<PAGE>
===============================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
---- EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2000
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 November 9, 2000
===============================================================================
<PAGE>
APEX MORTGAGE CAPITAL, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS AT SEPTEMBER 30, 2000 (UNAUDITED) AND DECEMBER 31, 1999 3
STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999 (UNAUDITED) 4
STATEMENT OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2000 (UNAUDITED) 5
STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2000 AND SEPTEMBER 30, 1999 (UNAUDITED) 6
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 29
ITEM 2. CHANGES IN SECURITIES 29
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 30
ITEM 5. OTHER INFORMATION 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURES 31
</TABLE>
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APEX MORTGAGE CAPITAL, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
---------------- -----------------
(Unaudited)
ASSETS
<S> <C> <C>
Cash and cash equivalents $ 119,000 $ 2,605,000
Fixed income securities available-for-sale, at fair value (Note 3) 551,827,000 701,143,000
Equity securities available-for-sale, at fair value (Note 3) 9,770,000 17,481,000
Accrued interest receivable 3,565,000 6,254,000
Principal payments receivable - 3,537,000
Unrealized gain on forward contracts (Note 10) - 3,909,000
Other assets 120,000 816,000
---------------- -----------------
$ 565,401,000 $ 735,745,000
================ =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Reverse repurchase agreements (Note 4) $ 512,535,000 $ 672,660,000
Accrued interest payable 892,000 3,660,000
Dividend payable 2,111,000 2,724,000
Payable on forward contracts (Note 10) 1,079,000 -
Accrued expenses and other liabilities 353,000 660,000
---------------- -----------------
516,970,000 679,704,000
================ =================
Commitments and contingencies (Notes 4, 9, and 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 7 and 8) 67,000 67,000
Additional paid-in-capital 93,337,000 93,265,000
Accumulated other comprehensive income (loss) 3,922,000 (26,513,000)
Accumulated dividend distributions in excess of net income (38,326,000) (209,000)
Treasury stock, at cost (947,100 shares) (Note 6) (10,569,000) (10,569,000)
---------------- -----------------
48,431,000 56,041,000
---------------- -----------------
$ 565,401,000 $ 735,745,000
================ =================
</TABLE>
See accompanying notes to financial statements
-3-
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999 SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Fixed income securities $ 9,559,000 $ 13,045,000 $ 32,427,000 $ 39,913,000
Cash and cash equivalents 21,000 79,000 183,000 229,000
------------- ----------- ------------- ------------
9,580,000 13,124,000 32,610,000 40,142,000
INTEREST EXPENSE 7,600,000 10,231,000 25,878,000 32,251,000
------------- ----------- ------------- ------------
NET INTEREST INCOME (LOSS) 1,980,000 2,893,000 6,732,000 7,891,000
------------- ----------- ------------- ------------
NET GAIN (LOSS) ON INVESTMENT TRANSACTIONS (29,912,000) 437,000 (37,444,000) 1,714,000
DIVIDEND INCOME 185,000 503,000 909,000 1,899,000
GENERAL AND ADMINISTRATIVE EXPENSES:
Management fee (Note 7) 124,000 158,000 427,000 472,000
Incentive fee (Note 7) - 480,000 - 1,498,000
Professional fees 308,000 19,000 359,000 50,000
Insurance expense 67,000 67,000 200,000 200,000
Directors' fees 26,000 15,000 55,000 45,000
Stock option expense (Note 8) 23,000 71,000 71,000 217,000
Other 132,000 58,000 332,000 240,000
------------- ----------- ------------- ------------
680,000 868,000 1,444,000 2,722,000
------------- ----------- ------------- ------------
NET INCOME (LOSS) $ (28,427,000) $ 2,965,000 $ (31,247,000) $ 8,782,000
============= =========== ============= ============
Net Income (Loss) Per Share:
Basic $ (4.94) $ 0.52 $ (5.43) $ 1.53
============= =========== ============= ============
Diluted $ (4.94) $ 0.51 $ (5.43) $ 1.52
============= =========== ============= ============
Weighted Average Number of Shares
Outstanding: Basic 5,753,000 5,753,000 5,753,000 5,753,000
============= =========== ============= ============
Diluted 5,753,000 5,784,000 5,753,000 5,782,000
============= =========== ============= ============
Dividends Declared Per Share $ 0.35 $ 0.46 $ 1.16 $ 1.26
============= =========== ============= ============
</TABLE>
See accompanying notes to financial statements
-4-
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED SEPTEMBER 30, 2000
(UNAUDITED)
<TABLE>
<CAPTION>
ACCCUMULATED
ACCCUMULATED DIVIDEND
COMMON STOCK ADDITIONAL OTHER DISTRIBUTIONS TREASURY
------------------ PAID-IN COMPREHENSIVE IN EXESSS OF COMPREHENSIVE STOCK,
SHARES AMOUNT CAPITAL INCOME (LOSS) NET INCOME INCOME/(LOSS) AT COST TOTAL
--------- ------- ----------- -------------- --------------- ------------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31, 1999 6,700,100 $67,000 $93,265,000 ($26,513,000) ($209,000) ($10,569,000) $56,041,000
Issuance of stock
options to non-
employees (Note 8) 24,000 24,000
Net income 2,296,000 2,296,000 2,296,000
Other comprehensive
income:
Net unrealized
(loss) on
investments
available-for-sale (2,982,000) (2,982,000) (2,982,000)
Unrealized loss and
net deferred gains
on forward contracts,
net of
reclassification
adjustment (1,456,000) (1,456,000) (1,456,000)
(Note 11)
-----------
Comprehensive income
(loss) ($2,142,000)
===========
Dividends declared (2,725,000) (2,725,000)
--------- ------- ----------- ------------- ---------- ----------- -----------
Balance,
March 31, 2000 6,700,100 $67,000 $93,289,000 ($30,951,000) ($638,000) ($10,569,000) $51,198,000
========= ======= =========== ============= ========== ============= =========== ===========
Issuance of stock
options to non-
employees (Note 8) 24,000 24,000
Net income (5,115,000) (5,115,000) (5,115,000)
Other comprehensive
income:
Net unrealized (loss)
on investments
available-for-sale, 3,536,000 3,536,000 3,536,000
net of
reclassification
adjustment (Note 11)
Unrealized (loss) and
net deferred losses
on forward contracts,
net of reclassification
adjustment (4,148,000) (4,148,000) (4,148,000)
(Note 11)
Net deferred gains from
interest rate swaps
closed during the
quarter, net of
reclassification
adjustment 4,914,000 4,914,000 4,914,000
(Note 11)
-----------
Comprehensive income
(loss) ($813,000)
===========
Dividends declared (2,073,000) (2,073,000)
--------- ------- ----------- ------------- ---------- ------------- ----------- -----------
Balance,
June 30, 2000 6,700,100 $67,000 $93,313,000 ($26,649,000) ($7,826,000) ($10,569,000) $48,336,000
========= ======= =========== ============= ========== ============= =========== ===========
Issuance of stock
options to non-
employees (Note 8) 24,000 24,000
Net loss (28,427,000) (28,427,000) (28,427,000)
Other comprehensive
income:
Net unrealized
(loss) on
investments
available-for-sale, 29,893,000 29,893,000 29,893,000
net of
reclassification
adjustment (Note 11)
Unrealized (loss)
and net deferred
losses on forward
contracts, net of
reclassification
adjustment 1,869,000 1,869,000 1,869,000
(Note 11)
Net deferred gains
from interest rate
swaps amortized
during the quarter,
net of
reclassification
adjustment (1,191,000) (1,191,000) (1,191,000)
