Interim Results
Prodesse Investment Limited
07 August 2006
Prodesse Investment Limited
Results for the Quarter and Six Months Ended 30 June 2006
Dividend per share of US$0.10
Highlights for second quarter 2006:
•Dividend per share of US$0.10 from net interest income - equates to an
annualised dividend yield of 5.39%1 (FTSE All Share annualised dividend
yield of 2.99%2)
•Core net income3 per average share of US$0.10
•Net loss per average share of US$1.38 including realised losses from sale
of securities of US$0.53 and non-cash unrealised losses of US$0.94
•NAV per share of US$7.52 (31 March 2006: US$8.03)
•Company to commence monthly reporting of NAV
•Repurchased 1,725,000 shares for cancellation and will continue to
repurchase shares when deemed beneficial to the Company.
•Portfolio remains 100% implied 'AAA' mortgage-backed securities.
1 Based on annualisation of Q2 dividend, an exchange rate of 1.8682 US$ per
Pound Sterling and a closing price of 396.5p on 31 July 2006
2 Based on closing share prices of the constituents of the FTSE All Share index
on 31 July 2006 (JCF Datastream).
3 Core net income is defined as net income excluding realised and unrealised
gains and losses on securities.
Wellington J. Denahan-Norris, Vice Chairman and Chief Investment Officer of
Fixed Income Discount Advisory Company, Investment Manager to Prodesse,
commented: 'Prodesse's second quarter results reflect not only the continued
spread and asset value pressure resulting from the sell-off in the front end of
the yield curve, but also the effects of the steps we have taken to manage the
portfolio through these conditions. We continued to reposition the portfolio in
order to increase the weighted average yield and introduce more floating rate
exposure while remaining faithful to our core strategy, our commitment to owning
implied 'AAA' assets and management transparency. To this last point, Prodesse
will report NAV on a monthly basis to enable investors to have more timely
information on portfolio performance.'
01 January 2006 08 April 2005
Financial Highlights Q2 2006 Q1 2006 to 30 June 2006 to 30 June 2005
______________________________________________________________
US$ US$
Dividend per share 0.10 0.12 0.22 0.20
Core net income per average share 0.10 0.12 0.22 0.20
Net (loss)/income per average share (1.38) 0.12 (1.25) 0.21
Net (loss)/income (37.6m) 3.2m (34.4m) 5.8m
Net asset value per share 7.52 8.03 7.52 9.56
GBP Sterling4 GBP Sterling4
Dividend per share 5p 7p 12p 11p
Core net income per average share 5p 7p 12p 11p
Net income/(loss) per average share (74p) 7p (67p) 12p
Net income/(loss) (£20.4m) £1.8m (£18.6m) £3.2m
Net asset value per share 407.2p 461.8p 407.2p 533.5p
4 Illustration is based upon an exchange rate of 1.8469, 1.739 and 1.7918 US$
per Pound Sterling at 30 June 2006, 31 March 2006 and 30 June 2005 respectively.
Translation to GBP Sterling is given for illustration purposes only as Prodesse
invests in US$ denominated assets only which produce US$ income. Should
shareholders choose to receive their dividends in GBP Sterling, the Q2 Sterling
dividend will be calculated based upon the prevailing exchange rate on 22 August
2006.
Enquiries
Rob Bailhache / Nick Henderson, Financial Dynamics
Tel: 020 7269 200 / 020 7269 7114
Sara Radford / Paul Smith, RBSI Fund Services (Guernsey) Limited
Tel: 01481 740820
About Prodesse
Prodesse Investment Limited is a limited liability Guernsey-incorporated
closed-end investment company, the investments of which are managed by Fixed
Income Discount Advisory Company. The Company's investment policy is to provide
net income for distribution from the spread between the interest income earned
from a portfolio of residential mortgage-backed securities and the cost of
repurchase agreements entered into to finance the acquisition of such
residential mortgage-backed securities.
Conference Call
There will be an analyst presentation on the results at 10:00 am on Monday 7
August 2006 at Financial Dynamics, Holborn Gate, 26 Southampton Buildings,
London WC2A 1PB. Those analysts wishing to attend, or to register are asked to
contact Nick Henderson at Financial Dynamics on +44 (0) 207 269 7114 or at
nick.henderson@fd.com.
The presentation will also be accessible via a conference call for those unable
to attend in person. To listen-in please call +44 (0) 1452 562 716.
A web cast of the presentation will be available following the meeting at
www.prodesse.co.uk.
Company performance
For the quarter ended 30 June 2006 Prodesse reported a net loss of US$37.6
million (quarter ended 31 March 2006: net income of US$3.2 million) or (US$1.38)
per share (quarter ended 31 March 2006: US$0.12 per share). For the six months
ended 30 June 2006 the Company reported a net loss of US$34.4 million (period
ended 30 June 2005: net income of US$5.8 million) or (US$1.25) per share (period
ended 30 June 2005: US$0.21 net income per share).
The Company determined that securities with a current face value of
approximately $1.0 billion with an unrealised loss of $25.7 million, or $0.94
per share, would be classified as other-than-temporarily impaired in value at 30
June 2006. The decline in the value of these securities is due to increases in
interest rates. All of the Company's assets continue to be Fannie Mae and
Freddie Mac mortgage-backed securities which carry an implied 'AAA' rating and
the guarantee of the timely payment of principal and interest. In accordance
with accounting policies, the unrealised loss on these securities will be
recorded in the income statement and the cost basis of these securities going
forward will reflect their value at 30 June 2006. Additionally, during the
second quarter $611 million face amount of securities were sold, resulting in a
realized loss of approximately $14.5 million, or approximately $0.53 per share.
