<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10 -Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1998
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ________ to ________
Commission file number: 001-13417
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 13-3950486
(State or other Jurisdiction of ( I.R.S. Employer Identification No.)
Incorporation or Organization)
90 WEST STREET, SUITE 1508, NEW YORK, NY 10006
(Address of principal executive offices) (Zip Code)
(212) 732-5086
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
The registrant had 6,321,899 shares of common stock outstanding as of
October 30, 1998.
<PAGE> 2
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
FORM 10-Q
For the Quarter Ended September 30, 1998
INDEX
PART I. FINANCIAL INFORMATION
Page No.
--------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 1998 and 1997 and for
the Nine Months Ended September 30, 1998 and for the Period
from June 10 to September 30, 1997 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and for the Period
from June 10 to September 30, 1997 5
Notes to Condensed Consolidated Financial Statements 6-16
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17-23
Item 3. Quantitative and Qualitative Disclosures 23
About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except as noted)
ASSETS SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(unaudited)
<S> <C> <C>
Mortgage loans:
Held for sale $ 628,332 $ 160,970
Held to maturity 72,559 --
Collateral for mortgage backed bonds 90,020 --
Mortgage securities, available for sale 228,506 348,131
Cash and cash equivalents 7,045 4,022
Accrued interest receivable 7,839 3,597
Equity investment 2,212 100
Notes receivable from related parties 10,266 482
Due from related parties 52 --
Other receivables 1,351 --
Prepaid expenses and other assets 734 241
----------- ---------
TOTAL ASSETS $ 1,048,916 $ 517,543
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reverse repurchase agreements $ 881,215 $ 435,138
Mortgage backed bonds 85,330 --
Accrued interest payable 4,478 2,250
Dividends payable 1,075 1,035
Due to related party -- 540
Accrued expenses and other liabilities 6,404 482
----------- ---------
Total liabilities 978,502 439,445
----------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01
authorized, 10 million shares, issued
and outstanding, -0- shares
Common stock, par value $.01
authorized, 90 million shares; 6,324,899 and
6,466,677 shares outstanding at September 30,
1998 and December 31, 1997, respectively 65 65
Additional paid-in-capital 79,414 79,411
Available for sale securities:
Unrealized (loss) on investments available for sale (4,365) (842)
Retained earnings (deficit) (3,376) (536)
Treasury stock - at cost (1,324) --
----------- ---------
Total stockholders' equity 70,414 78,098
----------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,048,916 $ 517,543
=========== =========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 4
<TABLE>
<CAPTION>
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended
September 30, Nine Months Ended Period from June 10
------------------- September 30, to September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
Interest income $ 15,256 $254 $ 36,186 $254
Interest expense 13,564 126 31,561 126
-------- ---- -------- ----
Net interest income 1,692 128 4,625 128
Loan loss provision 130 -- 278 --
-------- ---- -------- ----
Net interest income after loan loss
provision 1,562 128 4,347 128
(Loss) on sale of mortgage loans -- -- (49) --
-------- ---- -------- ----
Total revenues 1,562 128 4,298 128
-------- ---- -------- ----
EXPENSES:
General and administrative expenses
Personnel 172 -- 535 --
Management and administrative 193 37 522 37
Due diligence 158 45 578 45
Commissions 65 -- 282 --
Legal and professional 278 11 649 11
Other 62 2 194 2
-------- ---- -------- ----
Total expenses 928 95 2,760 95
-------- ---- -------- ----
Operating income 634 33 1,538 33
Equity in earnings (loss) of unconsolidated
subsidiary (288) 26 (588) 26
-------- ---- -------- ----
NET INCOME $ 346 $ 59 $ 950 $ 59
======== ==== ======== ====
BASIC EARNINGS PER SHARE $ 0.05 $.07 $ 0.15 $.09
======== ==== ======== ====
DILUTED EARNINGS PER SHARE $ 0.05 $.07 $ 0.15 $.09
======== ==== ======== ====
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE> 5
<TABLE>
<CAPTION>
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Period from June 10
Ended September 30, 1998 to September 30, 1997
------------------------ ---------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 950 $ 59
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Amortization of net premiums and deferred expenses 5,515
Loan loss provision 278
Loss on sale of mortgage loans 49
Equity in (earnings) loss of unconsolidated subsidiary 588 (26)
(Increase) in accrued interest receivable (4,242) (538)
(Increase) in loans to related parties (9,784)
(Increase) in other receivables (1,351)
(Increase) in prepaid expenses and other assets (493) (167)
Increase in accrued interest payable 2,228 125
Increase (decrease) in due to related party (592) 92
Increase in accrued expenses and other liabilities 5,923 1,039
--------- ---------
Net cash provided by (used in) operating activities (931) 584
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage loans (866,673) (21,502)
Purchase of mortgage securities (4,333)
Principal payments on mortgage securities 133,597
Principal payments on mortgage loans 182,514
Proceeds from sale of mortgage loans 20,118
Principal payments on collateral for mortgage backed bonds 15,096
--------- ---------
Net cash (used in) investing activities (519,681) (21,502)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements 446,077 142,531
Net borrowings from mortgage backed bonds 85,330
Net proceeds of offering -- 79,122
Exercise of stock warrants - net 3 --
Equity investment in HCP (2,700) --
Payment of dividends (3,751) --
Treasury stock purchases (1,324) --
--------- ---------
Net cash provided by investing activities 523,635 221,653
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,023 200,735
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,022 --
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 7,045 $ 200,735
========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
Operating activity- increase in dividends payable ($1,075) relating to the
declaration of dividends in September 1998.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Income taxes $ 1 --
========= =========
Interest $ 29,043 --
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 6
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
GENERAL
Hanover Capital Mortgage Holdings, Inc. was incorporated in Maryland on June 10,
1997. In April 1998 Hanover Capital Mortgage Holdings, Inc. acquired 100% of the
common stock of Hanover Capital SPC, Inc. Hanover Capital Mortgage Holdings,
Inc. is a real estate investment trust ("REIT"), formed to operate as a
specialty finance company. The principal business strategy of Hanover Capital
Mortgage Holdings, Inc. and its wholly owned subsidiary, Hanover Capital SPC,
Inc. (together referred to as the "Company") is to (i) acquire primarily
single-family mortgage loans that are at least twelve months old or that were
intended to be of certain credit quality but that do not meet the originally
intended market parameters due to errors or credit deterioration, (ii)
securitize the mortgage loans and retain interests therein, (iii) originate,
hold, sell and service multifamily loans and commercial loans and (iv) acquire
multifamily loans. The Company's principal business objective is to generate
increasing earnings and dividends for distribution to its stockholders. The
Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company may also acquire multifamily mortgage loans from a taxable
subsidiary of the Company.
