<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: MARCH 31, 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) 6,417,800 as of May 8, 1998
================================================================================
<PAGE>
APEX MORTGAGE CAPITAL, INC
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets at March 31, 1998 (unaudited) and December 31, 1997 3
Statement of Operations for the three months ended March 31, 1998
(unaudited) 4
Statement of Stockholders' Equity for the three months ended
March 31, 1998 (unaudited) 5
Statements of Cash Flows for the three months ended March 31, 1998
(unaudited) 6
Notes to Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
</TABLE>
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APEX MORTGAGE CAPITAL, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $5,157,000 $3,085,000
Mortgage-backed securities available-for-sale, at fair value (Note 3) 762,953,000 265,880,000
Hedging assets (Note 4) 242,000 174,000
Accrued interest receivable 4,129,000 1,316,000
Principal payments receivable 5,609,000 -
Other assets 804,000 852,000
------------ ------------
$778,894,000 $271,307,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Reverse repurchase agreements (Note 5) $597,282,000 $ 87,818,000
Payable for unsettled securities 87,094,000 88,638,000
Accrued interest payable 1,378,000 110,000
Dividend payable 1,626,000 268,000
Accrued expenses and other liabilities 539,000 1,476,000
------------ ------------
687,919,000 178,310,000
------------ ------------
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 92,888,000 92,860,000
Accumulated other comprehensive income 1,735,000 188,000
Accumulated dividend distributions in excess of net income (1,180,000) (118,000)
Treasury stock, at cost (197,700 shares) (Note 7) (2,535,000) -
------------ ------------
90,975,000 92,997,000
------------ ------------
$778,894,000 $271,307,000
============ ============
</TABLE>
See accompanying notes to financial statements
3
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
<S> <C>
INTEREST INCOME:
Mortgage-backed securities $4,726,000
Cash and cash equivalents 181,000
----------
4,907,000
INTEREST EXPENSE 4,011,000
----------
NET INTEREST INCOME 896,000
----------
GENERAL AND ADMINISTRATIVE EXPENSES:
Management fee (Note 8) 173,000
Audit and tax fees 11,000
Insurance expense 67,000
Directors' fees 20,000
Stock Option expense 28,000
Printing expense 6,000
Other 27,000
----------
332,000
----------
NET INCOME $ 564,000
==========
Net Income Per Share:
Basic $ 0.09
==========
Diluted $ 0.09
==========
Weighted Average Number of Shares Outstanding:
Basic 6,603,000
==========
Diluted 6,603,000
==========
Dividends Declared Per Share $ 0.25
==========
</TABLE>
See accompanying notes to financial statements
4
<PAGE>
Apex Mortgage Capital, Inc.
Statement of Stockholders' Equity
Three Months Ended March 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Accumulated Dividend
Additional Other Distribution
Paid-in Comprehensive In Excess of
Shares Amount Capital Income Net Income
---------- ---------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 6,700,100 $ 67,000 $ 92,860,000 $ 188,000 $ (118,000)
Repurchases of common stock - - - - -
Issuance of stock options
to non-employees (Note 9) - - 28,000 - -
Net income - - - - 564,000
Other comprehensive income:
Net unrealized gain on
mortgage-backed securities
available-for-sale - - - 1,547,000
Comprehensive income
Dividends declared - - - - (1,626,000)
---------- --------- ----------- ---------- -----------
Balance, March 31, 1998 6,700,100 $ 67,000 $92,888,000 $1,735,000 $(1,180,000)
========== ========= =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
Treasury
Comprehensive Stock,
Income At Cost Total
------------- ----------- ---------------
<S> <C> <C> <C>
Balance, December 31, 1997 $ - $ - $ 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
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)
----------- -------------
Balance, March 31, 1998 $(2,535,000) $ 90,975,000
=========== =============
</TABLE>
See accompanying notes to financial statements
5
<PAGE>
Apex Mortgage Capital, Inc.
