UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-21102
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
(Exact name of registrant as specified in charter)
ONE LIBERTY PLAZA, 165 BROADWAY, 36TH FLOOR
NEW YORK, NEW YORK 10006-1404
(Address of principal executive offices) (Zip code)
CLIFFORD E. LAI, PRESIDENT
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
ONE LIBERTY PLAZA, 165 BROADWAY, 36TH FLOOR
NEW YORK, NEW YORK, 10006-1404
(Name and address of agent for service)
Registrant's telephone number, including area code: 1 (800) Hyperion
Date of fiscal year end: November 30
Date of reporting period: November 30, 2003
Item 1. Reports to Shareholders.
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Report of the Investment Advisor
For the Year Ended November 30, 2003
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Dear Shareholder:
We welcome this opportunity to provide you with information about The Hyperion
Strategic Mortgage Income Fund, Inc. (the "Fund") for the fiscal year ended
November 30, 2003. The Fund's shares are traded on the New York Stock Exchange
("NYSE") under the symbol "HSM".
Description of the Fund
The Fund is a diversified closed-end management investment company. The Fund's
primary investment objective is to provide a high level of current income by
investing primarily in mortgage-backed securities that offer an attractive
combination of credit quality, yield and maturity. The Fund's secondary
investment objective is to provide capital appreciation. Under normal market
conditions, the Fund will invest at least 80% of its total assets in
investment-grade Mortgage-Backed Securities ("MBS") including Agency MBS,
Non-Agency Residential MBS ("RMBS"), and Commercial MBS ("CMBS"), and may invest
up to 20% of its total assets in U.S. Government securities, cash or other short
term instruments.
Performance
For the fiscal year ended November 30, 2003, shareholders realized a total
investment return of 17.55%, which assumes the reinvestment of dividends and is
exclusive of brokerage commissions. Based on the NYSE closing price of $14.67 on
November 30, 2003, the Fund had a yield of 8.83%, which was 5.47% higher than
the yield of the 5-year U.S. Treasury Note, and competitive with the yields of
other multi-sector bond funds in its category.
As of November 30, 2003, the Fund, inclusive of the effect of leverage, was
managed with an average duration (a bond's duration is the weighted average
number of years until maturity of all its cash flows, including coupon payments
and principal) of 3.6 years, as measured on a net asset basis.
Market Environment
After struggling for several years, the momentum of the economy turned more
positive in the second half of 2003. Housing sales and mortgage refinancings had
another very strong year in 2003 and helped to keep consumer activity robust.
Tax reductions and strength in the stock market added further fuel to the
economy with economic growth surging to 8.2% in the third quarter, its highest
rate since 1984. While we believe that we have seen the cyclical lows in
economic activity and in interest rates, the pace of the recovery and
accompanying rise in interest rates may be slower than past recoveries. The
unemployment rate remains stubbornly high and job creation subdued. In excess of
5 million jobs were lost in the recession that began in 2000 and it will take
some time to fully employ the population. Monthly job creation of at least
250,000 is needed to make significant steps towards long term and sustained
economic growth. Until then, the Federal Reserve will remain aggressive with
respect to Monetary Policy and keep interest rates low.
While corporate earnings have improved, and have helped push the stock market
higher, most of those gains have been due to reductions in expenses rather than
increases in revenues. Although clearly a positive for the equity markets,
revenue increases are needed for sustained stock market growth.
A growing concern for the economy has been weakness in the dollar, particularly
against the Euro which hit lifetime highs in the last month. The high current
account deficit combined with a growing budget deficit makes the U.S. ever more
dependent on foreign investment. A stronger economy, rising stock market, and
higher interest rates will attract foreigners to hold dollar financial assets
and temper any dollar decline. The key risk to the markets and the economy is
economic weakness that translates into dollar distress.
With the recent improvement in the economy and the weakness in the dollar we now
look for the Fed to begin shifting their bias toward tightening sometime in
mid-2004 (versus late 2004 or even 2005 as we had thought a few months ago). The
markets will be paying particularly close attention to the minutes of Fed
meetings and any Fed testimony for any signals to changes from their current
policy.
Portfolio Strategy
The Fund continues to be allocated primarily among the Agency MBS, RMBS and CMBS
sectors. We have also introduced some mortgage-related Asset-Backed Securities
("ABS"), such as Home Equity and Manufactured Housing ABS, into the portfolio
over the last four months. The Fund's limit on ABS is 10% of total assets and we
are currently near that limit as we view this sector as offering the best yield
and risk characteristics at the A and BBB rating levels. The Fund's allocation
to ABS comes from selectively decreasing the Fund's allocation to
below-investment-grade CMBS, where commercial real estate fundamentals have
continued to weaken due to rising vacancies and declining rents. An upturn in
commercial real estate fundamentals typically lags the general economic recovery
by 6 to 8 months and is highly dependent on employment growth: the more people
at work, the more office space needed, the higher the demand for both hotel
rooms and retail space. Commercial real estate delinquencies have continued to
rise as yield spreads on CMBS have narrowed, leading to our negative outlook on
the sector in favor of ABS. We are comfortable with our remaining CMBS exposures
and expect the entire CMBS sector to improve from these levels.
In the RMBS allocation of the Fund, we continue to maintain a mix of Fannie Mae
and Freddie Mac premium-priced MBS. While prepayment rates have been high in
this sector, these securities have offered an attractive alternative to other
shorter duration securities. RMBS have performed exceptionally well over the
past few years and have benefited from the faster prepayment environment. With
most of the RMBS held in the portfolio purchased at discount dollar prices, the
high levels of prepayment rates have led not only to strong price performance
but also to numerous credit rating upgrades.
In the summer of 2003, as interest rates fell below the cyclical level of 3.2%
yield on the 10-year Treasury, we lowered the duration of the Fund by
approximately one year. Signs of an economic recovery and increasing budget
deficit contributed to this strategy. At various points during the year, we
managed the portfolio near full leverage to take advantage of historically low
borrowing rates and have utilized interest rate swaps and floating rate
securities to hedge against rises in borrowing costs.
In 2003, the Fund outperformed many of the broad market bond indices due to its
allocation to below-investment-grade MBS, along with strength in the RMBS sector
due to faster prepayments, and to the strategic move to shorten duration during
the summer of 2003.
The below-investment-grade allocation to the Fund (16.5% of total assets) is
still well below the 20% allowed. As the economy improves we may elect to
increase that allocation.
Conclusion
We remain committed to the Fund and its shareholders. As always, we will
continue to actively seek out investment opportunities in the market and act on
them in a timely fashion in an effort to achieve the Fund's objectives. We
welcome your questions and comments, and encourage you to contact our
Shareholder Services Representatives at 1-800-HYPERION.
We appreciate the opportunity to serve your investment needs.
Sincerely,
[GRAPHIC OMITTED][GRAPHIC OMITTED]
CLIFFORD E. LAI
President and Director,
The Hyperion Strategic Mortgage Income Fund, Inc.
President and Chief Executive Officer,
Hyperion Capital Management, Inc.
[GRAPHIC OMITTED][GRAPHIC OMITTED]
JOHN H. DOLAN
Vice President,
The Hyperion Strategic Mortgage Income Fund, Inc.
Chief Investment Officer,
Hyperion Capital Management, Inc.
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
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Portfolio of Investments Principal
November 30, 2003 Interest Amount Value
Rate Maturity (000s) (Note 2)
------------------------------------------------------------ --------------- ---------- -------------- ---------------
------------
See notes to financial statements.
U.S. GOVERNMENT & AGENCY OBLIGATIONS -- 58.3%
U.S. Government Agency Pass-Through Certificates -- 58.3%
Federal Home Loan Mortgage Corporation
Pool C68878.......................................... 7.00% 06/01/32 $ 793# $ 836,486
Pool C69047.......................................... 7.00 06/01/32 1,921 2,027,293
--------------
2,863,779
` --------------
Federal National Mortgage Association
TBA.................................................. 5.50 TBA 28,000 28,057,960
Pool 694391.......................................... 5.50 03/01/33 5,273 5,309,078
TBA.................................................. 6.00 TBA 20,000 20,464,840
Pool 626299.......................................... 7.00 06/01/32 1,601 1,690,364
Pool 635095.......................................... 7.00 06/01/32 2,120 2,238,435
Pool 641575.......................................... 7.00 04/01/32 945 996,781
Pool 645399.......................................... 7.00 05/01/32 5,005 5,284,475
Pool 645466.......................................... 7.00 05/01/32 4,921@ 5,195,261
Pool 650131.......................................... 7.00 07/01/32 3,064 3,233,361
Pool 636449.......................................... 8.50 04/01/32 9,194@ 9,909,076
--------------
82,379,631
--------------
Total U.S. Government Agency Pass-Through Certificates
(Cost-- $84,890,939)............................ 85,243,410
--------------
Total U.S. Government & Agency Obligations
(Cost-- $84,890,939)............................ 85,243,410
--------------
------------------------------------------------------------ --------------- ---------- -------------- ---------------
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ASSET-BACKED SECURITIES -- 13.6%
Housing Related Asset-Backed Securities -- 13.6%
Asset Backed Funding Corp.
