-----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, WhCOeUcVga8aeJy2jLOJOpTlYz1R1h3IpTN4GX7xcn2Pd/t5yitxZM9Aoxm1a7lX QEo8XjRr/7AY+xC8cpDS/A== 0001047469-98-041070.txt : 19981118 0001047469-98-041070.hdr.sgml : 19981118 ACCESSION NUMBER: 0001047469-98-041070 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 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: 98750737 BUSINESS ADDRESS: STREET 1: 865 FIGUEROA STREET STREET 2: STE 1800 CITY: LOS ANGELES STATE: CA ZIP: 90017 BUSINESS PHONE: 2132440461 10-Q 1 FORM 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, 1998 OR - --- TRANSITION REPORT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____ COMMISSION FILE NUMBER: 001-13637 APEX MORTGAGE CAPITAL, INC. (Exact name of Registrant as specified in its Charter) MARYLAND 95-4650863 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 865 SOUTH FIGUEROA STREET LOS ANGELES, CALIFORNIA 90017 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (213) 244-0440 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of the issuer's classes of common stock, as of the last practicable date. Common Stock ($0.01 par value) 5,753,000 as of November 10,1998 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- APEX MORTGAGE CAPITAL, INC. FORM 10-Q INDEX
PART I. FINANCIAL INFORMATION PAGE ----- ITEM 1. FINANCIAL STATEMENTS BALANCE SHEETS AT SEPTEMBER 30, 1998 (UNAUDITED) AND DECEMBER 31, 1997 3 STATEMENT OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) 4 STATEMENT OF STOCKHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) 5 STATEMENTS OF CASH FLOWS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) 6 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 24 ITEM 2. CHANGES IN SECURITIES 24 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 24 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 24 ITEM 5. OTHER INFORMATION 24 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 24 SIGNATURES 25
PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS APEX MORTGAGE CAPITAL, INC. BALANCE SHEETS
SEPTEMBER 30, 1998 DECEMBER 31, 1997 ASSETS (Unaudited) Cash and cash equivalents $ 5,570,000 $ 3,085,000 Other investments, available-for-sale at fair value 9,706,000 - Interest rate cap agreements (Note 4) - 174,000 Mortgage-backed securities available-for-sale, at fair value (Note 3) 889,908,000 265,880,000 Accrued interest receivable 5,226,000 1,316,000 Principal payments receivable 158,000 - Other assets 652,000 852,000 $ 911,220,000 $ 271,307,000 ------------------ ----------------- ------------------ ----------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Reverse repurchase agreements (Note 5) $ 811,680,000 $ 87,818,000 Payable for unsettled securities 140,000 88,638,000 Accrued interest payable 3,124,000 110,000 Dividend payable 1,601,000 268,000 Accrued expenses and other liabilities 465,000 1,476,000 ------------------ ----------------- 817,010,000 178,310,000 ------------------ ----------------- Commitments and contingencies (Note 10) Stockholders' Equity Preferred Stock, par value $0.01 per share; 50,000,000 shares authorized; no shares outstanding Common Stock, par value $0.01 per share; 100,000,000 shares authorized; 6,700,100 shares outstanding (Notes 8 and 9) 67,000 67,000 Additional paid-in-capital 92,944,000 92,860,000 Accumulated other comprehensive income 12,047,000 188,000 Accumulated dividend distributions in excess of net income (1,740,000) (118,000) Treasury stock, at cost (782,500 shares) (Note 7) (9,108,000) - ------------------ ----------------- 94,210,000 92,997,000 ------------------ ----------------- $ 911,220,000 $ 271,307,000 ------------------ ----------------- ------------------ -----------------
See accompanying notes to financial statements 3 APEX MORTGAGE CAPITAL, INC. STATEMENT OF OPERATIONS (UNAUDITED)
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, 1998 SEPTEMBER 30, 1998 INTEREST INCOME: Mortgage-backed securities $ 13,469,000 $ 27,418,000 Cash and cash equivalents 173,000 629,000 ------------------ ------------------ 13,642,000 28,047,000 INTEREST EXPENSE 11,271,000 24,281,000 ------------------ ------------------ NET INTEREST INCOME 2,371,000 3,766,000 ------------------ ------------------ GAIN ON INVESTMENT TRANSACTIONS, NET 7,000 476,000 OTHER INCOME 186,000 186,000 GENERAL AND ADMINISTRATIVE EXPENSES: Management fee (Note 8) 353,000 687,000 Audit and tax fees 11,000 34,000 Insurance expense 67,000 200,000 Directors' fees 15,000 55,000 Stock option expense 28,000 84,000 Other 98,000 202,000 ------------------ ------------------ 572,000 1,262,000 ------------------ ------------------ NET INCOME $ 1,992,000 $ 3,166,000 ------------------ ------------------ ------------------ ------------------ Net Income Per Share: Basic $ 0.33 $ 0.50 ------------------ ------------------ ------------------ ------------------ Diluted $ 0.33 $ 0.50 ------------------ ------------------ ------------------ ------------------ Weighted Average Number of Shares Outstanding: Basic 6,022,000 6,334,000 ------------------ ------------------ ------------------ ------------------ Diluted 6,022,000 6,334,000 ------------------ ------------------ ------------------ ------------------ Dividends Declared Per Share $ 0.27 $ 0.77 ------------------ ------------------ ------------------ ------------------
See accompanying notes to financial statements 4 APEX MORTGAGE CAPITAL, INC. STATEMENT OF STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
Acccumulated Common Stock Additional Other ----------------------- Paid-in Comprehensive Shares Amount Capital Income ---------- ---------- ----------- ------------- Balance, December 31, 1997 6,700,100 $ 67,000 $92,860,000 $ 188,000 Repurchases of common stock - - - - Issuance of stock options to non-employees (Note 9) - - 28,000 - Net income - - - - Other comprehensive income: Net unrealized gain on mortgage-backed securities available-for-sale - - - 1,547,000 Comprehensive income Dividends declared - - - - ---------- ---------- ----------- ------------- Balance, March 31, 1998 6,700,100 67,000 92,888,000 1,735,000 Repurchases of common stock - - - - Issuance of stock options to non-employees (Note 9) - - 28,000 - Net income - - - - Other comprehensive income: Net unrealized gain (loss) on mortgage-backed securities available-for-sale - - - (291,000) Comprehensive income - - - - Dividends declared - - - - ---------- ---------- ----------- ------------- Balance, June 