<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1998
OR
- --- TRANSITION REPORT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER: 001-13637
APEX MORTGAGE CAPITAL, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 95-4650863
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
865 SOUTH FIGUEROA STREET
LOS ANGELES, CALIFORNIA 90017
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (213) 244-0440
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
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of the issuer's classes of common
stock, as of the last practicable date.
Common Stock ($0.01 par value) 5,753,000 as of November 10,1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
APEX MORTGAGE CAPITAL, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
-----
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS AT SEPTEMBER 30, 1998 (UNAUDITED) AND
DECEMBER 31, 1997 3
STATEMENT OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1998 (UNAUDITED) 4
STATEMENT OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998 (UNAUDITED) 5
STATEMENTS OF CASH FLOWS FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1998 (UNAUDITED) 6
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 24
ITEM 2. CHANGES IN SECURITIES 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24
ITEM 5. OTHER INFORMATION 24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 24
SIGNATURES 25
</TABLE>
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APEX MORTGAGE CAPITAL, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
<S> <C> <C>
ASSETS (Unaudited)
Cash and cash equivalents $ 5,570,000 $ 3,085,000
Other investments, available-for-sale at fair value 9,706,000 -
Interest rate cap agreements (Note 4) - 174,000
Mortgage-backed securities available-for-sale, at fair value (Note 3) 889,908,000 265,880,000
Accrued interest receivable 5,226,000 1,316,000
Principal payments receivable 158,000 -
Other assets 652,000 852,000
$ 911,220,000 $ 271,307,000
------------------ -----------------
------------------ -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Reverse repurchase agreements (Note 5) $ 811,680,000 $ 87,818,000
Payable for unsettled securities 140,000 88,638,000
Accrued interest payable 3,124,000 110,000
Dividend payable 1,601,000 268,000
Accrued expenses and other liabilities 465,000 1,476,000
------------------ -----------------
817,010,000 178,310,000
------------------ -----------------
Commitments and contingencies (Note 10)
Stockholders' Equity
Preferred Stock, par value $0.01 per share; 50,000,000 shares authorized;
no shares outstanding
Common Stock, par value $0.01 per share; 100,000,000 shares
authorized; 6,700,100 shares outstanding (Notes 8 and 9) 67,000 67,000
Additional paid-in-capital 92,944,000 92,860,000
Accumulated other comprehensive income 12,047,000 188,000
Accumulated dividend distributions in excess of net income (1,740,000) (118,000)
Treasury stock, at cost (782,500 shares) (Note 7) (9,108,000) -
------------------ -----------------
94,210,000 92,997,000
------------------ -----------------
$ 911,220,000 $ 271,307,000
------------------ -----------------
------------------ -----------------
</TABLE>
See accompanying notes to financial statements
3
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
<S> <C> <C>
INTEREST INCOME:
Mortgage-backed securities $ 13,469,000 $ 27,418,000
Cash and cash equivalents 173,000 629,000
------------------ ------------------
13,642,000 28,047,000
INTEREST EXPENSE 11,271,000 24,281,000
------------------ ------------------
NET INTEREST INCOME 2,371,000 3,766,000
------------------ ------------------
GAIN ON INVESTMENT TRANSACTIONS, NET 7,000 476,000
OTHER INCOME 186,000 186,000
GENERAL AND ADMINISTRATIVE EXPENSES:
Management fee (Note 8) 353,000 687,000
Audit and tax fees 11,000 34,000
Insurance expense 67,000 200,000
Directors' fees 15,000 55,000
Stock option expense 28,000 84,000
Other 98,000 202,000
------------------ ------------------
572,000 1,262,000
------------------ ------------------
NET INCOME $ 1,992,000 $ 3,166,000
------------------ ------------------
------------------ ------------------
Net Income Per Share:
Basic $ 0.33 $ 0.50
------------------ ------------------
------------------ ------------------
Diluted $ 0.33 $ 0.50
------------------ ------------------
------------------ ------------------
Weighted Average Number of Shares Outstanding:
Basic 6,022,000 6,334,000
------------------ ------------------
------------------ ------------------
Diluted 6,022,000 6,334,000
------------------ ------------------
------------------ ------------------
Dividends Declared Per Share $ 0.27 $ 0.77
------------------ ------------------
------------------ ------------------
</TABLE>
See accompanying notes to financial statements
4
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Acccumulated
Common Stock Additional Other
----------------------- Paid-in Comprehensive
Shares Amount Capital Income
---------- ---------- ----------- -------------
<S> <C> <C> <C> <C>
Balance, December 31, 1997 6,700,100 $ 67,000 $92,860,000 $ 188,000
Repurchases of common stock - - - -
Issuance of stock options
to non-employees (Note 9) - - 28,000 -
Net income - - - -
Other comprehensive income:
Net unrealized gain on
mortgage-backed securities
available-for-sale - - - 1,547,000
Comprehensive income
Dividends declared - - - -
---------- ---------- ----------- -------------
Balance, March 31, 1998 6,700,100 67,000 92,888,000 1,735,000
Repurchases of common stock - - - -
Issuance of stock options
to non-employees (Note 9) - - 28,000 -
Net income - - - -
Other comprehensive income:
Net unrealized gain (loss) on
mortgage-backed securities
available-for-sale - - - (291,000)
Comprehensive income - - - -
Dividends declared - - - -
---------- ---------- ----------- -------------
Balance, June 30, 1998 6,700,100 67,000 92,916,000 1,444,000
Repurchases of common stock - - - -
Issuance of stock options
to non-employees (Note 9) - - 28,000 -
Net income - - - -
Other comprehensive income:
Net unrealized gain (loss) on
investments available-for-
sale - - - 10,603,000
Comprehensive income - - - -
Dividends declared - - - -
---------- ---------- ----------- -------------
Balance, September 30, 1998 6,700,100 $ 67,000 $92,944,000 $12,047,000
---------- ---------- ----------- -------------
---------- ---------- ----------- -------------
<CAPTION>
Accumulated
Dividend
Distribution Treasury
In Excess of Comprehensive Stock,
Net Income Income At Cost Total
------------ ------------- ------------ ------------
<S> <C> <C> <C> <C>
Balance, December 31, 1997 $ (118,000) $ - $ - $92,997,000
Repurchases of common stock - - (2,535,000) (2,535,000)
Issuance of stock options
to non-employees (Note 9) - - - 28,000
Net income 564,000 564,000 - 564,000
Other comprehensive income:
Net unrealized gain on
mortgage-backed securities
available-for-sale - 1,547,000 - 1,547,000
-------------
Comprehensive income $ 2,111,000
-------------
-------------
Dividends declared (1,626,000) - (1,626,000)
------------ ------------ ------------
Balance, March 31, 1998 (1,180,000) 0 (2,535,000) 90,975,000
------------ ------------
Repurchases of common stock - - (3,901,000) (3,901,000)
Issuance of stock options
to non-employees (Note 9) - - - 28,000
Net income 609,000 609,000 - 609,000
Other comprehensive income:
Net unrealized gain (loss) on
mortgage-backed securities
available-for-sale - (291,000) - (291,000)
-------------
Comprehensive income $ 318,000
-------------
-------------
Dividends declared (1,560,000) - (1,560,000)
------------ ------------ ------------
Balance, June 30, 1998 (2,131,000) (6,436,000) 85,860,000
------------ ------------
Repurchases of common stock - - (2,672,000) (2,672,000)
Issuance of stock options
to non-employees (Note 9) - - - 28,000
Net income 1,992,000 1,992,000 - 1,992,000
Other comprehensive income:
Net unrealized gain (loss) on
investments available-for-
sale - 10,603,000 - 10,603,000
-------------
Comprehensive income $12,595,000
-------------
-------------
Dividends declared (1,601,000) - (1,601,000)
------------ ------------ ------------
Balance, September 30, 1998 $(1,740,000) $(9,108,000) $94,210,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying notes to financial statements
5
<PAGE>
STATEMENT OF CASH FLOWS
APEX MORTGAGE CAPITAL, INC.
