Last checked at 16 Mar 2009 15:03
Prodesse Investment Limited
Annual Report and Financial Statements
for the year ended 31 December 2008
Contents
Corporate Summary and Strategy
Directors and Advisors
Chairman's Statement
Investment Manager's Report
Directors' Report
Independent Auditors' Report
Income Statement
Statement of Changes in Shareholders' Equity
Balance Sheet
Cash Flow Statement
Notes to the Financial Statements
Investment Policy and Investment Restrictions
Glossary
Notice of Annual General Meeting
Form of Proxy
Corporate Summary and Strategy
Company Overview
Prodesse Investment Limited ("Prodesse" or the "Company") is a limited liability Guernsey-incorporated closed-end investment company, the investments of which are managed by Fixed Income Discount Advisory Company ("FIDAC"). The Company was incorporated on 22 February 2005 and in April 2005 completed the initial public offering of its Ordinary Shares, which are listed on The London Stock Exchange and The Channel Islands Stock Exchange.
The new Guernsey Fund Rules relating to authorised and registered funds (the Authorised Closed-Ended Investment Schemes Rules 2008 and the Registered Collective Investment Scheme Rules 2008, (together "the new rules")) became effective from 15 December 2008. All funds in existence as at that date are automatically deemed to be authorised funds but have a transition period of up to 30 April 2009 to write to the GFSC and convert to a registered fund. The Company's Directors at the board meeting on 2 February 2009 indicated their intention to keep the fund authorised.
Investment objective and policy
The investment objective of Prodesse is to generate distributable income yield on net assets (in US dollar terms) of 3.5 per cent. to 5.0 per cent. greater than the yield on the ten-year US Treasury on an annualized basis while preserving net asset value (in US Dollar Terms) over the long term.
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, while seeking to limit exposure to interest rate risk and credit risk. Prodesse invests primarily in a portfolio of US residential mortgage-backed securities created or issued by the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) or the Government National Mortgage Association (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.
Prodesse uses leverage to enhance the returns to shareholders and for this purpose borrows amounts equal to between five and ten times its net assets. Prodesse uses primarily short-term borrowings for the purpose of making investments and to pledge its assets to secure such borrowings. To effect such borrowings in a cost-efficient manner, Prodesse has entered into master repurchase agreements (an agreement effecting a current sale of a security with a concurrent agreement by the seller to repurchase the security at a later date at a higher fixed price reflecting the cost of funds for the term of the agreement) with various major financial institutions.
Investment Manager
The Company is managed by FIDAC, which is registered as an investment adviser with the US Securities and Exchange Commission. FIDAC is a wholly owned subsidiary of Annaly Capital Management, Inc. ("Annaly"), a New York Stock Exchange-listed real estate investment trust which owns and manages a portfolio of mortgage-backed securities.
Formed in 1994, FIDAC is a fixed income investment management company based in New York in the United States which specialises in investing in US Agency mortgage-backed securities and US Treasury securities and managing interest rate-sensitive strategies. FIDAC currently manages assets for private and public funds distributed in Latin America, Europe and the United States. It also manages numerous separate accounts for high net worth individuals and public funds. As at 31 December 2008, FIDAC and Annaly collectively had approximately US$72.4 billion in gross assets under management.
Directors and Advisors
John Edward Hallam (Chairman)
Mr. Hallam is a Fellow of the Institute of Chartered Accountants in England and Wales and qualified as an accountant in 1971. He is a former partner of PricewaterhouseCoopers having retired in 1999 after 27 years with the firm both in Guernsey and in other countries. He is currently chairman of EFG Private Bank (Channel Islands) Ltd, Cazenove Absolute Equity Ltd, M&G Recovery Investment Co Ltd and Partners Group Global Opportunities Ltd as well as being a director of a number of other financial services companies, some of which are listed on the London Stock Exchange. He also serves as Chairman of the Nomination Committee.
Christopher Norman Fish
Mr. Fish retired as the managing director of Close International Private Banking in Guernsey in July 2004 but remains non-executive Chairman of Close International Asset Management Holdings Limited and Close International Bank Holdings Limited. He has spent the past 30 years involved in all facets of offshore private banking including offshore fund administration and investment management. During these years, he held positions as a director of Royal Bank of Canada (Channel Islands) Limited and as the Americas Offshore Head of Coutts where he was responsible for the Bahamas, Bermuda, Cayman and Uruguay offices. In 1997 he was appointed to senior client partner for Coutts Offshore before taking up his last position in 1998. Mr. Fish serves as chairman of the Audit Committee.
Ronald Daniel Kazel
Mr. Kazel is Managing Director for Annaly Capital Management, Inc. and FIDAC. Mr. Kazel joined the companies in December 2001. Prior to joining the companies, Mr. Kazel was a Senior Vice President in Friedman Billings Ramsey's financial services investment banking group. During his tenure there, he was responsible for structuring both the private and public equity offerings for Annaly in 1997. From 1991 to 1996, Mr. Kazel served as a Vice President at Sandler O'Neill & Partners where he was involved in asset/liability management and fixed-income analysis and sales. Mr. Kazel has a Bachelor of Science in Finance and Management from New York University.
Talmai Phillip Morgan (Senior Independent Director)
Mr. Morgan qualified as a Barrister in 1976. He moved to Guernsey in 1988 where he worked for Barings and then for the Bank of Bermuda as Managing Director of Bermuda Trust (Guernsey) Limited. From January 1999 to June 2004, he was Director of Fiduciary Services and Enforcement at the Guernsey Financial Services Commission (Guernsey's financial regulatory agency). Whilst a regulator, he was involved in Working Groups of the Financial Action Task Force and the Offshore Group of Banking Supervisors. From July 2004 to May 2005, he was Chief Executive of Guernsey Finance which is the official body for the promotion of the Guernsey finance industry. He is a Director of a number of investment companies, which are listed on the London Stock Exchange.
Christopher Wade Sherwell
Mr. Sherwell is a non-executive director of a number of companies and investment funds. He moved to Guernsey in 1993 to become investment director at Schroders (CI) Limited and became managing director from April 2000 until January 2004. At Schroders (CI) Limited he was routinely involved in the oversight of fixed income and equity portfolios managed for institutional and private clients. Prior to 1993 he worked as Far East regional strategist with Smith New Court Securities in London and then Hong Kong. He was previously a journalist, working for the Financial Times. He serves as chairman of the Management Engagement Committee.
| Administrator, Company Secretary, Registrar and Registered Office BNP Paribas Fund Services (Guernsey) Limited BNP Paribas House St Julian's Avenue St Peter Port Guernsey GY1 1WA | Investment Manager Fixed Income Discount Advisory Company 1211 Avenue of the Americas Suite 2902 New York, New York 10036 USA |
| Custodian
The Bank of New York One Wall Street 25th Floor New York, New York 10286 USA | Principal Bankers The Bank of New York One Wall Street 25th Floor New York, New York 10286 USA |
| Legal Adviser to the Company (as to English and US law) Dechert LLP 160 Queen Victoria Street London EC4V 4QQ | Legal Adviser to the Company (as to Guernsey law) Ogier Ogier House St Julian's Avenue St Peter Port Guernsey GY1 1WA |
| Auditors Deloitte LLP Regency Court Glategny Esplanade St Peter Port Guernsey GY1 3HW | CREST Services Provider Computershare Investor Services (Channel Islands) Limited Ordnance House 31 Pier Road St Helier Jersey JE4 8PW |
| Corporate Brokers Merrill Lynch International Merrill Lynch Financial Centre 2 King Edward Street London EC1A 1HQ | |
| Daniel Stewart & Co Plc Becket House 36 Old Jewry London EC2R 8DD |
Chairman's Statement
I welcome shareholders to the 2008 Annual Report and financial statements of Prodesse Investment Limited.
If 2007 was a year for the history books, 2008 deserves an edition all to itself. At this time last year we wrote of uncertain times ahead, market implosions, and being on the brink of recession. In 2008 the US lost almost three million jobs, the home foreclosure rate nearly doubled, home resale prices tumbled 15% and The National Bureau of Economic Research officially declared that America is in a recession.
Policy makers in the United States and around the world belatedly-but forcefully- jumped into action to avert an economic disaster from occurring. The US Treasury was busy, arranging for the US$700 billion Troubled Asset Relief Program, and putting Fannie Mae and Freddie Mac into conservatorship when the two publicly traded companies began to show balance sheet weakness and investors began to lose confidence in the entities.
The Federal Reserve was among the first responders, as it slashed rates and instituted several different liquidity programs. Of direct importance to Prodesse was the Federal Reserve's decision to aggressively lower the Federal Funds Target Rate. During 2008 the Federal Reserve lowered the rate from 4.25% to a range of 0% to 0.25%, an unprecedented level. The effects of this move were evident, albeit in muted fashion, in the Company's portfolio. In the quarter ended 31 December 2008 the net interest rate spread in the portfolio was 1.32%; in the prior year comparable quarter the net interest rate spread was 0.88%.
The Board of Directors believes that the Company's Investment Manager, FIDAC, executed its investment strategy to the best of its abilities in 2008. The Manager actively lowered gearing throughout the year, from 9.3:1 at year-end 2007 to 7.8:1 at the end of 2008, while wide spreads enabled the Company to maintain a strong dividend. Prodesse declared US$0.87 in dividends for 2008, a 29.9% increase from the US$0.67 declared in 2007. The fourth quarter dividend of US$0.19 per share equates to an annualized dividend yield of 17.38%1. Prodesse continues to own only US Government Agency securities which, despite their actual or implied "AAA" rating and virtual lack of credit risk, were nevertheless affected by volatile market conditions. The NAV stood at US$6.28 and US$7.70 at 31 December 2008 and 31 December 2007, respectively. Nonetheless, the Company's shares produced a total return of (10.3%) for the year versus (29.8%) for the FTSE All-Share Index and (43.8%) for the FTSE Small Cap Index.
We expect short-term rates will remain low as the weakness in the US economy persists in the coming year, and believe policymakers will continue to be vigilant in their efforts to avert a financial crisis. The Company remains confident in the credit quality of the portfolio and will continue to cautiously pursue the investment strategy in the best interest of our shareholders.
As in 2006 the Board again received the support of virtually all non-dissident shareholders at the EGM held in December 2008. As we reported at the time, 92.3% of Prodesse shareholders participated in the vote and all the resolutions were duly rejected by shareholders. We believe this demonstrates that the majority of investors understand the risks of the Company's investment strategy as well as its potential performance through a wide range of interest rate environments. However, subsequent to year end the Requisitionist of the EGM held in 2008 put forth a substantially similar requisition for an EGM dated 24 February 2009. The date of this EGM will be 7 April 2009 further details of which are provided in the Directors' Report.
I thank you for your continued support
John E Hallam
Chairman
13 March 2009
1 Based on the annualized equivalent of the fourth quarter dividend, an exchange rate of 1.4575 US$ per Pound Sterling, and a closing price per share of 300.0p on 31 December 2008.
