<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 June 30, 1999
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 5,826,899 shares of common stock outstanding as of
August 9, 1999.
<PAGE> 2
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
FORM 10-Q
For the Quarter Ended June 30, 1999
INDEX
PART I. FINANCIAL INFORMATION
PAGE NO.
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 1999 and 1998 4
Condensed Consolidated Statement of Stockholders' Equity for
the Six Months Ended June 30, 1999 5
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998 6
Notes to Condensed Consolidated Financial Statements 7-25
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 26-44
Item 3. Quantitative and Qualitative Disclosures 45-47
About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 48
Item 2. Changes in Securities 48
Item 3. Defaults Upon Senior Securities 48
Item 4. Submission of Matters to a Vote of Security Holders 48
Item 5. Other Information 48
Item 6. Exhibits and Reports on Form 8-K 48
Signatures 49
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except as noted)
(unaudited)
ASSETS JUNE 30, DECEMBER 31,
1999 1998
-------- --------
Mortgage loans:
Held for sale $120,364 $256,833
Held to maturity -- 69,495
Collateral for CMOs and mortgage-backed bonds 196,024 81,666
Mortgage securities:
Available for sale 63,781 74,000
Held to maturity 7,181 4,478
Cash and cash equivalents 11,648 11,837
Accrued interest receivable 3,197 3,940
Equity investments
Operating (Hanover Capital Partners Ltd.) 1,077 1,761
Mortgage Finance (Hanover Capital Partners 2, Inc.) 4,831 5,728
Notes receivable from related parties 4,164 3,893
Due from related parties 377 313
Other receivables 616 1,621
Prepaid expenses and other assets 824 605
-------- --------
Total Assets $414,084 $516,170
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reverse repurchase agreements $164,653 $370,090
CMO and mortgage-backed bonds borrowing 183,918 77,305
Accrued interest payable 1,543 1,394
Deferred income 464 --
Dividends payable -- 695
Due to related party 41 --
Accrued expenses and other liabilities 1,104 906
-------- --------
Total liabilities 351,723 450,390
-------- --------
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, 5,826,899 and
6,321,899 shares outstanding at June 30, 1999
and December 31, 1998, respectively 58 65
Additional paid-in-capital 75,840 78,069
Retained earnings (deficit) (10,326) (9,955)
Accumulated other comprehensive (loss) (3,211) (2,399)
-------- --------
Total stockholders' equity 62,361 65,780
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $414,084 $516,170
======== ========
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 4
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
------ ------- ------- -------
REVENUES:
<S> <C> <C> <C> <C>
Interest income $7,566 $11,598 $15,980 $20,930
Interest expense 5,833 10,824 12,196 17,997
------ ------- ------- -------
Net interest income 1,733 774 3,784 2,933
Loan loss provision 113 97 232 148
------ ------- ------- -------
Net interest income after loan
loss provision 1,620 677 3,552 2,785
Gain on sale of servicing rights 2 -- 344 --
Gain (loss) on sale of mortgage assets -- (49) 163 (49)
------ ------- ------- -------
Total revenues 1,622 628 4,059 2,736
------ ------- ------- -------
EXPENSES:
Personnel 180 174 370 363
Management and administrative 177 168 370 329
Due diligence 44 245 107 420
Commissions 5 92 5 217
Legal and professional 328 158 552 239
Financing/commitment fees 71 72 148 132
Other 55 69 133 132
------ ------- ------- -------
Total expenses 860 978 1,685 1,832
------ ------- ------- -------
Operating income (loss) 762 (350) 2,374 904
Equity in (loss) of unconsolidated
subsidiaries:
Operating (Hanover Capital Partners Ltd.) (276) (294) (684) (300)
Mortgage finance (Hanover Capital Partners 2, Inc.) (428) -- (896) --
------ ------- ------- -------
NET INCOME (LOSS) $ 58 $ (644) $ 794 $ 604
====== ======= ======= =======
BASIC EARNINGS (LOSS) PER SHARE $ 0.01 $ (0.10) $ 0.13 $ 0.09
====== ======= ======= =======
DILUTED EARNINGS (LOSS) PER SHARE $ 0.01 $ (0.10) $ 0.13 $ 0.08
====== ======= ======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 1999
(in thousands except share data)
(unaudited)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL COMPREHENSIVE RETAINED OTHER
COMMON STOCK PAID-IN INCOME EARNINGS COMPREHENSIVE
SHARES AMOUNT CAPITAL (LOSS) (DEFICIT) (LOSS) TOTAL
--------- ------ ------- -------- --------- ------ -----
BALANCE,
<S> <C> <C> <C> <C> <C> <C> <C>
December 31, 1998 6,321,899 $65 $78,069 $ (9,955) $(2,399) $65,780
Repurchase of
common stock (495,000) (7) (2,229) (2,236)
Comprehensive income:
Net income $794 794 794
Other comprehensive (loss)
Unrealized (loss) (812) (812) (812)
-----
Comprehensive (loss) $(18)
=====
Dividends declared (1,165) (1,165)
--------- --- ------- -------- ------- -------
BALANCE,
June 30, 1999 5,826,899 $58 $75,840 $(10,326) $(3,211) $62,361
========= === ======= ======== ======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 794 $ 604
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Amortization of net premium and deferred costs 1,438 3,707
Amortization of deferred gain on sale (24) --
Loan loss provision 232 147
(Gain) on sale of servicing rights (344) --
(Gain) loss on sale of mortgage securities and loans (163) 49
Equity in loss of unconsolidated subsidiaries 1,580 300
(Increase) decrease in accrued interest receivable 743 (3,865)
(Increase) in loans to related parties (271) (4,872)
Decrease in due from related parties 1 --
(Increase) decrease in other receivables 1,005 (1,646)
(Increase) decrease in prepaid expenses and other assets 73 (545)
Increase in accrued interest payable 149 889
Increase in deferred income 464 --
Increase (decrease) in due to related party 41 (359)
Increase (decrease) in accrued expenses and
other liabilities (1) 4,424
-------- --------
Net cash provided by (used in) operating activities 5,717 (1,167)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in mortgage loans 58,084 (502,102)
Principal payments received on collateral for
CMOs and mortgage-backed bonds 25,838 8,038
Principal payments received on mortgage securities and loans 7,261 93,254
Proceeds from the sale of mortgage securities and loans 8,760 20,118
Proceeds from the sale of servicing rights 739 --
Purchase of mortgage securities (3,668) (4,333)
-------- --------
Net cash provided by (used in) investing activities 97,014 (385,025)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from CMOs and mortgage-backed bonds 106,613 92,719
Net borrowings from (repayments for) reverse repurchase
agreements (205,437) 308,111
Repurchase of common stock (2,236) --
Payment of dividends (1,860) (2,393)
Exercise of stock warrants -- 33
-------- --------
Net cash provided by (used in) financing activities (102,920) 398,470
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (189) 12,278
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 11,837 4,022
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,648 $ 16,300
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
Operating activity - increase in dividends payable ($1,358) relating to the
declaration of dividends in June 1998
SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the period for:
Income taxes $ 2 $ 1
======== ========
Interest $ 12,047 $ 16,818
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
6
<PAGE> 7
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
GENERAL
Hanover Capital Mortgage Holdings, Inc. ("Hanover") was incorporated in Maryland
on June 10, 1997. Hanover is a real estate investment trust ("REIT"), formed to
operate as a specialty finance company. The principal business strategy of
Hanover and its wholly-owned subsidiaries, (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 and (iii) acquire subordinated mortgage securities similar in nature to
the retained interests generated from internal securitizations. The principal
business strategy of the Company's primary unconsolidated subsidiary, Hanover
Capital Partners Ltd. ("HCP"), is to generate consulting and other fee income by
(i) performing loan file due diligence reviews for third parties, (ii)
performing loan sale advisory services and (iii) brokering and trading
portfolios of loans. Until recently, HCP was also engaged in the business of
originating multifamily and commercial loans. This business was discontinued in
the quarter ended June 30, 1999 and all charges associated with its
discontinuance were recognized in the quarter. The Company's principal business
objective is to generate net interest income on its portfolio of mortgage loans
and mortgage securities, and to generate fee income through HCP. The Company
acquires single-family mortgage loans through a network of sales representatives
targeting financial institutions throughout the United States.
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' over-allotment option, which was exercised in
full. Each warrant, as adjusted on January 1, 1999, entitles the holder to
purchase 1.0302 shares of common stock at the adjusted price of $14.56 per share
of common stock. 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. As of June 30, 1999,
there were 6,217,877 warrants outstanding, including 172,500 warrants issued
pursuant to the underwriters over-allotment option.
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 subsidiaries. All
significant intercompany accounts and transactions have been eliminated.
7
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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 six months ended June 30, 1999 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 1998 Form 10-K.
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
Hanover 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, Hanover will not be
subject to Federal or state income tax to the extent that its annual
distributions to stockholders are equal to at least 95% of its taxable income
and as long as certain asset, income and stock ownership tests are met.
EARNINGS PER SHARE
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.
8
<PAGE> 9
Calculations for earnings per share are shown below (dollars in thousands,
except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
---- ---- ---- ----
Earnings per share basic:
<S> <C> <C> <C> <C>
Net income (loss) [numerator] $ 58 $ (644) $ 794 $ 604
========== ========== ========== ==========
Average common shares
outstanding [denominator] 5,886,240 6,468,160 6,064,606 6,467,423
========== ========== ========== ==========
Per share $ 0.01 $ (0.10) $ 0.13 $ 0.09
========== ========== ========== ==========
Earnings (loss) per share diluted:
Net income (loss) [numerator] $ 58 $ (644) $ 794 $ 604
========== ========== ========== ==========
Average common shares
outstanding 5,886,240 6,468,160 6,064,606 6,467,423
---------- ---------- ---------- ----------
Add: Incremental shares from
assumed conversion of
warrants 54,818 115,204 22,051 767,912
---------- ---------- ---------- ----------
Dilutive potential common shares 54,818 115,204 22,051 767,912
---------- ---------- ---------- ----------
Adjusted weighted average shares
outstanding [denominator] 5,941,058 6,583,364 6,086,657 7,235,335
========== ========== ========== ==========
Per share $ 0.01 $ (0.10) $ 0.13 $ 0.08
========== ========== ========== ==========
</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 June 30, 1999 management had
made the determination that $120,364,000 of mortgage loans were held for sale.
No mortgage loans were designated as held to maturity and $196,024,000 of
mortgage loans were held as collateralized mortgage obligation ("CMO") and
mortgage-backed bonds collateral. 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. Mortgage loans designated as held to
maturity and CMO and mortgage-backed bonds collateral are reported at cost.
Premiums, discounts and certain deferred costs 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
9
<PAGE> 10
are removed, generally on or shortly before settlement date. Realized gains and
losses on mortgage loan transactions are determined on the specific
identification basis.
The accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest income is
reversed. Interest income is subsequently recognized only to the extent cash
payments are received.
HELD FOR SALE
The following table summarizes certain characteristics of the Company's
single-family mortgage loan pools, held for sale portfolio which are carried at
the lower of cost or market (dollars in thousands):
JUNE 30, 1999
Fixed Adjustable
Rate Rate (a) Total
------- -------- --------
Principal amount of mortgage loans $36,034 $ 82,514 $118,548
Net premium (discount) 946 676 1,622
Deferred costs 305 -- 305
Loan loss provision (45) (66) (111)
------- -------- --------
Carrying cost of mortgage loans $37,240 $ 83,124 $120,364
======= ======== ========
Mix 30.94% 69.06% 100.00%
Weighted average net coupon 8.655% 7.131% 7.595%
Weighted average maturity (b) 147 234 207
DECEMBER 31, 1998
Fixed Adjustable
Rate Rate (a) Total
------- -------- --------
Principal amount of mortgage loans $93,615 $159,901 $253,516
Net premium (discount) 1,826 1,146 2,972
Deferred costs 479 116 595
Loan loss provision (157) (93) (250)
------- -------- --------
Carrying cost of mortgage loans $95,763 $161,070 $256,833
======= ======== ========
Mix 37.29% 62.71% 100.00%
Weighted average net coupon 8.545% 7.542% 7.912%
Weighted average maturity (b) 187 264 235
The adjustable rate mortgage loans at June 30, 1999 had various reference rate
indexes with a weighted average 14 month repricing period and a weighted average
net life cap of 13.58%.
The adjustable rate mortgage loans at December 31, 1998 had various reference
rate indexes with a weighted average 13 month repricing period and a weighted
average net life cap of 13.23%
(a) The adjustable rate mortgage loans include $18,414,000 and $31,857,000 of
hybrid mortgage loans at June 30, 1999 and December 31, 1998 respectively,
which allow the coupon interest rate to change at one specified time during
the life of the loan.
(b) Weighted average maturity reflects the number of months until maturity.
10
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HELD TO MATURITY
The Company did not have any mortgage loans held to maturity at June 30, 1999.
The following table summarizes certain characteristics of the Company's
single-family mortgage loans, held to maturity which are carried at cost
(dollars in thousands):
DECEMBER 31, 1998
------------------------------------
Fixed Adjustable
Rate Rate Total
------- ----- -------
Principal balance of mortgage loans $67,515 $ 144 $67,659
Net premium (discount) 1,802 4 1,806
Deferred costs 72 -- 72
Loan loss provision (39) (3) (42)
------- ----- -------
Carrying cost of mortgage loans $69,350 $ 145 $69,495
======= ===== =======
Mix 99.79% 0.21% 100.00%
Weighted average net coupon 8.707% 7.625% 8.705%
Weighted average maturity 253 302 253
The adjustable rate mortgage loans had a 1 year CMT based reference rate with a
12 month repricing period and a net life cap of 10.25%.