(Note 11)
-----------
Comprehensive income
(loss) $2,144,000
===========
Dividends declared (2,073,000) (2,073,000)
--------- ------- ----------- ------------- ---------- ----------- -----------
Balance,
September 30, 2000 6,700,100 $67,000 $93,337,000 $3,922,000 ($38,326,000) ($10,569,000) $48,431,000
========= ======= =========== ============= ========== ============= =========== ===========
</TABLE>
See accompanying notes to financial statements
- 5 -
<PAGE>
APEX MORTGAGE CAPITAL, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999 SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net Income (Loss) $ (28,427,000) $ 2,965,000 $ (31,247,000) $ 8,782,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization (849,000) (52,000) (1,280,000) 394,000
Net (gain) loss on investment transactions 29,912,000 (437,000) 37,444,000 (1,714,000)
Change in assets and liabilities:
Accrued interest receivable 110,000 (116,000) 2,689,000 (700,000)
Other assets 224,000 390,000 696,000 169,000
Accrued interest payable 130,000 (210,000) (2,768,000) (3,700,000)
Accrued expenses and other liabilities 61,000 57,000 (307,000) 79,000
------------- ------------ ------------- ------------
Net cash provided by operating activities 1,161,000 2,597,000 5,227,000 3,310,000
------------- ------------ ------------- ------------
INVESTING ACTIVITIES:
Purchase of equity securities - (5,089,000) - (12,630,000)
Purchase of fixed income securities - (1,410,000) - (117,141,000)
Payments on closed forward contracts (6,645,000) - (13,107,000) -
Proceeds from sales of equity securities 1,393,000 2,494,000 6,481,000 6,870,000
Proceeds from sales of fixed income securities - 172,000 96,513,000 40,578,000
Proceeds from closed forward contracts 39,000 - 5,930,000 -
Proceeds from terminating interest rate swaps - - 5,554,000 -
Principal payments on fixed income securities 17,448,000 35,951,000 58,524,000 147,322,000
------------- ------------ ------------- ------------
Net cash provided by (used in) investing
activities 12,235,000 32,118,000 159,895,000 64,999,000
------------- ------------ ------------- ------------
FINANCING ACTIVITIES:
Net proceeds from reverse repurchase agreements (14,656,000) (37,021,000) (160,125,000) (68,261,000)
Dividend distributions (2,035,000) (2,487,000) (7,483,000) (6,491,000)
------------- ------------ ------------- ------------
Net cash used in financing activities (16,691,000) (39,508,000) (167,608,000) (74,752,000)
------------- ------------ ------------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (3,295,000) (4,793,000) (2,486,000) (6,443,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 3,414,000 11,029,000 2,605,000 12,679,000
------------- ------------ ------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 119,000 $ 6,236,000 $ 119,000 $ 6,236,000
============= ============ ============= ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 8,661,000 $ 10,474,000 $ 30,348,000 $ 35,908,000
============= ============ ============= ============
NONCASH INVESTING AND FINANCING ACTIVITIES:
Net unrealized loss on securities
available-for-sale and forward contracts $ 30,571,000 $(13,588,000) $ 30,435,000 $(29,485,000)
============= ============ ============= ============
Securities sold, not yet settled $ - $ (484,000) $ - $ 63,000
============= ============ ============= ============
Principal payments, not yet received $ - $ 463,000 $ 3,537,000 $ 2,890,000
============= ============ ============= ============
Securities purchased, not yet settled $ - $ 16,000 $ - $ (822,000)
============= ============ ============= ============
Dividends declared, not yet paid $ (2,111,000) $ (2,724,000) $ (2,724,000) $ (2,724,000)
============= ============ ============= ============
</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 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 investments 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
an average cost 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 accumulated 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 an average cost 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
accumulated 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>
The Company also enters into forward contracts to sell U.S. Treasury
notes in order to mitigate the negative impact of rising interest rates
on the fair value of its fixed income securities available-for-sale.
Unrealized gains are shown as an asset on the balance sheet. Unrealized
losses are shown as a liability on the balance sheet. All changes in
the fair value of the forward contracts are included in accumulated
other comprehensive income in the Statements of Stockholders' Equity.
Realized gains or losses on the termination of the contracts are
deferred in accumulated other comprehensive income on the Balance
Sheets and are amortized over the remaining lives of the fixed income
securities being hedged as an adjustment to interest income in the
Statements of Operations.
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 8. Options granted
to directors of the Company are accounted for using the intrinsic value
method, and generally no compensation expense is recognized in the
Statements 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 the majority
of 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. In addition, the Company has the ability to
purchase up to 10% of the portfolio in below investment grade
securities. The Company has exposure to credit losses on this portion
of the portfolio. Reserves for credit losses may be made if losses
become probable. The Company has not recorded any reserves for credit
losses since its inception.
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
Statement of Financial Accounting Standards ("SFAS") No. 130, REPORTING
COMPREHENSIVE INCOME, 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."
- 8 -
<PAGE>
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The
Statement establishes accounting and reporting standards requiring that
every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either
an asset or liability measured at its fair value. The Statement
requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative's
gains and losses to offset related results on the hedged item in the
income statement, and requires that a company must formally document,
designate, and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133, as amended, is effective for fiscal
years beginning after June 15, 2000. A company may also implement the
Statement as of the beginning of any fiscal quarter after issuance
(that is, fiscal quarters beginning June 16, 1998 and thereafter).
Statement 133 cannot be applied retroactively. Statement 133 must be
applied to (a) derivative instruments and (b) certain derivative
instruments embedded in hybrid contracts that were issued, acquired, or
substantively modified after December 31, 1997 (and, at the Company's
election, before January 1, 1998). The Company will be required to
adopt the reporting requirements of SFAS No. 133 in the first quarter
of 2001. The Company also expects that the non-effective portion of its
forward contracts will be recognized in earnings beginning with the
quarter ended March 31, 2001.
During the nine months ended September 30, 1999, the Company wrote off
$64,000 of unamortized organization costs in accordance with the
adoption of S.O.P. 98-5, "Reporting on the Cost of Start-Up
Activities."
