7th Aug 2006 07:01
Prodesse Investment Limited07 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$8.03) •Company to commence monthly reporting of NAV •Repurchased 1,725,000 shares for cancellation and will continue to repurchase shares when deemed beneficial to the Company. •Portfolio remains 100% implied "AAA" mortgage-backed securities. 1 Based on annualisation of Q2 dividend, an exchange rate of 1.8682 US$ perPound Sterling and a closing price of 396.5p on 31 July 20062 Based on closing share prices of the constituents of the FTSE All Share indexon 31 July 2006 (JCF Datastream).3 Core net income is defined as net income excluding realised and unrealisedgains and losses on securities. Wellington J. Denahan-Norris, Vice Chairman and Chief Investment Officer ofFixed Income Discount Advisory Company, Investment Manager to Prodesse,commented: "Prodesse's second quarter results reflect not only the continuedspread and asset value pressure resulting from the sell-off in the front end ofthe yield curve, but also the effects of the steps we have taken to manage theportfolio through these conditions. We continued to reposition the portfolio inorder to increase the weighted average yield and introduce more floating rateexposure while remaining faithful to our core strategy, our commitment to owningimplied "AAA" assets and management transparency. To this last point, Prodessewill report NAV on a monthly basis to enable investors to have more timelyinformation on portfolio performance." 01 January 2006 08 April 2005Financial Highlights Q2 2006 Q1 2006 to 30 June 2006 to 30 June 2005 ______________________________________________________________ US$ US$Dividend per share 0.10 0.12 0.22 0.20Core net income per average share 0.10 0.12 0.22 0.20Net (loss)/income per average share (1.38) 0.12 (1.25) 0.21Net (loss)/income (37.6m) 3.2m (34.4m) 5.8mNet asset value per share 7.52 8.03 7.52 9.56 GBP Sterling4 GBP Sterling4Dividend per share 5p 7p 12p 11pCore net income per average share 5p 7p 12p 11pNet income/(loss) per average share (74p) 7p (67p) 12pNet income/(loss) (£20.4m) £1.8m (£18.6m) £3.2mNet asset value per share 407.2p 461.8p 407.2p 533.5p 4 Illustration is based upon an exchange rate of 1.8469, 1.739 and 1.7918 US$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 Prodesseinvests in US$ denominated assets only which produce US$ income. Shouldshareholders choose to receive their dividends in GBP Sterling, the Q2 Sterlingdividend will be calculated based upon the prevailing exchange rate on 22 August2006. EnquiriesRob Bailhache / Nick Henderson, Financial DynamicsTel: 020 7269 200 / 020 7269 7114 Sara 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 Monday 7August 2006 at Financial Dynamics, Holborn Gate, 26 Southampton Buildings,London WC2A 1PB. Those analysts wishing to attend, or to register are asked tocontact Nick Henderson 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 562 716. A web cast of the presentation will be available following the meeting atwww.prodesse.co.uk. Company performance For the quarter ended 30 June 2006 Prodesse reported a net loss of US$37.6million (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 monthsended 30 June 2006 the Company reported a net loss of US$34.4 million (periodended 30 June 2005: net income of US$5.8 million) or (US$1.25) per share (periodended 30 June 2005: US$0.21 net income per share). The Company determined that securities with a current face value ofapproximately $1.0 billion with an unrealised loss of $25.7 million, or $0.94per share, would be classified as other-than-temporarily impaired in value at 30June 2006. The decline in the value of these securities is due to increases ininterest rates. All of the Company's assets continue to be Fannie Mae andFreddie Mac mortgage-backed securities which carry an implied "AAA" rating andthe guarantee of the timely payment of principal and interest. In accordancewith accounting policies, the unrealised loss on these securities will berecorded in the income statement and the cost basis of these securities goingforward will reflect their value at 30 June 2006. Additionally, during thesecond quarter $611 million face amount of securities were sold, resulting in arealized loss of approximately $14.5 million, or approximately $0.53 per share. Prodesse reported core net income, defined as net income excluding realised andunrealised gains and losses on securities, of US$2.7 million for the quarterended 30 June 2006 (quarter ended 31 March 2006: US$3.2 million) or US$0.10 pershare (quarter ended 31 March 2006: US$0.12 per share). For the six month periodended 30 June 2006 the Company reported core net income US$5.9 million (periodended 30 June 2005: US$3.2 million) or US$0.22 per share (period ended 30 June2005: US$0.21 per share). The Company delivered a core return on average equity for the quarter and sixmonths ended 30 June 2006 of 5.10% and 5.42%, respectively (quarter ended 31March 2006: 5.64% and period ended 30 June 2005: 9.67%). For the quarter and sixmonths 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 periodended 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 millionCore net income per average share US$0.10 US$0.12 US$0.22 US$0.21Annualised 