Statement of Cash Flows
Three Months Ended March 31, 1998
(Unaudited)
<TABLE>
<S> <C>
Operating Activities:
Net Income $ 564,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization 971,000
Increase in accrued interest receivable (2,813,000)
Increase in principal payments receivable (5,609,000)
Decrease in other assets 48,000
Decrease in payable for unsettled securities (1,544,000)
Increase in accrued interest payable 1,268,000
Decrease in accrued expenses and other liabilities (937,000)
-----------------
Net cash used in operating activities (8,052,000)
-----------------
Investing Activities:
Purchase of mortgage-backed securities (557,642,000)
Principal payments on mortgage-backed securities 61,185,000
Purchase of hedging assets (80,000)
-----------------
Net cash used in investing activities (496,537,000)
-----------------
Financing Activities:
Net proceeds from reverse repurchase agreements 509,464,000
Dividend distributions (268,000)
Purchase of treasury stock (2,535,000)
-----------------
Net cash provided by financing activities 506,661,000
-----------------
Net Increase in Cash and Cash Equivalents 2,072,000
Cash and Cash Equivalents at Beginning of Period 3,085,000
-----------------
Cash and Cash Equivalents at End of Period $ 5,157,000
=================
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 2,735,000
=================
Noncash Investing and Financing Activities:
Net unrealized gain on mortgage-backed securities available-for-sale $ 1,547,000
=================
Dividends declared, not yet paid $ 1,626,000
=================
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
APEX MORTGAGE CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 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 as a separate component of equity.
Hedging Assets
The Company purchases interest rate cap agreements in order to mitigate
the impact of rising interest rates on the cost of its short-term
borrowings. Premiums paid for interest rate cap agreements that are
matched to the
7
<PAGE>
Company's short-term borrowings are recorded as hedging assets and are
amortized over the life of the cap agreements as an adjustment to interest
expense. Periodic payments receivable under the term of the cap agreements
are recorded on a accrual basis as reduction of interest expense. In some
instances, interest rate cap agreements may be entered into based upon
anticipated future levels of funding. Under these circumstances, to the
extent the notional amount of interest rate caps exceed the existing level
of short-term borrowings, the cap agreements are recorded at fair value,
with unrealized gains or losses recorded as other income or expense, until
such time as the expected level is achieved.
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 will elect 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 March 31, 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 March 31, 1998, all of the
Company's mortgage-backed securities have an actual or implied "AAA"
rating.
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 quarter ended March 31, 1998, the Company adopted SFAS No. 130,
Reporting Comprehensive Income. This statement establishes standards for
reporting and display of comprehensive income and its
8
<PAGE>
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."
NOTE 3 - MORTGAGE-BACKED SECURITIES
At March 31, 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 $645,155 $108,342 $753,497
Unamortized Premium (Discount) 8,387 (666) 7,721
--------------------------------------------------------------------
Amortized Cost 653,542 107,676 761,218
Unrealized Gains 1,657 369 2,026
Unrealized Losses (291) 0 (291)
--------------------------------------------------------------------
Fair Value $654,908 $108,045 $762,953
====================================================================
</TABLE>
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 30 years at origination.
Because of prepayments on the underlying mortgage loans, the actual
weighted-average maturity is expected to be less.
The Company did not sell securities or realize any gains or losses in
the period ended March 31, 1998.
The adjustable rate mortgage-backed securities are typically subject to
periodic and lifetime caps that limit the amount an adjustable rate
mortgage-backed securities' interest rate can change during any given
period and over the life of the asset. At March 31, 1998, the average
periodic cap on the adjustable rate mortgage assets was 1.9% per annum
and the average lifetime cap was equal to 11.4%. 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%.
NOTE 4 - HEDGING ASSETS
The Company enters into derivative financial instruments for purposes
of managing interest rate risk, and does not enter into such
instruments for trading or speculative purposes. The Company's
mortgage-backed securities include adjustable rate mortgage products
that are funded primarily by short-term borrowings. Because these
securities are subject to lifetime interest rate caps, the Company
faces the risk in a rising interest rate environment that yields earned
on the securities will cease to increase when these cap levels are
reached, while borrowing costs
9
<PAGE>
continue to rise. In order to mitigate the impact of rising interest
rates on the cost of its short-term borrowings, the Company has entered
into interest rate cap agreements.
