6th Nov 2006 07:01
Prodesse Investment Limited06 November 2006 Prodesse Investment Limited Results for the Quarter Ended 30 September 2006 Core net income per average share of US$0.12 and net asset value per share increase of 7% Highlights for third quarter 2006: • Core net income1 per average share of US$0.12 • Previously declared dividend per share of US$0.12 from net interest income - equates to an annualised dividend yield of 5.88%2 (FTSE All Share annualised dividend yield of 2.97%3) • Net income per average share of US$0.25 • NAV per share of US$8.05 (30 June 2006: US$7.52) • Increased frequency of NAV reporting to monthly • Portfolio remains 100% implied "AAA" mortgage-backed securities. 1 Core net income is defined as net income excluding realised and unrealised gains and losses on securities. 2 Based on annualisation of Q3 dividend, an exchange rate of 1.9081 US$ per Pound Sterling and a closing price of 427.5p on 31 October 2006 3 Based on closing share prices of the constituents of the FTSE All Share index on 29 September 2006 (JCF Datastream). Michael A.J. Farrell, Chairman and CEO of FIDAC, Investment Manager to Prodesse,commented: "Third quarter results for Prodesse reflect several importantdevelopments. First, even as our cost of funds continued to roll into the higherinterest rate environment, the Company increased its dividend 20% from the priorquarter. Second, net interest spread improved during the quarter as the yield onassets rose relative to the cost of funds. Third, net asset value per shareincreased 7% from the prior quarter as the US bond market rallied inanticipation of the next move by the Federal Reserve. While we believe that thedecline in the housing market is leading to a general slowdown in economicactivity in the US, we continue to proactively manage the portfolio for a widerange of interest rate outcomes through the use of our barbell strategy and ourcommitment to owning US residential mortgage assets of the highest possiblecredit quality." Financial Highlights Q3 2006 Q2 2006 Q1 2006 Q4 2005 Q3 2005 US$Dividend per share 0.12 0.10 0.12 0.10 0.18Core net income per average share 0.12 0.10 0.12 0.10 0.18Net income/(loss) per average share 0.25 (1.38) 0.12 (0.68) 0.18Net income/(loss) 6.4m (37.6m) 3.2m (18.8m) 5.1mNet asset value per share 8.05 7.52 8.03 8.36 9.03 GBP Sterling4Dividend per share 6p 5p 7p 6p 10pCore net income per average share 6p 5p 7p 6p 10pNet income/(loss) per average share 13p (74p) 7p (40p) 10pNet income/(loss) £3.4m (£20.4m) £1.8m (£10.9m) £2.9mNet asset value per share 430.1p 407.2p 461.8p 486.4p 511.5p 4 Illustration is based upon an exchange rate of 1.8718, 1.8469, 1.7390, 1.7187and 1.7653 US$ per Pound Sterling at 30 September 2006, 30 June 2006, 31 March2006, 31 December 2005 and 30 September 2005 respectively. Translation to GBPSterling is given for illustration purposes only as Prodesse invests in US$denominated assets only which produce US$ income. Should shareholders choose toreceive their dividends in GBP Sterling they may elect to do so. EnquiriesInvestor RelationsRob Bailhache / Nick Henderson, Financial DynamicsTel: 020 7269 7200 / 020 7269 7114 Company Secretary and AdministratorSara Radford / Paul Smith, RBSI Fund Services (Guernsey) LimitedTel: 01481 740820 About Prodesse Prodesse Investment Limited is a limited liability Guernsey-incorporatedclosed-end investment company, the investments of which are managed by FixedIncome Discount Advisory Company. The Company's investment policy is to providenet income for distribution from the spread between the interest income earnedfrom a portfolio of residential mortgage-backed securities and the cost ofrepurchase agreements entered into to finance the acquisition of suchresidential mortgage-backed securities. Conference Call There will be an analyst presentation on the results at 10:00 am on 06 November2006 at Financial Dynamics, Holborn Gate, 26 Southampton Buildings, London WC2A1PB. Those analysts wishing to attend, or to register are asked to contact NickHenderson at Financial Dynamics on +44 (0) 207 269 7114 or [email protected]. The presentation will also be accessible via a conference call for those unableto attend in person. To listen in please call +44 (0) 1452 562 717. A web cast of the presentation will be available following the meeting atwww.prodesse.co.uk. Company