The average effective yield, which includes the amortization of net premium,
discounts and certain deferred costs for the periods shown below on the total
mortgage loan portfolio were as follows:
1999 1998
---- ----
Quarter ended March 7.092% 7.410%
Quarter ended June 30 7.010% 7.371%
COLLATERAL FOR CMOS AND MORTGAGE-BACKED BONDS
In April 1998, the Company issued its first CMO securitization transaction,
Hanover Capital 1998-A. $102,977,000 (par value) of single family fixed rate
residential mortgage loans were assigned as collateral for the 1998-A
securitization. In March 1999, the Company completed its second CMO
securitization transaction, Hanover Capital 1999-A. $138,357,000 (par value) of
single family fixed and adjustable rate residential loans were assigned as
collateral for the 1999-A securitization. The Company has limited exposure to
credit risk retained on loans it has securitized through the issuance of CMOs.
All mortgage loans held as CMO and mortgage-backed bonds collateral are reported
at cost. Premiums, discounts and all deferred costs associated with the mortgage
loans held as CMO and mortgage-backed bonds collateral are amortized into
interest income over the lives of the mortgage loans using the effective yield
method adjusted for the effects of estimated prepayments.
The following table summarizes the Company's single-family fixed and adjustable
rate mortgage loan pools held as CMO and mortgage-backed bonds collateral, which
are carried at cost (dollars in thousands):
11
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JUNE 30, 1999
------------------------------
Security
1998-A Security 1999-A
------- -------------------
Fixed Fixed Adjustable
Rate Rate Rate Total
------- ------- ------- --------
Principal balance of mortgage loans $64,648 $94,283 $33,402 $192,333
Net premium (discount) 727 1,622 575 2,924
Deferred costs 909 123 44 1,076
Loan loss provision (107) (149) (53) (309)
------- ------- ------- --------
Carrying cost of mortgage loans $66,177 $95,879 $33,968 $196,024
======= ======= ======= ========
Mix 33.76% 48.91% 17.33% 100.00%
Weighted average net coupon 7.772% 8.390% 7.269% 7.988%
Weighted average maturity 225 243 317 250
DECEMBER 31, 1998
Security
1998-A
-------
Fixed
Rate
-------
Principal balance of mortgage loans $79,812
Net premium (discount) 870
Deferred costs 1,064
Loan loss provision (80)
-------
Carrying cost of mortgage loans $81,666
=======
Mix 100.00%
Weighted average net coupon 7.787%
Weighted average maturity 231
The adjustable rate mortgage loans at June 30, 1999 had various reference rate
indexes with a weighted average 12 month repricing period and a weighted average
net life cap of 12.87%.
The average effective yield, which includes the amortization of net premiums,
discounts and certain deferred costs, for the periods shown below on the CMO and
mortgage-backed bonds collateral were as follows:
SECURITY 1999-A 1999 1998
--------------- ---- ----
Quarter ended March 31 7.054% N/A
Quarter ended June 30 7.302% N/A
SECURITY 1998-A 1999 1998
--------------- ---- ----
Quarter ended March 31 6.680% N/A
Quarter ended June 30 6.637% 7.158%
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4. MORTGAGE SECURITIES
The Company's policy is to generally classify its investment grade mortgage
securities as available-for-sale as they are acquired and to classify below
investment grade mortgage securities as held to maturity. Each available for
sale mortgage security 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. Management reevaluates the classification of the mortgage
securities on a quarterly basis. 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.
Mortgage securities classified as held to maturity are carried at the fair value
of the security at the time the designation is made. Any fair value adjustment
is reflected as a separate component of stockholders' equity and as a cost
adjustment of the mortgage security as of the date of the classification and is
amortized into interest income as a yield adjustment.
The Company makes periodic evaluations of all mortgage securities to determine
whether an other-than-temporary impairment is considered to have occurred. If a
decline in the fair value is judged to be other than temporary, the cost basis
of the mortgage security will be marked to fair value, resulting in a current
period loss in the consolidated statement of operations. The new cost basis
shall not be changed for further increases in market value; however, further
increases in market value will be reflected separately in the equity section of
the Company's balance sheet.
Premiums, discounts and certain deferred costs associated with the acquisition
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 mortgage 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.
At June 30, 1999, the Company had $63,781,000 of fixed rate mortgage securities
classified as available for sale. These mortgage securities are secured by fixed
rate mortgage loans on single-family residential housing. The following table
summarizes certain characteristics of the Company's mortgage securities
classified as available for sale, which are carried at their fair value (dollars
in thousands):
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MORTGAGE SECURITIES AVAILABLE FOR SALE
<TABLE>
<CAPTION>
JUNE 30, 1999
-----------------------------------------------------------
1998-B
Purchased Swapped Private
FNMA FNMA Placement
Certificate (a) Certificates (b) Notes (c)(e) Total
--------------- ---------------- ------------ --------
<S> <C> <C> <C> <C>
Principal balance of mortgage securities $2,724 $48,678 $ 12,003 $ 63,405
Net premium (discount) 142 508 1,684 2,334
Deferred costs -- 341 912 1,253
------ ------- -------- --------
Total amortized cost of mortgage securities 2,866 49,527 14,599 66,992
Gross unrealized loss (40) (520) (2,651) (3,211)
------ ------- -------- --------
Carrying cost of mortgage securities $2,826 $49,007 $ 11,948 $ 63,781
====== ======= ======== ========
Mix 4.43% 76.84% 18.73% 100.00%
Principal balance of mortgage loans $2,724 $48,678 $238,330 $289,732
Weighted average net coupon 9.000% 7.409% 25.990% 10.997%
Weighted average maturity 285 247 301 292
<CAPTION>
DECEMBER 31, 1998
-----------------------------------------------------------
1998-B
Purchased Swapped Private
FNMA FNMA Placement
Certificate (a) Certificates (b) Notes (d)(e) Total
--------------- ---------------- ------------ --------
Principal balance of mortgage securities $3,255 $55,207 $ 14,279 $ 72,741
Net premium (discount) 170 628 1,303 2,101
Deferred costs -- 381 1,176 1,557
------ ------- -------- --------
Total amortized cost of mortgage securities 3,425 56,216 16,758 76,399
Gross unrealized loss (46) -- (2,353) (2,399)
------ ------- -------- --------
Carrying cost of mortgage securities $3,379 $56,216 $ 14,405 $ 74,000
====== ======= ======== ========
Mix 4.57% 75.97% 19.46% 100.00%
Principal balance of mortgage loans $3,255 $55,207 $297,682 $356,144
Weighted average net coupon 9.000% 7.462% 28.592% 11.679%
Weighted average maturity 294 248 307 298
</TABLE>
(a) Represents one FNMA certificate with a fixed coupon interest rate of 9.00%
purchased from a "Wall Street" dealer firm. This certificate generates
normal principal and interest remittances to the Company on a monthly
basis.
(b) Represents 31 fixed rate FNMA certificates that the Company received
(swapped) for a like amount of fixed rate mortgage loans in December 1998.
The coupon interest rates range from 6.00% to 10.50%. These certificates
generate normal principal and interest remittances to the Company on a
monthly basis.
(c) Represents six investment grade ("AA", "A" and "BBB") notes and six
interest only notes purchased from an affiliate, Hanover Capital Partners
2, Inc. ("HCP-2"), in a private placement offering in October 1998 in
connection with the 1998-B securitization. The
14
<PAGE> 15
interest rates on the investment grade notes are fixed and range from 6.50%
to 6.75%. These notes generate normal principal and interest remittances to
the Company on a monthly basis. The interest only notes generate monthly
interest remittances to the Company (subject to the availability of funds)
from the excess interest generated from the underlying mortgages after
deducting all service fees and the coupon interest rate on the applicable
notes. The interest rate on each of the interest only notes is based on a
notional amount (the principal balance of those mortgage loans with an
interest rate in excess of the related note coupon interest rate). The
notional amounts decline each month to reflect the related normal principal
amortization, curtailments and prepayments for the related underlying
mortgage loans. At June 30, 1999 the interest only notes were divided into
two major categories; the first group had an effective weighted average
interest rate of 1.102% on a notional balance of $204,451,000 and the
second group had an effective weighted average interest rate of 0.25% on a
notional balance of $113,208,000.
(d) Represents nine investment grade ("AA", "A" and "BBB") notes and six
interest only notes purchased from HCP-2 in a private placement offering in
October 1998 in connection with the 1998-B securitization. The interest
rates on the investment grade notes are fixed and range from 6.25% to
6.75%. These notes generate normal principal and interest remittances to
the Company on a monthly basis. The interest only notes generate monthly
interest remittances to the Company (subject to the availability of funds)
from the excess interest generated from the underlying mortgages after
deducting all service fees and the coupon interest rate on the applicable
notes. The interest rate on each of the interest only notes is based on a
notional amount (the principal balance of those mortgage loans with an
interest rate in excess of the related note coupon interest rate). The
notional amounts decline each month to reflect the related normal principal
amortization, curtailments and prepayments for the related underlying
mortgage loans. At December 31, 1998 the interest only notes were divided
into two major categories; the first group had an effective weighted
average interest rate of 1.166% on a notional balance of $259,861,000 and
the second group had an effective weighted average interest rate of 0.25%
on a notional balance of $143,666,000.
(e) The 1998-B private placement notes represented a $12,003,000 subordinated
interest in $238,330,000 of mortgage loans at June 30, 1999, and a
$14,279,000 subordinated interest in $297,682,000 of mortgage loans at
December 31, 1998.
HELD TO MATURITY
At June 30, 1999, the Company had $7,181,000 of fixed rate mortgage securities
classified as held to maturity. These mortgage securities are secured by fixed
rate mortgage loans on single-family residential housing. The following tables
summarize certain characteristics of the Company's fixed rate mortgage
securities classified as held to maturity, which are carried at cost (dollars in
thousands):
15
<PAGE> 16
MORTGAGE SECURITIES HELD TO MATURITY
<TABLE>
<CAPTION>
JUNE 30, 1999
Third Party 1998-B
Private Private
Placement Placement
Notes (a) Notes (b) Total
---------- -------- ----------
<S> <C> <C> <C>
Principal balance of mortgage securities $ 6,149 $ 2,989 $ 9,138
Net premium (discount) (2,461) 419 (2,042)
Deferred costs 0 227 227
Loan loss provision (6) (136) (142)
---------- -------- ----------
Carrying cost of mortgage securities $ 3,682 $ 3,499 $ 7,181
========== ======== ==========
Mix 51.27% 48.73% 100.00%
Principal balance of mortgage loans (d) $1,089,683 $238,330 $1,328,013
Weighted average net coupon 6.478% 10.395% 7.656%
Weighted average maturity 320 301 317
<CAPTION>
DECEMBER 31, 1998
1998-B
Private
Placement
Notes (c)
--------
Principal balance of mortgage securities $ 3,816
Net premium (discount) 348
Deferred costs 314
--------
Carrying cost of mortgage securities $ 4,478
========
Mix 100.00%
Principal balance of mortgage loans (d) $297,682
Weighted average net coupon 9.899%
Weighted average maturity 307
</TABLE>
(a) Represents twelve below investment grade notes purchased from third parties
in the second quarter of 1999. The coupon interest rates on the below
investment grade notes are fixed and range from 6.25% to 6.68%. These notes
generate normal principal and interest remittances to the Company on a
monthly basis.
(b) Represents six below investment grade notes and three principal only notes
purchased from an affiliate, HCP-2, in October 1998 in connection with the
1998-B securitization. The coupon interest rates on the below investment
grade notes are fixed and range from 6.50% to 6.75%. These notes generate
normal principal and interest remittances to the Company on a monthly
basis.
(c) Represents nine below investment grade notes and three principal only notes
purchased from an affiliate, HCP-2, in October 1998 in connection with the
1998-B securitization. The coupon interest rates on the below investment
grade notes are fixed and range from 6.25% to 6.75%. These notes generate
normal principal and interest remittances to the Company on a monthly
basis.
16
<PAGE> 17
(d) The third party private placement notes represented a $6,149,000
subordinated interest in $1,089,683,000 of mortgage loans at June 30. The
1998-B private placement notes represented a $2,989,000 subordinated
interest in $238,330,000 of mortgage loans at June 30, 1999 and a
$3,816,000 subordinated interest in $297,682,000 of mortgage loans at
December 31, 1998.
The average effective yield, which includes amortization of net premiums and
deferred costs, for the periods shown below on the combined available for sale
and held to maturity mortgage securities portfolio were as follows:
1999 1998
---- ----
Quarter ended March 31 8.784% 6.116%
Quarter ended June 30 8.752% 3.992%
The proceeds and gross realized gain from sales of mortgage securities in March
1999 was as follows (dollars in thousands):
REALIZED
PROCEEDS GAIN
-------- --------
Private placement notes (a) $2,249 $163
====== ====
(a) Relates to the sale of six private placement notes acquired from HCP-2 in
October 1998.
5. LOAN LOSS PROVISION
The provision for loan loss charged to expense is based upon actual credit loss
experience and management's estimate and evaluation of potential losses in the
existing mortgage loan and mortgage securities portfolio, including the
evaluation of impaired loans. The following table summarizes the activity in the
loan loss provision for the following periods (dollars in thousands):
SIX MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1999 1998
-------------- ---------------
Balance - beginning of period $373 $ 18
Loan loss provision 232 148
Transfers/sales 39 --
Charge-offs (82) --
---- ----
Balance - end of period $562 $166
==== ====
6. EQUITY INVESTMENTS
Hanover owns 100% of the non-voting preferred stock of Hanover Capital Partners
Ltd. ("HCP"), which represents a 97% ownership interest in HCP and its wholly
owned subsidiaries. Hanover also owns 100% of the non-voting preferred stock of
Hanover Capital Partners 2, Inc. ("HCP-2"), which represents a 99% ownership
interest in HCP-2 and its wholly owned subsidiary. Hanover conducts
substantially all of its taxable business operations (i.e. due diligence
consulting, loan sale advisory, and loan brokering and trading) through HCP.
