<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10 -Q/A
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1998
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
-------------- --------------
Commission file number: 001-13417
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
MARYLAND 13-3950486
(State or other Jurisdiction of Incorporation or (I.R.S. Employer Identification No.)
Organization)
</TABLE>
90 WEST STREET, SUITE 1508, NEW YORK, NY 10006
(Address of principal executive offices) (Zip Code)
(212) 732-5086
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
The registrant had 6,321,899 shares of common stock outstanding as of
October 30, 1998.
<PAGE> 2
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
FORM 10-Q/A
For the Quarter Ended September 30, 1998
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
-------
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 1998 and 1997 and for the Nine
Months Ended September 30, 1998 and for the Period from June
10 to September 30, 1997 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and for the Period
from June 10 to September 30, 1997 5
Notes to Condensed Consolidated Financial Statements 6-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-22
Item 3. Quantitative and Qualitative Disclosures 23
About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except as noted)
<TABLE>
<CAPTION>
ASSETS SEPTEMBER 30, DECEMBER 31,
1998 1997
---- ----
(unaudited)
<S> <C> <C>
Mortgage loans:
Held for sale $ 628,332 $ 160,970
Held to maturity 72,559 --
Collateral for mortgage backed bonds 90,020 --
Mortgage securities, available for sale 228,506 348,131
Cash and cash equivalents 7,045 4,022
Accrued interest receivable 7,839 3,597
Equity investment 2,212 100
Notes receivable from related parties 10,266 482
Due from related parties 52 --
Other receivables 1,351 --
Prepaid expenses and other assets 734 241
---------- ---------
TOTAL ASSETS $1,048,916 $ 517,543
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reverse repurchase agreements $ 881,215 $ 435,138
Mortgage backed bonds 85,330 --
Accrued interest payable 4,478 2,250
Dividends payable 1,075 1,035
Due to related party -- 540
Accrued expenses and other liabilities 6,404 482
---------- ---------
Total liabilities 978,502 439,445
---------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01
authorized, 10 million shares, issued
and outstanding, -0- shares
Common stock, par value $.01 authorized,
90 million shares; 6, 324,899
and 6,466,677 shares outstanding at
September 30, 1998 and December 31,
1997, respectively 65 65
Additional paid-in-capital 79,414 79,411
Available for sale securities:
Unrealized (loss) on investments (4,365) (842)
available for sale
Retained earnings (deficit) (3,376) (536)
Treasury stock - at cost (1,324) --
---------- ---------
Total stockholders' equity 70,414 78,098
---------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $1,048,916 $ 517,543
========== =========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 4
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Period from
Three Months Ended Ended June 10 to
September 30, September 30, September 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
Interest income $15,256 $254 $36,186 $254
Interest expense 13,564 126 31,561 126
------- ---- ------- ----
Net interest income 1,692 128 4,625 128
Loan loss provision 130 -- 278 --
-------- ---- ------- ----
Net interest income after loan loss
provision 1,562 128 4,347 128
(Loss) on sale of mortgage loans -- -- (49) --
------- ---- ------- ----
Total revenues 1,562 128 4,298 128
------- ---- ------- ----
EXPENSES:
General and administrative expenses
Personnel 172 -- 535 --
Management and administrative 193 37 522 37
Due diligence 158 45 578 45
Commissions 65 -- 282 --
Legal and professional 278 11 649 11
Other 62 2 194 2
------- ---- ------- ----
Total expenses 928 95 2,760 95
------- ---- ------- ----
Operating income 634 33 1,538 33
Equity in earnings (loss) of unconsolidated
subsidiary (288) 26 (588) 26
------- ---- ------- ----
NET INCOME $ 346 $ 59 $ 950 $ 59
======= ==== ------- ====
BASIC EARNINGS PER SHARE $ 0.05 $.07 $ 0.15 $.09
======= ==== ======= ====
DILUTED EARNINGS PER SHARE $ 0.05 $.07 $ 0.15 $.09
======= ==== ======= ====
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE> 5
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Period from June 10
September 30, 1998 to September 30, 1997
------------------ ---------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 950 $ 59
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Amortization of net premiums and deferred expenses 5,515
Loan loss provision 278
Loss on sale of mortgage loans 49
Equity in (earnings) loss of unconsolidated subsidiary 588 (26)
(Increase) in accrued interest receivable (4,242) (538)
(Increase) in loans to related parties (9,784)
(Increase) in other receivables (1,351)
(Increase) in prepaid expenses and other assets (493) (167)
Increase in accrued interest payable 2,228 125
Increase (decrease) in due to related party (592) 92
Increase in accrued expenses and other liabilities 5,923 1,039
--------- --------
Net cash provided by (used in) operating activities (931) 584
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage loans (866,673) (21,502)
--------- --------
Purchase of mortgage securities (4,333)
---------
Principal payments on mortgage securities 133,597
Principal payments on mortgage loans 182,514
Proceeds from sale of mortgage loans 20,118
Principal payments on collateral for mortgage backed
bonds 15,096
---------
Net cash (used in) investing activities (519,681) (21,502)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from reverse repurchase agreements 446,077 142,531
Net borrowings from mortgage backed bonds 85,330
Net proceeds of offering -- 79,122
Exercise of stock warrants - net 3 --
Equity investment in HCP (2,700) --
Payment of dividends (3,751) --
Treasury stock purchases (1,324) --
--------- --------
Net cash provided by investing activities 523,635 221,653
--------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,023 200,735
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,022 --
--------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 7,045 $200,735
========= ========
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
Operating activity- increase in dividends payable ($1,075) relating to the
declaration of dividends in September 1998.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Income taxes $ 1 --
========= ========
Interest $ 29,043 --
========= ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 6
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
GENERAL
Hanover Capital Mortgage Holdings, Inc. was incorporated in Maryland on
June 10, 1997. In April 1998 Hanover Capital Mortgage Holdings, Inc. acquired
100% of the common stock of Hanover Capital SPC, Inc. Hanover Capital Mortgage
Holdings, Inc. is a real estate investment trust ("REIT"), formed to operate as
a specialty finance company. The principal business strategy of Hanover Capital
Mortgage Holdings, Inc. and its wholly owned subsidiary, Hanover Capital SPC,
Inc. (together referred to as the "Company") is to (i) acquire primarily
single-family mortgage loans that are at least twelve months old or that were
intended to be of certain credit quality but that do not meet the originally
intended market parameters due to errors or credit deterioration, (ii)
securitize the mortgage loans and retain interests therein, (iii) originate,
hold, sell and service multifamily loans and commercial loans and (iv) acquire
multifamily loans. The Company's principal business objective is to generate
increasing earnings and dividends for distribution to its stockholders. The
Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company may also acquire multifamily mortgage loans from a taxable
subsidiary of the Company.
Hanover Capital SPC, Inc., a wholly-owned subsidiary of the Company, was
incorporated in Delaware on April 7, 1998 for the sole purpose of issuing
mortgage notes through a private placement (REMIC) offering.
