**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

**FORM 10-Q**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

 

**                For the quarterly period ended:        MARCH 31, 2002**

 

**OR**

 
| **o** |   | **TRANSITION REPORT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------|--------------------------------------------------------------------------------------|

 

**                For thetransition period from                     to                 **

 

 

**Commission File Number: 001-13637**

 

**APEX MORTGAGE CAPITAL, INC.**

(Exact name of Registrantas specified in its Charter)

** **

| **Maryland**                                                    |   | **95-4650863**                                |
|-----------------------------------------------------------------|--------|-----------------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   |  (I.R.S. Employer Identification Number) |
|                                                            |   |                                          |
| **865 South Figueroa Street****Los Angeles, California**        |   | **90017**                                     |
| (Address of principal  executive offices)                       |   | (Zip Code)                                    |

 

Registrant’stelephone number, including area code **(213) 244-0000**

 

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

                Yes ý    No o

 

**APPLICABLE ONLY TO CORPORATE ISSUERS:**

 

 

 

Indicate the number ofshares outstanding of the issuer’s classes of common stock, as of the lastpracticable date.

 
| Common Stock ($0.01 par value) |   | 24,797,000 as of  May  10, 2002 |
|--------------------------------|--------|--------------------------------------|

 

----

**APEXMORTGAGE CAPITAL, INC.**

**FORM10-Q**

** **

**INDEX**

** **

 

 
| **PART I. FINANCIAL INFORMATION**    |
|--------------------------------------|
|                                 |   |
| Item 1.                              | Financial Statements |
|                                 |   |
|                                 |   | Balance Sheets at March 31, 2002  (unaudited) and December 31, 2001 |
|                                 |   |   |
|                                 |   | Statements of Operations for  the three months ended March 31, 2002 and March 31, 2001 (unaudited) |
|                                 |   |   |
|                                 |   | Statements of  Stockholders’ Equity for the three months ended March 31, 2002 (unaudited) |
|                                 |   |   |
|                                 |   | Statements of Cash Flows for  the quarters ended March 31, 2002 and March 31, 2001 (unaudited) |
|                                 |   |   |
|                                 |   | Notes to Financial  Statements (unaudited) |
|                                 |   |
| Item  2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                 |   |
| Item  3.                             | Quantitative  and Qualitative Disclosures about Market Risk |
|                                 |   |
| **PART II.  OTHER INFORMATION** |
|                                 |   |   |
| Item 1.                              |  Legal Proceedings |   |
|                                 |   |   |
| Item 2.                         | Changes in Securities |   |
|                                 |   |   |
| Item 3.                         | Defaults upon Senior  Securities |   |
|                                 |   |   |
| Item  4                         | Submission  of Matters to a Vote of Security Holders |   |
|                                 |   |   |
| Item  5.                        | Other  Information |   |
|                                 |   |   |
| Item 6.                         | Exhibits and Reports  on Form 8-K |   |
|                                 |   |   |
| Signatures                           |   |   |
|                                      |  |  |  |

 

 

 

 

2

----

 

**PART I. FINANCIAL INFORMATION**

** **

**Item 1.  Financial Statements**

 
| **Apex Mortgage Capital, Inc.** |
|---------------------------------|
|                            |
| **Balance Sheets**              |
| **(Unaudited)**                 |

 
|                                                                                                                                |   | **March 31, 2002** |          | **December 31, 2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------------|-----------------------|--------|
| **Assets**                                                                                                                          |   |               |          |                  |   |
|                                                                                                                                |   |               |          |                  |   |
| Cash and cash  equivalents                                                                                                          |   | $                  | 7,432,000     |                  | $      | 4,330,000 |   |
| Fixed income  trading securities, at fair value (Note 3)                                                                            |   | 703,973,000        |          | 437,954,000           |   |
| Fixed income  securities available-for-sale, at fair value (Note 3)                                                                 |   | 1,741,696,000      |          | 1,067,575,000         |   |
| Equity  securities available-for-sale, at fair value (Note 3)                                                                       |   | 4,882,000          |          | 6,028,000             |   |
| Forward  contracts, at fair value (Note 5)                                                                                          |   | 2,860,000          |          | —                |   |
| Interest rate  swaps, at fair value (Note 5)                                                                                        |   | 22,107,000         |          | 4,620,000             |   |
| Accrued interest  receivable                                                                                                        |   | 14,302,000         |          | 8,580,000             |   |
| Principal  payments receivable                                                                                                      |   | 424,000            |          | 485,000               |   |
| Receivable for  unsettled securities                                                                                                |   | 100,199,000        |          | 5,520,000             |   |
| Other assets                                                                                                                        |   | 442,000            |          | 333,000               |   |
|                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                |   | $                  | 2,598,317,000 |                  | $      | 1,535,425,000 |   |
|                                                                                                                                |   |               |          |                  |   |
| **Liabilities  and Stockholders’ Equity**                                                                                      |   |               |          |                  |   |
|                                                                                                                                |   |               |          |                  |   |
| Liabilities                                                                                                                         |   |               |          |                  |   |
|                                                                                                                                |   |               |          |                  |   |
| Reverse  repurchase agreements (Note 4)                                                                                             |   | $                  | 2,351,750,000 |                  | $      | 1,376,850,000 |   |
| Accrued interest  payable                                                                                                           |   | 2,674,000          |          | 975,000               |   |
| Dividend payable                                                                                                                    |   | 12,476,000         |          | 12,596,000            |   |
| Forward  contracts, at fair value (Note 5)                                                                                          |   | —             |          | 3,275,000             |   |
| Accrued expenses  and other liabilities                                                                                             |   | 16,914,000         |          | 11,699,000            |   |
|                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                |   | 2,383,814,000      |          | 1,405,395,000         |   |
|                                                                                                                                |   |               |          |                  |   |
| 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 sharesauthorized; 24,762,000 (2002) and 15,555,500 (2001)  shares outstanding |   | 248,000            |          | 155,000               |   |
| Additional  paid-in-capital                                                                                                         |   | 267,531,000        |          | 175,802,000           |   |
| Accumulated  other comprehensive loss                                                                                               |   | (12,438,000        | )             | (7,837,000            | )      |
| Accumulated  deficit                                                                                                                |   | (40,838,000        | )             | (38,090,000           | )      |
|                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                |   | 214,503,000        |          | 130,030,000           |   |
|                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                |   | $                  | 2,598,317,000 |                  | $      | 1,535,425,000 |   |
|                                                                                                                                |   |               |          |                  |   |
| See accompanying  notes to financial statements                                                                                     |   |               |          |                  |   |

 

 

3

----

 
| **Apex Mortgage Capital, Inc.** |
|---------------------------------|
|                            |
| **Statements of Operations**    |
| **(Unaudited)**                 |

 
|                                                               |   | **Three Months**   |       | **Three Months**   |   |
|--------------------------------------------------------------------|--------|--------------------|------------|--------------------|--------|
|                                                               |   | **Ended**          |       | **Ended**          |   |
|                                                               |   | **March 31, 2002** |       | **March 31, 2001** |   |
|                                                               |   |               |       |               |   |
| **Interest  Income:**                                              |   |               |       |               |   |
| Fixed income  securities                                           |   | $                  | 27,254,000 |               | $      | 10,978,000 |   |
| Cash and cash  equivalents                                         |   | 55,000             |       | 42,000             |   |
|                                                               |   |               |       |               |   |
| Total interest  income                                             |   | 27,309,000         |       | 11,020,000         |   |
| **Interest  Expense**                                              |   | 12,705,000         |       | 7,076,000          |   |
|                                                               |   |               |       |               |   |
| **Net  Interest Income**                                           |   | 14,604,000         |       | 3,944,000          |   |
|                                                               |   |               |       |               |   |
| **Dividend  Income**                                               |   | 126,000            |       | 188,000            |   |
|                                                               |   |               |       |               |   |
| **Operating  Income Before General and Administrative Expenses**   |   | 14,730,000         |       | 4,132,000          |   |
|                                                               |   |               |       |               |   |
| **General  and Administrative Expenses:**                          |   |               |       |               |   |
| Management fee                                                     |   | 319,000            |       | 88,000             |   |
| Incentive fee                                                      |   | 2,650,000          |       | —             |   |
| Insurance                                                          |   | 83,000             |       | 83,000             |   |
| Professional  fees                                                 |   | 27,000             |       | 23,000             |   |
| Directors’ fees                                               |   | 22,000             |       | 15,000             |   |
| Non-employee stock  options                                        |   | 27,000             |       | 1,000              |   |
| Other                                                              |   | 170,000            |       | 59,000             |   |
|                                                               |   |               |       |               |   |
| Total general  and administrative expense                          |   | 3,298,000          |       | 269,000            |   |
|                                                               |   |               |       |               |   |
| **Operating  Income, Net of General and Administrative Expenses**  |   | 11,432,000         |       | 3,863,000          |   |
|                                                               |   |               |       |               |   |
| **Net  (Loss) from Investment and Derivative Activities (Note 3)** |   | (1,704,000         | )          | (2,458,000         | )      |
|                                                               |   |               |       |               |   |
| **Reclassification  of Previously Unrealized Gains**               |   | —             |       | 1,742,000          |   |
|                                                               |   |               |       |               |   |
| **Net  Income Before Cumulative Effect of**                        |   |               |       |               |   |
| **Change  in Accounting Principle**                                |   | 9,728,000          |       | 3,147,000          |   |
|                                                               |   |               |       |               |   |
| **Cumulative  Effect of Change in Accounting Principle**           |   | —             |       | (2,173,000         | )      |
|                                                               |   |               |       |               |   |
| **Net  Income**                                                    |   | $                  | 9,728,000  |               | $      | 974,000 |   |
|                                                               |   |               |       |               |   |
| **Net  Income Per Share Before Cumulative Effect of**              |   |               |       |               |   |
| **Change  in Accounting Principle:**                               |   |               |       |               |   |
| Basic                                                              |   | $                  | 0.53       |               | $      | 0.55 |   |
| Diluted                                                            |   | $                  | 0.53       |               | $      | 0.54 |   |
|                                                               |   |               |       |               |   |
| **Effect  of Accounting Change Per Share:**                        |   |               |       |               |   |
| Basic                                                              |   | $                  | —     |               | $      | (0.38 | ) |
| Diluted                                                            |   | $                  | —     |               | $      | (0.37 | ) |
|                                                               |   |               |       |               |   |
| **Net  Income Per Share:**                                         |   |               |       |               |   |
| Basic                                                              |   | $                  | 0.53       |               | $      | 0.17 |   |
| Diluted                                                            |   | $                  | 0.53       |               | $      | 0.17 |   |
|                                                               |   |               |       |               |   |
| **Weighted  Average Number of Shares Outstanding:**                |   |               |       |               |   |
| Basic                                                              |   | 18,315,861         |       | 5,753,000          |   |
| Diluted                                                            |   | 18,427,683         |       | 5,783,000          |   |
|                                                               |   |               |       |               |   |
| See accompanying  notes to financial statements                    |   |               |       |               |   |

 

 