Hedging assets consisted of London Interbank Offered Rate ("LIBOR")
based interest rate cap agreements as follows:
<TABLE>
<CAPTION>
At March 31, 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 Company expects the level of its short-term borrowings to reach
approximately the $900,000,000 level of purchased interest rate
protection during the quarter ended June 30, 1998.
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.
At March 31, 1998, the Company had outstanding $597,282,000 of reverse
repurchase agreements with a weighted average current borrowing rate of
5.52% and a maturity of 6.8 months. The reverse repurchase agreements
were collateralized by mortgage-backed securities with an estimated
fair value of $600,829,000.
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 March 31, 1998, the average reverse repurchase
agreement balance was $287,088,000 with a weighted average interest
cost of 5.59%. The maximum reverse repurchase agreement balance
outstanding during the quarter ended March 31, 1998 was $597,282,000.
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 instruments as the amount at which the instrument
could be exchanged in current transaction between willing parties,
other than in a forced or liquidation sale (dollars in thousands):
<TABLE>
<CAPTION>
At March 31, 1998 At December 31, 1997
Amortized Cost Fair Value Amortized Cost Fair Value
---------------------------------------- ---------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $761,218 $762,953 $265,692 $265,880
Hedging assets 242 242 174 174
</TABLE>
10
<PAGE>
Management bases its fair value estimates for mortgage-backed
securities and hedging assets primarily on third party bid 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 January 13, 1998, the Company's board of directors authorized a
program to repurchase up to 750,000 shares of the Company's Common
Stock. The Company repurchased 197,700 shares of its Common Stock
pursuant to the program during the quarter ended March 31, 1998. The
average price per share repurchased was $12.82. The repurchased shares
are held in treasury at cost.
An additional 552,300 shares are currently authorized for potential
repurchase in the future. The Company may continue to repurchase shares
in the future when market conditions warrant.
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 $173,000 in base management compensation
in accordance with the terms of the Management Agreement for the
quarter ended March 31, 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 did not accrue for or pay the Manager any incentive
compensation for the quarter ended March 31, 1998.
The Company may also grant stock options to directors, officers and key
employees of the Company, the Manager, its directors, officers and key
employees.
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
11
<PAGE>
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 ended March 31, 1998. The Company recognized compensation
expense of $28,000 during the quarter ended March 31, 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
March 31, 1998
------------------
<S> <C>
Net income - as reported $564,000
Net income - pro forma 533,000
Basic and diluted earnings per share - as reported $ 0.09
Basis and diluted earnings per share - pro forma $ 0.08
</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 ended March
31, 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 remaining contractual life of each option is ten years. The
options vest in three equal installments on February 3, 1999, December
3, 1999 and December 3, 2000.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
A mortgage company with a similar name recently filed suit against the
Company demanding that the Company not operate under the name "Apex
Mortgage Capital." The litigation was instituted by Apex Mortgage
Corp., a Pennsylvania corporation engaged in the origination, trading
and servicing of mortgage loans, on November 24, 1997 in the United
States District Court for the Southern District of New York.
Subsequent to March 31, 1998, the Company began definitive settlement
negotiations with the plaintiff to resolve the pending litigation.
Although there can be no assurance that the matter will be resolved
favorably in a timely manner, the Company anticipates entering into a
settlement agreement with the plaintiff that will not have a material
impact on the financial statements or operations of the Company.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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. Some important factors that
would cause actual results to differ materially from those in any forward-
looking statements include 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.
GENERAL
Apex Mortgage Capital, Inc. (the "Company"), a Maryland corporation, was
formed on September 15, 1997, primarily to acquire United States agency and
other highly rated, single-family real estate 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 will elect to be taxed as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"). The Company will 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 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;
. 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;
13
<PAGE>
. 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;
. seek to structure its borrowings to have interest rate adjustment indices and
interest rate adjustment periods that, on an aggregate hedged basis,
generally correspond to the interest rate adjustment periods and weighted
average lives of its mortgage assets financed with leverage 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 March 31, 1998, the Company held $762,953,000 of mortgage assets as compared
to $265,880,000 at December 31, 1997. The original maturity of a significant
portion of the mortgage assets is approximately 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>
March 31, 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) $654,908 85.8% $240,819 90.6%
Fixed Rate 108,045 14.2% 25,061 9.4%
-------- ----- -------- -----
Totals $762,953 100.0% $265,880 100.0%
======== ===== ======== =====
</TABLE>
(1) At March 31, 1998, the interest rate indices for 98% and 2% 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.