30, 1998 6,700,100 67,000 92,916,000 1,444,000 Repurchases of common stock - - - - Issuance of stock options to non-employees (Note 9) - - 28,000 - Net income - - - - Other comprehensive income: Net unrealized gain (loss) on investments available-for- sale - - - 10,603,000 Comprehensive income - - - - Dividends declared - - - - ---------- ---------- ----------- ------------- Balance, September 30, 1998 6,700,100 $ 67,000 $92,944,000 $12,047,000 ---------- ---------- ----------- ------------- ---------- ---------- ----------- ------------- Accumulated Dividend Distribution Treasury In Excess of Comprehensive Stock, Net Income Income At Cost Total ------------ ------------- ------------ ------------ Balance, December 31, 1997 $ (118,000) $ - $ - $92,997,000 Repurchases of common stock - - (2,535,000) (2,535,000) Issuance of stock options to non-employees (Note 9) - - - 28,000 Net income 564,000 564,000 - 564,000 Other comprehensive income: Net unrealized gain on mortgage-backed securities available-for-sale - 1,547,000 - 1,547,000 ------------- Comprehensive income $ 2,111,000 ------------- ------------- Dividends declared (1,626,000) - (1,626,000) ------------ ------------ ------------ Balance, March 31, 1998 (1,180,000) 0 (2,535,000) 90,975,000 ------------ ------------ Repurchases of common stock - - (3,901,000) (3,901,000) Issuance of stock options to non-employees (Note 9) - - - 28,000 Net income 609,000 609,000 - 609,000 Other comprehensive income: Net unrealized gain (loss) on mortgage-backed securities available-for-sale - (291,000) - (291,000) ------------- Comprehensive income $ 318,000 ------------- ------------- Dividends declared (1,560,000) - (1,560,000) ------------ ------------ ------------ Balance, June 30, 1998 (2,131,000) (6,436,000) 85,860,000 ------------ ------------ Repurchases of common stock - - (2,672,000) (2,672,000) Issuance of stock options to non-employees (Note 9) - - - 28,000 Net income 1,992,000 1,992,000 - 1,992,000 Other comprehensive income: Net unrealized gain (loss) on investments available-for- sale - 10,603,000 - 10,603,000 ------------- Comprehensive income $12,595,000 ------------- ------------- Dividends declared (1,601,000) - (1,601,000) ------------ ------------ ------------ Balance, September 30, 1998 $(1,740,000) $(9,108,000) $94,210,000 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying notes to financial statements 5 STATEMENT OF CASH FLOWS APEX MORTGAGE CAPITAL, INC. (Unaudited)
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, 1998 SEPTEMBER 30, 1998 OPERATING ACTIVITIES: Net Income $ 1,992,000 $ 3,166,000 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 413,000 3,148,000 Gain on investment transactions, net (7,000) (476,000) Change in assets and liabilities: Accrued interest receivable 123,000 (3,910,000) Principal payments receivable 799,000 (158,000) Receivable for unsettled securities 56,593,000 - Other assets 100,000 200,000 Payable for unsettled securities (120,720,000) (88,498,000) Accrued interest payable (774,000) 3,014,000 Accrued expenses and other liabilities (668,000) (1,011,000) ------------------ ------------------ Net cash used in operating activities (62,149,000) (84,525,000) ------------------ ------------------ INVESTING ACTIVITIES: Purchase of other investments (9,980,000) (9,980,000) Purchase of interest rate cap agreements - (80,000) Purchase of mortgage-backed securities (133,907,000) (1,376,002,000) Proceeds from sales of mortgage-backed securities 80,199,000 541,801,000 Principal payments on mortgage-backed securities 38,844,000 219,971,000 ------------------ ------------------ Net cash used in investing activities (24,844,000) (624,290,000) ------------------ ------------------ FINANCING ACTIVITIES: Net proceeds from reverse repurchase agreements 57,928,000 723,862,000 Dividend distributions (1,560,000) (3,454,000) Purchase of treasury stock (2,672,000) (9,108,000) ------------------ ------------------ Net cash provided by financing activities 53,696,000 711,300,000 ------------------ ------------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (33,297,000) 2,485,000 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 38,867,000 3,085,000 ------------------ ------------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,570,000 $ 5,570,000 ------------------ ------------------ ------------------ ------------------ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest $ 12,001,000 $ 21,194,000 ------------------ ------------------ ------------------ ------------------ NONCASH INVESTING AND FINANCING ACTIVITIES: Net unrealized gain on assets available-for-sale $ 10,603,000 $ 11,859,000 ------------------ ------------------ ------------------ ------------------ Dividends declared, not yet paid $ 1,601,000 $ 1,601,000 ------------------ ------------------ ------------------ ------------------
See accompanying notes to financial statements 6 APEX MORTGAGE CAPITAL, INC. NOTES TO FINANCIAL STATEMENTS QUARTER ENDED SEPTEMBER 30, 1998 (UNAUDITED) NOTE 1 - THE COMPANY Apex Mortgage Capital, Inc. (the "Company") was incorporated in Maryland on September 15, 1997. The Company commenced its operations of acquiring and managing a portfolio of mortgage assets on December 9, 1997, upon receipt of the net proceeds from the initial public offering of the Company's common stock. The Company uses its equity capital and borrowed funds to seek to generate income based on the difference between the yield on its mortgage-backed securities and the cost of its borrowings. The Company is structured for tax purposes as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES These interim financial statements are unaudited, internally prepared statements, that reflect the necessary interim adjustments which, in the opinion of management, are necessary to present a fair statement of the results for such interim period. The results of operations for this interim period are not indicative of the results for a full fiscal year. This filing should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 1997. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates their fair value. MORTGAGE-BACKED SECURITIES The Company's mortgage-backed securities consist of securities backed by single-family residential real estate mortgage loans. Mortgage-backed securities are recorded at cost on the date the assets are purchased. Realized gains and losses on sales of the securities are determined on a specific identification basis. Substantially all of the Company's mortgage-backed securities are expected to qualify as real estate assets under the REIT provisions of the Code. Interest income is accrued based on the outstanding principal amount of the mortgage-backed securities and their contractual terms. Premiums and discounts are amortized into interest income over the lives of the securities using the effective yield method adjusted for the effects of estimated prepayments. The Company's policy is to generally classify its mortgage-backed securities as available-for-sale. The mortgage-backed securities are reported at fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income. OTHER INVESTMENTS The Company's other investments consist primarily of equity securities issued by other real estate investment trusts and other securities generally collateralized by mortgage assets. 7 Dividend income on equity securities is recorded on the declaration date. Interest income on other securities is accrued using the effective interest method applied prospectively based on current market assumptions. Both dividend and interest income earned on other investments are included in other income. The Company's policy is to generally classify its other investments as available-for-sale. Other investments 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 on the balance sheet as interest rate cap agreements and are amortized over the lives of such agreements as an adjustment to interest expense. 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 will not be subject to federal and state taxes on its income to the extent it distributes annually 95% of its predistribution taxable income to stockholders and meets certain other asset, income and stock ownership tests. As such, no accrual for income taxes has been included in the financial statements. NET INCOME PER SHARE Net income per share is computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, EARNINGS PER SHARE, and is calculated on the basis of the weighted average number of common shares outstanding during each period plus the additional dilutive effect of common stock equivalents. The dilutive effect of outstanding stock options is calculated using the treasury stock method. Stock options that could potentially dilute basic net income per share in the future were not included in the computation of diluted net income per share because to do so would have been antidilutive for the period presented. INCOME RECOGNITION Income and expenses are recorded on the accrual basis of accounting. CREDIT RISK At September 30, 1998, the Company has limited its exposure to credit losses on its portfolio of mortgage-backed securities by purchasing securities that are either rated "AAA" by at least one nationally recognized rating agency or are issued by the Federal Home Loan Mortgage Corporation ("FHLMC"), Fannie Mae (formerly known as the Federal National Mortgage Corporation) or the Government National Mortgage Association ("GNMA"). The payment of principal and interest on the FHLMC, Fannie Mae and GNMA securities are guaranteed by those respective agencies. At September 30, 1998, all of the Company's mortgage-backed securities have an actual or implied "AAA" rating. 8 USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. COMPREHENSIVE INCOME During the nine months ended September 30, 1998, the Company 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 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 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, 1997 (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. NOTE 3 - MORTGAGE-BACKED SECURITIES At September 30, 1998, mortgage-backed securities consisted of the following:
Adjustable Rate Fixed Rate (in thousands) Mortgage Mortgage Securities Securities Total ----------------------------------------------- Principal Amount $56,594 $819,673 $876,267 Unamortized Premium (Discount) 870 491 1,361 ----------------------------------------------- Amortized Cost 57,464 820,164 877,628 Unrealized Gains 15 12,388 12,403 Unrealized Losses (123) -- (123) ----------------------------------------------- Fair Value $57,356 $832,552 $889,908 ----------------------------------------------- -----------------------------------------------
9 At December 31, 1997, mortgage-backed securities consisted of the following:
Adjustable Rate Fixed Rate (in thousands) Mortgage Mortgage Securities Securities Total ----------------------------------------------- Principal Amount $237,929 $24,826 $262,755 Unamortized Premium 2,743 194 2,937 ----------------------------------------------- Amortized Cost 240,672 25,020 265,692 Unrealized Gains 162 41 203 Unrealized Losses (15) 0 (15) ----------------------------------------------- Fair Value $240,819 $25,061 $265,880 ----------------------------------------------- -----------------------------------------------
The contractual final maturity of the mortgage loans supporting the mortgage-backed 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 adjustable rate mortgage-backed 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, 1998, the average periodic cap on the adjustable rate mortgage assets was 1.9% per annum and the average lifetime cap was equal to 11.6%. At December 31, 1997, the average periodic cap on the adjustable rate mortgage assets was 2.0% per annum and the average lifetime cap was equal to 11.4%. During the quarter ended September 30, 1998 the Company realized $104,000 in gains on the sale of $79.3 million of mortgage-backed securities which were classified as available-for-sale. 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 quarter ended September 30, 1998 which approximates their fair value. A $97,000 charge for the write-off is included in Gain on Investment Transactions, net in the Statement of Operations. The terms of outstanding interest rate cap agreements are as follows:
At September 30, 1998 At December 31, 1997 --------------------------------------------- Notional Amount $900,000,000 $500,000,000 Average Contract Rate 10.4% 10.0% Average Final Maturity January 24, 2002 December 24, 2001