Investment Manager's Report
Overview
In 2008, the financial markets experienced significant volatility and price dislocation as a result of the rapid deterioration in the stability of financial institutions. Markets ended the year looking much different than they had at the beginning: Two leading investment banks, Bear Stearns and Lehman Brothers, came to the end of their corporate lives, the largest insurance company in the world, AIG, was nationalized and Fannie Mae and Freddie Mac were placed in conservatorship. Policymakers in the US and around the world took aggressive steps to manage the crisis, installing a wide range of facilities to restore liquidity to the markets and slashing benchmark lending rates. In the US, the Federal Reserve slashed its Federal Funds target rate to the lowest in history, a range of 0% to 0.25%.
Through this environment, the portfolio of Prodesse benefitted from its strategy of investing only in mortgage-backed securities guaranteed by US Government Agencies. Prodesse uses leverage to enhance returns to investors using primarily short-term borrowings in the repurchase markets whose rates are based on Fed Funds. The Company prudently reduced gearing in 2008 as it navigated this volatile period. The floating rate exposure in the portfolio as well as the reduced cost of borrowing created a favourable net interest rate spread and allowed Prodesse to maintain a strong dividend.
Investment Portfolio
During the year the Company sold approximately US$1,022.1 million of MBS resulting in net realized gain of US$7.1 million, and purchased approximately US$738.9 million, in addition to entering into interest rate swap agreements, which at year end totalled US$563.25 million in notional amount. The purchases and sales were consistent with the Investment Manager's Barbell Strategy. The FIDAC MBS Barbell Strategysm seeks to utilize the principal and interest cash flows of US Agency floating, adjustable and fixed-rate MBS to mitigate the primary risk of the company, interest rate risk. By maintaining an approximate two-thirds adjustable and floating-rate securities and one-third fixed-rate security balance, after taking into account the notional value of interest rate swaps, the portfolio is able to manage through a range of US interest rate environments.
| Summary details of the ten largest investments as at 31 December 2008 | |||
| Description | Market Value US $'000s | % of Portfolio | Current Coupon |
| FNR 2005-47 FG | 61,443 | 3.59% | 0.97% |
| FN 987020 CL 30YR 08/01/2038 | 42,482 | 2.49% | 6.00% |
| FN256233 | 37,997 | 2.22% | 6.00% |
| GNMA 1 POOL 673214 FLT 10/15/2038 | 37,195 | 2.18% | 6.50% |
| FN 924848 FLT 09/01/2037 | 37,129 | 2.17% | 6.50% |
| FG A48575 | 34,725 | 2.03% | 6.00% |
| FN 981043 FLT 04/01/2038 | 34,289 | 2.01% | 6.50% |
| FN 256492 | 32,530 | 1.90% | 6.00% |
| FN 850642 | 32,098 | 1.88% | 6.00% |
| FHR 2961 FC | 32,030 | 1.87% | 1.65% |
At 31 December 2008 the Company's net asset value per ordinary share was US$6.28 (before excluding the dividend declared for the quarter ended 31 December 2008), reflecting a decrease of 18.4% from 31 December 2007. While certain components of the Company's portfolio increased in value as US Treasury rates decreased, this was offset by the widening of mortgage spreads relative to their US Treasury benchmark and the decrease in value of the Company's interest rate swaps, or hedges.
| % of Portfolio | 31 December 2008 | 30 September 2008 | 30 June 2008 | 31 March 2008 |
| Fixed-rate MBS | 49% | 49% | 55% | 54% |
| Adjustable-rate MBS | 24% | 24% | 19% | 16% |
| Floating-rate MBS | 27% | 27% | 26% | 30% |
| Notional amount of interest rate swap | 33% | 35% | 28% | 33% |
In the quarter ended 31 December 2008 the annualized cost of funds in the portfolio was 3.92% while the annualized yield on average assets was 5.24%, resulting in a net interest rate spread of 1.32%; in the prior year comparable quarter the annualized cost of funds was 4.95% and the annualized yield on average assets was 5.83%, for a net interest rate spread of 0.88%.
| 31 December 2008 | 30 September 2008 | 30 June 2008 | 31 March 2008 | |
| Average Yield on Average Assets | 5.24% | 5.21% | 5.02% | 5.57% |
| Annualised Cost of Funds on Average Balance | 3.92% | 3.73% | 3.66% | 4.35% |
| Interest Rate Spread | 1.32% | 1.48% | 1.36% | 1.22% |
Liability Management and Leverage
The amount of leverage used during the year steadily decreased, ending the year at 7.8 debt-to-equity. The level of leverage will rise and fall accordingly as the value of the Company's assets increases or decreases, as well as be affected by the purchase or sale of assets. During the period the Investment Manager prudently applied leverage as the Company navigated a particularly volatile market environment.
The Company continues to utilize primarily short-term borrowings through the use of reverse-repurchase agreements and currently maintains such agreements with 14 counterparties. The reverse repurchase markets for US Agency MBS continues to be the most readily available and cost-efficient means of borrowings for the Company.
| 31 December 2008 | 30 September 2008 | 30 June 2008 | 31 March 2008 | |
| Average Leverage During Period | 8.5 | 8.4 | 8.3 | 9.6 |
| Leverage at Period End | 7.8 | 8.2 | 8.2 | 8.4 |
| Repurchase Agreements at Period End (US$000's) | 1,515,351 | 1,687,721 | 1,776,586 | 1,628,689 |
The Company utilized interest rate swap agreements to help manage the risks associated with its floating rate liabilities and the market value movements of its securities. During the year the Company terminated $173.8 million notional amount of interest rate swap agreements, resulting in a loss of $6.8 million, and entered into interest rate swap agreements totally $50.0 million in notional amount which resulted in a year end balance of $563 million.
| 31 December 2008 | 30 September 2008 | 30 June 2008 | 31 March 2008 | |
| Notional Amount (US$000,000's) | 563 | 601 | 560 | 588 |
| Average Pay Rate | 4.96% | 4.98% | 5.13% | 5.14% |
| Average Receive Rate | 1.08% | 2.79% | 2.47% | 2.84% |
Due to the volatility of the credit markets, it is not always practical to match the pricing dates of both the interest rate swaps and the repurchase agreements and the Company may not receive the most desirable rates by exactly matching the terms. As a result, the Company de-designated interest rate swaps as cash flow hedges effective 1 October 2008. The Company still considers the use of interest rate swaps beneficial as an economic hedge against increased funding cost risk. As a result of the cashflow hedge de-designation, market value fluctuations of the interest rate swaps are reflected in the income statement, rather than as previously reported in the balance sheet. Consequently, the income statement for the fourth quarter of the year reflects a loss, even though no losses were realized during the quarter.
Investment Management
We expect that financial markets will continue to be volatile in 2009. Global policy makers have taken extreme actions in their efforts to keep markets from experiencing Great Depression scenarios. As the effects of fiscal and monetary policy play out in the market, we believe that Prodesse's strategy of investing in mortgage-backed assets which are effectively guaranteed by the US Federal Government will continue to benefit shareholders.
Fixed Income Discount Advisory Company
13 March 2009
Directors' Report
The Directors present their Annual Report and the audited financial statements for the year ended 31 December 2008. The comparative figures are for the year ended 31 December 2007.
The Directors have prepared these financial statements in compliance with the provisions of the Companies (Guernsey) Law, 1994 as permitted by The Companies (Transitional Provisions) (No. 2) Regulations, 2008.
Incorporation and Regulation
Prodesse Investment Limited (the "Company") was incorporated in Guernsey, Channel Islands on 22 February 2005 and commenced operations on 8 April 2005.
On 6 April 2005 the Company's Ordinary Shares were admitted to the Official List of The London Stock Exchange and The Channel Islands Stock Exchange. On 22 November 2005 the currency in which the shares are quoted was changed from US Dollars to Sterling.
The new Guernsey Fund Rules relating to authorised and registered funds (the Authorised Closed-Ended Investment Schemes Rules 2008 and the Registered Collective Investment Scheme Rules 2008, (together "the new rules")) became effective from 15 December 2008. All funds in existence as at that date are automatically deemed to be authorised funds but have a transition period of up to 30 April 2009 to write to the GFSC and convert to a registered fund. The Company's Directors at the board meeting on 2 February 2009 indicated their intention to keep the fund authorised.
Principal Activity
The principal activity of the Company is to carry on business as an investment company. Further information on the Company's activities is included in the Corporate Summary and Strategy section.
Review of Business
The Company's net profit for the year ended 31 December 2008 amounted to US$4.4 million (2007: US$21.5 million) equivalent to US$0.15 (2007: US$0.78) per Ordinary Share. As at 31 December 2008, the Company's shareholders' equity was US$194,540,359 (2007: US$216,769,682) or US$6.28 (2007: US$7.70) per Ordinary Share. After including the effect of dividends declared for the quarter ended 31 December 2008 of US$0.19, the reported net asset value per Ordinary Share is US$6.09 (2007: US$7.49).
Dividends
During the year, three interim dividends relating to the current year have been paid. The first interim dividend of US$0.22 per share was paid on 6 June 2008. The second interim dividend of US$0.23 per share was paid on 29 August 2008. The third interim dividend of US$0.23 per share was paid on 28 November 2008. All dividends are declared and paid as interim dividends. A further interim dividend of US$0.19 per share, in respect of the final quarter of 2008 was declared on 10 February 2009 and is payable on 11 March 2009. The Directors do not therefore recommend a final dividend.
Administrator, Secretary and Custodian
BNP Paribas Fund Services (Guernsey) Limited, was appointed as Administrator and Company Secretary on 5 April 2005. The Bank of New York is the sub-Administrator of the Company. The Bank of New York was appointed as custodian on 5 April 2005.
Share Capital
The Company issued 2,816,500 Ordinary Shares of US$0.01 on 11 April 2008 at £3.68 each raising US$20.5 million. The issue costs associated with the issue amounted to US$617,000.
Authority to Buy Back Shares
The Company currently has authority to undertake a share purchase of up to 14.99% 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 which will enhance net asset value.
Directors
There have been no changes in Directors during the year.
The following Directors, including persons connected with them, held the following number of Ordinary Shares at 31 December 2008:
| Director | Number of Ordinary Shares | Percentage (%) |
| J Hallam | 12,876 | Less than 0.1 |
| C Fish | 2,592 | Less than 0.1 |
| T Morgan | 3,217 | Less than 0.1 |
| C Sherwell | 3,218 | Less than 0.1 |
Each of the Directors has signed a letter of appointment with the Company setting out the terms of their appointment. The basic fee payable to each independent non-executive director is at a rate of £20,000 per annum, except for the Chairman who receives £25,000 per annum.
None of the Directors had a service contract with the Company during the period and accordingly a Director is not entitled to any minimum period of notice or to compensation in the event of their removal as a Director.
