-----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, DNTLr9J71JFyAGzXG1nsfXagklHjhu4MCFLVpwnM/d51bftGQJSLSyQwhMeXt9kS BxDmZbhCDU4PWNjIT0HXdQ== 0001047469-99-021140.txt : 19990518 0001047469-99-021140.hdr.sgml : 19990518 ACCESSION NUMBER: 0001047469-99-021140 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APEX MORTGAGE CAPITAL INC CENTRAL INDEX KEY: 0001045956 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 954650863 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13637 FILM NUMBER: 99627470 BUSINESS ADDRESS: STREET 1: 865 FIGUEROA STREET STREET 2: STE 1800 CITY: LOS ANGELES STATE: CA ZIP: 90017 BUSINESS PHONE: 2132440461 10-Q 1 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: MARCH 31, 1999 OR TRANSITION REPORT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ---------- ---------- COMMISSION FILE NUMBER: 001-13637 APEX MORTGAGE CAPITAL, INC. (Exact name of Registrant as specified in its Charter) MARYLAND 95-4650863 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification Number) 865 SOUTH FIGUEROA STREET LOS ANGELES, CALIFORNIA 90017 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (213) 244-0440 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of the issuer's classes of common stock, as of the last practicable date. Common Stock ($0.01 par value) 5,753,000 as of May 14, 1999 - ------------------------------------------------------------------------------- APEX MORTGAGE CAPITAL, INC. FORM 10-Q INDEX
PART I. FINANCIAL INFORMATION PAGE ---- ITEM 1. FINANCIAL STATEMENTS BALANCE SHEETS AT MARCH 31, 1999 (UNAUDITED) AND DECEMBER 31, 1998 3 STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 (UNAUDITED) 4 STATEMENT OF STOCKHOLDERS' EQUITY FOR THE THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED) 5 STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 (UNAUDITED) 6 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14 ITEM 2A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 21 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 25 ITEM 2. CHANGES IN SECURITIES 25 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 25 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25 ITEM 5. OTHER INFORMATION 25 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25 SIGNATURES 26
PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS APEX MORTGAGE CAPITAL, INC. BALANCE SHEETS
MARCH 31, 1999 DECEMBER 31, 1998 ---------------------- ------------------- ASSETS (Unaudited) Cash and cash equivalents $ 3,426,000 $ 12,679,000 Fixed income securities available-for-sale, at fair value (Note 3) 821,117,000 829,712,000 Equity securities available-for-sale, at fair value (Note 4) 24,112,000 16,422,000 Accrued interest receivable 5,890,000 5,151,000 Principal payments receivable 1,463,000 937,000 Receivable for unsettled securities 8,000 - Other assets 459,000 577,000 ---------------------- ------------------- $ 856,475,000 $ 865,478,000 ---------------------- ------------------- ---------------------- ------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Reverse repurchase agreements (Note 5) $ 765,018,000 $ 767,908,000 Payable for unsettled securities 187,000 838,000 Accrued interest payable 2,160,000 6,173,000 Dividend payable 2,284,000 1,777,000 Accrued expenses and other liabilities 871,000 752,000 ---------------------- ------------------- 770,520,000 777,448,000 ---------------------- ------------------- ---------------------- ------------------- Commitments and contingencies (Note 10) Stockholders' Equity Preferred Stock, par value $0.01 per share; 50,000,000 shares authorized; no shares outstanding Common Stock, par value $0.01 per share; 100,000,000 shares authorized; 6,700,100 shares outstanding (Notes 8 and 9) 67,000 67,000 Additional paid-in-capital 93,052,000 92,978,000 Accumulated other comprehensive income 3,828,000 6,689,000 Accumulated dividend distributions in excess of net income (423,000) (1,135,000) Treasury stock, at cost (947,100 shares) (Note 7) (10,569,000) (10,569,000) ---------------------- ------------------- 85,955,000 88,030,000 ---------------------- ------------------- $ 856,475,000 $ 865,478,000 ---------------------- ------------------- ---------------------- -------------------
See accompanying notes to financial statements 3 APEX MORTGAGE CAPITAL, INC. STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, 1999 MARCH 31, 1998 ----------------------- ----------------------- INTEREST INCOME: Fixed Income securities $ 13,848,000 $ 4,726,000 Cash and cash equivalents 89,000 181,000 ----------------------- ----------------------- 13,937,000 4,907,000 INTEREST EXPENSE 11,261,000 4,011,000 ----------------------- ----------------------- NET INTEREST INCOME 2,676,000 896,000 ----------------------- ----------------------- NET GAIN ON SALE OF SECURITIES 614,000 - DIVIDEND INCOME 711,000 - GENERAL AND ADMINISTRATIVE EXPENSES: Management fee (Note 8) 157,000 173,000 Incentive Fee (Note 8) 591,000 - Audit and tax fees 11,000 11,000 Insurance expense 67,000 67,000 Directors' fees 15,000 20,000 Stock Option expense 74,000 28,000 Other 124,000 33,000 ----------------------- ----------------------- 1,039,000 332,000 ----------------------- ----------------------- NET INCOME $ 2,962,000 $ 564,000 ----------------------- ----------------------- ----------------------- ----------------------- Net Income Per Share: Basic $ 0.51 $ 0.09 ----------------------- ----------------------- ----------------------- ----------------------- Diluted $ 0.51 $ 0.09 ----------------------- ----------------------- ----------------------- ----------------------- Weighted Average Number of Shares Outstanding: Basic 5,753,000 6,603,000 ----------------------- ----------------------- ----------------------- ----------------------- Diluted 5,773,000 6,603,000 ----------------------- ----------------------- ----------------------- ----------------------- Dividends Declared Per Share $ 0.38 $ 0.25 ----------------------- ----------------------- ----------------------- -----------------------
See accompanying notes to financial statements 4 APEX MORTGAGE CAPITAL, INC. STATEMENT OF STOCKHOLDERS' EQUITY THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED)
Accumulated Acccumulated Dividend Common Stock Additional Other Distribution Treasury ------------------ Paid-in Comprehensive In Excess of Comprehensive Stock, Shares Amount Capital Income Net Income Income At Cost Total --------- -------- ----------- -------------- ------------- -------------- ------------- ------------ Balance, December 31, 1998 6,700,100 $67,000 $92,978,000 $6,689,000 ($1,135,000) ($10,569,000) $88,030,000 Repurchases of common stock - - - - - - - - Issuance of stock options to non-employees (Note 9) - - 74,000 - - - - 74,000 Net income - - - - 2,962,000 2,962,000 - 2,962,000 Other comprehensive income: Net unrealized gain (loss) on investments available- for-sale - - - (2,861,000) - (2,861,000) - (2,861,000) -------------- Comprehensive income - - - - $ 101,000 -------------- -------------- Dividends declared - - - - (2,250,000) - (2,250,000) --------- -------- ----------- -------------- ------------- ------------- ------------ Balance, March 31, 1999 6,700,100 $67,000 $93,052,000 $3,828,000 ($423,000) ($10,569,000) $85,955,000 --------- -------- ----------- -------------- ------------- ------------- ------------ --------- -------- ----------- -------------- ------------- ------------- ------------
5 APEX MORTGAGE CAPITAL, INC. STATEMENT OF CASH FLOWS (UNAUDITED)