4

----

 
| **Apex Mortgage Capital, Inc.**            |
|--------------------------------------------|
|                                       |
| **Statement of Stockholders’ Equity** |
| **(Unaudited)**                            |

 
|                                                                              |   |              |   |        |    |              |   | **Accumulated**    |   |                   |        |              |   |                 |      |
|-----------------------------------------------------------------------------------|--------|-------------------|--------|-------------|---------|-------------------|--------|--------------------|--------|------------------------|-------------|-------------------|--------|----------------------|-----------|
|                                                                              |   |              |   |        |    | **Additional**    |   | **Other**          |   |                   |        | **Total**         |   |                 |      |
|                                                                              |   | **Common  Stock** |   | **Paid-in** |    | **Comprehensive** |   | **Accumulated**    |   | **Stockholders’** |        | **Comprehensive** |   |
|                                                                              |   | **Shares**        |   | **Amount**  |    | **Capital**       |   | **Income  (Loss)** |   | **Deficit**            |        | **Equity**        |   | **Income /  (Loss)** |      |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Balance, December 31, 2001**                                                    |   | 15,555,500        |   | $           | 155,000 |              | $      | 175,802,000        |   | $                      | (7,837,000  | )                 | $      | (38,090,000          | )         | $ | 130,030,000 |   |   |   |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Issuance of common stock**                                                      |   | 9,206,500         |   | 93,000      |    | 91,702,000        |   | —             |   | —                 |        | 91,795,000        |   |                 |      |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Issuance of stock options****to non-employees**                                 |   | —            |   | —      |    | 27,000            |   | —             |   | —                 |        | 27,000            |   |                 |      |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Net income**                                                                    |   | —            |   | —      |    | —            |   | —             |   | 9,728,000              |        | 9,728,000         |   | $                    | 9,728,000 |   |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Other comprehensive income (loss):**                                            |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| Net change in unrealized(loss) on available-for-salesecurities                    |   | —            |   | —      |    | —            |   | (21,967,000        | )      | —                 |        | (21,967,000       | )      | (21,967,000          | )         |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| Net change in deferred gainon terminated interest rateswaps                       |   | —            |   | —      |    | —            |   | (121,000           | )      | —                 |        | (121,000          | )      | (121,000             | )         |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| Net change in unrealized gain oninterest rate swaps classifiedas cash flow hedges |   | —            |   | —      |    | —            |   | 17,487,000         |   | —                 |        | 17,487,000        |   | 17,487,000           |      |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Comprehensive income**                                                          |   |              |   |        |    |              |   |               |   |                   |        |              |   | $                    | 5,127,000 |   |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Dividends declared**                                                            |   | —            |   | —      |    | —            |   | —             |   | (12,476,000            | )           | (12,476,000       | )      |                 |      |
|                                                                              |   |              |   |        |    |              |   |               |   |                   |        |              |   |                 |      |
| **Balance, March 31, 2002**                                                       |   | 24,762,000        |   | $           | 248,000 |              | $      | 267,531,000        |   | $                      | (12,438,000 | )                 | $      | (40,838,000          | )         | $ | 214,503,000 |   |   |   |

 
| See accompanying notes to financial statements |   |   |   |   |   |   |   |
|------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|

 

 

5

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| **Apex Mortgage Capital, Inc.** |
|---------------------------------|
|                            |
| **Statements of Cash Flows**    |
| **(Unaudited)**                 |

 
|                                                                              |   | **For the Quarter** |       | **For the Quarter** |   |
|-----------------------------------------------------------------------------------|--------|---------------------|------------|---------------------|--------|
|                                                                              |   | **Ended**           |       | **Ended**           |   |
|                                                                              |   | **March 31, 2002**  |       | **March 31, 2001**  |   |
|                                                                              |   |                |       |                |   |
| **Operating  Activities:**                                                        |   |                |       |                |   |
| Net income                                                                        |   | $                   | 9,728,000  |                | $      | 974,000 |   |
| Adjustments to  reconcile net income to net cashprovided by operating activities: |   |                |       |                |   |
| Amortization                                                                      |   | (81,000             | )          | (1,730,000          | )      |
| Net loss on  investment and derivative activities                                 |   | 1,704,000           |       | 2,458,000           |   |
| Cumulative  effect of change in accounting principle                              |   | —              |       | 2,173,000           |   |
| Reclassification  of previously unrealized gains                                  |   | —              |       | (1,742,000          | )      |
| Trading  activities                                                               |   | (273,846,000        | )          | (6,336,000          | )      |
| Change in assets  and liabilities:                                                |   |                |       |                |   |
| Accrued interest  receivable                                                      |   | (5,722,000          | )          | (9,000              | )      |
| Other assets                                                                      |   | (109,000            | )          | 75,000              |   |
| Accrued interest  payable                                                         |   | 1,699,000           |       | 83,000              |   |
| Accrued expenses  and other liabilities                                           |   | 5,215,000           |       | (125,000            | )      |
| Net cash (used  in) operating activities                                          |   | (261,412,000        | )          | (4,179,000          | )      |
|                                                                              |   |                |       |                |   |
| **Investing  Activities:**                                                        |   |                |       |                |   |
| Purchase of  fixed income securities available-for sale                           |   | (810,655,000        | )          | —              |   |
| Proceeds from  sales of fixed income securities available-for-sale                |   | 5,520,000           |       | —              |   |
| Proceeds from  sales of equity securities                                         |   | 1,117,000           |       | —              |   |
| Principal  payments on fixed income securities available-for-sale                 |   | 14,374,000          |       | —              |   |
| Net cash (used  in) investing activities                                          |   | (789,644,000        | )          | —              |   |
|                                                                              |   |                |       |                |   |
| **Financing  Activities:**                                                        |   |                |       |                |   |
| Net change in  reverse repurchase agreements                                      |   | 974,900,000         |       | 10,313,000          |   |
| Dividend  distributions                                                           |   | (12,537,000         | )          | (2,035,000          | )      |
| Issuance of  common stock                                                         |   | 91,795,000          |       | —              |   |
| Net cash  provided by financing activities                                        |   | 1,054,158,000       |       | 8,278,000           |   |
|                                                                              |   |                |       |                |   |
| **Net  Increase in Cash and Cash Equivalents**                                    |   | 3,102,000           |       | 4,099,000           |   |
|                                                                              |   |                |       |                |   |
| **Cash  and Cash Equivalents at Beginning of Period**                             |   | 4,330,000           |       | 140,000             |   |
|                                                                              |   |                |       |                |   |
| **Cash  and Cash Equivalents at End of Period**                                   |   | $                   | 7,432,000  |                | $      | 4,239,000 |   |
|                                                                              |   |                |       |                |   |
| **Supplemental  Disclosure of Cash Flow Information:**                            |   |                |       |                |   |
| Cash paid for  interest                                                           |   | $                   | 11,006,375 |                | $      | 8,146,000 |   |
| Noncash  investing and financing activities:                                      |   |                |       |                |   |
|                                                                              |   |                |       |                |   |
| Change in  accumulated other comprehensive income                                 |   | (4,601,000          | )          | 4,275,000           |   |
|                                                                              |   |                |       |                |   |
| Change in  principal payments receivable                                          |   | 61,000              |       | 288,000             |   |
|                                                                              |   |                |       |                |   |
| Change in receivable  for unsettled securities                                    |   | (94,679,000         | )          | —              |   |
|                                                                              |   |                |       |                |   |
| Change in  dividends declared, not yet paid                                       |   | (120,000            | )          | 2,111,000           |   |

 
| See accompanying  notes to financial statements |   |   |   |   |   |
|-------------------------------------------------|--------|--------|--------|--------|--------|

 

6

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**Apex Mortgage Capital, Inc.**

**Notes to FinancialStatements**

**(Unaudited)**

 

# **Note 1 - The Company**

 

Apex MortgageCapital, Inc. (the “Company”) was incorporated in Maryland on September 15,1997.  The Company commenced itsoperations of acquiring and managing a portfolio of mortgage-related assets onDecember 9, 1997, upon receipt of the net proceeds from the initial publicoffering of the Company’s common stock. The Company uses its equity capital and borrowed funds to seek togenerate income based on the difference between the yield on its investmentsand the cost of its borrowings.  TheCompany is structured for tax purposes as a real estate investment trust(“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”).

 

The Company has enteredinto a Management Agreement (the “Management Agreement”), as amended, with TCWInvestment Management Company (the “Manager”), a wholly owned subsidiary of TheTCW Group, Inc., under which the Manager manages the Company’s day-to-dayoperations, subject to the direction and oversight of the Company’s Board ofDirectors.

 

 

# **Note 2 - Summary of Significant Accounting Policies and Certain Risks**

 

*Overview*

Certain information andnote disclosures normally included in annual financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”) have been condensed or omitted pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) for interimfinancial statements. The unaudited financial statements should be read inconjunction with the audited financial statements and notes thereto included inthe Company’s Annual Report on Form 10-K for the year ended December 31,2001.  The accounting policies used inthe preparation of these interim financial statements were consistent withthose used in the preparation of the financial statements for the year endedDecember 31, 2001, unless otherwise noted.  Certain reclassifications may have been made to the prior periodfinancial statements to conform to the current period presentation.

## ***Derivatives andHedging Transactions***

 

The Company may enterinto interest rate swaps and other financial instruments in order to mitigatethe impact of rising interest rates on the cost of its short-termborrowings.  The Company may also enterinto forward contracts to sell U.S. Treasury securities and other financialinstruments in order to mitigate the negative impact of rising interest rateson the fair value of its fixed income securities.   Such financial instruments are generally referred to as“derivatives.”

 

The Company adopted SFASNo. 133, *Accountingfor Derivative Instruments and Hedging Activities*, as amended, onJanuary 1, 2001.  Prior to adopting SFASNo. 133, the Company accounted for changes in fair values of the forwardcontracts through adjustments to accumulated other comprehensive income(loss).  Following adoption of SFAS No.133, the Company recognizes changes in fair values of forward contracts as acomponent of net gain (loss) on investment and derivative activities in thestatements of operations.

 

Under SFAS No. 133, allderivatives are recorded at fair value and presented as either assets orliabilities on the Company’s balance sheets. As of March 31, 2002, the Company has interest rate swaps that qualifyas cash flow hedges under SFAS No. 133. Changes in fair values of the swaps are not reflected in currentearnings, but are reflected in other comprehensive income.  To the extent changes in the fair value ofthe cash flow hedges are deemed to be due to ineffectiveness of the hedges,such changes are reflected in net gain (loss) on investment and derivativeactivities in the statements of operations. However, the Company’s swaps outstanding at March 31, 2002 are deemed tobe fully effective as hedges.

