<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, 1999
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 incorporation (I.R.S. Employer
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 May 14, 1999
- -------------------------------------------------------------------------------
<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 MARCH 31, 1999 (UNAUDITED) AND DECEMBER 31, 1998 3
STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999
AND MARCH 31, 1998 (UNAUDITED) 4
STATEMENT OF STOCKHOLDERS' EQUITY FOR THE THREE MONTHS ENDED
MARCH 31, 1999 (UNAUDITED) 5
STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED
MARCH 31, 1999 AND 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 14
ITEM 2A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 25
ITEM 2. CHANGES IN SECURITIES 25
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES 26
</TABLE>
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APEX MORTGAGE CAPITAL, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
---------------------- -------------------
ASSETS (Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 3,426,000 $ 12,679,000
Fixed income securities available-for-sale, at fair value (Note 3) 821,117,000 829,712,000
Equity securities available-for-sale, at fair value (Note 4) 24,112,000 16,422,000
Accrued interest receivable 5,890,000 5,151,000
Principal payments receivable 1,463,000 937,000
Receivable for unsettled securities 8,000 -
Other assets 459,000 577,000
---------------------- -------------------
$ 856,475,000 $ 865,478,000
---------------------- -------------------
---------------------- -------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Reverse repurchase agreements (Note 5) $ 765,018,000 $ 767,908,000
Payable for unsettled securities 187,000 838,000
Accrued interest payable 2,160,000 6,173,000
Dividend payable 2,284,000 1,777,000
Accrued expenses and other liabilities 871,000 752,000
---------------------- -------------------
770,520,000 777,448,000
---------------------- -------------------
---------------------- -------------------
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 93,052,000 92,978,000
Accumulated other comprehensive income 3,828,000 6,689,000
Accumulated dividend distributions in excess of net income (423,000) (1,135,000)
Treasury stock, at cost (947,100 shares) (Note 7) (10,569,000) (10,569,000)
---------------------- -------------------
85,955,000 88,030,000
---------------------- -------------------
$ 856,475,000 $ 865,478,000
---------------------- -------------------
---------------------- -------------------
</TABLE>
See accompanying notes to financial statements
3
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, 1999 MARCH 31, 1998
----------------------- -----------------------
<S> <C> <C>
INTEREST INCOME:
Fixed Income securities $ 13,848,000 $ 4,726,000
Cash and cash equivalents 89,000 181,000
----------------------- -----------------------
13,937,000 4,907,000
INTEREST EXPENSE 11,261,000 4,011,000
----------------------- -----------------------
NET INTEREST INCOME 2,676,000 896,000
----------------------- -----------------------
NET GAIN ON SALE OF SECURITIES 614,000 -
DIVIDEND INCOME 711,000 -
GENERAL AND ADMINISTRATIVE EXPENSES:
Management fee (Note 8) 157,000 173,000
Incentive Fee (Note 8) 591,000 -
Audit and tax fees 11,000 11,000
Insurance expense 67,000 67,000
Directors' fees 15,000 20,000
Stock Option expense 74,000 28,000
Other 124,000 33,000
----------------------- -----------------------
1,039,000 332,000
----------------------- -----------------------
NET INCOME $ 2,962,000 $ 564,000
----------------------- -----------------------
----------------------- -----------------------
Net Income Per Share:
Basic $ 0.51 $ 0.09
----------------------- -----------------------
----------------------- -----------------------
Diluted $ 0.51 $ 0.09
----------------------- -----------------------
----------------------- -----------------------
Weighted Average Number of Shares Outstanding:
Basic 5,753,000 6,603,000
----------------------- -----------------------
----------------------- -----------------------
Diluted 5,773,000 6,603,000
----------------------- -----------------------
----------------------- -----------------------
Dividends Declared Per Share $ 0.38 $ 0.25
----------------------- -----------------------
----------------------- -----------------------
</TABLE>
See accompanying notes to financial statements
4
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Accumulated
Acccumulated Dividend
Common Stock Additional Other Distribution Treasury
------------------ Paid-in Comprehensive In Excess of Comprehensive Stock,
Shares Amount Capital Income Net Income Income At Cost Total
--------- -------- ----------- -------------- ------------- -------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 6,700,100 $67,000 $92,978,000 $6,689,000 ($1,135,000) ($10,569,000) $88,030,000
Repurchases of common stock - - - - - - - -
Issuance of stock options
to non-employees (Note 9) - - 74,000 - - - - 74,000
Net income - - - - 2,962,000 2,962,000 - 2,962,000
Other comprehensive income:
Net unrealized gain (loss)
on investments available-
for-sale - - - (2,861,000) - (2,861,000) - (2,861,000)
--------------
Comprehensive income - - - - $ 101,000
--------------
--------------
Dividends declared - - - - (2,250,000) - (2,250,000)
--------- -------- ----------- -------------- ------------- ------------- ------------
Balance, March 31, 1999 6,700,100 $67,000 $93,052,000 $3,828,000 ($423,000) ($10,569,000) $85,955,000
--------- -------- ----------- -------------- ------------- ------------- ------------
--------- -------- ----------- -------------- ------------- ------------- ------------
</TABLE>
5
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE QUARTER FOR THE QUARTER
ENDED ENDED
MARCH 31, 1999 MARCH 31, 1998
<S> <C> <C>