Prodesse reported core net income, defined as net income excluding realised and
unrealised gains and losses on securities, of US$2.7 million for the quarter
ended 30 June 2006 (quarter ended 31 March 2006: US$3.2 million) or US$0.10 per
share (quarter ended 31 March 2006: US$0.12 per share). For the six month period
ended 30 June 2006 the Company reported core net income US$5.9 million (period
ended 30 June 2005: US$3.2 million) or US$0.22 per share (period ended 30 June
2005: US$0.21 per share).
The Company delivered a core return on average equity for the quarter and six
months ended 30 June 2006 of 5.10% and 5.42%, respectively (quarter ended 31
March 2006: 5.64% and period ended 30 June 2005: 9.67%). For the quarter and six
months ended 30 June 2006, the annualised return on average equity (RoAE) was
(71.8%) and (31.69%) respectively (quarter ended 31 March 2006: 5.64% and period
ended 30 June 2005: 9.67%).
01 April 2006 to 01 January 2006 01 January 2006 08 April 2005
30 June 2006 to 31 March 2006 to 30 June 2006 to 30 June 2005
____________________________________________________________________
Core net income US$2.7 million US$3.2 million US$5.9 million US$5.8 million
Core net income per average share US$0.10 US$0.12 US$0.22 US$0.21
Annualised Core RoAE 5.10% 5.64% 5.42% 9.67%
____________________________________________________________________
Reported Net(loss)/income (US$37.6 million) US$3.2 million (US$34.3 million) US$5.8 million
Net (loss)/income per average (US$1.38) US$0.12 (US$1.25) US$0.21
share
Annualised RoAE (71.80%) 5.64% (31.69%) 9.67%
Portfolio Performance
For the quarter and six months ended 30 June 2006 the annualised yield on
average assets, which is calculated based on the annualized interest income for
the period divided by the average interest earning assets for the period, was
5.24% and 5.07%, respectively (quarter ended 30 March 2006: 4.89% and period
ended 30 June 2005: 4.01%) and the annualised cost of funds on the average
repurchase balance was 4.99% and 4.79% (quarter ended 30 March 2006: 4.58% and
quarter ended 30 June 2005: 2.67%), which equates to an interest rate spread of
0.25% and 0.28%, respectively (quarter ended 30 March 2006: 0.31% and period
ended 30 June 2005: 1.34%). At 30 June 2006, the annualized yield on assets was
5.90%, after the cost basis was adjusted for impairment charges, and the
annualized cost of funds on the repurchase balances, including the effect of the
swaps, was 5.24%, which equates to an interest rate spread of 0.66%.
The Constant Prepayment Rate, or CPR, on the Company's mortgage-backed
securities portfolio averaged 15% and 17% for the quarter and six months ended
30 June 2006, respectively (quarter ended 30 March 2006: 18% and period ended 30
June 2005: 20%). Prepayment speeds on mortgage-backed securities, as reflected
by the CPR vary according to the type of investment, changes in interest rates,
conditions in the financial markets, competition and other factors, none of
which can be predicted with any certainty. In general, as prepayment speeds on
the Company's mortgage-backed securities portfolio increase, related purchase
premium amortization increases, thereby reducing the net yield on such assets.
01 April 2006 01 January 2006 01 January 2006 08 April 2005
to 30 June 2006 to 31 March 2006 to 30 June 2006 to 30 June 2005
___________________________________________________________________
Annualised Yield on Average Assets 5.24% 4.89% 5.07% 4.01%
Annualised Cost of Funds on Average
Repurchase Balance 4.99% 4.58% 4.79% 2.67%
Interest Rate Spread 0.25% 0.31% 0.28% 1.34%
CPR 15% 18% 17% 20%
As at 30 June 2006, all of the assets in the Company's portfolio were Fannie Mae
and Freddie Mac mortgage-backed securities, which carry an implied 'AAA' rating.
30 June 31 March 31 December 30 September 30 June
2006 2006 2005 2005 2005
_______________________________________________________________
Fixed-rate mortgage-backed securities 67% 61% 38% 32% 33%
Adjustable-rate mortgage-backed 9% 25% 43% 61% 59%
securities
Floating-rate mortgage-backed 24% 14% 19% 7% 8%
securities
Borrowings
The ratio of average daily repurchase agreements to equity resulted in leverage
of the Company of 9.7:1 and 9.1:1 during quarter and six months ended 30 June
2006, respectively (quarter ended 31 March 2006: 8.5:1 and period ended 30 June
2005: 5.8:1). The leverage at 30 June 2006 was 8.7:1 (31 March 2006: 8.9:1).
01 April 2006 to 01 January 2006 to 01 January 2006 08 April 2005 to
30 June 2006 31 March 2006 to 30 June 2006 30 June 2005
________________________________________________________________________
Average Leverage for Period 9.7:1 8.5:1 9.1:1 5.8:1
Leverage at Period End 8.7:1 8.9:1 8.7:1 8.1:1
As of 30 June 2006, the Company had entered into interest rate swap agreements
totalling US$714 million in notional amount in which the Company will pay an
average rate of 5.16% and receive 1 month LIBOR on a monthly basis. As of 31
March 2006 the Company had entered into interest rate swap agreements totalling
US$554 million in notional amount in which the Company will pay an average rate
of 4.82% and receive 1 month LIBOR on a monthly basis.
30 June 2006 31 March 2006 31 December 2005
____________________________________________________________
Notional Amount US$714,000,000 US$554,000,000 US$65,000,000
Average pay rate 5.16% 4.82% 4.79%
Average receive rate 5.22% 4.75% 4.45%
Capital
At 30 June 2006, the Company had a net asset value per share of US$7.52 (31
March 2006: US$8.03), after deducting the current dividends declared for the
quarter of 30 June 2006 of US$2,602,555 (for the quarter 31 March 2006:
US$3,330,066), reported net asset value per share is US$7.42 (31 March 2006:
US$7.91).