performance For the quarter ended 30 September 2006, Prodesse reported net income of US$6.4million (quarter ended 30 June 2006: net loss of US$37.6million) or US$0.25 peraverage share (quarter ended 30 June 2006: (US$1.38) per average share). Prodesse reported core net income, defined as net income excluding realised andunrealised gains and losses on securities, of US$3.0 million for the quarterended 30 September 2006 (quarter ended 30 June 2006: US$2.7 million) or US$0.12per average share (quarter ended 30 June 2006: US$0.10 per average share).During the quarter the Company sold US$569.4 million face amount of securitiesand US$166.5 million notional amount of interest rate swaps, resulting in arealised gain of approximately US$3.4 million or US$0.13 per average share. The Company delivered an annualised core return on average equity for thequarter ended 30 September 2006 of 6.07% (quarter ended 30 June 2006: 5.10%).For the quarter ended 30 September 2006, the annualised total return on averageequity (RoAE) was 12.77% (quarter ended 30 June 2006: (71.8%)). 01 July 2006 to 01 April 2006 to 01 January 2006 01 October 2005 01 July 2005 to 30 September 30 June 2006 to 31 March 2006 to 31 30 September 2006 December 2005 2005 Core net income US$3.0 million US$2.7 million US$3.2 million US$2.9 million US$5.1 millionCore net income peraverage share US$0.12 US$0.10 US$0.12 US$0.10 US$0.18 Annualised core RoAE 6.07% 5.10% 5.64% 4.69% 7.72% Reported net income/(loss) US$6.4 million (US$37.6 million) US$3.2 million (US$18.8 million) US$5.1 millionNet income/(loss) peraverage share US$0.25 (US$1.38) US$0.12 (US$0.68) US$0.18 Annualised RoAE 12.77% (71.80%) 5.64% (30.65)% 7.72% Portfolio Performance For the quarter ended 30 September 2006, the annualised yield on average assets,which is calculated based on the annualised interest income for the perioddivided by the average interest earning assets for the period, was 5.66%(quarter ended 30 June 2006: 5.24%) and the annualised cost of funds on theaverage repurchase balance was 5.31% (quarter ended 30 June 2006: 4.99%) whichequates to an interest rate spread of 0.35% (quarter ended 30 June 2006: 0.25%).At 30 September 2006, the annualised yield on assets was 5.92% and theannualised cost of funds on the repurchase balances was 5.28%, which equates toan interest rate spread of 0.64%. The Constant Prepayment Rate, or CPR, on the Company's mortgage-backedsecurities portfolio averaged 13% for the quarter ended 30 September 2006(quarter ended 30 June 2006: 15%). Prepayment speeds on mortgage-backedsecurities, as reflected by the CPR, vary according to the type of investment,changes in interest rates, conditions in the financial markets, competition andother factors, none of which can be predicted with any certainty. In general,as prepayment speeds on the Company's mortgage-backed securities portfolioincrease, related purchase premium amortization increases, thereby reducing thenet yield on such assets. 01 July 2006 to 01 April 2006 01 January 2006 01 October 2005 01 July 2005 to 30 September to 30 June to 31 March 2006 to 30 September 2005 2006 2006 31 December 2005Annualised yield onaverage assets 5.66% 5.24% 4.89% 4.49% 4.23% Annualised cost of fundson average repurchasebalance 5.31% 4.99% 4.58% 4.12% 3.57%Interest rate spread 0.35% 0.25% 0.31% 0.37% 0.66%CPR 13% 15% 18% 20% 23% As at 30 September 2006, all of the assets in the Company's portfolio wereFannie Mae and Freddie Mac mortgage-backed securities, which carry an implied"AAA" rating. 30 September 30 June 31 March 31 December 30 September 30 June 2006 2006 2006 2005 2005 2005 Fixed-rate mortgage-backed securities 63% 67% 61% 38% 32% 33%Adjustable-rate mortgage-backed securities 8% 9% 25% 43% 61% 59%Floating-rate mortgage-backed securities 29% 24% 14% 19% 7% 8% Borrowings The ratio of average daily repurchase agreements to equity resulted in leverageof the Company of 8.9:1 during quarter ended 30 September 2006 (quarter ended 30June 2006: 9.7:1). The leverage at 30 September 2006 was 8.5:1 (30 June 2006:8.7:1). 