Series 2003-OPT1, Class M4........................... 3.92+ 07/25/33 3,000 3,019,977
Equity One ABS, Inc.
Series 2003-4, Class B2.............................. 5.87+ 11/25/33 1,000 1,000,982
First Franklin Mortgage Loan Asset Backed
Certificates
Series 2003-FF4, Class M4............................ 4.02+ 10/25/33 3,000 3,032,535
Series 2003-FF1, Class M4............................ 4.12+ 03/25/33 2,000 1,953,342
Series 2003-FFH1, Class M4........................... 4.62+ 09/25/33 4,740 4,822,310
--------------
9,808,187
--------------
Long Beach Mortgage Loan Trust
Series 2002-5, Class M2.............................. 3.12+ 11/25/32 4,000 4,077,488
Merit Securities Corp.
Series 12-1, Class 1A3(a)............................ 6.45/6.95 07/28/33 1,989 2,012,905
--------------
Total Housing Related Asset-Backed Securities
(Cost-- $19,719,579)............................ 19,919,539
--------------
Total Asset-Backed Securities
(Cost-- $19,719,579)............................ 19,919,539
--------------
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
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Portfolio of Investments Principal
November 30, 2003 Interest Amount Value
Rate Maturity (000s) (Note 2)
------------------------------------------------------------ --------------- ---------- -------------- ---------------
------------
See notes to financial statements.
COMMERCIAL MORTGAGE BACKED SECURITIES -- 28.5%
Bear Stearns Commercial Mortgage Securities
Series 1999-C1, Class G*.............................
5.64% 02/14/31 $ 2,390 $ 1,808,144
Series 1999-C1, Class D.............................. 6.53 02/14/31 2,500 2,634,850
Series 2000-WF1, Class E............................. 7.90+ 02/15/32 2,000 2,263,280
--------------
6,706,274
--------------
GE Capital Commercial Mortgage Corp.
Series 2002-2A, Class G*............................. 6.04 08/11/36 3,000 3,122,070
Series 2000-1, Class G*.............................. 6.13 01/15/33 1,000 780,182
Series 2002-2A, Class H*............................. 6.31 08/11/36 2,000 2,055,920
Series 2000-1, Class E............................... 7.17+ 01/15/33 1,000 1,089,883
--------------
7,048,055
--------------
Government Lease Trust
Series 1999-C1A, Class B3*........................... 4.00 05/18/11 2,500 2,228,270
JP Morgan Chase Commercial Mortgage Securities
Series 2003-LN1, Class G*............................ 5.48+ 10/15/37 1,600 1,595,147
JP Morgan Commercial Mortgage Finance Corp.
Series 1999-C7, Class F*............................. 6.00 10/15/35 2,000 1,838,924
Morgan Stanley Capital I
Series 1999-FNV1, Class A2........................... 6.53 03/15/31 2,000 2,218,454
Series 1999-WF1, Class E............................. 6.99+ 11/15/31 5,500 6,192,175
Series 1999-FNV1, Class E............................ 7.46+ 03/15/31 2,000 2,249,800
--------------
10,660,429
--------------
Morgan Stanley Dean Witter Capital I
Series 2001-TOP1, Class A4........................... 6.66 02/15/33 4,500 5,052,042
Nationslink Funding Corp.
Series 1998-2, Class E............................... 7.11 08/20/30 4,000 4,377,480
UBS 400 Atlantic Street Mortgage Trust
Series 2002-C1A, Class B3*........................... 7.19 01/11/22 2,000 2,216,920
--------------
Total Commercial Mortgage Backed Securities
(Cost-- $41,029,937)............................ 41,723,541
--------------
------------------------------------------------------------ --------------- ---------- -------------- ---------------
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NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES -- 40.7%
Subordinated Collateralized Mortgage Obligations -- 40.7%
ABN AMRO Mortgage Corp.
Series 2002-7, Class B2.............................. 6.20+ 09/25/32 1,066 1,076,954
Bank of America Mortgage Securities, Inc.
Series 2002-H, Class B4.............................. 4.69+ 08/25/32 417 399,227
Series 2002-H, Class B5.............................. 4.69+ 08/25/32 278 234,073
Series 2002-H, Class B6.............................. 4.69+ 08/25/32 696 404,725
Series 2002-I, Class B4.............................. 4.74+ 08/25/32 694 664,767
Series 2002-10, Class 1B3............................ 6.00 11/25/32 1,482 1,507,965
Series 2002-8, Class 1B1............................. 6.25 08/25/32 7,327 7,427,205
Series 2002-8, Class 1B4*............................ 6.25 08/25/32 1,086 1,028,045
Series 2002-8, Class 1B5*............................ 6.25 08/25/32 814 601,454
Series 2002-8, Class 1B6*............................ 6.25 08/25/32 815 317,384
Series 2002-9, Class 1B3............................. 6.25 10/25/32 1,777 1,799,903
Series 2002-9, Class 1B4............................. 6.25 10/25/32 1,185 1,116,929
--------------
15,501,677
--------------
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES (continued)
Cendant Mortgage Corp.
Series 2002-4, Class B1.............................. 6.50 07/25/32 2,659 2,648,660
Series 2002-4, Class B2.............................. 6.50 07/25/32 1,064 1,054,961
Series 2002-4, Class B3.............................. 6.50 07/25/32 620 609,538
Series 2002-4, Class B4.............................. 6.50 07/25/32 355 322,600
Series 2002-4, Class B5.............................. 6.50 07/25/32 266 196,391
Series 2002-4, Class B6*............................. 6.50 07/25/32 355 141,818
--------------
4,973,968
--------------
Citicorp Mortgage Securities, Inc.
Series 2002-8, Class B1.............................. 6.18%+ 07/25/32 $ 3,602 $ 3,651,084
Series 2002-8, Class B2.............................. 6.18+ 07/25/32 1,567 1,587,570
Series 2002-8, Class B3.............................. 6.18+ 07/25/32 783 791,468
--------------
6,030,122
--------------
Countrywide Home Loans
Series 2001-12, Class B4............................. 6.50 07/25/31 887 760,493
Series 2001-12, Class B5............................. 6.50 07/25/31 830 314,246
--------------
1,074,739
--------------
G3 Mortgage Reinsurance Ltd.
Series 1, Class E*................................... 21.12+ 05/25/08 4,386 4,758,448
Master Asset Securitization Trust
Series 2002-3, Class B5.............................. 6.25+ 07/25/32 769 690,408
Series 2002-3, Class B6.............................. 6.25+ 07/25/32 769 503,714
--------------
1,194,122
--------------
Residential Finance Ltd. Partnership
Series 2002-A, Class B5*............................. 3.47+ 10/10/34 1,979 1,990,254
Series 2002-A, Class B7.............................. 6.82+ 10/10/34 1,991 2,051,699
--------------
4,041,953
--------------
Residential Funding Mortgage Security I
Series 2003-S7, Class B2............................. 5.50 05/25/33 542 138,311
Series 2003-S7, Class B3............................. 5.50 05/25/33 328 189,184
Series 2002-S10, Class B1*........................... 6.50 07/25/32 713 631,391
Series 2002-S10, Class B2*........................... 6.50 07/25/32 535 336,520
Series 2002-S10, Class B3*........................... 6.50 07/25/32 535 146,494
--------------
1,441,900
--------------
Structured Asset Mortgage Investments, Inc.
Series 2002-AR1, Class B4............................ 4.62+ 03/25/32 1,258 1,198,639
Washington Mutual Mortgage Securities Corp.
Series 2002-AR12, Class B4........................... 4.74+ 10/25/32 1,672 1,602,009
Series 2002-AR12, Class B5........................... 4.74+ 10/25/32 1,254 1,134,071
Series 2002-AR12, Class B6........................... 4.74+ 10/25/32 2,092 1,422,667
Series 2002-AR10, Class B4*.......................... 5.02+ 10/25/32 1,982 1,913,100
Series 2002-AR10, Class B5*.......................... 5.02+ 10/25/32 1,486 1,354,307
Series 2002-AR10, Class B6*.......................... 5.02+ 10/25/32 2,480 1,686,269
Series 2002-AR11, Class B5........................... 5.16+% 10/25/32 1,170 1,010,957
Series 2002-AR11, Class B6........................... 5.16+ 10/25/32 1,951 1,024,016
--------------
11,147,396
--------------
Wells Fargo Mortgage Backed Securities Trust
Series 2002, Class B5................................ 6.00 06/25/32 370 309,140
Series 2002-15, Class B1............................. 6.50 08/25/32 5,140 5,214,703
Series 2002-15, Class B4............................. 6.50 08/25/32 593 562,035
Series 2002-15, Class B5............................. 6.50 08/25/32 791 714,527
Series 2002-15, Class B6............................. 6.50 08/25/32 594 173,602
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6,974,007
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Total Subordinated Collateralized Mortgage Obligations
(Cost-- $57,040,567)............................ 59,413,925
--------------
Total Non-Agency Residential Mortgage Backed Securities
(Cost-- $57,040,567)............................ 59,413,925
--------------
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES (continued)
------------------------------------------------------------ --------------- ---------- -------------- ---------------
SHORT TERM INVESTMENTS -- 0.9%
Short Term Investments -- 0.9%
Federal National Mortgage Association Discount
Note(b)
(Cost-- $1,300,000)............................. 0.95% 12/01/03 $ 1,300 $ 1,300,000
--------------
Total Investments -- 142.0%
(Cost-- $203,981,022)........................... 207,600,415
Liabilities in Excess of Other
Assets-- (42.0)%....................................... (61,420,570)
--------------
NET ASSETS-- 100.0%...................................... $ 146,179,845
==============
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@ -- Portion or entire principal amount delivered as collateral for reverse
repurchase agreements (Note 5).
