Last checked at 11 Aug 2009 11:29
Prodesse Investment Limited
Unaudited Interim Report and Condensed Financial Statements
for the six months ended 30 June 2009
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.
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, Asia, Canada and the United States. It also manages numerous separate accounts for high net worth individuals and public funds. As at 30 June 2009, FIDAC and Annaly collectively had approximately $86.3 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 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 Noble & Company Limited 120 Old Broad Street London EC2N 1AR
| |
| Daniel Stewart & Co Plc Becket House 36 Old Jewry London EC2R 8DD |
Responsibility Statement
We confirm to the best of our knowledge:
By order of the Board
John E Hallam Christopher N Fish
Director Director
10 August 2009 10 August 2009
Interim Management report
Review of Business
A summary of the performance of the Company and future outlook is provided in the Investment Manager's report on pages 9 to 10.
Dividend
The Company paid an interim dividend for the quarter ended 31 March 2009 of US$0.23 per Ordinary Share on 11 June 2009. A second interim dividend of US$0.27 per Ordinary Share, in respect of the second quarter of 2009, was declared on 10 August 2009 and will be paid on 9 September 2009.
Financial position
At 30 June 2009, the reported net asset value per Ordinary Share (before including the effect of the dividend declared for the quarter ended 30 June 2009) is US$7.69 (30 June 2008: US$6.99 and 31 December 2008: US$6.28).
At 30 June 2009, the Company had a net asset value per share of US$7.42 (31 December 2008: US$6.09) after deducting the second interim dividend declared for the quarter of US$8,365,154 (31 December 2008: US$7,125,872). The NAV per share steadily increased during the six month period as continued US Government intervention in both the Treasury and Agency Mortgage-Backed Securities markets improved asset valuations. All of the Mortgage-Backed Securities are "AAA" rated or carry an implied "AAA" rating.
Related party transactions
Related party transactions are disclosed in note 17 to the condensed set of financial statements. There have been no material changes in the related party transactions described in the last annual report.
Risks and uncertainties
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. There are a number of potential risks and uncertainties which could have a material impact on the Company's performance over the remaining six months of the financial year and could cause actual results to differ materially from expected and historical results. Further information on the principal long-term risks and uncertainties of the Company is included in the latest annual report (as at 31 December 2008) which can be found on the Company's website. The Directors do not consider that the principal risks and uncertainties have changed since the publication of the latest annual report.
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.
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.
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.
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.
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.
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. 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, JP Morgan Chase Bank N.A., 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.
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. 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.
Interest Rate Risk (continued)
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 11.
Liquidity Risk
Liquidity risk arises as a result of the Company not having sufficient cash to meet its liabilities as they fall due. 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.
By order of the Board
John E Hallam Christopher N Fish
Director Director
10 August 2009 10 August 2009
Investment Manager's Report
Overview
Although financial conditions remained stressed for US households and businesses during the first half of 2009, with continued Government focus in the Agency MBS and Treasury markets, asset valuations and liquidity have seen noticeable improvement. The Federal Open Market Committee (FOMC) held the Federal Funds Target Rate (Fed Funds) in its lowest historical range of 0 to ¼ percent resulting in lower short-term financing rates. As Prodesse uses leverage to enhance returns to investors using primarily short-term borrowings, movements in short-term interest rates will drive the Company's largest expense, interest expense. In the first six months of 2009 the Company benefited from decreasing cost of funds and improving net interest rate spread which allowed for steady dividend increases. Prodesse paid a first interim dividend of US$0.23 on 11 June 2009 and has declared a second interim dividend of US$0.27 on 10 August 2009, payable on 9 September 2009.
Investment Portfolio
As the yield curve in the United States became more positively sloped during the first half of 2009, the Company remained well positioned to perform.
| Summary details of the ten largest investments as at 30 June 2009 | |||
| Description | Market Value US $'000s | % of portfolio | Current coupon |
| GN 673234 | 50,533 | 2.51% | 6.00% |
| FNR 2005-47 FG | 37,735 | 1.87% | 0.81% |
| FN 924848 | 37,496 | 1.86% | 6.50% |
| FG G08200 | 36,076 | 1.79% | 6.00% |
| FN 256233 | 33,090 | 1.64% | 6.00% |
| FN 981043 | 31,556 | 1.57% | 6.50% |
| FN 917129 | 31,467 | 1.56% | 6.00% |
| FN 256492 | 30,837 | 1.53% | 6.00% |
| FG A48575 | 30,087 | 1.49% | 6.00% |
| FN 987020 | 29,579 | 1.47% | 6.00% |
At 30 June 2009, after taking into account the effect of the swaps, the portfolio held 26% fixed-rate, 27% adjustable-rate and 47% floating-rate assets. During the second quarter, the annualized yield on earning assets was 4.33%, and the annualized cost of funds on average balance was 2.68%, resulting in a net interest rate spread of 1.65%. This represents an increase of 24 basis points over the net interest rate spread during the quarter ended 31 March 2009 and a 29 basis point increase over net interest rate spread during the quarter ended 30 June 2008.