01 April 2006 to 01 January 2006 to 01 January 2006 08 April 2005 to
30 June 2006 31 March 2006 to 30 June 2006 30 June 2005
_______________________________________________________________________
NAV per share US$7.52 US$8.03 US$7.52 US$9.56
Dividends declared for the period US$2,602,555 US$3,330,066 US$6,105,055 US$5,722,000
NAV per share after deducting
dividends declared US$7.42 US$7.91 US$7.42 US$9.36
For the quarter ended 30 June 2006, the Company acquired and cancelled 1,725,000
shares at a weighted average price of US$7.47 per share. The Company currently
has authority to undertake a share purchase of up to 3,901,230 shares of the
share capital of the Company and the Board of Directors has approved the use of
on-market purchases of ordinary shares for cancellation at appropriate prices
when deemed beneficial to the Company.
Dividend
The Company has declared a dividend for the quarter ended 30 June 2006 of
US$0.10 per share payable on 31 August 2006 to holders on the register on 18
August 2006. Dividends are calculated and paid in US dollars. Shareholders
resident in the UK wishing for the conversion of dividend payments into Sterling
should contact the Company's administrator. The exchange rate for payment to
those who have elected to receive their dividends in Sterling will be set on 22
August 2006.
01 April 2006 to 01 January 2006 01 January 2000 08 April 2005 to
30 June 2006 to 31 March 2006 to 30 June 2006 30 June 2005
_____________________________________________________________________
Core net income per average share US$0.10 US$0.12 US$0.22 US$0.21
Net (loss)/ income per average share (US$1.38) US$0.12 (US$1.26) US$0.21
Dividends per share US$0.10 US$0.12 US$0.22 US$0.20
Outlook
'Market expectations are still divided on whether the Federal Reserve will pause
at its next meeting on 8 August 2006,' said Wellington Denahan-Norris, Chief
Investment Officer for Prodesse's Investment Manager, FIDAC. 'While we believe
that after 17 consecutive interest rate tightenings the Fed is at or nearing
completion of its policy regime, our floating rate exposure in the portfolio,
after taking into account the effects of interest rate swaps, stands at
approximately 60%, which should further enhance the earnings potential of a
portion of our portfolio in the event short rates continue to rise. Moreover, a
pause in Fed policy or a move to monetary policy easing would benefit
performance as our cost of funds would stop rising or fall and asset values
would firm or increase. We continue to use all tools at our disposal in an
effort to manage through the tail end of this unprecedentedly long phase of the
interest rate cycle, and we believe that with the transition to the next phase
investors will come to enjoy the type of complete cycle, long-term results our
strategy has historically delivered.'
Prodesse Investment Limited
Balance Sheet
(unaudited) at 30 June 2006, 31 March 2006, 31 December 2005, 30 September
2005 and 30 June 2005
31-Dec-05
30-Jun-06 31-Mar-06 (Audited) 30-Sep-05 30-Jun-05
US$ US$ US$ US$ US$
____________________________________________________________________________
ASSETS
Current assets
Available for sale investments 1,946,995,591 2,190,680,570 1,405,412,720 2,688,176,717 2,627,255,210
Accrued income receivable 9,055,816 9,853,640 6,228,846 11,644,460 10,559,381
Receivable for principal paydowns 5,028,662 7,947,156 10,195,316 13,448,335 8,327,274
Receivable for securities sold 70,277,068 - - - -
Hedging instrument 10,245,969 8,971,875 - - -
Cash and cash equivalents 4,409 16,039 5,059 12,122 5,999
Prepaid expenses 122,099 28,011 34,904 66,798 98,256
____________________________________________________________________________
Total assets 2,041,729,614 2,217,497,291 1,421,876,845 2,713,348,432 2,646,246,120
____________________________________________________________________________
EQUITY AND LIABILITIES
Capital and reserves
Share capital:
26,025,550 at 30 June 2006,
27,750,550 at 31 March 2006 and
31 December 2005, 28,610,000 at
30 September 2005 and 30 June
2005 at US$ 0.01 260,255 277,506 277,506 286,100 286,100
Capital redemption reserve 25,845 8,594 8,594 - -
Share premium 50,000,000 50,000,000 50,000,000 50,000,000 50,000,000
Distributable reserve 201,412,622 214,300,104 214,300,104 220,173,663 220,299,299
Accumulated profits 2,741,945 3,404,481 2,972,952 5,246,367 5,843,027
Capital Reserve-Realised (loss)/
gain and impairment on available
for sale investments (61,890,519) (21,651,450) (21,651,450) 5,313 -
Revaluation reserve (7,017,861) (32,478,359) (13,940,391) (17,384,448) (2,843,493)
Cash flow hedge reserve 10,245,970 8,971,875 (19,500) - -
____________________________________________________________________________
Total shareholders' equity 195,778,257 222,832,751 231,947,815 258,326,995 273,584,933
____________________________________________________________________________
Current liabilities
Securities purchased payable 134,680,584 - 163,391,316 11,560,141 162,120,786
Repurchase agreements 1,706,674,000 1,983,618,000 1,022,067,000 2,436,369,000 2,206,752,000
Accrued interest expense 3,220,249 9,633,997 3,509,041 5,551,769 2,759,461
Accrued expenses payable 1,376,524 1,412,543 942,173 1,540,527 1,028,940
Hedging instrument - - 19,500 - -
____________________________________________________________________________
Total liabilities 1,845,951,357 1,994,664,540 1,189,929,030 2,455,021,437 2,372,661,187
____________________________________________________________________________
Total equity and liabilities 2,041,729,614 2,217,497,291 1,421,876,845 2,713,348,432 2,646,246,120
____________________________________________________________________________
Net Assets 195,778,257 222,832,751 231,947,815 258,326,995 273,584,933
Net Asset Value per share 7.52 8.03 8.36 9.03 9.56
Prodesse Investment Limited
(unaudited) Income Statement
01 January 01 April 2006 01 January 01 October 01 July 2005 08 April 2005
2006 to 30 to 30 June 2006 to 31 2005 to 31 to 30 to 30 June
June 2006 2006 March 2006 December 2005 September 2005*
2005
US$ US$ US$ US$ US$ US$
__________________________________________________________________________________________________________________
Income