CAPITALIZATION
In September 1997, the Company raised net proceeds of approximately $79
million in its initial public offering (the "IPO"). In the IPO, the Company sold
5,750,000 units (each unit consisting of one share of common stock, par value
$.01 and one stock warrant) at $15.00 per unit including 750,000 units sold
pursuant to the underwriters' overallotment option, which was exercised in full.
Each warrant entitles the holder to purchase one share of common stock at the
original issue price - $15.00. The warrants became exercisable on March 19, 1998
and expire on September 15, 2000. The Company utilized substantially all of the
net proceeds of the IPO to fund leveraged purchases of mortgage loans.
In connection with the closing of the IPO the Company acquired a 97%
ownership interest (representing a 100% ownership of the non-voting preferred
stock) in Hanover Capital Partners Ltd. and its wholly-owned subsidiaries:
Hanover Capital Mortgage Corporation and Hanover Capital Securities, Inc., in
exchange for 716,667 shares of the Company's common stock. Hanover Capital
Partners Ltd. ("HCP") and its wholly-owned subsidiaries, offer due diligence
services to buyers, sellers and holders of mortgage loans and originate, sell
and service multifamily mortgage loans and commercial loans.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of
Hanover Capital Mortgage Holdings, Inc. and its wholly-owned subsidiary, Hanover
Capital SPC, Inc. All significant intercompany accounts and transactions have
been eliminated.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared by the management of the Company in accordance with generally
accepted accounting principles for interim financial information and in
conformity with the rules and regulations of the Securities and Exchange
Commission. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. The results of operations for the three months ended
September 30, 1998 and for
6
<PAGE> 7
the nine months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the full year. For further information, refer
to the audited financial statements and footnotes included in the Company's Form
10-K for the period from June 10, 1997 (inception) to December 31, 1997.
METHOD OF ACCOUNTING
The condensed consolidated financial statements of the Company are prepared
on the accrual basis of accounting in accordance with generally accepted
accounting principles. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
INCOME TAXES
The Company has elected to be taxed as a real estate investment trust
("REIT") and intends to comply with the provisions of the Internal Revenue Code
of 1986, as amended (the "Code") with respect thereto. Accordingly, the Company
will not be subject to Federal income tax to the extent of its distributions to
stockholders as long as certain asset, income and stock ownership tests are met.
EARNINGS PER SHARE
In 1997 the Company adopted STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO.
128 "EARNINGS PER Share"("SFAS 128"). Under SFAS 128 basic earnings per share
excludes dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock that then shared in earnings. Shares
issued during the period and shares reacquired during the period are weighted
for the period they were outstanding.
Calculations for earnings per share are shown below (dollars in thousands,
except per share data):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
------------------ ------------------
<S> <C> <C>
Basic earnings per share:
Net income [numerator] $ 346 $ 950
========= =========
Average common shares
outstanding [denominator] 6,417,947 6,450,749
========= =========
Per share $ 0.05 $ 0.15
========= =========
Diluted earnings per share:
Net income [numerator] $ 346 $ 950
========= =========
Average common shares outstanding 6,417,947 6,450,749
--------- ---------
Add: Incremental shares from
assumed conversion of warrants -0- -0-
--------- ---------
-0- -0-
--------- ---------
Dilutive potential common shares
Adjusted weighted average shares
[denominator] 6,417,947 6,450,749
========= =========
Per share $ 0.05 $ 0.15
========= =========
</TABLE>
3. MORTGAGE LOANS
The Company's policy is to classify each of its mortgage loans as held for
sale as they are purchased and each asset is monitored for a period of time,
generally four to nine months, prior to making a determination as to whether the
asset will be classified as held to maturity. At September 30,
7
<PAGE> 8
1998 management has made the determination that $628,332,000 of mortgage loans
are held for sale, $72,559,000 of mortgage loans are being held to maturity and,
$90,020,000 of mortgage loans are held as collateral for mortgage backed bonds.
All mortgage loans designated as held for sale are reported at the lower of cost
or market, with unrealized losses reported as a charge to earnings in the
current period. All mortgage loans held to maturity are reported at cost.
Premiums and discounts associated with the purchase of mortgage loans are
amortized into interest income over the lives of the mortgage loans using the
effective yield method adjusted for the effects of estimated prepayments.
Mortgage loan transactions are recorded on the date the mortgage loans are
purchased or sold. Purchases of new mortgage loans are recorded when all
significant uncertainties regarding the characteristics of the mortgage loans
are removed, generally on or shortly before settlement date. Realized gains and
losses on mortgage loan transactions are determined on the specific
identification basis.
The following table summarizes the Company's single-family mortgage loan
pools, held for sale which are carried at the lower of cost or market (dollars
in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
Mortgage Loans Cost Mix Cost Mix
---- --- ---- ---
<S> <C> <C> <C> <C>
Fixed rate $511,003 82.9% $106,397 67.1%
Adjustable rate 105,766 17.1% 52,392 32.9%
-------- ----- -------- -----
Subtotal 616,769 100.0% 158,789 100.0%
Net deferred loan fees, ===== =====
premiums and discounts 11,751 2,199
Loan loss reserve (188) (18)
-------- --------
Carrying value $628,332 $160,970
======== ========
</TABLE>
The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loans, held for sale
portfolio (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
----------------------------------------------------------------------------
Carrying Principal Weighted Weighted
Value of Amount of Average Net Average
Mortgage Loans Mortgage Loans Coupon Maturity(1)
-------------- -------------- ------ ----------
<S> <C> <C> <C> <C>
Fixed Rate $522,030 $511,003 7.731% 226
Adjustable Rate 106,302 105,766 7.479% 274
-------- -------- ----- ---
$628,332 $616,769 7.688% 234
======== ======== ===== ===
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------------------------------------
Carrying Principal Weighted Weighted
Value of Amount of Average Net Average
Mortgage Loans Mortgage Loans Coupon Maturity(1)
-------------- -------------- ------ ----------
<S> <C> <C> <C> <C>
Fixed Rate $522,030 $106,424 8.265% 242
Adjustable Rate 106,302 52,365 7.925% 319
-------- -------- ----- ---
$628,332 $158,789 8.153% 267
======== ======== ===== ===
</TABLE>
(1) Weighted average maturity reflects the number of months until maturity
The following table summarizes the Company's single-family mortgage loans,
held to maturity which are carried at cost (dollars in thousands):
8
<PAGE> 9
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
<S> <C> <C>
Mortgage Loans
Fixed Rate $70,490 --
Adjustable Rate 145 --
------- --
Subtotal 70,635 --
Net deterred loan fees,
premiums and discounts 1,953 --
Loan loss reserve (29) --
------- --
Carrying value $72,559 --
======= ==
</TABLE>
The following table summarizes certain characteristics of the Company's
single-family fixed rate and adjustable rate mortgage loans, held to maturity
portfolio (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
Carrying Value of Principal Amount Weighted Average Weighted Average
Mortgage Loans of Mortgage Loans Net Coupon Maturity (1)
---------- -----------
<S> <C> <C> <C> <C>
Fixed Rate $72,414 $70,490 8.740% 252
Adjustable Rate 145 145 7.500% 305
------- ------- ----- ---
$72,559 $70,635 8.738% 252
======= ======= ===== ===
</TABLE>
The average effective yield for the three months ended September 30, 1998
on the total mortgage loan portfolio, including the amortization of the net
premiums paid for the mortgage loans, was 7.489%.