HCP-2 was organized in October 1998 to facilitate the securitization of $318
million of fixed and adjustable rate residential mortgage loans in connection
with the issuance of the Hanover Capital 1998-B security. HCP-2 does not conduct
any ongoing business.
17
<PAGE> 18
Hanover records its investment in HCP and HCP-2 on the equity method.
Accordingly, Hanover records 97% of the earnings or losses of HCP and 99% of the
earnings or losses of HCP-2 through its ownership of all of the non-voting
preferred stock of HCP and HCP-2, respectively. Summarized financial information
for HCP and HCP-2 is detailed below:
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except as noted)
(unaudited)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash $ 302 $ 635
Receivables from related parties 205 517
Other current assets 972 672
------ ------
Total current assets 1,479 1,824
PROPERTY AND EQUIPMENT- Net 116 141
INCOME TAX RECEIVABLE -- 220
OTHER ASSETS 1,167 930
------ ------
TOTAL ASSETS $2,762 $3,115
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $554 $467
Note payable to related party 1,053 713
Other current liabilities 35 110
------ ------
Total current liabilities 1,642 1,290
------ ------
STOCKHOLDERS' EQUITY:
Preferred stock: $.01 par value, 100,000 shares
authorized, 97,000 shares outstanding 1 1
Common stock:
Class A: $.01 par value, 5,000 shares authorized,
3,000 shares outstanding -- --
Additional paid-in capital 2,840 2,840
Retained earnings (deficit) (1,721) (1,016)
------ ------
Total stockholders' equity 1,120 1,825
------ ------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $2,762 $3,115
====== ======
</TABLE>
18
<PAGE> 19
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1999 JUNE 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Due diligence fees $1,060 $1,163 $1,944 $2,239
Mortgage sales and servicing 119 70 191 641
Loan brokering and other income 374 137 600 320
------ ------ ------ ------
Total revenues 1,553 1,370 2,735 3,200
------ ------ ------ ------
EXPENSES:
Personnel expense 1,398 1,303 2,685 2,591
General and administrative expense 121 156 276 321
Other expenses 300 353 565 645
Interest expense 93 32 107 63
Depreciation and amortization 21 26 42 54
------ ------ ------ ------
Total expenses 1,933 1,870 3,675 3,674
------ ------ ------ ------
(LOSS) BEFORE INCOME
TAX (BENEFIT) (380) (500) (940) (474)
INCOME TAX (BENEFIT) (95) (199) (235) (185)
------ ------ ------ ------
NET (LOSS) $ (285) $ (301) $ (705) $ (289)
====== ====== ====== ======
</TABLE>
HCP and its subsidiaries operate as a specialty finance company which is
principally engaged in performing due diligence consulting services, loan sale
advisory services and loan brokering and trading. A wholly-owned subsidiary of
HCP, Hanover Capital Mortgage Corporation ("HCMC"), operates as a servicer of
multifamily mortgage loans and prior to June 1999 was an originator of
multifamily and commercial mortgage loans. HCMC's origination operations were
discontinued in June 1999. Another wholly-owned subsidiary of HCP, Hanover
Capital Securities, Inc. ("HCS"), is a registered broker/dealer with the
Securities and Exchange Commission.
19
<PAGE> 20
HANOVER CAPITAL PARTNERS 2, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except as noted)
(unaudited)
<TABLE>
<CAPTION>
ASSETS JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Mortgage loans:
Collateral for CMOs and
mortgage-backed bonds $240,827 $300,599
Cash and cash equivalents -- 143
Accrued interest receivable 1,458 1,868
Deferred financing costs 2,745 3,191
-------- --------
TOTAL ASSETS $245,030 $305,801
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
CMO borrowing $238,330 $297,682
Accrued interest payable 1,458 1,868
Due to related parties 361 310
Accrued expenses and other
liabilities -- 154
-------- --------
Total liabilities 240,149 300,014
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock par value $.01
authorized, 9,900 shares; issued
and outstanding, 9,900 shares
Common stock, par value $.01
authorized, 100 shares; issued
and outstanding, 100 shares
Additional paid-in capital 14,319 14,319
Retained earnings (deficit) (9,438) (8,532)
-------- --------
Total stockholders' equity 4,881 5,787
-------- --------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $245,030 $305,801
======== ========
</TABLE>
20
<PAGE> 21
HANOVER CAPITAL PARTNERS 2, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
1999 1999
-------------- --------------
<S> <C> <C>
REVENUES
Interest income
Interest income $ 4,555 $ 9,607
Amortization of premium (106) (223)
Amortization of deferred costs (99) (207)
------- -------
Total interest income 4,350 9,177
------- -------
Interest expense
Interest expense 4,555 9,607
Amortization of deferred
financing costs 228 475
------- -------
Total interest expense 4,783 10,082
------- -------
Net interest (expense) (433) (905)
------- -------
EXPENSES:
Operating -- 1
------- -------
NET (LOSS) $ (433) $ (906)
======= =======
</TABLE>
Hanover Capital Partners 2, Inc. was formed to acquire single-family residential
mortgage loans from Hanover pursuant to its formation transaction and to finance
the purchase of these mortgage loans through a REMIC securitization, Hanover
Capital 1998-B. Hanover SPC-2, Inc., a wholly owned subsidiary of HCP-2, was
incorporated for the sole purpose of selling certain investment grade and
subordinated securities to certain wholly-owned subsidiaries of Hanover.
7. REVERSE REPURCHASE AGREEMENTS
Reverse repurchase agreements are accounted for as collateralized financing
transactions and recorded at their contractual amounts. At June 30, 1999 the
Company had a total of $400 million of committed and uncommitted mortgage asset
reverse repurchase agreement financing available pursuant to master reverse
repurchase agreements with three lenders. All borrowings pursuant to the master
repurchase agreements are secured by mortgage loans or other securities.
The reverse repurchase agreements collateralized by mortgage loans are short
term borrowings with interest rates that vary from LIBOR plus 100 basis points
to LIBOR plus 238 basis points. The lender will typically finance an amount
equal to 80% to 97% of the market value of the pledged collateral (mortgage
loans) depending on certain characteristics of the collateral (delinquencies,
liens, aging, etc.). The reverse repurchase agreement financing rates for
mortgage securities, accomplished through individual Public Securities
Association (PSA) agreements and through existing reverse repurchase agreements,
bear interest rates that vary from LIBOR to
21
<PAGE> 22
LIBOR plus 288 basis points. The lender will typically finance an amount equal
to 60% to 97% of the market value of the mortgage securities, depending on the
nature of the collateral.
At June 30, 1999 the Company had outstanding borrowings on mortgage loans of
$109,016,000 under the above mentioned reverse repurchase agreements with a
weighted average borrowing rate of 6.241% and a weighted average remaining
maturity of less than two months. The reverse repurchase financing agreements at
June 30, 1999 were collateralized by mortgage loans with a cost basis of
$116,122,000.
At June 30, 1999, the Company had outstanding borrowings on retained CMO
securities of $1,543,000 with a weighted average borrowing rate of 6.631% and a
weighted average remaining maturity of less than two months. Retained CMO
securities represent the Company's net investment in the CMOs issued by the
Company. The reverse repurchase financing agreements at June 30, 1999 were
collateralized by securities with a cost basis of $2,368,000.
At June 30, 1999, the Company had outstanding reverse repurchase agreement
financing for purchased mortgage securities of $54,094,000 with a weighted
average borrowing rate of 5.173% and a remaining maturity of less than one
month. Purchased mortgage securities are mortgage securities that the Company
has purchased or created in transactions other than CMOs. The repurchase
agreement financing at June 30, 1999 was collateralized by securities with a
cost basis of $57,411,000.
The table below details the scheduled maturities of the Company's committed and
uncommitted master reverse repurchase agreements at June 30, 1999:
<TABLE>
<CAPTION>
Committed Uncommitted Maturity Date
--------- ----------- -------------
<S> <C> <C> <C>
$ 50 million -- April 2000
100 million $100 million March 2000
150 million -- July 1999
</TABLE>
Information pertaining to reverse repurchase agreement financing as of and for
the three months ended June 30, 1999 is summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
Purchased
Mortgage Retained CMO Mortgage
REVERSE REPURCHASE AGREEMENTS Loans Securities Securities
----------------------------- ------ ---------- ----------
<S> <C> <C> <C>
Balance of borrowing at end of period $109,016 $1,543 $54,094
Average borrowing balance during the period $113,125 $1,518 $58,395
Average interest rate during the period 6.150% 6.379% 4.996%
Maximum month-end borrowing balance
during the period $121,972 $1,543 $61,559
COLLATERAL UNDERLYING THE AGREEMENTS
------------------------------------
Balance at end of period - carrying value $116,122 $2,368 $57,411
</TABLE>
8. CMO AND MORTGAGE-BACKED BONDS BORROWING
The Company issued its first collateralized mortgage obligation ("CMO", also
referred to as mortgage-backed bonds) borrowing secured by fixed rate mortgage
loans in April 1998 and issued its second CMO borrowing secured by fixed rate
and adjustable rate mortgage loans in March 1999. For GAAP purposes, the
mortgage loans financed through the issuance of CMOs
22
<PAGE> 23
are treated as assets of the Company and the CMOs are treated as debt of the
Company. Borrower remittances received on the CMO collateral are used to make
payments on the CMOs. The obligations of the CMO are payable solely from the
underlying mortgage loans collateralizing the debt and otherwise are
non-recourse to the Company. The maturity of each class of CMO is directly
affected by principal prepayments on the related CMO collateral. Each class of
CMO is also subject to redemption according to specific terms of the respective
indenture agreements. As a result, the actual maturity of any class of CMO is
likely to occur earlier than its stated maturity.
Information pertaining to the CMOs as of and for the three months ended June 30,
1999 is summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
1999-A 1998-A
SECURITIZATION SECURITIZATION TOTAL
-------------- -------------- -----
<S> <C> <C> <C>
Balance of borrowing at end of period $121,639 $62,279 $183,918
Average borrowing balance during the period $126,067 $65,791 $191,858
Average interest rate during the period 6.867% 6.829% 6.854%
Interest rate at end of period 6.899% 6.747% 6.848%
Maximum month-end borrowing balance
during the period $127,782 $66,934 $194,716
CMO AND MORTGAGE-BACKED BONDS COLLATERAL
- ----------------------------------------
Balance at end of period - carrying balance $129,847 $66,177 $196,024
</TABLE>
9. AFFILIATED PARTY TRANSACTIONS
The Company engaged HCP pursuant to a Management Agreement to render among other
things, due diligence, asset management and administrative services. The
consolidated statement of operations of the Company for the three months ended
June 30, 1999 includes management and administrative expenses of $177,000, due
diligence expenses of $44,000 and commissions of $5,000 relating to billings
from HCP. The consolidated statement of operations of the Company for the three
months ended June 30, 1998 included management and administrative expenses of
$168,000, due diligence expenses of $245,000 and commissions of $92,000 relating
to billings from HCP.
23
<PAGE> 24
Amounts due from related parties and due to related parties are detailed below
(dollars in thousands):
INTERCOMPANY BALANCES
---------------------
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
Due from HCP-2 $361 $310
Due from HCP 16 3
---- ----
$377 $313
==== ====
Due to HCP $41 --
==== ====
NOTES RECEIVABLE
----------------
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
Principals (a) (b) $3,111 $3,180
HCP 1,053 713
------ ------
$4,164 $3,893
====== ======
(a) The Principals are the four most senior officers/stockholders of Hanover.
(b) In March 1999, Hanover agreed to amend certain notes receivable (aggregating
$1,203,880) from the Principals that had a scheduled maturity date of March 31,
1999, by extending the maturity date for two additional years. The notes were
also modified to provide for accelerated repayment by a Principal in the event
of such Principals' voluntary termination of employment.
10. COMMON STOCK REPURCHASES
In July 1998, the Board of Directors of the Company authorized a share
repurchase program pursuant to which the Company was authorized to repurchase up
to 646,880 shares of the Company's outstanding common stock. The repurchases
were made from time to time in open market transactions. During the six months
ended June 30, 1999 the Company repurchased 495,000 shares of its common stock
at an average price of $4.51 per share for a total cost of $2,236,000. Through
June 30, 1999 the Company had repurchased a total of 641,900 shares of its
common stock at an average price of $5.58 per share for a total cost of
$3,580,000.
11. STOCK WARRANTS
In November 1998 Hanover entered into a short term financing agreement (that has
since terminated) with Residential Funding Corporation ("RFC"). In connection
with such financing arrangement, Hanover in April 1999 executed a Warrant
Agreement to issue and deliver to RFC warrants to purchase 299,999 shares of
Hanover's common stock exercisable at a price per share equal to the closing
price of Hanover's common stock on the American Stock Exchange on the date of
the November agreement, which was $4.00 per share. The warrants expire after
five years, in April 2004.
24
<PAGE> 25
12. GAIN ON SALE OF SERVICING RIGHTS
On March 31, 1999 Hanover entered into an agreement to sell the servicing rights
on $148 million of single-family mortgage loans. The total gain on the sale of
mortgage servicing rights was $566,000. A portion of the gain, ($344,000)
relating to mortgage loans that were previously securitized, was recognized at
the time of the sale, the balance of the gain ($222,000) relating to mortgage
loans classified as held for sale, was deferred and is being amortized into
interest income over the lives of the mortgage loans using the effective yield
method until the mortgage loans are either sold or securitized.
13. SUBSEQUENT EVENTS
On July 23, 1999 the Board of Directors of Hanover declared a cash dividend of
$0.10 per share for the second quarter of 1999 payable on August 23, 1999 to
stockholders of record as of August 12, 1999.