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 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. 10 At September 30, 1998, the Company had outstanding $811,680,000 of reverse repurchase agreements with a weighted average current borrowing rate of 5.53% and a maturity of 2.2 months. The reverse repurchase agreements were collateralized by mortgage-backed securities with an estimated fair value of $839,163,000. At December 31, 1997, the Company had outstanding $87,818,000 of reverse repurchase agreements with a weighted average current borrowing rate of 5.82% and a maturity of 2.8 months. The reverse repurchase agreements were collateralized by mortgage-backed securities with an estimated fair value of $90,043,000. For the quarter ended September 30, 1998, the average reverse repurchase agreement balance was $774,420,000 with a weighted average interest cost of 5.74%. The maximum reverse repurchase agreement balance outstanding during the quarter ended September 30, 1998 was $818,540,000. For the nine months ended September 30, 1998, the average reverse repurchase agreement balance was $568,630,000 with a weighted average interest cost of 5.64%. The maximum reverse repurchase agreement balance outstanding during the nine months ended September 30, 1998 was $818,540,000. 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 September 30, 1998 At December 31, 1997 Amortized Cost Fair Value Amortized Cost Fair Value ------------------------------- ------------------------------- Mortgage-backed securities $877,628 $889,908 $265,692 $265,880 Interest Rate Cap Agreements - - 174 174 Other Investments 9,803 9,706 - - Interest Rate Swaps - (15,464) - -
The Company bases its fair value estimates for mortgage-backed securities, other nivestments 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 On September 16, 1998, the Company's Board of Directors authorized a program to repurchase up to an additional 750,000 shares of the Company's common stock having completed an original repurchase program of 750,000 shares. The Company repurchased 247,500 shares of its common stock during the third quarter and 782,500 shares for the nine months ended September 30, 1998. The average price per share repurchased during the quarter and the nine months ended September 30, 1998 was $10.80 and $11.64, respectively. The repurchased shares are held in treasury at cost in the financial statements herein. An additional 717,500 shares are currently authorized for potential repurchase in the future. The Company may continue to repurchase shares in the future when market conditions warrant. 11 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 $156,000 in base management compensation in accordance with the terms of the Management Agreement for the quarter ended September 30, 1998. The Company paid the Manager $490,000 in base management compensation for the nine months ended September 30, 1998. The Company will also pay the Manager, as incentive compensation, an amount equal to 30% of the Net Income of the Company, before incentive compensation, in excess of the amount that would produce an annualized return on equity equal to the ten-year US Treasury rate plus 1% as further defined in the Management Agreement. The Company accrued $197,000 of incentive compensation to be paid to the Manager for the quarter and nine months ended September 30, 1998. At September 30, 1998, $249,000 of unpaid compensation was payable to the Manager. At December 31, 1997, $43,000 of unpaid compensation was payable to the Manager. 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 investments 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 pay any management fees directly to any affiliate of the Manager in connection with these investments. 12 NOTE 9 - STOCK OPTIONS The Company has adopted a stock option plan (the "1997 Stock Option Plan") that provides for the grant of both qualified incentive stock options that meet the requirements of Section 422 of the Code, and non-qualified stock options, stock appreciation rights and dividend equivalent rights. Stock options may be granted to directors, officers and key employees of the Company, the Manager, its directors, officers and key employees. The exercise price for any stock option granted under the 1997 Stock Option Plan may not be less than 100% of the fair market value of the shares of common stock at the time the option is granted. Each option must terminate no more than ten years from the date it is granted. Subject to anti-dilution provisions for stock splits, stock dividends and similar events, the 1997 Stock Option Plan authorizes the grant of options to purchase an aggregate of up to 10% of the outstanding shares of the Company's common stock, but not more than 1,000,000 shares of common stock. No options were granted under the 1997 Stock Option Plan during the quarter or nine months ended September 30, 1998. The Company recognized compensation expense of $28,000 during the quarter ended September 30, 1998 for stock options previously granted to non-employees. The Company recognized compensation expense of $84,000 during the nine months ended September 30, 1998 for stock options previously granted to non-employees. If the Company had recorded stock option grants to Company directors at fair value and related compensation expense, the pro forma effect on the Company's net income and earnings per share would have been as follows:
Quarter Ended Nine Months Ended September 30, 1998 September 30, 1998 ----------------------------------------- Net income - as reported $1,992,000 $3,166,000 Net income - pro forma 1,951,000 3,023,000 Basic and diluted earnings per share - as reported $0.33 $0.50 Basis and diluted earnings per share - pro forma $0.32 $0.48
The fair value of each option grant was estimated to be $1.05 as of the grant date using the Black-Scholes option pricing model with the following assumptions: dividend yield of 11% per annum; expected volatility of 30%; risk free interest rate of 5.82% per annum; and an expected life of 10 years. Information regarding stock option activity for the quarter and nine months ended September 30, 1998 is as follows:
Shares ------------- Outstanding, beginning of period 400,000 Exercised - Expired - ------------- Outstanding, end of period 400,000 ------------- -------------
The original contractual life as of December 3, 1997 of each option was ten years. The options vest in three equal installments on February 3, 1999, December 3, 1999 and December 3, 2000. 13 NOTE 10 - CONTRACTUAL COMMITMENTS The Company has entered into interest rate swap agreements with notional amounts as stated below. Under these agreements, the Company receives a floating rate and pays a fixed rate.