01 July 2006 to 01 April 2006 to 01 January 2006 to 01 October 2005 01 July 2005 to 30 September 30 June 2006 31 March 2006 to 30 September 2005 2006 31 December 2005Average leverage forperiod 8.9:1 9.7:1 8.5:1 9.3:1 8.9:1 Leverage at period end 8.5:1 8.7:1 8.9:1 4.4:1 9.4:1 As of 30 September 2006, the Company had entered into interest rate swapagreements totalling US$603 million in notional amount in which the Company willpay an average rate of 5.23% and receive 1 month LIBOR on a monthly basis. Asof 30 June 2006, the Company had entered into interest rate swap agreementstotalling US$714 million in notional amount in which the Company will pay anaverage rate of 5.16% and receive 1 month LIBOR on a monthly basis. 30 September 2006 30 June 2006 31 March 2006 31 December 2005Notional amount US$603 million US$714 million US$554 million US$65 millionAverage pay rate 5.23% 5.16% 4.82% 4.79%Average receive rate 5.33% 5.22% 4.75% 4.45% Capital At 30 September 2006, the Company had a net asset value per share of US$8.05 (30June 2006: US$7.52), after deducting the current dividends declared for thequarter of 30 September 2006 of US$3,075,066 (for the quarter 30 June 2006:US$2,602,555), reported net asset value per share is US$7.93 (30 June 2006:US$7.42). 01 July 2006 to 01 April 2006 to 01 January 2006 01 October 2005 01 July 2005 to 30 September 30 June 2006 to 31 March 2006 to 30 September 2005 2006 31 December 2005NAV per share US$8.05 US$7.52 US$8.03 US$8.36 US$9.03Dividends declared forthe period US$3,075,066 US$2,602,555 US$3,330,066 US$2,775,055 US$5,146,209 NAV per share afterdeducting dividendsdeclared US$7.93 US$7.42 US$7.91 US$8.26 US$8.85 For the quarter ended 30 September 2006, the Company acquired and cancelled400,000 shares at an average price of US$6.83 per share. Dividend The Company has declared a dividend for the quarter ended 30 September 2006 ofUS$0.12 per share payable on 31 October 2006 to holders on the register on 20October 2006. Dividends are calculated and paid in US dollars. Shareholdersresident in the UK wishing for the conversion of dividend payments into Sterlingshould contact the Company's administrator. The exchange rate for payment tothose who have elected to receive their dividends in Sterling was set on 24October 2006 at 1.8774 US$ per Pound Sterling. 01 July 2006 to 01 April 2006 01 January 2006 01 October 2006 to 01 July 2006 to 30 30 September 2006 to 30 June to 31 March 2006 31 December 2006 September 2006 2006Core net income peraverage share US$0.12 US$0.10 US$0.12 US$0.10 US$0.18 Net income/(loss) peraverage share US$0.25 (US$1.38) US$0.12 (US$0.68) US$0.18 Dividends per share US$0.12 US$0.10 US$0.12 US$0.10 US$0.18 Outlook "Recent economic data has supported the view that the US economy is slowing downfrom the pace of the second quarter," said Wellington Denahan-Norris, ChiefInvestment Officer for Prodesse's Investment Manager, FIDAC. "Nevertheless, theFederal Reserve has kept all options on the table for its next move in monetarypolicy as it tries to balance the risk of potential inflationary pressureagainst the risk of slowing growth. Using our barbell strategy, we havepositioned Prodesse's portfolio for performance in a wide range of possibleoutcomes. After taking into account the effect of our interest rate swapposition, our portfolio is comprised of 33% fixed-rate assets, 8%adjustable-rate assets and 59% floating-rate assets. This composition isconsistent with our desire to always have a part of the portfolio performingwhether rates are rising, falling or moving sideways." Prodesse Investment LimitedBalance Sheet(unaudited) at 30 September 2006, 30 June 2006, 31 March 2006, 31, 30 September 2005 31-Dec-05 30-Sep-06 30-Jun-06 31-Mar-06 (Audited) 30-Sep-05 US$ US$ US$ US$ US$ASSETSCurrent assetsAvailable for sale investments 2,016,901,365 1,946,995,591 2,190,680,570 1,405,412,720 2,688,176,717Accrued income receivable 8,001,243 9,055,816 9,853,640 6,228,846 11,644,460Receivable for principal paydowns 4,158,154 5,028,662 7,947,156 10,195,316 13,448,335Receivable for securities sold 68,692,786 70,277,068 - - -Hedging instrument - 10,245,969 8,971,875 - -Cash and cash equivalents 749,962 4,409 16,039 5,059 12,122Prepaid expenses 173,565 122,099 28,011 34,904 66,798Total assets 2,098,677,075 2,041,729,614 2,217,497,291 1,421,876,845 2,713,348,432 EQUITY AND LIABILITIES Capital and reserves Share capital: 25,625,550 at 30 September 2006, 26,025,550 at 30 June 2006, 27,750,550at 31 March 2006 and 31 December 2005,and 28,610,000 at 30 September 2005 atUS$ 0.01 256,255 260,255 277,506 277,506 286,100 Capital