+ -- Variable Rate Security: Interest rate is the rate in effect November 30,
2003.
* -- Security exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may only be resold in transactions exempt from
registration, normally to qualified institutional buyers.
# -- Portion or entire principal amount is held as collateral for open
futures contracts (Note 7).
(a) -- Security is a "step up" bond where coupon increases or steps up at a
predetermined date. Rates shown are current coupon and next coupon rate
when security steps up.
(b) -- Zero Coupon Note -- Interest rate represents current yield to maturity.
TBA -- Settlement is on a delayed delivery or when-issued basis with a final
maturity to be announced (TBA) in the future.
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
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Statement of Assets and Liabilities
November 30, 2003
------------------------------------------------------------ --------------- --
See notes to financial statements.
Assets:
Investments in securities, at market (cost $203,981,022) (Note 2)............................. $ 207,600,415
Cash.......................................................................................... 146,190
Interest receivable........................................................................... 911,965
Principal paydowns receivable................................................................. 209,728
Prepaid expenses and other assets............................................................. 17,331
----------------
Total assets.............................................................................. 208,885,629
----------------
Liabilities:
Reverse repurchase agreements (Note 5)........................................................ 13,488,000
Interest payable for reverse repurchase agreements (Note 5)................................... 2,073
Payable for investments purchased............................................................. 48,442,694
Payable on open swap contracts................................................................ 367,399
Unrealized depreciation on swap contracts (Note 7)............................................ 110,492
Investment advisory fee payable (Note 3)...................................................... 78,278
Payable for variation margin.................................................................. 55,000
Administration fee payable (Note 3)........................................................... 24,085
Directors' fees payable....................................................................... 750
Accrued expenses and other liabilities........................................................ 137,013
----------------
Total liabilities......................................................................... 62,705,784
----------------
Net Assets (equivalent to $14.41 per share based on 10,141,220 shares issued and outstanding)... $ 146,179,845
================
Composition of Net Assets:
Capital stock, at par value ($.01) (Note 6)................................................... $ 101,412
Additional paid-in capital (Note 6)........................................................... 144,108,196
Accumulated undistributed net investment income............................................... 1,159,112
Accumulated net realized loss................................................................. (2,619,607)
Net unrealized appreciation................................................................... 3,430,732
----------------
Net assets applicable to capital stock outstanding............................................ $ 146,179,845
================
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
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Statement of Operations
For the Year Ended November 30, 2003
------------------------------------------------------------ --------------- ---------- -------------- ---------------
See notes to financial statements.
Investment Income (Note 2):
Interest....................................................................................... $ 14,994,172
--------------
Expenses:
Investment advisory fee (Note 3)............................................................... 943,303
Administration fee (Note 3).................................................................... 290,247
Insurance...................................................................................... 146,944
Accounting and tax services.................................................................... 119,000
Reports to shareholders........................................................................ 85,469
Custodian...................................................................................... 73,173
Directors' fees................................................................................ 59,758
Legal.......................................................................................... 43,946
Registration fees.............................................................................. 41,185
Transfer agency................................................................................ 26,222
Miscellaneous.................................................................................. 24,336
--------------
Total operating expenses................................................................... 1,853,583
Interest expense on reverse repurchase agreements (Note 5).............................. 747,039
Interest expense on swaps (Note 2)...................................................... 522,260
--------------
Total expenses............................................................................. 3,122,882
--------------
Net investment income.......................................................................... 11,871,290
--------------
Realized and Unrealized Gain (Loss) on Investments
(Notes 2 and 7):
Net realized gain (loss) on:
Investment transactions........................................................................ (424,037)
Futures transactions........................................................................... 1,177,406
Swap contracts................................................................................. (505,091)
--------------
Net realized gain on investment transactions, futures transactions and swap contracts............ 248,278
--------------
Net change in unrealized appreciation/depreciation on:
Investments.................................................................................... 4,459,603
Futures........................................................................................ 43,728
Swap contracts................................................................................. (266,095)
--------------
Net change in unrealized appreciation/depreciation on investments, futures and swap contracts.... 4,237,236
--------------
Net realized and unrealized gain on investments, futures and swap contracts...................... 4,485,514
--------------
Net increase in net assets resulting from operations............................................. $ 16,356,804
==============
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
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Statements of Changes in Net Assets
============================================================
See notes to financial statements.
For the Year For the Period
Ended Ended
November 30, 2003 November 30, 2002*
--------------------------------------------------------------------------- ------------------- ----------------------
--------------------------------------------------------------------------- ------------------- ----------------------
Increase (Decrease) in Net Assets Resulting from Operations:
Net investment income................................................. $ 11,871,290 $ 3,692,691
Net realized gain (loss) on investment transactions,
futures transactions, swap contracts and short sales................ 248,278 (847,122)
Net change in unrealized appreciation/depreciation on
investments, futures, swap contracts and short sales................ 4,237,236 (806,504)
--------------- ---------------
Net increase in net assets resulting from operations.................. 16,356,804 2,039,065
--------------- ---------------
Dividends to Shareholders (Note 2):
Net investment income................................................. (13,140,962) (3,284,670)
--------------- ---------------
Capital Stock Transactions (Note 6):
Net proceeds from sale of shares (10,130,000 shares; net
of offering costs of $304,111)...................................... -- 144,048,389
Net asset value of shares issued through dividend
reinvestment (2,924 and 1,278 shares, respectively)................. 42,722 18,497
--------------- ---------------
Net increase from capital stock transactions.......................... 42,722 144,066,886
--------------- ---------------
Total increase in net assets...................................... 3,258,564 142,821,281
Net Assets:
Beginning of period................................................... 142,921,281 100,000
--------------- ---------------
End of period (including undistributed net investment
income of $1,159,112 and $540,088, respectively).................... $ 146,179,845 $ 142,921,281
=============== ===============
----------
* Commenced operations on July 26, 2002
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Cash Flows
For the Year Ended November 30, 2003
------------------------------------------------------------ --------------- --
See notes to financial statements.
Increase (Decrease) in Cash:
Cash flows provided by (used for) operating activities:
Interest received (including net accretion of $1,855,456).................................. $ 13,922,102
Interest expense paid...................................................................... (1,005,951)
Operating expenses paid.................................................................... (1,767,634)
Purchases of short-term portfolio investments, net......................................... (1,300,000)
Purchases of long-term portfolio investments............................................... (115,440,624)
Proceeds from disposition of long-term portfolio investments and principal paydowns........ 171,980,156
Net cash provided by futures transactions.................................................. 1,295,040
-----------------
Net cash provided by operating activities.................................................. 67,683,089
-----------------
Cash flows used for financing activities:
Net cash used for reverse repurchase agreements............................................ (54,776,000)
Cash dividends paid........................................................................ (13,098,353)
-----------------
Net cash used for financing activities..................................................... (67,874,353)
-----------------
Net decrease in cash......................................................................... (191,264)
Cash at beginning of year.................................................................... 337,454
-----------------
Cash at end of year.......................................................................... $ 146,190
=================
Reconciliation of Net Increase in Net Assets Resulting from Operations to
Net Cash Provided by Operating Activities:
Net increase in net assets resulting from operations......................................... $ 16,356,804
-----------------
Decrease in investments, at cost........................................................... 6,354,976
Increase in net unrealized appreciation/depreciation on investments and swaps.............. (4,193,508)
Decrease in interest receivable............................................................ 486,418
Decrease in variation margin receivable.................................................... 73,906
Increase in other assets................................................................... (199,204)
Increase in payables and other liabilities................................................. 48,803,697
-----------------
Total adjustments........................................................................ 51,326,285
-----------------
Net cash provided by operating activities.................................................... $ 67,683,089
=================
Noncash financing activities not included herein consist of reinvestment of dividends and distributions of $42,722.
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THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
================================================================================
Financial Highlights
============================================================
See notes to financial statements.