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
<S> <C> <C>
OPERATING ACTIVITIES:
Net Income $ 1,992,000 $ 3,166,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization 413,000 3,148,000
Gain on investment transactions, net (7,000) (476,000)
Change in assets and liabilities:
Accrued interest receivable 123,000 (3,910,000)
Principal payments receivable 799,000 (158,000)
Receivable for unsettled securities 56,593,000 -
Other assets 100,000 200,000
Payable for unsettled securities (120,720,000) (88,498,000)
Accrued interest payable (774,000) 3,014,000
Accrued expenses and other liabilities (668,000) (1,011,000)
------------------ ------------------
Net cash used in operating activities (62,149,000) (84,525,000)
------------------ ------------------
INVESTING ACTIVITIES:
Purchase of other investments (9,980,000) (9,980,000)
Purchase of interest rate cap agreements - (80,000)
Purchase of mortgage-backed securities (133,907,000) (1,376,002,000)
Proceeds from sales of mortgage-backed securities 80,199,000 541,801,000
Principal payments on mortgage-backed securities 38,844,000 219,971,000
------------------ ------------------
Net cash used in investing activities (24,844,000) (624,290,000)
------------------ ------------------
FINANCING ACTIVITIES:
Net proceeds from reverse repurchase agreements 57,928,000 723,862,000
Dividend distributions (1,560,000) (3,454,000)
Purchase of treasury stock (2,672,000) (9,108,000)
------------------ ------------------
Net cash provided by financing activities 53,696,000 711,300,000
------------------ ------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (33,297,000) 2,485,000
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 38,867,000 3,085,000
------------------ ------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,570,000 $ 5,570,000
------------------ ------------------
------------------ ------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 12,001,000 $ 21,194,000
------------------ ------------------
------------------ ------------------
NONCASH INVESTING AND FINANCING ACTIVITIES:
Net unrealized gain on assets
available-for-sale $ 10,603,000 $ 11,859,000
------------------ ------------------
------------------ ------------------
Dividends declared, not yet paid $ 1,601,000 $ 1,601,000
------------------ ------------------
------------------ ------------------
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
APEX MORTGAGE CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS
QUARTER ENDED SEPTEMBER 30, 1998
(UNAUDITED)
NOTE 1 - THE COMPANY
Apex Mortgage Capital, Inc. (the "Company") was incorporated in Maryland
on September 15, 1997. The Company commenced its operations of acquiring
and managing a portfolio of mortgage assets on December 9, 1997, upon
receipt of the net proceeds from the initial public offering of the
Company's common stock. The Company uses its equity capital and borrowed
funds to seek to generate income based on the difference between the
yield on its mortgage-backed securities and the cost of its borrowings.
The Company is structured for tax purposes as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986, as amended (the
"Code").
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These interim financial statements are unaudited, internally prepared
statements, that reflect the necessary interim adjustments which, in the
opinion of management, are necessary to present a fair statement of the
results for such interim period. The results of operations for this
interim period are not indicative of the results for a full fiscal year.
This filing should be read in conjunction with the Annual Report on Form
10-K for the year ended December 31, 1997.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid
investments with original maturities of three months or less. The
carrying amount of cash equivalents approximates their fair value.
MORTGAGE-BACKED SECURITIES
The Company's mortgage-backed securities consist of securities backed by
single-family residential real estate mortgage loans. Mortgage-backed
securities are recorded at cost on the date the assets are purchased.
Realized gains and losses on sales of the securities are determined on a
specific identification basis. Substantially all of the Company's
mortgage-backed securities are expected to qualify as real estate assets
under the REIT provisions of the Code.
Interest income is accrued based on the outstanding principal amount of
the mortgage-backed securities and their contractual terms. Premiums and
discounts are amortized into interest income over the lives of the
securities using the effective yield method adjusted for the effects of
estimated prepayments.
The Company's policy is to generally classify its mortgage-backed
securities as available-for-sale. The mortgage-backed securities are
reported at fair value with unrealized gains and losses excluded from
earnings and reported in other comprehensive income.
OTHER INVESTMENTS
The Company's other investments consist primarily of equity securities
issued by other real estate investment trusts and other securities
generally collateralized by mortgage assets.
7
<PAGE>
Dividend income on equity securities is recorded on the declaration
date. Interest income on other securities is accrued using the effective
interest method applied prospectively based on current market
assumptions. Both dividend and interest income earned on other
investments are included in other income.
The Company's policy is to generally classify its other investments as
available-for-sale. Other investments are reported at fair value with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income.
INTEREST RATE HEDGING TRANSACTIONS
The Company enters into interest rate swap and interest rate cap
agreements in order to mitigate the impact of rising interest rates on
the cost of its short-term borrowings. Amounts payable or receivable
from such agreements are accounted for on an accrual basis and
recognized as a net adjustment to interest expense. Premiums paid for
cap agreements accounted for as hedges are recorded on the balance sheet
as interest rate cap agreements and are amortized over the lives of such
agreements as an adjustment to interest expense.
STOCK BASED COMPENSATION
The Company grants stock options to its directors and officers and to
certain directors, officers and employees of its investment manager and
the investment manager itself, as discussed in Note 9. Options granted
to directors of the Company are accounted for using the intrinsic
method, and generally no compensation expense is recognized in the
statement of operations for such options. Other options are accounted
for using the fair value method; such options are measured at their fair
value when they are granted and are recognized as a general and
administrative expense during the periods when the options vest and the
related services are performed.
FEDERAL AND STATE INCOME TAXES
The Company has elected to be taxed as a REIT and generally will not be
subject to federal and state taxes on its income to the extent it
distributes annually 95% of its predistribution taxable income to
stockholders and meets certain other asset, income and stock ownership
tests. As such, no accrual for income taxes has been included in the
financial statements.
NET INCOME PER SHARE
Net income per share is computed in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 128, EARNINGS PER SHARE, and
is calculated on the basis of the weighted average number of common
shares outstanding during each period plus the additional dilutive
effect of common stock equivalents. The dilutive effect of outstanding
stock options is calculated using the treasury stock method.
Stock options that could potentially dilute basic net income per share
in the future were not included in the computation of diluted net income
per share because to do so would have been antidilutive for the period
presented.