| 30 June 2009 | 31 March 2009 | 31 December 2008 | 30 September 2008 | |
| Annualised Yield on Average Assets | 4.33% | 4.56% | 5.24% | 5.21% |
| Annualised Cost of Funds on Average Balance | 2.68% | 3.15% | 3.92% | 3.73% |
| Interest Rate Spread | 1.65% | 1.41% | 1.32% | 1.48% |
| % of Portfolio | ||||
| Fixed-rate MBS | 54% | 49% | 49% | 49% |
| Adjustable-rate MBS | 27% | 27% | 24% | 24% |
| Floating-rate MBS | 19% | 24% | 27% | 27% |
| Notional amount of interest rate swap | 28% | 28% | 33% | 35% |
Liability Management and Leverage
The amount of leverage used during the first half of the year remained fairly constant, averaging approximately 7.2 debt-to-equity. The Company continues to utilize primarily short-term borrowings through the use of reverse-repurchase agreements and currently maintains such agreement with 16 counterparties. Funding of US Agency MBS continues to be readily available and the reverse repurchase markets provide the most cost-efficient means of borrowings for the Company.
| 30 June 2009 | 31 March 2009 | 31 December 2008 | 30 September 2008 | |
| Average Leverage During Period | 7.2 | 7.6 | 8.5 | 8.4 |
| Leverage at Period End | 7.0 | 7.4 | 7.8 | 8.2 |
| Repurchase Agreements at Period End (000s) | 1,669,657 | 1,647,962 | 1,515,351 | 1,687,721 |
Outlook
Despite US investors' hopes of an imminent economic recovery, Federal Reserve Chairman, Ben Bernanke, acknowledged in his Semiannual Monetary Policy Report to the Congress that "economic conditions [were] likely to warrant maintaining the federal funds rate at exceptionally low levels for an extended period." Although monetary policy appears to be on hold, we continue to evaluate the effects of the US Government intervention programs affecting the mortgage market, while taking advantage of the lucrative interest rate spread presented by the current US yield curve.
As managers of the investment portfolio of Prodesse, the primary risk we must deal with is interest rate risk. FIDAC's MBS Barbell Strategysm seeks to utilise the principal and interest cash flows of US Agency floating-rate, adjustable-rate and fixed-rate MBS to help manage through a range of US interest rate environments. As we look forward to the second half of 2009, we believe Prodesse's portfolio of short-duration, high credit-quality assets will continue to be positioned to perform.
Fixed Income Discount Advisory Company
10 August 2009
Independent Review Report to Prodesse Investment Limited
We have been engaged by the Company to review the condensed set of financial statements in the half-yearly financial report for the six months ended 30 June 2009 which comprises the condensed income statement, the condensed statement of comprehensive income, the condensed statement of changes in shareholders' equity, the condensed balance sheet, the condensed cash flow statement and related notes 1 to 17. We have read the other information contained in the half-yearly financial report and considered whether it contains any apparent misstatements or material inconsistencies with the information in the condensed set of financial statements.
This report is made solely to the Company in accordance with International Standard on Review Engagements (UK and Ireland) 2410 issued by the Auditing Practices Board. Our work has been undertaken so that we might state to the Company those matters we are required to state to them in an independent review 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, for our review work, for this report, or for the conclusions we have formed.
Directors' responsibilities
The half-yearly financial report is the responsibility of, and has been approved by, the Directors. The Directors are responsible for preparing the half-yearly financial report in accordance with the Disclosure and Transparency Rules of the United Kingdoms' Financial Services Authority.
As disclosed in note 2, the annual financial statements of the Company are prepared in accordance with IFRSs. The condensed set of financial statements included in this half-yearly financial report has been prepared in accordance with International Accounting Standard 34 "Interim Financial Reporting".
Our responsibility
Our responsibility is to express to the Company a conclusion on the condensed set of financial statements contained in half-yearly financial report based on our review.
Scope of Review
We conducted our review in accordance with International Standard on Review Engagements (UK and Ireland) 2410, "Review of Interim Financial Information Performed by the Independent Auditor of the Entity" issued by the Auditing Practices Board for use in the United Kingdom. A review of interim financial information consists of making inquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures. A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK and Ireland) and consequently does not enable us to obtain assurance that we would become aware of all significant matters that might be identified in an audit. Accordingly, we do not express an audit opinion.
Conclusion
Based on our review, nothing has come to our attention that causes us to believe that the condensed set of financial statements in the half-yearly financial report for the six months ended 30 June 2009 is not prepared, in all material respects, in accordance with International Accounting Standard 34 and the Disclosure and Transparency Rules of the United Kingdom's Financial Services Authority.
Deloitte LLP
Chartered Accountants
Guernsey, Channel Islands
10 August 2009
Notes: A review does not provide assurance on the maintenance and integrity of the website, including controls used to achieve this, and in particular on whether any changes may have occurred to the financial information since first published. These matters are the responsibility of the directors but no control procedures can provide absolute assurance in this area.