For the Year Ended For the Period Ended
November 30, 2003 November 30, 2002*
--------------------------------------------------------------------------- -------------------- ---------------------
--------------------------------------------------------------------------- -------------------- ---------------------
Per Share Operating Performance:
Net asset value, beginning of period.................................... $ 14.10 $ 14.25**
----------- ----------
Net investment income................................................... 1.17 0.36
Net realized and unrealized gain (loss) on investments,
futures transactions, swap contracts and short sales.................. 0.44 (0.16)
----------- -----------
Net increase in net asset value resulting from operations............... 1.61 0.20
----------- -----------
Dividends from net investment income.................................... (1.30) (0.32)
Offering costs charged to additional paid-in-capital.................... -- (0.03)
----------- -----------
Net asset value, end of period.......................................... $ 14.41 $ 14.10
=========== ===========
Market price, end of period............................................. $ 14.6700 $ 13.6800
========== ==========
Total Investment Return+................................................ 17.55% (6.66%)(1)
Ratios to Average Net Assets/Supplementary Data:
Net assets, end of period (000's)....................................... $ 146,180 $ 142,921
Operating expenses...................................................... 1.28% 1.23%(2)
Interest expense........................................................ 0.87% 1.09%(2)
Total expenses........................................................ 2.15% 2.32%(2)
Net expenses............................................................ 2.15% 2.29%(2)
Net investment income................................................... 8.18% 7.38%(2)
Portfolio turnover rate................................................. 78% 70%(1)
----------
+ Total investment return is calculated assuming a purchase of common stock at
the current market price on the first day and a sale at the current market price
on the last day of the period reported. For the period ended November 30, 2002,
total investment return is based on a beginning period price of $15.00 (initial
offering price). Total investment return for subsequent periods is computed
based upon the New York Stock Exchange market price of the Fund's shares.
Dividends and distributions, if any, are assumed for purposes of this
calculation, to be reinvested at the prices obtained under the Fund's dividend
reinvestment plan. Total investment return does not reflect brokerage
commissions and is not annualized.
(1) Not Annualized
(2) Annualized
* Commenced operations on July 26, 2002
** Initial public offering price of $15.00 per share less underwriting discount
of $0.75 per share.
------------------------------------------------------------------------------
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
==============================================================================
Notes to Financial Statements
November 30, 2003
----------------------------------------------------------- -------------- ---
1. The Fund
The Hyperion Strategic Mortgage Income Fund, Inc. (the "Fund"), which was
incorporated under the laws of the State of Maryland on May 17, 2002, is
registered under the Investment Company Act of 1940 (the "1940 Act") as a
diversified, closed-end management investment company. The Fund commenced
operations on July 26, 2002. Prior to July 26, 2002, the Fund had no operations
other than the sale of 7,018 shares for $100,000 to Hyperion Capital Management,
Inc. (the "Advisor").
The Fund's investment objective is to provide a high level of current income by
investing primarily in mortgage-backed securities. No assurance can be given
that the Fund's investment objective will be achieved.
2. Significant Accounting Policies
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Valuation of Investments: Where market quotations are readily available,
securities held by the Fund are valued based upon the current bid price, except
preferred stocks, which are valued based upon the closing price. Securities may
be valued by independent pricing services that have been approved by the Board
of Directors. The prices provided by a pricing service take into account broker
dealer market price quotations for institutional size trading in similar groups
of securities, security quality, maturity, coupon and other security
characteristics as well as any developments related to the specific securities.
The Fund values mortgage-backed securities ("MBS") and other debt securities for
which market quotations are not readily available (approximately 30% of the
investments in securities held by the Fund at November 30, 2003) at their fair
value as determined in good faith, utilizing procedures approved by the Board of
Directors of the Fund, on the basis of information provided by dealers in such
securities. Some of the general factors which may be considered in determining
fair value include the fundamental analytic data relating to the investment and
an evaluation of the forces which influence the market in which these securities
are purchased and sold. Determination of fair value involves subjective
judgment, as the actual market value of a particular security can be established
only by negotiations between the parties in a sales transaction. Debt securities
having a remaining maturity of sixty days or less when purchased and debt
securities originally purchased with maturities in excess of sixty days but
which currently have maturities of sixty days or less are valued at amortized
cost.
The ability of issuers of debt securities held by the Fund to meet their
obligations may be affected by economic developments in a specific industry or
region. The values of MBS can be significantly affected by changes in interest
rates or in the financial condition of an issuer or market.
Options Written or Purchased: The Fund may write or purchase options as a method
of hedging potential declines in similar underlying securities. When the Fund
writes or purchases an option, an amount equal to the premium received or paid
by the Fund is recorded as a liability or an asset and is subsequently adjusted
to the current market value of the option written or purchased. Premiums
received or paid from writing or purchasing options which expire unexercised are
treated by the Fund on the expiration date as realized gains or losses. The
difference between the premium and the amount paid or received on effecting a
closing purchase or sale transaction, including brokerage commissions, also is
treated as a realized gain or loss. If an option is exercised, the premium paid
or received is added to the proceeds from the sale or cost of the purchase in
determining whether the Fund has realized a gain or a loss on the investment
transaction.
The Fund, as writer of an option, may have no control over whether the
underlying securities may be sold (call) or purchased (put) and as a result
bears the market risk of an unfavorable change in the price of the security
underlying the written option.
The Fund purchases or writes options to hedge against adverse market movements
or fluctuations in value caused by changes in interest rates. The Fund bears the
risk in purchasing an option, to the extent of the premium paid, that it will
expire without being exercised. If this occurs, the option expires worthless and
the premium paid for the option is recognized as a realized loss. The risk
associated with writing call options is that the Fund may forego the opportunity
for a profit if the market value of the underlying position increases and the
option is exercised. The Fund will only write call options on positions held in
its portfolio. The risk in writing a put option is that the Fund may incur a
loss if the market value of the underlying position decreases and the option is
exercised. In addition, the Fund bears the risk of not being able to enter into
a closing transaction for written options as a result of an illiquid market.
Short Sales: The Fund may make short sales of securities as a method of hedging
potential declines in similar securities owned. The Fund may have to pay a fee
to borrow the particular securities and may be obligated to pay to the lender an
amount equal to any payments received on such borrowed securities. A gain,
limited to the amount at which the Fund sold the security short, or a loss,
unlimited as to dollar amount, will be realized upon the termination of a short
sale if the market price is less or greater than the proceeds originally
received.
Financial Futures Contracts: A futures contract is an agreement between two
parties to buy and sell a financial instrument for a set price on a future date.
Initial margin deposits are made upon entering into futures contracts and can be
either cash or securities. During the period the futures contract is open,
changes in the value of the contract are recognized as unrealized gains or
losses by "marking-to-market" on a daily basis to reflect the market value of
the contract at the end of each day's trading. Variation margin payments are
made or received, depending upon whether unrealized gains or losses are
incurred. When the contract is closed, the Fund records a realized gain or loss
equal to the difference between the proceeds from (or cost of) the closing
transaction and the Fund's basis in the contract.
The Fund invests in financial futures contracts to hedge against fluctuations in
the value of portfolio securities caused by changes in prevailing market
interest rates. Should interest rates move unexpectedly, the Fund may not
achieve the anticipated benefits of the financial futures contracts and may
realize a loss. The use of futures transactions involves the risk of imperfect
correlation in movements in the price of futures contracts, interest rates and
the underlying hedged assets. The Fund is at risk that it may not be able to
close out a transaction because of an illiquid market.
Swap agreements: The Fund may enter into interest rate swap agreements to manage
its exposure to interest rates. Interest rate swap agreements involve the
exchange by the Fund with another party of their respective commitments to pay
or receive interest, e.g., an exchange of floating rate payments for fixed rate
payments with respect to a notional amount of principal. The Fund will usually
enter into interest rate swaps on a net basis, i.e., the two payment streams are
netted out, with the Fund receiving or paying, as the case may be, only the net
amount of the two payments. Swaps are marked to market based upon quotations
from market makers and the change, if any, is recorded as unrealized gain or
loss in the Statement of Operations. Net payments of interest on interest rate
swap agreements are included as part of interest expense. For the year ended
November 30, 2003, such net payments made by the Fund amounted to $522,260.
Entering into these agreements involves, to varying degrees, elements of credit
and market risk in excess of the amounts recognized on the Statement of Assets
and Liabilities. Such risks involve the possibility that there will be no liquid
market for these agreements, that the counterparty to the agreements may default
on its obligation to perform or that there may be unfavorable changes in the
fluctuation of interest rates. See Note 7 for a summary of all open swap
agreements as of November 30, 2003.