Hanover Capital SPC, Inc., a wholly-owned subsidiary of the Company, was
incorporated in Delaware on April 7, 1998 for the sole purpose of issuing
mortgage notes through a private placement (REMIC) offering.
CAPITALIZATION
In September 1997, the Company raised net proceeds of approximately $79 million
in its initial public offering (the "IPO"). In the IPO, the Company sold
5,750,000 units (each unit consisting of one share of common stock, par value
$.01 and one stock warrant) at $15.00 per unit including 750,000 units sold
pursuant to the underwriters' overallotment option, which was exercised in full.
Each warrant entitles the holder to purchase one share of common stock at the
original issue price - $15.00. The warrants became exercisable on March 19, 1998
and expire on September 15, 2000. The Company utilized substantially all of the
net proceeds of the IPO to fund leveraged purchases of mortgage loans.
In connection with the closing of the IPO the Company acquired a 97% ownership
interest (representing a 100% ownership of the non-voting preferred stock) in
Hanover Capital Partners Ltd. and its wholly-owned subsidiaries: Hanover Capital
Mortgage Corporation and Hanover Capital Securities, Inc., in exchange for
716,667 shares of the Company's common stock. Hanover Capital Partners Ltd.
("HCP") and its wholly-owned subsidiaries, offer due diligence services to
buyers, sellers and holders of mortgage loans and originate, sell and service
multifamily mortgage loans and commercial loans.
6
<PAGE> 7
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of Hanover
Capital Mortgage Holdings, Inc. and its wholly-owned subsidiary, Hanover Capital
SPC, Inc. All significant intercompany accounts and transactions have been
eliminated.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by the management of the Company in accordance with generally accepted
accounting principles for interim financial information and in conformity with
the rules and regulations of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
The results of operations for the three months ended September 30, 1998 and for
the nine months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the full year. For further information, refer
to the audited financial statements and footnotes included in the Company's Form
10-K for the period from June 10, 1997 (inception) to December 31, 1997.
METHOD OF ACCOUNTING
The condensed consolidated financial statements of the Company are prepared on
the accrual basis of accounting in accordance with generally accepted accounting
principles. 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 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.
INCOME TAXES
The Company has elected to be taxed as a real estate investment trust ("REIT")
and intends to comply with the provisions of the Internal Revenue Code of 1986,
as amended (the "Code") with respect thereto. Accordingly, the Company will not
be subject to Federal income tax to the extent of its distributions to
stockholders as long as certain asset, income and stock ownership tests are met.
EARNINGS PER SHARE
In 1997 the Company adopted Statement of Financial Accounting Standards No. 128
"Earnings per Share"("SFAS 128"). Under SFAS 128 basic earnings per share
excludes dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock that then shared in earnings. Shares
issued during the period and shares reacquired during the period are weighted
for the period they were outstanding.
7
<PAGE> 8
Calculations for earnings per share are shown below (dollars in thousands,
except per share data):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
------------------ ------------------
<S> <C> <C>
Basic earnings per share:
Net income [numerator] $ 346 $ 950
========= =========
Average common shares
outstanding [denominator] 6,417,947 6,450,749
========= =========
Per share $ 0.05 $ 0.15
========= =========
Diluted earnings per share:
Net income [numerator] $ 346 $ 950
========= =========
Average common shares
outstanding 6,417,947 6,450,749
--------- ---------
Add: Incremental shares from
assumed conversion of
warrants -0- -0-
--------- ---------
Dilutive potential common shares -0- -0-
--------- ---------
Adjusted weighted average shares
[denominator] 6,417,947 6,450,749
========= =========
Per share $ 0.05 $ 0.15
========= =========
</TABLE>
3. MORTGAGE LOANS
The Company's policy is to classify each of its mortgage loans as held for sale
as they are purchased and each asset is monitored for a period of time,
generally four to nine months, prior to making a determination as to whether the
asset will be classified as held to maturity. At September 30, 1998 management
has made the determination that $628,332,000 of mortgage loans are held for
sale, $72,559,000 of mortgage loans are being held to maturity and, $90,020,000
of mortgage loans are held as collateral for mortgage backed bonds. All mortgage
loans designated as held for sale are reported at the lower of cost or market,
with unrealized losses reported as a charge to earnings in the current period.
All mortgage loans held to maturity are reported at cost.
Premiums and discounts associated with the purchase of mortgage loans are
amortized into interest income over the lives of the mortgage loans using the
effective yield method adjusted for the effects of estimated prepayments.
Mortgage loan transactions are recorded on the date the mortgage loans are
purchased or sold. Purchases of new mortgage loans are recorded when all
significant uncertainties regarding the characteristics of the mortgage loans
are removed, generally on or shortly before settlement date.
Realized gains and losses on mortgage loan transactions are determined on the
specific identification basis.