Substantial Shareholdings
Based upon information deemed to be reliable as provided by the Company's registrar, as at 5 March 2009, the following shareholders showed ownership of 3% or more of the issued Ordinary Shares of the Company.
| Number of Ordinary Shares | Percentage (%) | |
| Vidacos Nominees Limited (2303) | 8,960,218 | 28.92 |
| Roy Nominees Limited (845000) | 2,896,661 | 9.35 |
| Nortrust Nominees Limited (TDS) | 2,152,859 | 6.95 |
| Nutraco Nominees Limited | 1,750,000 | 5.65 |
| HSBC Global Custody Nominee (UK) Limited (981648) | 1,280,000 | 4.13 |
| Chase Nominees Limited | 1,108,855 | 3.58 |
| Chase Nominees Limited (30521) | 1,105,815 | 3.57 |
| The Bank of New York (Nominees) Limited (RUIF) | 979,986 | 3.16 |
Notifications of Shareholdings
On 5 March 2009 the Company had been notified, in accordance with chapter 5 of the Disclosure and Transparency Rules (which covers the acquisition and disposal of major shareholdings and voting rights), of the following voting rights as a shareholder of the Company. When more than one notification has been received from any shareholder only the latest notification is shown.
| Date | Number of Ordinary Shares | Percentage (%) | |
| Henderson High Income Trust Plc | 12/02/08 | 900,000 | 3.19 |
| F&C Asset Management plc | 17/04/08 | 2,926,357 | 9.45 |
| Artemis Investment Management Limited | 26/06/08 | 2,627,563 | 8.48 |
| Laxey Partners Limited | 24/11/08 | 0 | 0.00 |
| Henderson Global Investors | 27/11/08 | 600,819 | 1.93 |
| Ruffer LLP | 05/02/09 | 8,119,777 | 26.20 |
Auditors
On 1 December 2008, Deloitte & Touche LLP changed its name to Deloitte LLP. A resolution for the re-appointment of Deloitte LLP as auditors will be proposed at the forthcoming Annual General Meeting.
Corporate Governance Principles
The Directors are committed to ensuring that high standards of corporate governance are maintained and have made it Company policy to comply with best practice on corporate governance, wherever the Directors believe it is relevant and appropriate to the Company. However the Company has availed itself of an exemption under the Listing Rules not to comply with the "Combined Code" (i.e. the Code of Best Practice published by the Committee on the Financial Aspects of Corporate Governance) as it is a Guernsey registered company. The Company complies with the corporate governance guidelines issued by the Guernsey Financial Services Commission on 10 December 2004, and the underlying principles are the same as those of the Combined Code. In addition, the Directors, in accordance with best practice, comply with the Combined Code provisions wherever thought appropriate.
Board Responsibilities
The Board comprises five non-executive directors all of whom, with the exception of Mr Kazel, are independent of the Investment Manager. As it has no employees of its own the Company does not have a Chief Executive.
The Company holds at least four Board meetings per year, at which the Directors review the Company's investments and all other important issues to ensure control is maintained over the Company's affairs. The Board also receives full management accounts.
The Board has formalised arrangements under which Directors, in the furtherance of their duties, may take independent advice at the Company's expense. The Directors have access to the advice and services of the Company Secretary through its appointed representatives who are responsible to the Board for ensuring that Board procedures are followed and that applicable rules and regulations are complied with.
To enable the Board to function effectively and allow Directors to discharge their responsibilities, full and timely access is given to all relevant information.
The Company's Articles require that all directors seek re-election every three years. Mr J Hallam and Mr R Kazel retire by rotation at this time and, being eligible, offer themselves for re-election at the forthcoming Annual General Meeting.
Relations with Shareholders
The Directors are always willing to consider representations from shareholders concerning the management of any aspect of the Company's affairs and such representations may be raised either through the offices of the Company Secretary or at the Annual General Meeting.
The Investment Manager has an active programme of communication with major investors and analysts both to provide information and to understand concerns. The Board requires the Investment Manager to keep it advised of issues raised.
Board Committees
The Board has established the following committees:
Audit Committee - Chaired by Mr C Fish and with Mr J Hallam, Mr T Morgan and Mr C Sherwell as members.
The Audit Committee met six times in 2008 with the duties being, inter alia:
To review and make recommendations to the Board on the appointment and remuneration of the Company's auditors, the scope of the audit, any questions of resignation or dismissal of the auditors and to approve the auditor's remuneration and terms of engagement.
To oversee the independence of the auditors particularly as it relates to the provision of both audit and non-audit services.
The Audit Committee is required to report any findings to the Board.
Management Engagement Committee - Chaired by Mr C Sherwell and with Mr C Fish, Mr J Hallam and Mr T Morgan as members.
The Management Engagement Committee met once in 2008, with the duties being, inter alia:
To review the terms of the Management Agreement;
To review the performance of the investment manager relative to any agreed benchmark;
To review any breaches by the investment manager; and
To review the standards of any administrative or company secretarial services provided.
Nomination Committee - Chaired by Mr J Hallam and with Mr C Fish, Mr T Morgan, Mr R Kazel and Mr C Sherwell as members.
The function of the Nomination Committee is to lead the process for Board appointments and make recommendations to the Board. The committee met once in the year.
Board meetings
Full Board meetings take place at least quarterly. In between its regular quarterly meetings, the Board has also met on a number of occasions during the year to address specific issues. The table below shows the number of Board Meetings during the year and the Directors attendance:
| Quarterly Board Meetings | Adhoc Board Meetings | Audit Committee Meetings | Management Engagement Committee Meetings | Nomination Committee Meetings | |
| J Hallam | 4 out of 4 | 5 out of 5 | 5 out of 6 | 1 out of 1 | 1 out of 1 |
| C Fish | 4 out of 4 | 4 out of 5 | 6 out of 6 | 1 out of 1 | 1 out of 1 |
| R Kazel | 4 out of 4 | 4 out of 5 | N/A | N/A | 1 out of 1 |
| T Morgan | 4 out of 4 | 4 out of 5 | 6 out of 6 | 1 out of 1 | 1 out of 1 |
| C Sherwell | 4 out of 4 | 5 out of 5 | 6 out of 6 | 1 out of 1 | 1 out of 1 |
Mr Kazel is not a member of the Audit Committee but he may attend meetings if invited to do so by the Chairman of that committee.
Internal Control and Financial Reporting
The Directors acknowledge that they are responsible for establishing and maintaining the Company's system of internal control and reviewing its effectiveness. Internal control systems are designed to manage rather than eliminate the failure to achieve business objectives and can only provide reasonable but not absolute assurance against material misstatements or loss.
The Directors review not just internal controls but all controls including operations, compliance and risk management. The key procedures which have been established to provide internal control are:-
Investment management is provided by FIDAC. The Board is responsible for setting the overall investment policy and monitors the action of the Manager at regular Board meetings. Administration and company secretarial services (including Registrar services) are provided by BNP Paribas Fund Services (Guernsey) Limited ("BNPFS"). Custody of assets is undertaken by The Bank of New York ("BONY"). The Board reviews the BONY internal controls report, SAS 70 report, and also receives regular compliance reports from the Administrator.
The duties of investment management, accounting and the custody of assets are segregated and the procedures of the individual parties are designed to complement each other.
The Board considers the arrangements for the provision of investment management and other services to the Company on an ongoing basis and a formal review is conducted annually. As part of this review the Board considered the quality and continuity of the personnel assigned to handle the Company's affairs, the investment process and the results achieved to date. As noted in the Chairman's and Investment Manager's report, the performance of the Company over the period has been impacted by market conditions. However, in line with the Company's objective, the Board places greater importance on the manager's ability to deliver long-term performance.
The non executive Directors of the company clearly define the duties and responsibilities of their agents and advisers whose appointment is made by the Board after due consideration. The Board monitors the ongoing performance of such agents and advisers.
FIDAC, BONY and BNPFS maintain their own systems of internal control, on which they report to the Board. The Company, in common with other investment companies, does not have an internal audit function. The Board has considered the need for an internal audit function, but because of the internal control systems in place by its service providers, has decided to place reliance on their systems and internal control procedures.
The systems are designed to ensure effectiveness and efficient operation, internal control and compliance with laws and regulations. In establishing the systems of internal control, regard is paid to the materiality of relevant risks, the likelihood of costs being incurred and costs of control. It follows therefore that the systems of internal control can only provide reasonable but not absolute assurance against the risk of material misstatement or loss.
Going Concern
The Directors believe it is appropriate to adopt the going concern basis in preparing the financial statements as, after due consideration, the Directors consider that the Company has adequate resources to continue in operational existence for the foreseeable future. Whilst the Company is reliant on the availability of short term financing, currently in the form of repurchase agreements, the directors believe that this form of financing will remain available to the Company for the foreseeable future. (See also liquidity risk disclosures in note 11(e)). Subsequent to year end, the Board received a requisition for an EGM from the same party who put forth resolutions for the 4 December 2008 EGM where such resolutions were defeated. The Directors will be convening an EGM on 7 April 2009, and a circular to shareholders outlining the resolutions and the Directors unanimous recommendation to vote against all resolutions, was sent to Shareholders on 24 February 2009. The requisition calls for a the removal of certain directors or the Company and appointment of the Requisitionist's selected directors and the requirement for the Directors to "evaluate all avenues to ensure that the intrinsic value of the Company is better reflected in the share price and thereby maximise returns to shareholders, such avenues to include without limitation steps to improve the liquidity and marketability of the Company's shares, the possible implementation of a share buy-back scheme, the creation of a liquidating pool of assets for interested shareholders and an orderly sale of all or part of the Company's underlying investments and thereafter to implement such steps as they consider reasonable necessary to achieve this stated objective."
At the EGM on 4 December 2008 92.3% of the Company's shares voted and, excluding the shares of the Requisitionists (who currently hold 26% of the voting rights of the Company), 95.6% of those shares voted against the resolutions. The Board believes that this recent vote, soundly defeating the resolutions, proved that the vast majority of shareholders do not desire a change and believe that the Company's Directors continue to act in the Shareholder's best interests. Despite the continued turbulent capital markets since the previous EGM, the Prodesse shares have produced a total shareholder return of 12.6% in comparison to the FTSE All Share, which was down 5.7% through 23 February 2009.
The Directors again believe the latest resolutions will be defeated and, having regard to the liquidity of the Company as described in note 11 to the financial statements, consider it appropriate to prepare the financial statements on a going concern basis.
Directors' Remuneration Report
The Board has prepared this report in line with the corporate governance practice disclosure.
Directors consideration
The Board is comprised entirely of non-executive Directors and considers, as a whole, the Directors' remuneration. The Board has not been provided with advice or services by any person in respect of its consideration of the Directors' remuneration although they review, from time to time, the fees paid to the Boards of Directors of other investment companies.
Policy on Directors' remuneration
The Board's policy is that the remuneration of the Directors should reflect the experience of the Board as a whole and be fair and comparable to that of other similar investment companies. It is intended that this policy will continue for the year ended 31 December 2009 and subsequent years.
The Company's policy is for the Directors to be remunerated in the form of fees, payable quarterly in arrears, to the Director personally. The Company's policy is that fees payable to the Directors should reflect the time spent by them on the Company's affairs and should be sufficient to enable candidates of high calibre to be recruited and retained. The non-executive Directors are not eligible for bonuses, pension benefits, share options, long term incentive schemes or other benefits. The Company's Articles of Association limit the aggregate fees payable to Directors to £100,000 per annum.
None of the Directors has a contract of service and a Director may resign by notice in writing to the Board at any time; there are no set notice periods. The Articles of Association provide that, at the Annual General Meeting each year, one third of the Directors for the time being (rounded down if not a whole number) shall be subject to retirement by rotation.
Directors' and officers' liability insurance cover is in place in respect of the Directors.