Current Notional Amount Termination Unrealized (000) Type Fixed Rate Floating Rate Date Gains (Losses) - ---------------------------------------------------------------------------------------------------- $ 95,000 Interest Rate Swap 5.880% 1Mo LIBOR 5/29/00 $ (1,663) 30,000 Interest Rate Swap 5.905% 1Mo LIBOR 6/30/00 (576) 28,636 Interest Rate Swap 5.765% 1Mo LIBOR 7/25/00 (446) 62,489 Interest Rate Swap 5.775% 1Mo LIBOR 8/25/00 (1,030) 47,811 Interest Rate Swap 5.710% 1Mo LIBOR 8/28/00 (755) 60,000 Interest Rate Swap 5.900% 1Mo LIBOR 5/18/01 (1,638) 98,694 Interest Rate Swap 5.883% 1Mo LIBOR 5/25/01 (2,407) 123,879 Interest Rate Swap 5.905% 1Mo LIBOR 5/25/01 (2,638) 55,172 Interest Rate Swap 5.750% 1Mo LIBOR 7/14/01 (1,136) 65,000 Interest Rate Swap 5.791% 1Mo LIBOR 7/25/01 (1,645) 49,134 Interest Rate Swap 5.960% 1Mo LIBOR 5/15/02 (1,530) - ---------------- ---------------- $715,815 $(15,464) - ---------------- ---------------- - ---------------- ----------------
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 September 30, 1998, the Company had securities with a fair market value of 16,984,000 on deposit with its counter-parties. 14 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 "Risk Factors" in the Prospectus included in the Registration Statement on Form S-11 (333-36069) filed by the Company on November 29, 1997 and incorporated by reference as Exhibit 99.1 in the Company's annual report on Form 10-K for the year ended December 31, 1997. 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, other mortgage securities and mortgage loans. The Company commenced operations on December 9, 1997, upon receipt of the net proceeds from the initial public offering of the Company's common stock. The Company's principal executive offices are located at 865 South Figueroa Street, Suite 1800, Los Angeles, California 90017, and its telephone number is (213) 244-0440. The Company uses its equity capital and borrowed funds to seek to generate income based on the difference between the yield on its mortgage assets and the cost of its borrowings. The Company 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 the Manager subject to the direction and oversight of the Company's Board of Directors, a majority of whom are unaffiliated with the Manager. The Manager is a wholly-owned subsidiary of The TCW Group, Inc. ("TCW"). The Manager was established in 1992 and TCW began operations in 1971 through one of its affiliates. The Company's investment management team consists of selected members of TCW's mortgage-backed securities group, all of whom have over ten years of experience in raising and managing mortgage capital. The Company has elected to be externally managed by the Manager to take advantage of the existing operational systems, expertise and economies of scale associated with the Manager's current business operations, among other reasons. STRATEGY To achieve its business objective and generate dividend yields that provide a competitive rate of return for its stockholders, the Company's strategy is to: - purchase primarily single-family mortgage assets; 15 - manage the credit risk of its mortgage assets through, among other activities (i) carefully selecting mortgage assets to be acquired, (ii) complying with the Company's policies with respect to credit risk concentration which, among other things, require the Company to maintain a mortgage asset portfolio with a weighted average rating generally equivalent to AA (or a comparable rating) or better, (iii) actively monitoring the ongoing credit quality and servicing of its mortgage assets, and (iv) maintaining appropriate capital levels and allowances for possible credit losses; - finance purchases of mortgage assets with the net proceeds of equity offerings and to utilize leverage to increase potential returns to stockholders through borrowings (primarily reverse repurchase agreements) with interest rates that will generally reflect changes in short-term market interest rates; and - utilize interest rate caps, swaps and similar financial instruments to mitigate the risk of the cost of its variable-rate liabilities exceeding the earnings on its mortgage assets during a period of rising interest rates. The Company has established the foregoing strategies along with certain operating policies and procedures to implement them. However, these strategies and policies may be modified or waived by the Board of Directors at any time without the consent or approval of the Company's stockholders. The ultimate effect of any such changes is uncertain. FINANCIAL CONDITION MORTGAGE ASSETS At September 30, 1998, the Company held $889,908,000 of mortgage assets as compared to $265,880,000 at December 31, 1997. The original maturity of a significant portion of the mortgage assets 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 mortgage assets held listed by security type (dollars in thousands):
September 30, 1998 December 31, 1997 ------------------------------------------------------ Carrying Percent of Carrying Percent of Mortgage-Backed Securities Value Portfolio Value Portfolio ----------------------------------------------------------------------------------- Adjustable Rate (1) $ 57,356 6.4% $240,819 90.6% Fixed Rate 832,552 93.6% 25,061 9.4% -------- ------ -------- ------ Totals $889,908 100.0% $265,880 100.0% -------- ------ -------- ------ -------- ------ -------- ------
(1) At September 30, 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. At December 31, 1997, the interest rate index for all adjustable rate mortgage securities was based on the one-year U.S. Treasury rate. 16 The following table shows various weighted average characteristics of the mortgage assets held by the Company at September 30, 1998 (dollars in thousands):