When-Issued Purchases and Forward Commitments: The Fund may purchase securities
on a "when-issued" basis and may purchase or sell securities on a "forward
commitment" basis in order to hedge against anticipated changes in interest
rates and prices and secure a favorable rate of return. When such transactions
are negotiated, the price, which is generally expressed in yield terms, is fixed
at the time the commitment is made, but delivery and payment for the securities
take place at a later date, which can be a month or more after the date of the
transaction. At the time the Fund makes the commitment to purchase securities on
a when-issued or forward commitment basis, it will record the transaction and
thereafter reflect the value of such securities in determining its net asset
value. At the time the Fund enters into a transaction on a when-issued or
forward commitment basis, the Advisor will identify collateral consisting of
cash or liquid securities equal to the value of the when-issued or forward
commitment securities and will monitor the adequacy of such collateral on a
daily basis. On the delivery date, the Fund will meet its obligations from
securities that are then maturing or sales of the securities identified as
collateral by the Advisor and/or from then available cash flow. When-issued
securities and forward commitments may be sold prior to the settlement date. If
the Fund disposes of the right to acquire a when-issued security prior to its
acquisition or disposes of its right to deliver or receive against a forward
commitment, it can incur a gain or loss due to market fluctuation. There is
always a risk that the securities may not be delivered and that the Fund may
incur a loss. Settlements in the ordinary course are not treated by the Fund as
when-issued or forward commitment transactions and, accordingly, are not subject
to the foregoing limitations even though some of the risks described above may
be present in such transactions.
Securities Transactions and Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses from securities
transactions are calculated on the identified cost basis. Interest income is
recorded on the accrual basis. Discounts and premiums on securities are accreted
and amortized, respectively, using the effective yield to maturity method.
Taxes: It is the Fund's intention to continue to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no federal income or excise tax provision is required.
Dividends and Distributions: The Fund declares and pays dividends monthly from
net investment income. Distributions of realized capital gains in excess of
capital loss carryforwards are distributed at least annually. Dividends and
distributions are recorded on the ex-dividend date. Dividends from net
investment income and distributions from realized gains from investment
transactions have been determined in accordance with Federal income tax
regulations and may differ from net investment income and realized gains
recorded by the Fund for financial reporting purposes. These differences, which
could be temporary or permanent in nature, may result in reclassification of
distributions; however, net investment income, net realized gains and net assets
are not affected.
Cash Flow Information: The Fund invests in securities and distributes dividends
and distributions which are paid in cash or are reinvested at the discretion of
shareholders. These activities are reported in the Statement of Changes in Net
Assets. Additional information on cash receipts and cash payments is presented
in the Statement of Cash Flows. Cash, as used in the Statement of Cash Flows, is
the amount reported as "Cash" in the Statement of Assets and Liabilities, and
does not include short-term investments.
Accounting practices that do not affect reporting activities on a cash basis
include carrying investments at value and accreting discounts and amortizing
premiums on debt obligations.
Repurchase Agreements: The Fund, through its custodian, receives delivery of the
underlying collateral, the market value of which at the time of purchase is
required to be in an amount at least equal to the resale price, including
accrued interest. The Advisor is responsible for determining that the value of
these underlying securities is sufficient at all times. If the seller defaults
and the value of the collateral declines or if bankruptcy proceedings commence
with respect to the seller of the security, realization of the collateral by the
Fund may be delayed or limited.
3. Investment Advisory Agreements and Affiliated Transactions
The Fund has entered into an Investment Advisory Agreement with the Advisor. The
Advisor is responsible for the management of the Fund's portfolio and provides
the necessary personnel, facilities, equipment and certain other services
necessary to the operations of the Fund. For such services, the Fund pays a
monthly fee at an annual rate of 0.65% of the Fund's average weekly net assets.
During the year ended November 30, 2003, the Advisor earned $943,303 in
investment advisory fees.
The Advisor had entered into a Sub-Advisory Agreement with Lend Lease Hyperion
Capital Advisors, LLC ("Lend Lease Hyperion"). Lend Lease Hyperion was owned
equally by Lend Lease Real Estate Investments, Inc. ("LLREI") and the Advisor
and was formed for the purpose of managing portfolios of commercial
mortgage-backed securities ("CMBS"). On August 12, 2003, GMAC Commercial
Mortgage Corporation purchased the assets of LLREI. As a result, the
Sub-Advisory Agreement terminated automatically by its terms due to a change of
control of Lend Lease Hyperion. In addition, Lend Lease Hyperion changed its
name to Hyperion GMAC Capital Advisors, LLC ("Hyperion/GMAC"). At a special
meeting held on April 15, 2003, the Board of Directors, in anticipation of Lend
Lease Hyperion's change of control and the resulting automatic termination of
the Sub-Advisory Agreement, approved (1) an Interim Sub-Advisory Agreement (the
"Interim Agreement") with Hyperion/GMAC effective when the Lend Lease Hyperion
change of control was completed, and (2) a new Sub-Advisory Agreement (the "New
Sub-Advisory Agreement") with Hyperion/GMAC. The Interim Agreement terminated on
December 9, 2003, the date on which the Fund's stockholders approved the New
Sub-Advisory Agreement. Under the terms of the New Sub-Advisory Agreement,
Hyperion/GMAC is to assist in managing the Fund's investments in CMBS and to
provide such investment research and advice regarding CMBS as may be necessary
for the operation of the Fund. The same fee paid under the Sub-Advisory
Agreement was paid by the Advisor, out of its advisory fee, to Hyperion/ GMAC
under the Interim Agreement and will continue to be paid by the Advisor under
the new Sub-Advisory Agreement. The monthly fee is equal to a percentage of the
portion of the Fund's average weekly net assets that are invested in CMBS. The
fee is determined by the credit rating of the CMBS at the time of purchase, and
ranges from 1.00% for unrated CMBS to 0.13% for AAA/Aaa rated CMBS.
The Fund has entered into an Administration Agreement with Hyperion Capital
Management, Inc. (the "Administrator"). The Administrator entered into a
sub-administration agreement with State Street Bank and Trust Company (the "Sub-
Administrator"). The Administrator and Sub-Administrator perform administrative
services necessary for the operation of the Fund, including maintaining certain
books and records of the Fund and preparing reports and other documents required
by federal, state, and other applicable laws and regulations, and providing the
Fund with administrative office facilities. For these services, the Fund pays to
the Administrator a monthly fee at an annual rate of 0.20% of the Fund's average
weekly net assets. During the year ended November 30, 2003, the Administrator
earned $290,247 in administration fees. The Administrator is responsible for any
fees due the Sub-Administrator.
Certain officers and/or directors of the Fund are officers and/or directors of
the Advisor and/or Administrator.
4. Purchases and Sales of Investments
Purchases and sales of investments, excluding short-term securities, U.S.
Government securities and reverse repurchase agreements, for the year ended
November 30, 2003, were $28,988,752 and $18,372,494, respectively. Purchases and
sales of U.S. Government securities, for the year ended November 30, 2003, were
$134,894,566 and $155,041,494, respectively. For purposes of this footnote, U.S.
Government securities may include securities issued by the U.S. Treasury,
Federal Home Loan Mortgage Corporation, and the Federal National Mortgage
Association.
5. Borrowings
The Fund may enter into reverse repurchase agreements with the same parties with
whom it may enter into repurchase agreements. Under a reverse repurchase
agreement, the Fund sells securities and agrees to repurchase them at a mutually
agreed upon date and price. Under the 1940 Act, reverse repurchase agreements
will be regarded as a form of borrowing by the Fund unless, at the time it
enters into a reverse repurchase agreement, it establishes and maintains a
segregated account with its custodian containing securities from its portfolio
having a value not less than the repurchase price (including accrued interest).
The Fund has established and maintained such an account for each of its reverse
repurchase agreements.
Reverse repurchase agreements involve the risk that the market value of the
securities retained in lieu of sale by the Fund may decline below the price of
the securities the Fund has sold but is obligated to repurchase. In the event
the buyer of securities under a reverse repurchase agreement files for
bankruptcy or becomes insolvent, such buyer or its trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the securities, and the Fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
decision.
At November 30, 2003 the Fund had the following reverse repurchase agreements
outstanding:
Maturity
Face Value Description Amount
---------------- ---------------------------------------------------------------------------- ------------
$ 4,540,000 UBS Warburg, 1.08%, dated 11/26/03, maturity date 12/10/03................. $ 4,541,907
8,948,000 Lehman Brothers, 1.12%, dated 11/26/03, maturity date 12/17/03............. 8,953,846
-------------- --------------
$ 13,488,000
==========
Maturity Amount, Including Interest Payable............................ $ 13,495,753
--------------
Market Value of Assets Sold Under Agreements........................... $ 13,954,834
--------------
Weighted Average Interest Rate......................................... 1.11%
--------------
The average daily balance of reverse repurchase agreements outstanding during
the year ended November 30, 2003, was approximately $62,803,448 at a weighted
average interest rate of 1.20%. The maximum amount of reverse repurchase
agreements outstanding at any time during the period was $75,802,346 as of April
15, 2003, which was 34.39% of total assets.
6. Capital Stock
There are 50 million shares of $0.01 par value common stock authorized. Of the
10,141,220 shares outstanding at November 30, 2003, the Advisor owned 7,018
shares.
In connection with the initial public offering of the Fund's Shares, the Advisor
made an undertaking to pay any offering costs in excess of $0.03 per common
share. The Advisor has advised the Fund that such excess amounted to $482,964.
