[graphic]
THE HYPERION
STRATEGIC
MORTGAGE
INCOME
FUND, INC.
Annual Report
November 30, 2002
[LOGO]
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Report of the Investment Advisor
January 29, 2003
Dear Shareholder:
We are pleased to present our first report to the shareholders of The Hyperion
Strategic Mortgage Income Fund, Inc. The Fund is a closed-end bond fund whose
shares are traded on the New York Stock Exchange ("NYSE") under the symbol
"HSM". The initial public offering of the Fund occurred July 23, 2002, and
investing began on July 26, 2002. This report summarizes the Fund's investment
activities from July 26, 2002 through November 30, 2002 (the end of the first
fiscal year).
For the fiscal year ending November 30, 2002, shareholders realized a total
investment return of -6.66%, which assumes the reinvestment of dividends and
is exclusive of brokerage commissions. Based on the NYSE closing price of
$13.68 on November 30, 2002, the Fund had a dividend yield of 9.47%, which was
6.20% 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, 2002, the Fund, inclusive of leverage, was managed with an
average duration (duration measures a bond portfolio's price sensitivity to
interest rate changes) of 4.8 years, as measured on a net asset basis.
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.
Market Environment
The economy limped through the second half of 2002. While economic growth has
been positive, it has been the consumer that has been the main driver for the
economy. The unemployment rate continues to drift higher in 2002, and consumer
confidence has declined. Both of these forces present the economy with the
risk of falling back into recession.
Against this backdrop of economic weakness, the Federal Reserve ("Fed")
lowered the discount rate by 50 basis points to 1.25% on November 6, 2002--the
lowest rate since 1958--clearly signaling a willingness to stimulate the
economy through monetary policy without fear of any near-term inflationary
impact. With capacity utilization low and the key European and Japanese
economies also performing poorly, we agree that there is little to fear from
inflation and believe that the prospect for an economic recovery is improving.
On the fiscal side, the Bush administration's juggling of the Treasury and
Economic Advisor positions indicates an imminent fiscal stimulus package is
being discussed. We are hopeful that one of the changes in any proposal will
be the elimination of the double taxation of dividends.
1
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Report of the Investment Advisor
The stock and bond markets have had a relatively positive reaction to the
actions of the Fed and the Bush administration. The "flight-to-quality" that
had been evident during the early days of the summer has disappeared, and the
yield on the 10-year Treasury has climbed to 4.21% from a low of 3.60% on
September 30, 2002. The currency markets have also signaled their support,
with the dollar holding its value against the Yen and Euro despite the cut in
rates. This increase in confidence has spilled over into the Corporate market.
After a year of financial scandals, growing distrust of corporate leaders, and
questionable accounting, investors have begun to believe that the worst is
over. As a result, corporations have returned to the market for debt issuance.
There are two events in the last six months that may have been the key to the
change in market sentiment. The first was the deadline of August 14, 2002 for
corporate officers to attest to the accuracy of financial statements. There
was a sense that any impropriety would be revealed by that date and that there
would be no more problems thereafter. The second was the purchase of Household
by HSBC, which showed that at distressed levels it is possible for some
assets--and entire companies--to become "too cheap" and grow to be attractive
targets for savvy buyers. Since the announcement of the purchase, yield
spreads on corporate bonds have been tightening.
Portfolio Strategy
With the Fed clearly in the mode of keeping short term interest rates low for
the foreseeable future, there are several themes that we believe are
appropriate for the Fund. First, the low yields for cash investments and
borrowing provide incentive to keep the Fund as fully invested and leveraged
as possible for the first half of 2003. As a result, we have continued to
lower and hedge our cost of financing for the leveraged portion of the Fund.
Second, lower rates continue to make it attractive for homeowners to
refinance, particularly into re-settable Adjustable Rate Mortgages (ARMs). As
refinancings occur, MBS supply will remain high, which will mean that as MBS
investors, we will be able to be more selective in the securities we purchase.
We think that the first half of next year will continue to offer such an
opportunity.
Finally, while our target allocation for the Fund is approximately 33% to each
of the three sectors--Agency MBS, CMBS and non-Agency RMBS--we have pursued a
"go slow" approach in terms of buying in the credit-sensitive sectors CMBS and
non-Agency RMBS sectors. The Agency MBS portion of the Fund is still in excess
of 50% of gross assets. We will modestly increase the non-Agency RMBS and CMBS
allocations, but will do so slowly as we wait to see further evidence of a
more sustained economic recovery.
2
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Report of the Investment Advisor
Conclusion
The officers and directors of the Fund appreciate your confidence. 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,
/s/ Clifford E. Lai
-------------------------------------------------
CLIFFORD E. LAI
President,
The Hyperion Strategic Mortgage Income Fund, Inc.
President and Chief Executive Officer,
Hyperion Capital Management, Inc.
/s/ John H. Dolan
-------------------------------------------------
JOHN H. DOLAN
Vice President,
The Hyperion Strategic Mortgage Income Fund, Inc.