NOTE 3 - FIXED INCOME AND EQUITY SECURITIES
At September 30, 2000, fixed income securities consisted of the
following:
<TABLE>
<CAPTION>
Adjustable Rate Fixed Rate Other Fixed
(in thousands) Mortgage Mortgage Income
Securities Securities Securities Total
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Principal Amount $25,077 $536,617 $10,400 $572,094
Unamortized Premium (Discount) 450 2,022 (3,573) (1,101)
Impairment Reserve (18,284) (18,284)
---------------------------------------------------------------
Amortized Cost 25,527 520,355 6,827 552,709
Unrealized Gains 32 - - 32
Unrealized Losses (114) - (800) (914)
===============================================================
Fair Value $25,445 $520,355 $6,027 $551,827
===============================================================
</TABLE>
At December 31, 1999, fixed income securities consisted of the
following:
<TABLE>
<CAPTION>
Adjustable Rate Fixed Rate Other Fixed
(in thousands) Mortgage Mortgage Income
Securities Securities Securities Total
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Principal Amount $31,923 $688,162 $10,400 $730,485
Unamortized Premium (Discount) 553 1,823 (3,185) (809)
---------------------------------------------------------------
Amortized Cost 32,476 689,985 7,215 729,676
Unrealized Gains 33 - - 33
Unrealized Losses (253) (27,637) (676) (28,566)
===============================================================
Fair Value $32,256 $662,348 $6,539 $701,143
===============================================================
</TABLE>
- 9 -
<PAGE>
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.
A portion of the other fixed income securities generally have an
original maturity of five years subject to certain acceleration
provisions. The expected average remaining maturity at September 30,
2000 and December 31, 1999 was approximately 2.3 and 3.0 years,
respectively. The remaining portion has a fixed remaining maturity of
approximately 1.8 years as of September 30, 2000.
The adjustable rate mortgage securities are typically subject to
periodic and lifetime caps that limit the amount an adjustable rate
mortgage-backed security's interest rate can change during any given
period and over the life of the asset. At September 30, 2000 and
December 31, 1999 the average periodic cap on the adjustable rate
mortgage assets was 2.0% per annum and the average lifetime cap was
equal to 11.3%.
During the quarters ended September 30, 2000 and September 30, 1999
there were no sales of fixed income securities.
During the quarter ended September 30, 2000, the Company recorded an
impairment reserve of $18,284,000 on its fixed-rate mortgage securities
which is included in Net Loss on Investment Transactions in the
Statements of Operations. The impairment reserve represents an other
than temporary decline in the fair value, as of September 30, 2000, of
investments held that the Company no longer intends to hold until
maturity. The Company could also incur additional losses depending on
the actual proceeds of future investment sales or if further impairment
charges are recorded.
The net deferred loss and unrealized loss of $7,346,000 and $1,079,000,
respectively, incurred on forward contracts through September 30, 2000
were reclassified from other comprehensive income into Net Loss on
Investment Transactions in The Statement of Operations during the
quarter ended September 30, 2000 as part of the impairment charge
recorded on the underlying assets being hedged. Future gains and losses
on forward contracts will either be amortized over the remaining life
of the fixed income securities being hedged or recognized in The
Statements of Operations in the period the hedged securities are sold.
At September 30, 2000 and December 31, 1999, equity securities
consisted of the following:
<TABLE>
<CAPTION>
(in thousands) September 30, 2000 December 31, 1999
------------------------ ---------------------
<S> <C> <C>
Cost $13,016 $19,370
Unrealized Gains 1,361 789
Unrealized Losses (281) (2,678)
Impairment Reserve (4,326) -
------------------------ ---------------------
Fair Value $9,770 $17,481
======================== =====================
</TABLE>
During the quarter ended September 30, 2000 the Company realized
$165,000 in net gains on the sale of $1,393,000 of equity securities
which were classified as available-for-sale. During the quarter ended
September 30, 1999, the Company realized $421,000 in gains on the sale
of $2,494,000 of equity securities that were classified as
available-for-sale.
At September 30, 2000, the Company held equity securities and senior
unsecured notes issued by Dynex Capital, Inc. ("Dynex") with fair
market values of $2,653,000 and $3,750,000, respectively. During the
year ended December 31, 1999, Dynex suspended the payment of dividends
on its preferred stock. Accordingly, the Company is no longer
recognizing dividend income on its equity investments in Dynex. Dynex
is currently paying interest on its senior notes. Accordingly, the
Company is recognizing interest income on the senior note investments
issued by Dynex. If Dynex were to suspend payment of interest on its
senior notes, interest income recognized by the Company would be
negatively impacted.
During the quarter ended September 30, 2000, the Company recorded an
impairment reserve of $3,368,000 on its Dynex preferred stock holdings
which is included in Net Loss on Investment Transactions in the
Statement of Operations. The Company could also incur additional losses
if the remaining Dynex investments are sold or written down further.
- 10 -
<PAGE>
NOTE 4 - REVERSE REPURCHASE AGREEMENTS
The Company has entered into reverse repurchase agreements to finance
certain of its investments. These agreements are secured by a portion
of the Company's investments and bear interest rates that have
historically moved in close relationship to LIBOR.
At September 30, 2000, the Company had outstanding $512,535,000 of
reverse repurchase agreements with a weighted average current borrowing
rate of 6.60% and a maturity of 1.0 months. The reverse repurchase
agreements were collateralized by securities with an estimated fair
value of $526,939,755.
At December 31, 1999, the Company had outstanding $672,660,000 of
reverse repurchase agreements with a weighted average current borrowing
rate of 5.98% and a maturity of 2.0 months. The reverse repurchase
agreements were collateralized by securities with an estimated fair
value of $689,396,000.
For the quarter ended September 30, 2000, the average reverse
repurchase agreement balance was $522,145,000 with a weighted average
interest cost of 6.59%. The maximum reverse repurchase agreement
balance outstanding during the quarter ended September 30, 2000 was
$527,191,000.
For the quarter ended September 30, 1999, the average reverse
repurchase agreement balance was $715,263,000 with a weighted average
interest cost of 5.18%. The maximum reverse repurchase agreement
balance outstanding during the quarter ended September 30, 1999 was
$736,668,000.
NOTE 5 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the amortized cost and estimated fair
values of the Company's financial instruments. SFAS No. 107,
DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, defines the fair
value of a financial instrument as the amount at which the instrument
could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale (dollars in thousands):
<TABLE>
<CAPTION>
At September 30, 2000 At December 31, 1999
Adjusted Adjusted
Cost Fair Value Cost Fair Value
------------------- ------------ -------------------- ---------------
<S> <C> <C> <C> <C>
Mortgage related securities $545,882 $545,800 $722,461 $694,604
Equity securities 8,690 9,770 19,370 17,481
Other fixed income securities 6,827 6,027 7,215 6,539
Interest rate swaps - - - 3,815
Forward contracts - (1,079) - 3,909
</TABLE>
The Company bases its fair value estimates for mortgage related
securities, equity securities, other fixed income securities, interest
rate swaps, and forward contracts 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 6 - STOCK REPURCHASE PROGRAM
The Company's Board of Directors has authorized a program to repurchase
shares of the Company's common stock. At September 30, 2000 and
December 31, 1999, the Company was authorized to repurchase an
additional 552,900 shares of the Company's common stock pursuant to the
repurchase program.
