
repayments on CDOs of $16.6 million, repayment of a note
payable to a related party of $35.0 million, dividend
payments of approximately $12.7 million and the deposit of
$64.0 million of restricted cash used to collateralize
certain financings.
Our financing activities provided net cash of
$1,838.5 million during the period March 15, 2005
(commencement of operations) to June 30, 2005 primarily
from the issuance of common stock, net of offering costs, of
$405.6 million and net proceeds from borrowings under
repurchase agreements of $1,436.5 million, partially offset
by the deposit of $3.7 million of restricted cash used to
collateralize certain financings.
Our source of funds as of June 30, 2006, excluding our
March 2005 private offering, consisted of net proceeds from
repurchase agreements totaling approximately
$2,496.7 million with a weighted-average current borrowing
rate of 5.24%, which we used to finance the acquisition of
securities available for sale. We expect to continue to borrow
funds in the form of repurchase agreements. As of June 30,
2006 we had established 17 borrowing arrangements with various
investment banking firms and other lenders, 14 of which were in
use on June 30, 2006. Increases in short-term interest
rates could negatively impact the valuation of our
mortgage-related assets, which could limit our borrowing ability
or cause our lenders to initiate margin calls. Amounts due upon
maturity of our repurchase agreements will be funded primarily
through the rollover/reissuance of repurchase agreements and
monthly principal and interest payments received on our
mortgage-backed securities.
|
|
|
Off-Balance Sheet Arrangements |
As of June 30, 2006, we did not maintain any relationships
with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance, or special
purpose or variable interest entities, established for the
purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. As of June 30,
2006, we had outstanding commitments to fund real estate
construction loans of $24.1 million, and as of such date,
advances of $21.4 million had been made under these
commitments.
|
|
|
Contractual Obligations and Commitments |
As of March 15, 2005, we had entered into a management
agreement with Hyperion Brookfield Crystal River. Hyperion
Brookfield Crystal River is entitled to receive a base
management fee, incentive compensation, reimbursement of certain
expenses and, in certain circumstances, a termination fee, all
as described in the management agreement. Such fees and expenses
do not have fixed and determinable payments. The base management
fee is payable
43
monthly in arrears in an amount equal to
1/12
of our equity (as defined in the management agreement) times
1.50%. Hyperion Brookfield Crystal River uses the proceeds from
its management fee in part to pay compensation to its officers
and employees who, notwithstanding that certain of them also are
our officers, receive no cash compensation directly from us.
Hyperion Brookfield Crystal River will receive quarterly
incentive compensation in an amount equal to the product of:
(a) 25% of the dollar amount by which (i) our net
income (determined in accordance with GAAP) and before non-cash
equity compensation expense and before incentive compensation,
for the quarter per common share (based on the weighted average
number of common shares outstanding for the quarter) exceeds
(ii) an amount equal to (A) the weighted average of
the price per share of the common shares in the March 2005
private offering and the prices per common shares in any
subsequent offerings by us (including our initial public
offering that closed in August 2006), in each case at the time
of issuance thereof, multiplied by (B) the greater of
(1) 2.4375% and (2) 0.50% plus one-fourth of the Ten
Year Treasury Rate for such quarter, multiplied by (b) the
weighted average number of shares of common stock outstanding
during the quarter; provided, that the foregoing calculation of
incentive compensation shall be adjusted to exclude one-time
events pursuant to changes in GAAP, as well as non-cash charges
after discussion between Hyperion Brookfield Crystal River and
our independent directors and approval by a majority of our
independent directors in the case of non-cash charges. In
accordance with the management agreement, our Manager and the
independent members of our board of directors have agreed to
adjust the calculation of the Managers incentive fee to
exclude non-cash adjustments required by SFAS 133 relating
to the valuation of interest rate swaps, currency swaps and
credit default swaps. See note 10 to our consolidated
financial statements contained elsewhere herein.
As of June 30, 2006, we had outstanding commitments to fund
real estate construction loans of $24.1 million, and as of
such date, advances of $21.4 million had been made under
these commitments.
The following table presents certain information regarding our
debt obligations as of June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average | |
|
|
|
|
Maturity of | |
|
|
|
|
Repurchase | |
Repurchase Agreement Counterparties |
|
Amount at Risk(1) | |
|
Agreement in Days | |
|
|
| |
|
| |
|
|
(In thousands) | |
Banc of America Securities LLC
|
|
$ |
5,951 |
|
|
|
36 |
|
Bear, Stearns & Co.
