<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 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 4,904,004 shares of common stock outstanding as
of July 18, 2000.
<PAGE> 2
HANOVER CAPITAL MORTGAGE HOLDINGS, INC.
FORM 10-Q
For the Quarter Ended June 30, 2000
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of
June 30, 2000 and December 31, 1999 3
Consolidated Statements of Operations
for the Three and Six Months Ended June 30, 2000 and 1999 4
Consolidated Statement of Stockholders'
Equity for the Six Months Ended June 30, 2000 5
Consolidated Statements of Cash Flows
for the Six Months Ended June 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 14
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 23
</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>
JUNE 30, DECEMBER 31,
2000 1999
--------- ----------
(unaudited)
<S> <C> <C>
ASSETS
Mortgage loans:
Held for sale $ 352 $ 251
Collateral for CMOs 243,112 269,833
Mortgage securities:
Available for sale 44,347 48,529
Held to maturity 4,616 8,238
Trading -- 5,919
Collateral for CMOs 9,908 --
Cash and cash equivalents 3,044 18,022
Accrued interest receivable 2,699 2,926
Equity investments
Hanover Capital Partners Ltd. 1,757 1,466
HanoverTrade.com, Inc. (99) (30)
Notes receivable from related parties 11,470 8,187
Due from related parties 89 232
Other receivables 276 151
Prepaid expenses and other assets 3,463 1,910
--------- ---------
TOTAL ASSETS $ 325,034 $ 365,634
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reverse repurchase agreements $ 33,404 $ 55,722
CMO borrowing 241,164 254,963
Accrued interest payable 2,005 2,433
Dividends payable -- 583
Due to related party -- 88
Accrued expenses and other liabilities 1,364 1,339
--------- ---------
TOTAL LIABILITIES 277,937 315,128
--------- ---------
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, 4,908,954 and
5,826,899 shares outstanding at June 30, 2000
and December 31, 1999, respectively 58 58
Additional paid-in-capital 71,793 75,840
Retained earnings (deficit) (24,761) (25,496)
Accumulated other comprehensive (loss) income 7 104
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 47,097 50,506
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 325,034 $ 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 SIX
MONTHS ENDED MONTHS ENDED
----------------------------- -----------------------------
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Interest income $ 6,466 $ 7,566 $ 13,140 $ 15,980
Interest expense 5,041 5,833 10,231 12,196
-------- -------- -------- ---------
Net interest income 1,425 1,733 2,909 3,784
Loan loss provision 99 113 202 232
-------- -------- -------- ---------
Net interest income
after loan loss provision 1,326 1,620 2,707 3,552
Gain on sale of servicing rights -- 2 -- 344
Gain on sale of mortgage assets -- -- -- 163
Gain on mark to market of mortgage
securities, net of associated hedge 316 -- 515 --
-------- -------- -------- ---------
Total revenue 1,642 1,622 3,222 4,059
EXPENSES:
Personnel 341 180 697 370
Management and administrative 218 177 441 370
Due diligence -- 44 -- 107
Commissions -- 5 -- 5
Legal and professional 127 328 319 552
Financing/commitment fees 115 71 178 148
Other 158 55 304 133
-------- -------- -------- ---------
Total expenses 959 860 1,939 1,685
-------- -------- -------- ---------
Operating income 683 762 1,283 2,374
Equity in income/(loss) of unconsolidated
subsidiaries
Hanover Capital Partners Ltd. 98 (276) 211 (684)
Hanover Capital Partners 2, Inc. -- (428) -- (896)
HanoverTrade.com, Inc. (46) -- (69) --
-------- -------- -------- ---------
NET INCOME $ 735 $ 58 $ 1,425 $ 794
======== ======== ======== =========
BASIC EARNINGS PER SHARE $ 0.14 $ 0.01 $ 0.26 $ 0.13
======== ======== ======== =========
DILUTED EARNINGS PER SHARE $ 0.14 $ 0.01 $ 0.26 $ 0.13
======== ======== ======== =========
</TABLE>
See notes to consolidated financial statements
4
<PAGE> 5
HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 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 (917,945) (4,047) (4,047)
Comprehensive income:
Net income $ 1, 425 1,425 1,425
Other comprehensive (loss):
Change in net unrealized
gain (loss) on securities
available for sale (176) (176) (176)
Equity in other comprehensive
income of unconsolidated
subsidiary 79 79 79
--------
Comprehensive income: $ 1,328