- 11 -
<PAGE>
At September 30, 2000 and December 31, 1999, the Company held 947,100
shares of treasury stock. During the three months ended September 30,
2000 and year ended December 31, 1999, the Company did not repurchase
any treasury shares.
NOTE 7 - TRANSACTIONS WITH AFFILIATES
The Company has entered into a Management Agreement (the "Management
Agreement"), as amended, 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 recorded expense of $124,000 and $158,000 in base
management compensation to the Manager during the quarters ended
September 30, 2000 and 1999, respectively.
The accrued liability for base management compensation was
$118,000 and $157,000 at September 30, 2000 and December 31, 1999,
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.
During the quarter ended September 30, 2000, the Company did not record
an expense for incentive compensation. The Company recorded an expense
of $480,000 for incentive compensation for quarter ended September 30,
1999.
At September 30, 2000, the Company had no accrued liability for
incentive compensation resulting from the credit recorded during the
quarter ended June 30, 2000. The accrued liability for incentive
compensation was $157,000 at December 31, 1999.
The Company may also grant stock options to directors, officers and key
employees of the Company, the Manager, its directors, officers and key
employees (see Note 8).
The Management Agreement may be renewed each year at the discretion of
the Company's Board of Directors, unless previously terminated by the
Company or the Manager upon written notice. Except in the case of a
termination or non-renewal by the Company for cause, upon termination
or non-renewal of the Management Agreement by the Company, the Company
is obligated to pay the Manager a termination or non-renewal fee, which
may be significant. The termination or non-renewal fee shall be equal
to the fair market value of the Management Agreement without regard to
the Company's termination right, as determined by an independent
appraisal. Neither the fair market value of the Management Agreement
nor the various factors which the appraiser may find relevant in its
determination of the fair market value can be determined at this time.
The fair market value of the Management Agreement will be affected by
significant variables, including (i) the historical management fees
paid to the Manager, (ii) any projections of future management fees to
be paid to the Manager determined by the independent appraiser, (iii)
the relative valuations of agreements similar to the Management
Agreement and (iv) other factors, all of which may be unrelated to the
performance of the Manager. Similar management agreements have been
valued at as much as eight times the historical annual fees paid under
such agreements. Any termination or non-renewal fee paid may be
materially greater than eight times historical fees and the Company can
provide no assurance at this time as to the amount of any such fee.
The Company's other fixed income investments include securities that
are issued by special purpose companies that invest primarily in
mortgage-related assets. 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
the Manager in connection with these investments.
- 12 -
<PAGE>
NOTE 8 - 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 of the Company ("employees"), and to the Manager and the
directors, officers and key employees of the Manager ("non-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 stock option expense relating to the options
granted to the non-employees of $23,000 and $71,000 during the quarters
ended September 30, 2000 and 1999, respectively.
For stock options outstanding at September 30, 2000, the range of
exercise prices is $10.38 to $15.00 per share and the weighted-average
remaining contractual life is 7.49 years.
For the year ended December 31, 1998, options to purchase 112,000
shares of the Company's common stock were granted to directors of the
Company and options to purchase 58,000 shares were granted to officers
of the Company and officers and key employees of the Manager. The
exercise price of the options granted during 1998 was $10.38 per share.
All of the options granted during 1998 include dividend equivalent
rights that entitle the option holder to receive a cash payment equal
to the dividends declared on the Company's common stock multiplied by
the number of options held until the options are exercised or expire.
The fair value of each option granted during 1998 was estimated to be
$5.32 as of the grant date using the Black-Scholes option pricing model
with the following assumptions: dividend yield of 0% per annum (to
account for the dividend equivalent rights); expected volatility of
30%; risk free interest rate of 4.57% per annum; and an expected life
of 10 years.
The options granted during 1998 expire in December 2008 and vest in two
equal installments during the month of December in 1999 and 2000.
For the year ended December 31, 1997, options to purchase 210,000
shares of the Company's common stock were granted to directors of the
Company and options to purchase 190,000 shares were granted to officers
of the Company and officers and key employees of the Manager. The
exercise price of the options granted during 1997 was $15 per share.
The fair value of each option granted during 1997 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.
The options granted during 1997 expire in December 2007 and vest in
three equal installments during the month of February in 1999, 2000 and
2001.
- 13 -
<PAGE>
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
September 30, 2000 September 30, 1999
-------------------------------------------
<S> <C> <C>
Net income (loss) - as reported $(28,427,000) $2,965,000
Net income (loss) - pro forma $(28,450,000) 2,840,000
Basic earnings per share - as reported $(4.94) $0.52
Diluted earnings per share - as reported $(4.94) $0.51
Basic earnings per share - pro forma $(4.95) $0.49
Diluted earnings per share - pro forma $(4.95) $0.49
</TABLE>
Information regarding stock option activity during the nine months
ended Septemeber 30, 2000 is as follows:
<TABLE>
<CAPTION>
Weighted Average
Shares Exercise Price
------------------ ------------------
<S> <C> <C>
Options Granted Prior to December 31, 1999 570,000 13.62
Exercised - -
Expired - -
------------------
Options Outstanding at September 30, 2000 570,000 $13.62
==================
</TABLE>
NOTE 9 - CONTRACTUAL COMMITMENTS
At September 30, 2000, the Company had no interest rate swap
agreements.
At December 31, 1999, the Company had entered into interest rate swap
agreements with the total current notional amount as stated below.
<TABLE>
<CAPTION>
Average Unrealized
Current Average Termination Gains
Notional Amount (000) Fixed Rate Floating Rate Date (000)
------------------------ --------------------------- ------------------------ -------------------- -----------------
<S> <C> <C> <C> <C>
$400,129 5.869% 1Mo LIBOR 8/9/2001 $3,815
</TABLE>
The Company had no transactions with swap counter-parties during the
quarter ended September 30, 2000. The Company paid $736,000 to the swap
counter-parties during the quarter ended September 30, 1999 which is
included in interest expense in the Statements of Operations.
During the quarter ended June 30, 2000, the Company terminated all
outstanding interest rate swap agreements with a combined notional
amount of $386,213,000 which resulted in a deferred gain of $5,554,000
that will be amortized over the remaining life of the original swap
agreements. The deferred gain is included in Other Comprehensive Income
on the Balance Sheet and the amortization expense is included in
Interest Expense in the Statement of Operations. During the quarter
ended September 30, 2000, $1,177,000 of the deferred gain was
amortized. Approximately 92% of the deferred gain will be amortized by
June 30, 2001. The remaining deferred gain will be fully amortized by
May 31, 2002.