Inc.
|
|
|
15,587 |
|
|
|
27 |
|
Citigroup Global Markets
Inc.
|
|
|
4,460 |
|
|
|
62 |
|
Credit Suisse First Boston LLC
|
|
|
22,936 |
|
|
|
35 |
|
Deutsche Bank Securities
Inc.
|
|
|
7,288 |
|
|
|
31 |
|
Greenwich Capital Markets,
Inc.
|
|
|
5,138 |
|
|
|
58 |
|
Lehman Brothers Inc.
|
|
|
12,149 |
|
|
|
12 |
|
Merrill Lynch, Pierce,
Fenner & Smith Incorporated
|
|
|
8,504 |
|
|
|
41 |
|
Morgan Stanley & Co.
Incorporated
|
|
|
4,448 |
|
|
|
30 |
|
Trilon International,
Inc.
|
|
|
4,448 |
|
|
|
27 |
|
Wachovia Bank, National Association
|
|
|
49,847 |
|
|
|
413 |
|
Wachovia Capital Markets, LLC
|
|
|
3,580 |
|
|
|
53 |
|
WaMu Capital Corp.
|
|
|
4,409 |
|
|
|
47 |
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
148,745 |
|
|
|
55 |
|
|
|
|
|
|
|
|
|
|
(1) |
Equal to the fair value of collateral minus repurchase agreement
liabilities and accrued interest expense. |
44
We purchase and sell securities on a trade date that is prior to
the related settlement date. As of June 30, 2006, we were
owed approximately $114.4 million for our sale of
securities, including interest, on or prior to June 30,
2006 that settled after June 30, 2006.
The repurchase agreements for our repurchase facilities
generally do not include substantive provisions other than those
contained in the standard master repurchase agreement as
published by the Bond Market Association. As noted below, some
of our master repurchase agreements that were in effect as of
September 8, 2006 contain negative covenants requiring us to
maintain certain levels of net asset value, tangible net worth
and available funds and comply with interest coverage ratios,
leverage ratios and distribution limitations. One of our master
repurchase agreements provides that it may be terminated if,
among other things, certain material decreases in net asset
value occur, our chief executive officer ceases to be involved
in the day-to-day
operations of our Manager, we lose our REIT status or our
Manager is terminated. Generally, if we violate one of these
covenants, the counterparty to the master repurchase agreement
has the option to declare an event of default, which would
accelerate the repurchase date. If such option is exercised,
then all of our obligations would come due, including either
purchasing the securities or selling the securities, as the case
may be. The counterparty to the master repurchase agreement, if
the buyer in such transaction, for example, will be entitled to
keep all income paid after the exercise, which will be applied
to the aggregate unpaid repurchase price and any other amounts
owed by us, and we are required to deliver any purchased
securities to the counterparty.
Our master repurchase agreement with Banc of America Securities
LLC contains a restrictive covenant that requires our net asset
value to be no less than the higher of
|
|
|
|
|
the NAV Floor (defined below) and |
|
|
|
50% of our net asset value as of December 31 of the prior
year. |
For 2006, the NAV Floor is $250.0 million. For
all future periods, the NAV Floor is equal to the higher of
|
|
|
|
|
the NAV Floor and |
|
|
|
50% of our net asset value, |
in each case as of December 31 of the prior year.
Our master repurchase agreements with Credit Suisse First
Boston, LLC and Credit Suisse First Boston, (Europe) Limited
each contain a restrictive covenant that would trigger an event
of default if our net asset value declines:
|
|
|
|
|
by 30% or more from the highest net asset value in the preceding
12-month period then
ending, |
|
|
|
by 20% or more from the highest net asset value in the preceding
three-month period then ending, |
|
|
|
by 15% or more from the highest net asset value in the preceding
one-month period then ending, or |
|
|
|
by 50% or more from the highest net asset value since the date
of the master repurchase agreement |
or, if we or our Manager receive redemption notices that will
result in an net asset value drop to the foregoing levels or
below $175.0 million.