Operating Activities:
Net Income $ 2,962,000 $ 564,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization 164,000 971,000
Net gain on sale of securities (614,000) -
Change in assets and liabilities:
Accrued interest receivable (739,000) (2,813,000)
Other Assets 118,000 48,000
Accrued interest payable (4,013,000) 1,268,000
Accrued expenses and other liabilities 119,000 (937,000)
---------------------- ----------------------
Net cash used in operating activities (2,003,000) (899,000)
---------------------- ----------------------
INVESTING ACTIVITIES:
Purchase of equity securities (7,005,000) -
Purchase of rate caps - (80,000)
Purchase of fixed income securities (92,947,000) (559,186,000)
Proceeds from sales of equity securities 1,441,000 -
Proceeds from sales of fixed income securities 40,406,000 -
Principal payments on fixed income securities 55,465,000 55,576,000
---------------------- ----------------------
Net cash used in investing activities (2,640,000) (503,690,000)
---------------------- ----------------------
FINANCING ACTIVITIES:
Net proceeds from reverse repurchase agreements (2,890,000) 509,464,000
Dividend distributions (1,720,000) (268,000)
Purchase of treasury stock - (2,535,000)
---------------------- ----------------------
Net cash used in provided by financing activities (4,610,000) 506,661,000
---------------------- ----------------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (9,253,000) 2,072,000
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,679,000 3,085,000
---------------------- ----------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,426,000 $ 5,157,000
---------------------- ----------------------
---------------------- ----------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 15,274,000 $ 2,735,000
---------------------- ----------------------
---------------------- ----------------------
NONCASH INVESTING AND FINANCING ACTIVITIES:
Net unrealized gain (loss) on mortgage-backed
securities available-for-sale $ (2,861,000) $ 1,547,000
---------------------- ----------------------
---------------------- ----------------------
Securities sold, not yet settled $ 8,000 $ 0
---------------------- ----------------------
---------------------- ----------------------
Principal payments, not yet received $ 526,000 $ 5,609,000
---------------------- ----------------------
---------------------- ----------------------
Securities purchased, not yet settled $ 651,000 $ 1,544,000
---------------------- ----------------------
---------------------- ----------------------
Dividends declared, not yet paid $ (2,250,000) $ 1,626,000
---------------------- ----------------------
---------------------- ----------------------
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
APEX MORTGAGE CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS
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 related 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 fixed income 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
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash and highly liquid investments
with original maturities of three months or less. The carrying amount
of cash equivalents approximates their fair value.
FIXED INCOME SECURITIES
The Company's fixed income securities consist primarily of residential
mortgage securities and other fixed income securities. All fixed income
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. A majority of the Company's fixed
income securities are expected to qualify as real estate assets under
the REIT Provisions of the Code.
Interest income on the Company's mortgage securities is accrued based
on the actual coupon rate and the outstanding principal amount.
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.
Interest Income on the Company's other fixed income securities is
accrued using the effective interest method applied prospectively based
on current market assumptions.
The Company's policy is to generally classify its fixed income
securities as available-for-sale. The fixed income securities are
reported at fair value with unrealized gains and losses excluded from
earnings and reported in other comprehensive income.
EQUITY SECURITIES
The Company's equity securities consist primarily of equity securities
issued by other real estate investment trusts. Dividend income on
equity securities is recorded on the declaration date. Realized gains
and losses on sales of the securities are determined on a specific
identification basis. A majority of the Company's equity securities are
expected to qualify as real estate assets under the REIT Provisions of
the Code.
The Company's policy is to generally classify its equity securities as
available-for-sale. Equity securities 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 as other assets and
amortized over the lives of such agreements as an adjustment to
interest expense.
7
<PAGE>
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 is not
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
Basic net income per share is calculated on the basis of the weighted
average number of common shares outstanding during each period. Diluted
net income per share includes the additional dilutive effect of common
stock equivalents and outstanding stock options and is calculated using
the treasury stock method.
INCOME RECOGNITION
Income and expenses are recorded on the accrual basis of accounting.
CREDIT RISK
The Company has limited its exposure to credit losses on its portfolio
of fixed income 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.
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
The Company has 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 the first quarter of 1999, the Company wrote off $64,000 of
unamortized organizational costs in accordance with the adoption of
S.O.P. 98-5, "Reporting on the Cost of Start-Up Activities."
