<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2000
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 2210, 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 4,800,364 shares of common stock outstanding as of
October 13, 2000.
<PAGE> 2
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
FORM 10-Q
For the Quarter Ended September 30, 2000
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations
for the Three and Nine Months Ended September 30, 2000 and 1999 4
Consolidated Statement of Stockholders'
Equity for the Nine Months Ended September 30, 2000 5
Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 27
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except as noted)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
ASSETS 2000 1999
------------- ------------
(unaudited)
<S> <C> <C>
Mortgage loans:
Held for sale $ 233 $ 251
Collateral for CMOs 228,105 269,833
Mortgage securities:
Available for sale 60,770 48,529
Held to maturity 4,588 8,238
Trading 2,743 5,919
Collateral for CMOs 9,912 --
Cash and cash equivalents 3,073 18,022
Accrued interest receivable 2,837 2,926
Equity investments
Hanover Capital Partners Ltd. 1,647 1,466
HanoverTrade.com, Inc. (692) (30)
Notes receivable from related parties 5,975 8,187
Due from related parties 259 232
Other receivables 301 151
Prepaid expenses and other assets 3,626 1,910
--------- ---------
TOTAL ASSETS $ 323,377 $ 365,634
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reverse repurchase agreements $ 46,493 $ 55,722
CMO borrowing 226,229 254,963
Accrued interest payable 1,972 2,433
Dividends payable -- 583
Due to related party -- 88
Accrued expenses and other liabilities 810 1,339
--------- ---------
TOTAL LIABILITIES 275,504 315,128
--------- ---------
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, 4,818,874 and
5,826,899 shares outstanding at September 30, 2000
and December 31, 1999, respectively 48 58
Additional paid-in-capital 71,388 75,840
Retained (deficit) (24,717) (25,496)
Accumulated other comprehensive income 1,154 104
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 47,873 50,506
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 323,377 $ 365,634
========= =========
</TABLE>
See notes to consolidated financial statements
3
<PAGE> 4
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
Interest income $ 7,154 $ 4,740 $ 20,295 $ 20,720
Interest expense 5,073 5,624 15,305 17,820
-------- -------- -------- --------
Net interest income (expense) 2,081 (884) 4,990 2,900
Loan loss provision 385 107 587 339
-------- -------- -------- --------
Net interest income
after loan loss provision 1,696 (991) 4,403 2,561
Gain on sale of servicing rights -- 196 -- 540
Gain on sale of mortgage assets -- (17) -- 146
Provision for (loss) on disposition of
unconsolidated subsidiary -- (4,793) -- (4,793)
Gain (Loss) on mark to market of mortgage
securities, net of associated hedge -- (6,534) 515 (6,534)
-------- -------- -------- --------
Total revenue 1,696 (12,139) 4,918 (8,080)
EXPENSES:
Personnel 128 508 826 878
Management and administrative 156 241 596 611
Due diligence -- 12 -- 119
Commissions -- -- -- 5
Legal and professional 97 375 388 927
Financing/commitment fees 2 82 208 230
Other 119 86 423 219
-------- -------- -------- --------
Total expenses 502 1,304 2,441 2,989
-------- -------- -------- --------
Operating income (loss) 1,194 (13,443) 2,477 (11,069)
Equity in income/(loss) of unconsolidated
subsidiaries
Hanover Capital Partners Ltd. 125 (142) 337 (826)
Hanover Capital Partners 2, Inc. -- (403) -- (1,299)
HanoverTrade.com, Inc. (592) (6) (662) (6)
-------- -------- -------- --------
NET INCOME (LOSS) $ 727 $(13,994) $ 2,152 $(13,200)
======== ======== ======== ========
BASIC EARNINGS (LOSS) PER SHARE $ 0.15 $ (2.40) $ 0.41 $ (2.21)
======== ======== ======== ========
DILUTED EARNINGS (LOSS) PER SHARE $ 0.15 $ (2.38) $ 0.40 $ (2.19)
======== ======== ======== ========
</TABLE>
See notes to consolidated financial statements
4
<PAGE> 5
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2000
(in thousands except share data)
(unaudited)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL RETAINED OTHER
------------ PAID-IN COMPREHENSIVE EARNINGS COMPREHENSIVE
SHARES AMOUNT CAPITAL INCOME (LOSS) (DEFICIT) INCOME TOTAL
------ ------ ---------- ------------- ----------- ------------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1999 5,826,899 $ 58 $75,840 $(25,496) $ 104 $50,506
Repurchase of common stock (1,008,025) (10) (4,452) (4,462)
Comprehensive income:
Net income $ 2,152 2,152 2,152
Other comprehensive income:
Change in net unrealized
gain (loss) on securities
available for sale 1,050 1,050 1,050
-----------
Comprehensive income: $ 3,202
===========
Dividends declared (1,373) (1,373)
----------- ---- ------- -------- ------ -------
Balance, September 30, 2000 4,818,874 $ 48 $71,388 $(24,717) $1,154 $47,873
=========== ==== ======= ======== ====== =======
</TABLE>
See notes to consolidated financial statements
5
<PAGE> 6
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
NINE
MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,152 $ (13,200)
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Amortization of net premium and discount 196 3,963
Loan loss provision 587 339
(Gain) on sale of servicing rights -- (540)
(Gain) on sale of mortgage assets -- (146)
(Gain) loss on mark to market of mortgage assets, net of associated
hedge (515) 6,534
Provision for loss on disposition of unconsolidated subsidiary -- 4,793
Equity in loss of unconsolidated subsidiaries 325 2,131
Decrease in accrued interest receivable 89 683
(Increase) decrease in loans to related parties 2,212 (4,485)
(Increase) in due from related parties (28) (131)
(Increase) decrease in other receivables (151) 1,447
Increase in CMO discount 1,069 --
(Increase) in prepaid expenses and other assets (1,716) (1,512)
Increase (decrease) in accrued interest payable (461) 738
Increase (decrease) in due to related party (88) 336
Increase (decrease) in accrued expenses and other liabilities (640) 707
--------- ---------
Net cash provided by operating activities 3,031 1,657
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in mortgage loans 19 64,859
Transfer of mortgage securities from HCP (13,845) --
Principal payments received on mortgage securities 5,666 10,580
Principal payments received on collateral for CMOs 41,336 42,875
Proceeds from sale of mortgage securities -- 8,743
Proceeds from sale of mortgage servicing -- 806
Purchase of mortgage securities (5,679) (3,668)
--------- ---------
Net cash provided by investing activities 27,497 124,195
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayment of) reverse repurchase agreement (9,229) (310,634)
Net (repayment of) borrowing from CMOs (29,830) 196,209
Repurchase of common stock (4,462) (2,236)
Payment of dividends (1,956) (2,443)
Equity investment subsidiary -- (1)
--------- ---------
Net cash (used in) financing activities (45,477) (119,105)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (14,949) 6,747
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 18,022 11,837
--------- ---------
CASH AND EQUIVALENTS, END OF PERIOD $ 3,073 $ 18,584
========= =========
SUPPLEMENTAL SCHEDULE OF NON CASH ACTIVITIES
Cash paid during the period for:
Income taxes: $ 13 $ 2
========= =========
Interest $ 2,498 $ 17,082
========= =========
</TABLE>
See notes to consolidated financial statements
6
<PAGE> 7
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. ORGANIZATION AND BASIS OF PRESENTATION
The interim consolidated financial statements of Hanover Capital Mortgage
Holdings, Inc. ("Hanover") and subsidiaries (with its subsidiaries, the
"Company") include the accounts of Hanover and its wholly-owned subsidiaries,