45
Our master repurchase agreement with Wachovia Bank, National
Association contains the following restrictive covenants:
|
|
|
|
|
We may not permit the ratio of the sum of adjusted EBITDA (as
defined in the master repurchase agreement) to interest expense
to be less than 1.25 to 1.00. |
|
|
|
We may not permit our debt to equity ratio to be greater than
10:1. |
|
|
|
We may not declare or make any payment on account of, or set
apart assets for, a sinking or other analogous fund for the
purchase, redemption, defeasance, retirement or other
acquisition of any of our equity interests, or make any other
distribution in respect thereof, either directly or indirectly,
whether in cash or property or in our obligations, except, so
long as there is no default, event of default or Margin
Deficit that has occurred and is continuing. We may
(i) make such payments solely to the extent necessary to
preserve our status as a REIT and (ii) make additional
payments in an amount equal to 100% of funds from operations. A
Margin Deficit occurs when the aggregate market value of all the
purchased securities subject to all repurchase transactions in
which a party is acting as buyer is less than the buyers
margin amount for all transactions, which is the amount obtained
by application of the buyers margin percentage to the
repurchase price. The margin percentage is a percentage agreed
to by the buyer and seller or the percentage obtained by
dividing the market value of the purchased securities on the
purchase date by the purchase price on the purchase date. |
|
|
|
Our tangible net worth may not be less than the sum of
$300.0 million plus the proceeds from all equity issuances,
net of investment banking fees, legal fees, accountants
fees, underwriting discounts and commissions and other customary
fees and expenses that we actually incur. |
|
|
|
We may not permit the amount of our cash and cash equivalents at
any time to be less than $10.0 million during the first
year following the closing date of the master repurchase
agreement or less than $15.0 million after the first year
following the closing date, in either case after giving effect
to any requested repurchase transaction. |
Certain of our repurchase agreements and our revolving credit
facility contain financial covenants, including maintaining our
REIT status and maintaining a specific net asset value or worth.
As of June 30, 2006, with respect to two debt obligations,
we failed to meet certain financial covenants including an
interest expense coverage ratio. We obtained waivers with
respect to all financial covenants which were not met. As a
result, we were in compliance with or have obtained the
necessary waivers with respect to all our financial covenants as
of June 30, 2006.
We intend to continue to make regular quarterly distributions of
all or substantially all of our REIT taxable income to holders
of our common stock. In order to maintain our qualification as a
REIT and to avoid corporate-level income tax on the income we
distribute to our stockholders, we are required to distribute at
least 90% of our REIT taxable income (which includes net
short-term capital gains) on an annual basis. This requirement
can impact our liquidity and capital resources.
For our short-term (one year or less) and long-term liquidity,
which includes investing and compliance with collateralization
requirements under our repurchase agreements (if the pledged
collateral decreases in value or in the event of margin calls
created by prepayments of the pledged collateral), we also rely
on the cash flow from operations, primarily monthly principal
and interest payments to be received on our mortgage-backed
securities, cash flow from the sale of securities as well as any
primary securities offerings authorized by our board of
directors.
46
Based on our current portfolio, leverage rate and available
borrowing arrangements, including our $275.0 million master
repurchase facility with Wachovia Bank, we believe that the net
proceeds of our initial public offering, which closed in
August 2006, together with existing equity capital,
combined with the cash flow from operations and the utilization
of borrowings, will be sufficient to enable us to meet
anticipated short-term (one year or less) liquidity requirements
such as to fund our investment activities, pay fees under our
management agreement, fund our distributions to stockholders and
for general corporate expenses. However, an increase in
prepayment rates substantially above our expectations could
cause a temporary liquidity shortfall due to the timing of the
necessary margin calls on the financing arrangements and the
actual receipt of the cash related to principal paydowns. If our
cash resources are at any time insufficient to satisfy our
liquidity requirements, we may have to sell debt or additional
equity securities. If required, the sale of MBS or real estate
loans at prices lower than their carrying value would result in
losses and reduced income. Although we have achieved a leverage
rate within our targeted leverage range as of June 30,
2006, we have additional capacity to leverage our equity further
should the need for additional short-term (one year or less)
liquidity arise.
Our ability to meet our long-term (greater than one year)
liquidity and capital resource requirements in excess of our
borrowing capacity under our $275.0 million master
repurchase facility with Wachovia Bank will be subject to
obtaining additional debt financing and equity capital. We may
increase our capital resources by making public offerings of
equity securities, possibly including classes of preferred
stock, common stock, commercial paper, medium-term notes, CDOs,
collateralized mortgage obligations and senior or subordinated
notes. Such financing will depend on market conditions for
capital raises and for the investment of any proceeds. If we are
unable to renew, replace or expand our sources of financing on
substantially similar terms, it may have an adverse effect on
our business and results of operations. Upon liquidation,
holders of our debt securities and shares of preferred stock and
lenders with respect to other borrowings will receive a
distribution of our available assets prior to the holders of our
common stock.