Percent of Weighted Par Total Par Amortized Market Current Average Security Type Amount Amount Cost Basis Price Coupon Life (1) - --------------------------------------------------------------------------------------------------------------- 15 Year Agency/AAA Pass-throughs $307,959 35.1% 100.43% 101.95% 6.51% 3.5 20 Year Agency Pass-throughs 189,517 21.6% 100.36% 101.92% 6.50% 5.0 AAA CMOs 322,198 36.8% 99.53% 101.01% 6.81% 2.1 -------- ------ ------- ------- ----- --- Total Fixed Rate Holdings 819,674 93.5% 100.06% 101.57% 6.63% 3.3 Adjustable Rate Holdings 56,593 6.5% 101.54% 101.35% 6.58% 1.0 -------- ------ ------- ------- ----- --- Total Portfolio $876,267 100.0% 100.16% 101.56% 6.62% 3.1 -------- ------ ------- ------- ----- --- -------- ------ ------- ------- ----- ---
The following table shows various weighted average characteristics of the mortgage assets held by the Company at December 31, 1997 (dollars in thousands):
Percent of Weighted Par Total Par Amortized Market Current Average Security Type Amount Amount Cost Basis Price Coupon Life (1) - --------------------------------------------------------------------------------------------------------------- Fixed Rate Agency CMO $24,826 9.5% 100.78% 100.95% 7.50% 0.9 Adjustable Rate Holdings 237,929 90.5% 101.12% 101.21% 6.90% 0.6 -------- ------ ------- ------- ----- --- Total Portfolio $262,755 100.0% 101.11% 101.19% 6.66% 0.6 -------- ------ ------- ------- ----- --- -------- ------ ------- ------- ----- ---
(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. HEDGING INSTRUMENTS AND OTHER INVESTMENTS 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 London Interbank Offered Rate ("LIBOR") based agreements as follows:
At September 30, 1998 At December 31, 1997 ------------------------------------------------ Notional Amount $900,000,000 $500,000,000 Average Contract Rate 10.4% 10.0% Average Final Maturity January 24, 2002 December 24, 2001
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 because the Company has entered into additional hedging transactions as discussed below. Accordingly, the Company now records the cap agreements at fair market value. During the quarter ended September 30, 1998, a $97,000 17 charge against earnings was taken to write the cap agreements down to zero which approximates their fair market value in the current market environment. The charge is included as an adjustment to gain on investment transactions on the income statement. The Company has entered into interest rate swap agreements with current notional amounts as stated below. Under these agreements, the Company receives a floating rate and pays a fixed rate.
Current Notional Amount Termination Unrealized (000) Type Fixed Rate Floating Rate Date Gains (Losses) - ----------------------------------------------------------------------------------------------- $ 95,000 Interest Rate Swap 5.880% 1Mo LIBOR 5/29/00 $ (1,663) 30,000 Interest Rate Swap 5.905% 1Mo LIBOR 6/30/00 (576) 28,636 Interest Rate Swap 5.765% 1Mo LIBOR 7/25/00 (446) 62,489 Interest Rate Swap 5.775% 1Mo LIBOR 8/25/00 (1,030) 47,811 Interest Rate Swap 5.710% 1Mo LIBOR 8/28/00 (755) 60,000 Interest Rate Swap 5.900% 1Mo LIBOR 5/18/01 (1,638) 98,694 Interest Rate Swap 5.883% 1Mo LIBOR 5/25/01 (2,407) 123,879 Interest Rate Swap 5.905% 1Mo LIBOR 5/25/01 (2,638) 55,172 Interest Rate Swap 5.750% 1Mo LIBOR 7/14/01 (1,136) 65,000 Interest Rate Swap 5.791% 1Mo LIBOR 7/25/01 (1,645) 49,134 Interest Rate Swap 5.960% 1Mo LIBOR 5/15/02 (1,530) - --------------- --------------- $ 715,815 $(15,464) - --------------- --------------- - --------------- ---------------
The weighted average coupon the Company pays on the interest rate swap agreements at September 30, 1998 was 5.85%. The weighted average life of the agreements at September 30, 1998 was 2.1 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 September 30, 1998, the Company had securities with a fair market value of 16,984,000 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. 18 At September 30, 1998, the Company had outstanding $811,680,000 of reverse repurchase agreements with a weighted average current borrowing rate of 5.53% and a maturity of 2.2 months. The reverse repurchase agreements were collateralized by mortgage-backed securities with an estimated fair value of $839,163,000. At December 31, 1997, the Company had outstanding $87,818,000 of reverse repurchase agreements with a weighted average current borrowing rate of 5.82% and a maturity of 2.8 months. The reverse repurchase agreements were collateralized by mortgage-backed securities with an estimated fair value of $90,043,000. The Company had $5,330,000 and $90,492,000 of other liabilities at September 30, 1998 and December 31, 1997, respectively, consisting primarily of payables for unsettled securities. The Company anticipates settling all other liabilities within one year by entering into additional reverse repurchase agreements. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 For the quarter ended September 30, 1998, the Company's net income was $1,992,000, or $0.33 per share on both a basic and diluted basis, based on a weighted average of 6,022,000 shares outstanding. Net interest income for the period was $2,371,000 consisting of interest income on mortgage assets and cash balances less interest expense on reverse repurchase agreements. The Company reported a net gain of $104,000 on the sale of mortgage-backed securities, which was offset by a charge of $97,000 to write off the interest rate cap agreements. The Company reported other income of $186,000 from dividends received on equity investments and interest income on other securities. The Company incurred operating expenses of $572,000 for the quarter consisting of management fees, audit, tax, legal, printing, insurance and other expenses. As a REIT, the Company is required to declare dividends amounting to 85% of each year's taxable income by the end of each calendar year and to have declared dividends amounting to 95% of its taxable income for each year by the time it files its applicable tax return. The Company currently intends to distribute approximately 100% of its taxable net income each year. The Company anticipates