Hanover Capital SPC, Inc., Hanover SPC-A, Inc., Hanover QRS-1 98-B, Inc. and
Hanover QRS-2 98-B, Inc. The interim consolidated financial statements included
herein should be read in conjunction with the Company's Annual Report on Form
10-K for the year ended December 31, 1999 and the Company's Quarterly Reports on
Form 10-Q for the quarters ended March 31, 2000 and June 30, 2000. The interim
consolidated financial statements reflect all normal and recurring adjustments
which are, in the opinion of management, considered necessary for a fair
presentation of the financial condition and results of operations for the
periods presented. There were no adjustments of a non-recurring nature recorded
during the nine months ended September 30, 2000. Note 14 details non-recurring
adjustments made during the nine months ended September 30, 1999. The interim
results of operations presented are not necessarily indicative of the results
for the full year. When necessary, reclassifications have been made to conform
to current period presentation.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 - Revenue Recognition in Financial Statements. The Staff
Accounting Bulletin summarizes certain of the staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. The staff is providing this guidance, due, in part, to the large
number of revenue recognition issues that registrants encounter. Implementation
of Staff Accounting Bulletin No. 101 must occur no later than the fourth fiscal
quarter of fiscal years beginning after December 15, 1999. As this Staff
Accounting Bulletin is not intended to change current guidance in the accounting
literature, management of the Company currently believes that the implementation
of such will not have an impact on its financial statements.
The Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") 133 Accounting for Derivative Instruments and
Hedging Activities in June 1998. SFAS 133 establishes accounting and reporting
standards for derivative instruments and hedging activities. SFAS 137, issued in
June 1999, delayed the effective date of SFAS 133 to make it effective for
quarters in fiscal years beginning after June 15, 2000. SFAS 138, issued in June
2000, amends certain technical provisions of SFAS 133. The Company expects to
implement SFAS 133, SFAS 137 and SFAS 138 beginning with its quarterly financial
statements for the period ending March 31, 2001.
In connection with the implementation of these financial standards, the Company
has adopted a hedging policy. Certain of the hedges that the Company currently
has in place will be designated as Fair Value Hedges, and certain of the hedges
that the Company has in place will be designated as Cash Flow Hedges.
Changes in the values of Fair Value Hedges will be reflected in income, and an
offsetting amount reflecting changes in value of the related hedged assets will
also be reflected in income. The effect of this treatment will be to reflect in
income any ineffective portion of such hedges. The Company's Fair Value Hedge as
of September 30, 2000 consisted of a short sale of $6,800,000 of FNMA agency
mortgage-backed securities. As of September 30, 2000, both the hedge and the
hedged asset were carried at fair value. The Company does not expect that this
treatment will materially change as a result of the adoption of SFAS 133, 137
and 138.
Changes in the value of Cash Flow Hedges will be reflected as other
comprehensive income or loss, but only to the extent that the hedging
relationship is expected to be highly effective. The Company's Cash Flow Hedges
at September 30, 2000 consist of five interest rate caps in effect at September
30, 2000 with
7
<PAGE> 8
an aggregate book value of $749,000 and an aggregate market value of $495,000.
These hedges were designated as hedges for floating rate borrowings. The Company
expects that these Cash Flow Hedges will be highly effective. If SFAS 133 had
been adopted for the period ending September 30, 2000, the Company's
"accumulated other comprehensive income (loss)" would be $254,000 lower than
reported, and the Company's net equity would be $254,000 lower than reported,
reflecting the difference between the amortized cost and the aggregate market
value of these caps.
In September 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities, a replacement of FASB
Statement No. 125 ("SFAS No. 140"). SFAS No. 140 replaces Statement No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("SFAS No. 125"). It revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures, but it carries over most of SFAS No. 125's
provisions without reconsideration. SFAS No. 140 provides an accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial components approach that focuses on control. Under
that approach, after a transfer of financial assets, an entity recognizes the
financial and servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. SFAS No. 140 provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. SFAS No. 140 is effective for transfers
and servicing of financial assets and extinguishments of liabilities occurring
after March 31, 2001. SFAS No. 140 is effective for recognition and
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
Company is currently evaluating the impact of SFAS No. 140 on its consolidated
financial statements and is currently addressing the recognition and
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for adoption of such provisions in the Company's
consolidated financial statements as of and for the year ending December 31,
2000.
8
<PAGE> 9
2. MORTGAGE LOANS
At September 30, 2000 management determined that $233,000 of mortgage loans were
held for sale. No mortgage loans were designated as held to maturity and
$228,105,000 of mortgage loans were held as collateralized mortgage obligation
("CMO") collateral.
HELD FOR SALE
The following table summarizes certain characteristics of the Company's
single-family mortgage loan pools held for sale which are reflected at the lower
of cost or market value (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
-------------------------------- --------------------------------
Fixed Adjustable Fixed Adjustable
Rate Rate Total Rate Rate Total
----- ---------- ----- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Principal amount of mortgage loans $ 33 $200 $233 $ 45 $206 $251
Net premium (discount)
and deferred cost -- -- -- -- -- --
Loan loss allowance -- -- -- -- -- --
---- ---- ---- ---- ---- ----
Carrying cost of mortgage loans $ 33 $200 $233 $ 45 $206 $251
==== ==== ==== ==== ==== ====
</TABLE>
COLLATERAL FOR CMOS
The following table summarizes the Company's single-family fixed and adjustable
rate mortgage loan pools held as CMO collateral (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
----------------------------------- -----------------------------------
Fixed Adjustable Fixed Adjustable
Rate Rate Total Rate Rate Total
----- ---------- ----- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Principal amount of mortgage loans $ 149,337 $ 77,496 $ 226,833 $ 174,761 $ 93,419 $ 268,180
Net premium (discount)
and deferred costs 2,069 (136) 1,933 2,361 (165) 2,196
Loan loss allowance (456) (205) (661) (371) (172) (543)
--------- --------- --------- --------- --------- ---------
Carrying cost of mortgage loans $ 150,950 $ 77,155 $ 228,105 $ 176,751 $ 93,082 $ 269,833
========= ========= ========= ========= ========= =========
</TABLE>
3. MORTGAGE SECURITIES
At September 30, 2000, the Company had $43,409,000 of fixed rate FNMA and FHLMC
mortgage backed securities ("MBS"), classified as available for sale and
trading, and $34,604,000 of fixed rate private-placement MBS, classified as
available for sale, held to maturity, and collateral for CMO.