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 millionNet (loss)/income per average (US$1.38) US$0.12 (US$1.25) US$0.21shareAnnualised RoAE (71.80%) 5.64% (31.69%) 9.67% Portfolio Performance For the quarter and six months ended 30 June 2006 the annualised yield onaverage assets, which is calculated based on the annualized interest income forthe period divided by the average interest earning assets for the period, was5.24% and 5.07%, respectively (quarter ended 30 March 2006: 4.89% and periodended 30 June 2005: 4.01%) and the annualised cost of funds on the averagerepurchase balance was 4.99% and 4.79% (quarter ended 30 March 2006: 4.58% andquarter ended 30 June 2005: 2.67%), which equates to an interest rate spread of0.25% and 0.28%, respectively (quarter ended 30 March 2006: 0.31% and periodended 30 June 2005: 1.34%). At 30 June 2006, the annualized yield on assets was5.90%, after the cost basis was adjusted for impairment charges, and theannualized cost of funds on the repurchase balances, including the effect of theswaps, was 5.24%, which equates to an interest rate spread of 0.66%. The Constant Prepayment Rate, or CPR, on the Company's mortgage-backedsecurities portfolio averaged 15% and 17% for the quarter and six months ended30 June 2006, respectively (quarter ended 30 March 2006: 18% and period ended 30June 2005: 20%). Prepayment speeds on mortgage-backed securities, as reflectedby the CPR vary according to the type of investment, changes in interest rates,conditions in the financial markets, competition and other factors, none ofwhich can be predicted with any certainty. In general, as prepayment speeds onthe Company's mortgage-backed securities portfolio increase, related purchasepremium 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 AverageRepurchase 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 Maeand 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%securitiesFloating-rate mortgage-backed 24% 14% 19% 7% 8%securities Borrowings The ratio of average daily repurchase agreements to equity resulted in leverageof the Company of 9.7:1 and 9.1:1 during quarter and six months ended 30 June2006, respectively (quarter ended 31 March 2006: 8.5:1 and period ended 30 June2005: 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 5.8:1Leverage 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 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. As of 31March 2006 the Company had entered into interest rate swap agreements totallingUS$554 million in notional amount in which the Company will pay an average rateof 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$65,000,000Average 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 (31March 2006: US$8.03), after deducting the current dividends declared for thequarter 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$9.56Dividends declared for the period US$2,602,555 US$3,330,066 US$6,105,055 US$5,722,000NAV per share after deductingdividends 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 1,725,000shares at a weighted average price of US$7.47 per share. The Company currentlyhas authority to undertake a share purchase of up to 3,901,230 shares of theshare capital of the Company and the Board of Directors has approved the use ofon-market purchases of ordinary shares for cancellation at appropriate priceswhen deemed beneficial to the Company. Dividend The Company has declared a dividend for the quarter ended 30 June 2006 ofUS$0.10 per share payable on 31 August 2006 to holders on the register on 18August 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 will be set on 22August 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$0.21Net (loss)/ income per average share (US$1.38) US$0.12 (US$1.26) US$0.21Dividends per share US$0.10 US$0.12 US$0.22 US$0.20 Outlook "Market expectations are still divided on whether the Federal Reserve will pauseat its next meeting on 8 August 2006," said Wellington Denahan-Norris, ChiefInvestment Officer for Prodesse's Investment Manager, FIDAC. "While we believethat after 17 consecutive interest rate tightenings the Fed is at or nearingcompletion of its policy regime, our floating rate exposure in the portfolio,after taking into account the effects of interest rate swaps, stands atapproximately 60%, which should further enhance the earnings potential of aportion of our portfolio in the event short rates continue to rise. Moreover, apause in Fed policy or a move to monetary policy easing would benefitperformance as our cost of funds would stop rising or fall and asset valueswould firm or increase. We continue to use all tools at our disposal in aneffort to manage through the tail end of this unprecedentedly long phase of theinterest rate cycle, and we believe that with the transition to the next phaseinvestors will come to enjoy the type of complete cycle, long-term results ourstrategy has historically delivered." Prodesse Investment Limited Balance Sheet(unaudited) at 30 June 2006, 31 March 2006, 31 December 2005, 30 September2005 and 30 June 2005 31-Dec-05 30-Jun-06 31-Mar-06 (Audited) 30-Sep-05 30-Jun-05 US$ US$ US$ US$ US$ ____________________________________________________________________________ASSETSCurrent assetsAvailable for sale investments 