8
<PAGE> 9
The following table summarizes the Company's single-family mortgage loan pools,
held for sale which are carried at the lower of cost or market (dollars in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
Cost Mix Cost Mix
---- --- ---- ---
<S> <C> <C> <C> <C>
Mortgage Loans
Fixed rate $511,003 82.9% $106,397 67.1%
Adjustable rate 105,766 17.1% 52,392 32.9%
-------- ----- -------- -----
Subtotal 616,769 100.0% 158,789 100.0%
===== =====
Net deferred loan fees,
premiums and discounts 11,751 2,199
Loan loss reserve (188) (18)
-------- --------
Carrying value $628,332 $160,970
======== ========
</TABLE>
The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loans, held for sale
portfolio (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------------------------------------------------------------------
Carrying Value Principal Weighted Weighted
of Mortgage Amount of Average Net Average
Loans Mortgage Loans Coupon Maturity (1)
----- -------------- ------ ------------
<S> <C> <C> <C> <C>
Fixed Rate $522,030 $511,003 7.731% 226
Adjustable Rate 106,302 105,766 7.479% 274
-------- -------- ----- ---
$628,332 $616,769 7.688% 234
======== ======== ===== ===
<CAPTION>
DECEMBER 31, 1997
- ---------------------------------------------------------------------------------------------------------
Carrying Value Principal Weighted Weighted
of Mortgage Amount of Average Net Average
Loans Mortgage Loans Coupon Maturity (1)
----- -------------- ------ ------------
<S> <C> <C> <C> <C>
Fixed Rate $107,953 $106,424 8.265% 242
Adjustable Rate 53,017 52,365 7.925% 319
-------- -------- ----- ---
$160,970 $158,789 8.153% 267
======== ======== ===== ===
</TABLE>
(1) Weighted average maturity reflects the number of months until maturity
9
<PAGE> 10
The following table summarizes the Company's single-family mortgage loans, held
to maturity which are carried at cost (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
<S> <C> <C>
Mortgage Loans
Fixed Rate $70,490 --
Adjustable Rate 145
------- -------
Subtotal 70,635 --
Net deterred loan fees, --
premiums and discounts 1,953 --
Loan loss reserve (29) --
------- -------
Carrying value $72,559 --
======= =======
</TABLE>
The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loans, held to maturity
portfolio (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
Carrying Value Principal Weighted Weighted
of Mortgage Amount of Average Net Average
Loans Mortgage Loans Coupon Maturity (1)
-------------- -------------- ----------- ------------
<S> <C> <C> <C> <C>
Fixed Rate $72,414 $70,490 8.740% 252
Adjustable Rate 145 145 7.500% 305
------- ------- ------ ---
$72,559 $70,635 8.738% 252
======= ======= ====== ===
</TABLE>
The average effective yield for the three months ended September 30, 1998 on the
total mortgage loan portfolio, including the amortization of the net premiums
paid for the mortgage loans, was 7.489%.
An analysis of the change in the loan loss reserve for the three months ended
September 30, 1998 is as follows (dollars in thousands):
<TABLE>
<S> <C>
Balance at beginning of period $117
Loan loss provision 111
Less amount transferred (2) (11)
----
Balance at September 30, 1998 $217
====
</TABLE>
(1) weighted average maturity reflects the number of months remaining until
maturity
(2) amount of loan loss reserve transferred to mortgage securities in
connection with a swap of $17,404,000 of fixed rate mortgage loans for FNMA
mortgage securities.
4. COLLATERAL FOR MORTGAGE BACKED BONDS
In April 1998 the Company issued its first REMIC (real estate mortgage
investment conduit) security. $102,976,872 of single family fixed rate
residential loans were assigned as collateral for the Company's mortgage backed
bond (REMIC) security. The Company has limited exposure to credit risk retained
on loans it has securitized through the issuance of collateralized bonds. All
mortgage loans held as collateral for mortgage backed bonds are reported at
cost.
Premiums, discounts and all deferred hedging costs associated with the mortgage
loans held as collateral for mortgage backed bonds are amortized into interest
income over the lives of the mortgage loans using the effective yield method
adjusted for the effects of prepayments.
10
<PAGE> 11
The following table summarizes the Company's single-family fixed rate mortgage
loan pools held as collateral for mortgage backed bonds which are carried at
cost (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
<S> <C>
Fixed rate $87,881
Net deferred loan
fees, premiums and discounts 2,204
Loan loss reserve (65)
-------
Carrying value $90,020
=======
</TABLE>
The following table summarizes certain characteristics of the Company's
single-family fixed rate mortgage loans held as collateral for mortgage backed
bonds (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
Carrying Value Principal Amount
of Collateral for of Collateral Weighted Weighted
Mortgage Backed for Mortgage Average Average
Bonds Backed Bonds Net Coupon Maturity (1)
- ----------------- ---------------- ----------- ------------
<C> <C> <C> <C>
$90,020 $87,881 7.818% 234
======= ======= ====== ===
</TABLE>
An analysis of the change in loan loss reserve for the three months ended
September 30, 1998 is as follows (dollars in thousands):
<TABLE>
<S> <C>
Balance at beginning of period $48
Loan loss provision 17
---
Balance at September 30, 1998 $65
===
</TABLE>
(1) weighted average maturity reflects the number of months remaining until
maturity
5. MORTGAGE SECURITIES
The Company's policy is to classify its mortgage securities as
available-for-sale as they are acquired and each asset is monitored for a period
of time, generally three to six months, prior to making a determination whether
the asset will be classified as held-to-maturity. All mortgage securities
designated as available-for-sale are reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity.
Premiums and discounts associated with the purchase of mortgage securities are
amortized into interest income over the lives of the securities using the
effective yield method adjusted for the effects of estimated prepayments.
Mortgage securities transactions are recorded on the date the mortgage
securities are purchased or sold. Purchases of new issue mortgage securities are
recorded when all significant uncertainties regarding the characteristics of the
securities are removed, generally on or shortly before settlement date. Realized
gains and losses on mortgage securities transactions are determined on the
specific identification basis.