The calculation of the amortization expense for these investments is based,
among other things, on management's estimates of the future expected prepayment
speeds of these investments. Management reviews these estimates each month and
revises them if and when experience and market factors warrant such a revision.
In the three months ended September 30, 2000, management revised its estimates
of the future expected prepayment speeds on certain of these investments. As a
result, amortization expense for
9
<PAGE> 10
the three months ended September 30, 2000 was $205,000 lower, and interest
income was $205,000 higher, than it would have been if these prepayment speed
assumptions had not been revised.
The following tables summarize the Company's FNMA and FHLMC MBS and Fixed Rate
Private Placement MBS (dollars in thousands):
<TABLE>
<CAPTION>
FIXED RATE FNMA & FHLMC MBS
SEPTEMBER 30, 2000 DECEMBER 31, 1999
--------------------------------------------------- -----------------------------------------------
Available Held Collateral Available Held Collateral
For to for for to for
Sale(a) Maturity Trading(b) CMO Total Sale(a) Maturity Trading CMO Total
--------- -------- ---------- ---------- ----- --------- -------- ------- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal balance of
mortgage securities $ 40,902 $ -- $ 2,441 $ -- $ 43,343 $ 46,156 $ -- $ -- $ -- $ 46,156
Net premium
and deferred costs 800 -- 303 -- 1,103 863 -- -- -- 863
-------- ----- -------- ------ -------- -------- ----- ----- ----- --------
Total amortized cost of
mortgage securities $ 41,702 $ -- $ 2,744 $ -- $ 44,446 $ 47,019 $ -- $ -- $ -- $ 47,019
Gross unrealized loss (1,037) -- -- -- (1,037) (1,540) -- -- -- (1,540)
-------- ----- -------- ------ -------- -------- ----- ----- ----- --------
Carrying cost of
mortgage securities $ 40,665 $ -- $ 2,744 $ -- $ 43,409 $ 45,479 $ -- $ -- $ -- $ 45,479
======== ===== ======== ====== ======== ======== ===== ===== ===== ========
</TABLE>
(a) Represents 31 fixed rate FNMA pass-through certificates that the Company
received in exchange for a like amount of fixed rate mortgage loans in
December 1998, and one FNMA pass-through certificate purchased from a "Wall
Street" dealer firm. 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.
(b) Represents 2 fixed rate FHLMC pass-through certificates purchased from a
"Wall Street" dealer firm. The coupon interest rate range from 12.5% to
13.0%.
<TABLE>
<CAPTION>
FIXED RATE PRIVATE PLACEMENT MBS
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------------------------------------ ---------------------------------------------------
Available Held Collateral Available Held Collateral
for to for for to for
Sale Maturity Trading CMO Total Sale Maturity Trading CMO Total
--------- -------- ------- ---------- ----- --------- -------- ------- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal balance of
mortgage securities $ 39,709 $ 7,197 $ -- $ 13,284 $ 60,190 $ -- $ 13,735 $ 7,105 $ -- $ 20,840
Net premium (discount)
and deferred costs (20,898) (2,520) -- (3,467) (26,885) 1,554 (5,241) (1,186) -- (4,873)
-------- -------- ---- -------- -------- -------- -------- -------- ---- --------
Total amortized cost of
mortgage securities 18,811 4,677 -- 9,817 33,305 1,554 8,494 5,919 $ -- 15,967
Loan loss allowance (1,010) (89) -- (289) (1,388) -- (256) -- -- (256)
Gross unrealized gain 2,303 -- -- 384 2,687 1,496 -- -- -- 1,496
-------- -------- ---- -------- -------- -------- -------- -------- ---- --------
Carrying cost of
mortgage securities $ 20,104 $ 4,588 $ -- $ 9,912 $ 34,604 $ 3,050 $ 8,238 $ 5,919 $ -- $ 17,207
======== ======== ==== ======== ======== ======== ======== ======== ==== ========
</TABLE>
10
<PAGE> 11
4. LOAN LOSS ALLOWANCE
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 allowance for the following periods (dollars in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
------------------ ------------------
<S> <C> <C>
Balance, beginning of period $ 799 $ 373
Loan loss provision 587 339
Transfers/sales 729 39
Charge-offs (70) (90)
Recoveries 3 49
------- -------
Balance, end of period $ 2,048 $ 710
======= =======
</TABLE>
5. EQUITY INVESTMENTS
Hanover owns 100% of the non-voting preferred stock of Hanover Capital Partners
Ltd. ("HCP"), a due diligence consulting firm, and HanoverTrade.com ("HTC"), a
start-up internet-based loan trading web-site. These ownership interests entitle
Hanover to receive 97% of the earnings or losses of HCP and HTC.
HANOVER CAPITAL PARTNERS LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 2000 30, 1999 30, 2000 30, 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES:
Due diligence fees $ 1,742 $ 1,917 $ 5,025 $ 3,861
Mortgage sales and servicing 8 28 25 219
Assignment fees 135 -- 408 --
Loan brokering and other income 41 141 77 741
Net interest income on mortgage securities -- 100 688 100
Gain on sale of mortgage securities 441 -- 440 --
------- ------- ------- -------
Total revenues 2,367 2,186 6,663 4,921
------- ------- ------- -------
EXPENSES:
Personnel expense 1,566 1,884 4,631 4,569
General and administrative expense 71 71 241 347
Other expenses 195 275 616 840
Interest expense 26 49 244 156
Depreciation and amortization 13 54 39 95
------- ------- ------- -------
Total expenses 1,871 2,333 5,771 6,007
------- ------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES 496 (147) 892 (1,086)
INCOME TAX PROVISION (BENEFIT) 368 -- 546 (235)
------- ------- ------- -------
NET INCOME (LOSS) $ 128 $ (147) $ 346 $ (851)
======= ======= ======= =======
</TABLE>
11
<PAGE> 12
On July 1, 2000 $13,845,000 of net book value subordinate MBS were transferred
from HCP to the Company. The MBS were transferred at fair market value for tax
purposes.
HANOVERTRADE.COM, INC.