Chief Investment Officer,
Hyperion Capital Management, Inc.
3
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC
Portfolio of Investments
November 30, 2002
Principal
Interest Amount Value
Rate Maturity (000s) (Note 2)
------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT & AGENCY OBLIGATIONS - 75.4%
U.S. Government Agency Pass-Through Certificates - 75.4%
Federal Home Loan
Mortgage Corporation
Pool C68878................................... 7.00% 06/01/32 $ 1,477# $ 1,541,166
Pool C69047................................... 7.00 06/01/32 3,159 3,296,728
---------------
4,837,894
---------------
Federal National
Mortgage Association
Pool 617729................................... 6.00 07/01/32 3,418 3,496,285
Pool 650718................................... 6.00 07/01/32 25,416@ 26,001,169
Pool 650133................................... 6.00 07/01/32 19,793 20,248,569
Pool 651723................................... 6.50 08/01/32 23,427@ 24,210,486
Pool 626299................................... 7.00 06/01/32 2,346 2,449,224
Pool 635095................................... 7.00 06/01/32 3,457 3,609,024
Pool 641575................................... 7.00 04/01/32 1,401 1,462,828
Pool 645399................................... 7.00 05/01/32 9,215@ 9,621,201
Pool 645466................................... 7.00 05/01/32 7,600@ 7,934,669
Pool 650131................................... 7.00 07/01/32 3,683@ 3,845,600
---------------
102,879,055
---------------
Total U.S. Government & Agency Obligations
(Cost - $107,286,060) 107,716,949
---------------
------------------------------------------------------------------------------------------------------------------------
ASSET-BACKED SECURITIES - 2.8%
Non-Housing Related
Asset-Backed Securities - 2.8%
Long Beach Mortgage
Loan Trust
Series 2002-5, Class M2
(Cost - $4,000,000)....................... 3.69+ 11/25/32 4,000 3,953,752
---------------
------------------------------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE BACKED SECURITIES - 17.4%
Banc of America
Commercial Mortgage, Inc.
Series 2002-2, Class J*....................... 6.30 07/11/43 1,900 1,878,572
Bear Stearns Commercial
Mortgage Securities
Series 1999-C1, Class G*...................... 5.64 02/14/31 2,390 1,942,120
Series 1999-C1, Class D....................... 6.53 10/14/13 2,500 2,585,875
Series 2000-WF1, Class E...................... 7.90 02/15/32 2,000 2,281,178
---------------
6,809,173
---------------
Chase Commercial
Mortgage Securities Corp.
Series 2000-2, Class G*....................... 6.65 07/15/10 3,000 2,757,219
GE Capital Commercial
Mortgage Corp.
Series 2002-2A, Class G*...................... 6.04 08/11/36 3,000 2,984,922
Series 2000-1, Class G*....................... 6.13 01/15/33 2,000 1,778,690
Series 2002-2A, Class H*...................... 6.31 08/11/36 2,000 1,998,636
Series 2000-1, Class E........................ 7.17+ 12/15/10 1,000 1,076,871
---------------
7,839,119
---------------
JP Morgan Commercial
Mortgage Finance Corp.
Series 1999-C7, Class F*..................... 6.00 10/15/35 2,000 1,816,418
LB-UBS Commercial
Mortgage Trust
Series 2001-C7, Class K*..................... 5.87 12/16/33 2,000 1,617,946
UBS 400 Atlantic Street
Mortgage Trust
Series 2002-C1A, Class B3..................... 7.19 01/11/22 2,000 2,154,980
---------------
Total Commercial Mortgage Backed Securities
(Cost -$25,153,538)....................... 24,873,427
---------------
------------------------------------------------------------------------------------------------------------------------
4
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC
Portfolio of Investments
November 30, 2002
Principal
Interest Amount Value
Rate Maturity (000s) (Note 2)
----------------------------------------------------------------------------------------------------------------------------
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES - 51.0%
Subordinated Collateralized Mortgage Obligations - 51.0%
ABN AMRO Mortgage Corp.
Series 2002-7, Class B2..................... 6.19% 09/25/32 $ 1,081 $ 1,018,147
Bank of America
Mortgage Securities, Inc.
Series 2002-H, Class B5..................... 4.68 08/25/32 378 270,753
Series 2002-H, Class B4..................... 4.68 08/25/32 566 504,020
Series 2002-H, Class B6..................... 4.68 08/25/32 945 273,937
Series 2002-I, Class B4..................... 4.74 08/25/32 1,027 888,979
Series 2002-10, Class 1B3................... 6.00 11/25/32 1,500 1,474,997
Series 2002-8, Class 1B1.................... 6.25 09/25/32 7,409 7,553,285
Series 2002-8, Class 1B4*................... 6.25 09/25/32 1,098 936,612
Series 2002-8, Class 1B5*................... 6.25 09/25/32 823 486,981
Series 2002-8, Class 1B6*................... 6.25 09/25/32 824 230,645
Series 2002-9, Class 1B3.................... 6.25 10/25/32 1,798 1,724,391
Series 2002-9, Class 1B4.................... 6.25 10/25/32 1,199 1,023,587
--------------
15,368,187
--------------
Cendant Mortgage Corp.