Directors fees
| 2008 | 2007 | |
| US$'000 | US$'000 | |
| Chairman: | ||
| John E Hallam | 51 | 48 |
| Directors: | ||
| Christopher N Fish | 41 | 38 |
| Talmai P Morgan | 41 | 38 |
| Christopher W Sherwell | 41 | 38 |
| Total | 174 | 162 |
Directors' Responsibilities
The Directors are responsible for preparing the Annual Report and Financial Statements for each financial year which give a true and fair view of the state of affairs of the Company as at the end of the financial year and of the net income or loss for that year in accordance with International Financial Reporting Standards and are in accordance with applicable laws.
International Accounting Standard 1 requires that financial statements present fairly for each financial year the Company's financial position, financial performance and cash flows. This requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the International Accounting Standards Board's "Framework for the Preparation and Presentation of Financial Statements". In virtually all circumstances, a fair presentation will be achieved by compliance with all applicable IFRSs.
Directors are also required to:
properly select and apply accounting policies;
present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; and
provide additional disclosures when compliance with the specific requirements of IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the Company's financial position and financial performance.
The Directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Company and to enable them to ensure that the Financial Statements comply with The Companies (Guernsey) Law, 1994. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The Company's Directors are responsible for the maintenance and integrity of the Company website. Legislation in the United Kingdom and in Guernsey governing the preparation and dissemination of financial statements differs from legislation in other jurisdictions.
Directors' Responsibilities Statement
We confirm to the best of our knowledge:
1. the financial statements, prepared in accordance with International Financial Reporting Standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and
2. the management report, which is incorporated in the Directors' report and Investment Manager's Report, includes a fair review of the development and performance of the business and the position of the Company together with a description of the principal risks and uncertainties it faces.
By order of the Board
John E Hallam Christopher W Sherwell
Director Director
13 March 2009 13 March 2009
Independent Auditors' Report to the Members of Prodesse Investment Limited
We have audited the financial statements of Prodesse Investment Limited (the "financial statements") for the year ended 31 December 2008 which comprise the income statement, the statement of changes in shareholders' equity, the balance sheet, the cash flow statement and the related notes 1 to 21. These financial statements have been prepared under the accounting policies set out therein.
This report is made solely to the Company's members, as a body, in accordance with section 64 of The Companies (Guernsey) Law, 1994. Our audit work has been undertaken so that we might state to the Company's members those matters we are required to state to them in an auditor's report and for no other purpose. To the fullest extent permitted by Law, we do not accept or assume responsibility to anyone other than the Company and the Company's members as a body, for our audit work, for this report, or for the opinions we have formed.
Respective Responsibilities of Directors and Auditors
The Directors' responsibilities for preparing the annual report and the financial statements in accordance with International Financial Reporting Standards and applicable Guernsey Law are set out in the statement of Directors' responsibilities. Our responsibility is to audit the financial statements in accordance with relevant Guernsey legal and regulatory requirements and International Standards on Auditing (UK and Ireland).
We report to you our opinion as to whether the financial statements give a true and fair view in accordance with the relevant financial reporting framework and are properly prepared in accordance with The Companies (Guernsey) Law, 1994. We also report if, in our opinion, the directors' report is not consistent with the financial statements, if the company has not kept proper accounting records or if we have not received all the information and explanations we require for our audit.
We read the other information contained in the annual report and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information.
Basis of Audit Opinion
We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Company's circumstances, consistently applied and adequately disclosed. We are not required to review any Corporate Governance disclosures required by The Listing Rules of the Financial Services Authority as the Company has availed itself of an exemption, as an overseas Company, from the requirement to publish a statement of compliance with The Combined Code.
We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view, in accordance with International Financial Reporting Standards, as issued and adopted by the International Accounting Standards Board, of the state of the Company's affairs as at 31 December 2008 and of the Company's profit for the year to 31 December 2008 and have been properly prepared in accordance with The Companies (Guernsey) Law, 1994.
Deloitte LLP
Chartered Accountants
Guernsey, Channel Islands
13 March 2009
Income Statement
For the year ended 31 December 2008
|
| Notes | 2008 | 2007 | |
| US $'000 | US $'000 | |||
| Income: | ||||
| Interest income | 5 | 103,638 | 130,149 | |
| Interest expense | 6 | (69,108) | (103,337) | |
| Net interest income | 34,530 | 26,812 | ||
| Realised gain on sale of available for sale investments | 13 | 7,074 | 1,663 | |
| Realised loss on cash flow hedge | 15 | (6,775) | - | |
| Amortisation of de-designation of cash flow hedge | 15 | (1,949) | - | |
| Unrealised loss on interest rate swaps | 15 | (22,696) | - | |
| Total income | 10,184 | 28,475 | ||
| Expenses | ||||
| Management, Custodian and Administration fees | 7 | (4,518) | (5,411) | |
| Other operating expenses | 7 | (1,259) | (1,613) | |
| Total expenses | 7 | (5,777) | (7,024) | |
| Net profit for the year | 4,407 | 21,451 | ||
| Profit per Ordinary Share | 10 | US$0.15 | US$0.78 | |
| Weighted Average Ordinary Shares outstanding | 10 | 30,204,819 | 27,574,043 | |
All items in the above statement are derived from continuing operations.
All income is attributable to the Ordinary Shareholders of the Company.
The accompanying notes form an integral part of the financial statements.
Statement of Changes in Shareholders' Equity
For the year ended 31 December 2008
| Note | Share capital | Capital redemption reserve | Share premium | Distributable reserve | Accumulated profits | |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2008 | 282 | 30 | 71,680 | 141,513 | 7,220 | |
| Available for sale investments: | ||||||
| - Unrealised loss on revaluation taken to equity | 13 | - |
- |
- |
- | - |
| - Realised gain on sale of investments | 13 | - | - | - | - | - |
| Net profit for the year | - | - | - | - | 4,407 | |
| Amortisation of de-designated cash flow hedge | - | - | - | - | - | |
| Transfer of net realised gains to capital reserve | 3,17 | - | - | - | - | (299) |
| Cash flow hedge reserve - Unrealised loss taken to equity | 15,17 | - | - | - | - | - |
| - Realised loss on cash flow hedge | 15,17 | - | - | - | - | - |
| Total recognised income and expenses for the year |
|
- |
- |
- |
- |
4,108 |
| Dividend paid | 9 | - | - | - | - | (26,984) |
| Issuance of shares | 17 | 28 | - | 20,497 | - | - |
| Issue costs | 17 | - | - | (617) | - | - |
| At 31 December 2008 | 17 | 310 | 30 | 91,560 | 141,513 | (15,656) |
| Note | Capital Reserve - Realised gains on available for sale investments | Revaluation reserve - Unrealised gain on available for sale investments | Cash flow hedge reserve | Total | |
| US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2008 | 1,600 | 16,411 | (21,966) | 216,770 | |
| Available for sale investments: | |||||
| - Unrealised loss on revaluation taken to equity |
13 |
- |
(19,441) |
- |
(19,441) |
| - Realised gain on sale of investments | 13 | - | (7,074) | - | (7,074) |
| Net profit for the year | - | - | - | 4,407 | |
| Amortisation of de-designated cash flow hedge |
- |
- |
1,949 |
1,949 | |
| Transfer of net realised gains to capital reserve | 3,17 | 299 | - | - | - |
| Cash flow hedge reserve - Unrealised loss taken to equity | 15,17 | - | - | (1,770) | (1,770) |
| - Realised loss on cash flow hedge | 15,17 | - | - | 6,775 | 6,775 |
| Total recognised income and expenses for the year |
|
299 | (26,515) |
6,954 |
(15,154) |
| Dividend paid | 9 | - | - | - | (26,984) |
| Issuance of shares | 17 | - | - | - | 20,525 |
| Issue costs | 17 | - | - | - | (617) |
| At 31 December 2008 | 17 | 1,899 | (10,104) | (15,012) | 194,540 |
The accompanying notes form an integral part of the financial statements.
Statement of Changes in Shareholders' Equity
For the year ended 31 December 2007
| Note | Share capital | Capital redemption reserve | Share premium | Distributable reserve | Accumulated profits | |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2007 | 256 | 30 | 50,000 | 198,681 | 3,720 | |
| Available for sale investments: | ||||||
| - Unrealised gain on revaluation taken to equity |
13 | - |
- |
- |
- |
- |
| - Realised gain on sale of investments | 13 | - | - | - | - | - |
| Net profit for the year | - | - | - | - | 21,451 | |
| Transfer of net realised gains to capital reserve | 3,17 | - | - | - | - | (1,663) |
| Cash flow hedge reserve - Loss taken to equity |
15,17 |
- |
- |
- |
- |
- |
| Total recognised income and expenses for the year |
- |
- |
- |
- |
19,788 | |
| Dividend paid | 9 | - | - | - | - | (16,288) |
| Issuance of shares | 17 | 26 | - | 21,837 | - | - |
| Issue costs | 17 | - | - | (157) | - | - |
| Transfer to capital reserve | 17 | - | - | - | (57,168) | - |
| At 31 December 2007 | 17 | 282 | 30 | 71,680 | 141,513 | 7,220 |
| Note | Capital Reserve - Realised loss on available for sale investments | Revaluation reserve - Unrealised gain (loss) on available for sale investments | Cash flow hedge reserve | Total | |
| US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2007 | (57,231) | 14,082 | (2,445) | 207,093 | |
| Available for sale investments: | |||||
| - Unrealised gain on revaluation taken to equity |
13 |
- |
3,992 |
- |
3,992 |
| - Realised gain on sale of investments | 13 | - | (1,663) | - | (1,663) |
| Net profit for the year | - | - | - | 21,451 | |
| Transfer of net realised gains to capital reserve | 3,17 | 1,663 | - | - | - |
| Cash flow hedge reserve - Loss taken to equity |
15,17 |
- |
- |
(19,521) |
(19,521) |
| Total recognised income and expenses for the year |
1,663 |
2,329 |
(19,521) |
4,259 | |
| Dividend paid | 9 | - | - | - | (16,288) |
| Issuance of shares | 17 | - | - | - | 21,863 |
| Issue costs | 17 | - | - | - | (157) |
| Transfer to capital reserve | 17 | 57,168 | - | - | - |
| At 31 December 2007 | 17 | 1,600 | 16,411 | (21,966) | 216,770 |
The accompanying notes form an integral part of the financial statements.