 

 

7

----

 

**Note 3 — Fixed Income and EquitySecurities**

 

At March 31, 2002, fixedincome and equity securities consisted of the following:

 
|                           |   |                   |    | **Fixed Income**       |   |                   |   |
|--------------------------------|--------|------------------------|---------|------------------------|--------|------------------------|--------|
| **(in thousands)**             |   | **Fixed Income**       |    | **Securities**         |   | **Equity Securities**  |   |
|                           |   | **Trading Securities** |    | **Available-For-Sale** |   | **Available-For-Sale** |   |
| Principal Amount               |   | $                      | 703,229 |                   | $      | 1,759,259              |   | $ | 4,370 |   |
| Unamortized Premium (Discount) |   | (6,363                 | )       | 18,513                 |   | (958                   | )      |
| Adjusted Cost                  |   | 696,866                |    | 1,777,772              |   | 3,412                  |   |
| Gross Unrealized Gains         |   | 12,547                 |    | —                 |   | 1,470                  |   |
| Gross Unrealized Losses        |   | (5,440                 | )       | (36,076                | )      | —                 |   |
| Fair Value                     |   | $                      | 703,973 |                   | $      | 1,741,696              |   | $ | 4,882 |   |

 

 

 

At December 31, 2001,fixed income and equity securities consisted of the following:

 
|                           |   |                   |    | **Fixed Income**       |   |                   |   |
|--------------------------------|--------|------------------------|---------|------------------------|--------|------------------------|--------|
|                           |   | **Fixed  Income** |    | **Securities**         |   | **Equity Securities**  |   |
| **(in thousands)**             |   | **Trading Securities** |    | **Available-For-Sale** |   | **Available-For-Sale** |   |
| Principal Amount               |   | $                      | 432,630 |                   | $      | 1,071,009              |   | $ | 5,145 |   |
| Unamortized Premium (Discount) |   | (9,266                 | )       | 11,044                 |   | (958                   | )      |
| Adjusted Cost                  |   | 423,364                |    | 1,082,053              |   | 4,187                  |   |
| Gross Unrealized Gains         |   | 14,725                 |    | 180                    |   | 1,841                  |   |
| Gross Unrealized Losses        |   | (135                   | )       | (14,658                | )      | —                 |   |
| Fair Value                     |   | $                      | 437,954 |                   | $      | 1,067,575              |   | $ | 6,028 |   |

 

 

The contractual finalmaturity of the mortgage loans supporting fixed income mortgage securities isgenerally between 15 and 30 years at origination.  Because of prepayments on the underlying mortgage loans, theactual weighted-average maturity is expected to be substantially less.  Fixed-rate mortgage securities composed over98% of the Company’s portfolio of fixed income securities at March 31, 2002 andDecember 31, 2001.  The expected averageremaining maturity of the Company’s other fixed income securities at March 31,2002 and December 31, 2001 was less than one year.

 

Adjustable-rate mortgagesecurities composed approximately 0.6% and 1.1% of the Company’s portfolio offixed income securities at March 31, 2002 and December 31, 2001,respectively.  A portion of theadjustable-rate mortgage securities in the Company’s portfolio are backed byloans subject to periodic and lifetime caps that limit the amount thesecurities’ effective interest rates can change during any given period andover the lives of the assets.  At March31, 2002 and December 31, 2001, the portion of adjustable-rate mortgagesecurities subject to periodic and lifetime caps had an average periodic capequal to 2.0% per annum and an average lifetime cap equal to 11.3%.

 

During the quarter endedMarch 31, 2002, the Company reported a net loss on investment and derivativeactivities of $1,704,000 in the statement of operations.  This loss consisted of a net loss of$481,000 on closed forward contracts, a loss of $232,000 on the sale of$99,881,000 of fixed income securities classified as available-for-sale, a gainof $17,000 on the sale of $6,535,000 of fixed income trading securities, a gainof $341,000 on the sale of $1,117,000 of equity securities available-for-sale,and an unrealized loss of $1,349,000 on fixed income trading securities.

 

8

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During the quarter endedMarch 31, 2001, the Company reported a net loss on investment and derivativeactivities of $2,458,000 in the statement of operations.  This loss was the result of  $9,082,000 in losses on closed forwardcontracts, $3,444,000 in gains on the sale of $142,809,000 of fixed incometrading securities and reported gains of $3,180,000 from the net increase infair market value of fixed income trading securities.

 

 

# **Note 4 - Reverse RepurchaseAgreements**

 

The Company has enteredinto reverse repurchase agreements to finance certain of its investments.  These agreements are secured by a portion ofthe Company’s investments and bear interest rates that have historically movedin close relationship to LIBOR.

 

At March 31, 2002, theCompany had outstanding $2,351,750,000 of reverse repurchase agreements with aweighted average current borrowing rate of 1.87% and a maturity of 1.0month.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$2,432,624,000.

At December 31, 2001, theCompany had outstanding $1,376,850,000 of reverse repurchase agreements with aweighted average current borrowing rate of 1.89% and a maturity of 1.0months.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$1,440,014,000.

# ** **

# **Note 5 — Derivative FinancialInstruments and Hedging Activities**

 

The Company has enteredinto interest rate swap agreements as summarized below.  Under these agreements, the Company receivesa floating rate and pays a fixed rate. The swaps qualify as cash flow hedges for accounting purposes, andeffectively fix the interest rate paid on $1,500,000,000, as of March 31, 2002,of current and anticipated future borrowings under reverse repurchaseagreements.

 

Interest Rate Swaps atMarch 31, 2002:

 
|                      |   |           |   |               |   | **Average**     |   | **Unrealized** |   |
|---------------------------|--------|----------------|--------|--------------------|--------|-----------------|--------|----------------|--------|
| **Current**               |   | **Average**    |   |               |   | **Termination** |   | **Gains**      |   |
| **Notional Amount (000)** |   | **Fixed Rate** |   | **Floating  Rate** |   | **Date**        |   | **(000)**      |   |
|                      |   |           |   |               |   |            |   |           |   |
| $1,500,000                |   | 4.374%         |   | 1Mo LIBOR          |   | 12/7/2007       |   | $22,107        |   |
|                      |   |           |   |               |   |            |   |           |   |

 

 

Interest Rate Swaps atDecember 31, 2001:

 
|                      |   |           |   |               |   | **Average**     |   | **Unrealized** |   |
|---------------------------|--------|----------------|--------|--------------------|--------|-----------------|--------|----------------|--------|
| **Current**               |   | **Average**    |   |               |   | **Termination** |   | **Gains**      |   |
| **Notional Amount (000)** |   | **Fixed Rate** |   | **Floating  Rate** |   | **Date**        |   | **(000)**      |   |
|                      |   |           |   |               |   |            |   |           |   |
| $850,000                  |   | 4.239%         |   | 1Mo LIBOR          |   | 3/3/2008        |   | $4,620         |   |
|                      |   |           |   |               |   |            |   |           |   |

 

During the year endedDecember 31, 2000, the Company terminated outstanding interest rate swapagreements with a combined notional amount of $386,213,000, which resulted in adeferred gain of $5,554,000.  Thedeferred gain is being amortized as an adjustment to interest expense over theremaining lives of the original swap agreements, and the remaining unamortizedamount is included in accumulated other comprehensive income (loss) as ofDecember 31, 2001.   During the quartersended March 31, 2002 and 2001, $121,000 and $1,152,000, respectively, of thedeferred gain was amortized.  Theremaining deferred gain will be fully amortized by May 31, 2002.

 

At March 31, 2002, theCompany held $7,500,000 in cash as collateral from a swap counterparty.

 

9

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At December 31, 2001, theCompany held $2,500,000 in cash as collateral from a swap counterparty.

 

At March 31, 2002, theCompany had open forward contracts to sell U.S. Treasury notes with termsstated below:

 
| **Current**         |   | **Average**     |   | **Net  Unrealized** |   | **Average  Maturity of** |   |
|---------------------|--------|-----------------|--------|---------------------|--------|--------------------------|--------|
| **Notional Amount** |   | **Termination** |   | **Gains**           |   | **Underlying**           |   |
| **($000)**          |   | **Date**        |   | **($000)**          |   | **Securities**           |   |
|                |   |            |   |                |   |                     |   |
| $625,000            |   | 4/16/2002       |   | $2,860              |   | 5.45 Years               |   |

 

 

At December 31, 2001, theCompany had open forward contracts to sell U.S. Treasury notes with termsstated below:

 

 

 
| **Current**         |   | **Average**     |   | **Net  Unrealized** |   | **Average  Maturity of** |   |
|---------------------|--------|-----------------|--------|---------------------|--------|--------------------------|--------|
| **Notional Amount** |   | **Termination** |   | **Losses**          |   | **Underlying**           |   |
| **($000)**          |   | **Date**        |   | **($000)**          |   | **Securities**           |   |
|                |   |            |   |                |   |                     |   |
| $359,000            |   | 1/14/2002       |   | ($3,275)            |   | 5.57 Years               |   |
|                |   |            |   |                |   |                     |   |

 

 

# **Item2**.                                   MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with the financial statements and notes to thosestatements included elsewhere in this Quarterly Report on Form 10-Q and ouraudited financial statements for the year ended December 31, 2001 included inour Annual Report on Form 10-K previously filed with the SEC.*

 

**SAFE HARBOR/FORWARD LOOKING STATEMENTS**

 

Certain informationcontained in this Quarterly Report on Form 10-Q constitutes “forward-lookingstatements” which can be identified by the use of forward-looking terminologysuch as “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “intend,”“continue,” or “believes” or the negatives thereof or other variations thereonor comparable terminology.  Discussedbelow are some important factors that would cause actual results to differmaterially from those in any forward-looking statements, including changes ininterest rates; domestic and foreign business, market, financial or legalconditions; differences in the actual allocation of the assets of the Companyfrom those assumed; and the degree to which assets are hedged and theeffectiveness of the hedge, among others. In addition, the degree of risk is increased by the Company’s leveragingof its assets.  For additionaldiscussion of factors that could cause actual results to differ from thosecontained in such forward-looking statements, see “Principal Risks and SpecialConsiderations”, “Item 7 Management’s Discussion and Analysis of FinancialConditions and Results of Operations” and “Item 7A Quantitative and QualitativeDisclosures About Market Risk” in the Company’s annual report on Form 10-K forthe year ended December 31, 2001.  TheCompany does not undertake, and specifically disclaims any obligation, toupdate any forward-looking statements to reflect occurrences or unanticipatedevents or circumstances after the date of such statements.

 

 

10

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**GENERAL**

 

         ApexMortgage Capital, Inc.  (the‘‘Company’’), a Maryland corporation, was formed on September 15, 1997,primarily to acquire United States agency and other highly rated, single-familyreal estate adjustable and fixed rate mortgage related assets.  The Company commenced operations on December9, 1997 following the initial public offering of the Company’s CommonStock.  The Company’s principalexecutive offices are located at 865 South Figueroa Street, Suite 1800, LosAngeles, California 90017, and its telephone number is (213) 244-0000.

 

         The Company uses its equity capital and borrowed funds toseek to generate income based on the difference between the yield on itsmortgage related assets and the cost of its borrowings.  The Company has elected to be taxed as areal estate investment trust (‘‘REIT’’) under the Internal Revenue Code of1986, as amended (the ‘‘Code’’).  TheCompany will not generally be subject to federal taxes on its income to theextent that it distributes its net income to its stockholders and maintains itsqualification as a REIT.

 

         The day-to-day operations of the Company are managed by anexternal management company, TCW Investment Management Company (the “Manager”),subject to the direction and oversight of the Company’s Board ofDirectors.  A majority of the Board ofDirectors are unaffiliated with The TCW Group, Inc.  (‘‘TCW’’ and, together with its subsidiaries and affiliates, the‘‘TCW Group’’) or the Manager.  TheManager is a wholly-owned subsidiary of TCW. The Manager was established in 1987 and the TCW Group began operationsin 1971 through one of its affiliates. The Company’s investment management team are selected members of the TCWGroup’s Mortgage-Backed Securities Group (the ‘‘MBS Group’’), all of whom haveover thirteen years of experience in raising and managing mortgagecapital.  The Company has elected to beexternally managed by the Manager to take advantage of the existing operationalsystems, expertise and economies of scale associated with the Manager’s currentbusiness operations, among other reasons. The Manager’s key officers haveexperience in raising and managing mortgage capital, mortgage finance and thepurchase and administration of mortgage related assets.