During the year ended December 31, 1999, the Company terminated
interest rate swap agreements with a combined notional amount of
$255,530,000 which resulted in a net deferred loss of $66,000, which
will be
- 14 -
<PAGE>
amortized over the remaining life of the original swap agreements.
The net deferred loss was composed of both deferred gains and
losses. The net deferred loss is included in Other Comprehensive
Income on the Balance Sheet and the amortization expense is included
in Interest Expense in the Statement of Operations. During the
quarter ended September 30, 2000, $14,000 of the gain portion of the
net deferred loss was amortized. The net deferred loss was fully
amortized during the quarter ended September 30, 2000.
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 December 31, 1999, the Company had securities
with a fair market value of $2,592,000 on deposit with its
counter-parties. At December 31, 1999, the Company received fixed
income securities with a fair market value of $1,600,000 as a deposit
from a swap agreement counter-party.
NOTE 10 - FORWARD CONTRACTS
At September 30, 2000, the Company had entered into forward contracts
to sell U.S. Treasury notes with terms stated below.
<TABLE>
<CAPTION>
Average Unrealized
Current Termination Losses Average Maturity of
Notional Amount (000) Date (000) Underlying Securities
------------------------ ------------------------------- -------------------------- ----------------------------
<S> <C> <C> <C>
$610,000 10/14/2000 $(1,079) 3.52 Years
</TABLE>
The following is a presentation of forward contracts closed during the
quarter ended September 30, 2000:
<TABLE>
<CAPTION>
Deferred
Notional Amount Closing Gain (Loss)
(000) Date (000)
----------------------------------------------------------------------------------------
<S> <C> <C>
150,000 07/05/00 (1,418)
100,000 07/10/00 (355)
125,000 07/14/00 (220)
135,000 07/21/00 (190)
100,000 07/24/00 39
100,000 07/28/00 (227)
150,000 08/04/00 (432)
125,000 08/11/00 (293)
135,000 08/18/00 (158)
100,000 08/31/00 (828)
100,000 09/08/00 (695)
150,000 09/22/00 (551)
125,000 09/22/00 (215)
135,000 09/29/00 (1,063)
---------------------------- -----------------------------
1,730,000 (6,606)
============================ =============================
</TABLE>
The deferred losses and gains are being amortized as an adjustment to
interest income over the remaining weighted average lives of the fixed
income securities being hedged, which was estimated to be 6.1 years at
September 30, 2000.
- 15 -
<PAGE>
At December 31, 1999, the Company had entered into forward contracts to
sell U.S. Treasury notes with terms stated below.
<TABLE>
<CAPTION>
Average Unrealized
Current Termination Gains Average Maturity of
Notional Amount (000) Date (000) Underlying Securities
------------------------ ------------------------------- -------------------------- ----------------------------
<S> <C> <C> <C>
$335,000 2/12/2000 $3,909 3.36 Years
</TABLE>
During the year ended December 31, 1999, two forward contracts to sell
U.S. Treasury notes with a notional amount of $135,000,000 and
$100,000,000 were closed resulting in a deferred loss of $390,000 and
deferred gain of $51,000, respectively. The deferred loss and gain are
being amortized as an adjustment to interest income over the remaining
weighted average lives of the fixed income securities being hedged,
which was estimated to be 4.8 years at December 31, 1999.
The contracts were entered into to mitigate the negative impact of
rising interest rates on fixed income securities available-for-sale
that generally have a market-weighted average duration approximately
equal to the contracts shown above.
NOTE 11 - RECLASSIFICATION ADJUSTMENTS OF COMPREHENSIVE INCOME
The following is a presentation of the reclassification amounts to
Comprehensive Income for the quarters ended September 30, 2000 and
1999:
<TABLE>
<CAPTION>
For the Quarter For the Quarter
Ended September 30, 2000 Ended September 30, 1999
------------------------ -------------------------
<S> <C> <C>
FORWARD CONTRACTS
Net deferred (losses) from forward contracts closed during the (6,606,000)
quarter -
Less: reclassification adjustment for net losses included in net 8,475,000
income -
------------------------ -------------------------
Net unrealized gains (losses) on forward contracts $ 1,869,000 $ -
======================== =========================
For the Quarter For the Quarter
Ended September 30, 2000 Ended September 30, 1999
------------------------ -------------------------
INVESTMENTS AVAILABLE FOR SALE
Unrealized (losses) gains arising during the quarter $ 7,480,000 $ (13,117,000)
Less: reclassification on net losses to impairment reserve 22,610,000 -
Less: reclassification adjustment for net losses (gains) resulting (197,000) (471,000)
from asset sales
------------------------ -------------------------
Net unrealized gains (losses) gains on investments $ 29,893,000 $ (13,588,000)
available-for-sale
======================== =========================
For the Quarter For the Quarter
Ended September 30, 2000 Ended September 30, 1999
------------------------ -------------------------
INTEREST RATE SWAP AGREEMENTS
Net deferred gains from interest rate swaps closed during the $ - $ -
quarter
Less: reclassification adjustment for net (gains) included in net (1,191,000) -
income
------------------------ -------------------------
Net unrealized (losses) on interest rate swaps $ (1,191,000) $ -
======================== =========================
</TABLE>
- 16 -
<PAGE>
NOTE 12 - ADOPTION OF SHAREHOLDER RIGHTS PLAN
On June 30, 1999, the Board of Directors of Apex Mortgage Capital, Inc.
(the "Company") declared a dividend distribution of one Right for each
outstanding share of Company Common Stock to stockholders of record at
the close of business on July 30, 1999 (the "Record Date"). Each Right
entitles the registered holder to purchase from the Company one
one-hundredth of a share of Series A Junior Participating Preferred
Stock, par value $0.01 per share (the "Preferred Stock"), at a Purchase
Price of $50, subject to adjustment. The description and terms of the
Rights are set forth in a Shareholder Rights Agreement (the "Rights
Agreement") between the Company and The Bank of New York, as Rights
Agent.
