-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WS0sTTn5hzCegEWR8tiIk1ta5Zib8tpfbimAFIPofw8Xczb8gIQKbZPFZE5uY9uM ZkWhvOV/1F9Ti9B7Npma5g== /in/edgar/work/0000912057-00-049150/0000912057-00-049150.txt : 20001114 0000912057-00-049150.hdr.sgml : 20001114 ACCESSION NUMBER: 0000912057-00-049150 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APEX MORTGAGE CAPITAL INC CENTRAL INDEX KEY: 0001045956 STANDARD INDUSTRIAL CLASSIFICATION: [6798 ] IRS NUMBER: 954650863 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13637 FILM NUMBER: 761333 BUSINESS ADDRESS: STREET 1: 865 FIGUEROA STREET STREET 2: STE 1800 CITY: LOS ANGELES STATE: CA ZIP: 90017 BUSINESS PHONE: 2132440461 10-Q 1 a2030029z10-q.txt 10-Q =============================================================================== 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 =============================================================================== APEX MORTGAGE CAPITAL, INC. FORM 10-Q INDEX
PART I. FINANCIAL INFORMATION PAGE 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
PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS APEX MORTGAGE CAPITAL, INC. BALANCE SHEETS
SEPTEMBER 30, 2000 DECEMBER 31, 1999 ---------------- ----------------- (Unaudited) ASSETS 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 ================ =================
See accompanying notes to financial statements -3- APEX MORTGAGE CAPITAL, INC. STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED SEPTEMBER 30, 2000 SEPTEMBER 30, 1999 SEPTEMBER 30, 2000 SEPTEMBER 30, 1999 ------------------ ------------------ ------------------ ------------------ 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 ============= =========== ============= ============
See accompanying notes to financial statements -4- APEX MORTGAGE CAPITAL, INC. STATEMENT OF STOCKHOLDERS' EQUITY SIX MONTHS ENDED SEPTEMBER 30, 2000 (UNAUDITED)
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 --------- ------- ----------- -------------- --------------- ------------- ----------- ------------ 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 ========= ======= =========== ============= ========== ============= =========== ===========
See accompanying notes to financial statements - 5 - APEX MORTGAGE CAPITAL, INC. STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED SEPTEMBER 30, 2000 SEPTEMBER 30, 1999 SEPTEMBER 30, 2000 SEPTEMBER 30, 1999 ------------------ ------------------ ------------------ ------------------ 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) ============= ============ ============= ============
See accompanying notes to financial statements - 6 - 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 - 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 - 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:
Adjustable Rate Fixed Rate Other Fixed (in thousands) Mortgage Mortgage Income Securities Securities Securities Total --------------------------------------------------------------- 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 ===============================================================
At December 31, 1999, fixed income securities consisted of the following:
Adjustable Rate Fixed Rate Other Fixed (in thousands) Mortgage Mortgage Income Securities Securities Securities Total --------------------------------------------------------------- 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 ===============================================================
- 9 - 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:
(in thousands) September 30, 2000 December 31, 1999 ------------------------ --------------------- 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 ======================== =====================
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 - 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):
At September 30, 2000 At December 31, 1999 Adjusted Adjusted Cost Fair Value Cost Fair Value ------------------- ------------ -------------------- --------------- 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
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 - 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 - 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 - 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:
Quarter Ended Quarter Ended September 30, 2000 September 30, 1999 ------------------------------------------- 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
Information regarding stock option activity during the nine months ended Septemeber 30, 2000 is as follows:
Weighted Average Shares Exercise Price ------------------ ------------------ Options Granted Prior to December 31, 1999 570,000 13.62 Exercised - - Expired - - ------------------ Options Outstanding at September 30, 2000 570,000 $13.62 ==================
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.
Average Unrealized Current Average Termination Gains Notional Amount (000) Fixed Rate Floating Rate Date (000) ------------------------ --------------------------- ------------------------ -------------------- ----------------- $400,129 5.869% 1Mo LIBOR 8/9/2001 $3,815
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 - 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.
Average Unrealized Current Termination Losses Average Maturity of Notional Amount (000) Date (000) Underlying Securities ------------------------ ------------------------------- -------------------------- ---------------------------- $610,000 10/14/2000 $(1,079) 3.52 Years
The following is a presentation of forward contracts closed during the quarter ended September 30, 2000:
Deferred Notional Amount Closing Gain (Loss) (000) Date (000) ---------------------------------------------------------------------------------------- 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) ============================ =============================
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 - At December 31, 1999, the Company had entered into forward contracts to sell U.S. Treasury notes with terms stated below.