 

 

**RECENT EVENTS**

 

 

                *DividendDeclaration*.  On February 19,2002, the Company’s Board of Directors declared a dividend distribution of$0.50 per common share.  The dividendwas paid on April 26, 2002, to stockholders of record on March 28, 2002.

 

                OnMarch 5, 2002, the Company issued 9,200,000 shares of common stock in a followon public offering.  The Companyreceived proceeds (net of underwriting discounts, commissions and otherexpenses) of $91,795,000 from this offering. The Company leveraged the new equity by entering into additional reverserepurchase agreements, and used the combined proceeds from the offering and thenew borrowings primarily to purchase additional mortgage-related securities.

 

                *ReportingPeriod*.  Unless otherwisenoted, this report describes the Company’s operations and developments throughthe date hereof.

 

 

 

 

**STRATEGY**

 

         Toachieve its business objective and generate dividend yields that provide acompetitive rate of return for its stockholders, the Company’s strategy is to:

 

•                  purchase primarily single-family fixed and adjustable rate mortgagerelated assets;

 

•                  manage the credit risk of its mortgage related assets through, amongother activities (i) carefully selecting mortgage related assets to beacquired, (ii) complying with the Company’s investment policy, (iii) activelymonitoring the ongoing credit quality and servicing of its mortgage relatedassets, and (iv) maintaining appropriate capital levels and allowances forpossible credit losses;

 

•                  finance purchases of mortgage related assets with the net proceeds ofequity offerings and, to the extent permitted by the Company’s leverage policy,to utilize leverage to increase potential returns to stockholders throughborrowings (primarily reverse repurchase agreements) with interest rates thatwill also reflect changes in short-term market interest rates;

 

•                  seek to structure its borrowings in accordance with its interest raterisk management policy;

 

•                  utilize interest rate swaps, forward contracts on U.S. Treasury notes, interestrate caps and similar financial instruments to mitigate interest rate risks;

 

•                  seek to minimize prepayment risk primarily by structuring a diversifiedportfolio with a variety of prepayment characteristics; and

•                  purchase equity and other securities issued by financial entities on anopportunistic basis.

 

11

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         Therecan be no assurance that the Company will be able to generate competitiveearnings and dividends while holding primarily high quality mortgage relatedassets and maintaining a disciplined risk-control profile.

 

         TheCompany may attempt to increase the return to stockholders over time by: (i)raising additional capital in order to increase its ability to invest inadditional mortgage related assets; (ii) lowering its effective borrowing coststhrough direct funding with collateralized lenders, in addition to using WallStreet intermediaries, and investigating the possibility of usingcollateralized commercial paper and medium-term note programs; and (iii)improving the efficiency of its balance sheet structure by issuinguncollateralized subordinated debt and other forms of capital.

 

 

 

**THEMANAGEMENT AGREEMENT**

 

         TheCompany has renewed its Management Agreement with the Manager for a one yearterm ending on December 31, 2002.  TheManager is primarily involved in two activities: (i) asset/liabilitymanagement—acquisition, financing, hedging, management and disposition ofmortgage related assets, including credit and prepayment risk management; and(ii) capital management—oversight of the Company’s structuring, analysis,capital raising and investor relations activities.  In conducting these activities, the Manager formulates operatingstrategies for the Company, arranges for the acquisition of mortgage relatedassets by the Company, arranges for various types of financing for the Company,monitors the performance of the Company’s mortgage related assets and providescertain administrative and managerial services in connection with the operationof the Company.  The Manager is requiredto manage the business affairs of the Company in conformity with the policiesthat are approved and monitored by the Company’s Board of Directors.  The Manager is required to prepare regularreports for the Company’s Board of Directors that will review the Company’sacquisitions of mortgage related assets, portfolio composition andcharacteristics, credit quality, performance and compliance with the policiesapproved by the Company’s Board of Directors.

 

         At alltimes, the Manager is subject to the direction and oversight of the Company’sBoard of Directors and has only such functions and authority as the Companydelegates to it.  The Manager isresponsible for the day-to-day operations of the Company.

 

         TheManagement Agreement may be renewed for additional one-year terms at thediscretion of the unaffiliated directors, unless previously terminated by theCompany or the Manager upon written notice. Except in the case of a termination or non-renewal by the Company forcause, upon termination or non-renewal of the Management Agreement by theCompany, the Company is obligated to pay the Manager a termination ornon-renewal fee, which may be significant. The termination or non-renewal fee shall be equal to the fair marketvalue of the Management Agreement without regard to the Company’s terminationright, as determined by an independent appraisal.  The selection of the independent appraiser shall be subject tothe approval of the unaffiliated directors. Neither the fair market value of the Management Agreement nor thevarious factors which the appraiser may find relevant in its determination ofthe fair market value can be determined at this time.

 

         The fairmarket value of the Management Agreement will be affected by significantvariables, including (i) the historical management fees paid to the Manager,(ii) any projections of future management fees to be paid to the Managerdetermined by the independent appraiser, (iii) the relative valuations ofagreements similar to the Management Agreement and (iv) other factors, all ofwhich may be unrelated to the performance of the Manager.

 

         TheManagement Agreement may be assigned by the Manager to an affiliate of TCWwithout the consent of the Company.  TheManagement Agreement may be assigned to a non-affiliate of TCW only with theapproval of a majority of the unaffiliated directors.

 

 

**Manager Compensation**

 

         TheManager will receive annual base management compensation based on the AverageNet Invested Capital of the Company, payable monthly in arrears, equal to 3/4of 1% of Average Net Invested Capital.  The term “Average Net Invested Capital” means themonth end sum of (1) the Company’s total stockholders’ equity computed inaccordance with generally accepted accounting principles plus (2) any unsecureddebt that has been approved for inclusion by the 

 

12

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unaffiliated directors atissuance plus or minus (3) an adjustment to exclude the impact of anyunrealized gains, losses or other items that do not affect realized net income. Accordingly, incurring collateralized debt to finance specificinvestment purchases does not ordinarily increase Average Net Invested Capital.

 

         TheManager shall also be entitled to receive as incentive compensation for eachfiscal quarter, an amount equal to 30% of the Net Income of the Company, beforeincentive compensation, in excess of the amount that would produce anannualized Return on Equity equal to the Ten-Year U.S. Treasury Rate plus 1%.  The incentive compensation calculation andpayment will be made quarterly in arrears. The term ‘‘Return on Equity’’ is calculated for any quarter by dividingthe Company’s Net Income for the quarter by its Average Net Worth for thequarter.  For purposes of calculatingthe incentive compensation payable, the definition ‘‘Return on Equity’’ is notrelated to the actual distributions received by stockholders or to anindividual investor’s actual return on investment.  For such calculations, the ‘‘Net Income’’ of the Company meansthe taxable income of the Company (including net capital gains, if any) beforethe Manager’s incentive compensation, net operating loss deductions arisingfrom losses in prior periods and deductions permitted by the Code incalculating taxable income for a REIT plus the effects of adjustments, if any,necessary to record hedging and interest transactions in accordance withgenerally accepted accounting principles. A deduction for all of the Company’s interest expenses for borrowedfunds is taken into account in calculating Net Income.  ‘‘Average Net Worth’’ for any period meansthe arithmetic average of the sum of the gross proceeds from any offering ofits equity securities by the Company, before deducting any underwritingdiscounts and commissions and other expenses and costs relating to theofferings, plus the Company’s retained earnings (without taking into accountany losses incurred in prior periods) computed by taking the average of suchvalues at the end of each month during such period, minus the cumulativeamounts paid by the Company to repurchase its shares.

 

         Theability of the Company to achieve an annualized Return on Equity in excess ofthe Ten-Year U.S.  Treasury Rate plus1%, and of the Manager to earn the incentive compensation described in thepreceding paragraph, is dependent upon the level and volatility of interestrates, the Company’s ability to react to changes in interest rates and toutilize successfully the operating strategies described herein, and otherfactors, many of which are not within the Company’s or the Manager’scontrol.  The Manager’s basecompensation shall be calculated by the Manager within 15 days after the end ofeach month, and such calculation shall be promptly delivered to theCompany.  The Company is obligated topay the base compensation within 30 days after the end of each month.  The Manager shall compute the quarterlyincentive compensation within 45 days after the end of each fiscal quarter, andthe Company shall pay the incentive compensation with respect to each fiscalquarter within 15 days following the delivery to the Company of the Manager’swritten statement setting forth the computation of the incentive compensationfor such quarter.  The Company’s Boardof Directors shall review and approve the calculation of base and incentivecompensations paid to the Manager quarterly, one quarter in arrears, duringeach scheduled quarterly Board of Directors meeting.  Quarterly incentive compensation is subject to an annualadjustment so that the incentive compensation is based on earnings for theentire year. The Company believes that this compensation arrangement benefitsits stockholders because it ties the Manager’s compensation to Return on Equityand, in periods of low earnings, the Manager’s incentive compensation isreduced or eliminated, thereby lowering the Company’s operating expenses.

 

 

####  

#### **POLICIES**

 

The Company’s currentinvestment policies are set forth in its Annual Report on Form 10-K for theyear ended December 31, 2001.

 

 

13

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**FINANCIAL CONDITION**

 

**FixedIncome Securities**

 

At March 31, 2002 andDecember 31, 2001, the Company held $2,445,669,000 and $1,505,529,000 of fixedincome securities, respectively.  Theoriginal maturity of a significant portion of the fixed income securitiesranges from fifteen to thirty years; the actual maturity is subject to changebased on the prepayments of the underlying mortgage loans.