Legislation in Guernsey and the United Kingdom governing the preparation and dissemination of financial information differs from legislation in other jurisdictions.
Condensed Income Statement
For the six months ended 30 June 2009
| | Notes | Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 |
| | | US $'000 | US $'000 | US $'000 |
| | | (unaudited) | (unaudited) | (audited) |
| Income: | | | | |
| Interest income | 3 | 42,353 | 56,214 | 103,638 |
| Interest expense | 4 | (23,831) | (38,056) | (69,108) |
| Net interest income | | 18,522 | 18,158 | 34,530 |
| | | | | |
| Realised gain/(loss) on sale of available for sale investments and termination of interest rate swaps | 9,13 | - | (60) | 7,074 |
| Realised loss on cash flow hedge | | - | - | (6,775) |
| Amortisation of de-designation of cash flow hedge | | (4,803) | - | (1,949) |
| Unrealised gain/(loss) on interest rate swaps | 11 | 10,585 | - | (22,696) |
| Total income | | 24,304 | 18,098 | 10,184 |
| | | | | |
| Expenses | | | | |
| Management, Custodian and Administration fees | 5 | (2,320) | (2,316) | (4,518) |
| Other operating expenses | 5 | (629) | (622) | (1,259) |
| Total expenses | 5 | (2,949) | (2,938) | (5,777) |
| | | | | |
| Net profit for the period / year | | 21,355 | 15,160 | 4,407 |
| | | | | |
| Earnings per Ordinary Share: | | | | |
| Basic - Ordinary Share | 8 | US$0.69 | US$0.52 | US$0.15 |
| | | | | |
| Weighted Average Ordinary Shares outstanding | | | | |
| Basic | 8 | 30,982,050 | 29,419,047 | 30,204,819 |
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 condensed set of financial statements.
Condensed Statement of Comprehensive Income
For the six months ended 30 June 2009
| | Notes | Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 |
| | | US $'000 | US $'000 | US $'000 |
| | | (unaudited) | (unaudited) | (audited) |
| | | | | |
| Net Profit for the period / year | | 21,355 | 15,160 | 4,407 |
| | | | | |
| Available for sale financial assets: | | | | |
| Unrealised gains / (losses) arising during the period / year | | 30,574 | (19,890) | (19,441) |
| Transfer of net realised gain / (loss) to capital reserve | | - | 60 | (299) |
| | | | | |
| | | 30,574 | (19,830) | (19,740) |
| | | | | |
| Cash flow hedges: | | | | |
| Unrealised losses arising during the period / year | | - | (2,666) | (1,770) |
| Amortisation of de-designated cash flow hedge | | 4,803 | - | 1,949 |
| | | | | |
| | | 4,803 | (2,666) | 179 |
| | | | | |
| | | | | |
| Total comprehensive income for the period / year | | 56,732 | (7,336) | (15,154) |
| | | | | |
All comprehensive income is attributable to the Ordinary Shareholders of the Company.
The accompanying notes form an integral part of the condensed set of financial statements.
| Condensed Statement of Changes in Shareholders' Equity For the six months ended 30 June 2009 (unaudited) | ||||||||||
| Notes | Share capital | Capital redemption reserve | Share premium | Distributable reserve | Accumulated profits | Capital Reserve - Realised gain / (loss) on available for sale investments and interest rate swaps | Revaluation reserve - Unrealised (loss) / gain on available for sale investments | Cash flow hedge reserve | Total | |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2009 | 310 | 30 | 91,560 | 141,513 | (15,656) | 1,899 | (10,104) | (15,012) | 194,540 | |
| Available for sale investments: | ||||||||||
| - Unrealised gain on revaluation taken to equity | 9 | - | - | - | - | - | - | 30,574 | - | 30,574 |
| Net profit for the period | - | - | - | - | 21,355 | - | - | - | 21,355 | |
| Amortisation of de-designated cash flow hedge | 13 | - | - | - | - | - | - | - | 4,803 | 4,803 |
| Total recognised income and expenses for the period | - | - | - | - | 21,355 | - | 30,574 | 4,803 | 56,732 | |
| Dividend paid | 7 | - | - | - | - | (13,013) | - | - | - | (13,013) |
| At 30 June 2009 | 13 | 310 | 30 | 91,560 | 141,513 | (7,314) | 1,899 | 20,470 | (10,209) | 238,259 |
The accompanying notes form an integral part of the condensed set of financial statements.