Interest income 55,823,269 29,233,473 26,589,796 27,307,521 28,394,099 16,231,405
Interest expense (47,059,697) (25,152,907) (21,906,790) (23,306,345) (21,084,466) (9,330,907)
___________________________________________________________________________________
Net interest income 8,763,572 4,080,566 4,683,006 4,001,176 7,309,633 6,900,498
___________________________________________________________________________________
Realised (loss)/gain on sale
of available for sale
investments (14,547,469) (14,547,469) - (21,656,763) 5,313 -
Loss from impairment (25,691,600) (25,691,600) - - - -
___________________________________________________________________________________
___________________________________________________________________________________
Total (loss)/ income (31,475,497) (36,158,503) 4,683,006 (17,655,587) 7,314,946 6,900,498
___________________________________________________________________________________
Expenses
Management, custodian and
administration fees 2,490,044 1,210,709 1,279,335 942,468 2,018,214 937,308
Other operating expenses 399,480 202,393 197,087 185,913 166,079 120,163
___________________________________________________________________________________
Total expenses 2,889,524 1,413,102 1,476,422 1,128,381 2,184,293 1,057,471
___________________________________________________________________________________
Net (loss)/income for the
period (34,365,021) (37,571,605) 3,206,584 (18,783,968) 5,130,653 5,843,027
___________________________________________________________________________________
Net (loss)/income per share
for the period (1.25) (1.38) 0.12 (0.68) 0.18 0.21
___________________________________________________________________________________
___________________________________________________________________________________
Dividend declared per share
for the period 0.22 0.10 0.12 0.10 0.18 0.20
___________________________________________________________________________________
Average shares outstanding 27,514,777 27,281,594 27,750,550 28,180,275 28,610,000 28,610,000
* commencement of operations
on 08 April 2005
Prodesse Investment Limited
Cash Flow Statement
(unaudited) from 01 January 2006 to 30 June 2006, 01 April 2006
to 01 June 2006, 01 January 2006 to 31 March 2006, and 08 April
2005 to 30 June 2005.
01 January 2006 01 April 2006 01 January 2006 01 October 2005 01 July 2005 to 08 April 2005
to 30 June 2006 to 30 June 2006 to 31 March to 31 December 30 September to 30 June 2005
2006 2005 2005 *
US$ US$ US$ US$ US$ US$
________________________________________________________________________________________________
Net cash inflow/
(outflow) from
operating
activities (Note 1) 18,991,886 16,205,851 2,786,035 11,012,705 5,853,758 (270,579,400)
________________________________________________________________________________________________
Financing
Net proceeds from - - - - - 270,585,399
offering
Offering Cost - - - - (125,635) -
Own shares acquired (12,887,481) (12,887,481) - (5,873,559) - -
Dividends paid (6,105,055) (3,330,000) (2,775,055) (5,146,209) (5,722,000) -
________________________________________________________________________________________________
Net cash (outflow)/
inflow from financing (18,992,536) (16,217,481) (2,775,055) (11,019,768) (5,847,635) 270,585,399
________________________________________________________________________________________________
(Decrease)/increase
in cash and cash
equivalents (650) (11,630) 10,980 (7,063) 6,123 5,999
Cash and cash
equivalents, at
beginning of period 5,059 16,039 5,059 12,122 5,999 -
________________________________________________________________________________________________
Cash and cash
equivalents, at end
of period 4,409 4,409 16,039 5,059 12,122 5,999
________________________________________________________________________________________________
Note 1
Net(loss)/income
for the period (34,365,021) (37,571,605) 3,206,584 (18,783,968) 5,130,653 5,843,027
Net amortisation of
premiums on
available for sale
investments 2,216,101 1,005,200 1,210,901 3,123,879 2,655,987 712,000
Realised loss/
(gain) on sale of
available for sale
investments 14,547,469 14,547,469 - 21,656,763 (5,313) -
Loss from impairment 25,691,600 25,691,600
Purchases of
investments (1,432,190,773) (349,722,450) (1,082,468,323) (55,678,354) (453,612,318) (2,542,805,196)
Proceeds from sale
of investments 530,854,272 530,854,272 - 1,253,691,106 5,666,667 -
Principal paydowns 230,277,069 113,805,308 116,471,761 218,359,667 214,429,874 65,484,813
Borrowings under
reverse repurchase
agreements 12,449,615,000 6,685,967,000 5,763,648,000 6,231,988,000 7,229,892,000 5,090,251,000
Repayments under
reverse repurchase
agreements (11,765,008,000) (6,962,911,000) (4,802,097,000) (7,646,290,000) (7,000,275,000) (2,883,499,000)
Receivables
(Increase)/decrease
in accrued income
receivable (2,704,195) 1,083,913 (3,788,108) 5,554,800 (1,364,146) (10,256,189)
(Increase)/decrease
in prepaid expenses
Liabilities (87,195) (94,089) 6,894 31,894 31,459 (98,256)
(Decrease)/increase
in accrued interest
expense (288,792) (6,413,748) 6,124,956 (2,042,728) 2,792,308 2,759,461
Increase/(decrease)
in accrued expenses
payable 434,351 (36,019) 470,370 (598,354) 511,587 1,028,940
________________________________________________________________________________________________
Net cash inflow/
(outflow) from
operating activities 18,991,886 16,205,851 2,786,035 11,012,705 5,853,758 (270,579,400)
________________________________________________________________________________________________
* commencement of
operations 08 April 2005
Prodesse Investment Limited
Statement of Changes in Shareholders' Equity
(unaudited) 01 January 2006 to 30 June 2006
Capital
Reserve -
realised
gain/
(loss) on
sales and
impairment
of
Capital available Cash
re- Distri- for sale Re- flow
Share demption Share butable invest- valuation Accumulated hedge
capital reserve premium reserve ments reserve profits reserve Total
_______________________________________________________________________________________________________________________
Balance at
period ended
31 December
2005 277,506 8,594 50,000,000 214,300,104 (21,651,450) (13,940,391) 2,972,952 (19,500) 231,947,815
Net income
for the
quarter 3,206,584 3,206,584
Available
for sale
investments:
Movement in
unrealised
gain/(loss) on
revaluation taken to
equity (18,537,968) (18,537,968)
Cash flow
hedge reserve 8,991,375 8,991,375
Dividends paid (2,775,055) (2,775,055)
_______________________________________________________________________________________________________
Balance at
31 March
2006 277,506 8,594 50,000,000 214,300,104 (21,651,450) (32,478,359) 3,404,481 8,971,875 222,832,751
Net loss
for the
quarter (37,571,605) (37,571,605)
Available
for sale
investments:
Transfer of
impairment
loss to capital
reserve (25,691,600) 25,691,600 -
Transfer of
realised
loss to capital (14,547,469) 14,547,469
reserve
Movement in
unrealised loss
on revaluation
taken to equity 25,460,498 25,460,498
Cash flow hedge
reserve 1,274,095 1,274,095
Buyback of
shares (17,251) 17,251 (12,887,482) (12,887,482)
Dividends paid (3,330,000) (3,330,000)
_______________________________________________________________________________________________________
Balance at
30 June 2006 260,255 25,845 50,000,000 201,412,622 (61,890,519) (7,017,861) 2,741,945 10,245,970 195,778,257
_______________________________________________________________________________________________________
Notes to the financial statements
1. General Information
Prodesse Investment Limited is a limited liability Guernsey-incorporated
closed-end investment company, the investments of which are managed by Fixed
Income Discount Advisory Company ('the Investment Manager'). The Company's share
capital structure consists solely of Ordinary Shares. The Company has a listing
on the London Stock Exchange and a listing on the Channel Islands Stock
Exchange. The Company will have an indefinite life but Shareholders will have
the opportunity to vote on its continuation at the Annual General Meeting to be
held in 2010.
The Company invests in a portfolio consisting primarily of implied 'AAA' rated
mortgage-backed securities on a leveraged basis. The Company's investment
strategy is to generate net income for distribution from the spread between the
interest income from the portfolio and the cost of borrowing pursuant to reverse
repurchase agreements used to finance the portfolio. The Investment Manager will
seek to enhance returns through what it considers an appropriate amount of
leverage.
At the date of authorisation of these financial statements, the following
Standard, which has not been applied in these financial statements, was in issue
but not yet effective:
IFRS 7 Financial Instruments: Disclosures; and the related amendment to IAS
1 on capital disclosures
The directors anticipate that the adoption of the above Standard in future
periods will not have a material impact on the financial statements of the
Company except for additional disclosures on capital and financial instruments
when the Standard comes into force for period commencing on or after 1 January
2007.
2. Significant Accounting Policies
Basis of Accounting
The financial statements of the Company have been prepared in accordance with
International Financial Reporting Standards ('IFRS'), which comprise standards
and interpretations approved by the International Accounting Standards Board
('the IASB'), and International Accounting Standards and Standing
Interpretations Committee interpretations approved by the International
Accounting Standards Committee ('IASC') that remain in effect, together with
applicable legal and regulatory requirements of Guernsey Law and the Listing
Rules of the UK Listing Authority and Channel Islands Stock Exchange.
The financial statements have been prepared on the historical cost basis except
for the revaluation of certain financial instruments. The principal accounting
policies are set out below. The preparation of financial statements in
conformity with International Financial Reporting Standards requires the Company
to make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
These financial statements are presented in US Dollars because that is the
currency of the primary economic environment in which the Company operates. The
functional currency of the Company is also considered to be US Dollars.
Investments
The Company invests in securities issued by the United States Government
Sponsored Enterprises such as the Federal Home Loan Mortgage Corporation
('Freddie Mac'), Federal National Mortgage Association ('Fannie Mae') and the
Federal Home Loan Banks ('FHLB') as well as Ginnie Mae, a US Government
Corporation. Freddie Mac, Fannie Mae, and FHLB, although chartered and sponsored
by Congress, are not Companies by congressional appropriations and the debt and
mortgage-backed securities issued by Freddie Mac, Fannie Mae and FHLB are
neither guaranteed nor insured by the United States Government.
Notes to the financial statements (continued)
2. Significant Accounting Policies (continued)
Investments (continued)
The payment of principal and interest on the Freddie Mac and Fannie Mae
mortgage-backed securities are backed by those respective agencies, the payment
of principal and interest on the Ginnie Mae mortgage backed securities are
backed by the full-faith-and-credit of the US Government. Although the Company
generally intends to hold most of its securities until maturity, it may, from
time to time, sell any of its mortgage-backed securities as part of its overall
management strategy. Accordingly the Company classifies all its mortgage-backed
securities as available for sale and these are reported at fair value. Expenses
incidental to the acquisition of available for sale investments are included
within the cost of that investment.
Realised and Unrealised Gains and Losses on Investments
Unrealised gains or losses arising on the revaluation of investments are
included in equity. Unrealised losses on investment securities that are
considered other than temporary, as measured by the amount of decline in fair
value attributable to factors other than temporary, are recognised in the income
statement and the cost basis of the mortgage-backed securities is adjusted.
Realised gains or losses arising on the sale of investments are recognised in
the income statement but will be transferred to a non-distributable capital
reserve in accordance with the Memorandum and Articles of Association of the
Company.