On July 23, 1999 Hanover's Board of Directors adopted and approved the 1999
Equity Incentive Plan (the "1999 Plan") which provides for the grant of both
non-qualified options and shares of restricted stock. The 1999 Plan is intended
to attract, retain and motivate employees, non-employee directors, and
consultants of the Company and to enable them to participate in the growth of
the Company by providing for or increasing the proprietary interests of such
persons in the Company. Awards may be granted pursuant to the 1999 Plan in
respect of up to 550,710 shares of Hanover's common stock.
25
<PAGE> 26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Hanover Capital Mortgage Holdings, Inc. ("Hanover") was incorporated in Maryland
on June 10, 1997. Hanover is a real estate investment trust ("REIT"), formed to
operate as a specialty finance company. The principal business strategy of
Hanover and its wholly-owned subsidiaries, (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 and (iii) acquire subordinated mortgage securities similar in nature to
the retained interests generated from internal securitizations. The principal
business strategy of the Company's primary unconsolidated subsidiary, Hanover
Capital Partners Ltd. ("HCP"), is to generate consulting fee income by (i)
performing loan file due diligence reviews for third parties, (ii) performing
loan sale advisory services and (iii) brokering and trading portfolios of loans.
Until recently, HCP was also engaged in the business of originating multifamily
and commercial loans. This business was discontinued in the quarter ended June
30, 1999 and all charges associated with its discontinuance were recognized in
the quarter.
The Company's principal business objective is to generate net interest income on
its portfolio of mortgage loans and mortgage securities, and to generate fee
income through HCP. The Company acquires single-family mortgage loans through a
network of sales representatives targeting financial institutions throughout the
United States. Hanover operates as a tax-advantaged REIT and is generally not
subject to Federal and state income tax to the extent that it distributes its
earnings to its stockholders and maintains its qualification as a REIT. Taxable
affiliates of Hanover, however, are subject to Federal and state income tax.
Hanover has engaged HCP to render due diligence, asset management and
administrative services pursuant to a Management Agreement.
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 obligations (CMO), real estate
mortgage investment conduits (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 .
26
<PAGE> 27
RESULTS OF OPERATIONS
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
-------------------- -----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net interest income $1,733 $ 774 $3,784 $2,933
Loan loss provision (113) (97) (232) (148)
Gain on sale of servicing rights 2 -- 344 --
Gain (loss) on sale of mortgage assets -- (49) 163 (49)
------ ------ ------ ------
Total revenues 1,622 628 4,059 2,736
Expenses 860 978 1,685 1,832
------ ------ ------ ------
Operating income (loss) 762 (350) 2,374 904
Equity in (loss) of unconsolidated subsidiaries (704) (294) (1,580) (300)
------ ------ ------ ------
Net income (loss) $ 58 $ (644) $ 794 $ 604
====== ====== ====== ======
Basic earnings (loss) per share $ 0.01 $(0.10) $ 0.13 $ 0.09
====== ====== ====== ======
Dividends declared per share (a) $ 0.10 $ 0.21 $ 0.30 $ 0.42
====== ====== ====== ======
</TABLE>
(a) The dividends relating to the three months ended June 30, 1999 were
declared on July 23, 1999.
The Company recorded net income of $58,000 or $0.01 per share based on 5,886,240
weighted shares of common stock outstanding for the quarter ended June 30, 1999
compared to a net loss of $(644,000) or $(0.10) per share based on 6,468,160
weighted shares of common stock outstanding for the same period in 1998. Total
revenues for the three months ended June 30, 1999 were $1,622,000 as compared to
$628,000 for the three month period ended June 30, 1998 (an increase of 158.2%).
The second quarter 1998 revenues were negatively impacted by soaring prepayment
speeds on the Company's Agency mortgage securities portfolios. As a result of
prepayment speeds increasing by more than 42% from the first quarter of 1998 to
the second quarter of 1998, the Company reflected premium amortization of
$2,148,000 in the second quarter of 1998 compared to $903,000 in the first
quarter of 1998.
Operating expenses for the second quarter of 1999 were $860,000, approximately
12.0% lower than in the similar period in 1998 ($978,000). The overall decrease
in operating expenses ($118,000) resulted from sizeable reductions in due
diligence and commission expenses, which were somewhat offset by increases in
the legal and professional category.
27
<PAGE> 28
The equity in loss of unconsolidated subsidiaries for the second quarter of 1999
($704,000) reflects a wide negative variance to the similar period in 1998
($294,000). This variance relates to the Company's investment in Hanover Capital
Partners 2, Inc. ("HCP-2"), an unconsolidated mortgage finance subsidiary that
was organized in October 1998 to execute a REMIC financing securitization for
the Company. The financing structure required certain costs of the
securitization (net premiums, hedging and deferred financing costs) to be
capitalized in this subsidiary. Substantially all of the $4,881,000 of net
equity in HCP-2 consists of these capitalized expenses. These deferred financing
costs are being amortized through net interest income (expense) over the
anticipated life of the respective mortgage loans. The Company reflects its
economic ownership percentage (99%) of this net loss.
For the six month period ended June 30, 1999, the Company reflected net income
of $794,000 or $0.13 per share, based on 6,064,606 weighted shares of common
stock outstanding, compared to the same period in 1998 when the Company
reflected net income of $604,000 or $0.09 per share based on 6,467,423 weighted
shares of common stock outstanding. Total revenues for the first two quarters of
1999 were $4,059,000 compared to $2,736,000 in the first two quarters of 1998,
an increase of 48.3%. The increase in revenues from 1998 to 1999 related to
increased premium amortization recorded in the second quarter of 1998 resulting
from very high prepayments on the Company's investment in Agency mortgage
securities, gains on the sale of mortgage servicing rights and the sale of
mortgage securities transacted in the first six months of 1999.
Operating expenses for the six months ended June 30, 1999 were $147,000 lower
than in the similar period in 1998. The Company did not purchase any mortgage
loans during the first six months of 1999 and accordingly incurred only a
fraction of the due diligence and commission expenses in 1999 ($112,000) as
compared to 1998 ($637,000) when the Company purchased in excess of $530,000,000
of mortgage loan pools. Offsetting the cost savings in due diligence and
commission expense were substantial increases in legal and professional expenses
($313,000).
During the first six months of 1998 the Company reflected a loss from its equity
investment in HCP of $(300,000). For the six month period ended June 30, 1999
the Company reflected a loss from its equity investment in HCP of $(684,000).
The losses generated by HCP in 1998 were considerably less than in 1999 because
HCP recorded revenues in 1998 of $400,000 as a result of a special consulting
assignment and an additional $350,000 of gains from the sale of mortgage
servicing rights owned by HCMC, a wholly owned subsidiary of HCP.
During the first six months of 1999, the Company reflected a loss from its
equity investment in HCP-2 of $896,000. There was no comparable loss in 1998,
since HCP-2 was formed in October 1998. As noted above, HCP-2's net loss is the
result of the amortization of approximately $4,881,000 of capitalized expenses,
which were created in the October 1998 securitization.
The table below highlights the Company's historical trends and components of
return on average equity.
28
<PAGE> 29
COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)
<TABLE>
<CAPTION>
Gain (loss) on Equity in
Net Interest Sale of Operating Earnings (Loss) Annualized
For the Income/ Assets/ Expenses/ of Subsidiaries/ 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%
December 31, 1998 11.12% (32.76%) 7.55% (4.89%) (34.08%)
March 31, 1999 11.36% 2.97% 4.85% (5.15%) 4.33%
June 30, 1999 9.89% 0.01% 5.25% (4.30%) 0.35%
</TABLE>
(1) Average equity excludes unrealized loss on investments available for sale.
(2) The Company was organized on June 10, 1997, but did not begin operations
until September 19, 1997.
(3) Average equity is based on equity balance at September 19, 1997 (IPO date)
and equity balance at September 30, 1997, excluding unrealized loss on
investments available for sale.
The following table reflects the average balances for each major category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities with the corresponding effective rate of interest annualized for the
periods shown below (dollars in thousands):
<TABLE>
<CAPTION>
INTEREST EARNING ASSETS AND RELATED LIABILITIES
-----------------------------------------------
QUARTER ENDED QUARTER ENDED
JUNE 30, 1999 JUNE 30, 1998
--------------------------------------------------------
Average Effective Average Effective
Balance Rate (2) Balance Rate (2)
<S> <C> <C> <C> <C>
Interest earning assets
Mortgage loans (1) $123,945 7.010% $370,811 7.371%
CMO collateral 1999-A 134,565 7.302%
CMO collateral 1998-A 69,904 6.637% 92,272 7.158%
FNMA swap securities 50,659 6.904%
Private placement notes - 1998-B 16,079 14.111%
Private placement notes - third
parties 1,183 18.466%
Purchased Agency securities 2,960 7.383% 281,933 3.992%
-------- ------ -------- ------
$399,295 7.352% $745,016 6.066%
======== ====== ======== ======
Interest bearing liabilities
Reverse repurchase borrowings on
mortgage loans $113,125 6.150% $332,424 6.452%
CMO borrowing - 1999-A 126,067 6.761%
CMO borrowing - 1998-A 65,791 6.850% 88,069 6.901%
Reverse repurchase borrowings on:
CMO collateral - 1998-A 1,518 6.379% 1,076 7.031%
FNMA swap securities 49,670 5.346%
Private placement notes - 1998-B 5,265 5.691%
Private placement notes - third
parties 571 6.061%
Purchased Agency securities 2,889 5.018% 272,176 5.616%
-------- ------ -------- ------
$364,896 6.394% $693,745 6.241%
======== ====== ======== ======
Net interest earning assets $ 34,399 $ 51,271
======== ========
Net interest spread 0.958% (0.175%)
====== ======
Yield on net interest earning
assets (3) (4) 17.519% 3.700%
====== ======
</TABLE>
(1) Includes mortgage loans held for sale and mortgage loans held to maturity.
29
<PAGE> 30
(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.
(4) This yield does not reflect the Company's combined overall effective yield
and the Company's total investment in private placement mortgage securities
because the table does not reflect net interest expense of and equity
employed by the Company's unconsolidated subsidiary, HCP-2. See the
discussion on page 39.
NET INTEREST INCOME
Net interest income for the three months ended June 30, 1999 was $1,733,000
compared to net interest income of $774,000 for the three months ended June 30,
1998. The following table reflects net interest income generated for each period
(dollars in thousands):
NET INTEREST INCOME
-------------------
QUARTER QUARTER
ENDED ENDED
JUNE 30, JUNE 30,
1999 1998
-------- --------
Mortgage loans $ 413 $ 1,412
CMO collateral - 1999-A 326 --
CMO collateral - 1998-A 9 113
FNMA swap securities 203 --
Private placement notes - 1998-B 491 --
Private placement notes - third party 46 --
------- -------
Core business - subtotal 1,488 1,525
------- -------
Purchased Agency securities 18 (1,050)
Other 227 299
------- -------
Total $ 1,733 $ 774
======= =======
30
<PAGE> 31
CORE BUSINESS - MORTGAGE LOANS
Net interest income generated from investments in mortgage loans (classified as
held for sale and held to maturity) during the three months ended June 30, 1999
and 1998, respectively, is detailed below (dollars in thousands):
QUARTER QUARTER
ENDED ENDED
JUNE 30, JUNE 30,
1999 1998
-------- --------
MORTGAGE LOANS
- --------------
Average asset balance $123,945 $370,811
Average repo balance 113,125 332,424
-------- --------
Net interest earning assets $ 10,820 $ 38,387
======== ========
Average leverage ratio 91.270% 89.648%
======== ========
Effective interest income rate 7.010% 7.371%
Effective interest expense rate 6.150% 6.452%
-------- --------
Net interest spread 0.860% 0.919%
======== ========
Interest income $ 2,172 $ 6,833
Interest expense 1,759 5,421
-------- --------
Net interest income $ 413 $ 1,412
======== ========
Yield on net interest earning assets 15.282% 14.712%
======== ========
The Company's core business of acquiring single-family seasoned mortgage loans
and holding the loans prior to making a determination as to whether the mortgage
loans will be securitized generated net interest income of $413,000 in the
second quarter of 1999 compared to $1,412,000 in the second quarter of 1998.
The Company held 67% fewer average mortgage loans in the second quarter of 1999
compared to the second quarter of 1998 ($123,945 vs. $370,811). The Company did
not purchase any mortgage loans in the second quarter of 1999. In the same
period during 1998 the Company purchased $272 million (par value) of mortgage
loans. The net interest spread decreased by 6.4% (from 0.919% to 0.860%). The
decrease in net interest spread is attributable to (i) higher prepayment speeds
(20% in the second quarter of 1998 compared to 27% in the second quarter of
1999), (ii) increase in non-accrual of interest income on delinquent mortgage
loans, and (iii) securitizing higher rated coupon mortgage loans.
31
<PAGE> 32
CORE BUSINESS - CMO COLLATERAL - 1999-A
Net interest income generated from the CMO collateral for the 1999-A
securitization during the second quarter of 1999 is detailed below (dollars in
thousands):
QUARTER
ENDED
JUNE 30,
CMO Collateral - 1999-A 1999
- ----------------------- --------
Average asset balance $134,565
Average CMO borrowing balance 126,067
--------
Net interest earning assets $ 8,498
========
Average leverage ratio 93.685%
========
Effective interest income rate 7.302%
Effective interest expense rate 6.761%
--------
Net interest spread 0.541%
========
Interest income $ 2,457
Interest expense 2,131
--------
Net interest income $ 326
========
Yield on net interest earning assets 15.334%
========
In March 1999, the Company securitized $138,357,000 (par value) of mortgage
loans. The securitization was accomplished in a grantor/owner trust format (CMO)
which entailed the creation of a wholly-owned subsidiary, Hanover SPC-A, Inc.
The transaction was accounted for as a financing for both GAAP and tax
accounting purposes.