| Condensed Statement of Changes in Shareholders' Equity For the six months ended 30 June 2008 (unaudited) | ||||||||||
| Notes | Share capital | Capital redemption reserve | Share premium | Distributable reserve | Accumulated profits | Capital Reserve - Realised gain / (loss) on available for sale investments and interest rate swaps | Revaluation reserve - Unrealised (loss) / gain on available for sale investments | Cash flow hedge reserve | Total | |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2008 | 282 | 30 | 71,680 | 141,513 | 7,220 | 1,600 | 16,411 | (21,966) | 216,770 | |
| Available for sale investments: | ||||||||||
| - Unrealised loss on revaluation taken to equity | 9,13 | - | - | - | - | - | - | (19,890) | - | (19,890) |
| -Realised gain on sale of investments | 9,13 | - | - | - | - | - | - | (6,715) | - | (6,715) |
| Net profit for the period | - | - | - | - | 15,160 | - | - | - | 15,160 | |
| Transfer of net realised loss to capital reserve | 2 | - | - | - | - | 60 | (60) | - | - | - |
| Cash flow hedge reserve | ||||||||||
| - Loss on termination transferred to income statement | 13 | - | - | - | - | - | - | - | 6,775 | 6,775 |
| - Gain taken to equity | 9,13 | - | - | - | - | - | - | - | (2,666) | (2,666) |
| Total recognised income and expenses for the period | - | - | - | - | 15,220 | (60) | (26,605) | 4,109 | (7,336) | |
| Dividend paid | 7 | - | - | - | - | (12,732) | - | - | - | (12,732) |
| Issuance of shares | 13 | 28 | - | 20,497 | - | - | - | - | - | 20,525 |
| Issue costs | 13 | - | - | (617) | - | - | - | - | - | (617) |
| At 30 June 2008 | 13 | 310 | 30 | 91,560 | 141,513 | 9,708 | 1,540 | (10,194) | (17,857) | 216,610 |
The accompanying notes form an integral part of the condensed set of financial statements.
| Condensed Statement of Changes in Shareholders' Equity For the year ended 31 December 2008 (audited) | ||||||||||
| Notes | Share capital | Capital redemption reserve | Share premium | Distributable reserve | Accumulated profits | Capital Reserve - Realised gain / (loss) on available for sale investments | Revaluation reserve - Unrealised (loss) / gain on available for sale investments | Cash flow hedge reserve | Total | |
| US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | US $'000 | ||
| At 1 January 2008 | 282 | 30 | 71,680 | 141,513 | 7,220 | 1,600 | 16,411 | (21,966) | 216,770 | |
| Available for sale investments: | ||||||||||
| - Unrealised loss on revaluation taken to equity | 9,13 | - | - | - | - | - | - | (19,441) | - | (19,441) |
| -Realised gain on sale of investments | 9,13 | - | - | - | - | - | - | (7,074) | - | (7,074) |
| Net profit for the year | - | - | - | - | 4,407 | - | - | - | 4,407 | |
| Amortisation of de-designated cash flow hedge | - | - | - | - | - | - | - | 1,949 | 1,949 | |
| Transfer of net realised loss to capital reserve | 2 | - | - | - | - | (299) | 299 | - | - | - |
| Cash flow hedge reserve | ||||||||||
| - Unrealised loss taken to equity | - | - | - | - | - | - | - | (1,770) | (1,770) | |
| - Realised loss on cash flow hedge | 9,13 | - | - | - | - | - | - | - | 6,775 | 6,775 |
| Total recognised income and expenses for the year | - | - | - | - | 4,108 | 299 | (26,515) | 6,954 | (15,154) | |
| Dividend paid | 7 | - | - | - | - | (26,984) | - | - | - | (26,984) |
| Issuance of shares | 13 | 28 | - | 20,497 | - | - | - | - | - | 20,525 |
| Issue costs | 13 | - | - | (617) | - | - | - | - | - | (617) |
| At 31 December 2008 | 13 | 310 | 30 | 91,560 | 141,513 | (15,656) | 1,899 | (10,104) | (15,012) | 194,540 |
The accompanying notes form an integral part of the condensed set of financial statements.