CONDENSED STATEMENT OF OPERATIONS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 2000 30, 1999 30, 2000 30, 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES:
Loan brokering and other income 59 -- 59 --
----- -----
Total revenues 59 -- 59 --
----- ----- ----- -----
EXPENSES:
Personnel expense 382 -- 382 --
Occupancy expense 63 -- 63 --
Network and technology expense 45 3 78 3
Professional fees 11 -- 23 --
Travel and trade shows 88 3 104 3
General and administrative 56 -- 59 --
Interest expense 24 -- 31 --
Depreciation and amortization expense 1 -- 1 --
----- ----- ----- -----
Total expenses 670 6 741 6
----- ----- ----- -----
(LOSS) BEFORE INCOME TAXES (611) (6) (682) (6)
INCOME TAX PROVISION (BENEFIT) -- -- -- --
----- ----- ----- -----
NET (LOSS) $(611) $ (6) $(682) $ (6)
===== ===== ===== =====
</TABLE>
For the three months ended September 30, 2000, certain expenses from HCP and the
Company were billed to HTC. The expenses billed include personnel expense,
occupancy expense, travel, entertainment and trade show expense, and general and
administrative expenses and were billed to reflect activity on behalf of HTC.
HCP and the Company expect similar billings in future periods.
HCP billed a total of $164,000 of net expenses to HTC for the three months ended
September 30, 2000. The billing included $150,000 of personnel expense, $13,000
of occupancy expense, $20,000 of travel, entertainment and trade show expense,
$40,000 general and administrative expense offset by $59,000 of loan brokering
revenue. This billing was included as an expense reduction by HCP.
The Company billed a total of $290,000 of expenses to HTC for the three months
ended September 30, 2000. The billing included $233,000 of personnel expense,
$49,000 of occupancy expense, $7,000 of general and administrative expense, and
$1,000 of depreciation expense. The billing was included as an expense reduction
by the Company.
HTC total assets of $2,314,000 at September 30, 2000 include $2,280,000 of
capitalized software costs. Amortization of these deferred costs is expected to
begin in the fourth quarter of 2000. HTC total liabilities of $3,027,000 at
September 30, 2000 include a note payable to the Company of $1,911,000 and
accrued expenses of $909,000.
12
<PAGE> 13
6. NOTES RECEIVABLE FROM RELATED PARTIES
During the third quarter of 2000, Hanover advanced funds to HCP and HTC pursuant
to unsecured loan agreements. These loans to HCP and HTC bear interest at 1.00%
below the prime rate. In addition, the Company has outstanding loans to John A.
Burchett, Thomas P. Kaplan, Joyce S. Mizerak, George J. Ostendorf, and Irma N.
Tavares ("Principals"). The loans to the Principals bear interest at the lowest
applicable Federal interest rate during the month the loans were made.
NOTES RECEIVABLE
(in thousands)
<TABLE>
<CAPTION>
June 30, 2000 September 30, 2000
Balance Advances Repayment Balance
------------- -------- --------- ------------------
<S> <C> <C> <C> <C>
Principal Loans $ 3,279 $ -- $ -- $ 3,279
HCP Loan 7,183 1,484 (7,882) 785
HTC Loan 1,008 903 -- 1,911
------- ------- ------- -------
$11,470 $ 2,387 $(7,882) $ 5,975
======= ======= ======= =======
</TABLE>
7. REVERSE REPURCHASE AGREEMENTS
Information pertaining to individual reverse repurchase agreement lenders at
September 30, 2000 is summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
Weighted June 30, Net September 30, Type
Maximum Average 2000 (Paydown) 2000 Underlying Of
Lender Borrowing Maturity Date Balance Advance Balance Collateral Collateral
------ --------- ------------- -------- --------- ------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Lender A $25,000 March 28, 2001 $ 3,274 $ 541 $ 3,815 $ 11,061 (b)Retained CMO
(committed) Securities
Lender A October 2, 2000(a)(d) 925 11 936 1,449 (c)Mortgage Securities
Lender B October 30, 2000(a) 24,795 (3,045) 21,750 35,322 (c)Mortgage Securities
Lender B October 5, 2000(a)(d) 6,820 (41) 6,779 8,759 (c)Mortgage Securities
Lender C October 30, 2000(a) 4,403 3,273 7,676 8,028 (c)Mortgage Securities
Lender D October 31, 2000(a)(e) 2,420 1,225 3,645 5,276 (c)Mortgage Securities
Lender E October 30, 2000(a) -- 1,029 1,029 1,279 (c)Mortgage Securities
Lender F October 30, 2000(a) 468 13 481 710 (c)Mortgage Securities
Lender G October 30, 2000(a)(d) 370 11 381 535 (c)Mortgage Securities
</TABLE>
(a) These borrowings are pursuant to uncommitted lines of credit which are
typically renewed monthly.
(b) Certificate balance at September 30, 2000.
(c) Book value at September 30, 2000.
(d) These borrowings were transferred from HCP on July 1, 2000.
(e) Borrowings of $1,956,000 were transferred from HCP on July 1, 2000.
13
<PAGE> 14
8. CMO BORROWING
In June 2000, the Company issued $13,222,000 of CMO borrowings at a discount of
$2,013,000 for net proceeds before expenses of $11,209,000. The "Hanover 2000-A"
CMO securities carry a fixed interest rate of 6.50%. The Hanover 2000-A
securities are collateralized by $25,588,000 principal balance of the retained
portions of Hanover's previous CMO borrowings, Hanover 98-A, Hanover 99-A and
Hanover 99-B and certain retained mortgage backed securities from Hanover 98-B.
The obligations of the 2000-A CMO are payable solely from the underlying
collateral and otherwise are non-recourse to the Company. The maturity of each
class of CMOs is directly affected by principal prepayments on the related CMO
collateral. Each class of CMOs is also subject to redemption according to
specific terms of the respective indenture agreements. As a result, the maturity
of any class of CMO is likely to occur earlier than its stated maturity.
9. 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 from time to time in
open market transactions.
In October 1999, the Board of Directors of the Company authorized a share
repurchase program pursuant to which the Company was authorized to repurchase up
to 1,000,000 shares of its outstanding common stock from time to time in open
market transactions.
In August 2000, the Board of Directors of the Company authorized a share
repurchase program pursuant to which the Company is authorized to repurchase up
to 1,000,000 shares of its outstanding common stock from time to time in open
market transactions up to a maximum of $3,000,000. During the quarter ended
September 30, 2000, the Company repurchased 90,080 shares at an average price of
$4.61 per share for a total of $414,950 pursuant to the share repurchase
programs. In aggregate, the Company has repurchased 646,880 shares pursuant to
the 1998 share repurchase program, 1,000,000 shares pursuant to the 1999 share
repurchase program, and 3,045 shares pursuant to the 2000 share repurchase
program as of September 30, 2000.
10. AFFILIATED PARTY TRANSACTIONS
The Company engaged HCP pursuant to a Management Agreement to provide, among
other things, due diligence, asset management and administrative services.