========
Dividends declared (690) (690)
---------- --- -------- -------- ----- --------
Balance, June 30, 2000 $4,908,954 $58 $ 71,793 $(24,761) $ 7 $ 47,097
========== === ======== ======== ===== ========
</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>
SIX
MONTHS ENDED
----------------------
JUNE 30, JUNE 30,
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,425 $ 794
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Amortization of net premium and discount 460 1,438
Amortization of deferred gain -- (24)
Loan loss provision 202 232
(Gain) on sale of servicing rights -- (344)
(Gain) on sale of mortgage assets -- (163)
(Gain) on mark to market of mortgage assets, net of
associated hedge (515) --
Equity in (income) loss of unconsolidated subsidiaries (142) 1,580
Decrease in accrued interest receivable 227 743
(Increase) in loans to related parties (3,283) (271)
Decrease in due from related parties 143 1
(Increase) decrease in other receivables (125) 1,005
Increase in CMO discount 1,069 --
(Increase) decrease in prepaid expenses and other
assets (1,553) 73
Increase (decrease) in accrued interest payable (428) 149
Increase in deferred income -- 464
Increase (decrease) in due to related party (88) 41
Increase (decrease) in accrued expenses and other
liabilities 25 (1)
--------- ---------
Net cash (used in) provided by operating
activities (2,583) 5,717
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in mortgage loans (101) 58,084
Principal payments received on mortgage securities 3,888 7,261
Principal payments received on collateral for CMOs 26,350 25,838
Proceeds from sale of mortgage securities -- 8,760
Proceeds from sale of mortgage servicing -- 739
Purchase of mortgage securities -- (3,668)
--------- ---------
Net cash provided by investing activities 30,137 97,014
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayment of) reverse repurchase agreement (22,318) (205,437)
Net borrowing from CMOs 11,209 132,253
Principal payments on CMOs (26,103) (25,640)
Repurchase of common stock (4,047) (2,236)
Payment of dividends (1,273) (1,860)
--------- ---------
Net cash (used in) financing activities (42,532) (102,920)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (14,978) (189)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 18,022 11,837
--------- ---------
CASH AND EQUIVALENTS, END OF PERIOD $ 3,044 $ 11,648
========= =========
SUPPLEMENTAL SCHEDULE OF NON CASH ACTIVITIES
Cash paid during the period for:
Income taxes: $ 4 $ 2
========= =========
Interest $ 1,725 $ 12,047
========= =========
</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 Report on
Form 10-Q for the quarter ended March 31, 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 six months
ended June 30, 2000 and 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. The Company has not
yet evaluated the impact of the implementation of Staff Accounting Bulletin No.
101. 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.
2. MORTGAGE LOANS
At June 30, 2000 management determined that $352,000 of mortgage loans were held
for sale. No mortgage loans were designated as held to maturity and $243,112,000
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>
JUNE 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 $ 70 $ 282 $ 352 $ 45 $ 206 $ 251
Net premium (discount)
and deferred cost -- -- -- -- -- --
Loan loss allowance -- -- -- -- -- --
----- ------ ----- ----- ----- ------
Carrying cost of mortgage loans $ 70 $ 282 $ 352 $ 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>
JUNE 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 $158,136 $ 83,687 $241,823 $174,761 $ 93,419 $268,180
Net premium (discount)
and deferred costs 2,072 (152) 1,920 2,361 (165) 2,196
Loan loss allowance (430) (201) (631) (371) (172) (543)
-------- -------- -------- -------- -------- --------
Carrying cost of mortgage loans $159,778 $ 83,334 $243,112 $176,751 $ 93,082 $269,833
======== ======== ======== ======== ======== ========
</TABLE>
7
<PAGE> 8
3. MORTGAGE SECURITIES
At June 30, 2000, the Company had $41,675,000 of fixed rate FNMA mortgage backed
securities ("MBS"), all classified as available for sale, and $17,196,000 of
fixed rate private-placement MBS, classified as available for sale, held to
maturity, and collateral for CMO, as shown in the table below (dollars in
thousands).