redemption reserve 29,845 25,845 8,594 8,594 -Share premium 50,000,000 50,000,000 50,000,000 50,000,000 50,000,000Distributable reserve 198,680,545 201,412,622 214,300,104 214,300,104 220,173,663Accumulated profits 3,228,548 2,741,945 3,404,481 2,972,952 5,246,367Capital Reserve-Realised (loss)/gain and impairment on available for sale investments (58,519,908) (61,890,519) (21,651,450) (21,651,450) 5,313Revaluation reserve 15,713,694 (7,017,861) (32,478,359) (13,940,391) (17,384,448)Cash flow hedge reserve (3,124,375) 10,245,970 8,971,875 (19,500) - Total shareholders' equity 206,264,604 195,778,257 222,832,751 231,947,815 258,326,995 Current liabilitiesSecurities purchased payable 124,033,750 134,680,584 - 163,391,316 11,560,141 Repurchase agreements 1,759,089,000 1,706,674,000 1,983,618,000 1,022,067,000 2,436,369,000Accrued interest expense 4,809,009 3,220,249 9,633,997 3,509,041 5,551,769Accrued expenses payable 1,356,337 1,376,524 1,412,543 942,173 1,540,527 Hedging instrument 3,124,375 - - 19,500 - Total liabilities 1,892,412,471 1,845,951,357 1,994,664,540 1,189,929,030 2,455,021,437 Total equity and liabilities 2,098,677,075 2,041,729,614 2,217,497,291 1,421,876,845 2,713,348,432 Net Assets 206,264,604 195,778,257 222,832,751 231,947,815 258,326,995Net Asset Value per share 8.05 7.52 8.03 8.36 9.03 Prodesse Investment Limited(unaudited) Income Statement 01 July 2006 to 01 April 2006 01 January 2006 01 October 2005 01 July 2005 to 30 September to 30 June to 31 March to 31 December 30 September 2006 2006 2006 2005 2005 US$ US$ US$ US$ US$ IncomeInterest income 28,199,546 29,233,473 26,589,796 27,307,521 28,394,099Interest expense (23,701,645) (25,152,907) (21,906,790) (23,306,345) (21,084,466) Net interest income 4,497,901 4,080,566 4,683,006 4,001,176 7,309,633 Realised gain/(loss) on sale of available for sale investments and interest rate swaps 3,370,611 (14,547,469) - (21,656,763) 5,313 Loss from impairment - (25,691,600) - - - Total income/(loss) 7,868,512 (36,158,503) 4,683,006 (17,655,587) 7,314,946 ExpensesManagement, custodian and administration fees 1,246,004 1,210,709 1,279,335 942,468 2,018,214 Other operating expenses 202,739 202,393 197,087 185,913 166,079 Total expenses 1,448,743 1,413,102 1,476,422 1,128,381 2,184,293 Net income/(loss) for the period 6,419,769 (37,571,605) 3,206,584 (18,783,968) 5,130,653 Net income/(loss) per average share for the period 0.25 (1.38) 0.12 (0.68) 0.18 Dividend declared per share for the period 0.12 0.10 0.12 0.10 0.18 Average shares outstanding 25,799,463 27,281,594 27,750,550 28,180,275 28,610,000 Prodesse Investment LimitedUnaudited Cash Flow Statement 01 July 2006 to 01 April 2006 to 01 January 2006 01 October 2005 01 July 2005 to 30 September 30 June 2006 to 31 March to 31 December 30 September 2006 2006 2005 2005 US$ US$ US$ US$ US$Net cash inflows from operating activities (Note 1) 6,040,184 16,205,851 2,786,035 11,012,705 5,853,758 FinancingOffering Cost - - - - (125,635)Own shares acquired (2,732,076) (12,887,481) - (5,873,559) -Dividends paid (2,562,555) (3,330,000) (2,775,055) (5,146,209) (5,722,000) Net cash (outflow) from financing (5,294,631) (16,217,481) (2,775,055) (11,019,768) (5,847,635) Increase/(decrease) in cash and cash equivalents 745,553 (11,630) 10,980 (7,063) 6,123 Cash and cash equivalents, at beginning of period 4,409 16,039 5,059 12,122 5,999 Cash and cash equivalents, at end of period 749,962 4,409 16,039 5,059 12,122 Note 1Net income/(loss) for the period 6,419,769 (37,571,605) 3,206,584 (18,783,968) 5,130,653Net amortisation of premiums on available for sale investments 143,076 1,005,200 1,210,901 3,123,879 2,655,987 Realised (gain)/loss on sale of available for sale investments (2,017,445) 14,547,469 - 21,656,763 (5,313) Realised gain in interest rate hedge (135,022) - - - -Loss from impairment - 25,691,600 - - -Purchases of investments (708,062,580) (349,722,450) (1,082,468,323) (55,678,354) (453,612,318)Proceeds from sale of investments 563,718,426 530,854,272 - 1,253,691,106 5,666,667Proceeds from sale of interest rate swaps 135,022 - - - -Principal paydowns 91,071,528 113,805,308 116,471,761 218,359,667 214,429,874Borrowings under reverse repurchase agreements 5,770,442,800 6,685,967,000 5,763,648,000 6,231,988,000 7,229,892,000Repayments under reverse repurchase agreements (5,718,027,800) (6,962,911,000) (4,802,097,000) (7,646,290,000) (7,000,275,000)ReceivablesDecrease/(Increase) in accrued income receivable 835,303 1,083,913 (3,788,108) 5,554,800 (1,364,146)(Increase)/decrease in prepaid expenses (51,465) (94,089) 6,894 31,894 31,459LiabilitiesIncrease/(Decrease) in accrued interest expense 1,588,759 (6,413,748) 6,124,956 (2,042,728) 2,792,308(Decrease)/Increase in accrued expenses payable (20,187) (36,019) 470,370 (598,354) 511,587 Net cash inflow from operating activities 6,040,184 16,205,851 2,786,035 11,012,705 5,853,758 Prodesse Investment LimitedStatement of Changes in Shareholders' Equity(unaudited) 01 January 2006 to 30 September 2006 Share Capital Share Distributable Capital Revaluation Accumulated Cash Total capital redemp- premium reserve Reserve - reserve profits flow tion realised hedge re- gain/(loss) reserve serve on sales and impairment of available for sale investments Balance at 277,506 8,594 50,000,000 214,300,104 (21,651,450) (13,940,391) 2,972,952 (19,500) 231,947,81531 December 2005 Net income - - - - - - 3,206,584 - 3,206,584for the quarter Available for sale investments: Movement in - - - - - (18,537,968) - - (18,537,968)unrealised gain/(loss) on revaluation taken to equity Cash flow 8,991,375 8,991,375hedge reserve Dividends - - - - - - (2,775,055) - (2,775,055)paid Balance at 277,506 8,594 50,000,000 214,300,104 (21,651,450) (32,478,359) 3,404,481 8,971,875 222,832,75131 March 2006 Net loss for - - - - - - (37,571,605) - (37,571,605)the quarter Available for sale investments: Transfer of - - - - (25,691,600) - 25,691,600 - -impairment loss to capital reserve Transfer of - - - - (14,547,469) - 14,547,469 - -realised loss to capital reserve Movement in - - - - - 25,460,498 - - 25,460,498unrealised loss on revaluation taken to equity Cash flow - - - - - - - 1,274,095 1,274,095hedge reserve Buyback of (17,251) 17,251 - (12,887,482) - - - - (12,887,482)shares Dividends - - - - - - (3,330,000) - (3,330,000)paid Balance at 260,255 25,845 50,000,000 201,412,622 (61,890,519) (7,017,861) 2,741,945 10,245,970 195,778,25730 June 2006 Net income - - - - - - 6,419,769 - 6,419,769for the quarter Available for sale investments: Transfer of - - - - 3,370,611 - (3,370,611) - -realised gain to capital reserve Movement in - - - - - 22,731,555 - 22,731,555unrealised loss on revaluation taken to equity Cash flow - - - - - - - (13,370,345) (13,370,345)hedge reserve Buyback of (4,000) 4,000 - (2,732,077) - - - - (2,732,077)shares Dividends - - - - - - (2,562,555) - (2,562,555)paid Balance at 256,255 29,845 50,000,000 198,680,545 (58,519,908) 15,713,694 3,228,548 (3,124,375) 206,264,60430 September 2006 Notes to the financial statements 1. General Information Prodesse Investment Limited is a limited liability Guernsey-incorporatedclosed-end investment company, the investments of which are managed by FixedIncome Discount Advisory Company ("the Investment Manager"). The Company'sshare capital structure consists solely of Ordinary Shares. The Company has alisting on the London Stock Exchange and a listing on the Channel Islands StockExchange. The Company will have an indefinite life but Shareholders will havethe opportunity to vote on its continuation at the Annual General Meeting to beheld in 2010. The Company invests in a portfolio consisting primarily of implied "AAA" ratedmortgage-backed securities on a leveraged basis. The Company's investmentstrategy is to generate net income for distribution from the spread between theinterest income from the portfolio and the cost of borrowing pursuant to reverserepurchase agreements used to finance the portfolio. The Investment Managerwill seek to enhance returns through what it considers an appropriate amount ofleverage. At the date of authorisation of these financial statements, the followingStandard, which has not been applied in these financial statements, was in issuebut not yet effective: IFRS 7 Financial Instruments: Disclosures; and the relatedamendment to IAS 1 on capital disclosures The directors anticipate that the adoption of the above Standard in futureperiods will not have a material impact on the financial statements of theCompany except for additional disclosures on capital and financial instrumentswhen the Standard comes into force for period commencing on or after 1 January2007. 