11
<PAGE> 12
The following table summarizes the Company's amortized cost basis and fair value
of mortgage securities available for sale (dollars in thousands):
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -------------------
Available Available
for Sale Mix for Sale Mix
--------- --- --------- ---
<S> <C> <C> <C> <C>
Mortgage Securities
Adjustable rate
FNMA certificates $ 86,373 37.1% $207,898 59.6%
FHLMC certificates 125,236 53.8% 141,075 40.4%
-------- ----- -------- -----
211,609 90.9% 348,973 100.0%
Fixed rate
FNMA certificates 21,275 9.1%
-------- ----- -------- -----
Total amortized cost 232,884 100.0% 348,973 100.0%
===== =====
Gross unrealized (losses) (4,365) (842)
Loan loss reserve (13) --
-------- --------
Fair value $228,506 $348,131
======== ========
</TABLE>
6. EQUITY INVESTMENT
The Company recorded its investment in HCP on the equity method. The Company is
entitled to 97% of the earnings or losses of HCP through its ownership of all of
the non-voting preferred stock of HCP. Summarized financial information for HCP
is detailed below:
<TABLE>
<CAPTION>
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1998
(in thousands, except as noted)
(unaudited)
<S> <C>
ASSETS
CURRENT ASSETS:
Cash $ 202
Receivables from related parties 308
Other current assets 2,133
---------
Total current assets 2,643
INVESTMENT IN MORTGAGE LOANS 103,010
PROPERTY AND EQUIPMENT - Net 166
INCOME TAX RECEIVABLE 639
DUE FROM OFFICER 54
OTHER ASSETS 186
---------
TOTAL ASSETS $ 106,698
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 533
Reverse repurchase agreement 96,507
Note payable to related party 7,312
Other current liabilities 60
---------
Total current liabilities 104,412
STOCKHOLDERS' EQUITY:
Preferred stock: $.01 par value, 100,000 shares authorized,
97,000 shares outstanding 1
Common stock:
Class A: $.01 par value, 5,000 shares authorized and
3,000 shares outstanding --
Additional paid-in capital 2,841
Retained earnings (deficit) (556)
---------
Total stockholders' equity 2,286
---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 106,698
=========
</TABLE>
12
<PAGE> 13
HANOVER CAPITAL PARTNERS, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1998 September 30, 1998
-------------------------------------
<S> <C> <C>
REVENUES:
Due diligence fees $ 1,295 $ 3,534
Mortgage sales and servicing 175 816
Loan brokering and other income 164 487
Net interest income - mortgage loans 7 7
--------------------------
Total revenues 1,641 4,844
--------------------------
EXPENSES:
Personnel expense 1,640 4,232
General and administrative expense 135 457
Other expenses 282 928
Interest expense 51 114
Depreciation and amortization 29 83
--------------------------
Total expenses 2,137 5,814
--------------------------
(LOSS) BEFORE INCOME TAX BENEFIT (496) (970)
INCOME TAX (BENEFIT) (197) (382)
--------------------------
NET (LOSS) ($299) ($588)
==========================
BASIC (LOSS) PER SHARE ($99.88) ($196.01)
==========================
</TABLE>
HCP and its subsidiaries operate as a specialty finance company which is
principally engaged in performing due diligence, mortgage and investment banking
services. A wholly-owned subsidiary of HCP, Hanover Capital Mortgage Corporation
("HCMC"), is an originator and servicer of multifamily mortgage loans. Another
wholly-owned subsidiary of HCP, Hanover Capital Securities, Inc. ("HCS") is a
registered broker/dealer with the Securities and Exchange Commission.
On September 30, 1998 HCP expanded its traditional areas of business to purchase
a fixed and adjustable rate mortgage pool for $103.8 million including accrued
interest. This purchase was funded by an advance from the Company of $7.3
million and reverse repurchase financing of approximately $96.5 million.
HCP's policy is to classify each of its mortgage loans as held as for sale as
they are purchased and each asset is monitored for a period of time, generally
four to nine months, prior to making a determination as to whether the asset
will be classified as held to maturity. At September 30, 1998 all of the
mortgage loans were classified as held for sale, loans designated as held for
sale are reported at the lower of cost or market, with unrealized losses
reported as a charge to earnings in the current period. Premiums and discounts
associated with the purchase of mortgage loans are amortized into interest
income over the lives of the mortgage loans using the effective yield method
adjusted for the effects of estimated prepayments. Reverse repurchase agreements
are accounted for as collateralized financing transactions and recorded at their
contractual amounts.
13
<PAGE> 14
At September 30, 1998 HCP had a total of $200 million of uncommitted mortgage
loan reverse repurchase agreement financing available pursuant to a master
repurchase agreement. At September 30, 1998 HCP had outstanding borrowings of
$96,507,000 under the above mentioned reverse repurchase agreement with a
borrowing rate of 6.075% and a maturity of less than one month. The reverse
repurchase agreement was collateralized by mortgage loans with a cost basis of
$103,010,000 (which approximates market value).
7. REVERSE REPURCHASE AGREEMENTS
Reverse repurchase agreements are accounted for as collateralized financing
transactions and recorded at their contractual amounts.
At September 30, 1998 the Company had a total of $707 million of uncommitted
mortgage loan reverse repurchase agreement financing available pursuant to
master repurchase agreements with three lenders. At September 30, 1998 the
Company had outstanding borrowings of $659,319,000 under the above mentioned
reverse repurchase agreements with a borrowing rate of 6.333% for the third
quarter of 1998 and a maturity of less than two months. The reverse repurchase
agreements at September 30, 1998 were collateralized by mortgage loans with a
cost basis of $700,473,000 (which approximates market value).
The Company also uses its reverse repurchase agreement financing to finance a
portion of the collateral for mortgage backed bonds. At September 30, 1998, the
Company had outstanding borrowings of $294,000 with a weighted average borrowing
rate of 6.145% for the third quarter of 1998 and a weighted average remaining
maturity of less than one month.
At September 30, 1998, the Company had outstanding mortgage securities reverse
repurchase agreement financing of $221,602,000 with a weighted average borrowing
rate of 5.701% for the third quarter of 1998 and a weighted average remaining
maturity of less than one month.
Information concerning the reverse repurchase agreements and the pledged
collateral at September 30, 1998 is summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
Collateral
Mortgage for Mortgage Mortgage
Loans (2) Backed Bonds Securities
--------- ------------ ----------
<S> <C> <C> <C> <C>
Reverse Repurchase Agreements
Average balance during the period (1) $523,403 $ 203 $241,388
Average interest rate during period (1) 6.333% 6.145% 5.701%
Maximum month-end balance during the period $659,319 $2,331 $249,450
Collateral Underlying the Agreements
Carrying Balance $700,473 $ 403 $228,506
</TABLE>
(1) above table reflects the period beginning July 1, 1998 through
September 30, 1998.
(2) collateral includes mortgages held for sale and mortgages held to maturity.
8. AFFILIATED PARTY TRANSACTIONS
The Company has engaged HCP pursuant to a Management Agreement to render among
other things, due diligence, asset management and administrative services. The
statement of operations of the Company for the three months ended September 30,
1998 includes management and administrative expenses of $193,000, due diligence
expenses of $158,000 and commission expenses of $65,000 relating to billings
from HCP. At September 30, 1998 the balance sheet of the Company included an
amount due from HCP of $52,000. During the three months ended September 30, 1998
the Company recorded a loss from its investment in HCP and Subsidiaries of
$288,000.