When-Issued/Delayed Securities
The Company may purchase or sell securities on a when-issued or delayed delivery
basis, including 'TBA' securities. TBA Securities are mortgaged-backed
securities for which details about the underlying mortgages have not yet been
announced. Securities traded on a when-issued basis are traded for delivery
beyond the normal settlement date at a stated price and yield, and no income
accrues to the purchaser prior to delivery.
Purchasing or selling securities on a when-issued or delayed delivery basis
involves the risk that the market price at the time of delivery may be lower or
higher than the agreed upon price, in which case an unrealised loss may be
incurred. The Company did not transact in when-issued or delayed delivery
securities during the period ended 30 June 2006.
Security Transactions and Investment Income Recognition
Security transactions are recorded on the trade date. Realised and unrealised
gains and losses are calculated based on specific identified cost. Interest
income is recorded as earned. Interest income and expense includes amortisation
of market discount and premium as calculated using a hybrid methodology
utilising the principles of effective interest method.
Other Receivables
Other receivables do not carry any interest and are short-term in nature and are
accordingly stated at their nominal value as reduced by appropriate allowances
for estimated irrecoverable amounts.
Cash and Cash Equivalents
Cash includes amounts held in interest bearing overnight accounts.
Financial Liabilities and Equity
Financial liabilities and equity are classified according to the substance of
the contractual arrangements entered into. An equity instrument is any contract
that evidences a residual interest in the assets of the Company after deducting
all of its liabilities. Financial liabilities and equity are recorded at the
proceeds received, net of issue costs.
Notes to the financial statements (continued)
2. Significant Accounting Policies (continued)
Other Accruals and Payables
Other accruals and payables are not interest-bearing and are stated at their
nominal value.
Reverse Repurchase Agreements
The Company enters into reverse repurchase agreements with qualified third party
financial institutions to finance its investment in mortgage-backed securities.
The agreements are secured by the value of the Company's mortgage-backed
securities. A repurchase agreement involves the sale by the Company of
securities that it holds with an agreement by the Company to repurchase the same
securities at an agreed price and date. Such an agreement involves the risk
that the value of the securities sold by the Company may decline in value below
the price of the securities.
Interest on the principal value of reverse repurchase agreements issued and
outstanding is based upon competitive market rates at the time of issuance. When
the Company enters into a reverse repurchase agreement, it establishes and
maintains a segregated account with the lender containing securities having a
value not less than the repurchase price, including accrued interest, of the
reverse repurchase agreement.
Repurchase agreements are treated as collateralised financing transactions and
are carried at their contractual amounts, including accrued interest, as
specified in the repurchase agreements. Accrued interest is recorded as a
separate line item.
Securities sold subject to repurchase agreements are retained in the financial
statements as available for sale securities and the counterparty liability is
included in liabilities under repurchase agreements.
Derivative Financial Instruments and Hedge Accounting
The Company's activities expose it primarily to the financial risks of changes
in interest rates. The Company uses interest rate swap contracts to hedge these
exposures. The Company does not use derivative financial instruments for
speculative purposes.
The use of financial derivatives is governed by the Company's policies approved
by the board of directors, which provide written principles on the use of
financial derivatives.
Changes in the fair value of derivative financial instruments that are designed
and effective as hedges of future cash flows are recognised directly in equity
and any ineffective portion is recognised immediately in the income statement.
The amount in equity is released to income when the forecast transaction impacts
profit or loss.
Hedge accounting is discontinued when the hedging instrument expires or is sold,
terminated, or exercised, or no longer qualified for hedge accounting. At that
time, any cumulative gain or loss on the hedging instrument recognised in equity
for cash flow hedges is retained in equity until the forecasted transaction
occurs. If a hedged transaction is no longer expected to occur, the net
cumulative gain or loss recognised in equity is transferred to net profit or
loss in the period.
Taxes
The Company is exempt from Guernsey taxation under the Income Tax (Exempt
Bodies) (Guernsey) Ordinance 1989 for which it pays an annual fee of £600.
Set-up Costs
The preliminary expenses of the Company directly attributable to the equity
transaction and costs associated with the establishment of the Company that
would otherwise have been avoided are taken to the share premium account.
Notes to the financial statements (continued)
2. Significant Accounting Policies (continued)
Business and Geographical Segments
The Directors are of the opinion that the Company is engaged in a single segment
of business of investing in debt securities, issued by companies operating and
generating revenue in the United States, and therefore no segmental reporting is
provided.
3. Expenses
01 January 2006 to 22 February 2005* to
30 June 2006 30 June 2005
US$ US$
_______________________________________
Investment management, custodian and administration fees
Investment management fee (note 4) 2,111,723 797,112
Administration fee (note 4) 268,076 96,833
Custodian fee (note 4) 110,245 43,362
_______________________________________
2,490,044 937,307
_______________________________________
Other operating expenses
Directors' fees 61,887 35,795
Insurance 55,524 24,995
Audit fee 86,987 14,341
Legal fee 37,192 21,512
Regulatory fee 11,855 6,980
Other expenses 146,037 16,541
_______________________________________
Total expense 2,889,526 1,057,471
_______________________________________
* Commencement of operations 08 April 2005
The Company has no employees. The Directors are the only key management
personnel of the Company. Their remuneration disclosed above is all in respect
of short term employee benefits.
4. Investment Management, Accounting and Administration, and Custodian Fees
Fixed Income Discount Advisory Company ('FIDAC'), a Delaware corporation serves
as the Investment Manager to the Company. Pursuant to the terms of the
Investment Management Agreement, the Investment Manager is paid periodic fees,
quarterly in arrears, at a rate equivalent to 0.2 per cent per annum of the
value of the gross assets of the Company.
The Bank of New York serves as the Company's custodian and is paid a monthly
accounting and administration fee, exclusive of out-of-pocket expenses. The
Custodian is entitled to receive a fee at a rate equivalent to 1 basis point per
annum on the value of the gross assets of the Company (plus transaction
charges).