Balance Sheet
As at 31 December 2008
|
| 2008 | 2007 | |
| Notes | US $'000 | US $'000 | |
| Non-current assets | |||
| Available for sale investments | 13 | 1,709,479 | 2,280,046 |
| 1,709,479 | 2,280,046 | ||
| Current assets | 14 | ||
| Accrued income receivable | 7,785 | 10,541 | |
| Receivable for principal paydowns | 1,519 | 2,839 | |
| Receivable for securities sold | 19,426 | - | |
| Prepaid expenses | 139 | 77 | |
| Cash and cash equivalents | 19,173 | 48 | |
| 48,042 | 13,505 | ||
| Total assets | 1,757,521 | 2,293,551 | |
| Equity attributable to equity shareholders | |||
| Ordinary share capital | 17 | 310 | 282 |
| Capital redemption reserve | 17 | 30 | 30 |
| Share premium | 17 | 91,560 | 71,680 |
| Distributable reserve | 17 | 141,513 | 141,513 |
| Accumulated (losses)/profits | 17 | (15,656) | 7,220 |
| Capital reserve - Realised gain/(loss) on available for sale investments and interest rate swaps | 17 | 1,899 | 1,600 |
| Revaluation reserve | 17 | (10,104) | 16,411 |
| Cash flow hedge reserve | 17 | (15,012) | (21,966) |
| Total equity | 194,540 | 216,770 | |
| Current liabilities | 14 | ||
| Securities purchased payable | - | 31,882 | |
| Reverse repurchase agreements | 16 | 1,515,351 | 2,011,384 |
| Accrued interest expense | 5,958 | 9,823 | |
| Accrued expenses payable | 2,015 | 1,726 | |
| Fair value of interest rate swaps | 15,17 | 39,657 | 21,966 |
| Total liabilities | 1,562,981 | 2,076,781 | |
| Total equity and liabilities | 1,757,521 | 2,293,551 | |
| Net Assets | US$194,540 | US$216,770 | |
| Net Asset Value per Ordinary Share | 18 | US$6.28 | US$7.70 |
The financial statements were approved by the Board of Directors on 13 March 2009
and are signed on its behalf by:
| John E Hallam | Christopher W Sherwell | |
| Director | Director |
The accompanying notes form an integral part of the financial statements.
Cash Flow Statement
For the year ended 31 December 2008
| 2008 | 2007 | ||
| Notes | US $'000 | US $'000 | |
| Net cash inflow/(outflow) from operating activities | 19 | 522,234 | (163,032) |
| Cash flows from financing activities | |||
| Borrowings under reverse repurchase agreements | 16 | 17,833,564 | 22,734,860 |
| Repayments under reverse repurchase agreements | 16 | (18,329,597) | (22,577,233) |
| Dividends paid to shareholders | 9 | (26,984) | (16,288) |
| Issue of shares | 17 | 19,908 | 21,706 |
| Net cash (outflow)/inflow from financing activities | (503,109) | 163,045 | |
| Net increase in cash and cash equivalents | 19,125 | 13 | |
| Cash and cash equivalents at the beginning of the year | 48 | 35 | |
| Cash and cash equivalents at the end of the year | 19,173 | 48 | |
The accompanying notes form an integral part of the financial statements.
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 June 2010.
The new Guernsey Fund Rules relating to authorised and registered funds (the Authorised Closed-Ended Investment Schemes Rules 2008 and the Registered Collective Investment Scheme Rules 2008, (together "the new rules")) became effective from 15 December 2008. All funds in existence as at that date are automatically deemed to be authorised funds but have a transition period of up to 30 April 2009 to write to the GFSC and convert to a registered fund The Company's Directors at the board meeting on 2 February 2009 indicated their intention to keep the fund authorised.
The Company invests in a portfolio consisting primarily of 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.
2. Adoption of new and revised Standards
At the date of authorisation of these financial statements, the following Standard applicable to the Company, which has not been applied in these financial statements, was in issue but not yet effective:
| IFRS 8 | Operating Segments |
| IAS 1 (revised 2007) | Presentation of Financial Statements |
| Improvements to IFRSs ( May 2008) |
The Directors anticipate that the adoption of the above Standard in future years will not have a material impact on the financial statements of the Company when the Standard comes into force for the period commencing 1 January 2009.
The Directors believe that other pronouncements which are in issue but not yet operative or adopted by the Company will not have a material impact on the financial statements of the Company.
3. Significant Accounting Policies
Basis of Accounting
The financial statements of the Company have been prepared in accordance with International Financial Reporting Standards ("IFRS") 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 as modified for the revaluation of certain financial instruments. The principal accounting policies are set out below. The preparation of financial statements in conformity with IFRS 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 year. 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.
Subsequent to year end, the Board received a requisition for an EGM by the same party whom put forth resolutions for the 4 December 2008 EGM where such resolutions were defeated. At the EGM on 4 December 2008 92.3% of the Company's shares voted and, excluding the shares of the Requisitionists (who currently hold 26% of the voting rights of the Company), 95.6% of those shares voted against the resolutions. The Board believes that this recent vote, soundly defeating the resolutions, proved that the vast majority of shareholders do not desire a change and believe that the Company's Directors continue to act in the Shareholder's best interests. The Directors again believe the latest resolution will be defeated and, having regard to the liquidity of the Company as described in note 11 to the financial statements, consider it appropriate to prepare the financial statements on a going concern basis. Further information is provided in the Directors' Report.
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 the Government National Mortgage Association ("Ginnie Mae"), a US Government Corporation.
On September 6, 2008 the Federal Housing Finance Agency (FHFA) was appointed as conservator of Freddie Mac and Fannie Mae. In addition, the US department of the Treasury agreed to provide up to $100 billion of capital to each company as needed to ensure they continue to provide liquidity to the housing and mortgage markets.
The payment of principal and interest on the debt of FHLB is backed by that agency, the debt and mortgage backed securities issued by Freddie Mac and Fannie Mae are backed by those respective agencies, which are operating under the conservatorship of FHFA, and 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 and Impairments
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 initially recognised in the income statement and are subsequently 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.
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.
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 year.
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.
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
4. Critical accounting judgements and key sources of estimation uncertainty
In the process of applying the Company's accounting policies (described in note 3 above), the Company has determined that the following judgements and estimates have the most significant effect on the amounts recognised in the financial statements:
Income recognition
As described in note 3 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.
Given the Company's current portfolio composition, if mortgage principal prepayment rates were to increase over the life of its mortgage-backed securities, all other factors being equal, the Company's net interest income would decrease during the life of these mortgage-backed securities as the Company would be required to amortize its net premium balance into income over a shorter time period. Similarly, if mortgage principal prepayment rates were to decrease over the life of the Company's mortgage-backed securities, all other factors being equal, the Company's net interest income would increase during the life of these mortgage-backed securities as the Company would amortise its net premium balance over a longer time period.
Fair values of financial instruments
Many of the Company's financial instruments are measured at fair value on the balance sheet and it is usually possible to determine fair values within a reasonable range of estimates.
For all the Company's investments there is an active market and quoted market prices are available. However certain financial instruments, for example over the counter derivatives, are fair valued using valuation techniques or via third party counterparties.
Impairment
The Company is required to evaluate the securities in its portfolio to determine if any of the securities are impaired. The Company's process for deciding whether a security is impaired incorporates an assessment of the following conditions and how the cash flow is affected:
whether the yield on the bond is lower than the current cost of funds; and
the effect interest rate swaps on funding cost for the assets.
However as a matter of accounting policy, Prodesse has determined, based on its business model, that it will have intent and ability to hold a security with unrealized loss until the cost of purchase has been recovered if the above conditions occur.
Fair value and impairment estimates are made at a specific point in time based on market conditions and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgement.
5. Interest income
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Interest income received on financial assets that are not at fair value through profit or loss: | ||
| - Cash and cash equivalents | (4) | 145 |
| - Available for sale investments | 105,193 | 130,323 |
| - Amortisation of expense in respect of available for sale investments | (1,551) | (319) |
| 103,638 | 130,149 |
6. Interest expense
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Interest expense for financial liabilities that are not at fair value through profit or loss: | ||
| - Repurchase agreements | 56,087 | 104,824 |
| - Interest rate swap contracts | 13,021 | (1,487) |
| 69,108 | 103,337 |
7. Expenses
| 2008 | 2007 | ||
| US $'000 | US $'000 | ||
| Investment management, Custodian and Administration fees | |||
| Investment management fee (note 8) | 3,726 | 4,505 | |
| Administration fee (note 8) | 507 | 538 | |
| Custodian fee (note 8) | 285 | 368 | |
| 4,518 | 5,411 | ||
| Other operating expenses | |||
| Directors' fees | 174 | 162 | |
| Insurance | 317 | 247 | |
| Audit fee | 256 | 239 | |
| Corporate broker fees | 30 | 471 | |
| Public relations and website costs | 250 | 234 | |
| Legal fee | 63 | 138 | |
| Regulatory fee | 49 | 47 | |
| Other expenses | 120 | 75 | |
| 1,259 | 1,613 | ||
| Total expense | 5,777 | 7,024 |
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. The basic fee payable to each independent non-executive director is at a rate of £20,000 per annum, except for the Chairman who receives £25,000 per annum.
8. 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.
Prior to 5 June 2007, The Bank of New York served as the Company's custodian pursuant to a Global Custody Agreement dated 5 April 2005. That custody agreement was replaced with effect from 5 June 2007 by (i) the Securities Clearing Agreement pursuant to which The Bank of New York will act as clearing agent and the Company's assets will be held in a clearing account for the benefit of the Company at The Bank of New York until sold or pledged as collateral to a financing counterparty, and (ii) an amendment to the Investment Management Agreement pursuant to which the Investment Manager will provide trade execution instructions over the Clearing Agent's computerised trading system.
The total fees for such services were decreased from one basis point per annum on the Company's gross assets plus the transaction based fees charged by The Bank of New York as custodian to 0.8 basis points per annum on the Company's gross assets charged by FIDAC plus the transaction based fees charged by the Clearing Agent.
BNP Paribas 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).
9. Dividends
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Amounts recognized as distributions to equity shareholders in the year: | ||
| Fourth interim dividend for the period ended 31 December 2007 of 21 cents per share (2006: 13 cents per share) |
5,915 |
3,331 |
| First interim dividend for the year ended 31 December 2008 of 22 cents per share (2007: 14 cents per share) | 6,817 | 3,943 |
| Second interim dividend for the year ended 31 December 2008 of 23 cents per share (2007: 16 cents per share) | 7,126 | 4,507 |
| Third interim dividend for the year ended 31 December 2008 of 23 cents per share (2007: 16 cents per share) | 7,126 | 4,507 |
| 26,984 | 16,288 |
A fourth interim dividend of US$0.19 cents per Ordinary share, in respect of the final quarter of 2008 was declared on 10 February 2009 and is payable on 11 March 2009.
10. Earnings Per Share
Basic earnings per share is calculated by dividing net profit available to Ordinary Shareholders by the weighted average number of Ordinary Shares outstanding during the year.
| 2008 | 2007 | |
| Number of shares | Number of shares | |
| Weighted average number of Ordinary Shares outstanding | 30,204,819 | 27,574,043 |
11. Financial Risk Management
The Company's activities expose it to a variety of financial risks. The main risks to which the Company is exposed are market risk, credit, interest rate and liquidity risk. The Company has limited exposure to foreign exchange risk.
Capital risk management
The capital structure of the Company consists of cash and cash equivalents and equity attributable to equity holders, comprising issued share capital, capital redemption reserve, share premium account, distributable reserve and retained earnings as disclosed in note 17. The Company does not have any externally imposed capital requirements. At 31 December 2008 the Company had capital of US$219.7 million (2007: US$222.3 million).
The investment objective of Prodesse is to generate distributable income yield on net assets (in US dollar terms) of 3.5 per cent. to 5.0 per cent. greater than the yield on the ten-year US Treasury on an annualized basis while preserving net asset value (in US Dollar Terms) over the long term.