<TABLE>
<CAPTION>
FIXED RATE FNMA MBS
JUNE 30, 2000 DECEMBER 31, 1999
---------------------------------------------- ---------------------------------------------------
Available Held Collateral Available Held Collateral
For to for for to for
Sale (a) Maturity Trading CMO Total Sale (a) Maturity Trading CMO Total
--------- -------- ------- ---------- ------ --------- -------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Principal balance of
mortgage securities $42,470 $ -- $ -- $ -- $42,270 $46,156 $ -- $ -- $ -- $46,156
Net premium
and deferred costs 775 -- -- -- 775 863 -- -- -- 863
------- ----- ----- ----- ------- ------- ----- ----- ------ -------
Total amortized cost of
mortgage securities $43,245 $ -- $ -- $ -- $43,245 $47,019 $ -- $ -- $ -- $47,019
Gross unrealized loss (1,570) -- -- -- (1,570) (1,540) -- -- -- (1,540)
------- ----- ----- ----- ------- ------- ----- ----- ------ -------
Carrying cost of
mortgage securities $41,675 $ -- $ -- $ -- $41,675 $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.
<TABLE>
<CAPTION>
FIXED RATE PRIVATE PLACEMENT MBS
JUNE 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 $ -- $ 7,263 $ -- $13,330 $20,593 $ -- $13,735 $ 7,105 $ -- $20,840
Net premium (discount)
and deferred costs 1,323 (2,575) -- (3,554) (4,806) 1,554 (5,241) (1,186) -- (4,873)
------- -------- ----- -------- ------- ------ ------- ------- ------ -------
Total amortized cost of
mortgage securities 1,323 4,688 -- 9,776 15,787 1,554 8,494 5,919 $ -- 15,967
Loan loss allowance -- (72) -- (252) (324) -- (256) -- -- (256)
Gross unrealized gain 1,349 -- -- 384 1,733 1,496 -- -- 1,496
------- ------- ----- ------ ------- ------ ------- -------- ------ -------
Carrying cost of
mortgage securities $ 2,672 $ 4,616 $ -- $ 9,908 $17,196 $3,050 $ 8,238 $ 5,919 $ -- $17,207
======= ======= ===== ======= ======= ====== ======= ======= ====== =======
</TABLE>
The Company also has substantially all of the economic benefit and risks
associated with $20,676,000 fixed rate private-placement subordinate MBS held by
its affiliate, Hanover Capital Partners Ltd. ("HCP"). Although HCP's assets are
not included in the Company's consolidated balance sheet, the Company receives
97% of HCP's income and has guaranteed HCP's debts associated with these
securities. See Note 5 "Equity Investments."
8
<PAGE> 9
FIXED RATE PRIVATE PLACEMENT MBS
(HELD BY AFFILIATE)
<TABLE>
<CAPTION>
JUNE 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 $ 45,403 $ -- $ -- $ -- $ 45,403 $ 33,401 $ -- $ -- $ -- $ 33,401
Net premium (discount)
and deferred costs (24,425) -- -- -- (24,425) (19,175) -- -- -- (19,175)
-------- ----- ----- ----- -------- -------- ----- ----- ----- --------
Total amortized cost of
mortgage securities $ 20,978 $ -- $ -- $ -- $ 20,978 $ 14,226 $ -- $ -- $ -- $ 14,226
Loan loss allowance (729) -- -- -- (729) (285) -- -- -- (285)
Gross unrealized gain 427 -- -- -- 427 239 -- -- -- 239
-------- ----- ----- ----- -------- -------- ----- ----- ----- --------
Carrying cost of
mortgage securities $ 20,676 $ -- $ -- $ -- $ 20,676 $ 14,180 $ -- $ -- $ -- $ 14,180
======== ===== ===== ===== ======== ======== ===== ===== ===== ========
</TABLE>
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):
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2000 JUNE 30, 1999
---------------- ----------------
Balance, beginning of period $ 799 $ 373
Loan loss provision 203 232
Transfers/sales -- 39
Charge-offs (47) (82)
Recoveries -- --
----- -----
Balance, end of period $ 955 $ 562
===== =====
9
<PAGE> 10
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 SIX MONTHS ENDED
------------------------ ----------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES:
Due diligence fees $ 1,742 $1,060 $ 3,284 $1,944
Mortgage sales and servicing 6 119 18 191
Assignment fees 102 -- 273 --
Loan brokering and other income 28 374 35 600
Net interest income on mortgage securities 373 -- 688 --
------- ------ ------- ------
Total revenues 2,251 1,553 4,298 2,735
------- ------ ------- ------
EXPENSES:
Personnel expense 1,587 1,398 3,066 2,685
General and administrative expense 88 121 170 276
Other expenses 252 300 421 565
Interest expense 121 93 218 107
Depreciation and amortization 14 21 26 42
------- ------ ------- ------
Total expenses 2,062 1,933 3,901 3,675
------- ------ ------- ------
INCOME (LOSS) BEFORE INCOME TAXES 189 (380) 397 (940)
INCOME TAX PROVISION (BENEFIT) 88 (95) 179 (235)
------ ------ ------- ------
NET INCOME (LOSS) $ 101 $ (285) $ 218 $ (705)
====== ====== ======= ======
</TABLE>
Since inception, HTC has incurred approximately $1,400,000 of deferred software
costs through June 30, 2000. HTC had a loss of ($46,000) for the second quarter
of 2000, the majority of which represent web page design, professional fees and
data processing costs.