The consolidated statement of operations of the Company for the quarter ended
September 30, 2000 includes management and administrative expenses of $156,000
relating to billings from HCP. The consolidated statement of operations of the
Company for the three months ended September 30, 1999 includes management and
administrative expenses of $241,000 and due diligence expenses of $12,000
relating to billings from HCP. The 1999 consolidated statement of operations
also reflects a reduction in personnel expenses for a portion of salaries
allocated (and billed) to HCP.
During the three months ended September 30, 2000 and 1999 the Company recorded
$46,000 and $44,000 of interest income generated from loans to the Principals,
$26,000 and $49,000 of interest income from loans to HCP and $24,000 and $ 0 of
interest income from loans to HTC. The term of the Management Agreement
continues until December 31, 2000 with provisions for automatic renewal.
14
<PAGE> 15
11. EARNINGS PER SHARE
Calculations for earnings per share are show below (dollars in thousands, except
per share data):
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 2000 30, 1999 30, 2000 30, 1999
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
EARNINGS PER SHARE BASIC:
Net income (loss) $ 727 $ (13,994) $ 2,152 $ (13,200)
=========== =========== =========== ===========
Average common shares outstanding 4,868,504 5,826,899 5,307,108 5,984,500
=========== =========== =========== ===========
Per share $ 0. 15 $ (2.40) $ 0.41 $ (2.21)
=========== =========== =========== ===========
EARNINGS PER SHARE DILUTED:
Net income (loss) $ 727 $ (13,994) $ 2,152 $ (13,200)
=========== =========== =========== ===========
Average common shares outstanding 4,868,504 5,826,899 5,307,108 5,984,500
----------- ----------- ----------- -----------
Add: Incremental shares
from assumed conversion of Warrants 45,207 50,000 8,093 32,294
Incremental shares from assumed exercise
of 1999 options 1,679 0 0 0
----------- ----------- ----------- -----------
Dilutive potential common shares 46,886 50,000 8,093 32,294
----------- ----------- ----------- -----------
Adjusted weighted average shares outstanding 4,915,390 5,876,899 5,315,201 6,016,794
=========== =========== =========== ===========
Per share $ 0.15 $ (2.38) $ 0.40 $ (2.19)
=========== =========== =========== ===========
</TABLE>
12. STOCK WARRANTS AND STOCK OPTIONS
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. Stock options totaling
282,210 were granted on May 18, 2000 to employees and to members of the Board of
Directors of the Company. These stock options are not exercisable until after
the first anniversary of the grant. Thereafter the options become exercisable
over a three-year period.
15
<PAGE> 16
13. CERTAIN CHARGES AND EXPENSES IN THE THREE MONTHS ENDED
SEPTEMBER 30, 1999
For the three-month period ended September 30, 1999 the Company recorded certain
charges and expenses totaling $14,061,000. These charges and expenses are
summarized as detailed below (dollars in thousands):
<TABLE>
<S> <C>
Realized (loss) on mark to
market of mortgage securities $ 1,312
Impairment charge on mortgage securities 2,225
Realized (loss) on mark to
market of mortgage loans 2,997
Provision for (loss) on disposition of
unconsolidated subsidiary (HCP-2) 4,793
Additional operating expenses relating
to the provision for (loss) on sale of
unconsolidated subsidiary (HCP-2) 153
Loss from unconsolidated subsidiary
(HCP-2) 403
Catch-up premium, (discount), deferred
financing adjustments on certain
CMOs and mortgage securities 1,821
Mortgage loan net interest
income adjustment 357
-------
$14,061
=======
</TABLE>
No similar charges or expenses were recorded in the three month period ended
September 30, 2000.
14. SUBSEQUENT EVENTS
On November 3, 2000 a $0.20 cash dividend was declared by the Board of Directors
for the quarter ended September 30, 2000 to be paid on November 27, 2000 to
stockholders of record as of November 20, 2000.
The Company has repurchased 488,410 shares of its common stock since September
30, 2000 for an aggregate purchase price of $2,805,016 including expenses, or an
average of $5.74 per share. As a result of the repurchases, the Company's
outstanding common stock has been reduced from 4,818,874 shares as of September
30 to 4,330,464 shares as of November 10, 2000.
16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER SEPTEMBER SEPTEMBER SEPTEMBER
30, 2000 30, 1999 30, 2000 30, 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net interest income $ 2,081 $ (884) $ 4,990 $ 2,900
Loan loss provision (385) (107) (587) (339)
Gain on sale of servicing rights -- 196 -- 540
Gain (loss) on sale of mortgage assets -- (17) -- 146
Provision for (loss) on disposition of
Unconsolidated subsidiary (4,793) (4,793)
Gain (loss) mark to market of mortgage securities,
net of associated hedge -- (6,534) 515 (6,534)
-------- -------- -------- --------
Total revenues 1,696 (12,139) 4,918 (8,080)
Expenses 502 1,304 2,441 2,989
-------- -------- -------- --------
Operating income (loss) 1,194 (13,443) 2,477 (11,019)
Equity in (loss) of unconsolidated
Subsidiaries (467) (551) (2,131)
-------- -------- -------- --------
(325)
Net income (loss) $ 727 $(13,994) $ 2,152 $(13,200)
======== ======== ======== ========
Basic earnings (loss) per share $ 0.15 $ (2.40) $ 0.41 $ (2.21)
======== ======== ======== ========
Dividends declared per share (a) $ 0.20 $ 0.10 $ 0.46 $ 0.40
======== ======== ======== ========
</TABLE>
(a) The dividends relating to the three months ended September 30, 2000 were
declared on November 3, 2000. The dividends relating to the three months ended
September 30, 1999 were declared on October 29, 1999.
The Company recorded net income of $727,000 or $0.15 per share based on
4,868,504 weighted average shares of common stock outstanding for the three
months ended September 30, 2000 compared to a net loss of ($13,994,000) or
($2.40) per share based on 5,826,899 weighted average common shares outstanding
for the three months ended September 30, 1999. Total revenue for the third
quarter of 2000 was $1,696,000 compared with ($12,139,000) for the third quarter
of 1999. The third quarter 2000 revenue was enhanced by an amortization
adjustment of $205,000 due to changes in prepayment speed assumptions and
$306,000 of net revenue from subordinate MBS transferred to the Company from HCP
on July 1, 2000. The third quarter 1999 was impacted by one time charges
totaling $14,061,000 relating to: provision for loss on disposition of
unconsolidated subsidiary; mark to market of mortgage securities; catch-up
premium, discount and deferred financing amortization; mortgage loan net
interest income adjustments; and additional operating expenses relating to the
disposition of an unconsolidated subsidiary.