The Company aims to deliver its objective by investing available cash and using leverage (in the form of repurchase agreements) whilst maintaining sufficient liquidity to meet on-going expenses and dividend payments.
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, while seeking to limit exposure to interest rate risk and credit risk. Prodesse invests primarily in a portfolio of US residential mortgage-backed securities created or issued by the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) or the Government National Mortgage Association (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.
Prodesse uses leverage to enhance the returns to shareholders and for this purpose borrows amounts equal to between five and ten times its net assets. Prodesse uses primarily short-term borrowings for the purpose of making investments and to pledge its assets to secure such borrowings. To effect such borrowings in a cost-efficient manner, Prodesse has entered into master repurchase agreements (an agreement effecting a current sale of a security with a concurrent agreement by the seller to repurchase the security at a later date at a higher fixed price reflecting the cost of funds for the term of the agreement) with various major financial institutions.
The purchases and sales were consistent with the Investment Manager's Barbell Strategy. The FIDAC MBS Barbell Strategysm seeks to utilize the principal and interest cash flows of US Agency floating, adjustable and fixed-rate MBS to mitigate the primary risk of the company, interest rate risk. By maintaining an approximate one-third adjustable and floating-rate securities and two-thirds fixed-rate security balance the portfolio is able to manage through a range of US interest rate environments.
To manage the risks, FIDAC, the Company's investment manager, uses several risk management models, including proprietary models and models that it believes are widely used by the investment management community. FIDAC has set capital investment guidelines that are incorporated into its portfolio management system. The Company's investment portfolio is monitored daily by FIDAC to ensure that it is operating within the guidelines. Reviews are conducted at least yearly to review the risk reward profile of the market and the capital investment guidelines. Key measures of risk include but are not limited to, duration, convexity, prepayments, coupon reset caps, cash-flow and leverage.
The Company's investment portfolio is also analysed to determine its performance in a wide range of interest
rate scenarios. In addition, price volatility levels are monitored daily and trading positions may be adjusted in response to changing risk measures and price volatility levels.
The Board has also adopted certain investment restrictions to manage the risk profile. These include:
Save in respect of cash deposits awaiting investment, no more than 20 per cent. of the gross assets of the Company (before deducting borrowed money) can be lent to or invested in any one company or group at the time the investment or loan is made;
Not more than 10 per cent., in aggregate, of the value of the gross assets of the Company (before deducting borrowed money) can be invested in other investment companies (including investment trusts) listed on the London Stock Exchange, except where the investment companies themselves have stated investment policies to invest no more than 15 per cent. of their gross assets in other investment companies (including investment trusts) listed on the London Stock Exchange;
Not more than 15 per cent., in aggregate, of the value of the gross assets of the Company (before deducting borrowed money) will be invested in other investment companies (including investment trusts) listed on the London Stock Exchange; and
Prodesse will not take legal or management control over investments in its portfolio.
11(a) Market Risk
The Company is exposed to the market risk on the underlying investments as changes in overall interest rate levels will affect their value.
Price Sensitivity
The following table quantifies the potential changes in the portfolio value should interest rates go down 225, 125, and 25 basis points from those rates in existence at 31 December 2007 and should interest rates go down 25, 50, and go up 150 basis points from those rates in existence at 31 December 2008, assuming the yield curves of the rate shocks will be parallel to each other and the current yield curve.
The rational for the selection of the interest rate movement was based on the federal funds target rate. Since the federal funds target interest rate has been reduced by 350 basis points since 31 December 2007 and is now a range of 0%-0.25%, the analysis of interest rate changes was prepared using an initial and an additional change in interest rates of 0.25% and then a 1.5% up from the base rate.
The base interest rate scenario assumes interest rates at December 31, 2008 and various estimates regarding prepayment and all activities are made at each level of rate shock. Actual results could differ significantly from these estimates.
| 2008 Estimated change in net income due to changes in interest rates US$ | 2007 Estimated change in net income due to changes in interest rates US$ | |||
| | | | | |
| Change in interest rates | | Change in interest rates | | |
| -0.25% | (1.0 million) | -0.25% | | 137,000 |
| -0.50% | (2.0 million) | -1.25% | | 1.3 million |
| +1.50% | 553,000 | -2.25% | | 2.2 million |
The sensitivity illustrates the benefit of lower interest rates on the fair value of fixed and adjustable rate assets over and above the negative impact on the fair value of the interest rate swaps in respect of smaller movements in interest rates and the impact of increased prepayments speeds on the value the assets and swaps as further falls in interest rates occur.
The analysis of price sensitive risk is based on management's experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in the above tables and in this report
11(b) 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. The Directors are of the opinion that the Company is not exposed to significant foreign exchange risk.
11(c) 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 and cash equivalents which represent the Company's maximum exposure to credit risk in relation to financial assets.
At the reporting date the Company's financial assets exposed to credit risk amounted to the following:
|
| 2008 | 2007 | |
| US $'000 | US $'000 | ||
| Available for sale investments | 1,709,479 | 2,280,046 | |
| Accrued income receivable | 7,785 | 10,541 | |
| Receivable for principal paydowns | 1,519 | 2,839 | |
| Receivable for securities sold | 19,426 | - | |
| Prepaid expenses | 139 | 77 | |
| Cash and cash equivalents | 19,173 | 48 | |
| Total assets | 1,757,521 | 2,293,551 |
Credit risk on investments 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.
The following table details the investment grade of the Company's investment portfolio.
| Rating | 2008 | 2007 |
| Implied "AAA" | 100% | 100% |
To date, all of the mortgage-backed securities that the Company has acquired have been agency mortgage-backed securities which, although not rated, carry an implied "AAA" rating.
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 as follows:
The Company's cash balances are held with Bank of New York ("BONY" or "the Bank"), who also act as custodian for the Company's investments. Bankruptcy or insolvency of BONY may cause the Company's rights with respect to the cash and securities held by the Bank to be delayed or limited.
The Company monitors this risk by monitoring the credit rating of the bank and if the credit quality of the bank deteriorates consideration may be given to transferring the assets to another bank.
The Company has also entered into a number of interest rate swap arrangements (as disclosed in note 15). The Company is exposed to credit risk from counterparties used in these transactions. This risk is again mitigated by the Company only engaging with credit-worthy counterparties. The counterparties for the swaps, being UBS AG London, Bear Stearns plc, Merrill Lynch Capital Services, Inc., have credit ratings of Aa2 to Aa3.
Credit risk on transactions arising with brokers relates to transactions awaiting settlement. Risk relating to unsettled transactions is considered small due to the short settlement period involved and the high credit ratings quality of the brokers used. The Company monitors the credit rating of the broker used to further mitigate this risk.
Other than outlined above, there were no significant concentrations of credit risk to counterparties at 31 December 2008 or 31 December 2007. No individual investment exceeded the investment restrictions adopted by the Directors (as described above) as at 31 December 2008 or 31 December 2007.
11(d) Interest Rate Risk
The Company's profitability is also subject to risks associated with changes in interest rates (in addition to the fair value impact of changes as a result of changes in interest rates illustrated in note 11(a) above). 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 as described in note 16. The estimated lives of the mortgage-backed securities at 31 December 2008 in the table below are based upon data provided through subscription-based financial information services, assuming constant principal prepayment rates to the reset date of each security. The prepayment model considers current yield, forward yield, steepness of the yield curve, current mortgage rates, mortgage rate of the outstanding loans, loan age, margin and volatility.
Actual maturities of Mortgage-Backed Securities are generally shorter than stated contractual maturities. Actual maturities of the Company's Mortgage-Backed Securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepayments of principal.
The Company has entered into repurchase agreements which provide the counterparty with the right to call the balance prior to maturity date. At December 31, 2008 and 2007 the principal balance of the structured repurchase agreements was $300 million and $300 million, respectively. These repurchase agreements are shown below as due within three months, even though it is not expected that they will be called prior to actual maturity date.
The principal value of the rate sensitive assets is reflected in the following tables.
The interest rate profile of the Company as at 31 December 2008 was as follows:
| At 31 December 2008 | Within 3 Months | 4-12 Months | More than 1 Year to 3 Years | 3 Years and Over | Total |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | |
| Rate Sensitive Assets: | |||||
| Investment Securities (Principal) | 554,225 | 72,730 | 124,923 | 952,146 | 1,704,024 |
| Rate Sensitive Liabilities: | |||||
| Repurchase Agreements, with effect of interest rate swaps | 666,051 | 65,750 | 555,500 | 228,050 | 1,515,351 |
| Interest rate sensitivity gap | (111,826) | 6,980 | (430,577) | 724,096 | 188,673 |
| Cumulative rate sensitivity gap | (111,826) | (104,846) | (535,423) | 188,673 | |
| Cumulative interest rate sensitivity gap as a percentage of total rate-sensitive assets |
(7%) |
(6%) | (31%) |
11% |
| At 31 December 2007 | Within 3 Months | 4-12 Months | More than 1 Year to 3 Years | 3 Years and Over | Total |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | |
| Rate Sensitive Assets: | |||||
| Investment Securities (Principal) | 524,334 | 67,115 | 431,320 | 1,236,085 | 2,258,854 |
| Rate Sensitive Liabilities: | |||||
| Repurchase Agreements, with effect of interest rate swaps | 949,634 | 86,000 | 632,000 | 343,750 | 2,011,384 |
| Interest rate sensitivity gap | (425,300) | (18,885) | (200,680) | 892,335 | 247,470 |
| Cumulative rate sensitivity gap | (425,300) | (444,185) | (644,865) | 247,470 | |
| Cumulative interest rate sensitivity gap as a percentage of total rate-sensitive assets |
(19%) |
(20%) | (29%) |
11% |
The weighted average yields on mortgage-backed securities by life expectancy are as follows:
| 2008 | Total | Within one year | One to five years | Over five years | ||||
| Market Value US$'000 | Weighted Average Yield | Market Value US$'000 | Weighted Average Yield | Market Value US$'000 | Weighted Average Yield | Market Value US$'000 | Weighted Average Yield | |
| Adjustable rate | 862,458 | 3.04 | 275,676 | 1.58 | 220,075 | 2.17 | 366,707 | 4.65 |
| Fixed rate | 847,021 | 5.96 | 62,679 | 5.74 | 754,545 | 5.98 | 29,797 | 5.86 |
| Total | 1,709,479 | 4.49 | 338,355 | 2.35 | 974,620 | 5.12 | 396,504 | 4.74 |
| 2007 | Total | Within one year | One to five years | Over five years | ||||
| Market Value US$'000 | Weighted Average Yield | Market Value US$'000 | Weighted Average Yield | Market Value US$'000 | Weighted Average Yield | Market Value US$'000 | Weighted Average Yield | |
| Adjustable rate | 843,579 | 5.52% | 2,540 | 4.86% | 162,878 | 5.36% | 678,161 | 5.56% |
| Fixed rate | 1,436,467 | 5.96% | 5,513 | 5.81% | 1,265,783 | 5.98% | 165,171 | 5.84% |
| Total | 2,280,046 | 5.79% | 8,053 | 5.51% | 1,428,661 | 5.91% | 843,332 | 5.62% |
Interest rate sensitivity
The following table quantifies the potential changes in net income should interest rates go down 225, 125, and 25 basis points from those rates in existence at 31 December 2007 and should interest rates go down 25, 50, and go up 150 basis points from those rates in existence at 31 December 2008, assuming the yield curves of the rate shocks will be parallel to each other and the current yield curve. The base interest rate scenario assumes interest rates at December 31, 2008 and various estimates regarding prepayment and all activities are made at each level of rate shock. Actual results could differ significantly from these estimates.