6. NOTES RECEIVABLE FROM RELATED PARTIES
During the second 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.
10
<PAGE> 11
NOTES RECEIVABLE
(in thousands)
<TABLE>
<CAPTION>
March 31, 2000 June 30, 2000
Balance Advances Repayment Balance
-------------- -------- --------- -------------
<S> <C> <C> <C> <C>
Principal Loans $ 3,291 $ -- $ (12) $ 3,279
HCP Loan 5,484 3,084 (1,385) 7,183
HTC Loan -- 1,008 -- 1,008
------- ------ ------- -------
$ 8,775 $4,092 $(1,397) $11,470
======= ====== ======= =======
</TABLE>
7. REVERSE REPURCHASE AGREEMENTS
During the quarter ended June 30, 2000, the Company renewed a $50 million
committed reverse repurchase agreement which will mature in May 2001.
Information pertaining to individual reverse repurchase agreement lenders at
June 30, 2000 is summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
Weighted March 31, Net June 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 (committed) $ 25,000 March 28, 2001 $ 3,342 $ (68) $ 3,274 $ 12,331 (b) Retained CMO Securities
Lender B July 26, 2000(a) 26,220 (1,425) 24,795 36,186 (c) Mortgage Securities
Lender C July 26, 2000(a) 7,827 (3,424) 4,403 5,488 (c) Mortgage Securities
Lender D July 26, 2000(a) 475 (7) 468 709 (c) Mortgage Securities
Lender E July 31, 2000(a) 474 (10) 464 693 (c) Mortgage Securities
</TABLE>
(a) These borrowings are pursuant to uncommitted lines of credit which are
typically renewed monthly.
(b) Certificate balance at June 30, 2000.
(c) Book value at June 30, 2000.
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 October 1999, 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. During the quarter ended June 30, 2000, the Company
repurchased 839,970 shares at an average price of $4.48 per share for a total of
$3,797,000 pursuant to the share repurchase program. In aggregate, the Company
had repurchased 917,945 shares pursuant to the share repurchase program as of
June 30, 2000.
11
<PAGE> 12
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
June 30, 2000 includes management and administrative expenses of $191,000
relating to billings from HCP. The consolidated statement of operations of the
Company for the three months ended June 30, 1999 includes management and
administrative expenses of $177,000 and due diligence expenses of $44,000
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 June 30, 2000 and 1999 the Company recorded
$46,000 and $44,000 of interest income generated from loans to the Principals,
$121,000 and $15,000 of interest income from loans to HCP and $7,000 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.