The Company's income from HCP, its consulting subsidiary, increased from a loss
of ($142,000) in the three months ended September 30, 1999 to income of $125,000
for the three months ended September 30, 2000. HCP's total revenue for the third
quarter of 2000 was $2,367,000 compared with $2,186,000 for the third quarter of
1999, an 8.3% increase. Due diligence fees were $1,741,000, a decrease of
$176,000 or 9.2% from the $1,917,000 earned in the third quarter of 1999.
Assignment fees contributed $135,000 of revenue for the third quarter of 2000.
HCP's investments in subordinate MBS contributed $441,000 gain from sales of
securities during the third quarter of 2000. HCP's investment in subordinate MBS
was
17
<PAGE> 18
transferred to the Company at the start of the third quarter and made no
contribution of net interest income (net of interest expense and loan loss
provision) to HCP during the third quarter of 2000. Loan brokering and other
income revenue decreased from $141,000 in the third quarter of 1999 to $41,000
for the third quarter of 2000.
During the three months and nine months ended September 30, 2000, the Company
did not record any equity in losses of its securitization subsidiary, HCP-2. In
the three months and nine months ended September 30, 1999, the Company reflected
equity in losses of HCP-2 of $403,000 and $1,299,000, respectively. The Company
has elected to liquidate HCP-2, and in connection with this decision took a loss
provision of $4,793,000 and recognized certain other operating expenses in the
quarter ended September 30, 1999. The Company does not anticipate any future
losses from HCP-2.
Also included in the equity in loss of unconsolidated subsidiaries for the third
quarter of 2000 is a $592,000 loss from a recently organized subsidiary,
HanoverTrade.com ("HTC"). HTC was organized in June 1999 to develop an
E-commerce business to broker mortgage loan pools to financial institutions and
other finance companies via the internet.
For the three months ended September 30, 2000, certain expenses from HCP and the
Company were billed to HTC. The expenses billed include personnel expense,
occupancy expense, travel and trade shows, and general and administrative
expenses and were billed to reflect activity on behalf of HTC. HCP and the
Company expect similar billings in future periods.
HCP billed a total of $164,000 of net expenses to HTC for the three months ended
September 30, 2000. The billing included $150,000 of personnel expense, $13,000
of occupancy expense, $20,000 of travel and trade show expense, $40,000 general
and administrative expense offset by $59,000 of loan brokering revenue. This
billing was included as an expense reduction by HCP.
The Company billed a total of $290,000 of expenses to HTC for the three months
ended September 30, 2000. The billing included $146,000 of personnel expense and
$76,000 of management and administrative expense recorded as personnel expense
at HTC, $49,000 of occupancy expense, $7,000 of general and administrative
expense, and $1,000 of depreciation expense. The billing was included as an
expense reduction by the Company.
Operating expenses of the Company for the three months ended September 30, 2000
were $502,000, compared to $1,304,000 for the three months ended September 30,
1999, a decrease of $802,000. The major components of the change are decreases
in personnel expenses of $380,000, legal and professional expenses of $278,000,
management and administrative expense of $85,000, financing and commitment fees
of $80,000, while other expenses increased by $33,000.
Personnel expenses declined from $508,000 in the third quarter of 1999 to
$128,000 for the third quarter of 2000, a decrease of $380,000. The major
components of the decrease are the previously mentioned $146,000 personnel
expense billed to HTC in the third quarter of 2000, $73,000 of personnel expense
billed to HCP in the third quarter of 2000 and a one time expense for loan
forgiveness of $103,000 in the third quarter of 1999.
Legal and professional fees decreased by $278,000 from the third quarter of 1999
compared to the third quarter of 2000 due to a lower level of legal expenses in
2000 and an accrual adjustment of $70,000 in the third quarter of 2000 to
reflect an ongoing lower level of legal expenditures.
Management and administrative expense decreased from the third quarter of 1999
compared to the third quarter of 2000 by $85,000 as a result of the billing of
$76,000 of management and administrative expense to HTC during the third quarter
of 2000.
18
<PAGE> 19
Financing and commitment fees decreased from the third quarter of 1999 to the
third quarter of 2000 by $80,000 due to a lower level of committed financing and
accrual adjustments to reflect lower ongoing financing fees.
Other expenses increased from the third quarter of 1999 compared to the third
quarter of 2000 by $33,000. Lower custodial fees and billings of premises
expense to HTC offset higher expenses for rent, utilities, administrative fees,
insurance, leasehold amortization and appraisal fees.
For the nine months ended September 30, 2000 the Company reflected net income of
$2,152,000 or $0.41 per share based on 5,307,108 weighted average shares of
common stock outstanding, compared to a loss of ($13,200,000) or ($2.21) per
share based on 5,984,500 weighted average shares of common stock outstanding for
the nine months ended September 30, 1999. Total revenue for the nine months
ended September 30, 2000 was $4,918,000 compared to expense of ($8,080,000) for
the nine months ended September 30, 1999. Net interest income after loan loss
provision increased from $2,561,000 for the nine months ended September 30, 1999
to $4,403,000 for the nine months ended September 30, 2000. The nine months
ended September 30, 1999 were impacted by the one time charges taken in the
third quarter and outlined previously and were enhanced by gain on sale of
servicing of $540,000 and gain on sale of mortgage assets of $146,000. The nine
months ended September 30, 2000 benefited from gain on mark to market of
mortgage securities of $515,000, amortization adjustment of $205,000, $306,000
of net interest revenue from subordinate MBS transferred to the Company from HCP
in the third quarter of 2000.
Operating expenses decreased from $2,989,000 for the nine months ended September
30, 1999 to $2,441,000 for the nine months ended September 30, 2000. Decreases
in legal and professional expenses and due diligence expenses were offset by
increases in other expenses. The increase in other expense is primarily premises
expense which is higher in 2000 due to increased office space, increase in
leasehold amortization and premises expenses recorded by the Company in 2000
which was recorded by HCP in 1999. These increases are offset in part by
premises expense billed to HTC in the third quarter of 2000.
The Company's third quarter 2000 and 1999 operating expenses did not include any
incentive bonus compensation pursuant to the Company's incentive bonus plan. 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%.
19
<PAGE> 20
NET INTEREST INCOME
Net interest income for the quarter ended September 30, 2000 was $2,081,000
compared to net interest expense of ($884,000) for 1999. The following table
reflects net interest income (expense) generated for each period (dollars in
thousands):
<TABLE>
<CAPTION>
NET INTEREST INCOME (EXPENSE)
THREE MONTHS ENDED
SEPTEMBER 30,
2000 1999
---- ----
<S> <C> <C>
Mortgage loans $ 15 $ (314)
CMO collateral 132 181
FNMA MBS 440 143
Private placement notes 1,383 (1,132)
Other 111 238
------- -------
Total net interest income (expense) $ 2,081 $ (884)
======= =======
</TABLE>
TAXABLE INCOME
Hanover's taxable income for the quarter ended September 30, 2000 is estimated
at $1,162,000. Taxable income differs from GAAP net income for the quarter ended
September 30, 2000 due to various recurring and one-time book/tax differences.