FOR THE QUARTER FOR THE QUARTER ENDED ENDED MARCH 31, 1999 MARCH 31, 1998 Operating Activities: Net Income $ 2,962,000 $ 564,000 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 164,000 971,000 Net gain on sale of securities (614,000) - Change in assets and liabilities: Accrued interest receivable (739,000) (2,813,000) Other Assets 118,000 48,000 Accrued interest payable (4,013,000) 1,268,000 Accrued expenses and other liabilities 119,000 (937,000) ---------------------- ---------------------- Net cash used in operating activities (2,003,000) (899,000) ---------------------- ---------------------- INVESTING ACTIVITIES: Purchase of equity securities (7,005,000) - Purchase of rate caps - (80,000) Purchase of fixed income securities (92,947,000) (559,186,000) Proceeds from sales of equity securities 1,441,000 - Proceeds from sales of fixed income securities 40,406,000 - Principal payments on fixed income securities 55,465,000 55,576,000 ---------------------- ---------------------- Net cash used in investing activities (2,640,000) (503,690,000) ---------------------- ---------------------- FINANCING ACTIVITIES: Net proceeds from reverse repurchase agreements (2,890,000) 509,464,000 Dividend distributions (1,720,000) (268,000) Purchase of treasury stock - (2,535,000) ---------------------- ---------------------- Net cash used in provided by financing activities (4,610,000) 506,661,000 ---------------------- ---------------------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (9,253,000) 2,072,000 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,679,000 3,085,000 ---------------------- ---------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,426,000 $ 5,157,000 ---------------------- ---------------------- ---------------------- ---------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 15,274,000 $ 2,735,000 ---------------------- ---------------------- ---------------------- ---------------------- NONCASH INVESTING AND FINANCING ACTIVITIES: Net unrealized gain (loss) on mortgage-backed securities available-for-sale $ (2,861,000) $ 1,547,000 ---------------------- ---------------------- ---------------------- ---------------------- Securities sold, not yet settled $ 8,000 $ 0 ---------------------- ---------------------- ---------------------- ---------------------- Principal payments, not yet received $ 526,000 $ 5,609,000 ---------------------- ---------------------- ---------------------- ---------------------- Securities purchased, not yet settled $ 651,000 $ 1,544,000 ---------------------- ---------------------- ---------------------- ---------------------- Dividends declared, not yet paid $ (2,250,000) $ 1,626,000 ---------------------- ---------------------- ---------------------- ----------------------
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 related assets on December 9, 1997, upon receipt of the net proceeds from the initial public offering of the Company's common stock. The Company uses its equity capital and borrowed funds to seek to generate income based on the difference between the yield on its fixed income securities and the cost of its borrowings. The Company is structured for tax purposes as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates their fair value. FIXED INCOME SECURITIES The Company's fixed income securities consist primarily of residential mortgage securities and other fixed income securities. All fixed income securities are recorded at cost on the date the assets are purchased. Realized gains and losses on sales of the securities are determined on a specific identification basis. A majority of the Company's fixed income securities are expected to qualify as real estate assets under the REIT Provisions of the Code. Interest income on the Company's mortgage securities is accrued based on the actual coupon rate and the outstanding principal amount. Premiums and discounts are amortized into interest income over the lives of the securities using the effective yield method adjusted for the effects of estimated prepayments. Interest Income on the Company's other fixed income securities is accrued using the effective interest method applied prospectively based on current market assumptions. The Company's policy is to generally classify its fixed income securities as available-for-sale. The fixed income securities are reported at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income. EQUITY SECURITIES The Company's equity securities consist primarily of equity securities issued by other real estate investment trusts. Dividend income on equity securities is recorded on the declaration date. Realized gains and losses on sales of the securities are determined on a specific identification basis. A majority of the Company's equity securities are expected to qualify as real estate assets under the REIT Provisions of the Code. The Company's policy is to generally classify its equity securities as available-for-sale. Equity securities are reported at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income. INTEREST RATE HEDGING TRANSACTIONS The Company enters into interest rate swap and interest rate cap agreements in order to mitigate the impact of rising interest rates on the cost of its short-term borrowings. Amounts payable or receivable from such agreements are accounted for on an accrual basis and recognized as a net adjustment to interest expense. Premiums paid for cap agreements accounted for as hedges are recorded as other assets and amortized over the lives of such agreements as an adjustment to interest expense. 7 STOCK BASED COMPENSATION The Company grants stock options to its directors and officers and to certain directors, officers and employees of its investment manager and the investment manager itself, as discussed in Note 9. Options granted to directors of the Company are accounted for using the intrinsic method, and generally no compensation expense is recognized in the statement of operations for such options. Other options are accounted for using the fair value method; such options are measured at their fair value when they are granted and are recognized as a general and administrative expense during the periods when the options vest and the related services are performed. FEDERAL AND STATE INCOME TAXES The Company has elected to be taxed as a REIT and generally is not subject to federal and state taxes on its income to the extent it distributes annually 95% of its predistribution taxable income to stockholders and meets certain other asset, income and stock ownership tests. As such, no accrual for income taxes has been included in the financial statements. NET INCOME PER SHARE Basic net income per share is calculated on the basis of the weighted average number of common shares outstanding during each period. Diluted net income per share includes the additional dilutive effect of common stock equivalents and outstanding stock options and is calculated using the treasury stock method. INCOME RECOGNITION Income and expenses are recorded on the accrual basis of accounting. CREDIT RISK The Company has limited its exposure to credit losses on its portfolio of fixed income securities by purchasing securities that are either rated "AAA" by at least one nationally recognized rating agency or are issued by the Federal Home Loan Mortgage Corporation ("FHLMC"), Fannie Mae (formerly known as the Federal National Mortgage Corporation) or the Government National Mortgage Association ("GNMA"). The payment of principal and interest on the FHLMC, Fannie Mae and GNMA securities are guaranteed by those respective agencies. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. COMPREHENSIVE INCOME The Company has adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME. This statement establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as "the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners." RECENTLY ISSUED ACCOUNTING STANDARDS In the first quarter of 1999, the Company wrote off $64,000 of unamortized organizational costs in accordance with the adoption of S.O.P. 98-5, "Reporting on the Cost of Start-Up Activities." In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The Statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for fiscal years 8 beginning after June 15, 1999. A company may also implement the Statement as of the beginning of any fiscal quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and thereafter). Statement 133 cannot be applied retroactively. Statement 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired, or substantively modified after December 31, 1998 (and, at the Company's election, before January 1, 1998). The Company will adopt the reporting requirements of SFAS No. 133 by the first quarter of 2000. An earlier adoption may be made if circumstances warrant. The Company expects the impact of the adoption of the reporting requirements of SFAS No. 133 to include the recording of the approximate fair value of the Company's interest rate swaps as comprehensive income. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. NOTE 3 - FIXED INCOME SECURITIES AND EQUITY SECURITIES At March 31, 1999, fixed income securities consisted of the following:
Adjustable Rate Fixed Rate Other Fixed (in thousands) Mortgage Securities Mortgage Securities Income Securities Total --------------------- -------------------- ------------------ ------------------ Principal Amount $42,131 $772,907 $5,400 $820,438 Unamortized Premium (Discount) 515 1,846 (1,535) 826 --------------------- -------------------- ------------------ ------------------ Amortized Cost 42,646 774,753 3,865 821,264 Unrealized Gains 181 1,723 0 1,904 Unrealized Losses (53) (1,547) (451) (2,051) --------------------- -------------------- ------------------ ------------------ Fair Value $42,774 $774,929 3,414 $821,117 --------------------- -------------------- ------------------ ------------------ --------------------- -------------------- ------------------ ------------------
At December 31, 1998, fixed income securities consisted of the following:
Adjustable Rate Fixed Rate Other Fixed (in thousands) Mortgage Securities Mortgage Securities Income Securities Total --------------------- -------------------- ------------------ ---------------- Principal Amount $61,590 $758,110 $5,400 $825,100 Unamortized Premium (Discount) 772 800 (1,380) 192 --------------------- -------------------- ------------------ ---------------- Amortized Cost 62,362 758,910 4,020 825,292 Unrealized Gains 86 4,762 0 4,848 Unrealized Losses (110) (15) (303) (428) --------------------- -------------------- ------------------ ---------------- Fair Value $62,338 $763,657 3,717 $829,712 --------------------- -------------------- ------------------ ---------------- --------------------- -------------------- ------------------ ----------------
The contractual final maturity of the mortgage loans supporting the mortgage securities is generally between 15 and 30 years at origination. Because of prepayments on the underlying mortgage loans, the actual weighted-average maturity is expected to be less. The other fixed income securities generally have an original maturity of five years subject to certain acceleration provisions. The expected average remaining maturity at March 31, 1999 and December 31, 1998 were approximately 3.8 and 4.0 years, respectively. The adjustable rate mortgage securities are typically subject to periodic and lifetime caps that limit the amount an adjustable rate mortgage security's interest rate can change during any given period and over the life of the asset. At March 31, 1999 and December 31, 1998, the average periodic cap on the adjustable rate mortgage was 2.0% per annum and the average lifetime cap was equal to 11.3%. 9 During the quarter ended March 31, 1999 the Company realized $194,000 in gains on the sale of $40,406,000 of mortgage securities which were classified as available-for-sale. During the quarter ended March 31, 1998, there were no sales of mortgage securities. At March 31, 1999 and December 31, 1998, equity securities consisted of the following:
(in thousands) March 31, 1999 December 31, 1998 -------------------- ---------------------- Cost Basis $20,137 $14,154 Unrealized Gains 4,777 2,268 Unrealized Losses (802) (0) -------------------- ---------------------- Fair Value $24,112 $16,422 -------------------- ---------------------- -------------------- ----------------------
During the quarter ended March 31, 1999, the Company realized $420,000 in gains on the sale of $1,441,000 of equity securities that were classified as available-for-sale. There were no equity securities sold in the first quarter ended March 31, 1998. NOTE 4 - INTEREST RATE CAP AGREEMENTS Interest rate cap agreements include the carrying value of purchased interest rate caps, entered into by the Company in order to mitigate the impact of rising interest rates on the cost of its short-term borrowings. As discussed in Note 10, the Company has entered into certain interest rate swap transactions. The execution of these swaps eliminated the need for the cap protection previously purchased. Accordingly, the interest rate cap agreements no longer qualify for hedge accounting and were written down to zero during the year ended December 31, 1998 which approximates their fair value. The terms of outstanding interest rate cap agreements are as follows:
At March 31, 1999 At December 31, 1998 --------------------------- -------------------------- Notional Amount $900,000,000 $900,000,000 Average Contract Rate 10.4% 10.4% Average Final Maturity January 24, 2002 January 24, 2002
Under these agreements, the Company will receive cash payments to the extent of the excess of three month London Interbank Offered Rate ("LIBOR") over the agreements' contract rate times the notional amount. NOTE 5 - REVERSE REPURCHASE AGREEMENTS The Company has entered into reverse repurchase agreements to finance certain of its fixed income securities. These agreements are secured by a portion of the Company's fixed income securities and bear interest rates that have historically moved in close relationship to LIBOR. At March 31, 1999, the Company had outstanding $765,018,000 of reverse repurchase agreements with a weighted average current borrowing rate of 4.96% and a maturity of 1.7 months. The reverse repurchase agreements were collateralized by fixed income securities with an estimated fair value of $796,251,000. At December 31, 1998, the Company had outstanding $767,908,000 of reverse repurchase agreements with a weighted average current borrowing rate of 5.34% and a maturity of 2.9 months. The reverse repurchase agreements were collateralized by fixed income securities with an estimated fair value of $800,260,000. For the quarter ended March 31, 1999, the average reverse repurchase agreement balance was $786,472,000 with a weighted average interest cost of 5.09%. The maximum reverse repurchase agreement balance outstanding during the quarter ended March 31, 1999 was $812,019,000. 10 For the quarter ended March 31, 1998, the average reverse repurchase agreement balance was $287,088,000 with a weighted average interest cost of 5.59%. The maximum reverse repurchase agreement balance outstanding during the quarter ended March 31, 1998 was $597,282,000. NOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the amortized cost and estimated fair values of the Company's financial instruments. SFAS No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale (dollars in thousands):
At March 31, 1999 At December 31, 1998 Amortized Amortized Cost Fair Value Cost Fair Value ------------------- ------------ -------------------- --------------- Mortgage related securities $817,399 $817,703 $821,272 $825,995 Equity securities 20,137 24,112 14,154 16,422 Other fixed income securities 3,865 3,414 4,020 3,717 Interest rate swaps - (5,633) - (9,994)
The Company bases its fair value estimates for fixed income securities, equity securities and interest rate swaps primarily on third party price indications provided by dealers who make markets in these financial instruments when such indications are available. However, the fair value reported reflects estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange. Cash and cash equivalents, interest receivable and reverse repurchase agreements are reflected in the financial statements at their costs, which approximates their fair value because of the short-term nature of these instruments. NOTE 7 - STOCK REPURCHASE PROGRAM The Company's Board of Directors has authorized a program to repurchase shares of the Company's common stock. At March 31, 1999 and December 31, 1998, the Company was authorized to repurchase 552,900 shares of the Company's common stock pursuant to the repurchase program. At March 31, 1999 and December 31, 1998, the Company held 947,100 shares of treasury stock. During the quarter ended March 31, 1999, the Company did not repurchase any treasury shares, however, for the quarter ended March 31, 1998, the Company repurchased 197,700 shares which are held at cost in the financial statements herein. NOTE 8 - TRANSACTIONS WITH AFFILIATES The Company has entered into a Management Agreement (the "Management Agreement") with TCW Investment Management Company (the "Manager"), a wholly owned subsidiary of The TCW Group, Inc., under which the Manager will manage its day-to-day operations, subject to the direction and oversight of the Company's Board of Directors. The Company will pay the Manager annual base management compensation, payable monthly in arrears, equal to 3/4 of 1% of the average net invested capital as further defined in the Management Agreement. The Company paid the Manager $157,000 and $173,000 in base management compensation during the quarter ended March 31, 1999 and March 31, 1998, respectively. The Company also pays the Manager, as incentive compensation, an amount equal to 30% of the Net Income of the Company, before incentive compensation, in excess of the amount that would produce an annualized return on equity equal to the ten-year US Treasury rate plus 1% as further defined in the Management Agreement. 