An analysis of the change in the loan loss reserve for the three months
ended September 30, 1998 is as follows (dollars in thousands):
Balance at beginning of period $117
Loan loss provision 111
Less amount transferred (2) (11)
----
Balance at September 30, 1998 $217
====
(1) weighted average maturity reflects the number of months remaining until
maturity
(2) amount of loan loss reserve transferred to mortgage securities in connection
with a swap of $17,404,000 of fixed rate mortgage loans for FNMA mortgage
securities.
4. COLLATERAL FOR MORTGAGE BACKED BONDS
In April 1998 the Company issued its first REMIC (real estate mortgage
investment conduit) security. $102,976,872 of single family fixed rate
residential loans were assigned as collateral for the Company's mortgage backed
bond (REMIC) security. The Company has limited exposure to credit risk retained
on loans it has securitized through the issuance of collateralized bonds. All
mortgage loans held as collateral for mortgage backed bonds are reported at
cost.
Premiums, discounts and all deferred hedging costs associated with the
mortgage loans held as collateral for mortgage backed bonds are amortized into
interest income over the lives of the mortgage loans using the effective yield
method adjusted for the effects of prepayments.
The following table summarizes the Company's single-family fixed rate
mortgage loan pools held as collateral for mortgage backed bonds which are
carried at cost (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
<S> <C>
Fixed rate $87,881
Net deferred loan fees, 2,204
premiums and discounts
Loan loss reserve (65)
-------
Carrying value $90,020
=======
</TABLE>
9
<PAGE> 10
The following table summarizes certain characteristics of the Company's
single-family fixed rate mortgage loans held as collateral for mortgage backed
bonds (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
Carrying Value of Principal Amount of Weighted Weighted
Collateral for Mortgage Collateral for Mortgage Average Average
Backed Bonds Backed Bonds Net Coupon Maturity (1)
------------ ------------ ---------- -----------
<S> <C> <C> <C>
$90,020 $87,881 7.818% 234
======= ======= ===== ===
</TABLE>
An analysis of the change in loan loss reserve for the three months ended
September 30, 1998 is as follows (dollars in thousands):
Balance at beginning of period $48
Loan loss provision 17
---
Balance at September 30, 1998 $65
===
(1) weighted average maturity reflects the number of months remaining until
maturity
5. MORTGAGE SECURITIES
The Company's policy is to classify its mortgage securities as
available-for-sale as they are acquired and each asset is monitored for a period
of time, generally three to six months, prior to making a determination whether
the asset will be classified as held-to-maturity. All mortgage securities
designated as available-for-sale are reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity.
Premiums and discounts associated with the purchase of mortgage securities
are amortized into interest income over the lives of the securities using the
effective yield method adjusted for the effects of estimated prepayments.
Mortgage securities transactions are recorded on the date the mortgage
securities are purchased or sold. Purchases of new issue mortgage securities are
recorded when all significant uncertainties regarding the characteristics of the
securities are removed, generally on or shortly before settlement date. Realized
gains and losses on mortgage securities transactions are determined on the
specific identification basis.
The following table summarizes the Company's amortized cost basis and fair
value of mortgage securities available for sale (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
Mortgage Securities Available Available
Adjustable rate for Sale Mix for Sale Mix
-------- -------- ---
<S> <C> <C> <C> <C>
FNMA certificates $ 86,373 37.1% $207,898 59.6%
FHLMC certificates 125,236 53.8% 141,075 40.4%
-------- ----- -------- -----
211,609 90.9% 348,973 100.0%
Fixed rate
FNMA certificates 21,275 9.1%
-------- ----- -------- -----
Total amortized cost 232,884 100.0% 348,973 100.0%
=====
Gross unrealized (losses) (4,365) (842)
Loan loss reserve (13) --
-------- --------
Fair value $228,506 $348,131
======== ========
</TABLE>
6. EQUITY INVESTMENT
The Company recorded its investment in HCP on the equity method. The
Company is entitled to 97% of the earnings or losses of HCP through its
ownership of all of the non-voting preferred stock of HCP. Summarized financial
information for HCP is detailed below:
10
<PAGE> 11
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1998
(in thousands, except as noted)
(unaudited)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
CURRENT ASSETS:
Cash $ 202
Receivables from related parties 308
Other current assets 2,133
--------
Total current assets 2,643
INVESTMENT IN MORTGAGE LOANS 103,010
PROPERTY AND EQUIPMENT - Net 166
INCOME TAX RECEIVABLE 639
DUE FROM OFFICER 54
OTHER ASSETS 186
--------
TOTAL ASSETS $106,698
========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 533
--------
Reverse repurchase agreement 96,507
Note payable to related party 7,312
Other current liabilities 60
Total current liabilities 104,412
STOCKHOLDERS' EQUITY:
Preferred stock: $.01 par value, 100,000 shares authorized, 1
97,000 shares outstanding
Common stock:
Class A: $.01 par value, 5,000 shares authorized and
3,000 shares outstanding --
Additional paid-in capital 2,841
Retained earnings (deficit) (556)
--------
Total stockholders' equity 2,286
--------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $106,698
========
</TABLE>
11
<PAGE> 12
HANOVER CAPITAL PARTNERS, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1998 September 30, 1998
------------------ ------------------
<S> <C> <C>
REVENUES:
Due diligence fees $ 1,295 $ 3,534
Mortgage sales and servicing 175 816
Loan brokering and other income 164 487
Net interest income - mortgage loans 7 7
------- --------
Total revenues 1,641 4,844
------- --------
EXPENSES:
Personnel expense 1,640 4,232
General and administrative expense 135 457
Other expenses 282 928
Interest expense 51 114
Depreciation and amortization 29 83
------- --------
Total expenses 2,137 5,814
------- --------
(LOSS) BEFORE INCOME TAX BENEFIT (496) (970)
INCOME TAX (BENEFIT) (197) (382)
------- --------
NET (LOSS) $(299) $(588)
------- --------
BASIC (LOSS) PER SHARE $(99.88) $(196.01)
======= ========
</TABLE>
HCP and its subsidiaries operate as a specialty finance company which is
principally engaged in performing due diligence, mortgage and investment banking
services. A wholly-owned subsidiary of HCP, Hanover Capital Mortgage Corporation
("HCMC"), is an originator and servicer of multifamily mortgage loans. Another
wholly-owned subsidiary of HCP, Hanover Capital Securities, Inc. ("HCS") is a
registered broker/dealer with the Securities and Exchange Commission.
On September 30, 1998 HCP expanded its traditional areas of business to
purchase a fixed and adjustable rate mortgage pool for $103.8 million including
accrued interest. This purchase was funded by an advance from the Company of
$7.3 million and reverse repurchase financing of approximately $96.5 million.