14
<PAGE> 15
In connection with the original formation transactions in September 1997, the
Company agreed to lend a maximum of $1,750,000 collectively, to four
officer/stockholders (collectively referred to as the "Principals") to enable
the Principals to pay personal income taxes on the gains they must recognize
upon contributing their HCP preferred stock to the Company for shares of the
Company's common stock. The loans are secured solely by 116,667 shares of the
Company's common stock owned by the Principals, collectively. The loans bear
interest at the lowest applicable federal tax rate during the month the loans
are made. At September 30, 1998 the Company had loaned the Principals the full
$1,750,000. The loans bear interest at 6.02% ($482,600 of loans) and 5.70%
($1,267,400 of loans).
In March 1998 the Company agreed to lend up to an additional $1,500,000 in
unsecured loans to the Principals, in lieu of incurring the costs and expenses
associated with the registration of 100,000 shares of the Company's common stock
owned by the Principals. The Company loaned the Principals an additional
$1,203,880 in April 1998. The additional loans are due and payable on March 31,
1999 and bear interest at 5.51%.
During 1998 the Company advanced funds to HCP pursuant to an unsecured loan
agreement. The loans to HCP bear interest at 1.00% below the prime rate. At
September 30, 1998 the loans outstanding to HCP totaled $7,312,472. The Company
agreed to lend $7,312,472 to HCP on September 30, 1998 in order for HCP to
purchase a $103 million fixed and adjustable rate mortgage pool.
In September 1998 the Company made a capital contribution of $2,700,000
to HCP. A prorata capital contribution was made by the shareholders owning
common stock, maintaining the 97% - 3% ownership relationship.
9. TREASURY STOCK
Pursuant to a stock repurchase program that began in July 1998, the Company
repurchased a total of 143,900 shares of its common stock in August and
September.
10. ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
In June 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No.130"). Effective January 1, 1998 the Company adopted SFAS No. 130, which
established disclosure standards for reporting comprehensive income in a full
set of general purpose financial statements. The comprehensive loss for the
three months and the nine months ended September 30, 1998 was $1,730,000, and
$2,573,000 which included an unrealized loss on investments available for sale
of $2,076,000 and $3,523,000, respectively.
15
<PAGE> 16
11. SUBSEQUENT EVENTS
On October 16, 1998 a $0.17 cash dividend previously declared by the Board of
Directors was paid to stockholders of record as of September 30, 1998.
During October 1998 the Company sold all of its adjustable rate mortgage
securities and the majority of its fixed rate mortgage securities for a loss of
approximately $6.9 million.
During October 1998 the Company swapped approximately $ 54 million of mortgage
loan assets for FNMA mortgage securities. These mortgage securities were
subsequently sold at a gain in excess of $500,000.
On October 30, 1998 the Company contributed certain fixed rate mortgage loans
($317 million) and the related reverse repurchase agreement financing ($308
million) to Hanover Capital Partners 2, Inc. in exchange for a 100% preferred
equity interest in Hanover Capital Partners 2, Inc. A wholly-owned subsidiary of
Hanover Capital Partners, 2, Inc. issued a REMIC security with the mortgage
loans as collateral for the security. The AAA rated bonds were sold to a third
party and the Company retained all of the junior bonds relating to this
security. At October 30, 1998, the carrying value of the junior bonds
classified as available for sale would require a market value allowance of
approximately $2.5 million.
16
<PAGE> 17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
OVERVIEW
Hanover Capital Mortgage Holdings, Inc. was incorporated in Maryland on June 10,
1997. In April 1998, Hanover Capital Mortgage Holdings, Inc. acquired 100% of
the common stock of Hanover Capital SPC, Inc. Hanover Capital Mortgage Holdings,
Inc. is a real estate investment trust ("REIT"), formed to operate as a
specialty finance company. The principal business strategy of Hanover Capital
Mortgage Holdings, Inc. and its wholly owned subsidiary, Hanover Capital SPC,
Inc. (together referred to as the "Company") is to (i) acquire primarily
single-family mortgage loans that are at least twelve months old or that were
intended to be of certain credit quality but that do not meet the originally
intended market parameters due to errors or credit deterioration, (ii)
securitize the mortgage loans and retain interests therein, (iii) originate,
hold, sell and service multifamily loans and commercial loans and (iv) acquire
multifamily loans. The Company's principal business objective is to generate
increasing earnings and dividends for distribution to its stockholders. The
Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company may also acquire multifamily mortgage loans through a taxable
subsidiary of the Company.
The Company's principal source of earnings is net interest income generated by
the Company's investment portfolio. As of September 30, 1998 the Company's
investment portfolio consisted of single-family mortgage loans held for sale,
single-family mortgage loans held to maturity, collateral for mortgage backed
bonds, and mortgage securities available for sale. The Company funds its
portfolio investments with both borrowings and cash raised from the issuance of
equity. For the portion of the portfolio investments funded with borrowings, the
Company generates net interest income to the extent that there is a positive
spread between the yield on the interest-earning assets and the cost of borrowed
funds. In addition the Company earns net interest income from the yield
generated by the portion of the investment portfolio that is funded solely with
equity. The cost of the Company's borrowings may increase or decrease through
the use of interest rate swaps, caps or floor agreements.
The Company's generation of net income is dependent upon (i) the spread between
interest earned on its investment portfolio and the cost of borrowed funds to
finance the investment portfolio; and (ii) the aggregate amount of the
investment portfolio on the Company's balance sheet. The Company strives to
create a diversified portfolio of investments that in the aggregate generates
increasing net income in a variety of interest rate and prepayment rate
environments and preserves the equity base of the Company. The Company's primary
strategy for its mortgage loan investment portfolio entails (1) efficient
acquisition pricing of mortgage loans, (2) financing in the short term by
reverse repurchase agreements or lines of credit, (3) hedging in the short term
to offset potential adverse effects of changes in interest rates, (4)
stratifying and segregating mortgage loans in securitizations to replace short
term financing with collateralized mortgage obligation (CMO), real estate
mortgage investment conduit (REMIC) or other types of long term debt financing,
thereby eliminating the majority of refinancing and interest rate risk and (5)
retaining certain residual interests of the securitization resulting in
increased yields .
The Company's operating strategy for its mortgage securities investment entails
(1) the efficient acquisition of mortgage securities on a temporary basis to
effectively (a) deploy capital and (b) meet certain REIT requirements, (2)
financing through reverse repurchase agreements and (3) identifying the
appropriate times to sell the mortgage securities to optimize the investment
yield to the Company and to free additional capital to fund additional mortgage
loan acquisitions.