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
8
<PAGE>
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, 1998 (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.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
NOTE 3 - FIXED INCOME SECURITIES AND EQUITY SECURITIES
At March 31, 1999, fixed income securities consisted of the following:
<TABLE>
<CAPTION>
Adjustable Rate Fixed Rate Other Fixed
(in thousands) Mortgage Securities Mortgage Securities Income Securities Total
--------------------- -------------------- ------------------ ------------------
<S> <C> <C> <C> <C>
Principal Amount $42,131 $772,907 $5,400 $820,438
Unamortized Premium (Discount) 515 1,846 (1,535) 826
--------------------- -------------------- ------------------ ------------------
Amortized Cost 42,646 774,753 3,865 821,264
Unrealized Gains 181 1,723 0 1,904
Unrealized Losses (53) (1,547) (451) (2,051)
--------------------- -------------------- ------------------ ------------------
Fair Value $42,774 $774,929 3,414 $821,117
--------------------- -------------------- ------------------ ------------------
--------------------- -------------------- ------------------ ------------------
</TABLE>
At December 31, 1998, fixed income securities consisted of the
following:
<TABLE>
<CAPTION>
Adjustable Rate Fixed Rate Other Fixed
(in thousands) Mortgage Securities Mortgage Securities Income Securities Total
--------------------- -------------------- ------------------ ----------------
<S> <C> <C> <C> <C>
Principal Amount $61,590 $758,110 $5,400 $825,100
Unamortized Premium (Discount) 772 800 (1,380) 192
--------------------- -------------------- ------------------ ----------------
Amortized Cost 62,362 758,910 4,020 825,292
Unrealized Gains 86 4,762 0 4,848
Unrealized Losses (110) (15) (303) (428)
--------------------- -------------------- ------------------ ----------------
Fair Value $62,338 $763,657 3,717 $829,712
--------------------- -------------------- ------------------ ----------------
--------------------- -------------------- ------------------ ----------------
</TABLE>
The contractual final maturity of the mortgage loans supporting the
mortgage 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 other fixed income securities generally have an original maturity
of five years subject to certain acceleration provisions. The expected
average remaining maturity at March 31, 1999 and December 31, 1998 were
approximately 3.8 and 4.0 years, respectively.
The adjustable rate mortgage securities are typically subject to
periodic and lifetime caps that limit the amount an adjustable rate
mortgage security's interest rate can change during any given period
and over the life of the asset. At March 31, 1999 and December 31,
1998, the average periodic cap on the adjustable rate mortgage was 2.0%
per annum and the average lifetime cap was equal to 11.3%.
9
<PAGE>
During the quarter ended March 31, 1999 the Company realized $194,000
in gains on the sale of $40,406,000 of mortgage securities which were
classified as available-for-sale. During the quarter ended March 31,
1998, there were no sales of mortgage securities.
At March 31, 1999 and December 31, 1998, equity securities consisted
of the following:
<TABLE>
<CAPTION>
(in thousands)
March 31, 1999 December 31, 1998
-------------------- ----------------------
<S> <C> <C>
Cost Basis $20,137 $14,154
Unrealized Gains 4,777 2,268
Unrealized Losses (802) (0)
-------------------- ----------------------
Fair Value $24,112 $16,422
-------------------- ----------------------
-------------------- ----------------------
</TABLE>
During the quarter ended March 31, 1999, the Company realized $420,000
in gains on the sale of $1,441,000 of equity securities that were
classified as available-for-sale. There were no equity securities sold
in the first quarter ended March 31, 1998.
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 year ended
December 31, 1998 which approximates their fair value.
The terms of outstanding interest rate cap agreements are as follows:
<TABLE>
<CAPTION>
At March 31, 1999 At December 31, 1998
--------------------------- --------------------------
<S> <C> <C>
Notional Amount $900,000,000 $900,000,000
Average Contract Rate 10.4% 10.4%
Average Final Maturity January 24, 2002 January 24, 2002
</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 fixed income securities. These agreements are secured by
a portion of the Company's fixed income securities and bear interest
rates that have historically moved in close relationship to LIBOR.
At March 31, 1999, the Company had outstanding $765,018,000 of reverse
repurchase agreements with a weighted average current borrowing rate of
4.96% and a maturity of 1.7 months. The reverse repurchase agreements
were collateralized by fixed income securities with an estimated fair
value of $796,251,000.
At December 31, 1998, the Company had outstanding $767,908,000 of
reverse repurchase agreements with a weighted average current borrowing
rate of 5.34% and a maturity of 2.9 months. The reverse repurchase
agreements were collateralized by fixed income securities with an
estimated fair value of $800,260,000.
For the quarter ended March 31, 1999, the average reverse repurchase
agreement balance was $786,472,000 with a weighted average interest
cost of 5.09%. The maximum reverse repurchase agreement balance
outstanding during the quarter ended March 31, 1999 was $812,019,000.
10
<PAGE>
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 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 March 31, 1999 At December 31, 1998
Amortized Amortized
Cost Fair Value Cost Fair Value
------------------- ------------ -------------------- ---------------
<S> <C> <C> <C> <C>
Mortgage related securities $817,399 $817,703 $821,272 $825,995
Equity securities 20,137 24,112 14,154 16,422
Other fixed income securities 3,865 3,414 4,020 3,717
Interest rate swaps - (5,633) - (9,994)
</TABLE>
The Company bases its fair value estimates for fixed income securities,
equity securities 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
The Company's Board of Directors has authorized a program to repurchase
shares of the Company's common stock. At March 31, 1999 and December
31, 1998, the Company was authorized to repurchase 552,900 shares of
the Company's common stock pursuant to the repurchase program.