We generally seek to borrow between four and eight times the
amount of our equity. At June 30, 2006, our total debt was
approximately $2,707.6 million, which represented a
leverage ratio of approximately 7.25 times.
Virtually all of our assets and liabilities are interest rate
sensitive in nature. As a result, interest rates and other
factors influence our performance far more so than does
inflation. Changes in interest rates do not necessarily
correlate with inflation rates or changes in inflation rates.
Our financial statements are prepared in accordance with GAAP
and our distributions are determined by our board of directors
consistent with our obligation to distribute to our stockholders
at least 90% of our REIT taxable income on an annual basis in
order to maintain our REIT qualification; in each case, our
activities and balance sheet are measured with reference to
historical cost and or fair market value without considering
inflation.
|
|
|
Quantitative and Qualitative Disclosures About Market
Risk |
As of June 30, 2006, the primary component of our market
risk was interest rate risk, as described below. While we do not
seek to avoid risk completely, we do believe the risk can be
quantified from historical experience and seek to actively
manage that risk, to earn sufficient compensation to justify
taking those risks and to maintain capital levels consistent
with the risks we undertake.
47
We are subject to interest rate risk in connection with most of
our investments and our related debt obligations, which are
generally repurchase agreements of limited duration that are
periodically refinanced at current market rates. We mitigate
this risk through utilization of derivative contracts, primarily
interest rate swap agreements.
Most of our investments are also subject to yield spread risk.
The majority of these securities are fixed rate securities,
which are valued based on a market credit spread over the rate
payable on fixed rate U.S. Treasuries of like maturity. In
other words, their value is dependent on the yield demanded on
such securities by the market, as based on their credit relative
to U.S. Treasuries. An excessive supply of these securities
combined with reduced demand will generally cause the market to
require a higher yield on these securities, resulting in the use
of a higher or wider spread over the benchmark rate
(usually the applicable U.S. Treasury security yield) to
value these securities. Under these conditions, the value of our
real estate securities portfolio would tend to decrease.
Conversely, if the spread used to value these securities were to
decrease or tighten, the value of our real estate
securities would tend to increase. Such changes in the market
value of our real estate securities portfolio may affect our net
equity or cash flow either directly through their impact on
unrealized gains or losses on available-for-sale securities by
diminishing our ability to realize gains on such securities, or
indirectly through their impact on our ability to borrow and
access capital.
|
|
|
Effect on Net Interest Income |
We fund our investments with short-term borrowings under
repurchase agreements. During periods of rising interest rates,
the borrowing costs associated with those investments tend to
increase while the income earned on such investments could
remain substantially unchanged. This results in a narrowing of
the net interest spread between the related assets and
borrowings and may even result in losses.
On June 30, 2006, we were party to 45 interest swap
contracts. The following table summarizes the expiration dates
of these contracts and their notional amounts (in thousands):
|
|
|
|
|
Expiration Date |
|
Notional Amount |
|
|
|
2006
|
|
$ |
15,000 |
|
2007
|
|
|
403,000 |
|
2008
|
|
|
596,000 |
|
2009
|
|
|
60,000 |
|
2010
|
|
|
127,500 |
|
2011
|
|
|
30,000 |
|
2013
|
|
|
53,084 |
|
2015
|
|
|
54,000 |
|
2016
|
|
|
67,000 |
|
2021
|
|
|
42,933 |
|
|
|
|
|
|
TOTAL
|
|
$ |
1,448,517 |
|
|
|
|
|
|
Hedging techniques are partly based on assumed levels of
prepayments of our fixed-rate and hybrid adjustable-rate RMBS.
If prepayments are slower or faster than assumed, the life of
the RMBS will be longer or shorter, which would reduce the
effectiveness of any hedging strategies we may use and may cause
losses on such transactions. Hedging strategies involving the
use of derivative securities are highly complex and may produce
volatile returns.
48
We invest in RMBS, some of which have interest rates that are
fixed for the first few years of the loan (typically three,
five, seven or ten years) and thereafter reset periodically on
the same basis as adjustable-rate RMBS. We compute the projected
weighted-average life of our RMBS based on assumptions regarding
the rate at which the borrowers will prepay the underlying
mortgages. In general, when a fixed-rate or hybrid
adjustable-rate residential mortgage-backed security is acquired
with borrowings, we may, but are not required to, enter into an
interest rate swap agreement or other hedging instrument that
effectively fixes our borrowing costs for a period close to the
anticipated average life of the fixed-rate portion of the
related RMBS. This strategy is designed to protect us from
rising interest rates because the borrowing costs are fixed for
the duration of the fixed-rate portion of the related
residential mortgage-backed security.