14
<PAGE>
The following table shows various weighted average characteristics of the
mortgage assets held by the Company:
<TABLE>
<CAPTION>
Weighted Average Values
-----------------------------------------------------------------------------------------------
At March 31, 1998 At December 31, 1997
----------------- --------------------
Adj. Fixed Adj. Fixed
Rate Rate Total Rate Rate Total
------------------------------------------------ ------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Current coupon 6.38% 6.91% 6.46% 6.14% 7.50% 6.27%
Coupon if fully indexed 7.44% 6.91% 7.36% 7.74% 7.50% 7.72%
Months until next reset 7.6 N/A N/A 7.2 N/A N/A
Weighted Avg. Life
In months (1) N/A 22 N/A N/A 11 N/A
Amortized cost basis 101.29% 99.46% 101.03% 101.12% 100.78% 101.11%
Annual periodic cap 1.86% N/A N/A 2.00% N/A N/A
Lifetime cap rate 11.41% N/A N/A 11.44% N/A N/A
</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.
HEDGING ASSETS
The Company enters into derivative financial instruments for purposes of
managing interest rate risk. The Company's mortgage-backed securities include
adjustable rate mortgage products that are funded primarily by short-term
borrowings. Because these securities are subject to lifetime interest rate
caps, the Company faces the risk in a rising interest rate environment that
yields earned on the securities will cease to increase when these cap levels are
reached, while borrowing costs continue to rise. In order to mitigate the
impact of rising interest rates on the cost of its short-term borrowings, the
Company has entered into interest rate cap agreements.
Hedging assets consisted of London Interbank Offered Rate ("LIBOR") based
interest rate cap agreements as follows:
<TABLE>
<CAPTION>
At March 31, 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.
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.
15
<PAGE>
At March 31, 1998, the Company had outstanding $597,282,000 of reverse
repurchase agreements with a weighted average current borrowing rate of 5.52%
and a maturity of 6.8 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$600,829,000.
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 $90,637,000 and $90,492,000 of other liabilities at March 31,
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 MARCH 31, 1998
For quarter ended March 31, 1998, the Company's net income was $564,000, or
$0.09 per share on both a basic and diluted basis, based on a weighted average
of 6,603,000 shares outstanding. Net interest income for the period was
$896,000 consisting of interest income on mortgage assets and cash balance less
interest expense on reverse repurchase agreements. The Company incurred
operating expenses of $332,000 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
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.
The following table provides a reconciliation between the Company's GAAP net
income and its taxable net income for the three months ended March 31, 1998:
<TABLE>
<CAPTION>
(dollars in thousands)
Description GAAP Tax Difference
---- --- ----------
<S> <C> <C> <C>
Coupon Interest Income $ 5,839 $ 5,839 -
Less Amortization Expense 932 177 755
---------------------------------------------
Net Interest Income 4,907 5,662 755
---------------------------------------------
Interest Expense 4,011 4,011 -
---------------------------------------------
Net Operating Income 896 1,651 755
Stock Option Expense 28 - 28
Other G & A Expenses 304 300 -
---------------------------------------------
Total G & A Expenses 332 300 28
---------------------------------------------
Net Income 564 1,351 783
=============================================
</TABLE>
The difference in amortization expense represents a timing difference that will
reverse in future periods.
At March 31, 1998, the Company had distributed $1,180,000 in excess of reported
net income due primarily to the differences between taxable and GAAP net income.