At March 31, 1999 and December 31, 1998, the Company held 947,100
shares of treasury stock. During the quarter ended March 31, 1999, the
Company did not repurchase any treasury shares, however, for the
quarter ended March 31, 1998, the Company repurchased 197,700 shares
which are held at cost in the financial statements herein.
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 $157,000 and $173,000 in base management
compensation during the quarter ended March 31, 1999 and March 31,
1998, respectively.
The Company also pays 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.
11
<PAGE>
The Company accrued $591,000 for incentive compensation to the Manager
for the quarter ended March 31, 1999. The Company did not accrue any
incentive compensation to the Manager 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.
The Company's other fixed income securities 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 anticipate paying any
management fees directly to any affiliate of the Manager in connection
with these investments.
NOTE 9 - STOCK OPTIONS
The Company has adopted a stock option plan (the "Amended and Restated
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 Amended and
Restated 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 Amended and Restated
1997 Stock Option Plan authorizes the grant of options to purchase an
aggregate 1,000,000 shares of common stock.
The Company recognized compensation expenses of $74,000 and $28,000
during the quarter ended March 31, 1999 and March 31, 1998,
respectively.
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 Quarter Ended
March 31, 1999 March 31, 1998
------------------------ ------------------------
<S> <C> <C>
Net income - as reported $2,962,000 $564,000
Net income - pro forma 2,837,000 533,000
Basic and diluted earnings per share - as reported $0.51 $0.09
Basic and diluted earnings per share - pro forma $0.49 $0.08
</TABLE>
Information regarding stock option activity during the quarter ended
March 31, 1999 is as follows:
<TABLE>
<CAPTION>
Weighted Average
Shares Exercise Price
------------------ ------------------
<S> <C> <C>
Options Granted Prior to December 31, 1998 570,000 $13.62
Exercised - -
Expired - -
------------------ ------------------
Options Outstanding at March 31, 1999 570,000 $13.62
------------------ ------------------
------------------ ------------------
</TABLE>
NOTE 10 - CONTRACTUAL COMMITMENTS
At March 31, 1999 the Company had entered into interest rate swap
agreements with the total current notional amount as stated below.
Under these agreements, the Company receives a floating rate and pays a
fixed rate.
(Amounts are in thousands)
12
<PAGE>
<TABLE>
<CAPTION>
Average
Current Average Termination Unrealized
Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses)
------------------------ ----------------------- ------------------ ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
690,995 Interest Rate Swap 5.850% 1Mo LIBOR 2/16/01 $(5,633)
</TABLE>
At December 31, 1998 the Company entered into interest rate swap
agreement as follows: (Amounts are in thousands)
<TABLE>
<CAPTION>
Average
Current Average Termination Unrealized
Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses)
------------------------ ----------------------- ------------------ ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
703,590 Interest Rate Swap 5.850% 1Mo LIBOR 2/16//01 $(9,994)
</TABLE>
The Company paid $1,262,000 to the swap counter-parties during the
quarter ended March 31, 1999 which is included in interest expense on
the statement of operations. There were no such payments made during
the quarter ended March 31, 1998.
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 March 31, 1999 and December 31, 1998, the
Company had securities with a fair market value of $10,424,000 and
$17,327,000, respectively, on deposit with its counter-parties. If
unrealized losses on the interest rate swap agreements were to
increase, the Company would be required to deposit additional
collateral.
13
<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 "Principal Risks and
Special Considerations", "Item 7 Management's Discussion and Analysis of
Financial Conditions and Results of Operations" and "Item 7A Quantitative and
Qualitative Disclosures About Market Risk" in the Company's annual report on
Form 10-K for the year ended December 31, 1998. 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 and other highly rated, single-family real estate adjustable and
fixed rate mortgage related assets. 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 related
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 an external
management company, TCW Investment Management Company (the "Manager"),
subject to the direction and oversight of the Company's Board of Directors. A
majority of the Board of Directors are unaffiliated with The TCW Group, Inc.
("TCW" and together with its subsidiaries and affiliates, the "TCW Group") or
the Manager. The Manager is a wholly-owned subsidiary of TCW. The Manager was
established in 1992 and the TCW Group 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
eleven 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. The Manager's key officers have experience in raising and managing
mortgage capital, mortgage finance and the purchase and administration of
mortgage related assets.