7. Financial Instruments
The Fund regularly trades in financial instruments with off-balance sheet risk
in the normal course of its investing activities to assist in managing exposure
to various market risks. These financial instruments include written options,
futures contracts and swap agreements and may involve, to a varying degree,
elements of risk in excess of the amounts recognized for financial statement
purposes. The notional or contractual amounts of these instruments represent the
investment the Fund has in particular classes of financial instruments and does
not necessarily represent the amounts potentially subject to risk. The
measurement of the risks associated with these instruments is meaningful only
when all related and offsetting transactions are considered. During the period,
the Fund had segregated sufficient cash and/or securities to cover any
commitments under these contracts.
There was no written option activity for the year ended November 30, 2003.
As of November 30, 2003, the following swap agreements were outstanding:
Net Unrealized
Expiration Appreciation/
Notional Amount Date Description (Depreciation)
------------------ ---------- -------------------------------------------------------------------- --------------
$ 18,800,000 01/02/06 Agreement with Goldman Sachs Capital Markets, LP, dated 12/30/02 to $ (46,797)
pay semi-annually the notional amount multiplied by 2.458% and to
receive quarterly the notional amount multiplied by 3 month
USD-LIBOR-BBA.
$ 25,800,000 01/02/06 Agreement with Morgan Stanley Capital Services Inc., dated 12/30/02 (63,695)
to pay semi-annually the notional amount multiplied by 2.457% and
to receive quarterly the notional amount multiplied by 3 month
USD-LIBOR-BBA.
$ (110,492)
==============
As of November 30, 2003, the following futures contract was outstanding:
Long:
Unrealized
Notional Cost at Value at Appreciation/
Amount Type Expiration Date Trade Date November 30, 2003 (Depreciation)
------------------ -------------------------- ----------------------------- ---------------------------------
$ 11,000,000 5 Yr. U.S. Treasury Note March 2004 $ 12,219,419 $ 12,141,250 $ (78,169)
8. Federal Income Tax Information
Income and capital gain distributions are determined in accordance with federal
income tax regulations, which may differ from generally accepted accounting
principles.
During the year ended November 30, 2003 the tax character of the $13,140,962 of
distributions paid was from ordinary income. During the year ended November 30,
2002 the tax character of the $3,284,670 of distributions paid was from ordinary
income.
At November 30, 2003 the components of net assets (excluding paid-in-capital) on
a tax basis were as follows:
Undistributed Tax ordinary income.......................................... $ 1,159,112
--------------
Accumulated capital loss................................................... $ (2,697,776)
==============
Book basis unrealized appreciation/(depreciation).......................... $ 3,430,732
Plus: Cumulative timing differences........................................ $ 78,169
--------------
Unrealized appreciation/(depreciation)................................... $ 3,508,901
==============
The cumulative timing differences under tax basis capital loss carryover are due
to post-October losses. The differences between book and tax basis unrealized
appreciation/(depreciation) is primarily attributable to the mark-to-market of
futures.
Federal Income Tax Basis: The federal income tax basis of the Fund's investments
at November 30, 2003 was $203,981,022. Net unrealized appreciation was
$3,619,393 (gross unrealized appreciation -- $4,409,073; gross unrealized
depreciation -- $789,680). At November 30, 2003, the Fund had a capital loss
carryforward of $2,697,776, of which $914,308 expires in 2010 and $1,783,468
expires in 2011, available to offset any future gains, to the extent provided by
regulations.
Capital Account Reclassification: For the year ended November 30, 2003, the
Fund's undistributed net investment income was increased by $1,888,696 with an
offsetting decrease in accumulated net realized loss. These adjustments were
primarily the result of current year paydown reclassifications.
9. Subsequent Events
Dividend: The Fund's Board of Directors declared the following regular monthly
dividends:
Dividend Record Payable
Per Share Date Date
--------- ------------- ---------
$0.1080 12/16/03 12/26/03
$0.1080 12/30/03 01/29/04
--------------------------------------------------------------------------------
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
================================================================================
Report of Independent Auditors
================================================================================
----------------------------------------------------------- -------------- -----
To the Board of Directors and Shareholders of
The Hyperion Strategic Mortgage Income Fund, Inc.:
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations, of cash
flows and of changes in net assets and the financial highlights present fairly,
in all material respects, the financial position of The Hyperion Strategic
Mortgage Income Fund, Inc. (the "Fund") at November 30, 2003, the results of its
operations and its cash flows for the year then ended, and the changes in its
net assets and the financial highlights for the year then ended and for the
period July 26, 2002 (date of commencement of operations) through November 30,
2002, in conformity with accounting principles generally accepted in the United
States of America. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with auditing standards generally accepted in
the United States of America, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at November 30, 2003 by
correspondence with the custodian and brokers, provide a reasonable basis for
our opinion.
PricewaterhouseCoopers LLP
New York, NY
January 23, 2004
--------------------------------------------------------------------------------
================================================================================
TAX INFORMATION (Unaudited)
================================================================================
------------------------------------------------------------ --------------- ---
The Fund is required by subchapter M of the Internal Revenue Code of 1986, as
amended, to advise you within 60 days of the Fund's fiscal year end (November
30, 2003) as to the federal tax status of distributions received by shareholders
during such fiscal year. Accordingly, we are advising you that all distributions
paid during the fiscal year were derived from net investment income and are
taxable as ordinary income. In addition, 2.60% of the Fund's distributions
during the fiscal year ended November 30, 2003 were earned from U.S. Treasury
obligations. None of the Fund's distributions qualify for the dividends received
deduction available to corporate shareholders.
Because the Fund's fiscal year is not the calendar year, another notification
will be sent with respect to calendar 2003. The second notification, which will
reflect the amount to be used by calendar year taxpayers on their federal, state
and local income tax returns, will be made in conjunction with Form 1099-DIV and
will be mailed in January 2004. Shareholders are advised to consult their own
tax advisors with respect to the tax consequences of their investment in the
Fund.
--------------------------------------------------------------------------------
================================================================================
PROXY RESULTS (Unaudited)
================================================================================
------------------------------------------------------------ --------------- ---
During the year ended November 30, 2003, The Hyperion Strategic Mortgage
Income Fund, Inc. shareholders voted on the following proposals at a
shareholders' meeting on April 15, 2003. The description of each proposal
and number of shares voted are as follows:
------------------------------------------------------------------------ ------------- -------------- -------------
Shares Voted Shares Voted Shares Voted
for Against Abstain
------------------------------------------------------------------------ ------------- -------------- -------------
------------------------------------------------------------------------ ------------- -------------- -------------
1. To elect to the Fund's Board of Directors 9,924,202 0 80,515
Robert F. Birch:
------------------------------------------------------------------------ ------------- -------------- -------------
Shares Voted Shares Voted Shares Voted
for Against Abstain
------------------------------------------------------------------------ ------------- -------------- -------------
------------------------------------------------------------------------ ------------- -------------- -------------
2. To select PricewaterhouseCoopers LLP as the 9,896,051 39,179 69,487
independent auditors:
------------------------------------------------------------------------ ------------- -------------- -------------
Subsequent to November 30, 2003, The Hyperion Strategic Mortgage Income Fund,
Inc. shareholders voted on the following proposal at the shareholders' meeting
on December 9, 2003. The description of the proposal and number of shares voted
are as follows:
------------------------------------------------------------------------ ------------- -------------- -------------
Shares Voted Shares Voted Shares Voted
for Against Abstain
------------------------------------------------------------------------ ------------- -------------- -------------
------------------------------------------------------------------------ ------------- -------------- -------------
1. Approval of New Investment Sub-Advisory 9,528,731 108,960 115,752
Agreement:
------------------------------------------------------------------------ ------------- -------------- -------------
-------------------------------------------------------------------------------
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
===============================================================================
Information Concerning Directors and Officers (Unaudited)
---------------------------------------------------------------------------- --
The following tables provide information concerning the directors and officers
of The Hyperion Strategic Mortgage Income Fund, Inc. (the "Fund").
Position(s) Held Number of
with Portfolios in
Name, Address Fund and Term of Principal Occupation(s) During Past 5 Years and Fund
and Age Office and Length of Other Directorships Held by Director Complex Overseen
Time Served by Director
---------------------------- --------------------- ------------------------------------------------ ------------------
--------------------------------------------------------------------------------------------------- ------------------
Disinterested Directors
Class II Directors to serve until 2004 Annual Meeting of Stockholders:
Rodman L. Drake Chairman Chairman (since 2003) and Director and/or 3
c/o One Liberty Plaza, Trustee of several investment companies
36th floor, New York, Elected 12/9/03 advised by Hyperion Capital Management, Inc.
New York 10006-1404 (the "Advisor") (1989- Present); Co-founder,
Director, Member of Baringo Capital LLC (2002- Present); Director,
Age 60 the Audit Animal Medical Center (2002- Present);
Committee, Chairman Director, Hotelevision, Inc. (1999-2003);
of Nominating and Director and/or Lead Director, Parsons
Compensation Brinckerhoff, Inc. (1995-Present); Director,
Committee Absolute Quality Inc. (2000- Present); Trustee
of Excelsior Funds (33) (1994- Present);
Elected for Two President, Continuation Investments Group Inc.