However, if prepayment rates decrease in a rising interest rate
environment, the life of the fixed-rate portion of the related
RMBS could extend beyond the term of the swap agreement or other
hedging instrument. This could have a negative impact on our
results from operations, as borrowing costs would no longer be
fixed after the end of the hedging instrument while the income
earned on the RMBS would remain fixed. This situation may also
cause the market value of our RMBS to decline, with little or no
offsetting gain from the related hedging transactions. In
extreme situations, we may be forced to sell assets to maintain
adequate liquidity, which could cause us to incur losses.
|
|
|
Hybrid Adjustable-Rate RMBS Interest Rate Cap Risk |
We also invest in hybrid adjustable-rate RMBS which are based on
mortgages that are typically subject to periodic and lifetime
interest rate caps and floors, which limit the amount by which
the securitys interest yield may change during any given
period. However, our borrowing costs pursuant to our repurchase
agreements will not be subject to similar restrictions.
Therefore, in a period of increasing interest rates, interest
rate costs on our borrowings could increase without limitation
by caps, while the interest-rate yields on our hybrid
adjustable-rate RMBS would effectively be limited by caps. This
problem will be magnified to the extent we acquire hybrid
adjustable-rate RMBS that are not based on mortgages which are
fully indexed. In addition, the underlying mortgages may be
subject to periodic payment caps that result in some portion of
the interest being deferred and added to the principal
outstanding. This could result in our receipt of less cash
income on our hybrid adjustable-rate RMBS than we need in order
to pay the interest cost on our related borrowings. These
factors could lower our net interest income or cause a net loss
during periods of rising interest rates, which would harm our
financial condition, cash flows and results of operations.
|
|
|
Interest Rate Mismatch Risk |
We intend to continue to fund a substantial portion of our
investments with borrowings that, after the effect of hedging,
have interest rates based on indices and repricing terms similar
to, but of somewhat shorter maturities than, the interest rate
indices and repricing terms of our investments. Thus, we
anticipate that in most cases the interest rate indices and
repricing terms of our mortgage assets and our funding sources
will not be identical, thereby creating an interest rate
mismatch between assets and liabilities. Therefore, our cost of
funds would likely rise or fall more quickly than would our
earnings rate on assets. During periods of changing interest
rates, such interest rate mismatches could negatively impact our
financial condition, cash flows and results of operations. To
mitigate interest rate mismatches, we may utilize hedging
strategies discussed above.
Our analysis of risks is based on managements experience,
estimates, models and assumptions. These analyses rely on models
which utilize estimates of fair value and interest
49
rate sensitivity. Actual economic conditions or implementation
of investment decisions by our management may produce results
that differ significantly from the estimates and assumptions
used in our models and the projected results shown in this
Quarterly Report on
Form 10-Q.
Prepayments are the full or partial repayment of principal prior
to the original term to maturity of a mortgage loan and
typically occur due to refinancing of mortgage loans. Prepayment
rates for existing RMBS generally increase when prevailing
interest rates fall below the market rate existing when the
underlying mortgages were originated. In addition, prepayment
rates on adjustable-rate and hybrid adjustable-rate RMBS
generally increase when the difference between long-term and
short-term interest rates declines or becomes negative.
Prepayments of RMBS could harm our results of operations in
several ways. Some adjustable-rate mortgages underlying our
adjustable-rate RMBS may bear initial teaser
interest rates that are lower than their
fully-indexed rates, which refers to the applicable
index rates plus a margin. In the event that such an
adjustable-rate mortgage is prepaid prior to or soon after the
time of adjustment to a fully-indexed rate, the holder of the
related residential mortgage-backed security would have held
such security while it was less profitable and lost the
opportunity to receive interest at the fully-indexed rate over
the expected life of the adjustable-rate residential
mortgage-backed security. Additionally, we currently own
mortgage assets that were purchased at a premium. The prepayment
of such assets at a rate faster than anticipated would result in
a write-off of any remaining capitalized premium amount and a
consequent reduction of our net interest income by such amount.