INCOME RECOGNITION
Income and expenses are recorded on the accrual basis of accounting.
CREDIT RISK
At September 30, 1998, the Company has limited its exposure to credit
losses on its portfolio of mortgage-backed securities by purchasing
securities that are either rated "AAA" by at least one nationally
recognized rating agency or are issued by the Federal Home Loan Mortgage
Corporation ("FHLMC"), Fannie Mae (formerly known as the Federal
National Mortgage Corporation) or the Government National Mortgage
Association ("GNMA"). The payment of principal and interest on the
FHLMC, Fannie Mae and GNMA securities are guaranteed by those respective
agencies. At September 30, 1998, all of the Company's mortgage-backed
securities have an actual or implied "AAA" rating.
8
<PAGE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
COMPREHENSIVE INCOME
During the nine months ended September 30, 1998, the Company adopted
SFAS No. 130, REPORTING COMPREHENSIVE INCOME. This statement establishes
standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements.
Comprehensive income is defined as "the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in equity
during a period except those resulting from investments by owners and
distributions to owners."
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The
Statement establishes accounting and reporting standards requiring that
every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either
an asset or liability measured at its fair value. The Statement requires
that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses
to offset related results on the hedged item in the income statement,
and requires that a company must formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting.
SFAS No. 133 is effective for fiscal years beginning after June 15,
1999. A company may also implement the Statement as of the beginning of
any fiscal quarter after issuance (that is, fiscal quarters beginning
June 16, 1998 and thereafter). Statement 133 cannot be applied
retroactively. Statement 133 must be applied to (a) derivative
instruments and (b) certain derivative instruments embedded in hybrid
contracts that were issued, acquired, or substantively modified after
December 31, 1997 (and, at the company's election, before January 1,
1998). The Company will adopt the reporting requirements of SFAS No. 133
by the first quarter of 2000. An earlier adoption may be made if
circumstances warrant. The Company expects the impact of the adoption of
the reporting requirements of SFAS No. 133 to include the recording of
the approximate fair value of the Company's interest rate swaps as
comprehensive income.
NOTE 3 - MORTGAGE-BACKED SECURITIES
At September 30, 1998, mortgage-backed securities consisted of the
following:
<TABLE>
<CAPTION>
Adjustable Rate Fixed Rate
(in thousands) Mortgage Mortgage
Securities Securities Total
-----------------------------------------------
<S> <C> <C> <C>
Principal Amount $56,594 $819,673 $876,267
Unamortized Premium (Discount) 870 491 1,361
-----------------------------------------------
Amortized Cost 57,464 820,164 877,628
Unrealized Gains 15 12,388 12,403
Unrealized Losses (123) -- (123)
-----------------------------------------------
Fair Value $57,356 $832,552 $889,908
-----------------------------------------------
-----------------------------------------------
</TABLE>
9
<PAGE>
At December 31, 1997, mortgage-backed securities consisted of the
following:
<TABLE>
<CAPTION>
Adjustable Rate Fixed Rate
(in thousands) Mortgage Mortgage
Securities Securities Total
-----------------------------------------------
<S> <C> <C> <C>
Principal Amount $237,929 $24,826 $262,755
Unamortized Premium 2,743 194 2,937
-----------------------------------------------
Amortized Cost 240,672 25,020 265,692
Unrealized Gains 162 41 203
Unrealized Losses (15) 0 (15)
-----------------------------------------------
Fair Value $240,819 $25,061 $265,880
-----------------------------------------------
-----------------------------------------------
</TABLE>
The contractual final maturity of the mortgage loans supporting the
mortgage-backed securities is generally between 15 and 30 years at
origination. Because of prepayments on the underlying mortgage loans,
the actual weighted-average maturity is expected to be less.
The adjustable rate mortgage-backed securities are typically subject to
periodic and lifetime caps that limit the amount an adjustable rate
mortgage-backed security's interest rate can change during any given
period and over the life of the asset. At September 30, 1998, the
average periodic cap on the adjustable rate mortgage assets was 1.9% per
annum and the average lifetime cap was equal to 11.6%. At December 31,
1997, the average periodic cap on the adjustable rate mortgage assets
was 2.0% per annum and the average lifetime cap was equal to 11.4%.
During the quarter ended September 30, 1998 the Company realized
$104,000 in gains on the sale of $79.3 million of mortgage-backed
securities which were classified as available-for-sale.
NOTE 4 - INTEREST RATE CAP AGREEMENTS
Interest rate cap agreements include the carrying value of purchased
interest rate caps, entered into by the Company in order to mitigate the
impact of rising interest rates on the cost of its short-term
borrowings. As discussed in Note 10, the Company has entered into
certain interest rate swap transactions. The execution of these swaps
eliminated the need for the cap protection previously purchased.
Accordingly, the interest rate cap agreements no longer qualify for
hedge accounting and were written down to zero during the quarter ended
September 30, 1998 which approximates their fair value. A $97,000 charge
for the write-off is included in Gain on Investment Transactions, net in
the Statement of Operations.
The terms of outstanding interest rate cap agreements are as follows:
<TABLE>
<CAPTION>
At September 30, 1998 At December 31, 1997
---------------------------------------------
<S> <C> <C>
Notional Amount $900,000,000 $500,000,000
Average Contract Rate 10.4% 10.0%
Average Final Maturity January 24, 2002 December 24, 2001
</TABLE>
Under these agreements, the Company will receive cash payments to the
extent of the excess of three month London Interbank Offered Rate
("LIBOR") over the agreements' contract rate times the notional amount.
NOTE 5 - REVERSE REPURCHASE AGREEMENTS
The Company has entered into reverse repurchase agreements to finance
certain of its mortgage-backed securities. These agreements are secured
by a portion of the Company's mortgage-backed securities and bear
interest rates that have historically moved in close relationship to
LIBOR.
10
<PAGE>
At September 30, 1998, the Company had outstanding $811,680,000 of
reverse repurchase agreements with a weighted average current borrowing
rate of 5.53% and a maturity of 2.2 months. The reverse repurchase
agreements were collateralized by mortgage-backed securities with an
estimated fair value of $839,163,000.
At December 31, 1997, the Company had outstanding $87,818,000 of reverse
repurchase agreements with a weighted average current borrowing rate of
5.82% and a maturity of 2.8 months. The reverse repurchase agreements
were collateralized by mortgage-backed securities with an estimated fair
value of $90,043,000.
For the quarter ended September 30, 1998, the average reverse repurchase
agreement balance was $774,420,000 with a weighted average interest cost
of 5.74%. The maximum reverse repurchase agreement balance outstanding
during the quarter ended September 30, 1998 was $818,540,000.
For the nine months ended September 30, 1998, the average reverse
repurchase agreement balance was $568,630,000 with a weighted average
interest cost of 5.64%. The maximum reverse repurchase agreement balance
outstanding during the nine months ended September 30, 1998 was
$818,540,000.
NOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the amortized cost and estimated fair
values of the Company's financial instruments. SFAS No. 107, DISCLOSURES
ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, defines the fair value of a
financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale (dollars in thousands):
<TABLE>
<CAPTION>
At September 30, 1998 At December 31, 1997
Amortized Cost Fair Value Amortized Cost Fair Value
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $877,628 $889,908 $265,692 $265,880
Interest Rate Cap Agreements - - 174 174
Other Investments 9,803 9,706 - -
Interest Rate Swaps - (15,464) - -
</TABLE>
The Company bases its fair value estimates for mortgage-backed
securities, other nivestments and interest rate swaps primarily on
third-party price indications provided by dealers who make markets in
these financial instruments when such indications are available.
However, the fair value reported reflects estimates and may not
necessarily be indicative of the amounts the Company could realize in a
current market exchange. Cash and cash equivalents, interest receivable
and reverse repurchase agreements are reflected in the financial
statements at their costs, which approximates their fair value because
of the short-term nature of these instruments.
NOTE 7 - STOCK REPURCHASE PROGRAM
On September 16, 1998, the Company's Board of Directors authorized a
program to repurchase up to an additional 750,000 shares of the
Company's common stock having completed an original repurchase program
of 750,000 shares. The Company repurchased 247,500 shares of its common
stock during the third quarter and 782,500 shares for the nine months
ended September 30, 1998. The average price per share repurchased during
the quarter and the nine months ended September 30, 1998 was $10.80 and
$11.64, respectively. The repurchased shares are held in treasury at
cost in the financial statements herein.
An additional 717,500 shares are currently authorized for potential
repurchase in the future. The Company may continue to repurchase shares
in the future when market conditions warrant.
11
<PAGE>
NOTE 8 - TRANSACTIONS WITH AFFILIATES
The Company has entered into a Management Agreement (the "Management
Agreement") with TCW Investment Management Company (the "Manager"), a
wholly owned subsidiary of The TCW Group, Inc., under which the Manager
will manage its day-to-day operations, subject to the direction and
oversight of the Company's Board of Directors. The Company will pay the
Manager annual base management compensation, payable monthly in arrears,
equal to 3/4 of 1% of the average net invested capital as further
defined in the Management Agreement.
The Company paid the Manager $156,000 in base management compensation in
accordance with the terms of the Management Agreement for the quarter
ended September 30, 1998. The Company paid the Manager $490,000 in base
management compensation for the nine months ended September 30, 1998.
The Company will also pay the Manager, as incentive compensation, an
amount equal to 30% of the Net Income of the Company, before incentive
compensation, in excess of the amount that would produce an annualized
return on equity equal to the ten-year US Treasury rate plus 1% as
further defined in the Management Agreement.
The Company accrued $197,000 of incentive compensation to be paid to the
Manager for the quarter and nine months ended September 30, 1998.
At September 30, 1998, $249,000 of unpaid compensation was payable to
the Manager. At December 31, 1997, $43,000 of unpaid compensation was
payable to the Manager.
The Company may also grant stock options to directors, officers and key
employees of the Company, the Manager, its directors, officers and key
employees.
The Company's other investments include securities that are issued by
special purpose companies that invest primarily in mortgage related
assets. An affiliate of the Manager serves as the investment manager to
these companies and is paid fees in connection with such services. The
Company does not pay any management fees directly to any affiliate of
the Manager in connection with these investments.
12
<PAGE>
NOTE 9 - STOCK OPTIONS
The Company has adopted a stock option plan (the "1997 Stock Option
Plan") that provides for the grant of both qualified incentive stock
options that meet the requirements of Section 422 of the Code, and
non-qualified stock options, stock appreciation rights and dividend
equivalent rights. Stock options may be granted to directors, officers
and key employees of the Company, the Manager, its directors, officers
and key employees.
The exercise price for any stock option granted under the 1997 Stock
Option Plan may not be less than 100% of the fair market value of the
shares of common stock at the time the option is granted. Each option
must terminate no more than ten years from the date it is granted.
Subject to anti-dilution provisions for stock splits, stock dividends
and similar events, the 1997 Stock Option Plan authorizes the grant of
options to purchase an aggregate of up to 10% of the outstanding shares
of the Company's common stock, but not more than 1,000,000 shares of
common stock.
No options were granted under the 1997 Stock Option Plan during the
quarter or nine months ended September 30, 1998. The Company recognized
compensation expense of $28,000 during the quarter ended September 30,
1998 for stock options previously granted to non-employees. The Company
recognized compensation expense of $84,000 during the nine months ended
September 30, 1998 for stock options previously granted to non-employees.
If the Company had recorded stock option grants to Company directors at
fair value and related compensation expense, the pro forma effect on the
Company's net income and earnings per share would have been as follows:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, 1998 September 30, 1998
-----------------------------------------
<S> <C> <C>
Net income - as reported $1,992,000 $3,166,000
Net income - pro forma 1,951,000 3,023,000
Basic and diluted earnings per share - as reported $0.33 $0.50
Basis and diluted earnings per share - pro forma $0.32 $0.48
</TABLE>
The fair value of each option grant was estimated to be $1.05 as of the
grant date using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 11% per annum; expected
volatility of 30%; risk free interest rate of 5.82% per annum; and an
expected life of 10 years.
Information regarding stock option activity for the quarter and nine
months ended September 30, 1998 is as follows:
<TABLE>
<CAPTION>
Shares
-------------
<S> <C>
Outstanding, beginning of period 400,000
Exercised -
Expired -
-------------
Outstanding, end of period 400,000
-------------
-------------
</TABLE>
The original contractual life as of December 3, 1997 of each option was
ten years. The options vest in three equal installments on February 3,
1999, December 3, 1999 and December 3, 2000.
13
<PAGE>
NOTE 10 - CONTRACTUAL COMMITMENTS
The Company has entered into interest rate swap agreements with notional
amounts as stated below. Under these agreements, the Company receives a
floating rate and pays a fixed rate.
<TABLE>
<CAPTION>
Current
Notional Amount Termination Unrealized
(000) Type Fixed Rate Floating Rate Date Gains (Losses)
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 95,000 Interest Rate Swap 5.880% 1Mo LIBOR 5/29/00 $ (1,663)
30,000 Interest Rate Swap 5.905% 1Mo LIBOR 6/30/00 (576)
28,636 Interest Rate Swap 5.765% 1Mo LIBOR 7/25/00 (446)
62,489 Interest Rate Swap 5.775% 1Mo LIBOR 8/25/00 (1,030)
47,811 Interest Rate Swap 5.710% 1Mo LIBOR 8/28/00 (755)
60,000 Interest Rate Swap 5.900% 1Mo LIBOR 5/18/01 (1,638)
98,694 Interest Rate Swap 5.883% 1Mo LIBOR 5/25/01 (2,407)
123,879 Interest Rate Swap 5.905% 1Mo LIBOR 5/25/01 (2,638)
55,172 Interest Rate Swap 5.750% 1Mo LIBOR 7/14/01 (1,136)
65,000 Interest Rate Swap 5.791% 1Mo LIBOR 7/25/01 (1,645)
49,134 Interest Rate Swap 5.960% 1Mo LIBOR 5/15/02 (1,530)
- ---------------- ----------------
$715,815 $(15,464)
- ---------------- ----------------
- ---------------- ----------------
</TABLE>
The Company is generally required to deposit collateral with the swap
agreement counter-parties in an amount at least equal to the amount of
any unrealized losses. At September 30, 1998, the Company had securities
with a fair market value of 16,984,000 on deposit with its
counter-parties.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SAFE HARBOR/FORWARD LOOKING STATEMENTS
Certain information contained in this Quarterly Report on Form 10-Q
constitutes "forward-looking statements" which can be identified by the use
of forward-looking terminology such as "may," "will," "should," "expect,"
"anticipate," "estimate," "intend," "continue," or "believes" or the
negatives thereof or other variations thereon or comparable terminology.