Average Unrealized Current Termination Gains Average Maturity of Notional Amount (000) Date (000) Underlying Securities ------------------------ ------------------------------- -------------------------- ---------------------------- $335,000 2/12/2000 $3,909 3.36 Years
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:
For the Quarter For the Quarter Ended September 30, 2000 Ended September 30, 1999 ------------------------ ------------------------- 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) $ - ======================== =========================
- 16 - 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 - 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 - 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):
September 30, 2000 December 31, 1999 ----------------------------------------------------------- Percent of Carrying Percent of Fixed Income Securities Carrying Value Portfolio Value Portfolio - --------------------------------------------------------------------------------------------------- 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% =============== ============ ============= ===============
(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):
Security Type Par Amount Percent of Adjusted Market Current Weighted Total Par Cost Basis Price Coupon Average Amount Life (1) - --------------------------------------------------------------------------------------------------------------------------- 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 =============== ============ ============= ============= ======== ===========
- 19 - The following table shows various weighted average characteristics of the Mortgage-Backed Securities held by the Company at December 31, 1999 (dollars in thousands):
Security Type Par Amount Percent of Amortized Market Price Current Weighted Total Par Cost Basis Coupon Average Amount Life (1) - --------------------------------------------------------------------------------------------------------------------------- 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 =============== ============ ============= ============== ======== ===========
(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:
(in thousands) Shares Held Adjusted Cost Fair Value --------------------------------------------------- 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 ==================================
- 20 - At December 31, 1999, equity securities consisted of the following:
(In thousands) Shares Held Cost Fair Value -------------------------------------------------- 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 =====================================
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.
Average Unrealized Current Weighted Average Termination Gains (Losses) Notional Amount (000) Average Life Fixed Rate Floating Rate Date (000) ------------------------ ------------- -------------------- -------------------- ------------------- ------------------- $400,129 1.6 years 5.869% 1Mo LIBOR 8/9/2001 $3,815
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 - 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.
Fair value of Average Unrealized Current Average Contract contracts Termination Gains (Losses) Notional Amount (000) Price (000) Date (000) ------------------------ -------------------- ---------------------- ---------------------- ------------------------ $610,000 99.448 607,712 10/14/2000 $(1,079)
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:
Deferred Notional Amount Closing Gain (Loss) (000) Date (000) ---------------------------------------------------------------------------------------- 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) ============================ =============================
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 - 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 - 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)
For the Quarter Ended For the Quarter Ended September 30, 2000 September 30, 1999 Average Effective Average Effective Balance Rate Balance Rate ------------ ------------ ------------ ----------- 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% ============ ============ ============ ===========
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)
For the Quarter Ended For the Quarter Ended September 30, 2000 September 30, 1999 Effective Effective Average Dividend Average Dividend Balance Yield Balance Yield ------------ ------------ ------------ ----------- Equity securities $13,354 5.54% $19,618 10.26%
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 - 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)
For the Nine Months Ended For the Nine Months Ended September 30, 2000 September 30, 1999 Average Effective Average Effective Balance Rate Balance Rate ------------ ------------ ------------ -------------- 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% ============ ============ ============ ==============
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)
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 ------------ ------------ ------------ -------------- Equity securities $16,438 7.37% $18,375 13.78%
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 - 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 - 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 - 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.)
- ---------------------------------------------------------------------------------------- Fair Value for Scenario Shown Interest Interest Rates Fall Rates Rise 100 Basis 100 Basis Points Unchanged Points - --------------------------------------------------------------- ------------ ----------- 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)
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 - 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.)
- -------------------------------------------- ---------------------------------------------- Fair Value for Scenario Shown Prices Prices Decrease 10% Unchanged Increase 10% - -------------------------------------------- --------------- --------------- -------------- 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
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. - 29 - 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.
EXHIBIT NO. DESCRIPTION - ---------- ---------------------------------------------------- 27 Financial Data Schedule
None. - 30 - 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) - 31 - EX-27 2 a2030029zex-27.txt EXHIBIT 27
5 1,000 3-MOS DEC-31-2000 JUL-01-2000 SEP-30-2000 119 561,597 3,565 0 0 120 0 0 565,401 516,970 0 0 0 67 48,364 565,401 0 (20,147) 0 0 680 0 7,600 (28,427) 0 (28,427) 0 0 0 (28,427) (4.94) (4.94)
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