 

The following table is aschedule of fixed income securities held listed by security type (dollars inthousands):

 
|                          |   | **March 31, 2002** |      | **December 31, 2001**    |   |
|-------------------------------|--------|--------------------|-----------|--------------------------|--------|
| **Fixed Income Securities**   |   | **Carrying Value** |      | **Percent of Portfolio** |   | **Carrying Value** |   | **Percent of Portfolio** |   |
|                          |   |               |      |                     |   |   |   |   |   |
| Mortgage Securities:          |   |               |      |                     |   |   |   |   |   |
| Adjustable Rate (1)           |   | $                  | 14,683    |                     | 0.60   | % | $ | 16,196 |   | 1.08 | % |
| Fixed Rate                    |   | 2,425,829          |      | 99.19                    | %      | 1,483,881 |   | 98.56 | % |
| Other Fixed Income Securities |   | 5,157              |      | 0.21                     | %      | 5,452 |   | 0.36 | % |
| Totals                        |   | $                  | 2,445,669 |                     | 100.00 | % | $ | 1,505,529 |   | 100.00 | % |

----

 (1)    AtMarch 31, 2002 and December 31, 2001, the interest rate indices for 98% and 2%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 showsvarious weighted average characteristics of the fixed income securities held bythe Company at March 31, 2002 (dollars in thousands):

 
|                          |   |           |      | **Par as a**   |   |           |   |       |   |        |   | **Weighted** |   |
|-------------------------------|--------|----------------|-----------|----------------|--------|----------------|--------|------------|--------|-------------|--------|--------------|--------|
|                          |   |           |      | **Percent of** |   | **Adjusted**   |   | **Market** |   | **Current** |   | **Average**  |   |
| **Security Type**             |   | **Par Amount** |      | **Category**   |   | **Cost Basis** |   | **Price**  |   | **Coupon**  |   | **Life (1)** |   |
|                          |   |           |      |           |   |           |   |       |   |        |   |         |   |
| 20 Year Agency Pass-throughs  |   | $              | 169,367   |           | 6.88   | %              | 96.88  | %          | 101.18 | %           | 6.50   | %            | 4.2    |   |
| 30 Year Agency Pass-throughs  |   | 2,196,370      |      | 89.19          | %      | 101.14         | %      | 99.32      | %      | 6.50        | %      | 8.1          |   |
| AAA CMOs                      |   | 71,914         |      | 2.92           | %      | 95.59          | %      | 101.56     | %      | 6.68        | %      | 3.2          |   |
| Total Fixed Rate Holdings     |   | 2,437,651      |      | 98.99          | %      | 100.68         | %      | 99.52      | %      | 6.50        | %      | 7.7          |   |
|                          |   |           |      |           |   |           |   |       |   |        |   |         |   |
| Other Fixed Income Securities |   | 10,400         |      | 0.42           | %      | 58.42          | %      | 49.59      | %      | 13.32       | %      | 0.5          |   |
| Adjustable Rate Holdings      |   | 14,437         |      | 0.59           | %      | 98.65          | %      | 101.71     | %      | 6.48        | %      | 1.0          |   |
|                          |   |           |      |           |   |           |   |       |   |        |   |         |   |
| Category Total                |   | $              | 2,462,488 |           | 100.00 | %              | 100.49 | %          | 99.32  | %           | 6.53   | %            | 7.6    |   |

 

 

 

 

14

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The following table showsvarious weighted average characteristics of the fixed income securities by theCompany at December 31, 2001 (dollars in thousands):

 
|                          |   |           |      | **Percent of** |   |           |   |       |   |        |   | **Weighted** |   |
|-------------------------------|--------|----------------|-----------|----------------|--------|----------------|--------|------------|--------|-------------|--------|--------------|--------|
|                          |   |           |      | **Total Par**  |   | **Adjusted**   |   | **Market** |   | **Current** |   | **Average**  |   |
| **Security Type**             |   | **Par Amount** |      | **Amount**     |   | **Cost Basis** |   | **Price**  |   | **Coupon**  |   | **Life (1)** |   |
|                          |   |           |      |           |   |           |   |       |   |        |   |         |   |
| 20 Year Agency Pass-throughs  |   | $              | 187,529   |           | 12.47  | %              | 97.09  | %          | 101.88 | %           | 6.50   | %            | 3.6    |   |
| 30 Year Agency Pass-throughs  |   | 1,203,215      |      | 80.02          | %      | 101.25         | %      | 100.15     | %      | 6.50        | %      | 6.8          |   |
| AAA CMOs                      |   | 86,600         |      | 5.76           | %      | 96.09          | %      | 101.38     | %      | 6.69        | %      | 2.5          |   |
| Total Fixed Rate Holdings     |   | 1,477,344      |      | 98.25          | %      | 100.42         | %      | 100.44     | %      | 6.51        | %      | 6.2          |   |
|                          |   |           |      |           |   |           |   |       |   |        |   |         |   |
| Other Fixed Income Securities |   | 10,400         |      | 0.69           | %      | 60.33          | %      | 52.42      | %      | 13.46       | %      | 0.8          |   |
| Adjustable Rate Holdings      |   | 15,895         |      | 1.06           | %      | 98.57          | %      | 101.89     | %      | 7.07        | %      | 1.0          |   |
|                          |   |           |      |           |   |           |   |       |   |        |   |         |   |
| Total Portfolio               |   | $              | 1,503,639 |           | 100.00 | %              | 100.12 | %          | 100.13 | %           | 6.56   | %            | 6.1    |   |

----

(1)  The weighted average life of the fixed ratemortgage securities is based upon market prepayment expectations as of thedates shown.  The actual weightedaverage life could be longer or shorter depending on the actual prepaymentrates experienced over the life of the securities.  The weighted average life shown for the adjustable rate mortgageassets represents the average time until the next coupon reset date.  All averages are shown in years.

 

 

### **EquitySecurities**

 

 

At March 31, 2002 andDecember 31, 2001 the Company held $4,882,000 and $6,028,000 of equitysecurities, respectively.  Equitysecurities consist primarily of investment in equities issued by other realestate investment trusts.

 

At March 31, 2002, equity securities consisted of the following:

                
| **(In thousands)**                      |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |   |
|-----------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|--------|
|                                    |   |            |   |              |   |           |   |
| Common Stock:                           |   |            |   |              |   |           |   |
| Dynex Capital, Inc.                     |   | 75              |   | $                 | 122    |           | $      | 264 |   |
| Total Common Stock                      |   |            |   | 122               |   | 264            |   |
|                                    |   |            |   |              |   |           |   |
| Convertible Preferred Stock:            |   |            |   |              |   |           |   |
| Capstead Mortgage Corporation, Series B |   | 388             |   | 3,290             |   | 4,618          |   |
| Total Convertible Preferred Stock       |   |            |   | 3,290             |   | 4,618          |   |
|                                    |   |            |   |              |   |           |   |
| Total Equity Securities                 |   |            |   | $                 | 3,412  |           | $      | 4,882 |   |

 

 

At December 31, 2001, equity securities consisted of the following:

                
| **(In thousands)**                      |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |   |
|-----------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|--------|
|                                    |   |            |   |              |   |           |   |
| Common Stock:                           |   |            |   |              |   |           |   |
| Dynex Capital, Inc.                     |   | 75              |   | $                 | 122    |           | $      | 158 |   |
| Total Common Stock                      |   |            |   | 122               |   | 158            |   |
|                                    |   |            |   |              |   |           |   |
| Convertible Preferred Stock:            |   |            |   |              |   |           |   |
| Capstead Mortgage Corporation, Series B |   | 480             |   | 4,065             |   | 5,870          |   |
| Total Convertible Preferred Stock       |   |            |   | 4,065             |   | 5,870          |   |
|                                    |   |            |   |              |   |           |   |
| Total Equity Securities                 |   |            |   | $                 | 4,187  |           | $      | 6,028 |   |

 

 

15

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**PRINCIPALRISKS AND SPECIAL CONSIDERATIONS**

 

 

         ***Leverage Risk****.*  The Company employs a leveraging strategy ofgenerally borrowing up to 92% of its total assets to finance the acquisition ofadditional mortgage related assets.  TheCompany’s borrowing may, at times, exceed 92% of its total assets.  In the event borrowing costs exceed theincome on its mortgage related assets, the Company will experience negativecash flow and incur losses. Another risk of leverage is the possibility thatthe value of the collateral securing the borrowings will decline.  In such event, additional collateral orrepayment of borrowings would be required. The Company could be required to sell mortgage related assets underadverse market conditions in order to maintain liquidity.  If these sales were made at prices lowerthan the carrying value of the mortgage related assets, the Company wouldexperience losses.

 

         ***Interest Rate Risk.***  There is the possibility that the value ofthe Company’s mortgage related assets may fall since fixed income securitiesgenerally fall when interest rates rise. The longer the term of a fixed income instrument, the more sensitive itwill be to fluctuations in value from interest rate changes.  Changes in interest rates may have asignificant effect on the Company’s operations, because it may hold mortgagerelated assets with long terms to maturity. Rising interest rates will negatively impact the Company’s borrowingssince the value of the collateral securing the borrowing will decline in value,requiring additional collateral or repayments of borrowing.  This could reduce the level of borrowingsand reduce returns.  Also, when interestrates rise, the Company’s holding of mortgage related assets can reduce returnsif the owners of the underlying mortgages pay-off their mortgages later thananticipated.  This is known as *extensionrisk*.  When interest ratesdrop, the Company’s holdings of the mortgage related assets can reduce returnsif the owners of the underlying mortgages pay off their mortgages sooner thananticipated since the funds prepaid will have to be invested at the then lowerprevailing rate.  This is known as *prepaymentrisk*.  In addition, wheninterest rates drop, not only can the value of mortgage related assets drop,but the yield can drop, particularly where the yield on the security is tied tointerest rates, such as adjustable mortgages.

 

         ***Liquidity Risk****.*  There is the possibility that the Companymay lose money or be prevented from earning capital gains if it cannot sell amortgage related asset at a time and price that is most beneficial to theCompany.  The Company is subject toliquidity risk because it invests in mortgage securities which have experiencedperiods of illiquidity.

 

         ***Credit Risk****.*  Credit risk is the possibility that theCompany could lose money if an issuer is unable to meet its financial obligations,such as the payment of principal and/or interest on an instrument, or goesbankrupt.  The Company may invest aportion of its assets in mortgage related assets which are not guaranteed bythe U.S. Government or investment grade, which may make the Company subject tosubstantial credit risk.  This isespecially true during periods of economic uncertainty or during economicdown-turns.

 

*         **Equity Risk.***  Equity riskis the possibility that the Company could lose money if its equity investmentsdecline in value.  Such a decline couldbe caused by a number of factors, including, but not limited to, overall marketconditions, suspension or omission of dividends, bankruptcies and litigation.  This is especially true during periods ofeconomic uncertainties and economic downturns.

 

*         **Failure to Maintain REIT Status Risk**.* Failure to maintain REIT status risk refers to the possibility that theCompany may become subject to federal income tax as a regular corporation.  The Company intends at all times to maintainsubstantially all of its investments in, and otherwise conduct its business ina manner consistent with, the REIT Provisions of the Code.  If the Company fails to qualify as a REIT,it would be treated as a regular corporation for federal tax purposes.  This would result in the Company beingsubject to federal income tax that would further result in a substantialreduction of cash available for distribution to stockholders.

 

*         **Failure to Maintain Investment Company Act ExemptionRisk**.*  The Company intends to conduct its businessso as not to become a “regulated investment company” under the InvestmentCompany Act.  As a result, the Company’sownership  of certain mortgage related assetsmay be limited by the Investment Company Act. This could have the effect of adversely affecting the Company’s operations and returns tostockholders.  In addition, if theCompany fails to qualify for  the exemptionfrom registration as an investment company, its ability to use leverage wouldbe substantially reduced.  This couldreduce income to the Company and returns to stockholders.

 

16

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**Hedging Instruments**

 

There can be no assurancethat the Company will enter into hedging activities or that, if entered into,such activities will have the desired beneficial impact on the Company’sresults of operations or financial condition. Moreover, no hedging activity can completely insulate the Company fromthe risks associated with changes in interest rates and prepayment rates.

 

Hedging involves risk andtypically involves costs, including transaction costs.  Such costs increase dramatically as theperiod covered by the hedging increases and during periods of rising andvolatile interest rates.  The Companymay increase its hedging activity and, thus, increase its hedging costs duringsuch periods when interest rates are volatile or rising and hedging costs haveincreased.  The Company intendsgenerally to hedge as much of the interest rate risk as the Manager determinesis in the best interest of the stockholders of the Company given the cost ofsuch hedging transactions and the Company’s desire to maintain its status as aREIT.  The Company’s policies do notcontain specific requirements as to the percentages or amount of interest raterisk that the Manager is required to hedge.