Discussed below are some important factors that would cause actual results to
differ materially from those in any forward-looking statements, including
changes in interest rates; domestic and foreign business, market, financial
or legal conditions; differences in the actual allocation of the assets of
the company from those assumed; and the degree to which assets are hedged and
the effectiveness of the hedge, among others. In addition, the degree of risk
is increased by the company's leveraging of its assets. For additional
discussion of factors that could cause actual results to differ from those
contained in such forward-looking statements, see "Risk Factors" in the
Prospectus included in the Registration Statement on Form S-11 (333-36069)
filed by the Company on November 29, 1997 and incorporated by reference as
Exhibit 99.1 in the Company's annual report on Form 10-K for the year ended
December 31, 1997. The Company does not undertake, and specifically disclaims
any obligation, to update any forward-looking statements to reflect
occurrences or unanticipated events or circumstances after the date of such
statements.
GENERAL
Apex Mortgage Capital, Inc. (the "Company"), a Maryland corporation, was
formed on September 15, 1997, primarily to acquire United States agency
securities, other mortgage securities and mortgage loans. The Company
commenced operations on December 9, 1997, upon receipt of the net proceeds
from the initial public offering of the Company's common stock. The Company's
principal executive offices are located at 865 South Figueroa Street, Suite
1800, Los Angeles, California 90017, and its telephone number is (213)
244-0440.
The Company uses its equity capital and borrowed funds to seek to generate
income based on the difference between the yield on its mortgage assets and
the cost of its borrowings. The Company has elected to be taxed as a real
estate investment trust ("REIT") under the Internal Revenue Code of 1986, as
amended (the "Code"). The Company should not generally be subject to federal
taxes on its income to the extent that it distributes its net income to its
stockholders and maintains its qualification as a REIT.
The goal of the Company is to be an efficient investor in mortgage assets.
The Company generally acquires mortgage assets primarily in the secondary
mortgage market through the operational experience and market relationships
of TCW Investment Management Company (the "Manager") and its affiliates.
The day-to-day operations of the Company are managed by the Manager subject
to the direction and oversight of the Company's Board of Directors, a
majority of whom are unaffiliated with the Manager. The Manager is a
wholly-owned subsidiary of The TCW Group, Inc. ("TCW"). The Manager was
established in 1992 and TCW began operations in 1971 through one of its
affiliates. The Company's investment management team consists of selected
members of TCW's mortgage-backed securities group, all of whom have over ten
years of experience in raising and managing mortgage capital. The Company has
elected to be externally managed by the Manager to take advantage of the
existing operational systems, expertise and economies of scale associated
with the Manager's current business operations, among other reasons.
STRATEGY
To achieve its business objective and generate dividend yields that provide a
competitive rate of return for its stockholders, the Company's strategy is to:
- purchase primarily single-family mortgage assets;
15
<PAGE>
- manage the credit risk of its mortgage assets through, among other
activities (i) carefully selecting mortgage assets to be acquired,
(ii) complying with the Company's policies with respect to credit risk
concentration which, among other things, require the Company to
maintain a mortgage asset portfolio with a weighted average rating
generally equivalent to AA (or a comparable rating) or better, (iii)
actively monitoring the ongoing credit quality and servicing of its
mortgage assets, and (iv) maintaining appropriate capital levels and
allowances for possible credit losses;
- finance purchases of mortgage assets with the net proceeds of equity
offerings and to utilize leverage to increase potential returns to
stockholders through borrowings (primarily reverse repurchase
agreements) with interest rates that will generally reflect changes in
short-term market interest rates; and
- utilize interest rate caps, swaps and similar financial instruments to
mitigate the risk of the cost of its variable-rate liabilities
exceeding the earnings on its mortgage assets during a period of
rising interest rates.
The Company has established the foregoing strategies along with certain
operating policies and procedures to implement them. However, these
strategies and policies may be modified or waived by the Board of Directors
at any time without the consent or approval of the Company's stockholders.
The ultimate effect of any such changes is uncertain.
FINANCIAL CONDITION
MORTGAGE ASSETS
At September 30, 1998, the Company held $889,908,000 of mortgage assets as
compared to $265,880,000 at December 31, 1997. The original maturity of a
significant portion of the mortgage assets ranges from fifteen to thirty
years; the actual maturity is subject to change based on the prepayments of
the underlying mortgage loans.
The following table is a schedule of mortgage assets held listed by security
type (dollars in thousands):
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------------------------------------------
Carrying Percent of Carrying Percent of
Mortgage-Backed Securities Value Portfolio Value Portfolio
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Adjustable Rate (1) $ 57,356 6.4% $240,819 90.6%
Fixed Rate 832,552 93.6% 25,061 9.4%
-------- ------ -------- ------
Totals $889,908 100.0% $265,880 100.0%
-------- ------ -------- ------
-------- ------ -------- ------
</TABLE>
(1) At September 30, 1998, the interest rate indices for 95% and 5% of the
adjustable rate mortgage securities were based on the one-year U.S.
Treasury rate and the six-month London Inter-Bank Offered Rate,
respectively. At December 31, 1997, the interest rate index for all
adjustable rate mortgage securities was based on the one-year U.S.
Treasury rate.
16
<PAGE>
The following table shows various weighted average characteristics of the
mortgage assets held by the Company at September 30, 1998 (dollars in
thousands):
<TABLE>
<CAPTION>
Percent of Weighted
Par Total Par Amortized Market Current Average
Security Type Amount Amount Cost Basis Price Coupon Life (1)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
15 Year Agency/AAA Pass-throughs $307,959 35.1% 100.43% 101.95% 6.51% 3.5
20 Year Agency Pass-throughs 189,517 21.6% 100.36% 101.92% 6.50% 5.0
AAA CMOs 322,198 36.8% 99.53% 101.01% 6.81% 2.1
-------- ------ ------- ------- ----- ---
Total Fixed Rate Holdings 819,674 93.5% 100.06% 101.57% 6.63% 3.3
Adjustable Rate Holdings 56,593 6.5% 101.54% 101.35% 6.58% 1.0
-------- ------ ------- ------- ----- ---
Total Portfolio $876,267 100.0% 100.16% 101.56% 6.62% 3.1
-------- ------ ------- ------- ----- ---
-------- ------ ------- ------- ----- ---
</TABLE>
The following table shows various weighted average characteristics of the
mortgage assets held by the Company at December 31, 1997 (dollars in
thousands):
<TABLE>
<CAPTION>
Percent of Weighted
Par Total Par Amortized Market Current Average
Security Type Amount Amount Cost Basis Price Coupon Life (1)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Fixed Rate Agency CMO $24,826 9.5% 100.78% 100.95% 7.50% 0.9
Adjustable Rate Holdings 237,929 90.5% 101.12% 101.21% 6.90% 0.6
-------- ------ ------- ------- ----- ---
Total Portfolio $262,755 100.0% 101.11% 101.19% 6.66% 0.6
-------- ------ ------- ------- ----- ---
-------- ------ ------- ------- ----- ---
</TABLE>
(1) The weighted average life of the fixed rate mortgage securities is
based upon market prepayment expectations as of the dates shown. The
actual weighted average life could be longer or shorter depending on the
actual prepayment rates experienced over the life of the securities. The
weighted average life shown for the adjustable rate mortgage assets
represents the average time until the next coupon reset date. All
averages are shown in years.