In a financing, the Company continues to record 100% of the interest income, net
of servicing and other fees, generated by the mortgage loans. The sole source of
financing for these mortgage loans was the CMO borrowing. This financing
represents the liability for certain investment grade mortgage notes issued by
the Company - $121,639,000 at June 30, 1999. The interest expense on this
financing represents the coupon interest amount to be paid to those note
holders. The notes, except for the interest only and principal only notes, have
fixed coupon interest rates of 6.50% and 6.75% and an adjustable rate at 5.68%
at June 30, 1999. The interest only notes generate monthly interest from the
excess interest generated on the underlying mortgages after deducting all
service fees and the coupon interest rate on the applicable notes. The interest
rate on each of the interest only notes is based on a notional amount (the
principal balance of those mortgage loans with an interest rate in excess of the
related notes' coupon interest rate). The notional amounts decline each month to
reflect the related normal principal amortization, curtailments, and prepayments
for the related underlying mortgage loans. Accordingly, the effective interest
rate will decline as prepayments on the underlying mortgages with interest rates
in excess of the coupon rates accelerate. The mortgage loans collateralizing the
mortgage backed bonds experienced annualized prepayment speeds during the second
quarter of 1999 of approximately 20%.
32
<PAGE> 33
CORE BUSINESS - CMO COLLATERAL - 1998-A
Net interest income generated from the CMO Collateral for the 1998-A
securitization during the second quarter of 1999 and 1998 is detailed below
(dollars in thousands):
QUARTER QUARTER
ENDED ENDED
JUNE 30, JUNE 30,
1999 1998
-----------------------------------
CMO Collateral - 1998-A
- -----------------------
Average asset balance $ 69,904 $ 92,272
Average CMO borrowing balance 65,791 88,069
Average repo balance 1,518 1,076
-----------------------------------
Net interest earning assets $ 2,595 $ 3,127
===================================
Average leverage ratio 96.288% 96.611%
===================================
Effective interest income rate 6.637% 7.158%
Effective interest expense rate 6.841% 6.903%
-----------------------------------
Net interest spread (0.204)% 0.255%
===================================
Interest income $ 1,160 $ 1,651
Interest expense 1,151 1,538
-----------------------------------
Net interest income $ 9 $ 113
===================================
Yield on net interest earning assets 1.361% 14.413%
===================================
In April 1998 the Company securitized $102,977,000 (par value) of mortgage
loans. This securitization was accomplished in a REMIC format, which was
accounted for as a financing for GAAP purposes and as a sale for tax accounting
purposes.
In a financing, the Company continues to record 100% of the interest income, net
of servicing fees, generated by the mortgage loans. The primary source of
financing for these mortgage loans is the CMO bonds. This financing represents
the liability for the investment grade mortgage bonds issued by the Company -
$62,279,000 at June 30, 1999. The interest expense on this financing represents
the coupon interest amount to be paid to the investment grade bond holders. The
Company's net equity in the secured transaction represents the non-investment
grade, interest only and principal only bonds. The Company's net equity
investment in collateral for mortgage backed bonds can also be leveraged through
reverse repurchase financing. At June 30, 1999 the Company had $1,543,000 of
reverse repurchase financing on a portion of the collateral for mortgage backed
bonds ($2,368,000). The bonds have fixed coupon interest rates of 6.75% and
7.00%. The mortgage loans collateralizing the mortgage backed bonds experienced
annualized prepayment speeds during the second quarter of 1999 of approximately
28%.
Interest expense includes the interest on the mortgage backed bonds, interest on
the related reverse repurchase agreements and amortization of certain deferred
financing costs.
33
<PAGE> 34
CORE-BUSINESS - FNMA MORTGAGE SECURITIES (SWAPPED FOR THE COMPANY'S MORTGAGE
LOANS)
Net interest income generated from investments in FNMA mortgage securities that
were converted from the Company's mortgage loans during 1999 is detailed below
(dollars in thousands):
QUARTER
ENDED
JUNE 30,
1999
--------
FNMA Mortgage Securities (swapped)
- ---------------------------------
Average asset balance $50,659
Average repo balance 49,670
-------
Net interest earning assets $ 989
=======
Average leverage ratio 98.043%
=======
Effective interest income rate 6.904%
Effective interest expense rate 5.346%
-------
Net interest spread 1.558%
=======
Interest income $ 874
Interest expense 671
-------
Net interest income $ 203
=======
Yield on net interest earning assets 82.159%
=======
In December 1998, the Company exchanged $55.2 million of fixed rate mortgage
loans for a like amount of mortgage securities in the form of 31 FNMA
certificates. The mortgage loans securing the FNMA mortgage securities
experienced annualized prepayment speeds of approximately 16% during the second
quarter of 1999.
34
<PAGE> 35
CORE BUSINESS - PRIVATE PLACEMENT NOTES - 1998-B
Net interest income generated from private placement securities for the 1998-B
securitization, purchased from an affiliate, HCP-2, in October 1998 is detailed
below (dollars in thousands):
QUARTER
ENDED
JUNE 30,
1999 (1)
--------
Private Placement Notes - 1998-B
- --------------------------------
Average asset balance $16,079
Average - repo balance 5,265
-------
Net interest earning assets $10,814
=======
Average leverage ratio 32.745%
=======
Effective interest income rate 14.111%
Effective interest expense rate 5.691%
-------
Net interest spread 8.420%
=======
Interest income $ 567
Interest expense 76
-------
Net interest income $ 491
=======
Yield on net interest earning assets 18.180%
=======
(1) This table does not reflect the Company's combined overall effective yield
and the Company's total investment in private placement mortgage securities
because the table does not reflect net interest income of and equity
employed by the Company's unconsolidated subsidiary, HCP-2. See the
discussion on page 39.
In October 1998, the Company completed its second private placement REMIC
securitization transaction, the 1998-B securitization. Hanover contributed
certain mortgage loan collateral to its newly organized unconsolidated
subsidiary, HCP-2. This had the effect of removing the mortgage loan collateral
from Hanover's balance sheet for GAAP and tax accounting purposes. HCP-2
accounted for the transaction as a financing for GAAP and as a sale for tax
accounting purposes.
HCP-2 issued a REMIC mortgage security and sold all of the REMIC securities
except the "AAA" rated notes to two newly created wholly-owned subsidiaries of
the Company. The Company's investment at June 30, 1999 includes six investment
grade ("AA", "A" and "BBB") notes and six interest only notes. The interest
rates on the investment grade notes are fixed and range from 6.50% to 6.75%.
These notes generate normal principal and interest remittances to the Company on
a monthly basis. The interest only notes generate monthly interest remittances
to the Company (subject to the availability of funds) from the excess interest
generated from the underlying mortgages after deducting all service fees and the
coupon interest rate on the applicable notes. The interest rate on each of the
interest only notes is based on a notional amount (the principal balance of
those mortgage loans with an interest rate in excess of the related note coupon
interest rate). The notional amounts decline each month to reflect the related
normal principal amortization, curtailments and prepayments for the related
underlying mortgage loans. At June 30, 1999 the interest only notes were divided
into two major categories; the first group had an effective weighted average
interest rate of 1.102% on a notional balance of
35
<PAGE> 36
$204,451,000 and the second group had an effective weighted average interest
rate of 0.250% on a notional balance of $113,208,000.
The interest only notes will be adversely affected more than other notes by
higher than expected prepayment speeds on underlying mortgage loans with
interest rates in excess of the net coupon rate. In all likelihood, mortgages
with higher interest rates will be repaid more rapidly than mortgages with lower
interest rates. Accordingly, the effective yield generated by this portfolio is
expected to decrease over time. The underlying mortgage loans were prepaying at
an annualized speed of approximately 30% during the second quarter of 1999,
somewhat higher than expected.
CORE BUSINESS - PRIVATE PLACEMENT NOTES - THIRD PARTIES
Net interest income generated from private placement notes purchased from third
parties is detailed below (dollars in thousands).
QUARTER
ENDED
JUNE 30,
1999
--------
Private Placement Notes-Third Parties
- -------------------------------------
Average asset balance $1,182
Average repo balance 571
------
Net interest earning assets $ 611
======
Average leverage ratio 48.308%
======
Effective interest income rate 18.466%
Effective interest expense rate 6.061%
------
Net interest spread 12.405%
======
Interest income $ 55
Interest expense 9
------
Net interest income $ 46
======
Yield on net interest earning assets 30.046%
======
At June 30, 1999, the Company had an investment of $3,682,000 in 12 subordinated
mortgage-backed securities issued by third parties, all of which were acquired
during the quarter ended June 30, 1999. These securities are either unrated or
are rated "BB" or "B" by a major rating agency. These securities represent
subordinated interests in $1,089,683,000 of mortgage loans. The mortgage loans
underlying these securities are generally newly originated, "A" quality loans.
36
<PAGE> 37
NON-CORE BUSINESS - PURCHASED AGENCY MORTGAGE SECURITIES
Net interest income (loss) generated from purchased Agency mortgage securities
in 1999 and 1998 is detailed below:
QUARTER QUARTER
ENDED ENDED
JUNE 30, JUNE 30,
1999 1998
-------- --------
Purchased Agency Mortgage Securities
- ------------------------------------
Average asset balance $ 2,960 $281,933
Average repo balance 2,889 272,176
------------------------------
Net interest earning assets $ 71 $ 9,757
==============================
Average leverage ratio 97.601% 96.539%
==============================
Effective interest income rate 7.383% 3.992%
Effective interest expense rate 5.018% 5.616%
------------------------------
Net interest spread 2.365% (1.624)%
==============================
Interest income $ 55 $ 2,814
Interest expense 37 3,864
------------------------------
Net interest income (loss) $ 18 $ (1,050)
==============================
Yield on net interest earning assets 101.161% (43.054)%
==============================
The Company invested a significant portion of its initial capital in December
1997, shortly after the inception of the Company, in Agency ARM securities
purchased from various "Wall Street" dealers and in March of 1998, the Company
purchased an additional fixed rate FNMA certificate from another dealer firm.
All of the ARM securities were subsequently sold in October 1998 at a loss of
$5,989,000. The Agency ARM securities experienced extremely high prepayment
speeds from March 1998 through October 1998, causing higher than anticipated
premium amortization write-offs, and accordingly were not contributing any
positive net interest income to the Company. Because of the rapid prepayment
experienced and the Company's desire to increase liquidity the ARM securities
were sold in October 1998. At June 30, 1999 the Company owned only the fixed
rate FNMA mortgage security purchased in March 1998.
OTHER INTEREST INCOME
Interest income generated during the three months ended June 30, 1999 and 1998
from non-mortgage assets is detailed below (dollars in thousands):
QUARTER QUARTER
ENDED ENDED
JUNE 30, JUNE 30,
1999 1998
-------- --------
Overnight investing $169 $ 82
Related party notes 58 60
Cash margin -- 157
---- ----
$227 $299
==== ====
Interest income on cash deposited as additional cash collateral (cash margin)
pursuant to reverse repurchase financing agreements with certain lenders earned
interest at the respective borrowing rate charged by the lender - approximately
5.60%.
37
<PAGE> 38
Interest income recorded on overnight investing was generated for the most part
from investing excess cash in Federal Home Loan Bank discount notes with
interest rates ranging from 4.2% to 4.5%. Overnight investing also includes, to
a much lesser extent, investments in the highest rated commercial paper and
savings accounts.
Notes receivable due from HCP earn interest at 7.0%. The balance due from HCP at
June 30, 1999 and 1998 was $1,053,000 and $2,400,000, respectively. Notes
receivable due from Principals earn interest at the lowest applicable Federal
rate in effect at the time of the loan. The balance due from Principals at June
30, 1999 and 1998 was $3,111,000 and $2,954,000, respectively.
EXPENSES
The Company did not purchase any mortgage loans in the second quarter of 1999
and accordingly incurred little to no expenses for due diligence and commissions
during this period. The due diligence costs incurred during the three months
ended June 30, 1999 ($44,000) related to additional costs identified on mortgage
loan purchases initiated in 1998 and subsequent mortgage loan file documentation
deficiency follow-up expenses. In the second quarter of 1998 the Company
recorded $245,000 and $92,000 of due diligence and commission expenses,
respectively, directly relating to the purchase of $272 million (par value) of
mortgage loans.
The Company continued to experience significant increases in legal and
professional expenses in the second quarter of 1999 ($328,000) compared to the
second quarter of 1998 ($158,000). During the three months ended June 30, 1999
general corporate legal and tax expenses increased greatly as the Company
incurred extensive billings relating to new business opportunities, credit line
negotiations, tax planning strategies, regulatory issues, warrant matters, etc.
For the three months ended June 30, 1999 and 1998 the Company's ratio of
operating expenses to average assets was 0.80% and 0.47%, respectively. The
Company's second quarter 1999 and 1998 operating expenses did not include any
incentive bonus compensation. In order for the eligible participants to earn
incentive bonus compensation, the rate of return on shareholders' investment
must exceed the average ten-year U.S. Treasury rate during the year plus 4.0%.
EQUITY IN (LOSS) OF UNCONSOLIDATED SUBSIDIARIES
Hanover owns 100% of the non-voting preferred stock of HCP, which represents a
97% ownership interest in HCP and its wholly-owned subsidiaries. The Company
conducts all of its taxable businesses (i.e., due diligence consulting, loan
sale advisory, and loan brokering) through HCP. Hanover's investment in HCP is
accounted for on the equity method. Hanover recorded a loss for the three months
ended June 30 1999 and 1998 of $276,000 and $294,000, respectively, from its
equity investment in HCP. HCP revenues in the second quarter of 1999 from due
diligence services, loan sale advisory, loan brokering and mortgage sales and
service, while higher than the corresponding period in 1998 and higher than the
first quarter of 1999, were still disappointing. The multifamily and commercial
mortgage origination business operated by HCMC, a wholly-owned subsidiary of HCP
reflected a pre-tax loss of $102,000 in the second quarter of 1999. Because of
ongoing losses the multifamily and commercial mortgage origination operation was
terminated in the second quarter of 1999.