 

 

The Company utilizes interest rate swap agreements asa tool to manage interest rate risk. Under the swap agreements, the Company receives a floating rate and paysa fixed rate.  The notional amount ofeach agreement is matched against a like amount of current and anticipatedborrowings under reverse repurchase agreements to mitigate the potential effecton cash flows and net interest income of rising interest rates by effectivelyfixing the rate paid on the matched borrowings over the life of thecontract.  In the absence of suchfinancial instruments, interest expense on reverse repurchase agreements andsimilar short-term borrowings, which mature and reprice frequently, canincrease faster than the Company can adjust its interest-earning assets andincrease interest income, because the Company’s mortgage related securitiesgenerally have much longer maturities and have fixed rates of interest.

 

The interest rate swap agreements entered into by theCompany are classified as cash flow hedges for accounting purposes, and meetthe requirements of SFAS No. 133 for such classification.  Therefore, changes in the fair value of theagreements are reported in accumulated other comprehensive income, a componentof stockholders’ equity, and do not affect net income in the period of thechange.  Periodic exchanges of cashflows with the counterparties to the agreements are recorded as adjustments tointerest expense.  If the Company wereto terminate the swap agreements prior to their contractual termination dates,or change current or anticipated borrowings so that they were no longerappropriately matched to the swap agreements, the agreements might no longerqualify for hedge accounting treatment. In that case, changes in their fair values would affect net income.

 

 Borrowingshedged by interest rate swaps are used primarily to acquire and hold fixedincome securities available-for-sale. Changes in the fair values of securities available-for-sale are alsoreported in accumulated other comprehensive income, a component ofstockholders’ equity.  Changes in fairvalues of the securities only affect periodic earnings when they are sold or ifthey have an other-than-temporary impairment.  Therefore, earnings volatility is reduced by the use of the swapagreements as cash flow hedges and the acquisition of available-for-salesecurities with the borrowings hedged by the agreements.  Impairment of the available-for-salesecurities or decisions to sell the securities prior to their expectedmaturities could result in unanticipated earnings volatility.

 

 

 

At March 31, 2002, the Company had entered intointerest rate swap agreements summarized below.

 
| **Current**         |   |              |   |           |   |               |   | **Average**     |   | **Unrealized** |   |
|---------------------|--------|-------------------|--------|----------------|--------|--------------------|--------|-----------------|--------|----------------|--------|
| **Notional Amount** |   | **Weighted**      |   | **Average**    |   |               |   | **Termination** |   | **Gains**      |   |
| **(000)**           |   | **Average  Life** |   | **Fixed Rate** |   | **Floating  Rate** |   | **Date**        |   | **(000)**      |   |
|                |   |              |   |           |   |               |   |            |   |           |   |
| $1,500,000          |   | 4.5 years         |   | 4.374%         |   | 1Mo LIBOR          |   | 12/7/2007       |   | $22,107        |   |
|                |   |              |   |           |   |               |   |            |   |           |   |

 

 

 

At December 31, 2001, the Company had entered intointerest rate swap agreements summarized below.

 
| **Current**         |   |              |   |           |   |               |   | **Average**     |   | **Unrealized** |   |
|---------------------|--------|-------------------|--------|----------------|--------|--------------------|--------|-----------------|--------|----------------|--------|
| **Notional Amount** |   | **Weighted**      |   | **Average**    |   |               |   | **Termination** |   | **Gains**      |   |
| **(000)**           |   | **Average  Life** |   | **Fixed Rate** |   | **Floating  Rate** |   | **Date**        |   | **(000)**      |   |
|                |   |              |   |           |   |               |   |            |   |           |   |
| $850,000            |   | 6.6 years         |   | 4.239%         |   | 1Mo LIBOR          |   | 3/3/2008        |   | $4,620         |   |
|                |   |              |   |           |   |               |   |            |   |           |   |

 

 

17

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Atvarious times the Company has used forward contracts to sell U.S. Treasurysecurities as a means to mitigate the effect of rising interest rates on thefair value of its mortgage related securities.   The fair values of these forward contracts generally move in theopposite direction of the fair values of the mortgage related securities, andapproximately in the same proportion when the maturities and other terms areappropriately matched.   When interestrates rise, the fair value of the Mortgage Related securities declines, but theincreasing fair values of the forward contracts help to preserve net assetvalue relative to the changing fair value of the short-term borrowings used tofund them.

 

                The Company’s forward contractsdo not meet the criteria for hedge accounting under SFAS No. 133.  Therefore, changes in their fair valuesaffect current earnings, as do changes in the fair values of the securities towhich they are matched — such securities are classified as tradingsecurities.  Although the changes in thefair values of the forward contracts and the trading securities are offsetting,the contracts are not fully effective as hedges, and there can be significantvolatility in periodic earnings to the extent they are not.

 

 

At March 31, 2002,the Company had open forward contracts to sell U.S. Treasury notes with termsstated below.

 
| **Current**         |   |                  |   | **Fair Value  of** |   | **Average**     |   | **Unrealized**      |   |
|---------------------|--------|-----------------------|--------|--------------------|--------|-----------------|--------|---------------------|--------|
| **Notional Amount** |   | **Average  Contract** |   | **Contracts**      |   | **Termination** |   | **Gains  (Losses)** |   |
| **(000)**           |   | **Price**             |   | **(000)**          |   | **Date**        |   | **(000)**           |   |
|                |   |                  |   |               |   |            |   |                |   |
| $625,000            |   | 102.712               |   | $639,093           |   | 4/16/2002       |   | $2,860              |   |
|                |   |                  |   |               |   |            |   |                |   |

 

 

At December 31,2001, the Company had open forward contracts to sell U.S. Treasury notes withterms stated below.

 
| **Current**         |   |                  |   | **Fair Value  of** |   | **Average**     |   | **Unrealized**      |   |
|---------------------|--------|-----------------------|--------|--------------------|--------|-----------------|--------|---------------------|--------|
| **Notional Amount** |   | **Average  Contract** |   | **Contracts**      |   | **Termination** |   | **Gains  (Losses)** |   |
| **(000)**           |   | **Price**             |   | **(000)**          |   | **Date**        |   | **(000)**           |   |
|                |   |                  |   |               |   |            |   |                |   |
| $359,000            |   | 100.825               |   | $365,235           |   | 1/14/2002       |   | ($3,275)            |   |
|                |   |                  |   |               |   |            |   |                |   |

 

The contracts wereentered into to mitigate the negative impact of rising interest rates oncertain fixed income securities that generally have a market weighted averageduration approximately equal to the contracts shown above.

 

 

**Liabilities**

 

The Company has enteredinto reverse repurchase agreements to finance certain of its mortgage-backedsecurities.  These agreements aresecured by a portion of the Company’s mortgage-backed securities and bearinterest rates that have historically moved in close relationship to LIBOR.

 

At March 31, 2002, theCompany had outstanding $2,351,750,000 of reverse repurchase agreements with aweighted average current borrowing rate of 1.87% and a maturity of 1.0months.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$2,432,624,000.

 

 

18

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At December 31, 2001, theCompany had outstanding $1,376,850,000 of reverse repurchase agreements with aweighted average current borrowing rate of 1.89% and a maturity of 1.0months.  The reverse repurchaseagreements were collateralized by mortgage-backed securities with an estimatedfair value of $1,440,014,000.

 

The Company had$32,064,000 and $28,545,000 of other liabilities at March 31, 2002 and December31, 2001, respectively, consisting primarily of accrued interest payable,dividend payable, and accrued expense and other liabilities at March 31, 2002and accrued interest payable, unrealized loss on forward contracts and accruedexpenses and other liabilities at December 31, 2001.  The Company anticipates settling all other liabilities within oneyear.

 

 

**Results ofOperations  for the Three Months EndedMarch 31, 2002**

 

*Overview*

 

For the three monthsended March 31, 2002, the Company’s net income was $9,728,000, or $0.53 percommon share on a basic and diluted basis, based on a weighted common averageof 18,315,861 and 18,427,683 shares outstanding, respectively.  That compares to net income of $974,000, or$0.17 per common share on both a basic basis and diluted basis, based on aweighted average of 5,753,000 and 5,783,000 shares outstanding for the threemonths ended March 31, 2001.  Theweighted average number of shares used to calculate net income per dilutedshare includes the effect of the assumed exercise of outstanding stock options.

 

*Net Interest Income*

 

Net interest income forthe three months ended March 31, 2002 was $14,604,000 consisting of interestincome on fixed income securities and cash balances less interest expense onreverse repurchase agreements compared to $3,944,000 for the three months endedMarch 31, 2001.  The Company reporteddividend income of $126,000 from dividends on equity investments for the threemonths ended March 31, 2002 compared to $188,000 for the three months endedMarch 31, 2001.

 

 

          The following table reflects the average balances for eachcategory of the Company’s interest earning assets as well as the Company’sinterest bearing liabilities, with the corresponding effective rate of interestannualized (dollars in thousands):

 

#### **AVERAGEBALANCE AND RATE TABLE**

(Dollarsin thousands)

 
|                                    |   | **For the Quarter Ended** |      | **For the Quarter Ended** |   |
|-----------------------------------------|--------|---------------------------|-----------|---------------------------|--------|
|                                    |   | **March 31, 2002**        |      | **March 31, 2001**        |   |
|                                    |   | **Average**               |      | **Effective**             |   | **Average** |   | **Effective** |   |
|                                    |   | **Balance**               |      | **Rate**                  |   | **Balance** |   | **Rate** |   |
| Interest  Earning Assets:               |   |                      |      |                      |   |   |   |   |   |
| Mortgage  Securities                    |   | $                         | 1,673,427 |                      | 6.48   | % | $ | 577,232 |   | 7.39 | % |
| Other  Fixed Income Assets              |   | 6,157                     |      | 9.63                      | %      | 6,699 |   | 18.98 | % |
| Cash  and Cash Equivalents              |   | 9,273                     |      | 2.37                      | %      | 3,343 |   | 5.03 | % |
| Total  Interest Earning Assets          |   | 1,688,857                 |      | 6.47                      | %      | 587,274 |   | 7.51 | % |
|                                    |   |                      |      |                      |   |   |   |   |   |
| Interest  Bearing Liabilities:          |   |                      |      |                      |   |   |   |   |   |
| Reverse  Repurchase Agreements          |   | 1,570,692                 |      | 3.24                      | %      | 562,610 |   | 5.03 | % |
|                                    |   |                      |      |                      |   |   |   |   |   |
| Net  Interest Earning Assets and Spread |   | $                         | 118,165   |                      | 3.23   | % | $ | 24,664 |   | 2.48 | % |

 

The effective yield datais computed by dividing the annualized net interest income or expense includinghedging transactions as applicable into the average daily balance shown.