HEDGING INSTRUMENTS AND OTHER INVESTMENTS
The Company utilizes interest rate caps, swaps and similar financial
instruments to mitigate the risk of the cost of its variable-rate liabilities
exceeding the earnings on its mortgage assets during a period of rising
interest rates. The Company is currently utilizing both interest rate cap and
interest rate swap agreements.
Interest rate cap agreements consisted of London Interbank Offered Rate
("LIBOR") based agreements as follows:
<TABLE>
<CAPTION>
At September 30, 1998 At December 31, 1997
------------------------------------------------
<S> <C> <C>
Notional Amount $900,000,000 $500,000,000
Average Contract Rate 10.4% 10.0%
Average Final Maturity January 24, 2002 December 24, 2001
</TABLE>
Under these agreements, the Company will receive cash payments to the extent
of the excess of three-month LIBOR over the agreements' contract rate times
the notional amount. The interest rate cap agreements no longer qualify for
hedge accounting because the Company has entered into additional hedging
transactions as discussed below. Accordingly, the Company now records the cap
agreements at fair market value. During the quarter ended September 30, 1998,
a $97,000
17
<PAGE>
charge against earnings was taken to write the cap agreements down to zero
which approximates their fair market value in the current market environment.
The charge is included as an adjustment to gain on investment transactions on
the income statement.
The Company has entered into interest rate swap agreements with current
notional amounts as stated below. Under these agreements, the Company
receives a floating rate and pays a fixed rate.
<TABLE>
<CAPTION>
Current
Notional Amount Termination Unrealized
(000) Type Fixed Rate Floating Rate Date Gains (Losses)
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 95,000 Interest Rate Swap 5.880% 1Mo LIBOR 5/29/00 $ (1,663)
30,000 Interest Rate Swap 5.905% 1Mo LIBOR 6/30/00 (576)
28,636 Interest Rate Swap 5.765% 1Mo LIBOR 7/25/00 (446)
62,489 Interest Rate Swap 5.775% 1Mo LIBOR 8/25/00 (1,030)
47,811 Interest Rate Swap 5.710% 1Mo LIBOR 8/28/00 (755)
60,000 Interest Rate Swap 5.900% 1Mo LIBOR 5/18/01 (1,638)
98,694 Interest Rate Swap 5.883% 1Mo LIBOR 5/25/01 (2,407)
123,879 Interest Rate Swap 5.905% 1Mo LIBOR 5/25/01 (2,638)
55,172 Interest Rate Swap 5.750% 1Mo LIBOR 7/14/01 (1,136)
65,000 Interest Rate Swap 5.791% 1Mo LIBOR 7/25/01 (1,645)
49,134 Interest Rate Swap 5.960% 1Mo LIBOR 5/15/02 (1,530)
- --------------- ---------------
$ 715,815 $(15,464)
- --------------- ---------------
- --------------- ---------------
</TABLE>
The weighted average coupon the Company pays on the interest rate swap
agreements at September 30, 1998 was 5.85%. The weighted average life of the
agreements at September 30, 1998 was 2.1 years.
The Company is generally required to deposit collateral with the swap
agreement counter-parties in an amount at least equal to the amount of any
unrealized losses. At September 30, 1998, the Company had securities with a
fair market value of 16,984,000 on deposit with its counter-parties. If the
unrealized losses on the interest rate swap agreements were to increase, the
Company would be required to deposit additional collateral.
There can be no assurance that the Company will enter into hedging activities
or that, if entered into, such activities will have the desired beneficial
impact on the Company's results of operations or financial condition.
Moreover, no hedging activity can completely insulate the Company from the
risks associated with changes in interest rates and prepayment rates.
Hedging involves risk and typically involves costs, including transaction
costs. Such costs increase dramatically as the period covered by the hedging
increases and during periods of rising and volatile interest rates. The
Company may increase its hedging activity and, thus, increase its hedging
costs during such periods when interest rates are volatile or rising and
hedging costs have increased. The Company intends generally to hedge as much
of the interest rate risk as the Manager determines is in the best interest
of the shareholders of the Company given the cost of such hedging
transactions and the Company's desire to maintain its status as a REIT. The
Company's policies do not contain specific requirements as to the percentages
or amount of interest rate risk which the Manager is required to hedge.
LIABILITIES
The Company has entered into reverse repurchase agreements to finance certain
of its mortgage-backed securities. These agreements are secured by a portion
of the Company's mortgage-backed securities and bear interest rates that have
historically moved in close relationship to LIBOR.
18
<PAGE>
At September 30, 1998, the Company had outstanding $811,680,000 of reverse
repurchase agreements with a weighted average current borrowing rate of 5.53%
and a maturity of 2.2 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$839,163,000.
At December 31, 1997, the Company had outstanding $87,818,000 of reverse
repurchase agreements with a weighted average current borrowing rate of 5.82%
and a maturity of 2.8 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$90,043,000.
The Company had $5,330,000 and $90,492,000 of other liabilities at September
30, 1998 and December 31, 1997, respectively, consisting primarily of
payables for unsettled securities. The Company anticipates settling all other
liabilities within one year by entering into additional reverse repurchase
agreements.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
For the quarter ended September 30, 1998, the Company's net income was
$1,992,000, or $0.33 per share on both a basic and diluted basis, based on a
weighted average of 6,022,000 shares outstanding. Net interest income for the
period was $2,371,000 consisting of interest income on mortgage assets and
cash balances less interest expense on reverse repurchase agreements. The
Company reported a net gain of $104,000 on the sale of mortgage-backed
securities, which was offset by a charge of $97,000 to write off the interest
rate cap agreements. The Company reported other income of $186,000 from
dividends received on equity investments and interest income on other
securities. The Company incurred operating expenses of $572,000 for the
quarter consisting of management fees, audit, tax, legal, printing, insurance
and other expenses.
As a REIT, the Company 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 its taxable income for each year by
the time it files its applicable tax return. The Company currently intends to
distribute approximately 100% of its taxable net income each year.