Series 2002-4, Class B1..................... 6.50 07/25/32 2,688 2,724,684
Series 2002-4, Class B2..................... 6.50 07/25/32 1,075 1,075,866
Series 2002-4, Class B3..................... 6.50 07/25/32 627 598,238
Series 2002-4, Class B4..................... 6.50 07/25/32 358 303,137
Series 2002-4, Class B5..................... 6.50 07/25/32 269 162,857
Series 2002-4, Class B6*.................... 6.50 07/25/32 358 86,006
--------------
4,950,788
--------------
Citicorp Mortgage
Securities, Inc.
Series 2002-8, Class B1..................... 6.28+ 07/25/32 3,677 3,667,161
Series 2002-8, Class B2..................... 6.28+ 07/25/32 1,600 1,575,008
Series 2002-8, Class B3..................... 6.28+ 07/25/32 799 768,904
--------------
6,011,073
--------------
Countrywide Home Loans
Series 2001-12, Class B4..................... 6.50 07/25/31 909 698,687
Series 2001-12, Class B5..................... 6.50 07/25/31 1,143 331,383
--------------
1,030,070
--------------
G3 Mortgage Reinsurance Ltd.
Series 1, Class EH*.......................... 21.38+ 05/25/08 4,839 5,274,002
Government Lease Trust
Series 1999-C1A, Class B3.................... 4.00 05/18/11 2,500 2,124,918
Morgan Stanley Capital I
Series 1999-FNV1, Class A2................... 6.53 03/15/31 2,000 2,209,256
Series 1999-FNV1, Class E.................... 7.46+ 03/15/31 2,000 2,208,094
Series 1999-WF1, Class E..................... 6.97+ 11/15/31 5,500 6,003,178
Series 1999-WF1, Class F..................... 6.97+ 08/15/10 3,000 3,224,016
--------------
13,644,544
--------------
5
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC
Portfolio of Investments
November 30, 2002
Principal
Interest Amount Value
Rate Maturity (000s) (Note 2)
----------------------------------------------------------------------------------------------------------------------------
NON-AGENCY RESIDENTIAL MORTGAGE BACKED SECURITIES (continued)
Morgan Stanley Dean
Witter Capital I
Series 2001-TOP1, Class A4.................... 6.66% 02/15/33 $ 4,500 $ 5,004,347
Residential Funding
Mortgage Security I
Series 2002-S10, Class B1*.................... 6.50 07/25/32 721 630,676
Series 2002-S10, Class B2*.................... 6.50 07/25/32 541 330,729
Series 2002-S10, Class B3*.................... 6.50 07/25/32 541 151,374
-----------------
1,112,779
-----------------
Structured Asset
Mortgage Investments, Inc.
Series 2002-AR1, Class B4..................... 5.63+ 03/25/32 1,516 1,274,979
Washington Mutual
Mortgage Securities Corp.
Series 2002-AR12, Class B4.................... 4.81+ 10/25/32 1,996 1,608,216
Series 2002-AR12, Class B6.................... 4.81+ 10/25/32 2,497 600,175
Series 2002-AR10, Class B6*................... 5.10+ 10/25/32 3,249 830,514
Series 2002-AR10, Class B4*................... 5.10+ 10/25/32 2,597 2,223,144
Series 2002-AR10, Class B5*................... 5.10+ 10/25/32 1,947 1,288,599
Series 2002-AR11, Class B6.................... 5.24+ 10/25/32 2,487 795,727
Series 2002-AR11, Class B5.................... 5.23+ 10/25/32 1,492 1,023,926
Series 2002-AR12, Class B5.................... 5.24+ 10/25/32 1,497 895,007
-----------------
9,265,308
-----------------
Wells Fargo Mortgage
Backed Securities Trust
Series 2002-10, Class B5 1.................... 6.00 06/25/32 374 269,268
Series 2002-15, Class B1...................... 6.50 08/25/32 5,191 5,384,293
Series 2002-15, Class B4...................... 6.50 08/25/32 599 539,988
Series 2002-15, Class B5...................... 6.50 08/25/32 798 505,155
Series 2002-15, Class B6...................... 6.50 08/25/32 599 173,814
-----------------
6,872,518
-----------------
Total Subordinated Collateralized
Mortgage Obligations
(Cost - $73,896,400)...................... 72,951,660
-----------------
Total Non-Agency Residential
Mortgage Backed Securities
(Cost - $73,896,400)...................... 72,951,660
-----------------
Total Investments - 146.6%
(Cost - $210,335,998)..................... 209,495,788
Liabilities in Excess of
Other Assets - (46.6)%.................... (66,574,507)
-----------------
NET ASSETS - 100.0%.............................. $ 142,921,281
=================
@ - 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, 2002.
* - 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 in a margin account as
collateral for open futures contracts (Note 7).
---------------
See notes to financial statements.