14
<PAGE>
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 adjustable and fixed rate mortgage
related assets;
- manage the credit risk of its mortgage related assets through, among
other activities (i) carefully selecting mortgage related assets to be
acquired, (ii) complying with the Company's investment policy, (iii)
actively monitoring the ongoing credit quality and servicing of its
mortgage related assets, and (iv) maintaining appropriate capital levels
and allowances for possible credit losses;
- finance purchases of mortgage related assets with the net proceeds of
equity offerings and, to the extent permitted by the Company's leverage
policy, to utilize leverage to increase potential returns to stockholders
through borrowings (primarily reverse repurchase agreements) with
interest rates that will also reflect changes in short-term market
interest rates;
- seek to structure its borrowings in accordance with its interest rate
risk management policy;
- utilize interest rate caps, swaps and similar financial instruments to
mitigate interest rate risks; and
- seek to minimize prepayment risk primarily by structuring a diversified
portfolio with a variety of prepayment characteristics.
There can be no assurance that the Company will be able to generate
competitive earnings and dividends while holding primarily high quality
mortgage related assets and maintaining a disciplined risk-control profile.
The Company may attempt to increase the return to stockholders over time
by: (i) raising additional capital in order to increase its ability to invest
in additional mortgage related assets; (ii) lowering its effective borrowing
costs through direct funding with collateralized lenders, in addition to
using Wall Street intermediaries, and investigating the possibility of using
collateralized commercial paper and medium-term note programs; and (iii)
improving the efficiency of its balance sheet structure by issuing
uncollateralized subordinated debt and other forms of capital.
15
<PAGE>
FINANCIAL CONDITION
FIXED INCOME SECURITIES
At March 31, 1999, the Company held $821,117,000 of Fixed Income Securities as
compared to $827,712,000 at December 31, 1998. The following table is a schedule
of Fixed Income Securities held listed by security type (dollars in thousands):
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
----------------------------------- ----------------------------------
Carrying Percent of Carrying Percent of
Fixed Income Securities Value Portfolio Value Portfolio
---------------------------------- ------------------ ---------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Mortgage Securities:
Adjustable Rate (1) $42,646 5.2% $62,362 7.6%
Fixed Rate 774,753 94.3% 758,910 91.0%
Other Fixed Income Securities 3,865 0.5% 4,020 1.4%
---------- -------- ---------- --------
Totals $821,264 100.0% $825,292 100.0%
---------- -------- ---------- --------
---------- -------- ---------- --------
</TABLE>
(1) At March 31, 1999 and December 31, 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.
The following table shows various weighted average characteristics of the
Fixed Income Securities held by the Company at March 31, 1999 (dollars in
thousands):
<TABLE>
<CAPTION>
Percent of Weighted
Total Par Amortized Market Current Average
Security Type Par Amount Amount Cost Basis Price Coupon Life (1)
- ------------------------------------------ --------------- ------------ -------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
15 Year Agency/AAA Pass-throughs $221,295 27.0% 100.41% 100.76% 6.50% 4.1
20 Year Agency Pass-throughs 247,997 30.2% 100.55% 100.20% 6.50% 6.3
30 Year Agency Pass-throughs 19,680 2.4% 102.15% 101.80% 7.20% 3.2
AAA CMOs 283,935 34.6% 99.70% 99.83% 6.84% 2.7
---------- ------- --------- --------- ------- -----
Total Fixed Rate Holdings $772,907 94.2% 100.24% 100.27% 6.63% 4.3
Other Fixed Income Securities 5,400 0.7% 74.96% 70.18% 21.83% 3.8
Adjustable Rate Holdings 42,132 5.1% 101.22% 101.53% 6.51% 1.0
---------- ------- --------- --------- ------- -----
Total Portfolio $820,439 100.0% 100.18% 100.19% 6.70% 4.1
---------- ------- --------- --------- ------- -----
---------- ------- --------- --------- ------- -----
</TABLE>
16
<PAGE>
The following table shows various weighted average characteristics of the
mortgage securities held by the Company at December 31, 1998 (dollars in
thousands):
<TABLE>
<CAPTION>
Percent of Weighted
Total Par Amortized Market Current Average
Security Type Par Amount Amount Cost Basis Price Coupon Life (1)
- ------------------------------------------ --------------- ------------ -------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
15 Year Agency/AAA Pass-throughs $253,581 33.4% 100.42% 101.23% 6.50% 3.7
20 Year Agency Pass-throughs 209,566 27.6% 100.45% 101.06% 6.50% 6.1
30 Year Agency Pass-throughs 8,076 1.1% 102.19% 101.99% 7.50% 3.2
AAA CMOs 286,887 37.8% 99.52% 100.01% 6.82% 2.7
---------- ------- --------- --------- ------- -----
Total Fixed Rate Holdings $758,110 91.9% 100.11% 100.73% 6.63% 3.9
Other Fixed Income Securities 5,400 0.7% 74.43% 72.24% 21.83% 4.0
Adjustable Rate Holdings 61,590 7.5% 101.25% 101.21% 6.79% 1.0
---------- ------- --------- --------- ------- -----
Total Portfolio $825,100 100.0% 100.02% 100.58% 6.74% 3.7
---------- ------- --------- --------- ------- -----
---------- ------- --------- --------- ------- -----
</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.