In October 1998, the Company completed the 1998-B REMIC securitization
transaction through its newly organized unconsolidated subsidiary, HCP-2.
Hanover contributed certain fixed rate
38
<PAGE> 39
mortgage loans, subject to the related reverse repurchase agreement financing,
to HCP-2 in exchange for a 99% economic ownership of HCP-2 (representing a 100%
ownership of the non-voting preferred stock in HCP-2). HCP-2 issued a REMIC
security and sold all of the REMIC security except the "AAA" rated notes to two
newly created wholly-owned subsidiaries of Hanover. Hanover's investment in
HCP-2 is accounted for on the equity method. Hanover recorded a loss in the
second quarter of 1999 from its equity investment in HCP-2 of $428,000.
The loss generated by HCP-2 is a result of the unique securitization transaction
entered into in October 1998. The REMIC security transaction effectively records
all of the underlying mortgage loans as assets and the same amount of CMO.
Accordingly, the gross interest income generated from the underlying mortgages
will match exactly the interest expense relating to the CMO. The net loss
generated by HCP-2 relates to (1) the amortization of net premiums and deferred
hedge costs, reflected as a reduction of interest income, (2) the amortization
of deferred financing costs and (3) to a much lesser extent, certain
administrative expenses. It is expected that HCP-2 will continue to reflect
decreasing losses in the future.
Management believes that the net interest income calculated relating to the
1998-B securitization transaction should be adjusted to reflect the operating
activity recorded from the equity in loss of HCP-2 to more fully comprehend the
yield on the net interest earning assets. Accordingly, the table below reflects
the adjusted net interest income generated from the $318 million securitization
transaction (dollars in thousands):
QUARTER
ENDED
JUNE 30,
1999
--------
Private Placement Notes - 1998-B (as adjusted)
- ----------------------------------------------
Average asset balance (as adjusted) $21,522
Average repo balance 5,265
-------
Net interest earning assets (as adjusted) $16,257
=======
Average leverage ratio (as adjusted) 24.463%
=======
Effective interest income rate (as adjusted) 2.583%
Effective interest expense rate 5.691%
-------
Net interest spread (as adjusted) (3.108)%
=======
Interest income (as adjusted) $ 139
Interest expense 76
-------
Net interest income (as adjusted) $ 63
=======
Yield on net interest earning assets (as adjusted) 1.556%
=======
39
<PAGE> 40
TAXABLE INCOME.
Hanover's taxable income for the three months ended June 30, 1999 is estimated
at $102,000. Taxable income exceeds GAAP net income recorded for the three
months ended June 30, 1999 due to certain book/tax differences. The following
table details the major book/tax differences in arriving at the estimated
taxable income for the three months ended June 30, 1999 (dollars in thousands):
QUARTER ENDED
JUNE 30,
1999
-------------
GAAP net income $ 58
Add: Equity in loss of unconsolidated
subsidiaries 704
Difference in gain recognition on sale
of servicing rights 175
Loan loss provision 113
Less: Additional tax amortization of net
premiums on mortgages, CMO
collateral and mortgage securities (93)
Hedging (cost) settlements (792)
Other (63)
----
Estimated taxable income $102
====
As a REIT, Hanover is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of Hanover's taxable income for each year by the time
Hanover files its Federal tax return. Therefore, a REIT generally passes through
substantially all of its earnings to shareholders without paying Federal income
tax at the corporate level.
LIQUIDITY
The Company expects to meet its future 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 CMOs and REMICs, and additional equity offerings. The
Company considers its ability to generate cash to be adequate to meet operating
requirements both 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 existing sources and ability to access
additional sources of credit 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.
The Company had three reverse repurchase agreement lines of credit in place at
June 30, 1999. One of these lines of credit was renewed in December 1998,
another line of credit was renewed in March 1999 and the third line of credit (a
$50 million line of credit facility) was closed in April 1999. Management may
add additional committed and uncommitted lines of credit in the third and fourth
quarter of 1999.
40
<PAGE> 41
In November 1998, Hanover entered into a short term financing arrangement (that
has since terminated) with Residential Funding Corporation ("RFC"). In
connection with such financing arrangement, Hanover in April 1999 executed a
Warrant Agreement to issue and deliver to RFC warrants to purchase 299,999
shares of Hanover's common stock exercisable at a price per share equal to the
closing price of Hanover's common stock on the American Stock Exchange on the
date of the November agreement, which was $4.00 per share. The warrants expire
after five years, in April 2004.
Net cash provided by operating activities for the six months ended June 30, 1999
was $5,717,000. Cash flows from operating activities were generated by net
income of $794,000, adjusted for certain non-cash items of $2,720,000, normal
recurring changes in operating assets and liabilities ($2,474,000) and net
remittances on loans to Principals of $69,000 and net advances to HCP of
$340,000.
Net cash provided by investing activities amounted to $97,014,000 during the
period from January 1, 1999 through June 30, 1999. The majority of cash proceeds
from investing activities was generated from regular principal amortization
payments, curtailment payments, payoffs of mortgage loans and the resale of
certain mortgage loans back to the original sellers for various document
deficiencies ($58,084,000). Additional proceeds were also received from
principal remittances on mortgage securities ($7,261,000) and CMO and
mortgage-backed bond collateral ($25,838,000), the sale of mortgage assets
($8,760,000) and mortgage servicing rights ($739,000) offset by the purchase of
12 below investment grade mortgage securities ($3,668,000).
Cash flows from financing activities used $102,920,000 during the six months
ended June 30, 1999. During the six months ended June 30, 1999, the Company made
net repayments to its reverse repurchase lenders of $205,437,000 and had net
borrowings on CMOs and mortgage-backed bonds of $106,613,000. The Company also
paid dividends of $1,860,000 and purchased an additional 495,000 shares of its
common stock ($2,236,000) during this six month period.
CAPITAL RESOURCES
The Company had no capital expenditure during the quarter and six months ended
June 30, 1999 and management does not anticipate the need for any material
capital expenditures in the near future.
YEAR 2000 (Y2K) DISCLOSURE
The Y2K issue is the result of computer systems that use two digits rather than
four to define the applicable year, which may prevent such systems from
accurately processing dates ending in the year 2000 and thereafter. This could
result in system failures or in miscalculations causing disruption of
operations, including, but not limited to, an inability to process transactions,
to send and receive electronic data, or to engage in routine activities and
operations.
The following information is provided relating to the Company's Y2K issues:
1. Y2K-READINESS- The Company has reviewed the status of all of its
information technology ("IT") systems and has determined that all of its
computer hardware is Y2K compliant. In addition, the Company has received
satisfactory certification from virtually all of its third party vendors
and/or verified to its satisfaction that their IT systems are Y2K
41
<PAGE> 42
compliant or have indicated that they are on schedule to be Y2K compliant prior
to December 31, 1999.
Key Third Party Vendors Services Provided
- ----------------------- -----------------
Securities dealer firms Financing, facilitate
purchase and sale of mortgage
assets, etc.
Information processing firms Accounting, word processing,
database software systems
Mortgage loan servicers Mortgage loan servicing
Communications firms Telephone, modems, fax,
financial software, internet,
postage
Facilities firms Office space, storage,
security
General Legal and accounting, office
supplies, etc.
By virtue of the responses received from third party vendors, the Company does
not anticipate any significant costs associated with Y2K non-compliance by the
third party vendors. The Company does not own any non-IT systems (i.e. elevator
systems, building air management systems, security and fire control systems).
The Company has received written and/or verbal confirmation that the non-IT
systems located in the Company's principal leased facilities are all Y2K
compliant.
2. Y2K-COSTS - The Company has not incurred any material costs related to its
Y2K issues and believes its total Y2K costs to date have been less than $25,000.
At this time it does not anticipate any material costs will be incurred on as
yet unidentified Y2K issues. The costs of these projects and the dates on which
the Company plans to complete modifications and replacements are based on
management's best estimates, the estimates of third-party specialists, if any,
who may assist the Company, the modification plans of third parties and other
factors. However, these estimates of future Y2K related costs may change if
actual results differ materially from the above indication.
3. Y2K-RISKS- Currently the Company's most reasonably likely worst case scenario
relating to the Y2K issue would occur if any of the companies which service its
mortgage asset portfolios had Y2K problems that prohibited such companies from
either (1) collecting and remitting funds or (2) providing the related loan data
to the Company on a timely basis. A scenario of this type could, if existing for
any significant length of time, create liquidity problems for the Company and
could result in decreased net income through decreased net interest income and
increased operating expenses. If the Company does not receive borrower
remittances from its servicers on a timely basis it may have to (1) use existing
capital, (2) sell other mortgage assets or (3) try to secure additional
financing sources to satisfy lenders' margin calls. Although the likelihood of
such an occurrence seems remote, a total cessation of borrower remittances to
the Company could potentially lead to monetary defaults by the Company on its
repo lending obligations. Additionally, the Company estimates that expenses
would increase as a result of legal and other actions taken to attempt to
collect the funds due the Company. While the Company believes the probability of
the above occurrences to be
42
<PAGE> 43
low, there can be no assurance at this time that the Company will not be
materially adversely affected by possible Y2K problems.
4. Y2K-CONTINGENCY PLANS- The development of contingency plans to handle the
most reasonably likely worst case Y2K scenario has been completed. The Y2K
contingency plans identify individuals within the Company to contact in the
event of a Y2K problem, as well as the availability of back-up systems. The
Company does not currently anticipate the need for any third-party consultants
for remediation efforts.
OTHER MATTERS
REIT Requirements
Hanover has elected to be taxed as a REIT under the Code. Hanover believes that
it was in full compliance with the REIT tax rules as of June 30, 1999 and
intends to remain in compliance with all REIT tax rules. If Hanover fails to
qualify as a REIT in any taxable year and certain relief provisions of the Code
do not apply, Hanover will be subject to Federal income tax as a regular,
domestic corporation, and its stockholders will be subject to tax in the same
manner as stockholders of a regular corporation. Distributions to its
stockholders in any year in which Hanover fails to qualify as a REIT would not
be deductible by Hanover in computing its taxable income. As a result, Hanover
could be subject to income tax liability, thereby significantly reducing or
eliminating the amount of cash available for distribution to its stockholders.
Further, Hanover could also be disqualified from re-electing REIT status for the
four taxable years following the year during which it became disqualified.
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 Exchange Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. These forward-looking
statements 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 reverse repurchase agreement financing; the sufficiency of the
Company's working capital, cash flows 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Other Matters," 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
43
<PAGE> 44
possible decline in the Company's ability to locate and acquire mortgage loans;
the possible adverse effect of changing economic conditions, including
fluctuations in interest rates 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
other mortgage REIT's; and the possible changes, if any, in the 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.
44
<PAGE> 45
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
During the second quarter of 1999 the Company used certain derivative financial
instruments (for purposes other than trading) as hedges of anticipated
transactions relating to its investment portfolio.
The Company from time to time enters into interest rate hedge mechanisms
(forward sales of Agency mortgage securities) to manage its exposure to market
pricing changes in connection with the purchase, holding of, securitization and
sale of its fixed rate mortgage loan portfolio. The Company generally closes out
the hedge position to coincide with the related loan sale or securitization
transactions and recognizes the results of the hedge transaction in determining
the amount of the related loan sale gain or loss for loans sold, or as a basis
adjustment to loans held to maturity.
At June 30, 1999 the Company did not have any forward sales of Agency mortgage
securities that had not yet settled.
The Company only hedges its fixed rate mortgage loan pools by selling short
similar coupon and duration matched Agency securities, usually for 30 to 60 day
periods. This hedging of mortgage assets should, if properly executed, adjust
the carrying value of the hedged fixed mortgage loan pools to reflect current
market pricing. The costs or gains of the individual hedging transactions can
vary greatly depending upon market conditions. Net hedging gains on the fixed
rate mortgage pools were $83,000 during the first six months of 1999. Management
is satisfied that the Company's hedging program has been utilized effectively as
no charges relating to impairment of mortgage loans were booked through June 30,
1999.
The primary risk associated with selling short Agency securities relates to
changes in interest rates. Generally, as market interest rates increase, the
market value of the hedged asset (fixed rate mortgage loans) will decrease. The
net effect of increasing interest rates will generally be a favorable or gain
settlement on the forward sale of the Agency security; this gain will result in
a negative basis adjustment to the hedged assets. Conversely, if interest rates
decrease, the market value of the hedged asset will increase. The net effect of
decreasing interest rates will generally be an unfavorable or loss settlement on
the forward sale of the Agency security; this loss should be offset by a
positive basis adjustment to the hedged assets. To mitigate interest rate risk
an effective matching of Agency securities with the hedged assets needs to be
monitored closely. Senior Management continually monitors the changes in
weighted average duration and coupons of the hedged assets and will
appropriately adjust the amount, duration and coupon of future forward sales of
Agency securities.
The Company also enters into interest rate hedge mechanisms (interest rate caps)
to manage its interest rate exposure on certain reverse repurchase agreement
financing. The cost of the interest rate caps is amortized over the life of the
interest rate cap and is reflected as a portion of interest expense in the
consolidated statement of operations.
At June 30, 1999 the Company had the following interest rate caps in effect
(dollars in thousands):
Notional Amount Index Strike % Maturity Date
- --------------------------------------------------------------------------------
$33,136 3 Month LIBOR 5.75% March 31, 2001
31,023 3 Month LIBOR 5.75% April 30, 2001
-------
$64,159
=======
45
<PAGE> 46
The primary risk associated with interest rate caps relates to interest rate
increases. The interest rate caps provide a cost of funds hedge against interest
rates that exceed 5.75%, subject to the limitation of the notional amount of
financing.