11. EARNINGS PER SHARE
Calculations for earnings per share are shown below (dollars in
thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
EARNINGS PER SHARE BASIC:
Net income $ 735 $ 58 $ 1,425 $ 794
========== ========== ========== ==========
Average common shares
Outstanding 5,404,957 5,886,240 5,570,844 6,064,606
========== ========== ========== ==========
Per share $ 0.14 $ 0.01 $ 0.26 $ 0.13
========== ========== ========== ==========
EARNINGS PER SHARE DILUTED:
Net income $ 735 $ 58 $ 1,425 $ 794
========== ========== ========== ==========
Average common shares
Outstanding 5,404,957 5,886,240 5,570,844 6,064,606
---------- ---------- ---------- ----------
Add: Incremental shares
from assumed conversion of Warrants 3,381 54,818 -0- 22,051
---------- ---------- ---------- ----------
Dilutive potential common shares 3,381 54,818 -0- 22,051
---------- ---------- ---------- ----------
Adjusted weighted average shares outstanding 5,408,338 5,941,058 5,570,844 6,086,657
========== ========== ========== ==========
Per share $ 0.14 $ 0.01 $ 0.26 $ 0.13
========== ========== ========== ==========
</TABLE>
12
<PAGE> 13
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.
13. COMMITMENTS AND CONTINGENCIES
Hanover has guaranteed four reverse repurchase financing agreements for HCP. The
amount of reverse repurchase financing outstanding at June 30, 2000 was
$15,077,950.
14. SUBSEQUENT EVENTS
On July 28, 2000 a $0.14 cash dividend was declared by the Board of Directors to
be paid on August 22, 2000 to stockholders of record as of August 15, 2000.
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------- ------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net interest income $ 1,425 $ 1,733 $ 2,909 $ 3,784
Loan loss provision (99) (113) (202) (232)
Gain on sale of servicing rights -- 2 -- 344
Gain on sale of mortgage assets -- -- -- 163
Gain mark to market of mortgage securities,
net of associated hedge 316 -- 515 --
------- ------- ------- -------
Total revenues 1,642 1,622 3,222 4,059
Expenses 959 860 1,939 1,685
------- ------- ------- -------
Operating income 683 762 1,283 2,374
Equity income (loss) of unconsolidated
Subsidiaries 52 (704) 142 (1,580)
------- ------- ------- -------
Net income $ 735 $ 58 $ 1,425 $ 794
======= ======= ======= =======
Basic earnings per share $ 0.14 $ 0.01 $ 0.26 $ 0.13
======= ======= ======= =======
Dividends declared per share (a) $ 0.14 $ 0.10 $ 0.26 $ 0.30
======= ======= ======= =======
</TABLE>
(a) The dividends relating to the three months ended June 30, 2000 were declared
on July 28, 2000. The dividends relating to the three months ended June 30, 1999
were declared on July 23, 1999.
The Company recorded net income of $735,000 or $0.14 per share based on
5,404,957 weighted average shares of common stock outstanding for the three
months ended June 30, 2000 compared to net income of $58,000 or $0.01 per share
based on 5,886,240 weighted average shares of common stock outstanding for the
three months ended June 30, 1999. Total revenue for the second quarter of 2000
was $1,642,000 compared with $1,622,000 for the second quarter of 1999. The
second quarter 2000 revenue was enhanced by net mark to market gains of $316,000
on mortgage securities held in a trading account.
The Company's income from HCP, its consulting subsidiary, increased from a loss
of ($276,000) in the three months ended June 30, 1999 to income of $98,000 for
the three months ended June 30, 2000. HCP's total revenue for the second quarter
of 2000 was $2,251,000 compared with $1,553,000 for the second quarter of 1999,
a 44.9% increase. Due diligence fees were $1,742,000, an increase of $682,000 or
64.3% over the $1,060,000 earned in the second quarter of 1999. HCP's
investments in subordinate MBS contributed $373,000 of net interest income (net
of interest expense and loan loss provision) for the second quarter of 2000.
These increases were offset by a decrease in mortgage sales and loan brokering
revenue from $493,000 in the second quarter of 1999 to $34,000 for the second
quarter of 2000.
During the three months and six months ended June 30, 2000, the Company did not
record any equity in losses of its securitization subsidiary, HCP-2. In the
three months and six months ended June 30, 1999, the Company reflected equity in
losses of HCP-2 of $428,000 and $896,000, 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.
14
<PAGE> 15
Also included in the equity in loss of unconsolidated subsidiaries for the
second quarter of 2000 is a ($46,000) 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.
Operating expenses for the three months ended June 30, 2000 were $959,000,
compared to $860,000 for the three months ended June 30, 1999. Personnel
expenses increased $161,000 resulting primarily from the reallocation of certain
personnel expenses from HCP to the Company to better reflect the proper
allocation of the affected individuals' time, and from the addition of a new
chief financial officer in July 1999. Legal and professional fees decreased from
$328,000 in the second quarter of 1999 to $127,000 in the second quarter 2000.