EQUITY SECURITIES
At March 31, 1999, the Company held $24,112,000 of equity securities
compared to $16,422,000 at December 31, 1998. Equity securities consist
primarily of investment in equities issued by other real estate investment
trusts.
The Company's investments in other real estate investment trusts consist
of publicly traded preferred and common stock securities issued by companies
involved in the mortgage finance industry. The Company generally expects to
receive dividend income on the majority of these investments.
INTEREST RATE CAP AGREEMENTS
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 LIBOR based agreements as
follows:
<TABLE>
<CAPTION>
At March 31, 1999 At December 31, 1998
--------------------------- --------------------------
<S> <C> <C>
Notional Amount $900,000,000 $900,000,000
Average Contract Rate 10.4% 10.4%
Average Final Maturity January 24, 2002 January 24, 2002
</TABLE>
17
<PAGE>
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 now that the Company has entered into additional hedging
transactions as discussed below. Accordingly, the Company now records the cap
agreements at fair market value, which is zero in the current market
environment.
At March 31, 1999, the Company had entered into interest rate swap
agreements with the total current notional amount as stated below. Under
these agreements, the Company receives a floating rate and pays a fixed rate.
<TABLE>
<CAPTION>
Average
Current Average Termination Unrealized
Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses)
------------------------ ----------------------- ------------------ ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
690,995 Interest Rate Swap 5.850% 1Mo LIBOR 2/16/01 $(5,633)
</TABLE>
The weighted average life of the agreements at March 31, 1999 was 1.7
years.
At December 31, 1998, the Company had entered into interest rate swap
agreements with the total current notional amount as stated below.
<TABLE>
<CAPTION>
Average
Current Average Termination Unrealized
Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses)
------------------------ ----------------------- ------------------ ----------------- ---------------- -----------------
<S> <C> <C> <C> <C> <C>
703,590 Interest Rate Swap 5.850% 1Mo LIBOR 2/16//01 $(9,994)
</TABLE>
The weighted average life of the agreements at December 31, 1998 was 1.9
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 March 31, 1999 the Company had
securities with a fair market value of $10,424,000 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.
At March 31, 1999, the Company had outstanding $765,018,000 of reverse
repurchase agreements with a weighted average current borrowing rate of 4.96%
and a maturity of 1.7 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$796,251,000.
18
<PAGE>
At December 31, 1998, the Company had outstanding $767,908,000 of
reverse repurchase agreements with a weighted average current borrowing rate
of 5.34% and a maturity of 2.9 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$800,260,000.
The Company had $5,502,000 and $9,540,000 of other liabilities at March
31, 1999 and December 31, 1998, respectively, consisting primarily of accrued
interest payable and payables for unsettled securities at March 31, 1999 and
December 31, 1998, respectively. The Company anticipates settling all other
liabilities within one year by entering into additional reverse repurchase
agreements.
RESULTS OF OPERATIONS FOR THE QUARTER ENDED MARCH 31, 1999
For the quarter ended March 31, 1999, the Company's net income was
$2,962,000, or $0.51 per share on both a basic and diluted basis, based on a
weighted average of 5,753,000 and 5,773,000 shares outstanding, respectively.
That compares to $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 for the
quarter ending March 31, 1998. Net interest income for the first quarter 1999
was $2,676,000 consisting of interest income on mortgage assets and cash
balances less interest expense on reverse repurchase agreements compared to
$896,000 for the first quarter in 1998. The Company reported dividend income
of $711,000 from dividends on equity investments at March 31, 1999. No
dividend interest was reported for the quarter ending March 31, 1998. The
Company reported gains on investment transactions, net of $614,000 primarily
from the sale of mortgage securities and equity securities during the quarter
ending March 31, 1999. There were no sales reported for the quarter ending
March 31, 1998. The Company incurred operating expenses of $1,039,000 for the
quarter ending March 31, 1999 consisting of management fees, audit, tax,
legal, printing, insurance and other expenses compared to $332,000 for the
quarter ending March 31, 1998.
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 (dollars in thousands):
AVERAGE BALANCE AND RATE TABLE
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Quarter Ended For the Quarter Ended
March 31, 1999 March 31, 1998
Average Effective Average Effective
Balance Rate Balance Rate
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Mortgage Securities $826,343 6.64% $351,633 5.38%
Other Fixed Income Assets 4,203 13.48% 0 0%
Cash and Cash Equivalents 6,687 5.32% 13,767 5.26%
------------ ------------ ------------ -----------
Total Interest Earning Assets 837,233 6.66% 365,400 5.37%
------------ ------------ ------------ -----------
Interest Bearing Liabilities:
Reverse Repurchase Agreements 786,472 5.73% 287,087 5.59%
------------ ------------ ------------ -----------
Net Interest Earning Assets and Spread $50,761 0.93% $78,313 (0.22%)
------------ ------------ ------------ -----------
------------ ------------ ------------ -----------
</TABLE>
The effective yield data is computed by dividing the annualized net
interest income or expense including hedging transactions into the average
daily balance shown.