HCP's policy is to classify each of its mortgage loans as held as for sale
as they are purchased and each asset is monitored for a period of time,
generally four to nine months, prior to making a determination as to whether the
asset will be classified as held to maturity. At September 30, 1998 all of the
mortgage loans were classified as held for sale, loans designated as held for
sale are reported at the lower of cost or market, with unrealized losses
reported as a charge to earnings in the current period. Premiums and discounts
associated with the purchase of mortgage loans are amortized into interest
income over the lives of the mortgage loans using the effective yield method
adjusted for the effects of estimated prepayments. Reverse repurchase agreements
are accounted for as collateralized financing transactions and recorded at their
contractual amounts.
At September 30, 1998 HCP had a total of $200 million of uncommitted
mortgage loan reverse repurchase agreement financing available pursuant to a
master repurchase agreement. At September 30, 1998 HCP had outstanding
borrowings of $96,507,000 under the above mentioned reverse repurchase
12
<PAGE> 13
agreement with a borrowing rate of 6.075% and a maturity of less than one month.
The reverse repurchase agreement was collateralized by mortgage loans with a
cost basis of $103,010,000 (which approximates market value).
7. REVERSE REPURCHASE AGREEMENTS
Reverse repurchase agreements are accounted for as collateralized financing
transactions and recorded at their contractual amounts.
At September 30, 1998 the Company had a total of $707 million of
uncommitted mortgage loan reverse repurchase agreement financing available
pursuant to master repurchase agreements with three lenders. At September 30,
1998 the Company had outstanding borrowings of $659,319,000 under the above
mentioned reverse repurchase agreements with a borrowing rate of 6.333% for the
third quarter of 1998 and a maturity of less than two months. The reverse
repurchase agreements at September 30, 1998 were collateralized by mortgage
loans with a cost basis of $700,473,000 (which approximates market value).
The Company also uses its reverse repurchase agreement financing to finance
a portion of the collateral for mortgage backed bonds. At September 30, 1998,
the Company had outstanding borrowings of $294,000 with a weighted average
borrowing rate of 6.145% for the third quarter of 1998 and a weighted average
remaining maturity of less than one month.
At September 30, 1998, the Company had outstanding mortgage securities
reverse repurchase agreement financing of $221,602,000 with a weighted average
borrowing rate of 5.701% for the third quarter of 1998 and a weighted average
remaining maturity of less than one month.
Information concerning the reverse repurchase agreements and the pledged
collateral at September 30, 1998 is summarized as follows (dollars in
thousands):
<TABLE>
<CAPTION>
Collateral
Mortgage for Mortgage Mortgage
Reverse Repurchase Agreements Loans (2) Backed Bonds Securities
--------- ------------ ----------
<S> <C> <C> <C>
Average balance during the period (1) $523,403 $ 203 $241,388
Average interest rate during period (1) 6.333% 6.145% 5.701%
Maximum month-end balance during the
period $659,319 $2,331 $249,450
Collateral Underlying the Agreements
Carrying Balance $700,473 $ 403 $228,506
</TABLE>
(1) above table reflects the period beginning July 1, 1998 through September 30,
1998. (2) collateral includes mortgages held for sale and mortgages held to
maturity.
8. AFFILIATED PARTY TRANSACTIONS
The Company has engaged HCP pursuant to a Management Agreement to render
among other things, due diligence, asset management and administrative services.
The statement of operations of the Company for the three months ended September
30, 1998 includes management and administrative expenses of $193,000, due
diligence expenses of $158,000 and commission expenses of $65,000 relating to
billings from HCP. At September 30, 1998 the balance sheet of the Company
included an amount due from HCP of $52,000. During the three months ended
September 30, 1998 the Company recorded a loss from its investment in HCP and
Subsidiaries of $288,000.
In connection with the original formation transactions in September 1997,
the Company agreed to lend a maximum of $1,750,000 collectively, to four
officer/stockholders (collectively referred to as the "Principals") to enable
the Principals to pay personal income taxes on the gains they must recognize
upon contributing their HCP preferred stock to the Company for shares of the
Company's common stock. The loans are secured solely by 116,667 shares of the
Company's common stock owned by the Principals, collectively. The loans bear
interest at the lowest applicable federal tax rate during the month the loans
are made. At September 30, 1998 the Company had loaned the Principals the full
$1,750,000. The loans bear interest at 6.02% ($482,600 of loans) and 5.70%
($1,267,400 of loans).
13
<PAGE> 14
In March 1998 the Company agreed to lend up to an additional $1,500,000 in
unsecured loans to the Principals, in lieu of incurring the costs and expenses
associated with the registration of 100,000 shares of the Company's common stock
owned by the Principals. The Company loaned the Principals an additional
$1,203,880 in April 1998. The additional loans are due and payable on March 31,
1999 and bear interest at 5.51%.
During 1998 the Company advanced funds to HCP pursuant to an unsecured loan
agreement. The loans to HCP bear interest at 1.00% below the prime rate. At
September 30, 1998 the loans outstanding to HCP totaled $7,312,472. The Company
agreed to lend $7,312,472 to HCP on September 30, 1998 in order for HCP to
purchase a $103 million fixed and adjustable rate mortgage pool.
In September 1998 the Company made a capital contribution of $2,700,000 to
HCP. A pro-rata capital contribution was made by the HCP shareholders owning
common stock, maintaining the 97% - 3% ownership relationship.
9. TREASURY STOCK
Pursuant to a stock repurchase program that began in July 1998, the Company
repurchased a total of 143,900 shares of its common stock in August and
September.
10. ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
In June 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
No.130"). Effective January 1, 1998 the Company adopted SFAS No. 130, which
established disclosure standards for reporting comprehensive income in a full
set of general purpose financial statements. The comprehensive loss for the
three months and the nine months ended September 30, 1998 was $1,730,000, and
$2,573,000 which included an unrealized loss on investments available for sale
of $2,076,000 and $3,523,000, respectively.
11. SUBSEQUENT EVENTS
On October 16, 1998 a $0.17 cash dividend previously declared by the Board
of Directors was paid to stockholders of record as of September 30, 1998.
During October 1998 the Company sold all of its adjustable rate mortgage
securities and the majority of its fixed rate mortgage securities for a loss of
approximately $6.9 million.
During October 1998 the Company swapped approximately $ 54 million of
mortgage loan assets for FNMA mortgage securities. These mortgage securities
were subsequently sold at a gain in excess of $500,000.
On October 30, 1998 the Company contributed certain fixed rate mortgage
loans ($317 million) and the related reverse repurchase agreement financing
($308 million) to Hanover Capital Partners 2, Inc. in exchange for a 100%
preferred equity interest in Hanover Capital Partners 2, Inc. A wholly-owned
subsidiary of Hanover Capital Partners, 2, Inc. issued a REMIC security with the
mortgage loans as collateral for the security. The proceeds derived from the
REMIC sale were $299 million and were used to repay the reverse repurchase
agreement. The AAA rated bonds were sold to a third party and the Company
retained all of the junior bonds relating to this security. At October 30, 1998,
the carrying value of the junior bonds classified as available for sale would
require a market value allowance of approximately $2.5 million.