1,946,995,591 2,190,680,570 1,405,412,720 2,688,176,717 2,627,255,210Accrued income receivable 9,055,816 9,853,640 6,228,846 11,644,460 10,559,381Receivable for principal paydowns 5,028,662 7,947,156 10,195,316 13,448,335 8,327,274Receivable 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 5,999Prepaid 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 reservesShare capital:26,025,550 at 30 June 2006, 27,750,550 at 31 March 2006 and31 December 2005, 28,610,000 at30 September 2005 and 30 June2005 at US$ 0.01 260,255 277,506 277,506 286,100 286,100Capital redemption reserve 25,845 8,594 8,594 - -Share premium 50,000,000 50,000,000 50,000,000 50,000,000 50,000,000Distributable reserve 201,412,622 214,300,104 214,300,104 220,173,663 220,299,299Accumulated profits 2,741,945 3,404,481 2,972,952 5,246,367 5,843,027Capital Reserve-Realised (loss)/ gain and impairment on availablefor 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 liabilitiesSecurities purchased payable 134,680,584 - 163,391,316 11,560,141 162,120,786Repurchase agreements 1,706,674,000 1,983,618,000 1,022,067,000 2,436,369,000 2,206,752,000Accrued interest expense 3,220,249 9,633,997 3,509,041 5,551,769 2,759,461Accrued expenses payable 1,376,524 1,412,543 942,173 1,540,527 1,028,940Hedging 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 195,778,257 222,832,751 231,947,815 258,326,995 273,584,933Net 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$__________________________________________________________________________________________________________________ IncomeInterest income 55,823,269 29,233,473 26,589,796 27,307,521 28,394,099 16,231,405Interest 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 ___________________________________________________________________________________ ExpensesManagement, custodian and administration fees 2,490,044 1,210,709 1,279,335 942,468 2,018,214 937,308Other 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 operationson 08 April 2005 Prodesse Investment Limited Cash Flow Statement(unaudited) from 01 January 2006 to 30 June 2006, 01 April 2006to 01 June 2006, 01 January 2006 to 31 March 2006, and 08 April2005 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) fromoperating activities (Note 1) 18,991,886 16,205,851 2,786,035 11,012,705 5,853,758 (270,579,400) ________________________________________________________________________________________________ FinancingNet proceeds from - - - - - 270,585,399offeringOffering 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 cashequivalents (650) (11,630) 10,980 (7,063) 6,123 5,999 Cash and cash equivalents, atbeginning of period 5,059 16,039 5,059 12,122 5,999 - ________________________________________________________________________________________________Cash and cash equivalents, at endof period 4,409 4,409 16,039 5,059 12,122 5,999 ________________________________________________________________________________________________ Note 1Net(loss)/income for the period (34,365,021) (37,571,605) 3,206,584 (18,783,968) 5,130,653 5,843,027Net amortisation of premiums onavailable for saleinvestments 2,216,101 1,005,200 1,210,901 3,123,879 2,655,987 712,000Realised loss/ (gain) on sale ofavailable for saleinvestments 14,547,469 14,547,469 - 21,656,763 (5,313) -Loss from impairment 25,691,600 25,691,600Purchases 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 65,484,813Borrowings under reverse repurchaseagreements 12,449,615,000 6,685,967,000 5,763,648,000 6,231,988,000 7,229,892,000 5,090,251,000Repayments under reverse repurchaseagreements (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 incomereceivable (2,704,195) 1,083,913 (3,788,108) 5,554,800 (1,364,146) (10,256,189)(Increase)/decrease in prepaid expensesLiabilities (87,195) (94,089) 6,894 31,894 31,459 (98,256)(Decrease)/increase in accrued interestexpense (288,792) (6,413,748) 6,124,956 (2,042,728) 2,792,308 2,759,461Increase/(decrease) in accrued expensespayable 434,351 (36,019) 470,370 (598,354) 511,587 1,028,940 ________________________________________________________________________________________________Net cash inflow/ (outflow) fromoperating activities 18,991,886 16,205,851 2,786,035 11,012,705 5,853,758 (270,579,400) ________________________________________________________________________________________________ * commencement ofoperations 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 saleinvestments: Movement in unrealised gain/(loss) onrevaluation taken toequity (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 March2006 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 saleinvestments: Transfer of impairment loss to capital reserve (25,691,600) 25,691,600 - Transfer of realised loss to capital (14,547,469) 14,547,469reserve 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-incorporatedclosed-end investment company, the investments of which are managed by FixedIncome Discount Advisory Company ("the Investment Manager"). The Company's sharecapital structure consists solely of Ordinary Shares. The Company has a listingon 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 Manager willseek 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 related amendment 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 StandingInterpretations Committee interpretations approved by the InternationalAccounting Standards Committee ("IASC") that remain in effect, together withapplicable legal and regulatory requirements of Guernsey Law and the ListingRules of the UK Listing Authority 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 by congressional appropriations and the debt andmortgage-backed securities issued by Freddie Mac, Fannie Mae and FHLB areneither 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 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 in the incomestatement and the cost basis of the mortgage-backed securities is adjusted. 