11 The Company accrued $591,000 for incentive compensation to the Manager for the quarter ended March 31, 1999. The Company did not accrue any incentive compensation to the Manager for the quarter ended March 31, 1998. The Company may also grant stock options to directors, officers and key employees of the Company, the Manager, its directors, officers and key employees. The Company's other fixed income securities include securities that are issued by special purpose companies that invest primarily in mortgage-related assets. An affiliate of the Manager serves as the investment manager to these companies and is paid fees in connection with such services. The Company does not anticipate paying any management fees directly to any affiliate of the Manager in connection with these investments. NOTE 9 - STOCK OPTIONS The Company has adopted a stock option plan (the "Amended and Restated 1997 Stock Option Plan") that provides for the grant of both qualified incentive stock options that meet the requirements of Section 422 of the Code, and non-qualified stock options, stock appreciation rights and dividend equivalent rights. Stock options may be granted to directors, officers and key employees of the Company, the Manager, its directors, officers and key employees. The exercise price for any stock option granted under the Amended and Restated 1997 Stock Option Plan may not be less than 100% of the fair market value of the shares of common stock at the time the option is granted. Each option must terminate no more than ten years from the date it is granted. Subject to anti-dilution provisions for stock splits, stock dividends and similar events, the Amended and Restated 1997 Stock Option Plan authorizes the grant of options to purchase an aggregate 1,000,000 shares of common stock. The Company recognized compensation expenses of $74,000 and $28,000 during the quarter ended March 31, 1999 and March 31, 1998, respectively. If the Company had recorded stock option grants to Company directors at fair value and related compensation expense, the pro forma effect on the Company's net income and earnings per share would have been as follows:
Quarter Ended Quarter Ended March 31, 1999 March 31, 1998 ------------------------ ------------------------ Net income - as reported $2,962,000 $564,000 Net income - pro forma 2,837,000 533,000 Basic and diluted earnings per share - as reported $0.51 $0.09 Basic and diluted earnings per share - pro forma $0.49 $0.08
Information regarding stock option activity during the quarter ended March 31, 1999 is as follows:
Weighted Average Shares Exercise Price ------------------ ------------------ Options Granted Prior to December 31, 1998 570,000 $13.62 Exercised - - Expired - - ------------------ ------------------ Options Outstanding at March 31, 1999 570,000 $13.62 ------------------ ------------------ ------------------ ------------------
NOTE 10 - CONTRACTUAL COMMITMENTS At March 31, 1999 the Company had entered into interest rate swap agreements with the total current notional amount as stated below. Under these agreements, the Company receives a floating rate and pays a fixed rate. (Amounts are in thousands) 12
Average Current Average Termination Unrealized Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses) ------------------------ ----------------------- ------------------ ----------------- ---------------- ----------------- 690,995 Interest Rate Swap 5.850% 1Mo LIBOR 2/16/01 $(5,633)
At December 31, 1998 the Company entered into interest rate swap agreement as follows: (Amounts are in thousands)
Average Current Average Termination Unrealized Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses) ------------------------ ----------------------- ------------------ ----------------- ---------------- ----------------- 703,590 Interest Rate Swap 5.850% 1Mo LIBOR 2/16//01 $(9,994)
The Company paid $1,262,000 to the swap counter-parties during the quarter ended March 31, 1999 which is included in interest expense on the statement of operations. There were no such payments made during the quarter ended March 31, 1998. The Company is generally required to deposit collateral with the swap agreement counter-parties in an amount at least equal to the amount of any unrealized losses. At March 31, 1999 and December 31, 1998, the Company had securities with a fair market value of $10,424,000 and $17,327,000, respectively, on deposit with its counter-parties. If unrealized losses on the interest rate swap agreements were to increase, the Company would be required to deposit additional collateral. 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAFE HARBOR/FORWARD LOOKING STATEMENTS Certain information contained in this Quarterly Report on Form 10-Q constitutes "forward-looking statements" which can be identified by the use of forward-looking terminology such as "may," "will," "should," "expect," "anticipate," "estimate," "intend," "continue," or "believes" or the negatives thereof or other variations thereon or comparable terminology. Discussed below are some important factors that would cause actual results to differ materially from those in any forward-looking statements, including changes in interest rates; domestic and foreign business, market, financial or legal conditions; differences in the actual allocation of the assets of the company from those assumed; and the degree to which assets are hedged and the effectiveness of the hedge, among others. In addition, the degree of risk is increased by the company's leveraging of its assets. For additional discussion of factors that could cause actual results to differ from those contained in such forward-looking statements, see "Principal Risks and Special Considerations", "Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations" and "Item 7A Quantitative and Qualitative Disclosures About Market Risk" in the Company's annual report on Form 10-K for the year ended December 31, 1998. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. GENERAL Apex Mortgage Capital, Inc. (the "Company"), a Maryland corporation, was formed on September 15, 1997, primarily to acquire United States agency securities and other highly rated, single-family real estate adjustable and fixed rate mortgage related assets. The Company commenced operations on December 9, 1997, upon receipt of the net proceeds from the initial public offering of the Company's common stock. The Company's principal executive offices are located at 865 South Figueroa Street, Suite 1800, Los Angeles, California 90017, and its telephone number is (213) 244-0440. The Company uses its equity capital and borrowed funds to seek to generate income based on the difference between the yield on its mortgage related assets and the cost of its borrowings. The Company has elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). The Company should not generally be subject to federal taxes on its income to the extent that it distributes its net income to its stockholders and maintains its qualification as a REIT. The goal of the Company is to be an efficient investor in mortgage assets. The Company generally acquires mortgage assets primarily in the secondary mortgage market through the operational experience and market relationships of TCW Investment Management Company (the "Manager") and its affiliates. The day-to-day operations of the Company are managed by an external management company, TCW Investment Management Company (the "Manager"), subject to the direction and oversight of the Company's Board of Directors. A majority of the Board of Directors are unaffiliated with The TCW Group, Inc. ("TCW" and together with its subsidiaries and affiliates, the "TCW Group") or the Manager. The Manager is a wholly-owned subsidiary of TCW. The Manager was established in 1992 and the TCW Group began operations in 1971 through one of its affiliates. The Company's investment management team consists of selected members of TCW's mortgage-backed securities group, all of whom have over eleven years of experience in raising and managing mortgage capital. The Company has elected to be externally managed by the Manager to take advantage of the existing operational systems, expertise and economies of scale associated with the Manager's current business operations, among other reasons. The Manager's key officers have experience in raising and managing mortgage capital, mortgage finance and the purchase and administration of mortgage related assets. 