INTEREST RATE SENSITIVITY
MORTGAGE LOAN ASSETS
The Company's mortgage loan assets are classified into two subcategories, fixed
rate loans and adjustable rate loans, and further classified as mortgages held
for sale vs. mortgages held to maturity. The financing of these assets during
the initial period (the time period during which management analyzes the loans
in detail and corrects deficiencies where possible before securitizing the
loans) is accomplished with reverse repurchase agreement ("repo") financing or
with equity alone in certain instances. The unsecuritized mortgage assets held
by the Company at June 30, 1999 were a combination of adjustable rate mortgage
("ARM") loans (69.1%) and fixed rate mortgage loans (30.9%). The yield on the
fixed rate mortgage loans would not be affected by changes in interest rates.
The ARM loans would be affected by interest rate changes depending upon
repricing frequencies, indexes and interest caps. There were no significant
coupon interest rate adjustments on the ARM pools during the second quarter of
1999. The Company's greatest interest rate volatility risk relates to its repo
financing. The Company's repo financing agreements at June 30, 1999 were indexed
to LIBOR plus a spread of 100 to 238 basis points. This financing generally is
rolled and matures every 30 to 90 days. Accordingly, any increases in LIBOR will
tend to reduce net interest income and any decreases in LIBOR will tend to
increase net interest income.
Interest income on the mortgage portfolio is also negatively affected by
prepayments on mortgage loan pools purchased at a premium and positively
impacted by prepayments on mortgage loan pools purchased at a discount. The
Company assigns an anticipated prepayment speed to each mortgage pool at the
time of purchase and records the appropriate amortization of the premium or
discount over the estimated life of the mortgage loan pool. To the extent the
actual prepayment speeds vary significantly from the anticipated prepayment
speeds for an extended period of time, the Company will adjust the anticipated
prepayment speeds and amortization of the premium or discount accordingly. This
will negatively (in the case of accelerated amortization of premiums or
decelerated amortization of discounts) or positively (in the case of decelerated
amortization of premiums or accelerated amortization of discounts) impact net
interest income. Based on management's evaluation of the prepayment speeds
relating to the mortgage loan pools, no such adjustment was deemed necessary for
the three months ended June 30, 1999.
Increases in delinquency rates and defaults by borrowers on their mortgages can
also negatively impact the Company's net interest income. The Company monitors
delinquencies and defaults in its mortgage loan portfolio in three categories:
government, conventional and uninsured. It adjusts its loan loss provision
policy and non-interest accrual policy in accordance with changes in the
delinquency and default trends.
Hedging gains and losses and other related hedging costs are deferred and are
recorded as an adjustment of the hedged assets or liabilities. The hedging gains
("Hedging Gains") and losses ("Hedging Costs") along with the other related
hedging costs are amortized over the estimated life of the asset or liability.
The Company only hedges its fixed rate mortgage portfolio and certain repo
exposure. The hedging program in place at June 30, 1999 included only the
hedging of certain repo liabilities with interest rate caps. The cost of hedging
repo liabilities with interest
46
<PAGE> 47
rate caps was transferred from the mortgage loan category to the mortgage
security category subsequent to the securitization of certain mortgage loans.
The Company's customary hedging of fixed rate mortgage loan pools by selling
short similar duration matched Agency securities, usually for 30 to 60 day
periods, was deemed to be unnecessary at June 30, 1999 due to the relatively low
principal balance of fixed rate mortgage loans held for sale. This hedging of
mortgage assets should, if properly executed, adjust the carrying value of the
fixed mortgage loan pools to reflect current market pricing. The costs of the
individual hedging transactions can vary greatly depending upon the market
conditions. Net Hedging Gains on fixed mortgage pools were $83,000 in the first
quarter of 1999. There were no net Hedging Gains or Hedging Costs in the second
quarter of 1999. Total unamortized Hedging Costs on mortgage loans held for sale
at June 30, 1999 were $305,000. As of June 30, 1999 the estimated fair market
value of these previously hedged assets was slightly higher than the book value
of these assets.
SECURITIZED MORTGAGE LOAN ASSETS
With respect to the match funding of assets and liabilities, the CMO and
mortgage-backed bond collateral relating to the Hanover Capital 1998-A and
Hanover Capital 1999-A securitizations reflect $162,056,000 of fixed rate
mortgage loans and $33,968,000 of adjustable rate mortgage loans at June 30,
1999. The primary financing for this asset category is the CMOs ($183,918,000)
and to a much lesser extent repo agreements ($1,543,000). Only the repo
financing, which is indexed to LIBOR, is subject to interest rate volatility as
the repo agreement matures and is extended. The financing provided by the CMOs
locks in long-term financing and thereby eliminates interest rate risk.
MORTGAGE SECURITIES
At June 30, 1999 the Company owned certain fixed rate Agency and private
placement mortgage securities and certain interest only and principal only
private placement mortgage securities ($70,962,000). The coupon interest rates
on the fixed rate mortgage securities would not be affected by changes in
interest rates. The interest only notes remit monthly interest generated from
the underlying mortgages after deducting all service fees and the coupon
interest rate on the applicable notes. The interest rate on each of the interest
only notes is based on a notional amount (the principal balance of those
mortgage loans with an interest rate in excess of the related note coupon
interest rate). The notional amounts decline each month to reflect the related
normal principal amortization, curtailments and prepayments for the related
underlying mortgage loans. Accordingly, net interest income on the mortgage
securities portfolio would be negatively affected by prepayments on mortgage
loans underlying the mortgage securities and would further be negatively
affected to the extent that higher rated coupon mortgage loans paid off more
rapidly than lower rated coupon mortgage loans.
Certain of the mortgage securities are financed with repo agreements
($54,094,000 at June 30, 1999) indexed to LIBOR, and as such any increase in
LIBOR will tend to reduce net interest income and any decreases in LIBOR will
tend to increase net interest income.
47
<PAGE> 48
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
During the second quarter of 1999, there were 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
Ex. 10.37 Hanover Capital Mortgage Holdings, Inc.
1999 Equity Incentive Plan
(b) Reports on Form 8-K
None
48
<PAGE> 49
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: August 10, 1999 By: /s/ John A. Burchett
--------------- ----------------------
John A. Burchett
Chairman of the Board of
Directors
Dated: August 10, 1999 By: /s/ Thomas P. Kaplan
--------------- ---------------------
Thomas P. Kaplan
Chief Financial Officer
49
<PAGE> 1
Exhibit 10.37
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
1999 EQUITY INCENTIVE PLAN
1. PURPOSE AND DURATION
1.1 Purposes. The purposes of the Hanover Capital Mortgage Holdings, Inc.
1999 Equity Incentive Plan are to attract, retain and motivate employees and
consultants of the Company and its Affiliated Entities and to enable them to
participate in the growth of the Company by providing for or increasing the
proprietary interests of such persons in the Company.
1.2 Effective Date. The Plan is effective as of the date of its adoption by
the Board.
1.3 Expiration Date. The Plan shall expire one day less than ten years from
the date of the adoption of the Plan by the Board. In no event shall any Awards
be made under the Plan after such expiration date, but Awards previously granted
may extend beyond such date.
2. DEFINITIONS
As used in the Plan, the following capitalized words shall have the
meanings indicated:
"Affiliated Entity" means HCP and any other corporation, partnership,
trust, limited liability company or other entity directly or indirectly
Controlling, Controlled by or under direct or indirect common Control with the
Company or HCP.
"Award" means, individually or collectively, a grant under the Plan of
Options or Restricted Stock.
"Award Agreement" means the written agreement setting forth the terms and
provisions applicable to an Award granted under the Plan.
"Board" means the Board of Directors of the Company.
"Code" means the Internal Revenue Code of 1986, as amended.
"Committee" means the Compensation Committee of the Board, which shall
consist of two or more directors, each of whom shall be a Non-Employee Director
and an "outside director" within the meaning of Section 162(m) of the Code, or
any successor provision.
"Company" means Hanover Capital Mortgage Holdings, Inc., a Maryland
corporation, or any successor thereto.
"Control" (including the terms "controlling," "controlled by," and "under
common control with") means the direct or indirect possession of the power to
direct or cause the direction of the management and policies of any corporation,
partnership, trust, limited liability company or other entity, whether through
the ownership of voting securities, by contract, or otherwise.
<PAGE> 2
"Director" means any individual who is a member of the Board.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Fair Market Value" means, with respect to a Share as of any date of
determination, in the discretion of the Committee, (i) the closing price per
Share on such date, as reported in the Wall Street Journal, on the principal
exchange for the Shares, (ii) the average closing price per Share, as reported
in the Wall Street Journal, during the twenty (20) day period that ends on such
date on the principal exchange for the Shares or (iii) if Shares are not
publicly traded, the fair market value of such Share as determined by the
Committee in accordance with a valuation methodology approved by the Committee
in good faith.
"Grant Date" means the effective date of an Award as specified by the
Committee and set forth in the applicable Award Agreement.
"HCP" means Hanover Capital Partners Ltd., a New York corporation, or any
successor thereto.
"Non-Employee Director" means a "non-employee director" as that term is
defined in Rule 16b-3 promulgated under the Exchange Act, or any successor
provision.
"Option" means an option to purchase Shares awarded to a Participant under
Section 6 of the Plan.
"Ownership Limit" means the limitation set forth in Article Ninth of the
Company's Articles of Incorporation on the percentage of the outstanding Shares
that any person or group of persons may own, applying certain constructive
ownership rules set forth therein.
"Participant" means an individual who has been selected by the Committee to
receive an Award under the Plan.
"Plan" means the Hanover Capital Mortgage Holdings, Inc. 1999 Equity
Incentive Plan set forth in this document and as hereafter amended from time to
time in accordance with Section 10.
"Restricted Period" means the period of time selected by the Committee
during which Shares of Restricted Stock are subject to forfeiture and/or
restrictions on transferability.
"Restricted Stock" means Shares awarded to a Participant under Section 7 of
the Plan pursuant to an Award that entitles the Participant to acquire Shares
for a purchase price (which may be zero if permissible under applicable law),
subject to such conditions as the Committee may determine to be appropriate,
including a Company right during a specified period or periods to repurchase the
Shares at their original purchase price (or to require forfeiture of the Shares
if the purchase price was zero and if permissible under applicable law) upon the
Participant's termination of employment.
2
<PAGE> 3
"Securities Act" means the Securities Act of 1933, as amended.
"Shares" means shares of the Company's common stock, par value $.01 per
share.
3. ADMINISTRATION OF THE PLAN
The Plan shall be administered by the Committee, which shall have the
authority to adopt, alter and repeal such administrative rules, guidelines and
practices governing the operation of the Plan as it shall consider advisable
from time to time, to interpret the provisions of the Plan and any Award and to
decide all disputes arising in connection with the Plan. The Committee's
decisions and interpretations shall be final and binding. In the event that
there is no Committee as provided in the Plan, the Plan shall be administered by
the Board, in which case all references in the Plan to the Committee shall be
references to the Board.
4. ELIGIBILITY OF PARTICIPANTS
The persons eligible to receive Awards under the Plan shall be the
executive officers of the Company, the executive officers of any Affiliated
Entity, and any other employees, consultants, advisers and agents of the Company
or any Affiliated Entity who, in the opinion of the Committee, are in a position
to make a significant contribution to the success of the Company. Directors,
including directors who are not employees, of the Company or any Affiliated
Entity shall be eligible to receive Awards under the Plan.
5. STOCK AVAILABLE FOR AWARDS
5.1 Number of Shares Under Plan. Subject to Section 8.12, Awards may be
granted under the Plan in respect of up to 550,710 of the Shares. Shares issued
under the Plan may consist in whole or in part of authorized but unissued Shares
or treasury Shares.
5.2 Lapsed, Forfeited or Expired Awards. If any Award in respect of Shares
expires or is terminated before exercise or is forfeited for any reason, the
Shares subject to such Award, to the extent of such expiration, termination or
forfeiture, shall again be available for award under the Plan.
5.3 Number of Shares Subject to any Award. Subject to Section 8.12, the
number of Shares in respect of which a Participant may receive an Award under
the Plan for any year shall not exceed 50,000.
6. STOCK OPTIONS
6.1 Grant of Options. Subject to the terms and provisions of the Plan, the
Committee may award Options and determine the number of shares to be covered by
each Option, the exercise price therefor, the term of the Option, and any other
conditions and limitations applicable to the exercise of the Option (including,
without limitation, any vesting requirements applicable to the Option) and the
holding of any Shares acquired upon exercise of the Option. Options granted
under the Plan are not intended to be "incentive stock options" within the
meaning of Section 422(b) of the Code.
3
<PAGE> 4
6.2 Exercise Price. Subject to the provisions of this Section 6 and Section
10, the exercise price for each Option shall be determined by the Committee in
its sole discretion.
6.3 Restrictions on Option Transferability and Exercisability. The
Committee may provide that an Option is transferable by the Participant and
exercisable by persons other than the Participant upon such terms and conditions
as it shall determine. In the absence of any such provision as to any Option,
however, the Option shall not be transferable by the Participant other than by
will or the laws of descent and distribution, and the Option shall be
exercisable, during the Participant's lifetime, only by the Participant.
7. RESTRICTED STOCK
7.1 Grant of Restricted Stock. The Committee may award Shares of Restricted
Stock and determine the purchase price, if any, therefor, the duration of the
Restricted Period, the conditions under which the Shares may be forfeited to or
repurchased by the Company and any other terms and conditions of the Awards. The
Committee may modify or waive any restrictions, terms and conditions with
respect to any Restricted Stock. Shares of Restricted Stock may be issued for
whatever consideration is determined by the Committee, subject to applicable
law.
7.2 Transferability. Shares of Restricted Stock may not be sold, assigned,
transferred, pledged or otherwise encumbered, except as permitted by the
Committee, during the Restricted Period.