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. Purchasing or selling securities on a when-issued or delayed delivery basisinvolves the risk that the market price at the time of delivery may be lower orhigher than the agreed upon price, in which case an unrealised loss may beincurred. The Company did not transact in when-issued or delayed deliverysecurities during the period ended 30 June 2006. 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. 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 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. Whenthe 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. 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 segmentof business of investing in debt securities, issued by companies operating andgenerating revenue in the United States, and therefore no segmental reporting isprovided. 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) 2,111,723 797,112Administration fee (note 4) 268,076 96,833Custodian fee (note 4) 110,245 43,362 _______________________________________ 2,490,044 937,307 _______________________________________ Other operating expensesDirectors' fees 61,887 35,795Insurance 55,524 24,995Audit fee 86,987 14,341Legal fee 37,192 21,512Regulatory fee 11,855 6,980Other 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 managementpersonnel of the Company. Their remuneration disclosed above is all in respectof short term employee benefits. 4. Investment Management, Accounting and Administration, and Custodian Fees Fixed Income Discount Advisory Company ("FIDAC"), a Delaware corporation servesas the Investment Manager to the Company. Pursuant to the terms of theInvestment Management Agreement, the Investment Manager is paid periodic fees,quarterly in arrears, at a rate equivalent to 0.2 per cent per annum of thevalue of the gross assets of the Company. The Bank of New York serves as the Company's custodian and is paid a monthlyaccounting and administration fee, exclusive of out-of-pocket expenses. TheCustodian is entitled to receive a fee at a rate equivalent to 1 basis point perannum on the value of the gross assets of the Company (plus transactioncharges). RBSI Fund Services (Guernsey) Limited serves as the Company's administrator. TheAdministrator is entitled to a fee calculated on the value of the gross assetsof the Company of 0.04 per cent, per annum on the first US$400 million of valueof gross assets, 0.0225 per cent per annum on the next US$1.6 billion ofvalue of the gross assets and 0.01 per cent per annum on any value of the grossassets in excess of US$2 billion payable monthly in arrears (subject to aminimum 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 inthe 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 OrdinaryShareholders by the weighted average number of ordinary shares outstandingduring 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 canfluctuate and there is no guarantee that the market price of Ordinary Shares inthe Company will reflect fully their underlying Net Asset Value. The Company is also exposed to the market risk on the underlying investments aschanges in overall interest rate levels will affect their value. Foreign Exchange Risk All or substantially all of the Company's assets and liabilities are denominatedin US dollars. The Company accounts for its assets and determines the value ofits Ordinary Shares and of dividends thereon in US dollars. For investorsresident outside the United States or whose functional currency is not the USdollar, fluctuations in the value of the US dollar may affect the value of theirinvestment. The Directors do not hedge foreign exchange risk. Hence theDirectors are of the opinion that the Company is not exposed to significantforeign exchange risk. Notes to the financial statements (continued) Credit Risk The Company is subject to credit risk with respect to its investments inmortgage-backed securities, hedging derivatives and other receivables, bankbalances and cash which represents the Company's maximum exposure to credit riskin relation to financial assets. This risk is mitigated as the Company invests primarily in a portfolio of USresidential mortgage-backed securities created or issued by Fannie Mae, FreddieMac or Ginnie Mae with a targeted (actual or implied) credit rating ofapproximately 'AAA', and, to a lesser extent, other 'AAA'-rated US residentialmortgage-backed securities, US government securities and debentures issued by aUS Agency. In addition, credit risk on liquid funds and derivative financial instruments islimited because the counterparties are banks