Finally, in the event that we are unable to acquire new mortgage
assets to replace the prepaid assets, our financial condition,
cash flow and results of operations could be negatively impacted.
Another component of interest rate risk is the effect changes in
interest rates will have on the market value of our assets. We
face the risk that the market value of our assets will increase
or decrease at different rates than that of our liabilities,
including our hedging instruments. We primarily assess our
interest rate risk by estimating the duration of our assets and
the duration of our liabilities. Duration essentially measures
the market price volatility of financial instruments as interest
rates change. We generally calculate duration using various
financial models and empirical data. Different models and
methodologies can produce different duration numbers for the
same securities.
The following interest rate sensitivity analysis is measured
using an option-adjusted spread model combined with a
proprietary prepayment model. We shock the curve up and down
100 basis points and analyze the change in interest rates,
prepayments and cash flows through a Monte Carlo simulation. We
then calculate an average price for each scenario which is used
in our risk management analysis.
The following sensitivity analysis table shows the estimated
impact on the fair value of our interest rate-sensitive
investments, repurchase agreement liabilities, CDO liabilities
and swaps,
50
at June 30, 2006, assuming rates instantaneously fall
100 basis points and rise 100 basis points:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rates |
|
|
|
Interest Rates |
|
|
Fall 100 |
|
|
|
Rise 100 |
|
|
Basis Points |
|
Unchanged |
|
Basis Points |
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
Mortgage assets and other
securities available for
sale(1)
|
Fair value
|
|
$ |
2,756,932 |
|
|
$ |
2,692,928 |
|
|
$ |
2,629,772 |
|
Change in fair value
|
|
$ |
64,004 |
|
|
$ |
0 |
|
|
$ |
(63,156 |
) |
Change as a percent of fair value
|
|
|
2.38 |
% |
|
|
0.00 |
% |
|
|
(2.35 |
)% |
Real Estate Loans
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
|
|
$ |
140,820 |
|
|
$ |
135,361 |
|
|
$ |
130,376 |
|
Change in fair value
|
|
$ |
5,459 |
|
|
$ |
0 |
|
|
$ |
(4,985 |
) |
Change as a percent of fair value
|
|
|
4.03 |
% |
|
|
0.00 |
% |
|
|
(3.68 |
)% |
Repurchase
Agreements(2)
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
|
|
$ |
(2,498,620 |
) |
|
$ |
(2,496,730 |
) |
|
$ |
(2,494,840 |
) |
Change in fair value
|
|
|
n/m |
|
|
|
n/m |
|
|
|
n/m |
|
Change as a percent of fair value
|
|
|
n/m |
|
|
|
n/m |
|
|
|
n/m |
|
CDO Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
|
|
$ |
(211,519 |
) |
|
$ |
(210,903 |
) |
|
$ |
(210,254 |
) |
Change in fair value
|
|
$ |
(616 |
) |
|
|
n/m |
|
|
$ |
649 |
|
Change as a percent of fair value
|
|
|
0.29 |
% |
|
|
n/m |
|
|
|
(0.31 |
)% |
Designated and undesignated
interest rate swaps |
Fair value
|
|
$ |
5,439 |
|
|
$ |
34,458 |
|
|
$ |
62,133 |
|
Change in fair value
|
|
$ |
(29,019 |
) |
|
$ |
0 |
|
|
$ |
27,675 |
|
Change as a percent of notional
value
|
|
|
(2.00 |
)% |
|
|
0.00 |
% |
|
|
1.91 |
% |
Credit default swaps
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
|
|
$ |
1,542 |
|
|
$ |
1,396 |
|
|
$ |
1,272 |
|
Change in fair value
|
|
$ |
146 |
|
|
$ |
0 |
|
|
$ |
(124 |
) |
Change as a percent of notional
value
|
|
|
0.14 |
% |
|
|
0.00 |
% |
|
|
(0.12 |
)% |
Cross currency swap
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
|
|
$ |
(931 |
) |
|
$ |
(329 |
) |
|
$ |
202 |
|
Change in fair value
|
|
$ |
(602 |
) |
|
$ |
0 |
|
|
$ |
531 |
|
Change as a percent of notional
value
|
|
|
(1.30 |
)% |
|
|
0.00 |
% |
|
|
1.14 |
% |
|
|
(1) |
The fair value of other available-for-sale investments that are
sensitive to interest rate changes are included. |
|
(2) |
The fair value of the repurchase agreements would not change
materially due to the short-term nature of these instruments. |
n/m = not meaningful
It is important to note that the impact of changing interest
rates on fair value can change significantly when interest rates
change beyond 100 basis points from current levels.