6
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Assets and Liabilities
November 30, 2002
Assets:
Investments in securities, at market (cost $210,335,998) (Note 2) ................................... $ 209,495,788
Cash ................................................................................................ 337,454
Interest receivable ................................................................................. 1,398,383
Principal paydowns receivable ....................................................................... 22,230
Unrealized appreciation on swap contracts (Note 7) .................................................. 155,603
Receivable from advisor ............................................................................. 57,689
Receivable for variation margin ..................................................................... 18,906
Prepaid expenses and other assets ................................................................... 5,512
-----------------
Total assets .................................................................................... 211,491,565
-----------------
Liabilities:
Reverse repurchase agreements (Note 5) .............................................................. 68,264,000
Interest payable for reverse repurchase agreements (Note 5) ......................................... 38,259
Payable on open swap contracts ...................................................................... 67,865
Investment advisory fee payable (Note 3) ............................................................ 77,267
Administration fee payable (Note 3) ................................................................. 23,774
Accrued expenses and other liabilities .............................................................. 99,119
-----------------
Total liabilities ............................................................................... 68,570,284
-----------------
Net Assets (equivalent to $14.10 per share based on 10,138,296 shares issued and outstanding) ....... $ 142,921,281
=================
Composition of Net Assets:
Capital stock, at par value ($.01) (Note 6) ......................................................... $ 101,383
Additional paid-in capital (Note 6) ................................................................. 144,065,503
Accumulated undistributed net investment income ..................................................... 540,088
Accumulated net realized loss ....................................................................... (979,189)
Net unrealized depreciation ......................................................................... (806,504)
-----------------
Net assets applicable to capital stock outstanding .................................................. $ 142,921,281
=================
---------------
See notes to financial statements.
7
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Operations
For the Period Ended November 30, 2002*
Investment Income (Note 2):
Interest ........................................................................................... $ 4,837,274
-----------------
Expenses:
Investment advisory fee (Note 3) ................................................................... 323,445
Administration fee (Note 3) ........................................................................ 99,521
Accounting and tax services ........................................................................ 46,160
Directors' fees .................................................................................... 42,000
Legal .............................................................................................. 28,502
Custodian .......................................................................................... 28,367
Reports to shareholders ............................................................................ 17,500
Transfer agency .................................................................................... 8,060
Registration fees .................................................................................. 5,453
Miscellaneous ...................................................................................... 18,533
-----------------
Total operating expenses.......................................................................... 617,541
-----------------
Interest expense on reverse repurchase agreements (Note 5)....................................... 403,886
Net interest expense on swaps (Note 2)........................................................... 141,010
-----------------
Total expenses.................................................................................... 1,162,437
Less expenses waived (Note 3)..................................................................... (17,854)
-----------------
Net expenses...................................................................................... 1,144,583
-----------------
Net investment income .............................................................................. 3,692,691
-----------------
Realized and Unrealized Gain (Loss) on Invesments (Notes 2 and 7):
Net realized gain (loss) on:
Investment transactions ............................................................................ 287,557
Futures transactions ............................................................................... (5,301)
Swap contracts ..................................................................................... (703,855)
Short sales ........................................................................................ (425,523)
-----------------
Net realized loss on investments, futures transactions, swap contracts and short sales............... (847,122)
-----------------
Net unrealized appreciation/depreciation on:
Investments ........................................................................................ (840,210)
Futures ............................................................................................ (121,897)
Swap contracts ..................................................................................... 155,603
-----------------
Net unrealized appreciation/depreciation on investments, futures and swap contracts.................. (806,504)
-----------------
Net realized and unrealized loss on investments, futures transactions, swap contracts and short
sales.............................................................................................. (1,653,626)
-----------------
Net increase in net assets resulting from operations................................................. $ 2,039,065
=================
---------------
* Commenced operations on July 26, 2002
See notes to financial statements.
8
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Changes in Net Assets
For the Period Ended November 30, 2002*
Increase (Decrease) in Net Assets Resulting from Operations:
Net investment income .............................................................................. $ 3,692,691
Net realized loss on investments, futures transactions, short sales and swap contracts.............. (847,122)
Net change in unrealized appreciation/depreciation on investments, swap contracts and futures
transactions...................................................................................... (806,504)
-----------------
Net increase in net assets resulting from operations................................................ 2,039,065
-----------------
Dividends to Shareholders (Note 2):
Net investment income .............................................................................. (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 (1,278 shares)....................... 18,497
-----------------
Net increase from capital stock transactions ....................................................... 144,066,886
-----------------
Total increase in net assets ....................................................................... 142,821,281
Net Assets:
Beginning of period ................................................................................ 100,000
-----------------
End of period (including undistributed net investment income of $540,088)........................... $ 142,921,281
=================
---------------
* Commenced operations on July 26, 2002
See notes to financial statements.