The following table details the significant book/tax differences in arriving at
the estimated taxable income for the quarter ended September 30, 2000 (dollars
in thousands):
<TABLE>
<S> <C>
GAAP NET INCOME $ 727
RECURRING ADJUSTMENTS:
Add: Loan loss provision, net of realized losses 315
Less: Tax amortization of net premiums
on mortgages, CMO collateral and
mortgage securities and interest accrual
in excess of GAAP amortization and
interest accrual (330)
Equity in (income) loss of unconsolidated subsidiaries 467
Other (17)
-------
ESTIMATED TAXABLE INCOME $ 1,162
=======
</TABLE>
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, Hanover generally passes
through substantially all of its earnings to shareholders without paying Federal
income tax at the corporate level.
LIQUIDITY
With the completion of the 2000-A securitization in June 2000 the Company
believes it has substantially reduced its exposure to liquidity events. 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.
20
<PAGE> 21
The Company considers its ability to generate cash to be adequate to meet
operating requirements both short-term and long-term.
The Company's remaining exposure to market-driven liquidity events is limited to
the short-term reverse repurchase financing it has in place against its
mortgage-backed securities. If a significant decline in the market value of the
Company's MBS 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 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 two committed reverse repurchase agreement lines of credit in
place at September 30, 2000 and eight uncommitted lines of credit. See Note 7 to
the financial statements. The Company may enter into additional committed and
uncommitted lines of credit in the future.
Net cash provided by operating activities for the nine months ended September
30, 2000 was $3,031,000 compared to net income of $2,152,000. The most
significant sources of cash in operating activities were decrease in loans to
related parties of $2,212,000, consisting primarily of repayment of loans to HCP
which were used to fund purchases by HCP of subordinate MBS offset by advances
to HTC to fund web-site development; increase in CMO discount of 1,069,000;
decrease in accrued interest payable of $461,000; decrease in due to related
parties of $88,000 and decrease in accrued expenses and other liabilities of
$640,000. The largest uses of cash in operating activities included an increase
of $1,716,000 in prepaid expenses and other assets and primarily due to an
increase in deferred financing expenses.
Net cash provided by investing activities amounted to $27,497,000 for the nine
months ended September 30, 2000. The majority of cash from investing activities
was generated from principal payments received on collateral for CMOs of
$41,336,000 and principal payments received on mortgage securities of
$5,666,000. Cash used in investing activities included purchases of MBS of
$5,679,000 and transfer of subordinate MBS from HCP to the Company of
$13,845,000.
Net cash used in financing activities totaled $45,477,000 during the nine months
ended September 30, 2000. The Company made net repayments to its reverse
repurchase lenders of $9,229,000 and net reductions on CMOs of $29,830,000. The
Company also paid dividends of $1,956,000 and purchased an additional 1,008,025
shares of its common stock for $4,462,000 during this period.
CAPITAL RESOURCES
The Company had no significant capital expenditure during the third quarter of
2000 and management does not anticipate the need for any material capital
expenditure in the near future.
YEAR 2000 (Y2K) DISCLOSURE
The Company did not experience any material Y2K issues. Nevertheless, there
still remain some future dates that could potentially cause computer systems
problems.
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.
21
<PAGE> 22
OTHER MATTERS
REIT Requirements
Hanover has elected to be treated as a REIT for federal income tax purposes,
pursuant to the Internal Revenue Code of 1986, as amended (sometimes referred to
as the "Code"). Hanover believes that it was in full compliance with the REIT
tax rules as of September 30, 2000 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.
Investments in Certain Mortgage Assets
The Company takes certain risks in investing in subprime single-family mortgage
loans and securities collateralized by such loans. If these mortgage loans are
missing relevant documents, such as the original note, they may be difficult to
enforce. These mortgage loans may also have inadequate property valuations. In
addition, if a single-family mortgage loan has a poor payment history, it is
more likely to have future delinquencies because of poor borrower payment habits
or a continuing cash flow problem.
Defaults on Mortgage Assets
The Company makes long-term investments in mortgage assets and securities.
During the time it holds mortgage assets for investment, the Company is subject
to the risks of borrower defaults and bankruptcies and hazard losses (such as
those occurring from earthquakes or floods) that are not covered by insurance.
If a default occurs on any mortgage loan held by the Company or on any mortgage
loan collateralizing below investment grade MBS held by the Company, the Company
will bear the risk of loss of principal to the extent of any deficiency between
the value of the mortgaged property, plus any payments from an insurer or
guarantor, and the amount owing on the mortgage loan.
If the Company were to invest in commercial mortgage loans, the Company may be
subject to certain additional risks. Commercial properties tend to be unique and
more difficult to value than single-family residential properties. Commercial
mortgage loans often have shorter maturities than single-family mortgage loans
and often have a significant principal balance or "balloon" due on maturity. A
balloon payment creates a greater risk for the lender because the ability of a
borrower to make a balloon payment normally depends on its ability to refinance
the loan or sell the related property at a price sufficient to permit the
borrower to make the payment. Commercial mortgage lending is generally viewed as
exposing the lender to a relatively greater risk of loss than single-family
mortgage lending because it usually involves larger mortgage loans to single
borrowers or groups of related borrowers and the repayment of the loans is
typically dependent upon the successful operation of the related properties. As
of September 30, 2000, the Company did not have any commercial mortgage loan
investments. However, the Company may elect to make such investments.
Negative Effects of Fluctuating Interest Rates
Changes in interest rates may impact the Company's earnings in various ways.
While the Company anticipates that over the long term less than 25% of its
mortgage loans will be adjustable rate mortgages ("ARMs"), rising short-term
interest rates may negatively affect the Company's earnings in the short term.
Increases in the interest rate on an ARM loan are generally limited to either 1%
or 2% per
22
<PAGE> 23
adjustment period. ARM loans owned by the Company are subject to such
limitations, while adjustments in the interest rate on the Company's borrowings
are not correspondingly limited. As a result, in periods of rising interest
rates, the Company's net interest income could temporarily decline.
The rate of prepayment on the Company's mortgage loans may increase if interest
rates decline, or if the difference between long-term and short-term interest
rates diminishes. Increased prepayments would cause the Company to amortize any
premiums paid on the acquisition of its mortgage loans faster than currently
anticipated, resulting in a reduced yield on its mortgage loans. Additionally,
to the extent proceeds of prepayments cannot be reinvested at a rate of interest
at least equal to the rate previously earned on the prepaid mortgage loans, the
Company's earnings may be adversely affected.