with high credit ratings assignedby international credit rating agencies. Interest Rate Risk The Company is subject to risks associated with changes in interest rates. Anincrease in the interest payments on the Company's financing relative to theinterest earned on its mortgage-backed securities may adversely affectprofitability. The Company enters into reverse repurchase agreements in order to increase theamount of capital available for investment. The use of leverage has thepotential to magnify the gains or the loss on the Company's investments. The Company may invest in, or sell short, various interest rate derivativeinstruments and futures contracts to reduce the impact of changes in interestrates. Should interest rates move unexpectedly, the Company may not achieve theanticipated benefits of the hedging instruments and may realise a loss. Further,the use of such derivative instruments involves the risk of imperfectcorrelation in movements in the price of the instruments, interest rates and theunderlying hedged assets. The primary interest rate exposures relate to its available for saleinvestments, repurchase agreements, cash balances and interest rate swaps. The Company hedges some of its exposure to floating interest rate payments inrespect of liabilities for reverse repurchase agreements. Liquidity Risk The Company's ability to execute its business strategy depends to a significantdegree on its ability to raise capital via reverse repurchase agreements andalso through interest and paydowns received on its investment portfolio. TheCompany maintains a low cash balance in order to meet short term requirements. The Company's primary source of funds for liquidity consists of net cashprovided by operating activities. Its reverse repurchase agreements are secureddirectly by its investment portfolio. The Company expects that its cash on handand cash flow provided through operations will satisfy its liquidity needs overthe next twelve months. In addition it is expected that further reverserepurchase agreements will be available and entered into to fund additionalinvestment 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 2,704,622,790Proceeds 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 FairAt 30 June 2006 Including Loss on Gain Loss Value Impairment _____________________________________________________________________________ US$ US$ US$ US$ Adjustable rate 649,096,245 735,890 (447,488) 649,384,647Fixed 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 FairAt 30 June 2005 Amortised Cost Gain Loss Value _____________________________________________________________________________ US$ US$ US$ US$ Adjustable rate 1,770,857,314 81,056 (1,619,753) 1,769,318,617Fixed 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 wereFannie 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 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. Notes to the financial statements (continued) 8. Available for Sale Investments (continued) 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. With the continued increase in the Federal Funds rate during the second quarterof 2006, the Company determined that it did not intend to hold certain of itssecurities until maturity and would reposition a portion of its assets. TheCompany recorded an impairment charge of $25.7 million for these securitiesduring the second quarter of 2006. The remaining investments are not consideredother-than-temporarily impaired since the Company currently has the ability andintent to hold the investments for a period of time or to maturity, ifnecessary, sufficient for a forecasted market price recovery up to or beyond thecost of the investments. 9. Current Assets and Current Liabilities The Directors consider that the carrying amount of other receivablesapproximates their fair value. Cash and cash equivalents comprise bank balances held by the Company. Thecarrying amount of these assets approximates their fair value. Other payables principally comprise amounts outstanding on purchases ofinvestments awaiting settlement and ongoing costs. The Directors consider thecarrying amount of other payables approximates to their fair value. 10. 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 June 30, 2006, the company had interest rate swap agreements of US$714million notional amount in which the Company will pay a weighted average rate of5.16% 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 atUS$10,245,969. The swaps are designated and effective as a cashflow hedge andthe 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 underreverse repurchase agreements exceeds the liability under such agreements byapproximately US$51.2 million (approximately 3% of such liability). The interestrates 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 2006and on 26,025,550 Ordinary Shares, being the number of Ordinary Shares in issueat the period end. At 30 June 2006, the reported net asset value per Ordinary Share (beforeexcluding 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 ofUS$7.42, after including the effect of the dividend declared for the quarter of30 June 2006 of US$2,602,555. This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
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