 

 

19

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The followingtable reflects the average balances for the Company’s equity securities(dollars in thousands):

 

#### **AVERAGEBALANCE AND RATE TABLE**

(Dollarsin thousands)

 

 
|               |   | **For the Quarter Ended** |   | **For the Quarter Ended** |   |
|--------------------|--------|---------------------------|--------|---------------------------|--------|
|               |   | **March 31, 2002**        |   | **March 31, 2001**        |   |
|               |   |                      |   | **Effective**             |   |   |   |   |   |
|               |   | **Average**               |   | **Dividend**              |   | **Average** |   | **Dividend** |   |
|               |   | **Balance**               |   | **Yield**                 |   | **Balance** |   | **Yield** |   |
|               |   |                      |   |                      |   |   |   |   |   |
| Equity  securities |   | $                         | 4,519  |                      | 4.07   | % | $ | 13,082 |   | 5.75 | % |
|                    |        |                           |        |                           |        |  |  |  |  |  |  |

 

 

Following is a table that shows the approximateamounts of the change in interest income and expense between 2002 and 2001 thatwas a function of rate and volume changes, and the amount of the change thatcannot be ascribed specifically to either rate or volume changes.

 

**RATE/ VOLUME TABLE**

(Dollars inthousands)

 
|                          |   | **Three  Months Ended March 31,** |   |
|-------------------------------|--------|-----------------------------------|--------|
|                          |   | **2002  compared to 2001**        |   |
|                          |   | **Total**                         |   | **Changes Due  to** |   |
|                          |   | **Change**                        |   | **Volume (1)** |   | **Rates (1)** |   |
| Interest-Earning Assets       |   |                              |   |   |   |   |   |
| Fixed Income Securities       |   | $                                 | 16,276 |   | $ | 20,598 |   | $ | (4,325 | ) |
| Cash and Cash Equivalents     |   | 13                                |   | (149 | ) | 124 |   |
|                          |   |                              |   |   |   |   |   |
| Total Interest Income         |   | $                                 | 16,289 |   | $ | 20,449 |   | $ | (4,201 | ) |
|                          |   |                              |   |   |   |   |   |
| Interest-Bearing Liabilities  |   |                              |   |   |   |   |   |
| Reverse Repurchase Agreements |   | $                                 | 5,629  |   | $ | 12,682 |   | $ | (7,053 | ) |
|                          |   |                              |   |   |   |   |   |
| Total Interest Expense        |   | $                                 | 5,629  |   | $ | 12,682 |   | $ | (7,053 | ) |
|                          |   |                              |   |   |   |   |   |
| Change in Net Interest Income |   | $                                 | 10,660 |   | $ | 7,767 |   | $ | 2,852 |   |

----

(1)  Changes in interest income/expense not arisingfrom volume or rate variances are allocated proportionately to rate and volume.

 

A portion of the change in interest expense in thetable above is related to the Company’s use of interest rate swaps.  Periodic settlements of the swap agreementswith their counter-parties result in adjustments to interest expense associatedwith the reverse repurchase agreements hedged by the swaps.  During the quarter ended March 31, 2001,interest expense was decreased by $1,152,000 from amortization of deferredgains on terminated swap contracts. During the quarter ended March 31, 2002, interest expense was increasedby $5,691,000 paid to swap counterparties and decreased by $121,000 fromamortization of deferred gains on terminated swap contracts.

 

 

*General and Administrative Expenses*

 

The Company incurredoperating expenses of $3,298,000 for the three months ended March 31, 2002consisting of management fees, incentive fees, professional, insurance andother expenses compared to $269,000 for the three months ended March 31,2001.  

 

 

20

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The primary reasons for the higher operating expenses in first quarter2002 compared to first quarter 2001 were that management fees, especiallyincentive fees, were much higher because of substantially improved operatingincome.  Also, the recently completedstock offerings resulted in additional capital and an increase in the Company’sinvestment portfolio which yielded higher net operating income compared toprior periods .

 

*Net Gain (Loss) on Investment andDerivative Activities*

 

During the quarter endedMarch 31, 2002, the Company reported a net loss on investment and derivativeactivities of $1,704,000 in the statement of operations.  This loss consisted of a net loss of$481,000 on closed forward contracts, a loss of $232,000 on the sale of$99,881,000 of fixed income securities available-for-sale, a gain of $17,000 onthe sale of $6,535,000 of fixed income trading securities, a gain of $341,000on the sale of $1,117,000 of equity securities available-for-sale, and anunrealized loss of $1,349,000 on trading securities.

 

During the quarter endedMarch 31, 2001, the Company realized $3,444,000 in gains on the sale of$142,809,000 of fixed income securities, reported gains of $3,180,000 from thenet increase in fair market value of fixed income securities held for tradingand realized $9,082,000 in losses on closed forward contracts.

 

 

*Accounting Changes*

 

During the quarter endedMarch 31, 2001, the Company adopted SFAS No. 133 and the relatedamendments.  This adoption resulted in atransition adjustment that reclassified $2,173,000 of net losses on unrealizedand deferred gains and losses on investment securities and forward contractsfrom accumulated other comprehensive income to current income.  Also, deferred gains on interest rate swapspreviously designated as hedges were reclassified from other liabilities toaccumulated other comprehensive income.

 

Also during the quarterended March 31, 2001, the Company reclassified $594,469,000 of its mortgagesecurities from the available-for-sale category to the trading category forinvestments accounted for under SFAS No. 115. This change resulted in the reclassification of $1,742,000 netunrealized gains from accumulated other comprehensive income to current income,in addition to net unrealized gains included in the SFAS No. 133 transitionadjustment discussed above.

 

No such accountingchanges were made during the quarter ended March 31, 2002.

 

 

 

**Liquidity and Capital Resources**

 

The Company’s primarysources of funds as of March 31, 2002 and December 31, 2001, consisted ofreverse repurchase agreements totaling $2,351,750,000 and $1,376,850,000,respectively.  The Company expects tocontinue to borrow funds in the form of reverse repurchase agreements.  At March 31, 2002, the Company had borrowingarrangements with over twenty different investment banking firms.  Increases in short-term interest rates couldnegatively impact the valuation of the Company’s mortgage assets which couldlimit the Company’s borrowing ability or cause its lenders to initiate margincalls.

 

The Company will alsorely on the cash flow from operations, primarily monthly principal and interestpayments to be received on the mortgage assets, for liquidity.

 

The Company believes thatequity capital, combined with the cash flow from operations and the utilizationof borrowings, will be sufficient to enable the Company to meet anticipatedliquidity requirements.  If the Company’scash resources are at any time insufficient to satisfy the Company’s liquidityrequirements, the Company may be required to liquidate mortgage assets or selldebt or additional equity securities. If required, the sale of mortgage assets at prices lower than thecarrying value of such assets would result in losses.

 

         TheCompany may in the future increase its capital resources by making additionalofferings of equity and debt securities, including classes of preferred stock,common stock, commercial paper, medium-term notes, CMOs and senior orsubordinated notes.  All debtsecurities, other borrowings, and classes of preferred stock will be senior tothe Common Stock in a liquidation of the Company.  The effect of additional equity offerings may be the dilution ofstockholders’ equity of the Company or the reduction of the price of shares ofthe Common Stock, or both.  The Companyis unable to estimate the amount, timing or nature of additional offerings asthey will depend upon market conditions and other factors.

 

 

21

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**Inflation**

 

                Virtually all ofthe Company’s assets and liabilities are financial in nature.  As a result, interest rates and otherfactors drive the Company’s performance far more than does inflation.  Changes in interest rates do not necessarilycorrelate with inflation rates or changes in inflation rates.  The Company’s financial statements areprepared in accordance with generally accepted accounting principles and theCompany’s dividends are determined by the Company’s net income as calculatedfor tax purposes; in each case, the Company’s activities and balance sheet aremeasured with reference to historical cost and or fair market value withoutconsidering inflation.

 

 

 

 

 

# **II.**                   ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

**MARKET RISK**

 

The Company’s two primary components of market riskare interest rate risk and equity price risk as discussed below.

### **InterestRate Risk**

 

*Effect on Net Interest Income. *TheCompany invests in fixed-rate mortgage assets that are expected to be fundedwith short-term borrowings.  Duringperiods of rising interest rates, the borrowing costs associated with fundingsuch fixed-rate assets are subject to increase while the income earned on suchassets may remain substantially unchanged. This would result in a narrowing of the net interest spread between therelated assets and borrowings and may even result in losses. The Company mayenter into derivative transactions seeking to mitigate the negative impact of arising interest rate environment. Hedging techniques will be based, in part, onassumed levels of prepayments of the Company’s mortgage assets.  If prepayments are slower or faster thanassumed, the life of the mortgage assets will be longer or shorter which wouldreduce the effectiveness of the Company’s hedging techniques and may result inlosses on such transactions.  Hedgingtechniques involving the use of derivative securities are highly complex and mayproduce volatile returns. The hedging activity of the Company will also belimited by the asset and sources of income requirements applicable to theCompany as a REIT.

 

 

22

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*                ExtensionRisk*.  Fixed-rate assets are generally acquiredwith a projected weighted average life based on certain assumptions regardingprepayments.  In general, when afixed-rate mortgage asset is acquired with borrowings, the Company may, but isnot required to, enter into an interest rate swap agreement or other hedging instrumentthat effectively fixes the Company’s borrowing costs for a period close to theanticipated average life of the related asset. This strategy is designed to protect the Company from rising interestrates because the borrowing costs are fixed for the duration of the asset.  However, if prepayment rates decrease in arising interest rate environment, the life of the mortgage asset could extendbeyond the term of the swap agreement or other hedging instrument.  This situation could negatively impact theCompany as borrowing costs would no longer be fixed after the end of thehedging instrument while the income earned on the asset would remainfixed.  This situation may also causethe market value of the Company’s mortgage assets to decline with little or nooffsetting gain from the related hedging transactions.  In certain situations, the Company may beforced to sell assets and incur losses to maintain adequate liquidity.

*Prepayment Risk*. Fixed-rate assets in combination with hedging instruments are alsosubject to prepayment risk.  In fallinginterest rate scenarios, the fixed-rate mortgage assets may prepay faster suchthat the average life becomes shorter than its related hedging instrument.  If this were to happen, the Company wouldpotentially need to reinvest at rates lower than that of the related hedginginstrument.  This situation may resultin the narrowing of interest rate spreads or may cause losses.

 

*Forward Contract Risk*. The Company may also enter in forward contracts to sell U.S. Treasurynotes in addition to or instead of interest rate swap agreements.  These forward contracts are generallyexpected to mitigate the impact of rising interest rates on the fair value ofthe Company’s fixed income securities. However, if the interest rate spread between mortgage securities andU.S. Treasury notes were to widen, the fair value of the Company’s portfoliowould generally be expected to decline. In addition, the use of forward contracts to sell U.S. Treasury notesgenerally does not directly impact borrowing costs in the same manner asinterest rate swap agreements. Therefore, the use of such forward contracts could result in net incomevolatility during periods of interest rate volatility.

 

         TheCompany also invests in adjustable-rate mortgage assets that are typicallysubject to periodic and lifetime interest rate caps that limit the amount anadjustable-rate mortgage asset’s interest rate can change during any givenperiod, as well as the minimum rate payable. The Company’s borrowings will not be subject to similarrestrictions.  Hence, in a period ofincreasing interest rates, interest rates on its borrowings could increasewithout limitation by caps, while the interest rates on its mortgage assets aregenerally limited by caps.  This problemwill be magnified to the extent the Company acquires mortgage assets that arenot fully indexed.  Further, someadjustable-rate mortgage assets may be subject to periodic payment caps thatresult in some portion of the interest being deferred and added to theprincipal outstanding.  This couldresult in receipt by the Company of less cash income on its adjustable-ratemortgage assets than is required to pay interest on the related borrowings.  These factors could lower the Company’s netinterest income or cause a net loss during periods of rising interest rates,which would negatively impact the Company’s financial condition, cash flows andresults of operations.