RBSI Fund Services (Guernsey) Limited serves as the Company's administrator. The
Administrator is entitled to a fee calculated on the value of the gross assets
of the Company of 0.04 per cent, per annum on the first US$400 million of value
of gross assets, 0.0225 per cent per annum on the next US$1.6 billion of
value of the gross assets and 0.01 per cent per annum on any value of the gross
assets in excess of US$2 billion payable monthly in arrears (subject to a
minimum annual fee of US$250,000).
Notes to the financial statements (continued)
5. Dividends
01 January 2006 to 22 February 2005* to
30 June 2006 30 June 2005
US$ US$
_______________________________________
Amounts recognized as distributions to equity shareholders in
the period:
First quarter dividend 3,330,000 -
Second quarter dividend 2,602,555 3,433,000
_______________________________________
5,932,555 3,433,000
_______________________________________
* Commencement of operations 08 April 2005.
6. Earnings Per Share
Basic earnings per share is calculated by dividing net loss related to Ordinary
Shareholders by the weighted average number of ordinary shares outstanding
during the period.
01 January 2006 to 22 February 2005* to
June 30 2006 30 June 2005
________________________________________
Number of shares
________________________________________
Weighted average number of Ordinary Shares outstanding 27,514,777 28,610,000
________________________________________
* Commencement of operations 08 April 2005.
7. Risk Factors
The main risks to which the Company is exposed are market, foreign currency,
credit, interest rate and liquidity risk.
Market Risk
The market price of the Ordinary Shares and the income derived from them can
fluctuate and there is no guarantee that the market price of Ordinary Shares in
the Company will reflect fully their underlying Net Asset Value.
The Company is also exposed to the market risk on the underlying investments as
changes in overall interest rate levels will affect their value.
Foreign Exchange Risk
All or substantially all of the Company's assets and liabilities are denominated
in US dollars. The Company accounts for its assets and determines the value of
its Ordinary Shares and of dividends thereon in US dollars. For investors
resident outside the United States or whose functional currency is not the US
dollar, fluctuations in the value of the US dollar may affect the value of their
investment. The Directors do not hedge foreign exchange risk. Hence the
Directors are of the opinion that the Company is not exposed to significant
foreign exchange risk.
Notes to the financial statements (continued)
Credit Risk
The Company is subject to credit risk with respect to its investments in
mortgage-backed securities, hedging derivatives and other receivables, bank
balances and cash which represents the Company's maximum exposure to credit risk
in relation to financial assets.
This risk is mitigated as the Company invests primarily in a portfolio of US
residential mortgage-backed securities created or issued by Fannie Mae, Freddie
Mac or Ginnie Mae with a targeted (actual or implied) credit rating of
approximately 'AAA', and, to a lesser extent, other 'AAA'-rated US residential
mortgage-backed securities, US government securities and debentures issued by a
US Agency.
In addition, credit risk on liquid funds and derivative financial instruments is
limited because the counterparties are banks with high credit ratings assigned
by international credit rating agencies.
Interest Rate Risk
The Company is subject to risks associated with changes in interest rates. An
increase in the interest payments on the Company's financing relative to the
interest earned on its mortgage-backed securities may adversely affect
profitability.
The Company enters into reverse repurchase agreements in order to increase the
amount of capital available for investment. The use of leverage has the
potential to magnify the gains or the loss on the Company's investments.
The Company may invest in, or sell short, various interest rate derivative
instruments and futures contracts to reduce the impact of changes in interest
rates. Should interest rates move unexpectedly, the Company may not achieve the
anticipated benefits of the hedging instruments and may realise a loss. Further,
the use of such derivative instruments involves the risk of imperfect
correlation in movements in the price of the instruments, interest rates and the
underlying hedged assets.
The primary interest rate exposures relate to its available for sale
investments, repurchase agreements, cash balances and interest rate swaps.
The Company hedges some of its exposure to floating interest rate payments in
respect of liabilities for reverse repurchase agreements.
Liquidity Risk
The Company's ability to execute its business strategy depends to a significant
degree on its ability to raise capital via reverse repurchase agreements and
also through interest and paydowns received on its investment portfolio. The
Company maintains a low cash balance in order to meet short term requirements.
The Company's primary source of funds for liquidity consists of net cash
provided by operating activities. Its reverse repurchase agreements are secured
directly by its investment portfolio. The Company expects that its cash on hand
and cash flow provided through operations will satisfy its liquidity needs over
the next twelve months. In addition it is expected that further reverse
repurchase agreements will be available and entered into to fund additional
investment purchases.
Notes to the financial statements (continued)
8. Available for Sale Investments
01 January 2006 to 22 February 2005* to 30
June 30 2006 June 2005
___________________________________________
US$ US$
Beginning Balance 1,405,412,720 -
Purchases of investments 1,403,358,159 2,704,622,790
Proceeds from sale of investments (601,132,234) -
Realised loss on sale of investments (14,547,469) -
Principal paydowns (225,110,413) (73,812,087)
Net amortisation of premiums (2,216,100) (712,000)
Loss on Impairment (25,691,600) -
Movement in unrealised loss on available for sale investments 6,922,530 (2,843,493)
___________________________________________
Ending Balance 1,946,995,591 2,627,255,210
___________________________________________
Amortised Cost, Gross Unrealised Gross Unrealised Estimated Fair
At 30 June 2006 Including Loss on Gain Loss Value
Impairment
_____________________________________________________________________________
US$ US$ US$ US$
Adjustable rate 649,096,245 735,890 (447,488) 649,384,647
Fixed rate 1,304,722,599 - (7,111,655) 1,297,610,944
_____________________________________________________________________________
Total 1,953,818,844 735,890 (7,559,143) 1,946,995,591
_____________________________________________________________________________
Gross Unrealised Gross Unrealised Estimated Fair
At 30 June 2005 Amortised Cost Gain Loss Value
_____________________________________________________________________________
US$ US$ US$ US$
Adjustable rate 1,770,857,314 81,056 (1,619,753) 1,769,318,617
Fixed rate 858,614,939 94,530 (772,876) 857,936,593
_____________________________________________________________________________
Total 2,629,472,254 175,585 (2,392,629) 2,627,255,210
_____________________________________________________________________________
As at 30 June 2006 and 2005, all of the assets in the Company's portfolio were
Fannie Mae and Freddie Mac mortgage-backed securities, which carry an implied
'AAA' rating.