19
<PAGE>
The following table reflects the average balances for the Company's equity
securities (dollars in thousands):
AVERAGE BALANCE AND RATE TABLE
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Quarter Ended For the Quarter Ended
March 31, 1999 March 31, 1998
Average Effective Average Effective
Balance Rate Balance Rate
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Equity securities $16,416 17.32% - -
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds as of March 31, 1999 and December
31, 1998, consisted of reverse repurchase agreements totaling $765,018,000
and $767,908,000, respectively. The Company expects to continue to borrow
funds in the form of reverse repurchase agreements. At March 31, 1999 and
December 31, 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.
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, 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 stockholders' equity 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.
INFLATION
Virtually all of the Company's assets and liabilities are financial
in nature. As a result, interest rates and other factors drive the Company's
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates. The
Company's financial statements are prepared in accordance with generally
accepted accounting principles and the Company's dividends are determined by
the Company's net income as calculated for tax purposes; in each case, the
Company's activities and balance sheet are measured with reference to
historical cost and or fair market value without considering inflation.
YEAR 2000 MATTERS
The year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Any computer system that the
Company relies on with time sensitive software may recognize a date entered
as "00" as the year 1900 rather than the year 2000. This could result in a
system failure or miscalculations causing disruption of operations,
including, among other things, a temporary inability to process transactions
or engage in normal business
20
<PAGE>
activities. The Company believes that most of its exposure to Year 2000
issues involves the readiness of external third parties such as, but not
limited to, loan servicers, security master servicers, security paying agents
and trustees, its stock transfer agent, its securities custodian, the
counterparties on its various financing agreements and hedging contracts and
vendors ("External Service Providers").
The Company relies on the Manager for its computer services and the
Manager has been addressing this issue at no cost to the Company.
Specifically, the Manager's internally developed computer systems have been
implemented within the past five years. These systems have been developed
with software tools that utilize a century date format (ccyymmdd). Although
it has been a standard procedure to use this format for all date fields, the
Manager is nonetheless in the process of unit testing its internally
developed applications for numerous date conditions, including: the first and
last day of the year 2000, the leap year day and the day after, the first day
of the year 2001, functions with date ranges from 1999 which cross over into
year 2000, functions which have both "from date" and "to date" in the year
2000, date arithmetic and validation using standard routines through the year
2199.
The Manager has been, and is currently in contact with, each of its
External Service Providers to evaluate their readiness for the year 2000. The
Manager has requested each of its External Service Providers to either (i)
prepare a description of its process for identifying date sensitive areas,
its approach for implementing changes, its testing methodology, along with
its timetable for completion, or (ii) certify as to its year 2000 compliance.
Due to the technical architecture of the Manager's internally developed
applications, its emphasis on using major providers and its ongoing
communication with those providers, the Manager anticipates it will be well
positioned to begin the year 2000. There can be no assurance, however, that
the Company's External Service Providers will resolve their own Year 2000
issues in a timely manner, or that any failure by these External Service
Providers to resolve such issues would not have an adverse effect on the
Company's operations and financial condition. Each External Service Provider
is in turn subject to the Year 2000 issues of various third parties with
which it does business, making the Company's exposure to the noncompliance of
any External Service Provider difficult to assess. In a worst case scenario,
a significant portion of the Company's External Service Providers and
contractual counter-parties could fail to fulfill their respective
obligations which would significantly impair the Company's ability to meet
its obligations under its financing and hedging agreements. This would in
turn cause the Company to liquidate assets at potentially substantial losses
and possibly render the Company insolvent. The Company believes it is
devoting the necessary resources to address the Year 2000 issues over which
it has control. The Company anticipates, although there can be no assurance,
completing all necessary procedures for Year 2000 compliance by June 30,
1999. With respect to the Year 2000 issues of External Service Providers,
over which the Company has no control, the Company's contingency plan is to
identify replacement vendors, where possible.
ITEM 2A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
The Company's two primary components of market risk are interest rate
risk and equity price risk as discussed below.
INTEREST RATE RISK
EFFECT ON NET INCOME. The Company 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.
Two primary risks the Company faces are that of extension risk and prepayment
risk.
21
<PAGE>
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 will 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.
The Company also 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 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.
EFFECT ON FAIR VALUE. Another component of interest rate risk is the
effect changes in interest rates will have on the market value of the
Company's assets. This is the risk that the market value of the Company's
assets will increase or decrease at different rates than that of the
Company's liabilities including its hedging instruments.
22
<PAGE>
The Company primarily assesses its interest rate risk by estimating the
duration of its assets and the duration of its liabilities including all
hedging instruments. Duration essentially measures the market price
volatility of financial instruments as interest rates change. The Company
generally calculates duration using various financial models and empirical
data.
The following sensitivity analysis table shows the estimated impact on
the fair value of the Company's interest rate sensitive investments net of
its hedging instruments and reverse repurchase agreement liabilities assuming
rates instantaneously fall one hundred basis points and rise one hundred
basis points. (Dollars are in thousands except per share amounts.)