 

         TheCompany intends to fund a substantial portion of its acquisitions ofadjustable-rate mortgage assets with borrowings that have interest rates basedon indices and repricing terms similar to, but of somewhat shorter maturitiesthan, the interest rate indices and repricing terms of the mortgageassets.  Thus, the Company anticipatesthat in most cases the interest rate indices and repricing terms of itsmortgage assets and its funding sources will not be identical, thereby creatingan interest rate mismatch between assets and liabilities.  While the historical spread between relevantshort-term interest rate indices has been relatively stable, there have beenperiods, 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 ratemismatches could negatively impact the Company’s financial condition, cashflows and results of operations.

 

         Prepaymentrates generally increase when prevailing interest rates fall below the interestrates on existing mortgage assets.  Inaddition, prepayment rates generally increase when the difference betweenlong-term and short-term interest rates declines.  Prepayments of mortgage assets could adversely affect theCompany’s results of operations in several ways.  The Company anticipates that a substantial portion of itsadjustable-rate mortgage assets may bear initial ‘‘teaser’’ interest rates thatare lower than their ‘‘fully indexed’’ rates (the applicable index plus amargin).  In the event that such an adjustable-ratemortgage asset is prepaid prior to or soon after the time of adjustment to afully indexed rate, the Company will have held the mortgage asset while it wasless profitable and lost the opportunity to receive interest at the fullyindexed rate over the expected life of the adjustable-rate mortgage asset.  In addition, the prepayment of any mortgageasset that had been

 

 

23

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purchased at a premium by the Company would result inthe immediate write-off of any remaining capitalized premium amount andconsequent reduction of the Company’s net interest income by such amount.  Finally, in the event that the Company isunable to acquire new mortgage assets to replace the prepaid mortgage assets,its financial condition, cash flow and results of operations could bematerially adversely affected.

 

*         Effect on FairValue.* Another component of interest rate risk isthe effect changes in interest rates will have on the market value of theCompany’s assets*. *This is the riskthat the market value of the Company’s assets will increase or decrease atdifferent rates than that of the Company’s liabilities including its hedginginstruments.

 

         TheCompany primarily assesses its interest rate risk by estimating the duration ofits assets and the duration of its liabilities including all hedginginstruments.  Duration essentiallymeasures the market price volatility of financial instruments as interest rateschange.  The Company generallycalculates duration using various financial models and empirical data.

 

 

24

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The following sensitivity analysis table shows theestimated impact on the fair value of the Company’s interest rate sensitiveinvestments net of its hedging instruments and reverse repurchase agreement liabilitiesassuming rates instantaneously fall one hundred basis points and rise onehundred basis points.  (Dollars are inthousands 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              |   | $                                  | 225,797 |   | $ | 213,994 |   | $ | 162,244 |   |
|                                              |   |                               |    |   |   |   |   |
| Change in Fair  Value                             |   | $11,803                            |    | — |   | ($51,750 | ) |
| Change as a  Percent of Fair Value                |   | (0.48%                             | )       | — |   | (2.12% | ) |
| Change as a  Percent of Stockholders’ Equity |   | (5.52%                             | )       | — |   | (24.19% | ) |
| Change on a Per  Share Basis                      |   | ($0.48                             | )       | — |   | ($2.09 | ) |
|                                              |   |                               |    |   |   |   |   |
|                                                   |        |                                    |         |  |  |  |  |  |  |  |

 

It is important to notethat the impact of changing interest rates on fair value can changesignificantly when interest rates change beyond one hundred basis points fromcurrent levels.  Therefore, thevolatility in fair value for the Company could increase significantly wheninterest rates change beyond one hundred basis points.  In addition, there are other factors thatimpact the fair value of the Company’s interest rate sensitive investments andhedging instruments such as the shape of the yield curve, market expectationsas to future interest rate changes and other market conditions.  Accordingly, there may be differences betweenthe fair value changes shown above and actual changes in fair value as interestrates change and those differences may be material.

 

The Company hasestablished an interest rate risk management policy that is intended tomitigate the negative impact of changing interest rates.  The Company generally intends to mitigateinterest rate risk by targeting the difference between the market weightedaverage duration on its mortgage related assets funded with secured borrowingsto the market weighted average duration of such borrowings to one year or less,taking into account all hedging transactions. The Company generally does not intend to have any specific durationtarget for the portion its mortgage related assets that are not funded bysecured borrowings.

 

There can be no assurancethat the Company will be able to limit such duration differences and there maybe periods of time when the duration difference will be greater than one year.

 

**EquityPrice Risk**

 

         Another component of market risk forthe Company is equity price risk.  Thisis the risk that the market value of the Company’s equity investments willdecrease.  The following table shows theimpact on the Company’s fair value as the price of its equity securities changeassuming price decreases of 10% and increases of 10%.  Actual price decreases or increases may be greater orsmaller.  (Dollars are in thousandsexcept per share amounts.)

 

 
|                                              |   | **Fair Value for Scenario Shown** |   |
|---------------------------------------------------|--------|-----------------------------------|--------|
|                                              |   | **Prices**                        |   |   |   | **Prices** |   |
|                                              |   | **Decrease**                      |   |   |   | **Increase** |   |
|                                              |   | **10%**                           |   | **Unchanged** |   | **10%** |   |
|                                              |   |                              |   |   |   |   |   |
| Equity  Investments                               |   | $                                 | 4,394  |   | $ | 4,882 |   | $ | 5,370 |   |
|                                              |   |                              |   |   |   |   |   |
| Change  in Fair Value                             |   | (488                              | )      | — |   | 488 |   |
| Change  as a Percent of Fair Value                |   | (10%                              | )      | — |   | 10 | % |
| Change  as a Percent of Stockholders’ Equity |   | (0.2%                             | )      | — |   | 0.2 | % |
| Change  on a Per Share Basis                      |   | (0.02                             | )      | — |   | 0.02 |   |
|                                                   |        |                                   |        |  |  |  |  |  |  |  |

 

 

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Although there is nodirect link between changes in fair value and changes in earnings in manycases, a decline in fair value for the Company may translate into decreasedearnings over the remaining life of the investment portfolio.

 

If the fair market valueof the Company’s portfolio were to decline significantly, the Company’s overallliquidity may be impaired which could result in the Company being required tosell assets at losses.

 

**The Company’s analysis of risks is based on management’sexperience, estimates, models and assumptions. These analyses rely on models of financial information which utilizeestimates of fair value and interest rate sensitivity.  Actual economic conditions or implementationof investment decisions by the Manager may produce results that differsignificantly from the estimates and assumptions used in the Company’s modelsand 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 inthe Private Securities Litigation Reform Act of 1995.**

# ** **

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| **PART II.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                  | **OTHER INFORMATION**                                |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------|------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
| Item 1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                  | Legal Proceedings                                    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | None.                 |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
| Item 2.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                  | Changes in Securities                                |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | None.                 |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
| Item 3.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                  | Defaults Upon Senior Securities                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | Not Applicable.       |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
| Item 4.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                  | Submission of Matters  to a Vote of Security Holders |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | None.                 |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
| Item 5.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                  | Other Information                                    |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | None.                 |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
| Item 6.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                  | Exhibits and Reports on Form 8-K                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | *Exhibits*            |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |   |
| The exhibits listed on  the Exhibit List, which appears below following the signature page, are  included or incorporated by reference in this Quarterly Report.                                                                                                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | *Reports on Form 8-K* |                                                 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |                  |                                                 |   |
| On February 27, 2002,  we filed a current report on Form 8-K, announcing that on February 22, 2002  our Board of Directors declared a dividend of $0.50 per share of common stock  for the first quarter 2002.  We also  attached (i) a form of underwriting agreement by and among the Company,  Credit Suisse First Boston, as representative, and the several underwriters  listed on Schedule A thereto, and (ii) an opinion and consent of  Ballard Spahr Andrews & Ingersoll dated February 27, 2002, as to the legality  of the shares being issued. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| On February 28, 2002,  we filed a current report on Form 8-K, attaching an opinion and consent of  Ballard Spahr Andrews & Ingersoll dated February 28, 2002, as to the  legality of the shares being issued.                                                                                                                                                                                                                                                                                                                                                    |

 

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securitiesand Exchange Act of 1934, the Registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 

 
|   | Apex Mortgage Capital, Inc. |
|--------|-----------------------------|
|   | (Registrant)                |

 

 
| Dated: May 15, 2002 |   | /s/ Philip A. Barach                  |
|---------------------|--------|---------------------------------------|
|                |   | Philip A. Barach                      |
|                |   | President and Chief Executive Officer |
|                |   | (Principal Executive Officer)         |

 

 
| Dated: May 15, 2002 |   | /s/ David S. DeVito            |
|---------------------|--------|--------------------------------|
|                |   | David S. DeVito                |
|                |   | Chief Financial Officer        |
|                |   | (Principal Accounting Officer) |

 

 

 

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**EXHIBITINDEX**

 

 

                Pursuant to Item 601(a)(2) ofRegulation S-K, this exhibit index immediately precedes the exhibits.

 

                The following exhibits are partof this Quarterly Report on Form 10-Q (and are numbered in accordance with Item601 of Regulation S-K).

 

 
| **Exhibit  No.** |   | **Description**                                                                                                                                                                                                                                                                                                                                                                 |
|------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                                                                                                                                                            |
| 3.1              |   | Articles of  Amendment and Restatement of the Company, as filed with the State Department  of Assessments and Taxation of Maryland on November 25, 1997, (previously  filed as Exhibit 3.1 to the Company's Registration Statement on Form S-11,  Commission File No. 333-36069, Amendment No. 3, filed November 21, 1997 and  incorporated herein by reference).               |
| 3.2              |   | Articles  Supplementary relating to the Company's Series A Junior Participating  Preferred Stock, as filed with the State Department of Assessments and  Taxation of the State of Maryland on July 26, 1999 (previously filed as  Exhibit 3.1 to the Company's Current Report on Form 8-K, dated June 30, 1999  and filed July 23, 1999, and incorporated herein by reference). |
| 3.3              |   | Amended and  Restated Bylaws of the Company (previously filed as Exhibit 4.4 to the  Company's S-3 filed on November 27, 2001 and incorporated herein by  reference).                                                                                                                                                                                                           |
| 4.1              |   | Form of Share  Certificate for our common stock (previously filed as Exhibit 4.3 to the  Company's Current Report on Form 8-K, dated June 30, 1999 and filed July 27,  1999, and incorporated herein by reference).                                                                                                                                                             |
| 4.2              |   | Shareholder Rights  Agreement between the Company and The Bank of New York, as Rights Agent  (including as Exhibit B the form of Rights Certificate) (previously filed as  Exhibit 4.1 to the Company's Current Report on Form 8-K, dated June 30, 1999  and filed July 27, 1999, and incorporated herein by reference).                                                        |

 

 

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