Condensed Balance Sheet
As at 30 June 2009
|
| 30 June 2009 | 30 June 2008 | 31 December 2008 | |
| Notes | US $'000 | US $'000 | US $'000 | |
| (unaudited) | (unaudited) | (audited) | ||
| Non-current assets | ||||
| Available for sale investments | 9 | 2,014,890 | 2,005,510 | 1,709,479 |
| 2,014,890 | 2,005,510 | 1,709,479 | ||
| Current assets | 10 | |||
| Accrued income receivable | 8,785 | 8,988 | 7,785 | |
| Receivable for principal paydowns | 5,525 | 3,556 | 1,519 | |
| Receivable for securities sold | - | - | 19,426 | |
| Prepaid expenses | 11 | 363 | 329 | 139 |
| Cash and cash equivalents | 215 | 89 | 19,173 | |
| 14,888 | 12,962 | 48,042 | ||
| Total assets | 2,029,778 | 2,018,472 | 1,757,521 | |
| Equity attributable to equity shareholders | ||||
| Ordinary share capital | 13 | 310 | 310 | 310 |
| Capital redemption reserve | 13 | 30 | 30 | 30 |
| Share premium | 13 | 91,560 | 91,560 | 91,560 |
| Distributable reserve | 13 | 141,513 | 141,513 | 141,513 |
| Accumulated (losses)/profits | 13 | (7,314) | 9,708 | (15,656) |
| Capital reserve - Realised gain on available for sale investments and interest rate swaps | 13 | 1,899 | 1,540 | 1,899 |
| Revaluation reserve - Unrealised gain/(loss) on available for sale investments | 13 | 20,470 | (10,194) | (10,104) |
| Cash flow hedge reserve | 11,13 | (10,209) | (17,857) | (15,012) |
| Total equity | 238,259 | 216,610 | 194,540 | |
| Current liabilities | 10 | |||
| Securities purchased payable | 86,484 | - | - | |
| Reverse repurchase agreements | 12 | 1,669,657 | 1,776,586 | 1,515,351 |
| Accrued interest expense | 4,010 | 5,639 | 5,958 | |
| Accrued expenses payable | 2,296 | 1,780 | 2,015 | |
| Fair values of interest rate swaps | 11,13 | 29,072 | 17,857 | 39,657 |
| Total liabilities | 1,791,519 | 1,801,862 | 1,562,981 | |
| Total equity and liabilities | 2,029,778 | 2,018,472 | 1,757,521 | |
| Net Assets | 238,259 |
216,610 |
194,540 | |
| Net Asset Value per Ordinary Share | 14 | US$7.69 | US$6.99 | US$6.28 |
The Interim Report was approved by the Board of Directors on 10 August 2009 and is signed on its behalf by:
John E Hallam Christopher N Fish
Director Director
The accompanying notes form an integral part of the condensed set of financial statements.
Condensed Cash Flow Statement
For the six months ended 30 June 2009
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | ||
| Notes | US $'000 | US $'000 | US $'000 | |
| (unaudited) | (unaudited) | (audited) | ||
| Net cash (outflow)/inflow from operating activities | 15 | (160,251) | 227,663 | 522,234 |
| Cash flows from financing activities | ||||
| Borrowings under reverse repurchase agreements | 6,961,472 | 10,047,328 | 17,833,564 | |
| Repayments under reverse repurchase agreements | (6,807,166) | (10,282,126) | (18,329,597) | |
| Dividends paid to shareholders | 7 | (13,013) | (12,732) | (26,984) |
| Issue of shares | 13 | - | 19,908 | 19,908 |
| Net cash from/(to) financing activities | 141,293 | (227,622) | (503,109) | |
| Net (decrease)/increase in cash and cash equivalents | (18,958) | 41 | 19,125 | |
| Cash and cash equivalents at the beginning of the period / year | 19,173 | 48 | 48 | |
| Cash and cash equivalents at the end of the period / year | 215 | 89 | 19,173 | |
The accompanying notes form an integral part of the condensed set of financial statements.
Notes to the Condensed Set of Financial Statements
1. General Information
Prodesse Investment Limited is a limited liability Guernsey-incorporated closed-end investment company, the investments of which are managed by Fixed Income Discount Advisory Company ("the Investment Manager"). The Company's share capital structure consists solely of Ordinary Shares. The Company has a listing on the London Stock Exchange and a listing on the Channel Islands Stock Exchange. The Company will have an indefinite life but Shareholders will have the opportunity to vote on its continuation at the Annual General Meeting to be held in 2010. The address of the registered office is given on page 4.
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.
The financial information for the year ended 31 December 2008 included in this half-yearly report does not constitute statutory accounts as defined in The Companies (Guernsey) Law, 2008. The auditors reported on those accounts, their report was unqualified, did not draw attention to any matters by way of emphasis, and did not contain a statement under section 263(2) and (3) of The Companies (Guernsey) Law, 2008.
2. Significant Accounting Policies
Basis of Accounting
The annual financial statements are prepared in accordance with International Financial Reporting Standards ("IFRS"). The condensed set of financial statements included in this half-yearly financial report has been prepared in accordance with International Accounting Standard (IAS) 34, "Interim Financial Reporting". The same accounting policies, presentation and methods of computation are followed in the condensed set of financial statements as applied in the Company's latest annual audited financial statements except as described below.
The condensed set of financial statements is 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.
Changes in accounting policy
In the current financial period, the Company has adopted International Financial Reporting Standard 8 "Operating Segments" and International Accounting Standard 1 "Presentation of Financial Statements" (revised 2007).
IFRS 8 requires operating segments to be identified on the basis of internal reports about components of the Company that are regularly reviewed by the Directors to allocate resources to the segments and to assess their performance. In contrast, the predecessor Standard IAS 14 "Segmental Reporting" required the Company to identify two sets of segments (business and geographical), using a risks and rewards approach, with the Company's system of internal financial reporting to Directors serving only as the starting point for the identification of such segments. However, as the Company is engaged in a single segment of business and no such segmental reporting is undertaken, this has not resulted in any changes to the financial information provided.
IAS 1 (revised) requires the presentation of a statement of changes in equity as primary statement, separate from the income statement and statement of comprehensive income. As a result, condensed statement of comprehensive income has been included in the primary statements, showing changes in each component of equity for each period presented.