Year Term/Director (1997-2001).
since June 2002
Harry E. Petersen, Jr. Director, Member of Director and/or Trustee of several investment 3
c/o One Liberty Plaza, the Audit companies advised by the Advisor or by its
36th floor, New York, Committee, Member affiliates (1992-Present); Senior Consultant
New York 10006-1404 of Compensation and to Cornerstone Equity Advisors, Inc.
Nominating (1998-2001).
Age 78 Committee, Member
of Executive
Committee
Elected for Two
Year Term/Director
since June 2002
Class I Director to serve until 2006 Annual Meeting of Stockholders:
Robert F. Birch Director, Member of Director and/or Trustee of several investment 4
c/o One Liberty Plaza, the companies advised by the Advisor or by its
36th floor, New York, Audit Committee, affiliates (1998-Present); Director, Hyperion
New York 10006-1404 Member of Strategic Bond Fund, Inc. (formerly Lend Lease
Nominating and Hyperion High Yield CMBS Fund, Inc.)
Age 67 Compensation (2002-Present); Chairman and President, New
Committee, Member America High Income Fund (1992-Present);
of Executive Chairman of the Board and Co-Founder, The
Committee China Business Group, Inc. (1996-Present);
Director, Brandywine Funds (3) (2001 to
Elected for Three Present).
Year
Term/Director since
June 2002
-----------------------------------------------------------------------------
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
==============================================================================
Information Concerning Directors and Officers (Unaudited)
---------------------------------------------------------------------------- -
Position(s) Held Number of
with Portfolios in
Name, Address Fund and Term of Principal Occupation(s) During Past 5 Years and Fund
and Age Office and Length of Other Directorships Held by Director Complex Overseen
Time Served by Director
---------------------------- --------------------- ------------------------------------------------ ------------------
----------------------------------------------------------------------------------------------------------------------
Class III Director to serve until 2005 Annual Meeting of Stockholders:
Leo M. Walsh, Jr. Director, Chairman Director and/or Trustee of several investment 5
c/o One Liberty Plaza, of companies advised by the Advisor or by its
36th floor, New York, the Audit Committee, affiliates (1989-Present); Financial
New York 10006-1404 Member of Nominating Consultant for Medco Health Solutions Inc.
and Compensation (1994-2003); Director, Hyperion Strategic Bond
Age 71 Committee Fund, Inc. (formerly Lend Lease Hyperion High
Yield CMBS Fund, Inc.) (1999-Present).
Elected for Three
Year
Term/Director since
June 2002
Interested Directors
Clifford E. Lai* Director President (1998-Present) and Chief Investment 5
c/o One Liberty Plaza, Officer (1993-2002) of the Advisor;
36th floor, New York, Elected December 9, Co-Chairman (2003- Present) and Board of
New York 10006-1404 2003 Managers (1995-Present) Hyperion GMAC Capital
Advisors, LLC (formerly Lend Lease Hyperion
Age 50 President Capital, LLC); President of several investment
companies advised by the Advisor (1995-
Elected Annually Present).
Since June 2002
Lewis S. Ranieri** Director, Member of Director (1989-Present) and Chairman of the 3
c/o One Liberty Plaza, the Executive Board (1989-1998 and 2002-Present) of the
36th floor, New York, Committee Advisor; Formerly, Vice Chairman of the Board
New York 10006-1404 of the Advisor (1998-2002); Chairman and Chief
Resigned December Executive Officer of Ranieri & Co., Inc.
Age 57 9, 2003 (1988-Present); President of LSR Hyperion
Corp., a general partner of the limited
Elected for Three partnership that is the general partner of
Year Term Hyperion Partners L.P. ("Hyperion Partners")
Director since June (1988-Present); Director and President of
1989 Hyperion Funding II Corp., the general partner
of the limited partnership that is the general
Chairman partner of Hyperion Partners II L.P.
Elected annually ("Hyperion Partners II") (1996-Present);
since Chairman and President of various other direct
June 2002 and indirect subsidiaries of Hyperion Partners
(1988-2002) and Hyperion Partners II
Resigned December (1995-Present); Chairman of the Board
9, 2003 (1989-1998 and 2002-2003) and/or Director
(1989-2003) of several investment companies
advised by the Advisor or by its affiliates;
Director and Chairman of Bank United Corp.,
and Director of Bank United (1988-2001).
----------
* Interested person as defined in the 1940 Act, because of affiliations with
Hyperion Capital Management, Inc., the Fund's Advisor.
** Mr. Ranieri is an "interested person" as defined in the Investment Company
Act of 1940, as amended, (the "1940 Act") because of affiliations with
Hyperion Capital Management, Inc., the Fund's advisor. Mr. Ranieri serves
as a Director and Chairman of the Advisor. As a result of his service with
the Advisor and certain affiliations with the Advisor as described, the
Fund considers Mr. Ranieri to be an "interested person" of the Fund within
the meaning of Section 2(a)(19) of the 1940 Act.
------------------------------------------------------------------------------
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Information Concerning Directors and Officers (Unaudited)
---------------------------------------------------------------------------- -
Officers of the Fund
Position(s) Term of Office and Principal Occupation(s)
Name, Address and Age Held with Fund Length of Time During Past 5 Years
Served
---------------------------- ----------------- --------------------- -------------------------------------------------
---------------------------- ----------------- --------------------- -------------------------------------------------
Lewis S. Ranieri Chairman Elected Annually Please see "Information Concerning Directors
c/o One Liberty Plaza, Since June 2002 and Officers" page 23.
36th floor, New York, Resigned
New York 10006-1404 December 9, 2003
Age 57
Rodman L. Drake Chairman Elected 12/9/03 Please see "Information Concerning Directors
c/o One Liberty Plaza, and Officers" page 22.
36th floor, New York, Director, Elected for Two
New York 10006-1404 Member of the Year Term/Director
Audit since June 2002
Age 60 Committee,
Chairman of
Nominating and
Compensation
Committee
Clifford E. Lai Director Elected December 9, Please see "Information Concerning Directors
c/o One Liberty Plaza, 2003 and Officers" page 23.
36th floor, New York,
New York 10006-1404 President Elected Annually
Since June 2002
Age 50
John Dolan Vice President Elected Annually Chief Investment Strategist (1998-Present) and
c/o One Liberty Plaza, Since June 2002 Chief Investment Officer (2002-Present) of the
36th floor, New York, Advisor.
New York 10006-1404
Age 50
Patricia A. Sloan Vice President Elected Annually Consultant of Ranieri & Co., Inc.
c/o One Liberty Plaza, Since June 2002 (2000-Present); Secretary, Director and/or
36th floor, New York, Trustee of several investment companies advised
New York 10006-1404 by the Advisor or by its affiliates (1989-
2002).
Age 60
Joseph Tropeano Secretary Elected Annually Director and Compliance Officer of the Advisor
c/o One Liberty Plaza, Since June 2002 (1993- Present); Secretary and Compliance
36th floor, New York, Officer of several investment companies advised
New York 10006-1404 by the Advisor (1994- Present); Secretary and
Compliance Officer, Hyperion GMAC Capital
Age 42 Advisors (formerly Lend Lease Hyperion Capital
Advisors, LLC) (1995-Present); Secretary and
Compliance Officer of Hyperion Strategic Bond
Fund, Inc. (formerly Lend Lease Hyperion
High-Yield CMBS Fund, Inc.) (1998-Present);
Assistant Secretary and Compliance Officer, AIG
Hyperion Inc. (1994-2002); Vice President and
Compliance Officer, Hyperion Distributors, Inc.
(1994-1998).
Thomas F. Doodian Treasurer Elected Annually Managing Director, Chief Operating Officer
c/o One Liberty Plaza, Since June 2002 (1998-Present) and Director of Finance and
36th floor, New York, Operations of the Advisor (July 1995-Present);
New York 10006-1404 Treasurer of several investment companies
Age 44 advised by the Advisor (February 1998-Present).
The Fund's Statement of Additional Information includes additional information
about the directors and is available, without charge, upon request by calling
1-800-497-3746.
--------------------------------------------------------------------------------
DIVIDEND REINVESTMENT PLAN
================================================================================
------------------------------------------------------------ --------------- ---
A Dividend Reinvestment Plan (the "Plan") is available to shareholders of the
Fund pursuant to which they may elect to have all distributions of dividends and
capital gains automatically reinvested by American Stock Transfer & Trust
Company (the "Plan Agent") in additional Fund shares. Shareholders who do not
participate in the Plan will receive all distributions in cash paid by check
mailed directly to the shareholder of record (or if the shares are held in
street or other nominee name, then to the nominee) by the Fund's Custodian, as
Dividend Disbursing Agent.
The Plan Agent serves as agent for the shareholders in administering the Plan.