14
<PAGE> 15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
Hanover Capital Mortgage Holdings, Inc. was incorporated in Maryland on
June 10, 1997. In April 1998, Hanover Capital Mortgage Holdings, Inc. acquired
100% of the common stock of Hanover Capital SPC, Inc. Hanover Capital Mortgage
Holdings, Inc. is a real estate investment trust ("REIT"), formed to operate as
a specialty finance company. The principal business strategy of Hanover Capital
Mortgage Holdings, Inc. and its wholly owned subsidiary, Hanover Capital SPC,
Inc. (together referred to as the "Company") is to (i) acquire primarily
single-family mortgage loans that are at least twelve months old or that were
intended to be of certain credit quality but that do not meet the originally
intended market parameters due to errors or credit deterioration, (ii)
securitize the mortgage loans and retain interests therein, (iii) originate,
hold, sell and service multifamily loans and commercial loans and (iv) acquire
multifamily loans. The Company's principal business objective is to generate
increasing earnings and dividends for distribution to its stockholders. The
Company acquires single-family mortgage loans through a network of sales
representatives targeting financial institutions throughout the United States.
The Company may also acquire multifamily mortgage loans through a taxable
subsidiary of the Company.
The Company's principal source of earnings is net interest income generated
by the Company's investment portfolio. As of September 30, 1998 the Company's
investment portfolio consisted of single-family mortgage loans held for sale,
single-family mortgage loans held to maturity, collateral for mortgage backed
bonds, and mortgage securities available for sale. The Company funds its
portfolio investments with both borrowings and cash raised from the issuance of
equity. For the portion of the portfolio investments funded with borrowings, the
Company generates net interest income to the extent that there is a positive
spread between the yield on the interest-earning assets and the cost of borrowed
funds. In addition the Company earns net interest income from the yield
generated by the portion of the investment portfolio that is funded solely with
equity. The cost of the Company's borrowings may increase or decrease through
the use of interest rate swaps, caps or floor agreements.
The Company's generation of net income is dependent upon (i) the spread
between interest earned on its investment portfolio and the cost of borrowed
funds to finance the investment portfolio; and (ii) the aggregate amount of the
investment portfolio on the Company's balance sheet. The Company strives to
create a diversified portfolio of investments that in the aggregate generates
increasing net income in a variety of interest rate and prepayment rate
environments and preserves the equity base of the Company. The Company's primary
strategy for its mortgage loan investment portfolio entails (1) efficient
acquisition pricing of mortgage loans, (2) financing in the short term by
reverse repurchase agreements or lines of credit, (3) hedging in the short term
to offset potential adverse effects of changes in interest rates, (4)
stratifying and segregating mortgage loans in securitizations to replace short
term financing with collateralized mortgage obligation (CMO), real estate
mortgage investment conduit (REMIC) or other types of long term debt financing,
thereby eliminating the majority of refinancing and interest rate risk and (5)
retaining certain residual interests of the securitization resulting in
increased yields.
The Company's operating strategy for its mortgage securities investment
entails (1) the efficient acquisition of mortgage securities on a temporary
basis to effectively (a) deploy capital and (b) meet certain REIT requirements,
(2) financing through reverse repurchase agreements and (3) identifying the
appropriate times to sell the mortgage securities to optimize the investment
yield to the Company and to free additional capital to fund additional mortgage
loan acquisitions.
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
15
<PAGE> 16
mortgage assets held by the Company at September 30, 1998 were mainly fixed rate
loans (84.6%) and as such would not be affected by changes in interest rates.
The ARM pools (15.4%) 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 third quarter of
1998. The Company's greatest interest rate volatility risk relates to its repo
financing. The Company's repo financing agreements at September 30, 1998 were
indexed to LIBOR plus a spread of 60 to 70 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 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
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 third quarter ended September 30, 1998. 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 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 and losses represent net hedging costs ("Hedging Costs") which 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 September 30, 1998
included hedging of certain repo liabilities with interest rate caps and hedging
of fixed rate mortgage loan pools by selling short similar 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 fixed
mortgage loan pools to reflect current market pricing. The costs of the
individual hedging transactions can vary greatly depending upon the market
conditions. Hedging Costs of fixed mortgage pools were $541,000 in the first
quarter of 1998, $1,287,000 in the second quarter and $2,632,000 in the third
quarter of 1998. Total unamortized Hedging Costs through September 30, 1998 were
$5,992,000. As of September 30, 1998 the estimated fair market value of the
hedged assets was equal to the book value of the hedged assets.
Securitized Mortgage Loan Assets
- --------------------------------
With respect to the match funding of assets and liabilities, the collateral
for mortgage backed bonds, which was accounted for as a financing transaction
for GAAP, was composed totally of fixed rate mortgage loans ($90,020,000) at
September 30, 1998. The primary financing for this asset category is the
mortgage backed bonds ($85,330,000) and to a much lesser extent repo agreements
($294,000). 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 mortgage backed bonds locks in long-term financing and
thereby eliminates interest rate risk.
Mortgage Securities
- -------------------
The final interest earnings asset category is mortgage securities. The
majority (90.9%) of mortgage securities at September 30, 1998 were adjustable
rate securities. These securities are more vulnerable to interest rate
volatility during periods of declining interest rates. The mortgage securities
were all financed with repo agreements with several "Wall Street" dealers at
September 30, 1998 and as such are subject to LIBOR interest rate changes. The
mortgage securities experienced a very high prepayment speed for the majority of
1998. During the third quarter of 1998, the weighted average prepayment speed
for the Company's investment in mortgage securities was 45.9%, as compared to an
anticipated weighted average prepayment speed of 40.5%. The high prepayment
speeds caused the repo
16
<PAGE> 17
lenders to reduce their market price on the mortgage securities collateralizing
the repo financing. This reduction in market value reduces the amount of
financing the Company can employ with respect to the mortgage securities.
RESULTS OF OPERATIONS
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS PERIOD FROM
ENDED ENDED JUNE 10 TO
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
------------ ------------ ------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net interest income $1,692 $ 128 $4,625 128
Loan (loss) provision (130) -- (278) --
(Loss) on sale of mortgages -- -- (49) --
General and administrative
(expenses) (928) (95) (2,760) (95)
Equity in earnings (loss) of
unconsolidated subsidiary (288) 26 (588) 26
------ ----- ------ -----
Net income $ 346 $ 59 $ 950 $ 59
====== ===== ====== =====
Basic earnings per share $ 0.05 $0.07 $ 0.15 $0.09
====== ===== ====== =====
Dividends declared per share $ 0.17 $0.16 $ 0.59 $0.16
====== ===== ====== =====
</TABLE>
Net interest income for the three months ended September 30, 1998 totaled
$1,692,000 and net interest income for the nine month period ended September 30,
1998 was $4,625,000. The majority of the net interest income for the nine month
period ended September 30, 1998 was generated by the Company's investment in
mortgage loans. The balance of net interest income was generated from mortgage
securities, collateral for mortgage backed bonds, agency paper investments, cash
collateral on deposit with certain mortgage security lenders, a savings account,
loans to certain Principals and loans to HCP. Management anticipates that the
net interest income generated by mortgage loans will continue to reflect a
substantial percentage of the Company's total net interest income. The Company's
total mortgage loan holdings including mortgages held as collateral for mortgage
backed bonds increased from $160,970,000 at December 31, 1997 to $790,911,000 at
September 30, 1998.