17
<PAGE> 18
RESULTS OF OPERATIONS
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Nine Months Period from
Ended Ended June 10 to
September 30, September 30, September 30,
----------------- ------------- ------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net interest income $ 1,692 $ 128 $ 4,625 128
Loan (loss) provision (130) -- (278) --
(Loss) on sale of mortgages -- -- (49) --
General and administrative
(expenses) (928) (95) (2,760) (95)
Equity in earnings (loss) of
unconsolidated subsidiary (288) 26 (588) 26
------- ----- ------- -----
Net income $ 346 $ 59 $ 950 $ 59
======= ===== ======= =====
Basic earnings per share $ 0.05 $0.07 $ 0.15 $0.09
======= ===== ======= =====
Dividends declared per share $ 0.17 $0.16 $ 0.59 $0.16
======= ===== ======= =====
</TABLE>
Net interest income for the three months ended September 30, 1998 totaled
$1,692,000 and net interest income for the nine month period ended September 30,
1998 was $4,625,000. The majority of the net interest income for the nine month
period ended September 30, 1998 was generated by the Company's investment in
mortgage loans. The balance of net interest income was generated from mortgage
securities, collateral for mortgage backed bonds, agency paper investments, cash
collateral on deposit with certain mortgage security lenders, a savings account,
loans to certain Principals and loans to HCP. Management anticipates that the
net interest income generated by mortgage loans will continue to reflect a
substantial percentage of the Company's total net interest income. The Company's
total mortgage loan holdings including mortgages held as collateral for mortgage
backed bonds increased from $160,970,000 at December 31, 1997 to $790,911,000 at
September 30, 1998.
Third quarter net interest income from the Company's mortgage loan portfolio,
including mortgages held as collateral for mortgage backed bonds, was $2,185,000
compared to $1,525,000 in the second quarter; an increase of 43.3%. The
substantial increase in the net interest income resulted from the volume of
mortgage pool acquisitions in late June through September. These acquisitions,
offset by normal principal reductions and prepayments, resulted in an increase
in the average balance of mortgage loans held from $370.81 million in the second
quarter to $566.46 million in the third quarter.
The third quarter net interest income continued to be negatively impacted by
high prepayment speeds on the Company's mortgage securities portfolio. The
Company reflected premium amortization of $1,519,000 in the third quarter of
1998 as compared to $2,148,000 and $903,000 in the second quarter and first
quarter of 1998, respectively. The premium amortization is recorded as an
adjustment to interest income and accordingly reduces the net interest income on
the Company's mortgage securities portfolio.
The Company's net income was again detrimentally impacted by the losses
generated by its equity investment in HCP. A net loss of $288,000 from HCP was
recorded by the Company in the third quarter of 1998 compared to losses of
$294,000 and $6,000 in the second quarter and first quarter of 1998,
respectively.
The following table reflects the average balances for the Company's investment
portfolio as well as the Company's interest bearing liabilities with the
corresponding effective rates of interest annualized for the period July 1, 1998
through September 30, 1998 (dollars in thousands):
18
<PAGE> 19
<TABLE>
<CAPTION>
Effective
Average Interest
Balance Rate
------- ---------
<S> <C> <C>
Interest Earning Assets
Mortgage Loans (1) $566,456 7.489%
Collateral for mortgage
backed bonds (2) 91,980 7.071%
Mortgage securities (2) 243,299 4.528%
-------- -----
$901,735 6.648%
======== =====
Interest Bearing Liabilities
Reverse repurchase borrowings
on mortgage loans $523,403 6.377%
Mortgage backed bonds 87,524 6.766%
Reverse repurchase borrowings
on collateral for mortgage
backed bonds 203 6.145%
Reverse repurchase borrowings
on mortgage securities 241,388 5.701%
-------- -----
$852,518 6.364%
======== =====
Net Interest Earning Assets $ 49,217
========
Net Interest Spread 0.284%
======
Yield on Net Interest Earning
Assets (3) 11.562%
=======
</TABLE>
(1) Includes mortgage loans held for sale and mortgage loans held to maturity.
Loan loss provisions are excluded in the above calculations.
(2) Loan loss provisions are excluded in the above calculations.
(3) Yield on Net Interest Earning Assets is computed by dividing the applicable
net interest income by the average daily balance of Net Interest Earning
Assets.
The effective rate for interest earning assets has been adjusted to reflect
amortization of premiums paid or discounts received on the acquisition of
mortgage loans and mortgage securities. By engaging HCP to perform due diligence
on mortgage loans the Company acquires, management believes that premium amounts
paid for the purchase of mortgage loans are less than if they were acquired in
the market. Net unamortized premiums on the Company's mortgage loans (including
both mortgage loans held for sale and mortgage loans held to maturity),
collateral for mortgage backed bonds and mortgage securities were $7,712,000,
$983,000 and $8,166,000 at September 30, 1998 or approximately 1.12%, 1.11% and
3.63% of the respective par value investments in total mortgage loans,
collateral for mortgage backed bonds and mortgage securities.
The Company's largest expense is the interest cost on borrowed funds. The
majority of funds to finance the investment portfolio in the third quarter of
1998 were borrowed in the form of reverse repurchase agreements, which is
indexed to LIBOR. The Company also used interest rate caps to manage its
interest rate risk and may also in the future use interest rate swaps and
financial futures. The net cost of those instruments is included in the cost of
funds as a component of interest expense for the period to which it relates.