9
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Statement of Cash Flows
For the Period Ended November 30, 2002*
Increase (Decrease) in Cash:
Cash flows provided by (used for) operating activities:
Interest received (including net amortization of $606,048).......................................... $ 3,423,301
Interest expense paid .............................................................................. (438,772)
Operating expenses paid ............................................................................ (462,728)
Purchases of long-term portfolio investments ....................................................... (353,897,538)
Proceeds from disposition of long-term portfolio investments and principal paydowns................. 142,713,079
Net cash used for futures transactions ............................................................. (146,104)
-----------------
Net cash used for operating activities ............................................................. (208,808,762)
-----------------
Cash flows provided by (used for) financing activities:
Proceeds from issuance of capital stock ............................................................ 144,048,389
Net cash provided by reverse repurchase agreements.................................................. 68,264,000
Cash dividends paid ................................................................................ (3,266,173)
-----------------
Net cash provided by financing activities .......................................................... 209,046,216
-----------------
Net increase in cash................................................................................. 237,454
Cash at beginning of period.......................................................................... 100,000
-----------------
Cash at end of period................................................................................ $ 337,454
=================
Reconciliation of Net Increase in Net Assets Resulting from Operations to
Net Cash Used for Operating Activities:
Net increase in net assets resulting from operations................................................ $ 2,039,065
-----------------
Increase in investments ............................................................................ (210,335,998)
Decrease in net unrealized appreciation/depreciation on investments................................. 684,607
Increase in interest receivable .................................................................... (1,398,383)
Increase in variation margin receivable ............................................................ (18,906)
Increase in other assets ........................................................................... (85,431)
Increase in payables and other liabilities ......................................................... 306,284
-----------------
Total adjustments................................................................................ (210,847,827)
-----------------
Net cash used for operating activities............................................................... $ (208,808,762)
=================
---------------
Noncash financing activites not included herein consist of reinvestment of
dividends and distributions of $18,497.
* Commenced operations on July 26, 2002
See notes to financial statements.
10
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Financial Highlights
For the Period Ended November 30, 2002*
Per Share Operating Performance:
Net asset value, beginning of period................................................................. $ 14.25**
-----------------
Net investment income................................................................................ 0.36
Net realized and unrealized loss on investments, futures transactions, swap contracts
and short sales.................................................................................... (0.16)
-----------------
Net increase in net asset value resulting from operations............................................ 0.20
-----------------
Dividends from net investment income................................................................. (0.32)
Offering costs charged to additional paid-in-capital................................................. (0.03)
-----------------
Net asset value, end of period....................................................................... $ 14.10
=================
Market price, end of period.......................................................................... $ 13.6800
=================
Total Investment Return +............................................................................ (6.66%) (1)
Ratios to Average Net Assets/Supplementary Data:
Net assets, end of period (000's).................................................................... $ 142,921
Operating expenses................................................................................... 1.23% (2)
Interest expense..................................................................................... 1.09% (2)
Total expenses................................................................................... 2.32% (2)
Net expenses......................................................................................... 2.29% (2)
Net investment income................................................................................ 7.38% (2)
Portfolio turnover rate.............................................................................. 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). Dividends and distributions, if
any, are assumed, for purposes of this calculation, to be reinvested at
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.
** Initial public offering price of $15.00 per share less underwriting
discount of $0.75 per share.
---------------
* Commenced operations on July 26, 2002
See notes to financial statements.
11
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Notes to Financial Statements
November 30, 2002
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 "Adviser").
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 44% of the investments in securities held by the Fund at
November 30, 2002) 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
12
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Notes to Financial Statements
November 30, 2002
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 invest in 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. Swaps are marked to market daily 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 period ended November 30, 2002, such net payments made by the
Fund amounted to $141,010. 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, 2002.
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 using the effective yield to maturity method.
Taxes: It is the Fund's intention 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.
13
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Notes to Financial Statements
November 30, 2002
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 period ended November 30, 2002, the Advisor earned $323,445
in investment advisory fees of which the Advisor has waived $13,653 of its
fee.
The Advisor has entered into a Sub-Advisory Agreement with Lend Lease Hyperion
Capital Advisors, LLC (the "Subadvisor"). The Subadvisor is owned equally by
Lend Lease Real Estate Investments, Inc. and the Advisor and was formed for
the purpose of managing portfolios of commercial mortgage-backed securities
("CMBS"). Under the terms of the agreement, the Subadvisor 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. For such services, the Advisor pays, out of its advisory fee, a
monthly fee 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 Corp. (the "Sub-Administrator"), an
affiliate of the Fund's Custodian. 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 period ended November 30, 2002, the Administrator earned $99,521 in
administration fees, of which the Administrator has waived $4,201 of its fee.