Initially, the Rights will be attached to all Common Stock certificates
representing shares then outstanding, and no separate Rights
Certificates will be distributed. Subject to certain exceptions
specified in the Rights Agreement, the Rights will separate from the
Common Stock and a Distribution Date will occur upon the earlier of (i)
10 business days following a public announcement that a person or group
of affiliated or associated persons (an "Acquiring Person") has
acquired, or obtained the right to acquire, beneficial ownership of 15%
or more of the outstanding shares of Common Stock (the "Stock
Acquisition Date"), other than as a result of repurchases of stock by
the Company or certain inadvertent actions by institutional or certain
other stockholders or (ii) 10 business days (or such later date as the
Board shall determine) following the commencement of a tender offer or
exchange offer that would result in a person or group becoming an
Acquiring Person. Until the Distribution Date, (i) the Rights will be
evidenced by the Common Stock certificates and will be transferred with
and only with such Common Stock certificates, (ii) new Common Stock
certificates issued after the Record Date will contain a notation
incorporating the Rights Agreement by reference and (iii) the surrender
for transfer of any certificates for Common Stock outstanding will also
constitute the transfer of the Rights associated with the Common Stock
represented by such certificate. Pursuant to the Rights Agreement, the
Company reserves the right to require prior to the occurrence of a
triggering event that, upon any exercise of Rights, a number of Rights
be exercised so that only whole shares of Preferred Stock will be
issued.
The Rights are not exercisable until the Distribution Date and will
expire on July 30, 2009, unless earlier redeemed or exchanged by the
Company.
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, 1999. 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 and
other highly rated, single-family real estate adjustable and fixed rate Mortgage
Related Assets. The Company commenced operations on December 9, 1997 following
the initial public
- 17 -
<PAGE>
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 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 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 are selected
members of the TCW Group's Mortgage-Backed Securities Group (the "MBS
Group"), all of whom have over twelve 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.
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.
- 18 -
<PAGE>
POLICIES
The Company's current investment policies are set forth in its Annual
Report on Form 10-K for the year ended December 31, 1999.
FINANCIAL CONDITION
FIXED INCOME SECURITIES
At September 30, 2000, the Company held $551,827,000 of Fixed Income Securities
as compared to $701,143,000 at December 31, 1999. The original maturity of a
significant portion of the Fixed Income Securities ranges from fifteen to thirty
years; the actual maturity is subject to change based on the prepayments of the
underlying mortgage loans. The following table is a schedule of Fixed Income
Securities held listed by security type (dollars in thousands):
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
-----------------------------------------------------------
Percent of Carrying Percent of
Fixed Income Securities Carrying Value Portfolio Value Portfolio
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage Securities:
Adjustable Rate (1) $25,445 4.60% $32,256 4.60%
Fixed Rate 520,355 94.30% 662,348 94.40%
Other Fixed Income Securities 6,027 1.10% 6,539 1.00%
--------------- ------------ ------------- ---------------
Totals $551,827 100.00% $701,143 100.00%
=============== ============ ============= ===============
</TABLE>
(1) At September 30, 2000 and December 31, 1999, the interest rate
indices for 97% and 3% 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 September 30, 2000 (dollars in
thousands):
<TABLE>
<CAPTION>
Security Type Par Amount Percent of Adjusted Market Current Weighted
Total Par Cost Basis Price Coupon Average
Amount Life (1)
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
15 Year Agency/AAA Pass-throughs $150,624 26.30% 98.00% 98.00% 6.50% 4.8
20 Year Agency Pass-throughs 235,796 41.20% 97.00% 97.00% 6.50% 6.0
30 Year Agency Pass-throughs 28,289 4.90% 96.86% 96.86% 6.98% 6.1
AAA CMOs 121,908 21.30% 95.66% 95.66% 6.92% 8.5
--------------- ------------ ------------- ------------- -------- -----------
Total Fixed Rate Holdings $536,617 93.80% 96.97% 96.97% 6.62% 6.2
Other Fixed Income Securities 10,400 1.80% 65.64% 57.95% 15.20% 2.0
Adjustable Rate Holdings 25,077 4.40% 101.79% 101.47% 7.75% 1.0
--------------- ------------ ------------- ------------- -------- -----------
Total Portfolio $572,094 100.00% 96.61% 96.46% 6.82% 5.9
=============== ============ ============= ============= ======== ===========
</TABLE>
- 19 -
<PAGE>
The following table shows various weighted average characteristics of the
Mortgage-Backed Securities held by the Company at December 31, 1999 (dollars in
thousands):
<TABLE>
<CAPTION>
Security Type Par Amount Percent of Amortized Market Price Current Weighted
Total Par Cost Basis Coupon Average
Amount Life (1)
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
15 Year Agency/AAA Pass-throughs $167,717 23.00% 100.49% 97.30% 6.50% 5.1
20 Year Agency Pass-throughs 251,819 34.50% 100.46% 96.26% 6.50% 6.4
30 Year Agency Pass-throughs 31,424 4.30% 101.36% 95.98% 6.99% 7.7
AAA CMOs 237,202 32.40% 99.76% 95.53% 6.82% 7.2
--------------- ------------ ------------- -------------- -------- -----------
Total Fixed Rate Holdings $688,162 94.20% 100.26% 96.25% 6.63% 6.4
Other Fixed Income Securities 10,400 1.40% 69.38% 62.88% 15.53% 2.1
Adjustable Rate Holdings 31,923 4.40% 101.73% 101.04% 6.62% 1.0
--------------- ------------ ------------- -------------- -------- -----------
Total Portfolio $730,485 100.00% 99.89% 95.88% 6.76% 6.1
=============== ============ ============= ============== ======== ===========
</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 September 30, 2000 the Company held $9,770,000 of equity securities
compared to $17,481,000 at December 31, 1999. Equity securities consist
primarily of investment in equities issued by other real estate investment
trusts.
At September 30, 2000, equity securities consisted of the following:
<TABLE>
<CAPTION>
(in thousands) Shares Held Adjusted Cost Fair Value
---------------------------------------------------
<S> <C> <C> <C>
COMMON STOCK:
American Residential Investment Trust, Inc. 109 $611 $354
Anworth Mortgage Asset Corporation 222 994 1,108
Dynex Cap, Inc. 75 122 98
----------------------------------
Total Common Stock 1,727 1,560
----------------------------------
CONVERTIBLE PREFERRED STOCK:
Capstead Mortgage Corporation, Series B 520 4,408 5,655
Dynex Capital, Inc., Series A 53 420 420
Dynex Capital, Inc., Series B 150 1,167 1,167
Dynex Capital, Inc., Series C 108 968 968
----------------------------------
Total Convertible Preferred Stock 6,963 8,210
----------------------------------
Total Equity Securities $8,690 $9,770
==================================
</TABLE>
- 20 -
<PAGE>
At December 31, 1999, equity securities consisted of the following:
<TABLE>
<CAPTION>
(In thousands) Shares Held Cost Fair Value
--------------------------------------------------
<S> <C> <C> <C>
COMMON STOCK:
American Residential Investment Trust, Inc. 109 $ 611 $748
Anthracite Capital, Inc. 500 3,071 3,188
Anworth Mortgage Asset Corporation 222 994 997
Dynex Capital, Inc. 75 1,080 483
Hanover Capital Mortgage Holdings, Inc. 385 1,842 1,396
Impac Commercial Holdings, Inc. 249 1,441 1,307
-------------------------------------
Total Common Stock 9,039 8,119
-------------------------------------
CONVERTIBLE PREFERRED STOCK:
Capstead Mortgage Corporation, Series B 520 4,408 4,940
Dynex Capital, Inc., Series A 53 920 715
Dynex Capital, Inc., Series B 150 2,711 1,987
Dynex Capital, Inc., Series C 108 2,292 1,720
-------------------------------------
Total Convertible Preferred Stock 10,331 9,362
-------------------------------------
Total Equity Securities $19,370 $17,481
=====================================
</TABLE>
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.