14 STRATEGY To achieve its business objective and generate dividend yields that provide a competitive rate of return for its stockholders, the Company's strategy is to: - purchase primarily single-family adjustable and fixed rate mortgage related assets; - manage the credit risk of its mortgage related assets through, among other activities (i) carefully selecting mortgage related assets to be acquired, (ii) complying with the Company's investment policy, (iii) actively monitoring the ongoing credit quality and servicing of its mortgage related assets, and (iv) maintaining appropriate capital levels and allowances for possible credit losses; - finance purchases of mortgage related assets with the net proceeds of equity offerings and, to the extent permitted by the Company's leverage policy, to utilize leverage to increase potential returns to stockholders through borrowings (primarily reverse repurchase agreements) with interest rates that will also reflect changes in short-term market interest rates; - seek to structure its borrowings in accordance with its interest rate risk management policy; - utilize interest rate caps, swaps and similar financial instruments to mitigate interest rate risks; and - seek to minimize prepayment risk primarily by structuring a diversified portfolio with a variety of prepayment characteristics. There can be no assurance that the Company will be able to generate competitive earnings and dividends while holding primarily high quality mortgage related assets and maintaining a disciplined risk-control profile. The Company may attempt to increase the return to stockholders over time by: (i) raising additional capital in order to increase its ability to invest in additional mortgage related assets; (ii) lowering its effective borrowing costs through direct funding with collateralized lenders, in addition to using Wall Street intermediaries, and investigating the possibility of using collateralized commercial paper and medium-term note programs; and (iii) improving the efficiency of its balance sheet structure by issuing uncollateralized subordinated debt and other forms of capital. 15 FINANCIAL CONDITION FIXED INCOME SECURITIES At March 31, 1999, the Company held $821,117,000 of Fixed Income Securities as compared to $827,712,000 at December 31, 1998. The following table is a schedule of Fixed Income Securities held listed by security type (dollars in thousands):
March 31, 1999 December 31, 1998 ----------------------------------- ---------------------------------- Carrying Percent of Carrying Percent of Fixed Income Securities Value Portfolio Value Portfolio ---------------------------------- ------------------ ---------------- ---------------- ----------------- Mortgage Securities: Adjustable Rate (1) $42,646 5.2% $62,362 7.6% Fixed Rate 774,753 94.3% 758,910 91.0% Other Fixed Income Securities 3,865 0.5% 4,020 1.4% ---------- -------- ---------- -------- Totals $821,264 100.0% $825,292 100.0% ---------- -------- ---------- -------- ---------- -------- ---------- --------
(1) At March 31, 1999 and December 31, 1998, the interest rate indices for 95% and 5% of the adjustable rate mortgage securities were based on the one-year U.S. Treasury rate and the six-month London Inter-Bank Offered Rate, respectively. The following table shows various weighted average characteristics of the Fixed Income Securities held by the Company at March 31, 1999 (dollars in thousands):
Percent of Weighted Total Par Amortized Market Current Average Security Type Par Amount Amount Cost Basis Price Coupon Life (1) - ------------------------------------------ --------------- ------------ -------------- ----------- ----------- ------------- 15 Year Agency/AAA Pass-throughs $221,295 27.0% 100.41% 100.76% 6.50% 4.1 20 Year Agency Pass-throughs 247,997 30.2% 100.55% 100.20% 6.50% 6.3 30 Year Agency Pass-throughs 19,680 2.4% 102.15% 101.80% 7.20% 3.2 AAA CMOs 283,935 34.6% 99.70% 99.83% 6.84% 2.7 ---------- ------- --------- --------- ------- ----- Total Fixed Rate Holdings $772,907 94.2% 100.24% 100.27% 6.63% 4.3 Other Fixed Income Securities 5,400 0.7% 74.96% 70.18% 21.83% 3.8 Adjustable Rate Holdings 42,132 5.1% 101.22% 101.53% 6.51% 1.0 ---------- ------- --------- --------- ------- ----- Total Portfolio $820,439 100.0% 100.18% 100.19% 6.70% 4.1 ---------- ------- --------- --------- ------- ----- ---------- ------- --------- --------- ------- -----
16 The following table shows various weighted average characteristics of the mortgage securities held by the Company at December 31, 1998 (dollars in thousands):
Percent of Weighted Total Par Amortized Market Current Average Security Type Par Amount Amount Cost Basis Price Coupon Life (1) - ------------------------------------------ --------------- ------------ -------------- ----------- ----------- ------------- 15 Year Agency/AAA Pass-throughs $253,581 33.4% 100.42% 101.23% 6.50% 3.7 20 Year Agency Pass-throughs 209,566 27.6% 100.45% 101.06% 6.50% 6.1 30 Year Agency Pass-throughs 8,076 1.1% 102.19% 101.99% 7.50% 3.2 AAA CMOs 286,887 37.8% 99.52% 100.01% 6.82% 2.7 ---------- ------- --------- --------- ------- ----- Total Fixed Rate Holdings $758,110 91.9% 100.11% 100.73% 6.63% 3.9 Other Fixed Income Securities 5,400 0.7% 74.43% 72.24% 21.83% 4.0 Adjustable Rate Holdings 61,590 7.5% 101.25% 101.21% 6.79% 1.0 ---------- ------- --------- --------- ------- ----- Total Portfolio $825,100 100.0% 100.02% 100.58% 6.74% 3.7 ---------- ------- --------- --------- ------- ----- ---------- ------- --------- --------- ------- -----
(1) The weighted average life of the fixed rate mortgage securities is based upon market prepayment expectations as of the dates shown. The actual weighted average life could be longer or shorter depending on the actual prepayment rates experienced over the life of the securities. The weighted average life shown for the adjustable rate mortgage assets represents the average time until the next coupon reset date. All averages are shown in years. EQUITY SECURITIES At March 31, 1999, the Company held $24,112,000 of equity securities compared to $16,422,000 at December 31, 1998. Equity securities consist primarily of investment in equities issued by other real estate investment trusts. The Company's investments in other real estate investment trusts consist of publicly traded preferred and common stock securities issued by companies involved in the mortgage finance industry. The Company generally expects to receive dividend income on the majority of these investments. INTEREST RATE CAP AGREEMENTS The Company utilizes interest rate caps, swaps and similar financial instruments to mitigate the risk of the cost of its variable-rate liabilities exceeding the earnings on its mortgage assets during a period of rising interest rates. The Company is currently utilizing both interest rate cap and interest rate swap agreements. Interest rate cap agreements consisted of LIBOR based agreements as follows:
At March 31, 1999 At December 31, 1998 --------------------------- -------------------------- Notional Amount $900,000,000 $900,000,000 Average Contract Rate 10.4% 10.4% Average Final Maturity January 24, 2002 January 24, 2002
17 Under these agreements, the Company will receive cash payments to the extent of the excess of three-month LIBOR over the agreements' contract rate times the notional amount. The interest rate cap agreements no longer qualify for hedge accounting now that the Company has entered into additional hedging transactions as discussed below. Accordingly, the Company now records the cap agreements at fair market value, which is zero in the current market environment. At March 31, 1999, the Company had entered into interest rate swap agreements with the total current notional amount as stated below. Under these agreements, the Company receives a floating rate and pays a fixed rate.