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 the Interim Management Report).
The Company's non-cash assets are largely actual or implied AAA assets, and accordingly, the Directors have not had, nor do they anticipate having, difficulty in converting the Company's assets to cash. The balance sheet also generates liquidity on an on-going basis through mortgage principal repayments and net earnings held prior to payment as dividends. Should the Company's needs ever exceed these on-going sources of liquidity plus the immediate sources of liquidity discussed above, the Directors believe that in most circumstances the Company's investments could be sold to raise cash.
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 Freddie Mac and Fannie Mae mortgage-backed securities are backed by those respective agencies. The payment of principal and interest on the Ginnie Mae mortgage backed securities are backed by the full-faith-and-credit of the US Government. Although the Company generally intends to hold most of its securities until maturity, it may, from time to time, sell any of its mortgage-backed securities as part of its overall management strategy. Accordingly the Company classifies all its mortgage-backed securities as available for sale and these are reported at fair value. Expenses incidental to the acquisition of available for sale investments are included within the cost of that investment.
Realised and Unrealised Gains and Losses on Investments
Unrealised gains or losses arising on the revaluation of investments are included in equity in the revaluation reserve. 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 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. The Company voluntarily discontinued hedge accounting in the fourth quarter of 2008 through a combination of de-designating previously defined hedge relationships and not designating new contracts as cash flow hedges. In respect of the de-designation of cash flow hedges, IAS 39 requires that any cumulative gain or loss on the hedging instrument recognised in equity for cash flow hedges is retained in equity until the forecasted transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised in equity is transferred to net profit or loss in the period. The Company continues to hold repurchase agreements in excess of swap contracts and has no indication that interest payments on the hedged repurchase agreements are in jeopardy of discontinuing. Therefore, the unrealised losses related to the cashflow hedges that have been de-designated are not recognised immediately and these losses are expected to be reclassified into earnings during the contractual terms of the swap agreements starting as of 1 October 2008. Changes in the fair value of the interest rate swaps subsequent to 30 September 2008 are reflected in the Company's income statement.
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. In addition no separate segmental reporting to the Directors is carried out and therefore no segmental reporting is provided.
3. Interest Income
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | 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) |
| - Available for sale investments | 43,888 | 56,671 | 105,193 |
| - Amortisation of premium in respect of available for sale investments | (1,535) | (457) | (1,551) |
| 42,353 | 56,214 | 103,638 |
4. Interest Expense
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Interest expense on financial liabilities at fair value through profit or loss: | |||
| - Interest rate swap contracts | 12,122 | 6,168 | 13,021 |
| Interest expense on financial liabilities that are not at fair value through profit or loss: | |||
| - Repurchase agreements | 11,709 | 31,888 | 56,087 |
| 23,831 | 38,056 | 69,108 |
5. Expenses
| | Notes | Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 |
| | | US $'000 | US $'000 | US $'000 |
| Investment management, Custodian and Administration fees | | | | |
| | | | | |
| Investment management fee | 6 | 1,932 | 1,905 | 3,726 |
| Administration fee | 6 | 250 | 264 | 507 |
| Custodian fee | 6 | 138 | 147 | 285 |
| | | 2,320 | 2,316 | 4,518 |
| Other operating expenses | | | | |
| Directors' fees | | 86 | 86 | 174 |
| Insurance | | 161 | 153 | 317 |
| Audit fee | | 126 | 127 | 256 |
| Corporate broker fees | | 15 | 15 | 30 |
| Public relations and website costs | | 123 | 124 | 250 |
| Legal fee | | 31 | 31 | 63 |
| Regulatory fee | | 24 | 24 | 49 |
| Other expenses | | 63 | 62 | 120 |
| | | 629 | 622 | 1,259 |
| | | | | |
| Total expenses | | 2,949 | 2,938 | 5,777 |
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.
6. 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).
7. Dividends
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2009 | |
| US $'000 | US $'000 | US $'000 | |
| Amounts recognised as distributions to equity shareholders in the period / year: | |||
| Final interim dividend for the year ended 31 December 2008 of 19 cents per share (year ended 31 December 2007: 21 cents per share) | 5,887 | 5,915 | 5,915 |
| First interim dividend for the year ended 31 December 2009 of 23 cents per share (year ended 31 December 2008: 22 cents per share) | 7,126 | 6,817 | 6,817 |
| Second interim dividend for the year ended 31 December 2009 of 27 cents per share (year ended 31 December 2008: 23 cents per share) | - | - | 7,126 |
| Third interim dividend for the year ended 31 December 2008 of 23 cents per share | - | - | 7,126 |
| 13,013 | 12,732 | 26,984 |
A second interim dividend of 0.27 cents per Ordinary share, in respect of the second quarter of 2009 was declared on 10 August 2009 and will be paid on 9 September 2009.
8. Earnings Per Ordinary Share
Basic earnings per Ordinary share is calculated by dividing net profit available to Ordinary Shareholders by the weighted average number of ordinary shares outstanding during the period.