that it will experience differences between its net income based on generally accepted accounting principles ("GAAP") and its taxable net income due primarily to differences in the methods used to amortize purchase premiums and discounts and to the recognition of certain compensation expenses that are not recognized for tax purposes. During the quarter ended September 30, 1998, the Company elected to use a different premium amortization method for its adjustable rate mortgage securities than had been used in the previous two quarters to estimate taxable income. The net effect of this change is generally expected to decrease the ordinary taxable income recognized on the Company's adjustable rate mortgage securities and decrease the loss recognized on the sale of such securities during the taxable year ended December 31, 1998. During the quarter ended September 30, 1998, the Company began investing in other investments that generally only report taxable income information annually. Accordingly, the Company will no longer report taxable income on a quarterly basis as this information is generally not available on a timely basis for all of the Company's investments. At September 30, 1998, the Company had distributed $1,740,000 in excess of reported net income. 19 The following table reflects the average balances for each category of the Company's interest earning assets, excluding other investments, as well as the Company's interest bearing liabilities, with the corresponding annualized effective yield recognized for the three months ended September 30, 1998 (dollars in thousands):
AVERAGE BALANCE AND YIELD TABLE (Dollars in thousands) For the Quarter Ended September 30, 1998 ------------------------------- Average Effective Balance Yield ----------- ------------ Interest Earning Assets: Mortgage Assets $830,079 6.49% Cash and Cash Equivalents 13,185 5.25% ----------- ------------ Total Interest Earning Assets 843,264 6.47% ----------- ------------ Interest Bearing Liabilities: Reverse Repurchase Agreements 774,420 5.82% ----------- ------------ Net Interest Earning Assets and Spread $ 68,844 0.65% ----------- ------------ ----------- ------------
The following table reflects the average balances for each category of the Company's other investments with the corresponding annualized effective yield recognized for the three months ended September 30, 1998 (dollars in thousands):
AVERAGE BALANCE AND YIELD TABLE (Dollars in thousands) For the Quarter Ended September 30, 1998 ------------------------------- Average Effective Balance Yield ----------- ------------ Other Investments: Equity Securities $3,343 16.73% Other Securities 1,245 15.04% ----------- ------------ Total Other Investments 4,588 16.27% ----------- ------------ ----------- ------------
The effective yield data is computed by dividing the annualized net interest income or expense into the average daily balance shown. On September 16, 1998, the Company's Board of Directors authorized a program to repurchase up to an additional 750,000 shares of the Company's common stock having completed an original repurchase program of 750,000 shares. The Company repurchased 247,500 shares of its common stock pursuant to both programs during the quarter ended September 30, 1998. The average price per share repurchased was $10.80. The repurchased shares are held in treasury at cost in the financial statements herein. An additional 717,500 shares are currently authorized for potential repurchase in the future. The Company may continue to repurchase shares in the future when market conditions warrant. 20 RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 For the nine months ended September 30, 1998, the Company's net income was $3,166,000, or $0.50 per share on both a basic and diluted basis, based on a weighted average of 6,334,000 shares outstanding. Net interest income for the period was $3,766,000 consisting of interest income on mortgage assets and cash balances less interest expense on reverse repurchase agreements. The Company reported a net gain of $686,000 on the sale of mortgage-backed securities, which was offset by a charge of $210,000 to write off the interest rate cap agreements. The Company reported other income of $186,000 from dividends received on equity investments and interest income on other securities. The Company incurred operating expenses of $1,262,000 for the period consisting of management fees, audit, tax, legal, printing, insurance and other expenses. The following table reflects the average balances for each category of the Company's interest earning assets, excluding other investments, as well as the Company's interest bearing liabilities, with the corresponding annualized effective yield recognized for the nine months ended September 30, 1998 (dollars in thousands):
AVERAGE BALANCE AND YIELD TABLE (Dollars in thousands) For the Nine Months Ended September 30, 1998 ------------------------------- Average Effective Balance Yield ----------- ------------ Interest Earning Assets: Mortgage Assets $621,082 5.89% Cash and Cash Equivalents 16,306 5.14% ----------- ------------ Total Interest Earning Assets 637,388 5.87% ----------- ------------ Interest Bearing Liabilities: Reverse Repurchase Agreements 568,630 5.69% ----------- ------------ Net Interest Earning Assets and Spread $ 68,758 0.18% ----------- ------------ ----------- ------------