7.3 Evidence of Award. Shares of Restricted Stock shall be evidenced in
such manner as the Committee may determine. Any certificates issued in respect
of Shares of Restricted Stock shall be registered in the name of the Participant
and, unless otherwise determined by the Committee, deposited by the Participant,
together with a stock power endorsed in blank, with the Company. At the
expiration of the Restricted Period, the Company shall deliver the certificates
and stock power to the Participant.
7.4 Shareholder Rights. A Participant shall have all the rights of a
shareholder with respect to Restricted Stock awarded, including voting and
dividend rights, unless otherwise provided in the Award Agreement.
8. GENERAL PROVISIONS APPLICABLE TO AWARDS
8.1 Legal and Regulatory Matters. The grant of Awards and the delivery of
Shares shall be subject to compliance with (i) applicable federal and state laws
and regulations, (ii) if outstanding Shares are listed at the time on any stock
exchange, the listing requirements of such exchange, (iii) the Ownership Limit
and (iii) the Company's counsel's approval of all other legal matters in
connection with such Award and the issuance and delivery of the Shares. If the
sale of the Shares has not been registered under the Securities Act, the Company
may require, as a condition to delivery of the Shares, such representations or
agreements as counsel for the Company may consider appropriate to avoid
violation of such Act and may require that the certificates evidencing the
Shares bear an appropriate legend restricting transfer.
4
<PAGE> 5
8.2 Written Award Agreement. The terms and provisions of an Award shall be
set forth in an Award Agreement approved by the Committee and delivered or made
available to the Participant as soon as practicable following the Grant Date.
8.3 Determination of Restrictions on the Award. The vesting,
exercisability, payment and other restrictions applicable to an Award (which may
include, without limitation, restrictions on transferability or provision for
mandatory resale to the Company) shall be determined by the Committee and set
forth in the applicable Award Agreement. Notwithstanding the foregoing, the
Committee may accelerate (i) the vesting or payment of any Award, (ii) the lapse
of restrictions on any Award (including an Award of Restricted Stock) and (iii)
the date on which any Option first becomes exercisable.
8.4 Mergers, etc. Notwithstanding any other provision of the Plan, but
subject to the provisions of any particular Award Agreement, in the event of a
consolidation or merger in which the Company is not the surviving corporation or
which results in the acquisition of substantially all the Company's outstanding
shares by a single person or entity or by a group of persons and/or entities
acting in concert, or in the event of the sale or transfer of substantially all
the Company's assets (any of such events, a "Change in Control"), the Committee,
in its sole discretion (and in addition to or in lieu of any actions permitted
to be taken by the Company under the terms of any particular Award Agreement),
may (i) accelerate the exercisability, prior to the effective date of such
Change in Control, of all outstanding Options (and terminate the restrictions
applicable to any shares of Restricted Stock), (ii) arrange, if there is a
surviving or acquiring entity, subject to the consummation of such Change in
Control, to have that entity or an affiliate of that entity grant to
Participants replacement awards, (iii) cancel all outstanding Options for (or
permit the purchaser of the Company's stock or assets to deliver in exchange for
all outstanding Options) an amount equal to the value of the Shares, as
determined by the Committee in good faith, the Optionholder would have received
had the Option been exercised (to the extent then exercisable or to a greater
extent, including in full, as the Committee may determine) less the exercise
price therefor (upon any such cancellation such Options shall immediately
terminate and be of no further force or effect), (iv) repurchase (or permit the
purchaser of the Company's stock or assets to purchase) any Shares of Restricted
Stock for an amount equal to the amount that would have been paid therefor had
such Shares not been Restricted Stock, or (v) take any combination (or none) of
the foregoing actions.
8.5 Termination of Employment. The date of a Participant's termination of
employment for any reason shall be determined in the sole discretion of the
Committee. For purposes of the Plan, the following events shall not be deemed a
termination of employment of a Participant: (i) a transfer of employment between
the Company and an Affiliated Entity or between two Affiliated Entities; or (ii)
an approved leave of absence for military service or sickness, or for any other
purpose approved by the Company, if the Participant's right to employment is
guaranteed either by a statute or by contract or under the policy pursuant to
which the leave of absence was granted or if the Committee otherwise so provides
in writing. For purposes of the Plan, employees of an Affiliated Entity shall be
deemed to have terminated their employment on the date on which such Affiliated
Entity ceases to be an Affiliated Entity.
5
<PAGE> 6
8.6 Effect of Termination of Employment. The Committee shall have full
authority to determine and specify in the applicable Award Agreement the effect,
if any, that a Participant's termination of employment for any reason will have
on the vesting, exercisability, payment or lapse of restrictions applicable to
an outstanding Award.
8.7 Grant of Awards. Each Award may be made alone, in addition to or in
relation to any other Award. The terms of each Award need not be identical, and
the Committee need not treat Participants uniformly.
8.8 Settlement of Awards. No Shares shall be delivered pursuant to any
exercise of an Award until payment in full of the price therefor, if any, is
received by the Company. Such payment may be made in whole or in part in cash or
by certified or bank check or, to the extent permitted by the Committee at or
after the Grant Date, by delivery of a note or Shares, including Restricted
Stock, valued at their Fair Market Value on the date of delivery, or such other
lawful consideration as the Committee shall determine.
8.9 Withholding Requirements and Arrangements. The Participant shall pay to
the Company, or make provision satisfactory to the Committee for payment of, any
taxes required by law to be withheld in respect of Awards under the Plan no
later than the date of the event creating the tax liability. In the Committee's
discretion, such tax obligations may be paid in whole or in part in Shares,
including Shares retained from the Award creating the tax obligation, valued at
Fair Market Value on the date of delivery, provided, however, that with respect
to any Participant subject to Section 16(a) of the Exchange Act, any such
retention of Shares shall be made in compliance with any applicable requirements
of Rule 16b-3(e) or any successor rule under the Exchange Act. The Company may,
to the extent permitted by law, deduct any such tax obligations from any payment
of any kind otherwise due to the Participant.
8.10 No Effect on Employment. The Plan shall not give rise to any right on
the part of any Participant to continue in the employ of the Company or any
Affiliated Entity. The loss of existing or potential profit in Awards granted
under the Plan shall not constitute an element of damages in the event of
termination of the relationship of a Participant even if the termination is in
violation of an obligation of the Company to the Participant by contract or
otherwise.
8.11 No Rights as Shareholder. Subject to the provisions of the Plan and
the applicable Award Agreement, no Participant shall have any rights as a
shareholder with respect to any Shares to be distributed under the Plan until he
or she becomes the holder thereof.
8.12 Adjustments. Upon the happening of any of the following described
events, a Participant's rights with respect to Awards granted hereunder shall be
adjusted as hereinafter provided, unless otherwise specifically provided in the
Award Agreement.
8.12.1 Stock Splits and Recapitalizations. In the event the Company
issues any of its Shares as a stock dividend upon or with respect to Shares, or
in the event Shares shall be subdivided or combined into a greater or smaller
number of Shares, or if, upon a merger or consolidation (except those described
in Section 8.4), reorganization, split-up, liquidation, combination,
recapitalization or the like of the Company, Shares shall be exchanged for other
6
<PAGE> 7
securities of the Company, securities of another entity, cash or other property,
each Participant upon exercising an Award (for the purchase price to be paid
under the Award) shall be entitled to purchase such number of Shares, other
securities of the Company, securities of such other entity, cash or other
property as the Participant would have received if the Participant had been the
holder of the Shares with respect to which the Award is exercised at all times
between the Grant Date of the Award and the date of its exercise, and
appropriate adjustments shall be made in the purchase price per Share.
8.12.2 Restricted Stock. If any person owning Restricted Stock
receives new or additional or different shares or securities ("New Securities")
in connection with a corporate transaction described in Section 8.12.1 or a
stock dividend described in Section 8.12.1 as a result of owning such Restricted
Stock, the New Securities shall be subject to all of the conditions and
restrictions applicable to the Restricted Stock with respect to which such New
Securities were issued.
8.12.3 Fractional Shares. No fractional Shares shall be issued under
the Plan. Any fractional Shares which, but for this Section, would have been
issued shall be deemed to have been issued and immediately sold to the Company
for their Fair Market Value, and the Participant shall receive from the Company
cash in lieu of such fractional Shares.
8.12.4 Recapitalization. The Committee may adjust the number of Shares
subject to outstanding Awards and the exercise price and the terms of
outstanding Awards to take into consideration material changes in accounting
practices or principles, extraordinary dividends, acquisitions or dispositions
of stock or property, or any other event if it is determined by the Committee
that such adjustment is appropriate to avoid distortion in the operation of the
Plan.
8.12.5 Further Adjustment. Upon the happening of any of the events
described in Sections 8.12.1 or 8.12.4, the class and aggregate number of Shares
set forth in Section 5.1 hereof that are subject to Awards which previously have
been or subsequently may be granted under the Plan shall be appropriately
adjusted to reflect the events described in such Sections. The Committee shall
determine the specific adjustments to be made under this Section 8.12.5.
8.13 Other Transfer Restrictions. Notwithstanding any other provision of
the Plan, in order to qualify for the exemption provided by Rule 16b-3 under the
Exchange Act, and any successor provision, (i) any Shares or other equity
security offered under the Plan to a Participant subject to Section 16 of the
Exchange Act (a "Section 16 Participant") may not be sold for six (6) months
after acquisition; and any Shares or other equity security acquired by a Section
16 Participant upon exercise of an Option may not be sold for six (6) months
after the date of grant of the Option; and (ii) any Option or other similar
right related to an equity security issued under the Plan shall not be
transferable except in accordance with the rules under Section 16 of the
Exchange Act, subject to any other applicable transfer restrictions under the
Plan or the Award Agreement. The Committee shall have no authority to take any
action if the authority to take such action, or the taking of such action, would
disqualify a transaction under the Plan from the exemption provided by Rule
16b-3 under the Act, and any successor provision.
8.14 Ownership Limit. Notwithstanding any other provision of the Plan, the
rights of any
7
<PAGE> 8
Participant to acquire Shares under the Plan are subject to the Ownership Limit.
9. AMENDMENT AND TERMINATION
9.1 Amendment, Suspension, Termination of the Plan. The Committee may
modify, amend, suspend or terminate the Plan in whole or in part at any time;
provided, however, that no modification, amendment, suspension or termination of
the Plan shall be made without shareholder approval if such approval is
necessary to comply with any applicable tax, regulatory or stock exchange
requirement; provided, further, that such modification, amendment, suspension or
termination shall not, without a Participant's consent, affect adversely the
rights of such Participant with respect to any Award previously made.
9.2 Amendment, Suspension, Termination of an Award. The Committee may
modify, amend or terminate any outstanding Award, including, without limitation,
substituting therefor another Award of the same or a different type and changing
the date of exercise or realization; provided, however, that the Participant's
consent to such action shall be required unless the Committee determines that
the action, taking into account any related action, would not materially and
adversely affect the Participant.
10. NONDISCRETIONARY GRANTS OF OPTIONS TO NON-EMPLOYEE DIRECTORS
On the date upon which a Non-Employee Director is first elected a member of
the Company's Board of Directors, such Non-Employee Director will receive the
grant of an Option to purchase 2,000 Shares. In addition, a Non-Employee
Director will receive a grant of an Option to purchase an additional 2,000
Shares as of the date of each subsequent meeting of the shareholders at which
such Non-Employee Director is re-elected to the Company's Board of Directors
(less the number of Shares subject to any option then granted to such
Non-Employee Director under the Company's 1997 Executive and Non-Employee
Director Stock Option Plan). The purchase price per Share of the Shares subject
to each Option granted to a Non-Employee Director shall be the Fair Market Value
on the date the Option is granted. Options granted to Non-Employee Directors
shall be fully vested and immediately exercisable. The term of each Option
granted to a Non-Employee Director pursuant to this Section 10 shall be one day
less than ten (10) years from its Grant Date, unless sooner terminated or
extended in accordance with Section 9. If a Non-Employee Director dies while
serving as a Director, such Non-Employee Director's Options shall be exercisable
by either his or her executor or administrator or, if not so exercised, by the
legatees or the distributees of his or her estate, only during the twelve (12)
months following his or her death. If a Non-Employee Director's membership on
the Board terminates for any reason other than death, such Non-Employee
Director's Options shall be exercisable only during the three (3) months
following the date of termination. Any Option, and the number and nature of
Shares subject to any such Option, held by a Non-Employee Director will be
subject to adjustment only to the extent set forth in Section 8.12 and not
pursuant to any other provision of the Plan.
11. LEGAL CONSTRUCTION
11.1 Captions. The captions provided herein are included solely for
convenience of reference and shall not affect the meaning of any of the
provisions of the Plan or serve as a basis for
8
<PAGE> 9
interpretation or construction of the Plan.
11.2 Severability. In the event any provision of the Plan is held invalid
or illegal for any reason, the illegality or invalidity shall not affect the
remaining provisions of the Plan, and the Plan shall be construed and enforced
as if the illegal or invalid provision had not been included.
11.3 Governing Law. The Plan and all rights under the Plan shall be
construed in accordance with and governed by the internal laws of the State of
Maryland.
9
<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, 1999 TO JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 11,648
<SECURITIES> 387,350
<RECEIVABLES> 3,813
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 414,084
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 414,084
<CURRENT-LIABILITIES> 167,805<F1>
<BONDS> 183,918
0
0
<COMMON> 58
<OTHER-SE> 62,303<F2>
<TOTAL-LIABILITY-AND-EQUITY> 414,084
<SALES> 15,980
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,685
<LOSS-PROVISION> 232
<INTEREST-EXPENSE> 12,196
<INCOME-PRETAX> 794
<INCOME-TAX> 0
<INCOME-CONTINUING> 794
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 794
<EPS-BASIC> 0.13
<EPS-DILUTED> 0.13
<FN>
<F1>As a Real Estate Investment Trust our balance sheet is not classified.
<F2>Includes Retained Earnings and Paid In Capital.
</FN>
</TABLE>