After the Fund declares a dividend or determines to make a capital gain
distribution, payable in cash, if (1) the market price is lower than net asset
value, the participants in the Plan will receive the equivalent in Fund shares
valued at the market price determined as of the time of purchase (generally, the
payment date of the dividend or distribution); or if (2) the market price of the
shares on the payment date of the dividend or distribution is equal to or
exceeds their net asset value, participants will be issued Fund shares at the
higher of net asset value or 95% of the market price. This discount reflects
savings in underwriting and other costs that the Fund otherwise will be required
to incur to raise additional capital. If net asset value exceeds the market
price of the Fund shares on the payment date or the Fund declares a dividend or
other distribution payable only in cash (i.e., if the Board of Directors
precludes reinvestment in Fund shares for that purpose), the Plan Agent will, as
agent for the participants, receive the cash payment and use it to buy Fund
shares in the open market, on the New York Stock Exchange or elsewhere, for the
participants' accounts. If, before the Plan Agent has completed its purchases,
the market price exceeds the net asset value of the Fund's shares, the average
per share purchase price paid by the Plan Agent may exceed the net asset value
of the Fund's shares, resulting in the acquisition of fewer shares than if the
dividend or distribution had been paid in shares issued by the Fund. The Fund
will not issue shares under the Plan below net asset value.
Participants in the Plan may withdraw from the Plan upon written notice to the
Plan Agent. When a participant withdraws from the Plan or upon termination of
the Plan by the Fund, certificates for whole shares credited to his or her
account under the Plan will be issued and a cash payment will be made for any
fraction of a share credited to such account.
There is no charge to participants for reinvesting dividends or capital gain
distributions, except for certain brokerage commissions, as described below. The
Plan Agent's fees for handling the reinvestment of dividends and distributions
are paid by the Fund. There are no brokerage commissions charged with respect to
shares issued directly by the Fund. However, each participant will pay a pro
rata share of brokerage commissions incurred with respect to the Plan Agent's
open market purchases in connection with the reinvestment of dividends and
distributions.
The automatic reinvestment of dividends and distributions will not relieve
participants of any federal income tax that may be payable on such dividends or
distributions.
A brochure describing the Plan is available from the Plan Agent, by calling
1-212-936-5100.
If you wish to participate in the Plan and your shares are held in your name,
you may simply complete and mail the enrollment form in the brochure. If your
shares are held in the name of your brokerage firm, bank or other nominee, you
should ask them whether or how you can participate in the Plan. Shareholders
whose shares are held in the name of a brokerage firm, bank or other nominee and
are participating in the Plan may not be able to continue participating in the
Plan if they transfer their shares to a different brokerage firm, bank or other
nominee, since such shareholders may participate only if permitted by the
brokerage firm, bank or other nominee to which their shares are transferred.
(This page intentionally left blank)
INVESTMENT ADVISOR AND ADMINISTRATOR TRANSFER AGENT
HYPERION CAPITAL MANAGEMENT, INC. AMERICAN STOCK TRANSFER & TRUST
One Liberty Plaza COMPANY
165 Broadway, 36th Floor Investor Relations Department
New York, New York 10006-1404 59 Maiden Lane
For General Information about the Trust: New York, NY 10038
(800) HYPERION For Shareholder Services:
(800) 937-5449
SUB-ADVISOR
INDEPENDENT AUDITORS
HYPERION GMAC CAPITAL ADVISORS, LLC
One Liberty Plaza PRICEWATERHOUSECOOPERS LLP
165 Broadway, 36th Floor 1177 Avenue of the Americas
New York, New York 10006-1404 New York, New York 10036
SUB-ADMINISTRATOR LEGAL COUNSEL
STATE STREET BANK and TRUST COMPANY SULLIVAN & WORCESTER LLP
225 Franklin Street 1666 K Street, Northwest
Boston, Massachusetts 02116 Washington, D.C. 20006
CUSTODIAN AND FUND ACCOUNTING AGENT
STATE STREET BANK and TRUST COMPANY
225 Franklin Street
Boston, Massachusetts 02116
Notice is hereby given in accordance with Section 23(c) of the Investment
Company Act of 1940 that periodically the Fund may purchase its shares in the
open market at prevailing market prices.
--------------------------------------------------------------------------------
Officers & Directors
================================================================================
================================================================================
------------------------------------------------------------ --------------- ---
Rodman L. Drake*
Chairman
Robert F. Birch*
Director
Leo M. Walsh, Jr.*
Director
Harry E. Petersen, Jr.*
Director
Clifford E. Lai
Director and President
Patricia A. Sloan
Vice President
John Dolan
Vice President
Thomas F. Doodian
Treasurer
Joseph Tropeano
Secretary
----------
* Audit Committee Members
---------------------------------------------------------------------
[GRAPHIC OMITTED][GRAPHIC OMITTED]
---------------------------------------------------------------------
---------------------------------------------------------------------
This report is for shareholder information. This is not a
prospectus intended for use in the purchase or sale of Fund shares.
The Hyperion Strategic Mortgage
Income Fund, Inc.
One Liberty Plaza
165 Broadway, 36th Floor
New York, NY 10006-1404
Item 2. Code of Ethics.
As of the end of the period covered by this report, the Registrant had
adopted a Code of Ethics for Principal Executive and Principal Financial
Officers (the "Code"). There were no amendments to or waivers from the Code
during the period covered by this report. A copy of the Registrant's Code will
be provided upon request to any person without charge by contacting Joseph
Tropeano at 1-800-HYPERION or by writing to Mr. Tropeano at One Liberty Plaza,
165 Broadway, 36th Floor, New York, NY 10006-1404.
Item 3. Audit Committee Financial Expert.
The Registrant's Board of Directors has determined that the Registrant has
at least one audit committee financial expert serving on its audit committee,
and his name is Rodman L. Drake. Mr. Drake is independent.
Item 4. Principal Accountant Fees and Services.
Audit Fees
For the fiscal year ended November 30, 2003, PriceWaterhouseCoopers LLP
("PwC") billed the Registrant aggregate fees of $59,000 for professional
services rendered for the audit of the Registrant's annual financial statements
and review of financial statements included in the Registrant's annual report to
shareholders.
For the fiscal year ended November 30, 2002, PwC billed the Registrant
aggregate fees of $53,500 for professional services rendered for the audit of
the Registrant's annual financial statements and review of financial statements
included in the Registrant's annual report to shareholders.
Tax Fees
For the fiscal year ended November 30, 2003, PwC billed the Registrant
aggregate fees of $7,000 for professional services rendered for tax compliance,
tax advice and tax planning. The nature of the services comprising the Tax Fees
was the review of the Registrant's income tax returns and tax distribution
requirements.
For the fiscal year ended November 30, 2002, PwC billed the Registrant
aggregate fees of $8,160 for professional services rendered for tax compliance,
tax advice and tax planning. The nature of the services comprising the Tax Fees
was the review of the Registrant's income tax returns and tax distribution
requirements.
All Other Fees
For the fiscal year ended November 30, 2003, PwC billed the Registrant
aggregate fees of $39,500 for professional services rendered for the review of
financial statements included in the Registrant's semi-annual report to
shareholders.
For the fiscal year ended November 30, 2002, PwC billed the Registrant
aggregate fees of $8,000 for comfort letters provided to the Registrant.
Item 5. Audit Committee of Listed Registrants.
The Registrant has a separately-designated standing Audit Committee
established in accordance with Section 3(a)(58)(A) of the Securities Exchange
Act of 1934. The Registrant's Audit Committee members include Leo M. Walsh, Jr.,
Rodman L. Drake, Robert F. Birch and Harry E. Petersen, Jr.
Item 6. [Reserved]
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
This Item is not applicable as the Registrant invested exclusively in
non-voting securities during the period covered by this report.
Item 8.
Not applicable.
Item 9. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 10. Controls and Procedures.
(a) The Registrant's principal executive officer and principal financial
officer have concluded that the Registrant's Disclosure Controls and Procedures
are effective, based on their evaluation of such Disclosure Controls and
Procedures as of a date within 90 days of the filing of this report on Form
N-CSR.
(b) As of the date of filing this Form N-CSR, the Registrant's principal
executive officer and principal financial officer are aware of no changes in the
Registrant's internal control over financial reporting that occurred during the
Registrant's second fiscal half-year that has materially affected or is
reasonably likely to materially affect the Registrant's internal control over
financial reporting.
Item 11. Exhibits.
(a) None.
(b) A separate certification for each principal executive officer and
principal financial officer of the Registrant as required by Rule 30a-2 under
the Investment Company Act of 1940 is attached as an exhibit to this Form N-CSR.
(c) None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
By: /s/ Clifford E. Lai
__________________
Clifford E. Lai
Principal Executive Officer
Date: February 6, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
By: /s/ Clifford E. Lai
___________________
Clifford E. Lai
Principal Executive Officer
Date: February 6, 2004
By: /s/ Thomas F. Doodian
_____________________
Thomas F. Doodian
Treasurer and Principal Financial Officer
Date: February 6, 2004