Therefore, the volatility in the fair value of our assets could
increase significantly when interest rates change beyond
100 basis points. In addition, other factors impact the
fair value of our interest rate-sensitive investments and
hedging instruments, such as the shape of the yield curve,
market expectations as to future interest rate changes and other
market conditions. Accordingly, in the event of changes in
actual interest rates, the change in the fair value of our
assets would likely differ from that shown above, and such
difference might be material and adverse to our stockholders.
51
We have foreign currency exposure related to one commercial real
estate loan, which is denominated in Canadian dollars. From time
to time, we may make other investments that are denominated in a
foreign currency through which we may be subject to foreign
currency exchange risk.
Changes in currency rates can adversely impact the fair values
and earnings of our non-U.S. holdings. We expect to attempt to
mitigate this impact by utilizing currency swaps on our foreign
currency-denominated investments or foreign currency forward
commitments to hedge the net exposure.
Risk Management
To the extent consistent with maintaining our REIT status, we
seek to manage our interest rate risk exposure to protect our
portfolio of RMBS and other mortgage securities and related debt
against the effects of major interest rate changes. We generally
seek to manage our interest rate risk by:
|
|
|
|
|
monitoring and adjusting, if necessary, the reset indices and
interest rates related to our MBS and our borrowings; |
|
|
|
attempting to structure our borrowing agreements to have a range
of different maturities, terms, amortizations and interest rate
adjustment periods; |
|
|
|
using derivatives, financial futures, swaps, options, caps,
floors and forward sales, to adjust the interest rate
sensitivity of our MBS and our borrowings; and |
|
|
|
actively managing, on an aggregate basis, the interest rate
indices, interest rate adjustment periods, and gross reset
margins of our MBS and the interest rate indices and adjustment
periods of our borrowings. |
Note on Forward-Looking Statements
Except for historical information contained herein, this
quarterly report on
Form 10-Q contains
forward-looking statements within the meaning of
Section 21E of the Securities and Exchange Act of 1934, as
amended, which involve certain risks and uncertainties.
Forward-looking statements are included with respect to, among
other things, the our current business plan, business and
investment strategy and portfolio management. These
forward-looking statements are identified by their use of such
terms and phrases as intends, intend,
intended, estimate,
estimates, expects, expect,
expected, project,
projected, projections,
anticipates, anticipated,
should, designed to, foreseeable
future, believe and believes and
similar expressions. Our actual results or outcomes may differ
materially from those anticipated. Readers are cautioned not to
place undue reliance on these forward-looking statements, which
speak only as of the date the statement was made. We assume no
obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future
events or otherwise.
Important factors that we believe might cause actual results to
differ from any results expressed or implied by these
forward-looking statements are discussed in the cautionary
statements contained in Exhibit 99.1 to this
Form 10-Q, which
are incorporated herein by reference. In assessing
forward-looking statements contained herein, readers are urged
to read carefully all cautionary statements contained in this
Form 10-Q.
52
|
|
Item 3. |
Quantitative and Qualitative Disclosures about Market
Risk |
See the discussion of quantitative and qualitative disclosures
about market risk in the Quantitative and Qualitative
Disclosures About Market Risk section of Managements
Discussion and Analysis of Financial Condition and Results of
Operations above.
|
|
Item 4. |
Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed
to ensure that information required to be disclosed in our
Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SECs
rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure based closely on
the definition of disclosure controls and procedures
in Rule 13a-15(e).
Notwithstanding the foregoing, no matter how well a control
system is designed and operated, it can provide only reasonable,
not absolute, assurance that it will detect or uncover failures
within our Company to disclose material information otherwise
required to be set forth in our periodic reports. Also, we may
have investments in certain unconsolidated entities. Because we
do not control these entities, our disclosure controls and
procedures with respect to such entities are necessarily
substantially more limited than those we maintain with respect
to our consolidated subsidiaries.
As of the end of the period covered by this report, we carried
out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive
Officer and our Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and
procedures. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of the end
of the period covered by this report.
Changes in Internal Controls
There have been no significant changes in our internal
control over financial reporting (as defined in Rule
13a-15(f) under the
Securities Exchange Act) that occurred during the period covered
by this quarterly report that has materially affected, or is
reasonably likely to materially affect, our internal control
over financial reporting.