2. Significant Accounting Policies Basis of Accounting The financial statements of the Company have been prepared in accordance withInternational Financial Reporting Standards ("IFRS"), which comprise standardsand interpretations approved by the International Accounting Standards Board ("the IASB"), and International Accounting Standards and Standing InterpretationsCommittee interpretations approved by the International Accounting StandardsCommittee ("IASC") that remain in effect, together with applicable legal andregulatory requirements of Guernsey Law and the Listing Rules of the UK ListingAuthority and Channel Islands Stock Exchange. The financial statements have been prepared on the historical cost basis exceptfor the revaluation of certain financial instruments. The principal accountingpolicies are set out below. The preparation of financial statements inconformity with International Financial Reporting Standards requires the Companyto make estimates and assumptions that affect the reported amounts of assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates. These financial statements are presented in US Dollars because that is thecurrency of the primary economic environment in which the Company operates. Thefunctional currency of the Company is also considered to be US Dollars. Investments The Company invests in securities issued by the United States GovernmentSponsored Enterprises such as the Federal Home Loan Mortgage Corporation ("Freddie Mac"), Federal National Mortgage Association ("Fannie Mae") and theFederal Home Loan Banks ("FHLB") as well as Ginnie Mae, a US GovernmentCorporation. Freddie Mac, Fannie Mae, and FHLB, although chartered and sponsoredby Congress, are not Companies funded by congressional appropriations and thedebt and mortgage-backed securities issued by Freddie Mac, Fannie Mae and FHLBare neither guaranteed nor insured by the United States Government. The payment of principal and interest on the Freddie Mac and Fannie Maemortgage-backed securities are backed by those respective agencies, the paymentof principal and interest on the Ginnie Mae mortgage backed securities arebacked by the full-faith-and-credit of the US Government. Although the Companygenerally intends to hold most of its securities until maturity, it may, fromtime to time, sell any of its mortgage-backed securities as part of its overallmanagement strategy. Accordingly the Company classifies all its mortgage-backedsecurities as available for sale and these are reported at fair value. Expensesincidental to the acquisition of available for sale investments are includedwithin the cost of that investment. Realised and Unrealised Gains and Losses on Investments Unrealised gains or losses arising on the revaluation of investments areincluded in equity. Unrealised losses on investment securities that areconsidered other than temporary, as measured by the amount of decline in fairvalue attributable to factors other than temporary, are recognised as animpairment loss in the income statement and the cost basis of themortgage-backed securities is adjusted. The impairment loss is then transferredto a non-distributable capital reserve in accordance with the Memorandum andArticles of Association of the Company. Realised gains or losses arising on the sale of investments are recognised inthe income statement but will be transferred to a non-distributable capitalreserve in accordance with the Memorandum and Articles of Association of theCompany. When-Issued/Delayed Securities The Company may purchase or sell securities on a when-issued or delayed deliverybasis, including "TBA" securities. TBA Securities are mortgaged-backedsecurities for which details about the underlying mortgages have not yet beenannounced. Securities traded on a when-issued basis are traded for deliverybeyond the normal settlement date at a stated price and yield, and no incomeaccrues to the purchaser prior to delivery. Security Transactions and Investment Income Recognition Security transactions are recorded on the trade date. Realised and unrealisedgains and losses are calculated based on specific identified cost. Interestincome is recorded as earned. Interest income and expense includes amortisationof market discount and premium as calculated using a hybrid methodologyutilising the principles of effective interest method. Other Receivables