The effective yield data is computed by dividing the annualized net interest income or expense into the average daily balance shown. On September 16, 1998, the Company's Board of Directors authorized a program to repurchase up to an additional 750,000 shares of the Company's common stock having completed an original repurchase program of 750,000 shares. The Company repurchased 782,500 shares of its common stock pursuant to both programs during the nine months ended September 30, 1998. The average price per share repurchased was $11.64. The repurchased shares are held in treasury at cost in the financial statements herein. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of funds for the quarter ended September 30, 1998 consisted of reverse repurchase agreements totaling $811,860,000. The Company expects to continue to borrow funds in the form of reverse repurchase agreements. At September 30, 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. 21 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. During the quarter ended September 30, 1998, the Company noted a distinct impairment in overall liquidity in the capital markets. Specifically, several other mortgage companies, hedge funds and other leveraged mortgage investors publicly announced an inability to obtain suitable financing in the capital markets including the inability to obtain reverse repurchase agreement financing. In light of these conditions, some of the Company's lenders have increased the equity requirement for financing certain mortgage assets through reverse repurchase agreements. If liquidity conditions in the capital markets continue to deteriorate, the Company's lenders may continue to increase the equity required to obtain financing or the lenders may stop providing financing altogether. If this were to occur, the Company's liquidity would be adversely affected, which could negatively impact operating results. 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 the equity of stockholders of the Company or the reduction of the price of shares of the common stock, or both. The Company is unable to estimate the amount, timing or nature of additional offerings as they will depend upon market conditions and other factors. EFFECTS OF INTEREST RATE CHANGES The Company invests in adjustable-rate mortgage assets that are typically subject to periodic and lifetime interest rate caps that limit the amount an adjustable-rate mortgage asset's interest rate can change during any given period, as well as the minimum rate payable. The Company's borrowings will not be subject to similar restrictions. Hence, in a period of increasing interest rates, interest rates on its borrowings could increase without limitation by caps, while the interest rates on its mortgage assets are generally limited by caps. This problem will be magnified to the extent the Company acquires mortgage assets that are not fully indexed. Further, some adjustable-rate mortgage assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in receipt by the Company of less cash income on its adjustable-rate mortgage assets than is required to pay interest on the related borrowings. These factors could lower the Company's net interest income or cause a net loss during periods of rising interest rates, which would negatively impact the Company's financial condition, cash flows and results of operations. The Company intends to fund 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- 22 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. The Company also invests in fixed-rate mortgage assets that are expected to be funded with short-term borrowings. During periods of rising interest rates, the borrowing costs associated with funding such fixed-rate assets are subject to increase while the income earned on such assets may remain substantially unchanged. This would result in a narrowing of the net interest spread between the related assets and borrowings and may even result in losses. The Company may enter into derivative transactions seeking to mitigate the negative impact of a rising interest rate environment. Hedging techniques will be based, in part, on assumed levels of prepayments of the Company's mortgage assets. If prepayments are slower or faster than assumed, the life of the mortgage assets will be longer or shorter which would reduce the effectiveness of the Company's hedging techniques and may result in losses on such transactions. Hedging techniques involving the use of derivative securities are highly complex and may produce volatile returns. The hedging activity of the Company will also be limited by the asset and sources of income requirements applicable to the Company as a REIT. The Company's current allocation to fixed-rate mortgage assets was 93.5% at September 30, 1998. The Company may increase or decrease this allocation as market conditions warrant. As mentioned above, there are certain risks associated with investing in fixed-rate mortgage assets in combination with hedging instruments. The two main risks the Company faces are that of extension risk and prepayment risk. 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 may 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. 23 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 At the 1998 Annual Meeting of Shareholders held July 1, 1998 shareholders of record as of April 30, 1998 ratified the selection of Deloitte & Touche LLP as the Company's independent auditors. In total, 6,342,792 shares were voted for the proposal, 15,365 shares were voted against the proposal, no shares were withheld, 21,150 shares abstained and no shares were broker non-votes. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits Exhibit #27 Financial Data Schedule (b) Reports on Form 8-K None 24 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: November 12, 1998 By: /s/ Philip A. Barach ----------------------------------- Philip A. Barach President and Chief Executive Officer (Principal Executive Officer) By: /s/ Daniel K. Osborne ----------------------------------- Daniel K. Osborne Executive Vice President Chief Operating Officer Chief Financial Officer (Principal Accounting Officer) 25 EX-27 2 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION OF THE REGISTRANT AS OF SEPTEMBER 30, 1998 AND THE CONSOLIDATED STATEMENTS OF OPERATIONS OF THE REGISTRANT FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1998 JUL-01-1998 SEP-30-1998 5,570 889,908 5,384 0 0 652 0 0 911,220 817,010 0 0 0 67 94,210 967,063 0 13,828 0 0 572 0 11,271 1,992 0 1,992 0 0 0 1,992 0.33 0.33
-----END PRIVACY-ENHANCED MESSAGE-----