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/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 period ended
November 30, 2002, were $121,088,209 and $18,204,996, respectively. Purchases
and sales of U.S. Government securities, excluding short-term securities, for
the period ended November 30, 2002 were $232,809,329 and $125,381,833,
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
14
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Notes to Financial Statements
November 30, 2002
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, 2002, the Fund had the following reverse repurchase agreements
outstanding:
Face Value Description Maturity Amount
------------------ ------------------------------------------------------------------- -----------------
$ 3,479,000 Lehman Brothers, 1.33%, dated 11/13/02, maturity date 12/11/02 ..... $ 3,482,599
23,580,000 Lehman Brothers, 1.33%, dated 11/13/02, maturity date 12/11/02 ..... 23,604,392
9,349,000 Goldman Sachs, 1.35%, dated 11/14/02, maturity date 12/12/02 ....... 9,358,816
7,710,000 Goldman Sachs, 1.35%, dated 11/14/02, maturity date 12/12/02 ....... 7,718,096
24,146,000 Goldman Sachs, 1.40%, dated 11/21/02, maturity date 12/10/02 ....... 24,163,841
------------------ -----------------
$ 68,264,000
Maturity Amount, Including Interest Payable ........................
Market Value of Assets Sold Under Agreements ....................... $ 68,327,744
Weighted Average Interest Rate ..................................... -----------------
$ 70,532,653
-----------------
1.36%
-----------------
The average daily balance of reverse repurchase agreements outstanding during
the period ended November 30, 2002, was approximately $24,970,734 at a
weighted average interest rate of 1.72%. The maximum amount of reverse
repurchase agreements outstanding at any time during the period was
$76,339,965 as of October 1, 2002, which was 34.08% of total assets.
6. Capital Stock
There are 50 million shares of $0.01 par value common stock authorized. Of the
10,138,296 shares outstanding at November 30, 2002, 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 period ended November 30, 2002.
As of November 30, 2002, the following swap agreements were outstanding:
Net Unrealized
Notional Appreciation/
Amount Expiration Date Description (Depreciation)
-------- ----------------- --------------------------------------------------------- ---------------
$18,800,000 09/09/05 Agreement with Goldman Sachs Capital Markets, LP, $ 51,823
dated 09/05/02 to pay semi- annually the notional
amount multiplied by 2.788% and to receive quarterly
the notional amount multiplied by 3 month LIBOR.
$37,600,000 10/04/04 Agreement with Morgan Stanley Capital 103,780
Services Inc., dated 10/02/02 to pay
semi-annually the notional amount multiplied
by 2.190% and to receive quarterly the
notional amount multiplied by 3 month LIBOR.
------------------
$ 155,603
===================
15
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Notes to Financial Statements
November 30, 2002
As of November 30, 2002, the following futures contracts were outstanding:
Long:
-----
Unrealized
Notional Expiration Value at Value at Appreciation/
Amount Type Date Trade Date November 30, 2002 (Depreciation)
--------------- --------------------------- ------------- ------------- ------------------- -------------------
$ 5,500,000 10 Yr. U.S. Treasury Note December 2002 $6,310,256 $6,188,359 $ (121,897)
-------------------
$ (121,897)
===================
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 period ended November 30, 2002 the tax character of the $3,284,670
of distributions paid was from ordinary income.
At November 30, 2002 the components of net assets (excluding paid-in-capital)
on a tax basis were as follows:
Undistributed Tax ordinary income $ 540,088
===========
Tax basis capital loss carryover $ (914,308)
Less: Cumulative timing differences (186,778)
-----------
Accumulated capital loss $(1,101,086)
===========
Book basis unrealized appreciation/(depreciation) $ (806,504)
Plus: Cumulative timing differences 121,897
-----------
Unrealized appreciation/(depreciation) $ (684,607)
===========
The cumulative timing differences under tax basis capital loss carryover is
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, 2002 was $210,335,998. Net unrealized depreciation
was $840,210 (gross unrealized appreciation - $946,696; gross unrealized
depreciation - $1,786,906). At November 30, 2002, the Fund had a capital loss
carryforward of $914,308, which expires in 2010, available to offset any
future gains.
Capital Account Reclassification: For the period ended November 30, 2002, the
Fund's undistributed net investment income was increased by $132,067 and
accumulated net realized loss was increased by $132,067. These adjustments
were primarily the result of 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 12/19/02 12/31/02
$0.1080 12/31/02 1/30/03
16
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Report of Independent Accountants
November 30, 2002
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,
2002, and the results of its operations, its cash flows, the changes in its
net assets and the financial highlights 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 audit. We conducted our audit 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 audit, which included confirmation of securities at November 30, 2002 by
correspondence with the custodian and brokers, provides a reasonable basis for
our opinion.
PricewaterhouseCoopers LLP
New York, NY
January 29, 2003
17
-------------------------------------------------------------------------------
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, 2002) 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, 0.39% of the Fund's
distributions during the fiscal year ended November 30, 2002 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 2002. 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 2003. Shareholders are advised to
consult their own tax advisors with respect to the tax consequences of their
investment in the Fund.