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| Number of shares | Number of shares | Number of shares | |
| Weighted average number of Ordinary Shares outstanding | 30,982,050 | 29,419,047 | 30,204,819 |
9. Available for Sale Investments
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Cost at 1 January | 1,719,583 | 2,263,635 | 2,263,635 |
| Purchases of investments | 530,278 | 488,968 | 738,887 |
| Proceeds from sale of investments | (3) | (563,082) | (1,029,158) |
| Realised gain on sale of investments | - | 6,715 | 7,074 |
| Principal paydowns | (253,908) | (180,075) | (259,304) |
| Net amortisation of premiums | (1,530) | (457) | (1,551) |
| Amortised cost at 30 June / 31 December | 1,994,420 | 2,015,704 | 1,719,583 |
| Unrealised (loss) / gain on available for sale investments | 20,470 | (10,194) | (10,104) |
| Market value at 30 June / 31 December | 2,014,890 | 2,005,510 | 1,709,479 |
| At 30 June 2009 | Amortised Cost | Gross Unrealised Gain | Gross Unrealised Loss | Estimated Fair Value |
| US $'000 | US $'000 | US $'000 | US $'000 | |
| Adjustable rate | 532,949 | 4,955 | (1,262) | 536,642 |
| Floating rate | 365,241 | - | (9,651) | 355,590 |
| Fixed rate | 1,096,230 | 26,965 | (537) | 1,122,658 |
| Total | 1,994,420 | 31,920 | (11,450) | 2,014,890 |
| At 30 June 2008 | Amortised Cost | Gross Unrealised Gain | Gross Unrealised Loss | Estimated Fair Value |
| US $'000 | US $'000 | US $'000 | US $'000 | |
| Adjustable rate | 385,516 | 2,427 | (617) | 387,326 |
| Floating rate | 513,039 | - | (18,386) | 494,653 |
| Fixed rate | 1,117,149 | 9,688 | (3,306) | 1,123,531 |
| Total | 2,015,704 | 12,115 | (22,309) | 2,005,510 |
| 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 |
As at 30 June 2009, all of the assets in the Company's portfolio were Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities, which carry an actual or implied "AAA" rating. The portfolio held the following types of assets (excluding the effect of interest rate swaps) as at 30 June 2009, 31 December 2008 and 30 June 2008:
| 30 June 2009 | 30 June 2008 | 31 December 2008 | |
| Fixed-rate mortgage-backed securities | 54% | 55% | 49% |
| Adjustable-rate mortgage-backed securities | 27% | 19% | 24% |
| Floating-rate mortgage-backed securities | 19% | 26% | 27% |
As at 30 June 2009, investments totalling US$1.7 billion (30 June 2008: US$1.8 billion, 31 December 2008: US$1.5 billion) were pledged as security in respect of reverse repurchase agreements (see note 12).
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.
10. 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.
11. 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 against the benchmark interest rate risk associated with the Company's borrowings until 30 September 2008. 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 30 June 2009, the Company had interest swap agreements of US$567 million notional amount (30 June 2008: US$560 million, 31 December 2008: US$563 million) in which the Company will pay a weighted average rate of 4.76% (30 June 2008: 5.13%, 31 December 2008: 4.96%) and receive a weighted average rate of 0.32% (30 June 2008: 2.47%, 31 December 2008: 1.08%).
The fair value of the swaps entered into at 30 June 2009 is estimated at a loss of US$29,071,883 (30 June 2008: loss of US$17,857,141, 31 December 2008: loss of US$39,656,907). The unrealised gain through the income account for the six months to 30 June 2009 was US$10,585,024 (year to 31 December 2008: loss of US$22,695,804).
12. Reverse Repurchase Agreements
At 30 June 2009 the aggregate value of securities pledged by the Company under reverse repurchase agreements exceeds the liability under such agreements by approximately US$96.3 million (30 June 2008: US$70.7 million, 31 December 2008: US$81.3 million) (approximately 5.77% of such liability). The interest rates on the open reverse repurchase agreements at 30 June 2009 range from 0.02% to 4.57% (30 June 2008: from 2.15% to 4.57%, 31 December 2008: from 0.15% to 4.57%) and have maturity dates ranging from 1 days to 973 days (30 June 2008: from 1 day to 1,338 days, 31 December 2008: from 2 days to 1,154 days).
13. Issued Capital and Reserves
Ordinary Share Capital
| 30 June 2009 | 30 June 2008 | 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Authorised | |||
| 60,000,000 Ordinary Shares of US$0.01 each | 600 | 600 | 600 |
| Issued | |||
| 30,982,050 Ordinary Shares of US$0.01 each | 310 | 310 | 310 |
Repurchase of shares
The Company has not purchased shares for cancellation in the current six month period to 30 June 2009.