Third quarter net interest income from the Company's mortgage loan
portfolio, including mortgages held as collateral for mortgage backed bonds, was
$2,185,000 compared to $1,525,000 in the second quarter; an increase of 43.3%.
The substantial increase in the net interest income resulted from the volume of
mortgage pool acquisitions in late June through September. These acquisitions,
offset by normal principal reductions and prepayments, resulted in an increase
in the average balance of mortgage loans held from $370.81 million in the second
quarter to $566.46 million in the third quarter.
The third quarter net interest income continued to be negatively impacted
by high prepayment speeds on the Company's mortgage securities portfolio. The
Company reflected premium amortization of $1,519,000 in the third quarter of
1998 as compared to $2,148,000 and $903,000 in the second quarter and first
quarter of 1998, respectively. The premium amortization is recorded as an
adjustment to interest income and accordingly reduces the net interest income on
the Company's mortgage securities portfolio.
The Company's net income was again detrimentally impacted by the losses
generated by its equity investment in HCP. A net loss of $288,000 from HCP was
recorded by the Company in the third quarter of 1998 compared to losses of
$294,000 and $6,000 in the second quarter and first quarter of 1998,
respectively.
The following table reflects the average balances for the Company's
investment portfolio as well as the Company's interest bearing liabilities with
the corresponding effective rates of interest annualized for the period July 1,
1998 through September 30, 1998 (dollars in thousands):
17
<PAGE> 18
<TABLE>
<CAPTION>
Effective
Average Interest
Balance Rate
------- ----
<S> <C> <C>
Interest Earning Assets
Mortgage Loans (1) $566,456 7.489%
Collateral for mortgage backed bonds (2)
91,980 7.071%
Mortgage securities (2) 243,299 4.528%
-------- -----
$901,735 6.648%
======== =====
Interest Bearing Liabilities
Reverse repurchase borrowings on
mortgage loans $523,403 6.377%
Mortgage backed bonds 87,524 6.766%
Reverse repurchase borrowings on
collateral for mortgage backed bonds 203 6.145%
Reverse repurchase borrowings on
mortgage securities 241,388 5.701%
-------- -----
$852,518 6.364%
======== =====
Net Interest Earning Assets $ 49,217
========
Net Interest Spread 0.284%
======
Yield on Net Interest Earning
Assets (3) 11.562%
======
</TABLE>
(1) Includes mortgage loans held for sale and mortgage loans held to maturity.
Loan loss provisions are excluded in the above calculations.
(2) Loan loss provisions are excluded in the above calculations.
(3) Yield on Net Interest Earning Assets is computed by dividing the applicable
net interest income by the average daily balance of Net Interest Earning
Assets.
The effective rate for interest earning assets has been adjusted to reflect
amortization of premiums paid or discounts received on the acquisition of
mortgage loans and mortgage securities. By engaging HCP to perform due diligence
on mortgage loans the Company acquires, management believes that premium amounts
paid for the purchase of mortgage loans are less than if they were acquired in
the market. Net unamortized premiums on the Company's mortgage loans (including
both mortgage loans held for sale and mortgage loans held to maturity),
collateral for mortgage backed bonds and mortgage securities were $7,712,000,
$983,000 and $8,166,000 at September 30, 1998 or approximately 1.12%, 1.11% and
3.63% of the respective par value investments in total mortgage loans,
collateral for mortgage backed bonds and mortgage securities.
The Company's largest expense is the interest cost on borrowed funds. The
majority of funds to finance the investment portfolio in the third quarter of
1998 were borrowed in the form of reverse repurchase agreements, which are
indexed to LIBOR. The Company also used interest rate caps to manage its
interest rate risk and may also in the future use interest rate swaps and
financial futures. The net cost of those instruments is included in the cost of
funds as a component of interest expense for the period to which it relates.
At September 30, 1998 the Company's mortgage loan investment portfolio
comprised 75.4% of total assets in the following types of single family mortgage
loans (dollars in thousands, except average loan size):
18
<PAGE> 19
<TABLE>
<CAPTION>
Mortgage Loan Summary Mortgages Mortgages Collateral for
Held for Held to Mortgage
Sale Maturity Backed Bonds Total
---- -------- ------------ -----
Fixed Rate Mortgage Loans
- -------------------------
<S> <C> <C> <C> <C>
Face or principal amount $511,003 $ 70,490 $87,881 $669,374
Carrying value $522,030 $ 72,414 $90,020 $684,464
Weighted average net coupon 7.73% 8.74% 7.82% 7.85%
Weighted average maturity (in months) 226 252 234 230
Number of loans 9,255 1,518 1,181 11,954
Average loan size $ 55,214 $ 46,436 $74,412 $ 55,996
Adjustable Rate Mortgage (ARM) Loans
- ------------------------------------
Face or principal amount $105,766 $ 145 -- $105,911
Carrying value $106,302 $ 145 -- $106,447
Weighted average net coupon 7.48% 7.50% -- 7.48%
Weighted average maturity (in months) 274 305 -- 274
Number of loans 1,122 1 -- 1,123
Average loan size $ 94,265 $144,986 -- $ 94,310
</TABLE>
At September 30, 1998 the Company's mortgage securities investment
portfolio comprised 21.8% of total assets in the following categories (dollars
in thousands):
<TABLE>
<CAPTION>
Federal National Mortgage Association
- ------------------------------------- Adjustable Fixed
(FNMA) Securities Rate Rate Total
- ----------------- ---- ---- -----
<S> <C> <C> <C>
Par value at purchase date $200,524 $21,663 $222,187
September 30, 1998 adjusted principal $120,496 $20,750 $141,246
Amortized cost basis $125,236 $21,275 $146,511
Market Value $122,726 $21,190 $143,916
Weighted average net coupon 7.49% 7.93% 7.56%
Weighted average maturity
(in months) 276 297 279
</TABLE>
<TABLE>
<CAPTION>
Federal Home Loan Mortgage Corp.