Other receivables do not carry any interest and are short-term in nature and areaccordingly stated at their nominal value as reduced by appropriate allowancesfor 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 ofthe contractual arrangements entered into. An equity instrument is any contractthat evidences a residual interest in the assets of the Company after deductingall of its liabilities. Financial liabilities and equity are recorded at theproceeds received, net of issue costs. Other Accruals and Payables Other accruals and payables are not interest-bearing and are stated at theirnominal value. Reverse Repurchase Agreements The Company enters into reverse repurchase agreements with qualified third partyfinancial institutions to finance its investment in mortgage-backed securities.The agreements are secured by the value of the Company's mortgage-backedsecurities. A repurchase agreement involves the sale by the Company ofsecurities that it holds with an agreement by the Company to repurchase the samesecurities at an agreed price and date. Such an agreement involves the riskthat the value of the securities sold by the Company may decline in value belowthe price of the securities. Interest on the principal value of reverse repurchase agreements issued andoutstanding is based upon competitive market rates at the time of issuance.When the Company enters into a reverse repurchase agreement, it establishes andmaintains a segregated account with the lender containing securities having avalue not less than the repurchase price, including accrued interest, of thereverse repurchase agreement. Repurchase agreements are treated as collateralised financing transactions andare carried at their contractual amounts, including accrued interest, asspecified in the repurchase agreements. Accrued interest is recorded as aseparate line item. Securities sold subject to repurchase agreements are retained in the financialstatements as available for sale securities and the counterparty liability isincluded in liabilities under repurchase agreements. Derivative Financial Instruments and Hedge Accounting The Company's activities expose it primarily to the financial risks of changesin interest rates. The Company uses interest rate swap contracts to hedge theseexposures. The Company does not use derivative financial instruments forspeculative purposes. The use of financial derivatives is governed by the Company's policies approvedby the board of directors, which provide written principles on the use offinancial derivatives. Changes in the fair value of derivative financial instruments that are designedand effective as hedges of future cash flows are recognised directly in equityand any ineffective portion is recognised immediately in the income statement.The amount in equity is released to income when the forecast transaction impactsprofit 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 thattime, any cumulative gain or loss on the hedging instrument recognised in equityfor cash flow hedges is retained in equity until the forecasted transactionoccurs. If a hedged transaction is no longer expected to occur, the netcumulative gain or loss recognised in equity is transferred to net profit orloss in the period. Taxes The Company is exempt from Guernsey taxation under the Income Tax (ExemptBodies) (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 equitytransaction and costs associated with the establishment of the Company thatwould otherwise have been avoided are taken to the share premium account. 3. Available for Sale Investments Gross Unrealised Gross EstimatedAt 30 September 2006 Amortised Cost Gain Unrealised Loss Fair Value US$ US$ US$ US$ Adjustable rate 755,427,962 1,874,464 (188,366) 757,114,060Fixed rate 1,245,759,709 15,516,503 (1,488,907) 1,259,787,305Total 2,001,187,671 17,390,967 (1,677,273) 2,016,901,365 As at 30 September 2006, all of the assets in the Company's portfolio wereFannie Mae and Freddie Mac mortgage-backed securities, which carry an implied"AAA" rating. During the quarter ended September 30, 2006, the Company did nothave any securities that it deemed to be other-than-temporarily impaired. Mortgage-backed securities are created when mortgages and their attendantstreams of interest and principal payments are pooled to serve as collateral forthe issuance of securities