At September 30, 1998 the Company's mortgage loan investment portfolio comprised
75.4% of total assets in the following types of single family mortgage loans
(dollars in thousands, except average loan size):
19
<PAGE> 20
<TABLE>
<CAPTION>
Mortgage Loan Summary Mortgages Mortgages Collateral
Held for Held to for Mortgage
Sale Maturity Backed Bonds Total
---- -------- ------------ -----
<S> <C> <C> <C> <C>
FIXED RATE MORTGAGE LOANS
Face or principal amount $511,003 $ 70,490 $87,881 $669,374
Carrying value $522,030 $ 72,414 $90,020 $684,464
Weighted average net coupon 7.73% 8.74% 7.82% 7.85%
Weighted average maturity (in months) 226 252 234 230
Number of loans 9,255 1,518 1,181 11,954
Average loan size $ 55,214 $ 46,436 $74,412 $ 55,996
ADJUSTABLE RATE MORTGAGE (ARM) LOANS
Face or principal amount $105,766 $ 145 -- $105,911
Carrying value $106,302 $ 145 -- $106,447
Weighted average net coupon 7.48% 7.50% -- 7.48%
Weighted average maturity (in months) 274 305 -- 274
Number of loans 1,122 1 -- 1,123
Average loan size $ 94,265 $144,986 -- $ 94,310
</TABLE>
At September 30, 1998 the Company's mortgage securities investment portfolio
comprised 21.8% of total assets in the following categories (dollars in
thousands):
<TABLE>
<CAPTION>
Adjustable Fixed
Rate Rate Total
---- ---- -----
<S> <C> <C> <C>
FEDERAL NATIONAL MORTGAGE ASSOCIATION
(FNMA) SECURITIES
Par value at purchase date $200,524 $21,663 $222,187
September 30, 1998 adjusted principal $120,496 $20,750 $141,246
Amortized cost basis $125,236 $21,275 $146,511
Market Value $122,726 $21,190 $143,916
Weighted average net coupon 7.49% 7.93% 7.56%
Weighted average maturity
(in months) 276 297 279
<CAPTION>
Adjustable Fixed
Rate Rate Total
---- ---- -----
<S> <C> <C>
FEDERAL HOME LOAN MORTGAGE CORP.
(FHLMC) SECURITIES
Par value at purchase date $136,237 - $136,237
September 30, 1998 adjusted principal $ 83,444 - $83,444
Amortized cost basis $ 86,373 - $86,373
Market Value $ 84,590 - $84,590
Weighted average net coupon 7.70% - 7.70%
Weighted average maturity -
(in months) 294 - 294
</TABLE>
General and administrative expenses (G &A expenses) totaled $928,000 for the
third quarter of 1998. G & A expenses consist substantially of expenses relating
to the acquisition of and management of the Company's investment portfolio, as
well as various other corporate expenses. Most of the G & A expenses are likely
to remain relatively stable on a quarterly basis with the possible exception of
the following: (1) due diligence, (2) commissions and (3) legal and
professional. The due diligence expenses will vary based upon various factors,
including but not limited to the number of loans purchased, complexity of
documentation problems encountered, type of mortgage loans, ease of converting
data to the Company's proprietary software system, geographic location, and
creditworthiness of the borrower. Commission expense is also directly related to
mortgage loans acquired. Commissions are paid on all mortgage loan acquisitions
initiated by HCP's sales representatives. However, certain mortgage loan
acquisitions are also initiated by the Principals. No commission expense is
recorded when the mortgage loan acquisitions are originated by the Principals.
Legal and professional fees will also vary based on the usage of various
professional firms from time to time.
20
<PAGE> 21
The Company recorded a loss from its investment in Hanover Capital Partners Ltd.
and Subsidiaries of $288,000 for the period July 1, 1998 through September 30,
1998. Summarized operating results for Hanover Capital Partners Ltd and
Subsidiaries representing the Company's 97% ownership interest are shown below
(dollars in thousands):
<TABLE>
<S> <C>
Revenues $ 1,591
Expenses (1,379)
-------
Net (loss) ($288)
=======
</TABLE>
The Company's net income for the period July 1, 1998 through September 30, 1998
was $346,000 or an annualized return on equity of 1.82% . The table below
highlights the Company's historical trends and components of annualized return
on average equity.
COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)
<TABLE>
<CAPTION>
Gain (Loss) on Equity in
Net Interest Sale of G & A Earnings (Loss) Annualized
For the Income/ Securities/ Expense/ of Subsidiary/ Return on
Quarter Ended Equity Equity Equity Equity Equity
------------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
June 30, 1997 (2) 0.00% 0.00% 0.00% 0.00% 0.00%
September 30, 1997 (3) 4.85% 0.00% 3.59% 0.97% 2.23%
December 31, 1997 7.71% 0.18% 4.26% (1.41%) 2.22%
March 31, 1998 10.78% 0.00% 4.37% (0.03%) 6.38%
June 30, 1998 3.47% (0.25%) 5.00% (1.50%) (3.28%)
September 30, 1998 8.23% 0.00% 4.89% (1.52%) 1.82%
</TABLE>
(1) Average equity excludes unrealized loss on investments available for sale.
(2) Hanover Capital Mortgage Holdings, Inc. was organized on June 10, 1997, but
did not begin operations until September 19, 1997
(3) Average equity is based on equity balances at September 19, 1997 (IPO date)
and equity balances at September 30, 1997, excluding unrealized loss on
investments available for sale.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to meet its short-term and long-term liquidity requirements
generally from its existing working capital, cash flow provided by operations,
reverse repurchase agreements, and other possible sources of financing,
including CMO's and REMICs, additional equity generated by the exercise of some
or all of the Company's outstanding stock warrants and additional equity
offerings. The Company considers its ability to generate cash to be adequate to
meet operating requirements both in the short-term and long-term. However, if a
significant decline in the market value of the Company's investment portfolio
should occur, the Company's available liquidity from these other borrowings may
be reduced. As a result of such a reduction in liquidity, the Company may be
forced to sell certain investments in order to maintain liquidity. If required,
these sales could be made at prices lower than the carrying value of such
assets, which could result in losses.
Net cash used in operations for the first nine months of 1998 was $931,000.
Actual cash proceeds generated from net income adjusted for non cash items
($7,379,000) and net changes in operating assets and liabilities ($1,474,000)
were offset by loans to related parties ($9,784,000). Loans to Principals
totaled $2,472,000 and loans to HCP totaled $7,312,000. The Company advanced
$7,312,000 to HCP on September 30, 1998 to assist HCP in the purchase of a $103
million fixed and adjustable rate single-family mortgage loan pool.
21
<PAGE> 22
Net cash used in investing activities amounted to $519,681,000 during the period
January 1, 1998 through September 30, 1998. The majority of the cash used in
investing activities related to the purchase of assets for the Company's
investment portfolio ($866,673,000). Mortgage loans were purchased at an average
price of 101.26% of par. Offsetting the cash outlay for purchases of mortgage
assets were receipts of principal proceeds from the investment portfolio
totaling $331,207,000 during the first nine months of 1998.