HEDGING INSTRUMENTS
At September 30, 2000, the Company had no interest rate swap agreements.
At December 31, 1999, the Company had entered into interest rate swap
agreements with the total current notional amount as stated below.
<TABLE>
<CAPTION>
Average Unrealized
Current Weighted Average Termination Gains (Losses)
Notional Amount (000) Average Life Fixed Rate Floating Rate Date (000)
------------------------ ------------- -------------------- -------------------- ------------------- -------------------
<S> <C> <C> <C> <C> <C>
$400,129 1.6 years 5.869% 1Mo LIBOR 8/9/2001 $3,815
</TABLE>
The Company is generally required to deposit collateral with the swap
agreement counter-parties in an amount at least equal to the amount of any
unrealized losses. At December 31, 1999, the Company had securities with a fair
market value of $2,592,000 on deposit with its counter-parties. At December 31,
1999, the Company received fixed income securities with a fair market value of
$1,600,000 as a deposit from a swap agreement counter-party.
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
- 21 -
<PAGE>
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.
At September 30, 2000, the Company had entered into forward contracts to sell
U.S. Treasury notes with terms stated below.
<TABLE>
<CAPTION>
Fair value of Average Unrealized
Current Average Contract contracts Termination Gains (Losses)
Notional Amount (000) Price (000) Date (000)
------------------------ -------------------- ---------------------- ---------------------- ------------------------
<S> <C> <C> <C> <C>
$610,000 99.448 607,712 10/14/2000 $(1,079)
</TABLE>
The contracts were entered into to mitigate the negative impact of rising
interest rates on fixed income securities available-for-sale that generally have
a market weighted average duration approximately equal to the contracts shown
above.
The following is a presentation of forward contracts closed during the
quarter ended September 30, 2000:
<TABLE>
<CAPTION>
Deferred
Notional Amount Closing Gain (Loss)
(000) Date (000)
----------------------------------------------------------------------------------------
<S> <C> <C>
150,000 07/05/00 (1,418)
100,000 07/10/00 (355)
125,000 07/14/00 (220)
135,000 07/21/00 (190)
100,000 07/24/00 39
100,000 07/28/00 (227)
150,000 08/04/00 (432)
125,000 08/11/00 (293)
135,000 08/18/00 (158)
100,000 08/31/00 (828)
100,000 09/08/00 (695)
150,000 09/22/00 (551)
125,000 09/22/00 (215)
135,000 09/29/00 (1,063)
---------------------------- -----------------------------
1,730,000 (6,606)
============================ =============================
</TABLE>
The net deferred loss and unrealized loss of $7,346,000 and $1,079,000,
respectively, incurred on forward contracts through September 30, 2000 were
reclassified from other comprehensive income into Net Loss on Investment
Transactions in The Statement of Operations during the quarter ended
September 30, 2000 as part of the impairment charge recorded on the
underlying assets being hedged. Future gains and losses on forward contracts
will either be amortized over the remaining life of the fixed income
securities being hedged or recognized in The Statements of Operations in the
period the hedged securities are sold.
- 22 -
<PAGE>
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 September 30, 2000, the Company had outstanding $512,535,000 of reverse
repurchase agreements with a weighted average current borrowing rate of 6.60%
and a maturity of 1.0 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$526,939,755.
At December 31, 1999, the Company had outstanding $672,660,000 of reverse
repurchase agreements with a weighted average current borrowing rate of 5.98%
and a maturity of 2.0 months. The reverse repurchase agreements were
collateralized by mortgage-backed securities with an estimated fair value of
$689,396,000.
The Company had $4,435,000 and $7,044,000 of other liabilities at September
30, 2000 and December 31, 1999, respectively, consisting primarily of dividend
payable and unrealized loss on open forward contracts at September 30, 2000 and
accrued interest payable and dividend payable at December 31, 1999. The Company
anticipates settling all other liabilities within one year.
OTHER MATTERS
At September 30, 2000, the Company held equity securities and senior
unsecured notes issued by Dynex Capital, Inc. ("Dynex") with fair market values
of $2,653,000 and $3,750,000, respectively. During the year ended December 31,
1999, Dynex suspended the payment of dividends on its preferred stock.
Accordingly, the Company is no longer recognizing dividend income on its equity
investments in Dynex. Dynex is currently paying interest on its senior notes.
Accordingly, the Company is recognizing interest income on the senior note
investments issued by Dynex. If Dynex were to suspend payment of interest on its
senior notes, interest income recognized by the Company would be negatively
impacted.
During the quarter ended September 30, 2000, the Company recorded an
impairment reserve of $3,368,000 on its Dynex preferred stock holdings which is
included in Net Loss on Investment Transactions in the Statement of Operations.
The Company could also incur additional losses if the remaining Dynex
investments are sold or written down further.
RESULTS OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 2000
For the quarter ended September 30, 2000, the Company's net loss was
$28,427,000, or $4.94 per share on both a basic and diluted basis, based on a
weighted average of 5,753,000 shares outstanding. That compares to net income of
$2,965,000, or $0.52 per share on basic basis and $0.51 per share on a diluted
basis, based on a weighted average of 5,753,000 and 5,784,000 shares
outstanding, respectively, for the quarter ended September 30, 1999. Net
interest income for the quarter ended September 30, 2000 was $1,980,000
consisting of interest income on mortgage assets and cash balances less interest
expense on reverse repurchase agreements. Net interest income for the quarter
ended September 30, 1999 was $2,893,000. The Company reported dividend income of
$185,000 from dividends on equity investments for the quarter ended September
30, 2000. The Company reported dividend income of $503,000 from dividends on
equity investments for the quarter ended September 30, 1999. The Company
reported a net loss on investment transactions of $29,912,000 for the quarter
ended September 30, 2000. The loss consisted of an impairment charge on certain
fixed-rate mortgage securities that may be sold prior to maturity of
$21,652,000, the recognition of the associated unrealized loss and deferred
hedging losses on the impaired assets of $8,475,000 and a gain of $165,000 on
the sale of equity securities. The Company realized gains on investment
transactions, net of $437,000 primarily from the sale of equity securities for
the quarter ended September 30, 1999. The Company incurred operating expenses of
$680,000 for the quarter ended September 30, 2000 consisting of management fees,
professional fees, legal, printing, insurance and other expenses. Included in
professional fees and other expenses was approximately $350,000 of professional
service fees incurred in connection with an analysis of the Company's portfolio
restructuring. The Company incurred operating expenses of $868,000 for the
quarter ended September 30, 1999.