Average Current Average Termination Unrealized Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses) ------------------------ ----------------------- ------------------ ----------------- ---------------- ----------------- 690,995 Interest Rate Swap 5.850% 1Mo LIBOR 2/16/01 $(5,633)
The weighted average life of the agreements at March 31, 1999 was 1.7 years. At December 31, 1998, the Company had entered into interest rate swap agreements with the total current notional amount as stated below.
Average Current Average Termination Unrealized Notional Amount (000) Type Fixed Rate Floating Rate Date Gains (Losses) ------------------------ ----------------------- ------------------ ----------------- ---------------- ----------------- 703,590 Interest Rate Swap 5.850% 1Mo LIBOR 2/16//01 $(9,994)
The weighted average life of the agreements at December 31, 1998 was 1.9 years. The Company is generally required to deposit collateral with the swap agreement counter-parties in an amount at least equal to the amount of any unrealized losses. At March 31, 1999 the Company had securities with a fair market value of $10,424,000 on deposit with its counter-parties. If the unrealized losses on the interest rate swap agreements were to increase, the Company would be required to deposit additional collateral. There can be no assurance that the Company will enter into hedging activities or that, if entered into, such activities will have the desired beneficial impact on the Company's results of operations or financial condition. Moreover, no hedging activity can completely insulate the Company from the risks associated with changes in interest rates and prepayment rates. Hedging involves risk and typically involves costs, including transaction costs. Such costs increase dramatically as the period covered by the hedging increases and during periods of rising and volatile interest rates. The Company may increase its hedging activity and, thus, increase its hedging costs during such periods when interest rates are volatile or rising and hedging costs have increased. The Company intends generally to hedge as much of the interest rate risk as the Manager determines is in the best interest of the shareholders of the Company given the cost of such hedging transactions and the Company's desire to maintain its status as a REIT. The Company's policies do not contain specific requirements as to the percentages or amount of interest rate risk which the Manager is required to hedge. LIABILITIES The Company has entered into reverse repurchase agreements to finance certain of its mortgage-backed securities. These agreements are secured by a portion of the Company's mortgage-backed securities and bear interest rates that have historically moved in close relationship to LIBOR. At March 31, 1999, the Company had outstanding $765,018,000 of reverse repurchase agreements with a weighted average current borrowing rate of 4.96% and a maturity of 1.7 months. The reverse repurchase agreements were collateralized by mortgage-backed securities with an estimated fair value of $796,251,000. 18 At December 31, 1998, the Company had outstanding $767,908,000 of reverse repurchase agreements with a weighted average current borrowing rate of 5.34% and a maturity of 2.9 months. The reverse repurchase agreements were collateralized by mortgage-backed securities with an estimated fair value of $800,260,000. The Company had $5,502,000 and $9,540,000 of other liabilities at March 31, 1999 and December 31, 1998, respectively, consisting primarily of accrued interest payable and payables for unsettled securities at March 31, 1999 and December 31, 1998, respectively. The Company anticipates settling all other liabilities within one year by entering into additional reverse repurchase agreements. RESULTS OF OPERATIONS FOR THE QUARTER ENDED MARCH 31, 1999 For the quarter ended March 31, 1999, the Company's net income was $2,962,000, or $0.51 per share on both a basic and diluted basis, based on a weighted average of 5,753,000 and 5,773,000 shares outstanding, respectively. That compares to $564,000, or $0.09 per share on both a basic and diluted basis, based on a weighted average of 6,603,000 shares outstanding for the quarter ending March 31, 1998. Net interest income for the first quarter 1999 was $2,676,000 consisting of interest income on mortgage assets and cash balances less interest expense on reverse repurchase agreements compared to $896,000 for the first quarter in 1998. The Company reported dividend income of $711,000 from dividends on equity investments at March 31, 1999. No dividend interest was reported for the quarter ending March 31, 1998. The Company reported gains on investment transactions, net of $614,000 primarily from the sale of mortgage securities and equity securities during the quarter ending March 31, 1999. There were no sales reported for the quarter ending March 31, 1998. The Company incurred operating expenses of $1,039,000 for the quarter ending March 31, 1999 consisting of management fees, audit, tax, legal, printing, insurance and other expenses compared to $332,000 for the quarter ending March 31, 1998. The following table reflects the average balances for each category of the Company's interest earning assets as well as the Company's interest bearing liabilities, with the corresponding effective rate of interest annualized (dollars in thousands): AVERAGE BALANCE AND RATE TABLE (Dollars in thousands)
For the Quarter Ended For the Quarter Ended March 31, 1999 March 31, 1998 Average Effective Average Effective Balance Rate Balance Rate ------------ ------------ ------------ ----------- Interest Earning Assets: Mortgage Securities $826,343 6.64% $351,633 5.38% Other Fixed Income Assets 4,203 13.48% 0 0% Cash and Cash Equivalents 6,687 5.32% 13,767 5.26% ------------ ------------ ------------ ----------- Total Interest Earning Assets 837,233 6.66% 365,400 5.37% ------------ ------------ ------------ ----------- Interest Bearing Liabilities: Reverse Repurchase Agreements 786,472 5.73% 287,087 5.59% ------------ ------------ ------------ ----------- Net Interest Earning Assets and Spread $50,761 0.93% $78,313 (0.22%) ------------ ------------ ------------ ----------- ------------ ------------ ------------ -----------
The effective yield data is computed by dividing the annualized net interest income or expense including hedging transactions into the average daily balance shown. 19 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 March 31, 1999 March 31, 1998 Average Effective Average Effective Balance Rate Balance Rate ------------ ------------ ------------ ----------- Equity securities $16,416 17.32% - -
LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds as of March 31, 1999 and December 31, 1998, consisted of reverse repurchase agreements totaling $765,018,000 and $767,908,000, respectively. The Company expects to continue to borrow funds in the form of reverse repurchase agreements. At March 31, 1999 and December 31, 1998, the Company had borrowing arrangements with twenty-three different investment banking firms. Increases in short-term interest rates could negatively impact the valuation of the Company's mortgage assets which could limit the Company's borrowing ability or cause its lenders to initiate margin calls. The Company will also rely on the cash flow from operations, primarily monthly principal and interest payments to be received on the mortgage assets, for liquidity. The Company believes that equity capital, combined with the cash flow from operations and the utilization of borrowings, will be sufficient to enable the Company to meet anticipated liquidity requirements. If the Company's cash resources are at any time insufficient to satisfy the Company's liquidity requirements, the Company may be required to liquidate mortgage assets or sell debt or additional equity securities. If required, the sale of mortgage assets at prices lower than the carrying value of such assets would result in losses. The Company may in the future increase its capital resources by making additional offerings of equity and debt securities, including classes of preferred stock, common stock, commercial paper, medium-term notes, CMOs and senior or subordinated notes. All