- --------------------------------- Adjustable Fixed
(FHLMC) Securities Rate Rate Total
- ------------------ ---- ---- -----
<S> <C> <C> <C>
Par value at purchase date $136,237 -- $136,237
September 30, 1998 adjusted principal $ 83,444 -- $ 83,444
Amortized cost basis $ 86,373 -- $ 86,373
Market Value $ 84,590 -- $ 84,590
Weighted average net coupon 7.70% -- 7.70%
Weighted average maturity --
(in months) 294 -- 294
</TABLE>
General and administrative expenses (G &A expenses) totaled $928,000 for
the third quarter of 1998. G&A expenses consist substantially of expenses
relating to the acquisition of and management of the Company's investment
portfolio, as well as various other corporate expenses. Most of the G & A
expenses are likely to remain relatively stable on a quarterly basis with the
possible exception of the following: (1) due diligence, (2) commissions and (3)
legal and professional. The due diligence expenses will vary based upon various
factors, including but not limited to the number of loans purchased, complexity
of documentation problems encountered, type of mortgage loans, ease of
converting data to the Company's proprietary software system, geographic
location, and creditworthiness of the borrower. Commission expense is also
directly related to mortgage loans acquired. Commissions are paid on all
mortgage loan acquisitions initiated by HCP's sales representatives. However,
certain mortgage loan acquisitions are also initiated by the Principals. No
commission expense is recorded when the mortgage loan acquisitions are
originated by the Principals. Legal and professional fees will also vary based
on the usage of various professional firms from time to time.
19
<PAGE> 20
The Company recorded a loss from its investment in Hanover Capital Partners
Ltd. and Subsidiaries of $288,000 for the period July 1, 1998 through September
30, 1998. For the three months ended September 30, 1998, Hanover Capital
Partners Ltd. incurred personnel expenses of $1,640,000, general and
administrative expenses of $135,000, other expenses of $282,000, interest
expense of $51,000 and depreciation and amortization expense of $29,000, for
total expenses of $2,137,000 versus total revenues of $1,641,000. After taxes,
this resulted in a net loss of $299,000. The Company absorbed 97% of this loss,
or $288,000, from its 97% equity ownership interest in Hanover Capital Partners
Ltd. Summarized operating results for Hanover Capital Partners Ltd and
Subsidiaries representing the Company's 97% ownership interest are shown below
(dollars in thousands):
Revenues $1,591
Expenses (1,879)
------
Net (loss) $ (288)
======
The Company's net income for the period July 1, 1998 through September 30,
1998 was $346,000 or an annualized return on equity of 1.82%. The table below
highlights the Company's historical trends and components of annualized return
on average equity.
COMPONENTS OF ANNUALIZED RETURN ON AVERAGE EQUITY (1)
<TABLE>
<CAPTION>
Equity in
Gain (Loss) Earnings
Net Interest on Sale of G & A (Loss) of Annualized
For the Income/ Securities/ Expense/ Subsidiary/ Return on
Quarter Ended Equity Equity Equity Equity Equity
------------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
June 30, 1997 (2) 0.00% 0.00% 0.00% 0.00% 0.00%
September 30, 1997 (3) 4.85% 0.00% 3.59% 0.97% 2.23%
December 31, 1997 7.71% 0.18% 4.26% (1.41%) 2.22%
March 31, 1998 10.78% 0.00% 4.37% (0.03%) 6.38%
June 30, 1998 3.47% (0.25%) 5.00% (1.50%) (3.28%)
September 30, 1998 8.23% 0.00% 4.89% (1.52%) 1.82%
</TABLE>
(1) Average equity excludes unrealized loss on investments available for sale.
(2) Hanover Capital Mortgage Holdings, Inc. was organized on June 10, 1997, but
did not begin operations until September 19, 1997
(3) Average equity is based on equity balances at September 19, 1997 (IPO date)
and equity balances at September 30, 1997, excluding unrealized loss on
investments available for sale.
LIQUIDITY AND CAPITAL RESOURCES
The Company expects to meet its short-term and long-term liquidity
requirements generally from its existing working capital, cash flow provided by
operations, reverse repurchase agreements, and other possible sources of
financing, including CMO's and REMICs, additional equity generated by the
exercise of some or all of the Company's outstanding stock warrants and
additional equity offerings. The Company considers its ability to generate cash
to be adequate to meet operating requirements both in the short-term and
long-term. However, if a significant decline in the market value of the
Company's investment portfolio should occur, the Company's available liquidity
from these other borrowings may be reduced. As a result of such a reduction in
liquidity, the Company may be forced to sell certain investments in order to
maintain liquidity. If required, these sales could be made at prices lower than
the carrying value of such assets, which could result in losses.
In October 1998, the volatility of the mortgage market caused certain repo
lenders to widen their lending haircuts, increase borrowing rates and/or
discontinue or reduce their lending activities. Further, the turmoil in the
mortgage markets resulted in repo lenders taking a more conservative approach to
valuing the underlying mortgage collateral, often resulting in higher margin
calls. If the Company were unable to meet the lenders' margin calls or if
lenders were reluctant to extend repo financing, the Company would be forced to
use its existing liquidity to satisfy margin calls. Further, the Company might
be forced to sell certain investments in order to meet margin calls. The recent
volatility in the mortgage markets has caused repo financing to become
marginally more expensive and has reduced the number of lenders willing to
extend repo lending to finance mortgage loan pool acquisitions.
20
<PAGE> 21
Management expects that the purchase of single-family loan pools will
significantly slow in the fourth quarter of 1998 as the Company focuses on
certain securitization transactions and liquidity issues. Such issues reflect
the extraordinarily adverse conditions in the mortgage securities markets which
arose suddenly in early October, leading to the need to increase the Company's
liquidity and decrease its leverage. Accordingly, on October 15, 1998 the
Company announced a plan to maximize liquidity through the sale of securities,
securitization of whole loans, increased credit facilities and conversion and
possible sale of whole loans into FNMA securities.
Net cash used in operations for the first nine months of 1998 was $931,000.
Actual cash proceeds generated from net income adjusted for non cash items
($7,379,000) and net changes in operating assets and liabilities ($1,474,000)
were offset by loans to related parties ($9,784,000). Loans to Principals
totaled $2,472,000 and loans to HCP totaled $7,312,000. The Company advanced
$7,312,000 to HCP on September 30, 1998 to assist HCP in the purchase of a $103
million fixed and adjustable rate single-family mortgage loan pool.
Net cash used in investing activities amounted to $519,681,000 during the
period January 1, 1998 through September 30, 1998. The majority of the cash used
in investing activities related to the purchase of assets for the Company's
investment portfolio ($866,673,000). Mortgage loans were purchased at an average
price of 101.26% of par. Offsetting the cash outlay for purchases of mortgage
assets were receipts of principal proceeds from the investment portfolio
totaling $331,207,000 during the first nine months of 1998.
Cash flows from financing activities generated $523,635,000 for the period
January 1, 1998 through September 30, 1998. The cash flows from financing
activities resulted from net borrowings on reverse repurchase agreements
($446,077,000), net borrowings on the mortgage backed bonds ($85,330,000), net
proceeds from the exercise of 2,122 warrants ($3,000) reduced by dividends paid
($3,751,000), an additional capital contribution to HCP ($2,700,000) and
treasury stock purchases ($1,324,000).
An unconsolidated subsidiary of the Company securitized approximately $317
million of fixed rate mortgage loans on October 30,1998 that the Company
contributed net of the respective reverse repurchase financing to the affiliate.