18
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 Fund and Portfolios in
Term of Office Principal Occupation(s) Fund Complex
Name, Address and Length of During Past 5 Years and Overseen
and Age Time Served Other Directorships Held by Director by Director
-------------------------------------------------------------------------------------------------------------------------
Class I Nominee/Directors to serve until 2003 Annual Meeting of Stockholders:
Robert F. Birch Director, Member of The Chairman and President, New America High 4
c/o One Liberty Plaza, New Audit Committee, Member Income Fund (1992-Present); Chairman of the
York, New York 10006-1404 of Nominating and Board and Co-Founder, The China Business
Compensation Committee Group, Inc. (1996-Present); Director,
Age 66 and Member of Executive Brandywine Funds (2) (2001 to Present)
Committee
Elected for One Year
Term/Director since June Formerly, Director and Strategic Planning
2002 Consultant, Dewe Rogerson, Ltd. (1994-1998).
Class II Director to serve until 2004 Annual Meeting of Stockholders:
Rodman L. Drake Director, Member of the Director and/or Trustee of several 4
c/o One Liberty Plaza, New Audit Committee, Chairman investment companies (3) advised by Hyperion
York, New York 10006-1404 of Nominating and Capital Management, Inc. (1989-Present);
Compensation Committees Co-founder, Baringo Capital LLC
Age 60 (2002-Present); Director, Animal Medical
Elected for Two Year Center (2002-Present); Director,
Term/Director since June Hotelevision, Inc. (1999-Present); Chairman,
2002 Metro Cash Card International
(1999-Present). Director, Parsons
Brinckerhoff, Inc. (1995-Present);
Director, Absolute Quality Inc.
(2000-Present); Trustee of Excelsior Funds
(33) (1994-Present). Formerly, President,
Continuation Investments Group Inc.
(1997-2001); Director, Alliance Group
Services, Inc. (1998-2001); Co-Chairman of
KMR Power Corporation (1993-1997);
President, Mandrake Group (1993-1997).
Harry E. Petersen, Jr. Director, Member of the Director and/or Trustee of several 4
c/o One Liberty Plaza, New Audit Committee, Member investment companies (3) advised by Hyperion
York, New York 10006-1404 of Nominating and Capital Management, Inc. or by its
Compensation Committees, affiliates (1992-Present)
Age 78 Member of Executive
Committee Formerly, Senior Consultant to Cornerstone
Equity Advisors, Inc. (1998-2001); Senior
Elected for Two Year Consultant to Potomac Babson Inc.
Term/Director since June (1995-1998); Director of Equitable Real
2002 Estate Hyperion Mortgage Opportunity Fund,
Inc. and Equitable Real Estate Hyperion High
Yield Commercial Mortgage Fund, Inc. (1995-
1997); Director of Lexington Corporate
Properties, Inc. (1993-1997).
19
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Information Concerning Directors and Officers (Unaudited)
Position(s) Held Number of
with Fund and Portfolios in
Term of Office Principal Occupation(s) Fund Complex
Name, Address and Length of During Past 5 Years and Overseen
and Age Time Served Other Directorships Held by Director by Director
----------------------------------------------------------------------------------------------------------------------------
Class III Director to serve until 2005 Annual Meeting of Stockholders:
Lewis S. Ranieri* Chairman, Elected annually Chairman and Chief Executive Officer of 4
c/o One Liberty Plaza, New since June 2002 Ranieri & Co., Inc. (since 1988); President
York, New York 10006-1404 of LSR Hyperion Corp., a general partner of
Director, Member of the limited partnership that is the general
Age 56 Executive Committee partner of Hyperion Partners L.P. ("Hyperion
Partners") (since 1988); Director and
Elected for Three Year Chairman of the Board of Hyperion Capital
Term/Director since June Management, Inc. (since June 2002); Director
2002 and Vice Chairman of the Board of Hyperion
Capital Management, Inc. (from November 1998
through June 2002); Director and Chairman of
the Board of Hyperion Capital Management,
Inc. (1989-November 1998); Director and
President of Hyperion Funding II Corp., the
general partnership that is the general
partner of Hyperion Partners II, L.P.
(Hyperion Partners II); Chairman and
President of various other direct and
indirect subsidiaries of Hyperion Partners
(since 1989) and Hyperion Partners II (since
1995); Chairman of the Board (1989-December
1998 and June 2002 through present) and/or
Director (since 1989) of several investment
companies (4) advised by Hyperion Capital
Management, Inc. or by its affiliates.
Formerly, Director and Chairman of Bank
United Corp., and Director of Bank United
(1988-2001); Director of Lend Lease Hyperion
Mortgage Opportunity Fund, Inc. (formerly,
Equitable Real Estate Hyperion Mortgage
Opportunity Fund, Inc.) and Lend Lease
Hyperion High Yield Commercial Mortgage
Fund, Inc. (formerly, Equitable Real Estate
Hyperion High Yield Commercial Mortgage
Fund, Inc.) (1995-1999).
Leo M. Walsh, Jr. Director, Chairman of the Director and/or Trustee of several 4
c/o One Liberty Plaza, New Audit Committee, Member of investment companies (3) advised by Hyperion
York, New York 10006-1404 Nominating and Compensation Capital Management, Inc. or by its
Committees affiliates (1989-Present); Financial
Age 70 Consultant for Medco Health Solutions, Inc.