16
<PAGE>
The following table reflects the average balances for each category of the
Company's interest earning assets as well as the Company's interest bearing
liabilities, with the corresponding effective rate of interest annualized for
the three months ended March 31, 1998 (dollars in thousands):
AVERAGE BALANCE AND RATE TABLE
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Quarter Ended
March 31, 1998
--------------------------------------------
Average Balance Effective Rate
------------------ ------------------
<S> <C> <C>
Interest Earning Assets:
Mortgage Assets $ 351,633 5.38%
Cash and Cash Equivalents 13,767 5.26%
--------- --------
Total Interest Earning Assets 365,400 5.37%
--------- --------
Interest Bearing Liabilities:
Reverse Repurchase Agreements 287,087 5.59%
--------- --------
Net Interest Earning Assets and Spread $ 78,313 (0.22%)
========= ========
</TABLE>
The effective yield data is computed by dividing the annualized net interest
income or expense into the average daily balance shown.
The Company experienced a negative net interest spread during the quarter ended
March 31, 1998 resulting from faster than expected prepayments on its mortgage
assets. When actual prepayment experience exceeds expectations, the Company
must amortize its purchase premiums over a shorter time period, resulting in a
reduced yield on the Company's mortgage assets. For the three months ended
March 31, 1998, the Company's mortgage assets prepaid at an approximate average
annualized constant prepayment rate of 48%.
Although the Company has invested the majority of its assets in adjustable-rate
mortgage securities since its initial public offering in December 1997, the
Company has invested in fixed-rate mortgage assets. The Company may continue to
purchase fixed-rate mortgage assets in the future should the potential returns
on capital invested, after hedging and all other costs, exceed the returns
available from adjustable-rate mortgage assets or if the purchase of such fixed-
rate mortgage assets would serve to reduce or diversify the risks of the
Company's balance sheet. If the current high level of prepayment activity in
the adjustable-rate mortgage market continues, the Company may significantly
increase its investments in fixed-rate mortgage assets and correspondingly
reduce its adjustable-rate mortgage holdings.
On January 13, 1998, the Company's board of directors authorized a program to
repurchase up to 750,000 shares of the Company's Common Stock. The Company
repurchased 197,700 shares of its Common Stock pursuant to the program during
the quarter ended March 31, 1998. The average price per share repurchased was
$12.82. The repurchased shares are held in treasury at cost.
An additional 552,300 shares are currently authorized for potential repurchase
in the future. The Company may continue to repurchase shares in the future when
market conditions warrant.
Liquidity and Capital Resources
The Company's primary sources of funds for the quarter ended March 31, 1998
consisted of reverse repurchase agreements totaling $597,282,000. The Company
expects to continue to borrow funds in the form of reverse repurchase agreements
with maturities that generally correspond to the average reset date or average
life of the Company's mortgage assets after
17
<PAGE>
taking into account certain hedging transactions. At March 31, 1998, the Company
had borrowing arrangements with twelve 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.
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.
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, and 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 a substantial portion of 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-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
18
<PAGE>
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.
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
A mortgage company with a similar name recently filed suit against
the Company demanding that the Company not operate under the name
"Apex Mortgage Capital." The litigation was instituted by Apex
Mortgage Corp., a Pennsylvania corporation engaged in the
origination, trading and servicing of mortgage loans, on November 24,
1997 in the United States District Court for the Southern District of
New York.
Subsequent to March 31, 1998, the Company began definitive settlement
negotiations with the plaintiff to resolve the pending litigation.
Although there can be no assurance that the matter will be resolved
favorably in a timely manner, the Company anticipates entering into a
settlement agreement with the plaintiff that will not have a material
impact on the financial statements or operations of the Company.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit #27 Financial Data Schedule
(b) Reports on Form 8-K
None
19
<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: May 14, 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)
20
<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 MARCH 31,
1998 AND THE CONSOLIDATED STATEMENTS OF OPERATIONS OF THE REGISTRANT FOR THE
THREE MONTHS ENDED MARCH 31, 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> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 5,157
<SECURITIES> 763,195
<RECEIVABLES> 9,738
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 804
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 778,894
<CURRENT-LIABILITIES> 687,919
<BONDS> 0
0
0
<COMMON> 67
<OTHER-SE> 90,908
<TOTAL-LIABILITY-AND-EQUITY> 778,894
<SALES> 0
<TOTAL-REVENUES> 4,907
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 332
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,011
<INCOME-PRETAX> 564
<INCOME-TAX> 0
<INCOME-CONTINUING> 564
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 564
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
</TABLE>