The "AAA" rated bonds were sold to a third party and the Company retained all of
the junior bonds relating to this security. At October 30, 1998, the carrying
value of the junior bonds classified as available for sale would require a
market value allowance of approximately $2.5 million. The Company also sold
substantially all of its mortgage securities during October. The sale of
mortgage securities resulted in losses in excess of $6 million. At the same time
the sale freed up in excess of $2.2 million in capital that had previously been
invested in such mortgage securities. In addition, the Company swapped
approximately $54 million of mortgage loan assets for FNMA mortgage securities.
These mortgage securities were also sold in October. This transaction also
increased the Company's liquidity.
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 certain of its third party vendors
and/or verified to its satisfaction that their IT systems are Y2K
compliant. The Company is preparing a detailed questionnaire for the
remainder of the Company's significant other third party relationships.
These include:
21
<PAGE> 22
Certain Third Party Vendors Services Provided
- --------------------------- -----------------
Securities dealer firms Financing, facilitate purchase and sale
of mortgage assets, etc.
Information processing firms Accounting, word processing, databased
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.
The Company has sent letters requiring verification of compliance with
Year 2000 matters and has followed up such letters with telephone calls as
appropriate. An evaluation of these questionnaires as well as other Y2K
disclosure information should allow the Company to assess each third
party's respective Y2K readiness. This process is scheduled to be completed
by March 31, 1999. The Company will then determine the most cost-effective
method to remedy any third party non-compliance. The Company does not have
any non-IT systems.
2. Y2K-COSTS - The Company has not incurred any material costs to date related
to its Y2K issues, and 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 when the
assessment of third-party issues is complete and actual results could
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 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. The third-party questionnaire described
in Item 1 above is intended to assess these risks and the alternatives
available to reduce or eliminate them. While the Company believes the
probability of the above occurrences to be 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 is dependent upon the
completion of the assessment of the third-party questionnaires described
above. The Company anticipates it will have such a contingency plan in
place by June 30, 1999. When completed, it is intended that the Company's
documented Y2K contingency plan will include identified "individuals"
within the Company to contact in the event of a Y2K problem, as well as the
availability of back-up systems. Due to the nature of the preliminary open
issues at this time, which involve only third-party issues, the Company
does not currently anticipate the need for any third-party consultants for
remediation efforts.
22
<PAGE> 23
OTHER MATTERS
The Company calculated its Qualified REIT Assets at September 30, 1998, as
defined in the Internal Revenue Code ("Code"), to be 97.1% of the value of its
total assets, as compared to the federal tax requirement that at least 75.0% of
the value of its total assets must be Qualified REIT Assets. The Company also
estimates that 97.0% of its 1998 revenue will qualify for the 75.0% source of
income test and 99.0% of its revenue will qualify for the 95.0% source of income
test under the REIT rules.
The Company believes that it was in full compliance with the REIT tax rules
as of September 30, 1998 and intends to remain in compliance with all REIT tax
rules and to continue to qualify as a REIT under the provisions of the Code.
The Company at all times intends to conduct its business so as not to
become regulated as an investment company under the Investment Company Act. If
the Company were to become regulated as an investment company, then the
Company's use of leverage would be substantially reduced. The Investment Company
Act exempts entities that are "primarily engaged in the business of purchasing
or otherwise acquiring mortgages and other liens on interests in real estate"
("Qualifying Interests"). Under current interpretations of the staff of the SEC,
in order to qualify for this exemption, the Company must maintain at least 55%
of its assets directly in Qualifying Interests. As of September 30, 1998, the
Company calculates that it is in compliance with this requirement.
IMPORTANT FACTORS RELATED TO FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
The preceding section, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and other sections of this Quarterly
Report contain various "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which represent the Company's
expectations or beliefs concerning future events, including, without limitation,
statements containing the words "believes," "anticipates," "expects" and words
of similar import; and also including, without limitation, the following:
statements regarding the Company's continuing ability to target and acquire
mortgage loans; expected availability of the master repurchase agreements; the
sufficiency of the Company's working capital, cash flow and financing to support
the Company's future operating and capital requirements; results of operations
and overall financial performance; the expected dividend distribution rate; and
the expected tax treatment of the Company's operations. Such forward-looking
statements relate to future events and the future financial performance of the
Company and the industry and involve known and unknown risks, uncertainties and
other important factors which could cause actual results, performance or
achievements of the Company or industry to differ materially from the future
results, performance or achievements expressed or implied by such
forward-looking statements.
Investors should carefully consider the various factors identified in the
preceding section, "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and elsewhere in this Quarterly Report that could
cause actual results to differ materially from the results predicted in the
forward-looking statements. Further, the Company specifically cautions investors
to consider the following important factors in conjunction with the
forward-looking statements: the possible decline in the Company's ability to
locate and acquire mortgage loans; the possible adverse effect of changing
economic conditions, including interest rate movements and changes in the real
estate market both locally and nationally; the effect of severe weather or
natural disasters; the effect of competitive pressures from other financial
institutions, including mortgage REITS; and the possible changes, if any, in the
Code REIT rules. Because of the foregoing factors, the actual results achieved
by the Company in the future may differ materially from the expected results
described in the forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
23
<PAGE> 24
PART II OTHER INFORMATION
Item 1. Legal Proceedings
During the third quarter of 1998, there have been no material
developments with respect to legal proceedings to which the
Company or any of its affiliates have been a party.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits filed with this Form 10-Q Ex.27 Financial Data Schedule
(b) Reports on Form 8-K
None
24
<PAGE> 25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Hanover Capital Mortgage Holdings, Inc.
By: /s/ John A. Burchett
------------------------
John A. Burchett
Chairman of the Board of Directors
Dated: April 26, 1999 By: /s/ Ralph F. Laughlin
-------------- ------------------------
Ralph F. Laughlin
Chief Financial Officer and
Principal Accounting Officer
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE HANOVER CAPITAL MORTGAGE HOLDINGS, INC'S QUARTERLY REPORT ON
FORM 10-Q FOR THE PERIOD FROM JANUARY 1, 1998 TO SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 7,045
<SECURITIES> 1,019,417
<RECEIVABLES> 9,190
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,048,916
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,048,916
<CURRENT-LIABILITIES> 978,502<F1>
<BONDS> 0
0
0
<COMMON> 65
<OTHER-SE> 70,349<F2>
<TOTAL-LIABILITY-AND-EQUITY> 1,048,916
<SALES> 0
<TOTAL-REVENUES> 36,186
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,760
<LOSS-PROVISION> 278
<INTEREST-EXPENSE> 31,561
<INCOME-PRETAX> 950
<INCOME-TAX> 0
<INCOME-CONTINUING> 950
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 950
<EPS-PRIMARY> 0.15
<EPS-DILUTED> 0.15
<FN>
<F1>As a Real Estate Investment Trust our balance sheet is
not classified.
<F2>Includes Retained Earnings and Paid In Capital.
</FN>
</TABLE>