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
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 30 June / 31 December | 30 | 30 | 30 |
Share Premium
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 1 January | 91,560 | 71,680 | 71,680 |
| Premium arising on issue of equity shares | - | 20,497 | 20,497 |
| Expenses incurred on issue of equity shares | - | (617) | (617) |
| Balance at 30 June / 31 December | 91,560 | 91,560 | 91,560 |
Distributable Reserve
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 30 June / 31 December | 141,513 | 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
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 1 January | (15,656) | 7,220 | 7,220 |
| Net profit for the period / year | 21,355 | 15,160 | 4,407 |
| Realised losses / (gains) transferred to non-distributable capital reserve (see below) | - | 60 | (299) |
| Dividends paid | (13,013) | (12,732) | (26,984) |
| Balance at 30 June / 31 December | (7,314) | 9,708 | (15,656) |
Capital Reserve - Realised Gain/(Loss) on Available for Sale Investments and interest rate swaps
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 1 January | 1,899 | 1,600 | 1,600 |
| Net gains / (losses) on sale of available for sale investments and swaps transferred from accumulated profits | - | (60) | 7,074 |
| Loss on termination of cash flow hedges | - | - | (6,775) |
| Balance at 30 June / 31 December | 1,899 | 1,540 | 1,899 |
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
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 1 January | (10,104) | 16,411 | 16,411 |
| Unrealised gains/(losses) on revaluation taken to equity | 30,574 | (19,890) | (19,441) |
| Transferred to income statement on sale of investments | - | (6,715) | (7,074) |
| Balance at 30 June / 31 December | 20,470 | (10,194) | (10,104) |
Cash Flow Hedge Reserve
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Balance at 1 January | (15,012) | (21,966) | (21,966) |
| Transfer to income statement on termination of cash flow hedges | - | 6,775 | 6,775 |
| (Decrease)/increase in fair value of hedging instruments taken to equity | - | (2,666) | (1,770) |
| Amortisation of de-designated cash flow hedge | 4,803 | - | 1,949 |
| Balance at 30 June / 31 December | (10,209) | (17,857) | (15,012) |
14. Net Asset Value
The net asset value per Ordinary Share is based on net assets at the period end and on 30,982,050 (30 June 2008: 30,982,050 and 31 December 2008: 30,982,050) Ordinary Shares, being the number of Ordinary Shares in issue at the period end.
At 30 June 2009, the reported net asset value per Ordinary Share (before including the effect of the dividend declared for the quarter ended 30 June 2009) is US$7.69 (30 June 2008: US$6.99 and 31 December 2008: US$6.28).
At 30 June 2009, the Company had a net asset value per Ordinary Share of US$7.42 (30 June 2008: US$6.76, 31 December 2008: US$6.09), after including the effect of the dividend declared for the quarter of 30 June 2009 of US$8,365,154 (30 June 2008: US$7,125,872, 31 December 2008: US$5,886,590).
15. Cash Flows from Operating Activities
| Six months ended 30 June 2009 | Six months ended 30 June 2008 | Year ended 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| Net profit for the period / year | 21,355 | 15,160 | 4,407 |
| Net amortisation of premiums on available for sale investments | 1,530 | 457 | 1,551 |
| Unrealised (gain)/loss on interest rate swaps | (10,585) | - | 22,696 |
| Amortisation of de-designated cash flow hedge | 4,803 | - | 1,949 |
| Realised (gain)/loss on available for sale investments | - | 60 | (7,074) |
| Realised loss on termination of interest rate swaps | - | - | 6,775 |
| (4,252) | 517 | 25,897 | |
| Purchases of investments | (443,794) | (520,850) | (770,769) |
| Proceeds from sale of investments | 19,429 | 563,082 | 1,009,732 |
| Termination of interest rate swap | - | (6,775) | (6,775) |
| (424,365) | 35,457 | 232,188 | |
| Principal paydowns | 249,902 | 179,358 | 260,624 |
| (Increase)/decrease in receivables | (1,224) | 1,301 | 2,694 |
| (Decrease)/increase in payables | (1,667) | (4,130) | (3,576) |
| (2,891) | (2,829) | (882) | |
| Net cash (outflow)/inflow from operating activities | (160,251) | 227,663 | 522,234 |
16. 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 15 above. Cash and cash equivalents (which are presented as a single class on the face of the balance sheet) comprise cash at bank.
Related Party Transactions
The relationship between the Company and FIDAC is disclosed in Note 6. The amounts paid to FIDAC during the period are disclosed in Note 5. The amounts outstanding at the period end were:
| 30 June 2009 | 30 June 2008 | 31 December 2008 | |
| US $'000 | US $'000 | US $'000 | |
| FIDAC investment management fee | 997 | 995 | 870 |
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 FHLBank 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 institutional investors finance their securities purchases. Investors sell (pledge) 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 Unaudited Interim Report and Condensed Financial Statements for the six months 30 June 2009, can be viewed or downloaded from the Company's website: www.prodesse.co.uk
For further information:
BNP Paribas Fund Services (Guernsey) Limited 01481 750850
Jean McMillan/Sara Bourne