Due diligence expenses also decreased from $44,000 for the second quarter of
1999 to zero for the second quarter of 2000. These savings were offset by an
increase in financing fees of $44,000 in the second quarter of 2000 compared to
second quarter of 1999 and an increase in premises expenses previously allocated
to HCP.
For the six months ended June 30, 2000 the Company reflected net income of
$1,425,000 or $0.26 per share, based on 5,570,844 weighted average shares of
common stock outstanding, compared to $794,000 or $0.13 per share, based on
6,064,606 weighted average shares of common stock outstanding for the six months
ended June 30, 1999. Total revenue for the six months ended June 30, 2000 was
$3,222,000 compared to $4,059,000 for the six months ended June 30, 1999. Net
interest income decreased from $3,784,000 for the six months ended June 30, 1999
to $2,909,000 for the first six months of 2000. The first six months of 2000
benefited from a $515,000 gain on market to market on MBS while the six months
ended June 30, 1999 benefited from a $344,000 gain on sale of servicing rights
and a $163,000 gain on sale of mortgage assets.
Operating expenses increased from $1,685,000 for the six months ended June 30,
1999 to $1,939,000 for the comparable 2000 period. Personnel expenses increased
$327,000 resulting primarily from the reallocation of certain personnel expenses
from HCP to the Company to better reflect the proper allocation of the affected
individuals time, and from the addition of a new chief financial officer in July
1999. Premises expenses increased $141,000 in the first six months of 2000.
These expenses were allocated to HCP in the first six months of 1999. These
increases were offset by decreases in due diligence, legal and professional and
commission expense.
The Company's second 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%.
15
<PAGE> 16
NET INTEREST INCOME
Net interest income for the quarter ended June 30, 2000 was $1,425,000 compared
to net interest income of $1,733,000 for 1999. The following table reflects net
interest income generated for each period (dollars in thousands):
NET INTEREST INCOME
THREE MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999
--------- ----------
Mortgage loans $ 4 $ 413
CMO collateral 222 335
FNMA MBS 261 221
Private placement notes 736 537
Other 202 227
--------- ---------
Total net interest income $ 1,425 $ 1,733
========= =========
TAXABLE INCOME
Hanover's taxable income for the quarter ended June 30, 2000 is estimated at $
248,000. Taxable income differs from GAAP net income for the quarter ended June
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 June 30, 2000 (dollars in
thousands):
GAAP net income $ 735
---------------
Recurring adjustments:
---------------------
Add: Loan loss provision, net of realized losses 57
Less: Tax amortization of net premiums
on mortgages, CMO collateral and
mortgage securities and interest accrual
in excess of GAAP amortization and
interest accrual (475)
Equity in income of unconsolidated subsidiaries (52)
Other (17)
------
Estimated taxable income $ 248
------------------------ ======
As a REIT, Hanover is required to declare dividends amounting to 85% of each
year's taxable income by the end of each calendar year and to have declared
dividends amounting to 95% of Hanover's taxable income for each year by the time
Hanover files its Federal tax return. Therefore, a REIT generally passes through
substantially all of its earnings to shareholders without paying Federal income
tax at the corporate level.
LIQUIDITY
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,
16
<PAGE> 17
reverse repurchase agreements and other possible sources of financing,
including CMOs and REMICs. 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 June 30, 2000 and four uncommitted lines of credit. The Company may
enter into additional committed and uncommitted lines of credit in the future.
Net cash used in operating activities for the six months ended June 30, 2000 was
$2,583,000 compared to net income of $1,425,000. The most significant uses of
cash in operating activities were loans to related parties of $3,283,000,
consisting primarily of loans to HCP which were used to fund purchases by HCP of
subordinate MBS and a loan to HTC to fund web-site development, and an increase
of $1,553,000 in prepaid expenses and other assets primarily due to an increase
in deferred financing expenses. These were offset by an increase in CMO discount
of $1,069,000.
Net cash provided by investing activities amounted to $30,137,000 for the six
months ended June 30, 2000. The majority of cash proceeds from investing
activities was generated from principal payments received on collateral for CMOs
of $26,350,000 and principal payments received on mortgage securities of
$3,888,000.