53
PART II. OTHER INFORMATION
|
|
Item 1: |
Legal Proceedings |
None
There have been no material changes to the risk factors
previously disclosed in the prospectus filed pursuant to
Rule 424b(4) on July 31, 2006 with the Securities and
Exchange Commission in connection with our initial public
offering. Such risk factors, as revised, are attached hereto as
Exhibit 99.1 and are incorporated herein by reference.
|
|
Item 2: |
Unregistered Sales of Equity Securities and Use of
Proceeds |
Unregistered Sales of Securities
During the three month period ended June 30, 2006, we
issued 4,000 shares of restricted stock to an employee of
Hyperion Brookfield Asset Management, Inc. who provides
services to us. The issuance of these securities was exempt from
registration under the Securities Act of 1933 in reliance on
Rule 701 of the Securities Act of 1933 pursuant to a
compensatory benefit plan approved by our board of directors.
There were no underwriters employed in connection with this
issuance.
Use of Proceeds from Sale of Registered Securities
On July 27, 2006, the Securities and Exchange Commission
declared effective our Registration Statement on
Form S-11
(File No. 333-130256)
relating to our initial public offering. The offering date was
July 27, 2006. The initial public offering was underwritten
by Deutsche Bank Securities Inc. and Wachovia Securities acting
as joint book-running managers, and Banc of America Securities
LLC, Credit Suisse Securities (USA) LLC,
UBS Securities LLC,
A.G. Edwards & Sons, Inc. and
RBC Capital Markets Corporation, acting as
co-managers. We
registered 7,500,000 shares of our common stock, par value
$0.001 per share. On August 2, 2006, we sold
7,500,000 shares of common stock in our initial public
offering at a price to the public of $23.00 per share for
an aggregate offering price of $172.5 million. In
connection with the offering, we paid approximately
$10.1 million in underwriting discounts and commissions and
incurred an estimated $3.5 million of other offering
expenses. None of the underwriting discounts and commissions or
offering expenses were incurred or paid, directly or indirectly,
to directors or officers of ours or their associates or to
persons owning 10% or more of our common stock or to any
affiliates of ours. After deducting the underwriting discounts
and commissions and these other offering expenses, we estimate
that the net proceeds from the offering equaled approximately
$158.9 million. We have invested the net proceeds of the
offering in accordance with our investment objectives and
strategies as described in the prospectus comprising a part of
the Registration Statement referenced above. There has been no
material change in our planned use of proceeds from our initial
public offering as described in our final prospectus filed with
the Securities and Exchange Commission pursuant to
Rule 424(b).
|
|
Item 3: |
Defaults Upon Senior Securities |
None
|
|
Item 4: |
Submission of Matters to a Vote of Security Holders |
None
54
|
|
Item 5: |
Other Information |
None
|
|
|
3.1
|
|
Charter of Crystal River Capital,
Inc. (filed as Exhibit 3.1 to the Companys
Registration Statement on Amendment No. 1 to Form S-11
(File No. 333-130256) filed on March 1, 2006 and
incorporated herein by reference)
|
3.2
|
|
Amended and Restated Bylaws of
Crystal River Capital, Inc. (filed as Exhibit 3.2 to the
Companys Registration Statement on Amendment No. 1 to
Form S-11 (File No. 333-130256) filed on March 1,
2006 and incorporated herein by reference)
|
11.1
|
|
Statements regarding Computation of
Earnings per Share (Data required by Statement of Financial
Accounting Standard No. 128, Earnings per Share, is
provided in Note 11 to the consolidated financial
statements contained in this report)
|
31.1
|
|
Certification of Clifford E. Lai,
President and Chief Executive Officer, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
|
31.2
|
|
Certification of Barry L. Sunshine,
Chief Financial Officer, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
|
32.1
|
|
Certification of Clifford E. Lai,
President and Chief Executive Officer, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
|
32.2
|
|
Certification of Barry L. Sunshine,
Chief Financial Officer, pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
|
99.1
|
|
Risk Factors
|
55
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
|
|
|
CRYSTAL RIVER CAPITAL, INC. |
|
|
/s/ Clifford E. Lai
|
|
|
|
Clifford E. Lai |
|
President and Chief Executive Officer |
September 11, 2006
Date
|
|
|
/s/ Barry L. Sunshine
|
|
|
|
Barry L. Sunshine |
|
Chief Financial Officer |
September 11, 2006
Date
S-1