The Company anticipates that it will experience differences between its net
income based on generally accepted accounting principles ("GAAP") and its
taxable net income due primarily to differences in the methods used to
amortize purchase premiums and discounts and to the recognition of certain
compensation expenses that are not recognized for tax purposes. During the
quarter ended September 30, 1998, the Company elected to use a different
premium amortization method for its adjustable rate mortgage securities than
had been used in the previous two quarters to estimate taxable income. The
net effect of this change is generally expected to decrease the ordinary
taxable income recognized on the Company's adjustable rate mortgage
securities and decrease the loss recognized on the sale of such securities
during the taxable year ended December 31, 1998.
During the quarter ended September 30, 1998, the Company began investing in
other investments that generally only report taxable income information
annually. Accordingly, the Company will no longer report taxable income on a
quarterly basis as this information is generally not available on a timely
basis for all of the Company's investments.
At September 30, 1998, the Company had distributed $1,740,000 in excess of
reported net income.
19
<PAGE>
The following table reflects the average balances for each category of the
Company's interest earning assets, excluding other investments, as well as
the Company's interest bearing liabilities, with the corresponding annualized
effective yield recognized for the three months ended September 30, 1998
(dollars in thousands):
<TABLE>
<CAPTION>
AVERAGE BALANCE AND YIELD TABLE
(Dollars in thousands)
For the Quarter Ended
September 30, 1998
-------------------------------
Average Effective
Balance Yield
----------- ------------
<S> <C> <C>
Interest Earning Assets:
Mortgage Assets $830,079 6.49%
Cash and Cash Equivalents 13,185 5.25%
----------- ------------
Total Interest Earning Assets 843,264 6.47%
----------- ------------
Interest Bearing Liabilities:
Reverse Repurchase Agreements 774,420 5.82%
----------- ------------
Net Interest Earning Assets and Spread $ 68,844 0.65%
----------- ------------
----------- ------------
</TABLE>
The following table reflects the average balances for each category of the
Company's other investments with the corresponding annualized effective yield
recognized for the three months ended September 30, 1998 (dollars in
thousands):
<TABLE>
<CAPTION>
AVERAGE BALANCE AND YIELD TABLE
(Dollars in thousands)
For the Quarter Ended
September 30, 1998
-------------------------------
Average Effective
Balance Yield
----------- ------------
<S> <C> <C>
Other Investments:
Equity Securities $3,343 16.73%
Other Securities 1,245 15.04%
----------- ------------
Total Other Investments 4,588 16.27%
----------- ------------
----------- ------------
</TABLE>
The effective yield data is computed by dividing the annualized net interest
income or expense into the average daily balance shown.
On September 16, 1998, the Company's Board of Directors authorized a program
to repurchase up to an additional 750,000 shares of the Company's common
stock having completed an original repurchase program of 750,000 shares. The
Company repurchased 247,500 shares of its common stock pursuant to both
programs during the quarter ended September 30, 1998. The average price per
share repurchased was $10.80. The repurchased shares are held in treasury at
cost in the financial statements herein.
An additional 717,500 shares are currently authorized for potential
repurchase in the future. The Company may continue to repurchase shares in
the future when market conditions warrant.
20
<PAGE>
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
For the nine months ended September 30, 1998, the Company's net income was
$3,166,000, or $0.50 per share on both a basic and diluted basis, based on a
weighted average of 6,334,000 shares outstanding. Net interest income for the
period was $3,766,000 consisting of interest income on mortgage assets and
cash balances less interest expense on reverse repurchase agreements. The
Company reported a net gain of $686,000 on the sale of mortgage-backed
securities, which was offset by a charge of $210,000 to write off the
interest rate cap agreements. The Company reported other income of $186,000
from dividends received on equity investments and interest income on other
securities. The Company incurred operating expenses of $1,262,000 for the
period consisting of management fees, audit, tax, legal, printing, insurance
and other expenses.
The following table reflects the average balances for each category of the
Company's interest earning assets, excluding other investments, as well as
the Company's interest bearing liabilities, with the corresponding annualized
effective yield recognized for the nine months ended September 30, 1998
(dollars in thousands):
<TABLE>
<CAPTION>
AVERAGE BALANCE AND YIELD TABLE
(Dollars in thousands)
For the Nine Months Ended
September 30, 1998
-------------------------------
Average Effective
Balance Yield
----------- ------------
<S> <C> <C>
Interest Earning Assets:
Mortgage Assets $621,082 5.89%
Cash and Cash Equivalents 16,306 5.14%
----------- ------------
Total Interest Earning Assets 637,388 5.87%
----------- ------------
Interest Bearing Liabilities:
Reverse Repurchase Agreements 568,630 5.69%
----------- ------------
Net Interest Earning Assets and Spread $ 68,758 0.18%
----------- ------------
----------- ------------
</TABLE>
The effective yield data is computed by dividing the annualized net interest
income or expense into the average daily balance shown.
On September 16, 1998, the Company's Board of Directors authorized a program
to repurchase up to an additional 750,000 shares of the Company's common
stock having completed an original repurchase program of 750,000 shares. The
Company repurchased 782,500 shares of its common stock pursuant to both
programs during the nine months ended September 30, 1998. The average price
per share repurchased was $11.64. The repurchased shares are held in treasury
at cost in the financial statements herein.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds for the quarter ended September 30,
1998 consisted of reverse repurchase agreements totaling $811,860,000. The
Company expects to continue to borrow funds in the form of reverse repurchase
agreements. At September 30, 1998, the Company had borrowing arrangements
with twenty-three different investment-banking firms. Increases in short-term
interest rates could negatively impact the valuation of the Company's
mortgage assets which could limit the Company's borrowing ability or cause
its lenders to initiate margin calls.
21
<PAGE>
The Company will also rely on the cash flow from operations; primarily
monthly principal and interest payments to be received on the mortgage
assets, for liquidity.
During the quarter ended September 30, 1998, the Company noted a distinct
impairment in overall liquidity in the capital markets. Specifically, several
other mortgage companies, hedge funds and other leveraged mortgage investors
publicly announced an inability to obtain suitable financing in the capital
markets including the inability to obtain reverse repurchase agreement
financing. In light of these conditions, some of the Company's lenders have
increased the equity requirement for financing certain mortgage assets
through reverse repurchase agreements. If liquidity conditions in the capital
markets continue to deteriorate, the Company's lenders may continue to
increase the equity required to obtain financing or the lenders may stop
providing financing altogether. If this were to occur, the Company's
liquidity would be adversely affected, which could negatively impact
operating results.
The Company believes that equity capital, combined with the cash flow from
operations and the utilization of borrowings, will be sufficient to enable
the Company to meet anticipated liquidity requirements. If the Company's cash
resources are at any time insufficient to satisfy the Company's liquidity
requirements, the Company may be required to liquidate mortgage assets or
sell debt or additional equity securities. If required, the sale of mortgage
assets at prices lower than the carrying value of such assets would result in
losses.
The Company may in the future increase its capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, common stock, commercial paper, medium-term notes, CMOs and
senior or subordinated notes. All debt securities, other borrowings, and
classes of preferred stock will be senior to the common stock in a
liquidation of the Company. The effect of additional equity offerings may be
the dilution of the equity of stockholders of the Company or the reduction of
the price of shares of the common stock, or both. The Company is unable to
estimate the amount, timing or nature of additional offerings as they will
depend upon market conditions and other factors.