to investors. Interests in mortgage-backed securitiesdiffer from other forms of traditional debt securities, which normally providefor periodic payment of interest in fixed amounts with principal payments atmaturity or specified call dates. Instead, mortgage-backed securities typicallyprovide irregular cash flows consisting of both interest and principal. An investment consideration of any mortgage-backed security is the structure ofthe payment of the cash flow streams from the underlying mortgages to theholders of the mortgage-backed securities. The cash flows can be simply passedfrom the mortgage holder to the investor or they can be structured in a numberof different ways. The market values of the various structures will vary indifferent interest rate or prepayment environments, with the more derivative orcomplex structures (e.g., interest-only or principal-only securities) being moresensitive to movements in interest rates or rates of prepayment. Beyond the basic security of the mortgages and properties that underliemortgage-backed securities, a critical attribute of mortgage-backed securitiesissued by the US Agencies is the credit enhancement that the US Agenciesprovide. The holder of mortgage-backed securities issued or guaranteed by the USAgencies is guaranteed the timely payment of principal and interest. Ginnie Maeis the principal governmental (i.e., backed by the full credit of the USGovernment) guarantor of mortgage-backed securities. Fannie Mae and Freddie Macare the principal US Government-related (i.e. not backed by the full credit ofthe US Government) guarantors. Adjustable-rate and floating-rate mortgage-backed securities in which theCompany may invest include pass-through mortgage-backed securities issued by theUS Agencies backed by adjustable-rate mortgages and Floaters. The interest rateson adjustable-rate mortgage-backed securities are reset at periodic intervals toan increment over some predetermined reference interest rate. There are two maincategories 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 amoving average of mortgage rates. Commonly utilised reference rates include theone-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 inmarket interest rate levels. Others tend to lag changes in market rate levelsand tend to be somewhat less volatile. Adjustable-rate mortgages frequently have upper and lower limits on the interestrates to which a residential borrower may be subject (i) in any reset oradjustment interval and (ii) over the life of the loan. These upper and lowerlimits are commonly known as ''caps'' and ''floors'' respectively. 4. Hedging Instrument The Company uses interest rate swaps to manage its exposure to interest ratemovements. When the Company enters into an interest rate swap, it agrees to paya fixed rate of interest and to receive a variable interest rate, generallybased on the London Interbank Offered Rate ("LIBOR"). The Company's swaps aredesignated as cash flow hedges against the benchmark interest rate riskassociated with the Company's borrowings. At September 30, 2006, the company had interest rate swap agreements of US$603million notional amount in which the Company will pay a weighted average rate of5.23% and have a weighted average receive rate of 5.33%. 5. Reverse Repurchase Agreements At 30 September 2006 the aggregate value of securities pledged by the Companyunder reverse repurchase agreements exceeds the liability under such agreementsby approximately US$52.8 million (approximately 3% of such liability). Theinterest rates on the reverse repurchase agreements at 30 September 2006 rangefrom 5.28% to 5.46% and have maturity dates ranging from one day to 40 days. 6. Net Asset Value The net asset value per Ordinary Share is based on net assets at 30 September2006 and on 25,625,550 Ordinary Shares, being the number of Ordinary Shares inissue at the period end. At 30 September 2006, the reported net asset value per Ordinary Share (beforeexcluding the dividend declared for the quarter ended 30 September 2006) isUS$8.05. At 30 September 2006, the Company had a net asset value per Ordinary Share ofUS$7.93, after including the effect of the dividend declared for the quarter of30 September 2006 of US$3,075,066. This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
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