debt securities, other borrowings, and classes of preferred stock will be senior to the Common Stock in a liquidation of the Company. The effect of additional equity offerings may be the dilution of stockholders' equity of the Company or the reduction of the price of shares of the Common Stock, or both. The Company is unable to estimate the amount, timing or nature of additional offerings as they will depend upon market conditions and other factors. INFLATION Virtually all of the Company's assets and liabilities are financial in nature. As a result, interest rates and other factors drive the Company's performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. The Company's financial statements are prepared in accordance with generally accepted accounting principles and the Company's dividends are determined by the Company's net income as calculated for tax purposes; in each case, the Company's activities and balance sheet are measured with reference to historical cost and or fair market value without considering inflation. YEAR 2000 MATTERS The year 2000 issue is the result of computer programs using two digits rather than four to define the applicable year. Any computer system that the Company relies on with time sensitive software may recognize a date entered as "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruption of operations, including, among other things, a temporary inability to process transactions or engage in normal business 20 activities. The Company believes that most of its exposure to Year 2000 issues involves the readiness of external third parties such as, but not limited to, loan servicers, security master servicers, security paying agents and trustees, its stock transfer agent, its securities custodian, the counterparties on its various financing agreements and hedging contracts and vendors ("External Service Providers"). The Company relies on the Manager for its computer services and the Manager has been addressing this issue at no cost to the Company. Specifically, the Manager's internally developed computer systems have been implemented within the past five years. These systems have been developed with software tools that utilize a century date format (ccyymmdd). Although it has been a standard procedure to use this format for all date fields, the Manager is nonetheless in the process of unit testing its internally developed applications for numerous date conditions, including: the first and last day of the year 2000, the leap year day and the day after, the first day of the year 2001, functions with date ranges from 1999 which cross over into year 2000, functions which have both "from date" and "to date" in the year 2000, date arithmetic and validation using standard routines through the year 2199. The Manager has been, and is currently in contact with, each of its External Service Providers to evaluate their readiness for the year 2000. The Manager has requested each of its External Service Providers to either (i) prepare a description of its process for identifying date sensitive areas, its approach for implementing changes, its testing methodology, along with its timetable for completion, or (ii) certify as to its year 2000 compliance. Due to the technical architecture of the Manager's internally developed applications, its emphasis on using major providers and its ongoing communication with those providers, the Manager anticipates it will be well positioned to begin the year 2000. There can be no assurance, however, that the Company's External Service Providers will resolve their own Year 2000 issues in a timely manner, or that any failure by these External Service Providers to resolve such issues would not have an adverse effect on the Company's operations and financial condition. Each External Service Provider is in turn subject to the Year 2000 issues of various third parties with which it does business, making the Company's exposure to the noncompliance of any External Service Provider difficult to assess. In a worst case scenario, a significant portion of the Company's External Service Providers and contractual counter-parties could fail to fulfill their respective obligations which would significantly impair the Company's ability to meet its obligations under its financing and hedging agreements. This would in turn cause the Company to liquidate assets at potentially substantial losses and possibly render the Company insolvent. The Company believes it is devoting the necessary resources to address the Year 2000 issues over which it has control. The Company anticipates, although there can be no assurance, completing all necessary procedures for Year 2000 compliance by June 30, 1999. With respect to the Year 2000 issues of External Service Providers, over which the Company has no control, the Company's contingency plan is to identify replacement vendors, where possible. ITEM 2A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The Company's two primary components of market risk are interest rate risk and equity price risk as discussed below. INTEREST RATE RISK EFFECT ON NET INCOME. The Company invests in fixed-rate mortgage assets that are expected to be funded with short-term borrowings. During periods of rising interest rates, the borrowing costs associated with funding such fixed-rate assets are subject to increase while the income earned on such assets may remain substantially unchanged. This would result in a narrowing of the net interest spread between the related assets and borrowings and may even result in losses. The Company may enter into derivative transactions seeking to mitigate the negative impact of a rising interest rate environment. Hedging techniques will be based, in part, on assumed levels of prepayments of the Company's mortgage assets. If prepayments are slower or faster than assumed, the life of the mortgage assets will be longer or shorter which would reduce the effectiveness of the Company's hedging techniques and may result in losses on such transactions. Hedging techniques involving the use of derivative securities are highly complex and may produce volatile returns. The hedging activity of the Company will also be limited by the asset and sources of income requirements applicable to the Company as a REIT. Two primary risks the Company faces are that of extension risk and prepayment risk. 21 EXTENSION RISK. Fixed-rate assets are generally acquired with a projected weighted average life based on certain assumptions regarding prepayments. In general, when a fixed-rate mortgage asset is acquired with borrowings, the Company will enter into an interest rate swap agreement or other hedging instrument that effectively fixes the Company's borrowing costs for a period close to the anticipated average life of the related asset. This strategy is designed to protect the Company from rising interest rates because the borrowing costs are fixed for the duration of the asset. However, if prepayment rates decrease in a rising interest rate environment, the life of the mortgage asset could extend beyond the term of the swap agreement or other hedging instrument. This situation could negatively impact the Company as borrowing costs would no longer be fixed after the end of the hedging instrument while the income earned on the asset would remain fixed. This situation may also cause the market value of the Company's mortgage assets to decline with little or no offsetting gain from the related hedging transactions. In certain situations, the Company may be forced to sell assets and incur losses to maintain adequate liquidity. PREPAYMENT RISK. Fixed-rate assets in combination with hedging instruments are also subject to prepayment risk. In falling interest rate scenarios, the fixed-rate mortgage assets may prepay faster such that the average life becomes shorter than its related hedging instrument. If this were to happen, the Company would potentially need to reinvest at rates lower than that of the related hedging instrument. This situation may result in the narrowing of interest rate spreads or may cause losses. The Company also invests in adjustable-rate mortgage assets that are typically subject to periodic and lifetime interest rate caps that limit the amount an adjustable-rate mortgage