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Fair Value for Scenario Shown
Interest Interest
Rates Fall Rates Rise
100 Basis 100 Basis
Points Unchanged Points
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest Rate Sensitive Instruments $47,111 $50,466 $40,338
Change in Fair Value ($3,355) - ($10,128)
Change as a Percent of Fair Value (0.41%) - (1.23%)
Change as a Percent of Stockholders' Equity (3.90%) - (11.78%)
Change on a Per Share Basis ($0.58) - ($1.76)
</TABLE>
It is important to note that the impact of changing interest rates on
fair value can change significantly when interest rates change beyond one
hundred basis points from current levels. Therefore, the volatility in fair
value for the Company could increase significantly when interest rates change
beyond one hundred basis points. In addition, there are other factors that
impact the fair value of the Company's interest rate sensitive investments
and hedging instruments such as the shape of the yield curve, market
expectations as to future interest rate changes and other market conditions.
Accordingly, there may be differences between the fair value changes shown
above and actual changes in fair value as interest rates change and those
differences may be material.
The contract terms of the Company's liabilities exclusive of
hedging instruments are subject to change as interest rates change.
In general, the Company utilizes short-term borrowings in the form
of 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.
23
<PAGE>
EQUITY PRICE RISK
Another component of market risk for the Company is equity price risk.
This is the risk that the market value of the Company's equity investments
will decrease. The following table shows the impact on the Company's fair
value as the price of its equity securities change assuming price decreases
of 10% and increases of 10%. Actual price decreases or increases may be
greater or smaller. (Dollars are in thousands except per share amounts.)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
Fair Value for Scenario Shown
Prices Prices
Decrease 10% Unchanged Increase 10%
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity Investments $21,701 $24,112 $26,523
Change in Fair Value (2,411) - 2,411
Change as a Percent of Fair Value (10%) - 10%
Change as a Percent of Stockholders' Equity (2.8%) - 2.8%
Change on a Per Share Basis (0.42) - 0.42
</TABLE>
Although there is no direct link between changes in fair value and
changes in earnings in many cases, a decline in fair value for the Company
may translate into decreased earnings over the remaining life of the
investment portfolio.
If the fair market value of the Company's portfolio were to decline
significantly, the Company's overall liquidity may be impaired which could
result in the Company being required to sell assets at losses.
THE COMPANY'S ANALYSIS OF RISKS IS BASED ON MANAGEMENT'S EXPERIENCE,
ESTIMATES, MODELS AND ASSUMPTIONS. THESE ANALYSES RELY ON MODELS OF FINANCIAL
INFORMATION WHICH UTILIZE ESTIMATES OF FAIR VALUE AND INTEREST RATE
SENSITIVITY. ACTUAL ECONOMIC CONDITIONS OR IMPLEMENTATION OF INVESTMENT
DECISIONS BY THE MANAGER MAY PRODUCE RESULTS THAT DIFFER SIGNIFICANTLY FROM
THE ESTIMATES AND ASSUMPTIONS USED IN THE COMPANY'S MODELS AND THE PROJECTED
RESULTS SHOWN IN THE ABOVE TABLES AND IN THIS REPORT. THESE ANALYSES CONTAIN
CERTAIN "FORWARD-LOOKING STATEMENTS" AND ARE SUBJECT TO THE SAFE HARBOR
CONTAINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
24
<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
Not Applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit #11 Computation of Earnings Per Share
Exhibit #27 Financial Data Schedule
(b) Reports on Form 8-K
None
25
<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, 1999
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)
26
<PAGE>
EXHIBIT 11
APEX MORTGAGE CAPITAL, INC.
COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
QUARTER ENDED
MARCH 31, 1999 MARCH 31, 1998
----------------------------------------
<S> <C> <C>
BASIC:
Net Income 2,962,000 564,000
Average Number of Shares Oustanding 5,753,000 6,603,000
Basic Earnings Per Share 0.51 0.09
DILUTED:
Effect of dilutive securities:
Incremental shares from dilutive stock options 20,000 -
Diluted Average Number of Shares Outstanding 5,773,000 6,603,000
----------------------------------------
Diluted Earnings Per Share $0.51 $0.09
----------------------------------------
----------------------------------------
</TABLE>
<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, 1999 AND THE CONSOLIDATED STATEMENTS OF OPERATIONS OF THE
REGISTRANT FOR THE PERIOD FROM JANUARY 1, 1999 TO MARCH 31, 1999 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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 3,426
<SECURITIES> 845,229
<RECEIVABLES> 7,353
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 467
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 856,475
<CURRENT-LIABILITIES> 770,520
<BONDS> 0
0
0
<COMMON> 67
<OTHER-SE> 85,888
<TOTAL-LIABILITY-AND-EQUITY> 856,475
<SALES> 0
<TOTAL-REVENUES> 15,262
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,039
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,261
<INCOME-PRETAX> 2,962
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,962
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,962
<EPS-PRIMARY> 0.51
<EPS-DILUTED> 0.51
</TABLE>