As for the sensitivity analysis for changes in fair value shown in 11(a) above, the rational for the selection of the interest rate movement was based on the federal funds target rate. Since the federal funds target interest rate has been reduced by 350 basis points since 31 December 2007 and is now a range of 0%-0.25%, the analysis of interest rate changes was prepared using an initial and an additional change in interest rates of 0.25% and then a 1.5% up from the base rate.
| 2008 Estimated change in net income due to changes in interest rates US$ | 2007 Estimated change in net income due to changes in interest rates US$ | |||
| Change in interest rates | Change in interest rates | |||
| -0.25% | (1.0 million) | -0.25% | 137,000 | |
| -0.50% | (2.0 million) | -1.25% | 1.3 million | |
| +1.50% | 553,000 | -2.25% | 2.2 million | |
The analysis of price sensitive risk is based on management's experience, estimates, models and assumptions. These analyses rely on models which utilize estimates of fair value and interest rate sensitivity. Actual economic conditions or implementation of investment decisions by our management may produce results that differ significantly from the estimates and assumptions used in our models and the projected results shown in the above tables and in this report.
11(e) Liquidity Risk
Liquidity risk arises as a result of the Company not having sufficient cash to meet its liabilities as they fall due. A maturity analysis of the Company's contractual undiscounted liabilities is included in the table below:
|
| Maturity | 2008 | 2007 |
| US $'000 | US $'000 | ||
| Reverse repurchase agreements | See table below | 1,515,351 | 2,011,384 |
| Accrued interest expense | < 1 month | 5,958 | 9,823 |
| Accrued expenses payable | < 1 month | 2,015 | 1,726 |
| Securities purchased payable | < 1 month | - | 31,882 |
| 1,523,324 | 2,054,815 |
The following table presents cash needs to meet liquidity requirements on repurchase agreements, without the effect of interest rate swaps and assuming that structured repurchase agreements are called on their first available call date.
| Within 3 Months | 4-12 Months | More than 1 Year to 3 Years | 3 Years and Over | Total | |
| U$ $'000 | U$ $'000 | U$ $'000 | U$ $'000 | U$ $'000 | |
| At 31 December 2008 | |||||
| Repurchase Agreements | 1,515,351 | - | - | - | 1,515,351 |
| At 31 December 2007 | |||||
| Repurchase Agreements | 2,011,384 | - | - | - | 2,011,384 |
The Company's liquidity risk is managed through the Company's ability to execute its business strategy and 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. The investments are also traded in an active market at the present time and hence could be realised to provide additional liquidity to the Company.
A substantial portion of the Company's borrowings are short-term or variable-rate borrowings. The borrowings are implemented primarily through repurchase agreements, but in the future may also be obtained through other credit facilities with institutional lenders. The Company enters into financing transactions only with institutions that the Directors believe are sound credit risks and follow other internal policies designed to limit the Company's credit and other exposure to financing institutions.
The current situation in the sub-prime mortgage sector, and the current weakness in the broader mortgage market, could adversely affect one or more of the Company's lenders and could cause one or more of the Company's lenders to be unwilling or unable to provide it with additional financing. This could potentially increase the Company's financing costs and reduce liquidity. If one or more major market participants fails, it could negatively impact the marketability of all fixed income securities, including government mortgage securities, and this could negatively impact the value of the securities in the Company's portfolio, thus reducing its net book value. Furthermore, if many of the Company's lenders are unwilling or unable to provide it with additional financing, the Company could be forced to sell its Investment Securities at an inopportune time when prices are depressed. Even with the current situation in the sub-prime mortgage sector, the Company does not anticipate having difficulty converting its assets to cash or extending financing term, due to the fact that its investment securities have an actual or implied "AAA" rating and principal payment is guaranteed.
12. Financial instruments
12(a) Categories of financial instruments
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Assets | ||
| Designated as available for sale: | ||
| - Investments | 1,709,479 | 2,280,046 |
| Receivables | 48,042 | 13,505 |
| 1,757,521 | 2,293,551 | |
| Liabilities | ||
| Financial liabilities measured at amortised cost | 1,562,981 | 2,076,781 |
| 1,562,981 | 2,076,781 |
Receivables presented above represent, interest and principal paydowns as detailed in the balance sheet.
Financial liabilities measured at amortised cost presented above represent balances due to brokers, payables under repurchase agreements, accounts payable and accrued expenses and the market value of interest rate swaps as detailed in the balance sheet.
12(b) Fair value information
Many of the Company's financial instruments are carried at fair value on the balance sheet. The fair value can generally be reliably determined within a reasonable range of estimates. For certain other financial instruments, including amounts due to brokers, other receivables and payables, the carrying amounts approximate fair value due to the short term nature of these financial instruments.
The carrying amounts of all the Company's financial assets and liabilities at the balance sheet date approximated their fair values. The fair value of repurchase agreements may be greater than the book cost given that lenders may be unwilling to provide financing at these rates given current economic conditions (see note 11(e) above). However it is not expected that this difference would be material.
At 31 December 2008, the carrying amounts of investments (for which there is an active market) whose fair values were determined by the investment advisor and are compared to an outside pricing source amounted to US$1,709,479 (2007: US$2,280,046,000).
At 31 December 2008, the carrying value of derivative financial instruments for which fair values were determined by the counter party were US$39,657,000 loss (2007: US$ 21,966,000 loss).
13. Available for Sale Investments
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Cost at 1 January | 2,263,635 | 2,059,520 |
| Purchases of investments | 738,887 | 861,374 |
| Proceeds from sale of investments | (1,029,158) | (229,534) |
| Realised gain on sale of investments | 7,074 | 1,663 |
| Principal paydowns | (259,304) | (429,069) |
| Net amortisation of premiums | (1,551) | (319) |
| Amortised cost at 31 December | 1,719,583 | 2,263,635 |
| Unrealised gain on available for sale investments | (10,104) | 16,411 |
| Market value at 31 December | 1,709,479 | 2,280,046 |
| At 31 December 2008 | Amortised Cost | Gross Unrealised Gain | Gross Unrealised Loss | Estimated Fair Value |
| US $'000 | US $'000 | US $'000 | US $'000 | |
| Adjustable rate | 417,503 | 1,699 | (1,606) | 417,596 |
| Floating rate | 466,385 | - | (21,524) | 444,861 |
| Fixed rate | 835,695 | 11,540 | (213) | 847,022 |
| Total | 1,719,583 | 13,239 | (23,343) | 1,709,479 |
| At 31 December 2007 | Amortised Cost | Gross Unrealised Gain | Gross Unrealised Loss | Estimated Fair Value |
| US $'000 | US $'000 | US $'000 | US $'000 | |
| Adjustable rate | 342,694 | 2,044 | (60) | 344,678 |
| Floating Rate | 503,796 | 92 | (4,987) | 498,901 |
| Fixed rate | 1,417,145 | 19,616 | (294) | 1,436,467 |
| Total | 2,263,635 | 21,752 | (5,341) | 2,280,046 |
As at 31 December 2008, all of the assets in the Company's portfolio were Fannie Mae and Freddie Mac mortgage-backed securities, which carry an implied "AAA" rating.
| 2008 | 2007 | |
| Fixed-rate mortgage-backed securities | 49% | 63% |
| Adjustable-rate mortgage-backed securities | 24% | 15% |
| Floating-rate mortgage-backed securities | 27% | 22% |
As at 31 December 2008, investments totalling US$1.5 billion (2007: US$2.0 billion) were pledged as security in respect of reverse repurchase agreements (see note 16).
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.
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. On September 6, 2008, the Federal Housing Finance Agency (FHFA) was appointed as conservator of Freddie Mac and Fannie Mae. In addition, the US Department of the Treasury agreed to provide up to $100 billion of capital to each company as needed to ensure they continue to provide liquidity to the housing and mortgage markets.
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.
14. Current Assets and Current Liabilities
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.
15. Hedging Instruments
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 were designated as cash flow hedges up until 1 October 2008 against the benchmark interest rate risk associated with the Company's borrowings. From 1 October 2008 the swaps are no longer designated as cash flow hedges.
The amortisation taken into income is the Present Value of the cash flows for each swap calculated monthly. The amortisation adjustment is applied quarterly and taken into income and reduces the Cash flow hedge reserve - de-designated balance in the equity section.
At 31 December 2008, the Company had interest swap agreements of US$563 million notional amount (2007: US$778 million) in which the Company will pay a weighted average rate of 4.96% (2007: 5.15%) and receive a weighted average rate of 1.08% (2007: 5.06%).
The fair value of the swaps entered into at 31 December 2008 is estimated at US$39,656,907 loss (2007: US$21,966,934 loss).
16. Reverse Repurchase Agreements
At 31 December 2008 the aggregate value of securities pledged by the Company under reverse repurchase agreements exceeds the liability under such agreements by approximately US$81.3 million (2007: US$60.3 million) (approximately 5.37% of such liability). The interest rates on the open reverse repurchase agreements at 31 December 2008 range from 0.15% to 4.57% (2007: from 4.47% to 5.15%) and have maturity dates ranging from 2 days to 1,154 days (2007: 2 days to 1,520 days).
The current situation in the sub-prime mortgage sector, and the current weakness in the broader mortgage market, could adversely affect one or more of the Company's lenders and could cause one or more of the Company's lenders to be unwilling or unable to provide it with additional financing. This could potentially increase the Company's financing costs and reduce liquidity as disclosed in note 11(e).
17. Issued Capital and Reserves
Ordinary Share Capital
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Authorised | ||
| 60,000,000 Ordinary Shares of US$0.01 each | 600 | 600 |
| Issued | ||
| 30,982,050 (2007: 28,165,550) Ordinary Shares of US$0.01 each | 310 | 282 |
The share capital of the Company comprises one class of Ordinary shares which carry no right to fixed income.
Issue of shares
The Company issued 2,816,500 Ordinary Shares of US$0.01 on 11 April 2008 at £3.68 each raising US$20.5 million. The issue costs associated with the issue amounted to US$617,000.
Repurchase of shares
The Company has not purchased shares for cancellation in the current year to 31 December 2008.
Authority to buyback shares
The Company currently has authority to undertake a share purchase of up to 14.99% 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 which will enhance net asset value.
Capital Redemption Reserve
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January and 31 December | 30 | 30 |
Share Premium
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January | 71,680 | 50,000 |
| Premium arising on issue of equity shares | 20,497 | 21,837 |
| Expenses incurred on issue of equity shares | (617) | (157) |
| Balance at 31 December | 91,560 | 71,680 |
Distributable Reserve
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January and 31 December | 141,513 | 141,513 |
The Distributable Reserve was set up following the cancellation of the share premium account following the Initial Public Offering. A transfer has been made from the Distributable Reserve to the Capital Reserve - Realised Gain/(Loss) on Available for Sale Investments to make good the realised loss on investments.