Net cash used in financing activities totaled $42,532,000 during the six months
ended June 30, 2000. The Company made net repayments to its reverse repurchase
lenders of $22,318,000 and principal payments on CMOs of $26,103,000. The
Company increased CMO borrowings by $11,209,000 with the Hanover 2000-A
securitization. The Company also paid dividends of $1,273,000 and purchased an
additional 839,970 shares of its common stock for $4,047,000 during this period.
CAPITAL RESOURCES
The Company had no significant capital expenditure during the second quarter of
2000 and management does not anticipate the need for any material capital
expenditures 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.
17
<PAGE> 18
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 June 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 June 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
18
<PAGE> 19
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 June
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-
19
<PAGE> 20
looking statements relate to future events and the future financial
performance of the Company and the industry and involve known and unknown risks,
uncertainties and other important factors which could cause actual results,
performance or achievements of the Company or industry to differ materially from
the future results, performance or achievements expressed or implied by such
forward-looking statements.
Investors should carefully consider the various factors identified in
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Other Matters," and elsewhere in this 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 second 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 June 30, 2000 the Company's affiliate, HCP, 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 $21 million of rated subordinate mortgage-backed securities and
the financing associated with these securities. HCP had unrealized hedging
losses on the subordinate MBS of $23,000 at June 30, 2000.
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.
20
<PAGE> 21
At June 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>
$ 26,680 3 Month LIBOR 5.75% March, 2001
25,810 3 Month LIBOR 5.75% April, 2001
75,000 1 Month LIBOR 7.25% August, 2002
35,000 1 Month LIBOR 7.75% August, 2004
--------
$162,490
========
</TABLE>
In addition, the Company's affiliate, HCP, had the following interest rate caps
in effect at June 30, 2000:
<TABLE>
<CAPTION>
NOTIONAL AMOUNT INDEX STRIKE % MATURITY DATE
--------------------------------------------------------------------------
<S> <C> <C> <C>
$11,000 3 month LIBOR 7.695% October, 2003
</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 June 30, 2000, the Company owned a de minimus 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 June 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 June 30, 2000, the Company had a total
of $30,131,000 of floating rate reverse repo financing compared to $43,076,000
of fixed rate mortgage-backed securities investments, and $3,274,000 floating
rate reverse repo financing against $12,331,000 principal balance retained CMO
securities. The Company's affiliate, HCP, had $15,078,000 of such financing
against $20,676,000 carrying value of fixed-rate 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.
21
<PAGE> 22
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.
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
$159,778,000 of fixed rate mortgage loans, $83,334,000 of adjustable rate
mortgage loans and $9,908,000 of mortgage securities at June 30, 2000. The
primary financing for this asset category is the CMOs ($241,164,000) and to a
much lesser extent repo agreements ($3,274,000). 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 June 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 $48,964,000. 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
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<PAGE> 23
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.
PART II OTHER INFORMATION
Item 1. Legal Proceedings
During the second 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
The Company's annual meeting was held on May 18, 2000. John A.
Burchett, John A. Clymer and Saiyid T. Naqvi were elected to
the Board of Directors for 3 year terms. James F. Stone was
elected to the Board for a two year term. Deloitte & Touche,
LLP were appointed as auditor for fiscal year 2000.
Item 5. Other Information
On August 10, 2000 the Board of Directors approved the Termination
of the Shareholders' Agreement of Hanover Capital Partners Ltd.
dated May 26, 1992. The Shareholders' Agreement restricted the
transfer of the Hanover shares acquired by the Principals in
connection with the original formation of Hanover. The
Principals are now able to sell their shares of Hanover
without these restrictions.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed with this Form 10-Q
Exhibit 27 Financial Data Schedule.
Exhibit 10.4.1 Termination of the Shareholders'
Agreement of Hanover Capital Partners Ltd.
Exhibit 10.32.2 Fourth Amendment to Warehousing Credit and
Security Agreement dated as of April 30,
1999 by and between Bank United and the
Company.
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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: August 11, 2000 ----------------------------------
--------------- John A. Burchett
Chairman of the Board of Directors
By: /s/ Thomas P. Kaplan
Dated: August 11, 2000 ----------------------------------
--------------- Thomas P. Kaplan
Chief Financial Officer
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