Cash flows from financing activities generated $523,635,000 for the period
January 1, 1998 through September 30, 1998. The cash flows from financing
activities resulted from net borrowings on reverse repurchase agreements
($446,077,000), net borrowings on the mortgage backed bonds ($85,330,000), net
proceeds from the exercise of 2,122 warrants ($3,000) reduced by dividends paid
($3,751,000), an additional capital contribution to HCP ($2,700,000) and
treasury stock purchases ($1,324,000).
Management expects that the purchase of single-family loan pools will
significantly slow in the fourth quarter of 1998 as the Company focuses on
certain securitization transactions and liquidity issues. Such issues reflect
the extraordinarily adverse conditions in the mortgage securities markets which
arose suddenly in early October, leading to the need to increase the Company's
liquidity and decrease its leverage. Accordingly, on October 15, 1998 the
Company announced a plan to maximize liquidity through the sale of securities,
securitization of whole loans, increased credit facilities and conversion and
possible sale of whole loans into FNMA securities.
An unconsolidated subsidiary of the Company securitized approximately $317
million of fixed rate mortgage loans on October 30,1998 that the Company
contributed net of the respective reverse repurchase financing to the affiliate.
The AAA rated bonds were sold to a third party and the Company retained all of
the junior bonds relating to this security. At October 30, 1998, the carrying
value of the junior bonds classified as available for sale would require a
market value allowance of approximately $2.5 million. The Company also sold
substantially all of its mortgage securities during October. The sale of
mortgage securities resulted in losses in excess of $6 million. At the same time
the sale freed up in excess of $2.2 million in capital that had previously been
invested in such mortgage securities. In addition, the Company swapped
approximately $54 million of mortgage loan assets for FNMA mortgage securities.
These mortgage securities were also sold in October. This transaction also
increased the Company's liquidity.
OTHER MATTERS
The Company calculated its Qualified REIT Assets at September 30, 1998, as
defined in the Internal Revenue Code ("Code"), to be 97.1% of the value of its
total assets, as compared to the federal tax requirement that at least 75.0% of
the value of its total assets must be Qualified REIT Assets. The Company also
estimates that 97.0% of its 1998 revenue will qualify for the 75.0% source of
income test and 99.0% of its revenue will qualify for the 95.0% source of income
test under the REIT rules.
The Company believes that it was in full compliance with the REIT tax rules as
of September 30, 1998 and intends to remain in compliance with all REIT tax
rules and to continue to qualify as a REIT under the provisions of the Code.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act. If the
Company were to become regulated as an investment company, then the Company's
use of leverage would be substantially reduced. The Investment Company Act
exempts entities that are "primarily engaged in the business of purchasing or
otherwise acquiring mortgages and other liens on interests in real estate"
("Qualifying Interests"). Under current interpretations of the staff of the SEC,
in order to qualify for this exemption, the Company must maintain at least 55%
of its assets directly in Qualifying Interests. As of September 30, 1998, the
Company calculates that it is in compliance with this requirement.
22
<PAGE> 23
IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
The preceding section, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and other sections of this Quarterly
Report contain various "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which represent the Company's
expectations or beliefs concerning future events, including, without limitation,
statements containing the words "believes," "anticipates," "expects" and words
of similar import; and also including, without limitation, the following:
statements regarding the Company's continuing ability to target and acquire
mortgage loans; expected availability of the master repurchase agreements; the
sufficiency of the Company's working capital, cash flow and financing to support
the Company's future operating and capital requirements; results of operations
and overall financial performance; the expected dividend distribution rate; and
the expected tax treatment of the Company's operations. Such forward-looking
statements relate to future events and the future financial performance of the
Company and the industry and involve known and unknown risks, uncertainties and
other important factors which could cause actual results, performance or
achievements of the Company or industry to differ materially from the future
results, performance or achievements expressed or implied by such
forward-looking statements.
Investors should carefully consider the various factors identified in the
preceding section, "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and elsewhere in this Quarterly Report that could
cause actual results to differ materially from the results predicted in the
forward-looking statements. Further, the Company specifically cautions investors
to consider the following important factors in conjunction with the
forward-looking statements: the possible decline in the Company's ability to
locate and acquire mortgage loans; the possible adverse effect of changing
economic conditions, including interest rate movements and changes in the real
estate market both locally and nationally; the effect of severe weather or
natural disasters; the effect of competitive pressures from other financial
institutions, including mortgage REITS; and the possible changes, if any, in the
Code REIT rules. Because of the foregoing factors, the actual results achieved
by the Company in the future may differ materially from the expected results
described in the forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
23
<PAGE> 24
PART II OTHER INFORMATION
Item 1. Legal Proceedings
During the third quarter of 1998, there have been no
material developments with respect to legal proceedings
to which the Company or any of its affiliates have been
a party.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits filed with this Form 10-Q
Ex. 27 Financial Data Schedule
(b) Reports on Form 8-K
None
24
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
Dated: November 9, 1998 By: /s/ John A. Burchett
---------------- -----------------------------------
John A. Burchett
Chairman of the Board of Directors
Dated: November 9, 1998 By: /s/ Ralph F. Laughlin
---------------- ----------------------------------
Ralph F. Laughlin
Chief Financial Officer and
Principal Accounting Officer
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE HANOVER
CAPITAL MORTGAGE HOLDINGS, INC'S QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD
FROM JANUARY 1, 1998 TO SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 7,045
<SECURITIES> 1,019,417
<RECEIVABLES> 9,190
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,048,916
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,048,916
<CURRENT-LIABILITIES> 978,502<F1>
<BONDS> 0
0
0
<COMMON> 65
<OTHER-SE> 70,349<F2>
<TOTAL-LIABILITY-AND-EQUITY> 1,048,916
<SALES> 0
<TOTAL-REVENUES> 36,186
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,760
<LOSS-PROVISION> 278
<INTEREST-EXPENSE> 31,561
<INCOME-PRETAX> 950
<INCOME-TAX> 0
<INCOME-CONTINUING> 950
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 950
<EPS-PRIMARY> 0.15
<EPS-DILUTED> 0.15
<FN>
<F1>As a Real Estate Investment Trust our balance sheet is not classified.
<F2>Includes Retained Earnings and Paid In Capital.
</FN>
</TABLE>