Insufficient Demand for Mortgage Loans and the Company's Loan Products
The availability of mortgage loans that meet the Company's criteria depends on,
among other things, the size of and level of activity in the residential,
multifamily and commercial real estate lending markets. The size and level of
activity in these markets, in turn, depends on the level of interest rates,
regional and national economic conditions, inflation and deflation in property
values and the general regulatory and tax environment as it relates to mortgage
lending. If the Company can not obtain sufficient mortgage loans or mortgage
securities that meet its criteria, its business will be adversely affected.
Investment Company Act
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, 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 interest in real estate" ("Qualifying
Interests"). Under current interpretation of the staff of the Securities and
Exchange Commission, 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, 2000, management determined that the Company is in compliance with
this requirement.
State and Local Taxes
Hanover and its shareholders may be subject to state or local taxation in
various jurisdictions, including those in which it or they transact business or
reside. The state and local tax treatment of Hanover and its shareholders may
not conform to federal income tax consequence discussed above. Consequently,
prospective shareholders should consult their own tax advisors regarding the
effect of state and local tax laws on an investment in Hanover shares.
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
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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 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
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.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
During the third quarter of 2000 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 and certain mortgage securities.
The Company generally closes out the hedge position to coincide with the related
sale or securitization transactions and recognizes the results of the hedge
transaction in determining the amount of the related gain or loss for loans or
securities sold, or as a basis adjustment to loans held to maturity.
At September 30, 2000 the Company had forward commitments to sell $6.8 million
(par value) of Agency mortgage securities that had not yet settled. This forward
sale was entered into to hedge the net interest margin between approximately
$17.6 million of rated subordinate mortgage-backed securities and the financing
associated with these securities.
The primary risk associated with selling short Agency securities relates to
changes in interest rates. Generally, as market interest rates increase, the
market yield of the hedged asset (fixed rate mortgage loans) will increase. 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 should offset a
corresponding decline in the net interest margin of the hedged assets.
Conversely, if interest rates decrease, the market yield of the hedged asset
will generally decrease. 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 corresponding increase in net interest
margin of 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 of the Company continually monitors the changes in
weighted average duration and coupons of the hedged net interest margin 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 and floating rate CMOs. 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.
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<PAGE> 25
At September 30, 2000 the Company had the following interest rate caps in effect
(dollars in thousands):
<TABLE>
<CAPTION>
NOTIONAL AMOUNT INDEX STRIKE % MATURITY DATE
--------------------------------------------------------------------------------
<S> <C> <C> <C>
$ 25,265 3 Month LIBOR 5.75% March, 2001
24,418 3 Month LIBOR 5.75% April, 2001
11,000 3 Month LIBOR 7.695% October, 2003
50,000 1 Month LIBOR 7.25% August, 2002
25,000 1 Month LIBOR 7.75% August, 2004
--------
$135,683
========
</TABLE>
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 the strike rate, subject to the limitation of the notional
amount of financing.
INTEREST RATE SENSITIVITY
Interest Rate Mismatch Risk - Reverse Repo Financing
At September 30, 2000, the Company owned a deminimus amount of mortgage loans
held for sale. If the Company resumes its strategy of purchasing mortgage loans,
it would finance 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) with reverse repurchase agreement
("repo") financing or with equity alone in certain instances. In this scenario,
the Company would be exposed to the mismatch between the cost of funds on its
repo financing and the yield on the mortgage loans. The Company's repo financing
agreements at September 30, 2000 were indexed to LIBOR plus a spread of 125 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.
The Company also has floating rate reverse repurchase financing for certain
fixed-rate mortgage backed securities. At September 30, 2000, the Company had a
total of $42,677,000 of floating rate reverse repo financing compared to
$61,358,000 of fixed rate mortgage-backed securities investments, and $3,815,000
floating rate reverse repo financing against $11,061,000 principal balance
retained CMO securities. The Company has attempted to hedge exposure by using
the rate caps and short sales of agency MBS described above.
Price Risk
The market value of mortgage loans and mortgage securities will fluctuate with
changes in interest rates. In the case of mortgage loans held for sale and
mortgage securities available for sale or held for trading, the Company will be
required to record changes in the market value of such assets. In the case of
mortgage loans held for sale and mortgage securities held in trading, the
Company generally attempts to hedge these changes through the short sale of
mortgage securities, described above. At June 30, 2000, the Company did not have
any significant mortgage loans held for sale.
In the case of mortgage loans held for sale, 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. 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.
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Prepayment Risk
Interest income on the mortgage loan and mortgage securities portfolio is also
negatively affected by prepayments on mortgage loan pools or MBS purchased at a
premium and positively impacted by prepayments on mortgage loan pools or MBS
purchased at a discount. The Company assigns an anticipated prepayment speed to
each mortgage pool and MBS at the time of purchase and records the appropriate
amortization of the premium or discount over the estimated life of the mortgage
loan pool or MBS. 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.
Delinquency and Default Risk
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.
Securitized Mortgage Loan Assets
With respect to the match funding of assets and liabilities, the CMO collateral
relating to the 1998-A, 1999-A, 1999-B and 2000-A securitizations reflect
$150,950,000 of fixed rate mortgage loans, $77,155,000 of adjustable rate
mortgage loans and $9,912,000 of mortgage securities at September 30, 2000. The
primary financing for this asset category is the CMOs of $226,229,000 and to a
much lesser extent repo agreements of $3,815,000. 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 for the 1998-A,
1999-A and 2000-A securitizations lock in long-term fixed financing and thereby
eliminates most interest rate risk. The financing for the 1999-B securitization
is indexed to LIBOR. Accordingly, the Company has hedged this interest rate risk
through the purchase of interest rate caps. The Company purchased amortizing
interest rate caps with notional balances of $110 million in August 1999 to
hedge the 1999-B securitization.
Mortgage Securities
At September 30, 2000 the Company owned fixed rate Agency and private placement
mortgage securities and interest only and principal only private placement
mortgage securities with an aggregate carrying value of $68,101,000. 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.
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<TABLE>
<CAPTION>
PART II OTHER INFORMATION
<S> <C>
Item 1. Legal Proceedings
During the third quarter of 2000, 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
On August 10, 2000 the Company's Board of Directors approved a common stock
repurchase program which authorized the Company to repurchase the lessor of
$3,000,000 worth of issued and outstanding common stock or 1,000,000 shares of issued
and outstanding common stock. Such purchases to be effected from time to time on the
American Stock Exchange in such amounts and at such prices as determined by the
officers of the Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed with this Form 10-Q
Exhibit 27 Financial Data Schedule.
</TABLE>
--------------------------------------------------------------------------------
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
Dated: November 13, 2000 ---------------------------------------
----------------- John A. Burchett
Chairman of the Board of Directors
By: /s/ Thomas P. Kaplan
Dated: November 13, 2000 ---------------------------------------
----------------- Thomas P. Kaplan
Chief Financial Officer
27