- 23 -
<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
(dollars in thousands):
AVERAGE BALANCE AND RATE TABLE
(Dollars in thousands)
<TABLE>
<CAPTION>
For the Quarter Ended For the Quarter Ended
September 30, 2000 September 30, 1999
Average Effective Average Effective
Balance Rate Balance Rate
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Mortgage Securities $570,523 6.52% $754,167 6.77%
Other Fixed Income Assets 6,881 14.94% 6,458 17.62%
Cash and Cash Equivalents 1,510 5.56% 7,128 4.43%
------------ ------------ ------------ -----------
Total Interest Earning Assets 578,914 6.62% 767,753 6.84%
------------ ------------ ------------ -----------
Interest Bearing Liabilities:
Reverse Repurchase Agreements 522,145 5.82% 715,263 5.72%
------------ ------------ ------------ -----------
Net Interest Earning Assets and Spread $56,769 0.80% $52,490 1.12%
============ ============ ============ ===========
</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.
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
September 30, 2000 September 30, 1999
Effective Effective
Average Dividend Average Dividend
Balance Yield Balance Yield
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Equity securities $13,354 5.54% $19,618 10.26%
</TABLE>
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
For the nine months ended September 30, 2000, the Company's net loss was
$31,247,000, or $5.43 per share on both a basic and diluted basis, based on a
weighted average of 5,753,000 shares outstanding. That compares to net income of
$8,782,000 or $1.53 per share on a basic basis and $1.52 per share on a diluted
basis, based on a weighted average of 5,753,000 and 5,782,000 shares
outstanding, respectively, for the nine months ended September 30, 1999. Net
interest income for the nine months ended September 30, 2000 was $6,732,000
consisting of interest income on mortgage assets and cash balances less interest
expense on reverse repurchase agreements. Net interest income for the nine
months ended September 30, 1999 was $7,891,000. The Company reported dividend
income of $909,000 from dividends on equity investments for the nine months
ended September 30, 2000. The Company reported dividend income of $1,899,000
from dividends on equity investments for the nine months ended September 30,
1999. The Company realized a net loss of $37,444,000 on investment transactions
for the nine months ended September 30, 2000. The loss consisted of an
impairment charge on certain fixed-rate mortgage securities that may be sold
prior to maturity of $21,652,000, the recognition of the associated unrealized
loss and deferred hedging losses on the impaired assets of $8,475,000 and a net
loss of $7,367,000 on the sale of mortgage and equity securities. The Company
realized gains on investment transactions, net of $1,714,000 primarily from the
sale of mortgage and equity securities for the nine months
- 24 -
<PAGE>
ended September 30, 1999. The Company incurred operating expenses of
$1,444,000 for the nine months ended September 30, 2000 consisting of
management fees, professional fees, legal, printing, insurance and other
expenses. Included in professional fees and other expenses was approximately
$350,000 of professional service fees incurred in connection with an analysis
of the Company's portfolio restructuring. The Company incurred operating
expenses of $2,722,000 for the nine months ended September 30, 1999.
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 Nine Months Ended For the Nine Months Ended
September 30, 2000 September 30, 1999
Average Effective Average Effective
Balance Rate Balance Rate
------------ ------------ ------------ --------------
<S> <C> <C> <C> <C>
Interest Earning Assets:
Mortgage Securities $637,532 6.61% $786,934 6.67%
Other Fixed Income Assets 7,015 15.89% 5,339 14.24%
Cash and Cash Equivalents 4,129 5.91% 6,365 4.80%
------------ ------------ ------------ --------------
Total Interest Earning Assets 648,676 6.70% 798,638 6.70%
------------ ------------ ------------ --------------
Interest Bearing Liabilities:
Reverse Repurchase Agreements 589,618 5.85% 748,533 5.74%
------------ ------------ ------------ --------------
Net Interest Earning Assets and Spread $59,058 0.85% $50,105 0.96%
============ ============ ============ ==============
</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.
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 Nine Months Ended For the Nine Months Ended
September 30, 2000 September 30, 1999
Effective Effective
Average Dividend Average Dividend
Balance Yield Balance Yield
------------ ------------ ------------ --------------
<S> <C> <C> <C> <C>
Equity securities $16,438 7.37% $18,375 13.78%
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of funds as of September 30, 2000 and
December 31, 1999, consisted of reverse repurchase agreements totaling
$512,535,000 and $672,660,000, respectively. The Company expects to continue to
borrow funds in the form of reverse repurchase agreements. At September 30, 2000
and December 31, 1999, the Company had borrowing arrangements with over twenty
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.
- 25 -
<PAGE>
The Company will also rely on the cash flow from operations, primarily
monthly principal and interest payments to be received on the mortgage assets,
for liquidity.
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.
ITEM 3. 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.
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
- 26 -
<PAGE>
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.
- 27 -
<PAGE>
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.
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 $38,293 $38,213 $35,070
Change in Fair Value $80 - ($3,143)
Change as a Percent of Fair Value 0.01% - (0.57%)
Change as a Percent of Stockholders' Equity 0.17% - (6.49%)
Change on a Per Share Basis $0.01 - ($0.55)
</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 Company has established an interest rate risk management policy that
is intended to mitigate the negative impact of changing interest rates. The
Company generally intends to mitigate interest rate risk by targeting the
difference between the market weighted average duration on its mortgage
related assets funded with secured borrowings to the market weighted average
duration of such borrowings to one year or less, taking into account all
hedging transactions. The Company generally does not intend to have any
specific duration target for the portion its mortgage related assets that are
not funded by secured borrowings.
There can be no assurance that the Company will be able to limit such
duration differences and there may be periods of time when the duration
difference will be greater than one year.
- 28 -
<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 $8,793 $9,770 $10,747
Change in Fair Value (977) - 977
Change as a Percent of Fair Value (10%) - 10%
Change as a Percent of Stockholders' Equity (2.0%) - 2.0%
Change on a Per Share Basis (0.17) - 0.17
</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.
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
Not Applicable.
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<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K:
(a) EXHIBITS
The following exhibits are part of this quarterly report on Form 10-Q and are
numbered in accordance with Item 601 of Regulation S-K.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
---------- ----------------------------------------------------
<S> <C>
27 Financial Data Schedule
</TABLE>
None.
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<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
(Registrant)
Dated: November 13, 2000 /S/ PHILIP A. BARACH
-------------------------------------
Philip A. Barach
President and Chief Executive Officer
(Principal Executive Officer)
Dated: November 13, 2000 /S/ DANIEL K. OSBORNE
-------------------------------------
Daniel K. Osborne
Executive Vice President
Chief Operating Officer and
Chief Financial Officer
(Principal Accounting Officer)
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