asset's interest rate can change during any given period, as well as the minimum rate payable. The Company's borrowings will not be subject to similar restrictions. Hence, in a period of increasing interest rates, interest rates on its borrowings could increase without limitation by caps, while the interest rates on its mortgage assets are generally limited by caps. This problem will be magnified to the extent the Company acquires mortgage assets that are not fully indexed. Further, some adjustable-rate mortgage assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in receipt by the Company of less cash income on its adjustable-rate mortgage assets than is required to pay interest on the related borrowings. These factors could lower the Company's net interest income or cause a net loss during periods of rising interest rates, which would negatively impact the Company's financial condition, cash flows and results of operations. The Company intends to fund a substantial portion of its acquisitions of adjustable-rate mortgage assets with borrowings that have interest rates based on indices and repricing terms similar to, but of somewhat shorter maturities than, the interest rate indices and repricing terms of the mortgage assets. Thus, the Company anticipates that in most cases the interest rate indices and repricing terms of its mortgage assets and its funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. While the historical spread between relevant short-term interest rate indices has been relatively stable, there have been periods, especially during the 1979-1982 and 1994 interest rate environments, when the spread between such indices was volatile. During periods of changing interest rates, such interest rate mismatches could negatively impact the Company's financial condition, cash flows and results of operations. Prepayment rates generally increase when prevailing interest rates fall below the interest rates on existing mortgage assets. In addition, prepayment rates generally increase when the difference between long-term and short-term interest rates declines. Prepayments of mortgage assets could adversely affect the Company's results of operations in several ways. The Company anticipates that a substantial portion of its adjustable-rate mortgage assets may bear initial "teaser" interest rates that are lower than their "fully indexed" rates (the applicable index plus a margin). In the event that such an adjustable-rate mortgage asset is prepaid prior to or soon after the time of adjustment to a fully indexed rate, the Company will have held the mortgage asset while it was less profitable and lost the opportunity to receive interest at the fully indexed rate over the expected life of the adjustable-rate mortgage asset. In addition, the prepayment of any mortgage asset that had been purchased at a premium by the Company would result in the immediate write-off of any remaining capitalized premium amount and consequent reduction of the Company's net interest income by such amount. Finally, in the event that the Company is unable to acquire new mortgage assets to replace the prepaid mortgage assets, its financial condition, cash flow and results of operations could be materially adversely affected. EFFECT ON FAIR VALUE. Another component of interest rate risk is the effect changes in interest rates will have on the market value of the Company's assets. This is the risk that the market value of the Company's assets will increase or decrease at different rates than that of the Company's liabilities including its hedging instruments. 22 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 $47,111 $50,466 $40,338 Change in Fair Value ($3,355) - ($10,128) Change as a Percent of Fair Value (0.41%) - (1.23%) Change as a Percent of Stockholders' Equity (3.90%) - (11.78%) Change on a Per Share Basis ($0.58) - ($1.76)
It is important to note that the impact of changing interest rates on fair value can change significantly when interest rates change beyond one hundred basis points from current levels. Therefore, the volatility in fair value for the Company could increase significantly when interest rates change beyond one hundred basis points. In addition, there are other factors that impact the fair value of the Company's interest rate sensitive investments and hedging instruments such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, there may be differences between the fair value changes shown above and actual changes in fair value as interest rates change and those differences may be material. The contract terms of the Company's liabilities exclusive of hedging instruments are subject to change as interest rates change. In general, the Company utilizes short-term borrowings in the form of reverse repurchase agreements to finance certain of its mortgage-backed securities. These agreements are secured by a portion of the Company's mortgage-backed securities and bear interest rates that have historically moved in close relationship to LIBOR. 23 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 $21,701 $24,112 $26,523 Change in Fair Value (2,411) - 2,411 Change as a Percent of Fair Value (10%) - 10% Change as a Percent of Stockholders' Equity (2.8%) - 2.8% Change on a Per Share Basis (0.42) - 0.42
Although there is no direct link between changes in fair value and changes in earnings in many cases, a decline in fair value for the Company may translate into decreased earnings over the remaining life of the investment portfolio. If the fair market value of the Company's portfolio were to decline significantly, the Company's overall liquidity may be impaired which could result in the Company being required to sell assets at losses. THE COMPANY'S ANALYSIS OF RISKS IS BASED ON MANAGEMENT'S EXPERIENCE, ESTIMATES, MODELS AND ASSUMPTIONS. THESE ANALYSES RELY ON MODELS OF FINANCIAL INFORMATION WHICH UTILIZE ESTIMATES OF FAIR VALUE AND INTEREST RATE SENSITIVITY. ACTUAL ECONOMIC CONDITIONS OR IMPLEMENTATION OF INVESTMENT DECISIONS BY THE MANAGER MAY PRODUCE RESULTS THAT DIFFER SIGNIFICANTLY FROM THE ESTIMATES AND ASSUMPTIONS USED IN THE COMPANY'S MODELS AND THE PROJECTED RESULTS SHOWN IN THE ABOVE TABLES AND IN THIS REPORT. THESE ANALYSES CONTAIN CERTAIN "FORWARD-LOOKING STATEMENTS" AND ARE SUBJECT TO THE SAFE HARBOR CONTAINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. 24 PART 2. OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities Not Applicable Item 3. Defaults Upon Senior Securities Not Applicable Item 4. Submission of Matters to a Vote of Security Holders Not Applicable Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits Exhibit #11 Computation of Earnings Per Share Exhibit #27 Financial Data Schedule (b) Reports on Form 8-K None 25 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Apex Mortgage Capital, Inc. Dated: May 14, 1999 By: /s/ Philip A. Barach -------------------------------------- Philip A. Barach President and Chief Executive Officer (Principal Executive Officer) By: /s/ Daniel K. Osborne -------------------------------------- Daniel K. Osborne Executive Vice President Chief Operating Officer Chief Financial Officer (Principal Accounting Officer) 26 EX-11 2 EXHIBIT 11 EXHIBIT 11 APEX MORTGAGE CAPITAL, INC. COMPUTATION OF EARNINGS PER SHARE
QUARTER ENDED MARCH 31, 1999 MARCH 31, 1998 ---------------------------------------- BASIC: Net Income 2,962,000 564,000 Average Number of Shares Oustanding 5,753,000 6,603,000 Basic Earnings Per Share 0.51 0.09 DILUTED: Effect of dilutive securities: Incremental shares from dilutive stock options 20,000 - Diluted Average Number of Shares Outstanding 5,773,000 6,603,000 ---------------------------------------- Diluted Earnings Per Share $0.51 $0.09 ---------------------------------------- ----------------------------------------
EX-27 3 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION OF THE REGISTRANT AS OF MARCH 31, 1999 AND THE CONSOLIDATED STATEMENTS OF OPERATIONS OF THE REGISTRANT FOR THE PERIOD FROM JANUARY 1, 1999 TO MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 3,426 845,229 7,353 0 0 467 0 0 856,475 770,520 0 0 0 67 85,888 856,475 0 15,262 0 0 1,039 0 11,261 2,962 0 2,962 0 0 0 2,962 0.51 0.51
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