Accumulated Profits
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January | 7,220 | 3,720 |
| Net profit for the year | 4,407 | 21,451 |
| Realised gains transferred to non-distributable capital reserve (see below) | (299) | (1,663) |
| Dividends paid | (26,984) | (16,288) |
| Balance at 31 December | (15,656) | 7,220 |
Capital Reserve - Realised Gains on Available for Sale Investments
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January | 1,600 | (57,231) |
| Transfer from distributable reserve (see above) | - | 57,168 |
| Net gains on sale of available for sale investments and impairment of available for sale investments transferred from accumulated profits | 7,074 | 1,663 |
| Loss on termination of cash flow hedges | (6,775) | - |
| Balance at 31 December | 1,899 | 1,600 |
Realised gains or losses arising on the sale of investments are initially recognised in the income statement as required under International Financial Reporting Standards but are transferred to a non-distributable capital reserve in accordance with the Memorandum and Articles of Association of the Company.
Revaluation Reserve - Unrealised Gain on Available for Sale Investments
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January | 16,411 | 14,082 |
| Unrealised (losses)/gains on revaluation taken to equity | (19,441) | 3,992 |
| Transferred to income statement on sale of investments | (7,074) | (1,663) |
| Balance at 31 December | (10,104) | 16,411 |
Cash Flow Hedge Reserve
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Balance at 1 January | (21,966) | (2,445) |
| Decrease in fair value of hedging instruments taken to equity | (1,770) | (19,521) |
| Transferred to income statement on termination of cash flow hedges | 6,775 | - |
| Amortisation of de-designated cash flow hedge | 1,949 | - |
| Balance at 31 December | (15,012) | (21,966) |
18. Net Asset Value
The net asset value per Ordinary Share is based on net assets at the year end and on 30,982,050 (2007: 28,165,550) Ordinary Shares, being the number of Ordinary Shares in issue at the year end.
At 31 December 2008, the reported net asset value per Ordinary Share (before excluding the dividend declared for the quarter ended 31 December 2008) is US$6.28 (2007: US$7.70).
At 31 December 2008, the Company had a net asset value per Ordinary Share of US$6.09 (2007: US$7.49), after including the effect of the dividend declared for the quarter of 31 December 2008 of US$5,886,590 (2007: US$5,914,766).
19. Cash Flows from Operating Activities
| 2008 | 2007 | |
| US $'000 | US $'000 | |
| Net profit for the year | 4,407 | 21,451 |
| Net amortisation of premiums on available for sale investments | 1,551 | 319 |
| Unrealised loss on interest rate swaps | 24,645 | - |
| Realised gain on available for sale investments | (7,074) | (1,663) |
| Realised loss on termination of interest rate swaps | 6,775 | - |
| 25,897 | (1,344) | |
| Purchases of investments | (770,769) | (844,899) |
| Proceeds from sale of investments | 1,009,732 | 229,534 |
| Termination of interest rate swap | (6,775) | - |
| 232,188 | (615,365) | |
| Principal paydowns | 260,624 | 429,440 |
| Decrease/(increase) in receivables | 2,694 | (1,817) |
| (Decrease)/increase in payables | (3,576) | 4,603 |
| (882) | 2,786 | |
| Net cash outflow from operating activities | 522,234 | (163,032) |
20. Notes to the Cash Flow Statement
Purchases and sale of investments are considered to be operating activities of the Company, given its purpose, rather than investing activities. The cash flows arising from these activities are shown in Note 19 above. Cash and cash equivalents (which are presented as a single class on the face of the balance sheet) comprise cash at bank.
21. Related Party Transactions
The relationship between the Company and FIDAC is disclosed in Note 8. The amounts paid to FIDAC during the year are disclosed in Note 7. The amounts outstanding at the year end were:
| 2008 US$'000 | 2007 US$'000 | |
| FIDAC investment management fee | 870 | 1,145 |
Mr R Kazel is Managing Director of FIDAC and as such he has waived his right to remuneration as a Director of the Company.
Investment Policy and Investment Restrictions
Investment Policy
Prodesse invests primarily in a portfolio of US residential mortgage-backed securities issued or created by Fannie Mae, Freddie Mac or Ginnie Mae, with a targeted weighted average actual or implied credit rating, of approximately 'Triple-A', and other 'Triple-A'-rated US residential mortgage-backed securities, but Prodesse may also acquire US government securities, debentures issued by a US Agency, and other short-term instruments. Prodesse invests principally in adjustable-rate mortgage-backed securities and Floaters whose interest rate (coupon) resets periodically based on changes in short-term interest rates. Prodesse uses leverage to enhance the returns to Shareholders and for this purpose intends to borrow from time to time amounts equal to between 5 and 10 times its net assets. The Company will not seek investment returns through short positions.The Board has adopted investment restrictions, including concentration limits. In relation to mortgage backed securities created by Fannie Mae, Freddie Mac and Ginnie Mae that are referable to a particular pool of mortgages (all are at present), the 20 per cent. concentration limit will be applied to the pool, rather than the relevant US Agency, so that more than 20 per cent of the gross assets of the Company may be invested in such mortgage-backed securities created by any of the US Agencies provided that not more than 20 per cent. is invested in such securities referable to any particular pool. While each such mortgage-backed security is guaranteed by the relevant US Agency, the underlying credit and collateral in relation to the securities referable to each particular pool is the relevant pool's particular underlying mortgage borrowers and their homes.The Company may purchase interest rate caps. Interest rate caps are intended to enable the Company to hedge against the risk of the coupon rates on the Company's adjustable-rate mortgage-backed securities and Floaters reaching their caps during periods of rising interest rates. In an interest rate cap contract, the purchaser will be paid an agreed amount if rates move above an agreed upon level. This is intended to offset the effects of the coupon rates on adjustable-rate mortgage-backed securities and Floaters reaching their caps during periods of rising interest rates. The Company may also enter into interest rate swaps. Interest rate swaps are intended to enable the Company to mitigate the risk of the cost of its liabilities increasing at a faster rate than the earnings on its portfolio during a period of rising interest rates. The Company will not purchase interest rate caps or interest rate swaps unless the unsecured commercial paper, senior debt or claims paying ability of the counterparty is rated either A-1 or A or better by Standard & Poor's or either P1 or A or better by Moody's.
Investment Restrictions
The Directors will ensure that the following investment restrictions are observed: - Save in respect of cash deposits awaiting investment, no more than 20 per cent. of the gross assets of the Company (before deducting borrowed money) will be lent to or invested in any one company or group (including loans to or shares in the Company's own subsidiaries) at the time the investment or loan is made. For this purpose any existing holding in the company or group concerned will be aggregated with the proposed investment and securities created by Fannie Mae, Freddie Mac or Ginnie Mae referable to a particular pool of mortgages (but not debentures issued by any of them) will only be treated as issued by the same company or group if they are referable to the same pool;- Not more than 10 per cent., in aggregate, of the value of the gross assets of the Company (before deducting borrowed money) will be invested in other investment companies (including investment trusts) listed on the London Stock Exchange, except where the investment companies themselves have stated investment policies to invest no more than 15 per cent. Of their gross assets in other investment companies (including investment trusts) listed on the London Stock Exchange; - Not more than 15 per cent., in aggregate, of the value of the gross assets of the Company (before deducting borrowed money) will be invested in other investment companies (including investment trusts) listed on the London Stock Exchange; - Prodesse will not take legal or management control over investments in its portfolio. In accordance with the requirements of the UK Listing Authority, any material changes in the principal investment policies and restrictions (as set out above) of the Company will only be made with the approval of Shareholders by ordinary resolution.
Glossary
Collateralized Mortgage Obligations (CMOs)-The CMO is a multi-class bond backed by a pool of mortgage pass-through securities or mortgage loans.
Credit Risk-The risk that the underlying borrower on the mortgage defaults on his mortgage payment either in part or in whole, which would result in a loss on the investment.
Currency Risk-The risk that a company's operations or an investment's value could be affected by changes in one currency's value relative to another. Global business' operations, in particular, are exposed to currency risk.
GNMA (Government National Mortgage Association)-Ginnie Mae is a government-owned corporation within the Department of Housing and Urban Development. Ginnie Mae guarantees the timely payment of principal and interest on all of its pass-through securities, and Ginnie Mae's guarantee is backed by the full faith and credit of the U.S. government. This guarantees prompt payment of monthly interest, whether or not mortgage payments are collected and full repayment of principal even if the mortgages in the pool default.
Fed Funds-Funds in excess of the reserve requirements that banks deposit in Federal Reserve Banks. Member banks may lend reserves to one another.
FHLB (Federal Home Loan Bank) - The FHLB System is a government-sponsored enterprise (GSE) chartered by US Congress. Its purpose is to support residential mortgage lending and community investment at the local level. This is accomplished by providing primary mortgage liquidity (direct loans) to member financial institutions.
FHLMC (Federal Home Loan Mortgage Corporation)-Freddie Mac is chartered by Congress, but owned by stockholders. Freddie Mac guarantees timely payment of both principal and interest on its Gold PCs. Some older series of Freddie Mac PCs guarantee timely payment of interest and eventual payment of principal. It is not a U.S. Government Agency.
Fixed-Rate MBS-The coupon on these MBS is fixed for the life of the security.
Floating-Rate or Adjustable-Rate MBS-The coupon on these MBS adjusts to changes in an index, generally a short-term interest rate benchmark such as Libor (London Inter Bank Offered Rate) or the CMT (Constant Maturity Treasury), at a predetermined spread to that index. (e.g.; if LIBOR equals 6% and the spread equals 1% then the resulting coupon equals 7 %.)
FNMA (Federal National Mortgage Association)-Fannie Mae is chartered by Congress, but owned by stockholders. Fannie Mae guarantees timely payment of both principal and interest on its mortgage securities whether or not the payments have been collected from the borrower. It is not a U.S. Government Agency.
FOMC (Federal Open Market Committee)-The FOMC is a committee within the Federal Reserve System that makes short-term monetary policy for the Fed.
LIBOR-The London Interbank Offered Rate Index (LIBOR) is an average of the interest rates that major international banks charge each other to borrow US dollars in the London money market. Like the US treasury the CD indexes, LIBOR tends to move and adjust quite rapidly to changes in interest rates.
Mortgage-backed securities (MBS)-an ownership interest in mortgage loans made by financial institutions (savings & loans, commercial banks, or mortgage companies) to finance a borrower's purchase of a home or other real estate. Investors may purchase mortgage securities either when they are issued or afterward in the secondary market from a dealer. Residential mortgage-backed securities are backed by pools of residential real estate mortgage loans.
Repurchase Market-A market in which an institutional investor finances their securities purchases. The investor sells (pledges) their securities to a broker-dealer for a loan, with the agreement that the investor will buy them back on a predetermined date at a specified price. The difference between the principal received and the amount paid to the broker-dealer represents the interest on the loan. The term of each transaction can be as short as one day or as long as five years. The interest rate is highly correlated to the Fed Funds rate.
A full copy of the Annual Report and Accounts for the year to 31st December 2008, can be viewed or downloaded from the Company's website: www.prodesse.co.uk
For further information:
BNP Paribas Fund Service (Guernsey) Limited 01481 750850
Jean McMillan/Sara Radford