30 June 2006 30 June 2005
__________________________________________
Fixed-rate mortgage-backed securities 67% 33%
Adjustable-rate mortgage-backed securities 9% 59%
Floating-rate mortgage-backed securities 24% 8%
Mortgage-backed securities are created when mortgages and their attendant
streams of interest and principal payments are pooled to serve as collateral for
the issuance of securities to investors. Interests in mortgage-backed securities
differ from other forms of traditional debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. Instead, mortgage-backed securities typically
provide irregular cash flows consisting of both interest and principal.
An investment consideration of any mortgage-backed security is the structure of
the payment of the cash flow streams from the underlying mortgages to the
holders of the mortgage-backed securities. The cash flows can be simply passed
from the mortgage holder to the investor or they can be structured in a number
of different ways. The market values of the various structures will vary in
different interest rate or prepayment environments, with the more derivative or
complex structures (e.g., interest-only or principal-only securities) being more
sensitive to movements in interest rates or rates of prepayment.
Notes to the financial statements (continued)
8. Available for Sale Investments (continued)
Beyond the basic security of the mortgages and properties that underlie
mortgage-backed securities, a critical attribute of mortgage-backed securities
issued by the US Agencies is the credit enhancement that the US Agencies
provide. The holder of mortgage-backed securities issued or guaranteed by the US
Agencies is guaranteed the timely payment of principal and interest. Ginnie Mae
is the principal governmental (i.e., backed by the full credit of the US
Government) guarantor of mortgage-backed securities. Fannie Mae and Freddie Mac
are the principal US Government-related (i.e. not backed by the full credit of
the US Government) guarantors.
Adjustable-rate and floating-rate mortgage-backed securities in which the
Company may invest include pass-through mortgage-backed securities issued by the
US Agencies backed by adjustable-rate mortgages and Floaters. The interest rates
on adjustable-rate mortgage-backed securities are reset at periodic intervals to
an increment over some predetermined reference interest rate. There are two main
categories of reference rates: (i) those based on US Treasury securities and
(ii) those derived from a calculated measure such as a cost of funds index or a
moving average of mortgage rates. Commonly utilised reference rates include the
one-year Treasury Bill rate or one-month US dollar LIBOR. Some reference rates,
such as the one-year Treasury Bill rate or LIBOR, closely mirror changes in
market interest rate levels. Others tend to lag changes in market rate levels
and tend to be somewhat less volatile.
Adjustable-rate mortgages frequently have upper and lower limits on the interest
rates to which a residential borrower may be subject (i) in any reset or
adjustment interval and (ii) over the life of the loan. These upper and lower
limits are commonly known as ''caps'' and ''floors'' respectively.
With the continued increase in the Federal Funds rate during the second quarter
of 2006, the Company determined that it did not intend to hold certain of its
securities until maturity and would reposition a portion of its assets. The
Company recorded an impairment charge of $25.7 million for these securities
during the second quarter of 2006. The remaining investments are not considered
other-than-temporarily impaired since the Company currently has the ability and
intent to hold the investments for a period of time or to maturity, if
necessary, sufficient for a forecasted market price recovery up to or beyond the
cost of the investments.
9. Current Assets and Current Liabilities
The Directors consider that the carrying amount of other receivables
approximates their fair value.
Cash and cash equivalents comprise bank balances held by the Company. The
carrying amount of these assets approximates their fair value.
Other payables principally comprise amounts outstanding on purchases of
investments awaiting settlement and ongoing costs. The Directors consider the
carrying amount of other payables approximates to their fair value.
10. Hedging Instrument
The Company uses interest rate swaps to manage its exposure to interest rate
movements. When the Company enters into an interest rate swap, it agrees to pay
a fixed rate of interest and to receive a variable interest rate, generally
based on the London Interbank Offered Rate ('LIBOR'). The Company's swaps are
designated as cash flow hedges against the benchmark interest rate risk
associated with the Company's borrowings.
At June 30, 2006, the company had interest rate swap agreements of US$714
million notional amount in which the Company will pay a weighted average rate of
5.16% and a weighted average receive rate of 5.22%.
Notes to the financial statements (continued)
The fair value of the swaps entered into at 30 June 2006 is estimated at
US$10,245,969. The swaps are designated and effective as a cashflow hedge and
the fair value thereof has been deferred in equity.
11. Reverse Repurchase Agreements
At 30 June 2006 the aggregate value of securities pledged by the Company under
reverse repurchase agreements exceeds the liability under such agreements by
approximately US$51.2 million (approximately 3% of such liability). The interest
rates on the open reverse repurchase agreements at 30 June 2006 range from 5.12%
to 5.37% and have maturity dates ranging from one day to 32 days.
12. Net Asset Value
The net asset value per Ordinary Share is based on net assets at 30 June 2006
and on 26,025,550 Ordinary Shares, being the number of Ordinary Shares in issue
at the period end.
At 30 June 2006, the reported net asset value per Ordinary Share (before
excluding the dividend declared for the quarter ended 30 June 2006) is US$7.52.
At 30 June 2006, the Company had a net asset value per Ordinary Share of
US$7.42, after including the effect of the dividend declared for the quarter of
30 June 2006 of US$2,602,555.
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