EFFECTS OF INTEREST RATE CHANGES
The Company invests in adjustable-rate mortgage assets that are typically
subject to periodic and lifetime interest rate caps that limit the amount an
adjustable-rate mortgage asset's interest rate can change during any given
period, as well as the minimum rate payable. The Company's borrowings will
not be subject to similar restrictions. Hence, in a period of increasing
interest rates, interest rates on its borrowings could increase without
limitation by caps, while the interest rates on its mortgage assets are
generally limited by caps. This problem will be magnified to the extent the
Company acquires mortgage assets that are not fully indexed. Further, some
adjustable-rate mortgage assets may be subject to periodic payment caps that
result in some portion of the interest being deferred and added to the
principal outstanding. This could result in receipt by the Company of less
cash income on its adjustable-rate mortgage assets than is required to pay
interest on the related borrowings. These factors could lower the Company's
net interest income or cause a net loss during periods of rising interest
rates, which would negatively impact the Company's financial condition, cash
flows and results of operations.
The Company intends to fund its acquisitions of adjustable-rate mortgage
assets with borrowings that have interest rates based on indices and
repricing terms similar to, but of somewhat shorter maturities than, the
interest rate indices and repricing terms of the mortgage assets. Thus, the
Company anticipates that in most cases the interest rate indices and
repricing terms of its mortgage assets and its funding sources will not be
identical, thereby creating an interest rate mismatch between assets and
liabilities. While the historical spread between relevant short-term interest
rate indices has been relatively stable, there have been periods, especially
during the 1979-1982 and 1994 interest rate environments, when the spread
between such indices was volatile. During periods of changing interest rates,
such interest rate mismatches could negatively impact the Company's financial
condition, cash flows and results of operations.
Prepayment rates generally increase when prevailing interest rates fall below
the interest rates on existing mortgage assets. In addition, prepayment rates
generally increase when the difference between long-term and short-term
interest rates declines. Prepayments of mortgage assets could adversely
affect the Company's results of operations in several ways. The Company
anticipates that a substantial portion of its adjustable-rate mortgage assets
may bear initial "teaser" interest rates that are lower than their "fully
indexed" rates (the applicable index plus a margin). In the event that such
an adjustable-
22
<PAGE>
rate mortgage asset is prepaid prior to or soon after the time of adjustment
to a fully indexed rate, the Company will have held the mortgage asset while
it was less profitable and lost the opportunity to receive interest at the
fully indexed rate over the expected life of the adjustable-rate mortgage
asset. In addition, the prepayment of any mortgage asset that had been
purchased at a premium by the Company would result in the immediate write-off
of any remaining capitalized premium amount and consequent reduction of the
Company's net interest income by such amount. Finally, in the event that the
Company is unable to acquire new mortgage assets to replace the prepaid
mortgage assets, its financial condition, cash flow and results of operations
could be materially adversely affected.
The Company also invests in fixed-rate mortgage assets that are expected to
be funded with short-term borrowings. During periods of rising interest
rates, the borrowing costs associated with funding such fixed-rate assets are
subject to increase while the income earned on such assets may remain
substantially unchanged. This would result in a narrowing of the net interest
spread between the related assets and borrowings and may even result in
losses. The Company may enter into derivative transactions seeking to
mitigate the negative impact of a rising interest rate environment. Hedging
techniques will be based, in part, on assumed levels of prepayments of the
Company's mortgage assets. If prepayments are slower or faster than assumed,
the life of the mortgage assets will be longer or shorter which would reduce
the effectiveness of the Company's hedging techniques and may result in
losses on such transactions. Hedging techniques involving the use of
derivative securities are highly complex and may produce volatile returns.
The hedging activity of the Company will also be limited by the asset and
sources of income requirements applicable to the Company as a REIT.
The Company's current allocation to fixed-rate mortgage assets was 93.5% at
September 30, 1998. The Company may increase or decrease this allocation as
market conditions warrant. As mentioned above, there are certain risks
associated with investing in fixed-rate mortgage assets in combination with
hedging instruments. The two main risks the Company faces are that of
extension risk and prepayment risk.
EXTENSION RISK
Fixed-rate assets are generally acquired with a projected weighted average
life based on certain assumptions regarding prepayments. In general, when a
fixed-rate mortgage asset is acquired with borrowings, the Company may enter
into an interest rate swap agreement or other hedging instrument that
effectively fixes the Company's borrowing costs for a period close to the
anticipated average life of the related asset. This strategy is designed to
protect the Company from rising interest rates because the borrowing costs
are fixed for the duration of the asset. However, if prepayment rates
decrease in a rising interest rate environment, the life of the mortgage
asset could extend beyond the term of the swap agreement or other hedging
instrument. This situation could negatively impact the Company as borrowing
costs would no longer be fixed after the end of the hedging instrument while
the income earned on the asset would remain fixed. This situation may also
cause the market value of the Company's mortgage assets to decline with
little or no offsetting gain from the related hedging transactions. In
certain situations, the Company may be forced to sell assets and incur losses
to maintain adequate liquidity.
PREPAYMENT RISK
Fixed-rate assets in combination with hedging instruments are also subject to
prepayment risk. In falling interest rate scenarios, the fixed-rate mortgage
assets may prepay faster such that the average life becomes shorter than its
related hedging instrument. If this were to happen, the Company would
potentially need to reinvest at rates lower than that of the related hedging
instrument. This situation may result in the narrowing of interest rate
spreads or may cause losses.
23
<PAGE>
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
None
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
At the 1998 Annual Meeting of Shareholders held July 1, 1998
shareholders of record as of April 30, 1998 ratified the selection
of Deloitte & Touche LLP as the Company's independent auditors. In
total, 6,342,792 shares were voted for the proposal, 15,365 shares
were voted against the proposal, no shares were withheld, 21,150
shares abstained and no shares were broker non-votes.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit #27 Financial Data Schedule
(b) Reports on Form 8-K
None
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Apex Mortgage Capital, Inc.
Dated: November 12, 1998
By: /s/ Philip A. Barach
-----------------------------------
Philip A. Barach
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Daniel K. Osborne
-----------------------------------
Daniel K. Osborne
Executive Vice President
Chief Operating Officer
Chief Financial Officer
(Principal Accounting Officer)
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION OF THE REGISTRANT AS OF SEPTEMBER
30, 1998 AND THE CONSOLIDATED STATEMENTS OF OPERATIONS OF THE REGISTRANT FOR THE
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 5,570
<SECURITIES> 889,908
<RECEIVABLES> 5,384
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 652
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 911,220
<CURRENT-LIABILITIES> 817,010
<BONDS> 0
0
0
<COMMON> 67
<OTHER-SE> 94,210
<TOTAL-LIABILITY-AND-EQUITY> 967,063
<SALES> 0
<TOTAL-REVENUES> 13,828
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 572
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,271
<INCOME-PRETAX> 1,992
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,992
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,992
<EPS-PRIMARY> 0.33
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</TABLE>