Elected for Three Year (formerly, Merck-Medco Managed Care LLC)
Term/Director since June (1994-Present); Director of Lend Lease
2002 Hyperion Mortgage Opportunity Fund, Inc.
(formerly, Equitable Real Estate Hyperion
Mortgage Opportunity Fund, Inc.) and Lend
Lease Hyperion High Yield CMBS Fund, Inc.
(formerly, Equitable Real Estate Hyperion
High Yield Commercial Mortgage Fund, Inc.)
(1999-Present).
--------
* Interested persons as defined in the 1940 Act, because of affiliations
with Hyperion Capital Management, Inc., the Fund's Advisor.
20
THE HYPERION STRATEGIC MORTGAGE INCOME FUND, INC.
Information Concerning Directors and Officers (Unaudited)
Officers of the Fund
Name, Address Position(s) Held Term of Office and Principal Occupation(s)
and Age with Fund Length of Time During Past 5 Years
------------------------------------------------------------------------------------------------------------------------------
Lewis S.Ranieri* Chairman Elected Annually Please see "Information Concerning
c/o One Liberty Plaza, Since June 2002 Directors."
New York,
New York 10006-1404
Age 56
Clifford E. Lai* President Elected Annually President (since November 1998) of Hyperion
c/o One Liberty Plaza, Since June 2002 Capital Management, Inc. (March
New York, 1993-Present); President (since June 1997)
New York 10006-1404 of Hyperion 2005 Investment Grade
Opportunity Term Trust, Inc. (Senior Vice
President from April 1993 to June 1997);
President (since October 1995) of The
Hyperion Total Return Fund, Inc.; Director
Age 49 and Chairman of the Board (since October
2000) of the Lend Lease Hyperion High-Yield
CMBS Fund, Inc. Formerly, President
(December 1999-October 2000) of the Lend
Lease Hyperion High-Yield CMBS Fund, Inc.;
Senior Vice President (November
1998-December 1999) of the Lend Lease
Hyperion High-Yield Commercial Mortgage
Fund, Inc; Senior Vice President (September
1995-November 1998) of the Equitable Real
Estate Hyperion High-Yield Commercial
Mortgage Fund, Inc.
John Dolan* Vice President Elected Annually Chief Investment Strategist (1998-Present)
c/o One Liberty Plaza, Since June 2002 and Chief Investment Officer (since 2002) of
New York, Hyperion Capital Management. Formerly
New York 10006-1404 Managing Director at Bankers Trust
(1995-1997).
Age 49
Patricia A. Sloan* Vice President Elected Annually Consultant (2000-Present) and Managing
c/o One Liberty Plaza, Since June 2002 Director (1988-2000) of Ranieri & Co., Inc.;
New York, Secretary, Director and/or Trustee of
New York 10006-1404 several investment companies (3) advised by
Hyperion Capital Management, Inc. or by its
Age 59 affiliates (1989-2002); Director of Bank
United Corp., the parent of Bank United
(1988-2001).
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
New York, Operations, Hyperion Capital Management,
New York 10006-1404 Inc. (July 1995-Present). Treasurer of
several investment companies advised by
Age 43 Hyperion Capital Management, Inc. (February
1998-Present).
Joseph Tropeano Secretary Elected Annually Director and Compliance Officer, Hyperion
c/o One Liberty Plaza, Sine June 2002 Capital Management, Inc. (1993-Present);
New York, Secretary and Compliance Officer of several
New York 10006-1404 investment companies advised by Hyperion
Capital Management, Inc. (1994-Present);
Age 41 Secretary and Compliance Officer, Lend Lease
Hyperion Capital Advisors, LLC (1995-
Present); Secretary and Compliance Officer
of Lend Lease Hyperion High-Yield CMBS Fund,
Inc. (1998-Present). Formerly, Assistant
Secretary and Compliance Officer, AIG
Hyperion Inc. (1994-2002); Vice President
and Compliance Officer, Hyperion
Distributors, Inc. (1994-1998).
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.
--------
* Interested persons as defined in the 1940 Act, because of affiliations
with Hyperion Capital Management, Inc., the Fund's Advisor.
21
--------------------------------------------------------------------------------
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.
22
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
LEND LEASE HYPERION CAPITAL ADVISORS, LLC INDEPENDENT ACCOUNTANTS
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 CORP. SULLIVAN & WORCESTER LLP
225 Franklin Street 1666 K Street, North West
Boston, Massachusetts 02116 Washington, D.C. 20036
CUSTODIAN AND FUND ACCOUNTING AGENT
STATE STREET CORP.
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
--------------------------------------------------------------------------------
Lewis S. Ranieri
Chairman
Robert F. Birch*
Director
Rodman L. Drake*
Director
Garth Marston
Director Emeritus
Leo M. Walsh, Jr.*
Director
Harry E. Petersen, Jr.*
Director
Clifford E. Lai
President
Patricia A. Sloan
Vice President
John Dolan
Vice President
Thomas F. Doodian
Treasurer
Joseph Tropeano
Secretary
* Audit Committee Members
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HYPERION [LOGO]
--------------------------------------------------------------------------------
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