**UNITEDSTATES 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:        JUNE  30, 2002**  |

 

**OR**

 
| **o**  |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES   EXCHANGE ACT OF 1934**                                                                    |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                               |
|   |   | **For  the transition period from             to            ** |

 

**Commission File Number: 001-13637**

 

**APEXMORTGAGE 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) |   | 29,857,000 as of August 9, 2002 |
|--------------------------------|--------|---------------------------------|

 

 

----

 

**APEX MORTGAGE CAPITAL, INC.**

# **FORM 10-Q**

 

**INDEX**

 
| PART I.           | FINANCIAL INFORMATION                                                                       |
|-------------------|---------------------------------------------------------------------------------------------|
|              |                                                                                        |
|  ITEM 1.     | FINANCIAL STATEMENTS                                                                        |
|              |                                                                                        |   |
|              |                                                                                        | BALANCE SHEETS AT  JUNE 30, 2002 (UNAUDITED) AND DECEMBER 31, 2001 |
|              |                                                                                        |   |
|              |                                                                                        | STATEMENTS  OF OPERATIONS FOR THE SIX MONTHS ENDED  JUNE 30, 2002 AND JUNE 30, 2001 (UNAUDITED) |
|              |                                                                                        |   |
|              |                                                                                        | STATEMENT OF  STOCKHOLDERS’ EQUITY FOR THE SIX MONTHS ENDED  JUNE 30, 2002 (UNAUDITED) |
|              |                                                                                        |   |
|              |                                                                                        | STATEMENTS  OF CASH FLOWS FOR THE SIX MONTHS ENDED   JUNE 30, 2002 AND JUNE 30, 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)**

 
|                                                                                                                                 |   | **June 30, 2002** |          | **December 31, 2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|---------------|-----------------------|--------|
| **Assets**                                                                                                                           |   |              |          |                  |   |
|                                                                                                                                 |   |              |          |                  |   |
| Cash and cash  equivalents                                                                                                           |   | $                 | 17,610,000    |                  | $      | 4,330,000 |   |
| Fixed income  trading securities, at fair value (Note 3)                                                                             |   | 1,192,528,000     |          | 437,954,000           |   |
| Fixed income  securities available-for-sale, at fair value (Note 3)                                                                  |   | 2,300,913,000     |          | 1,067,575,000         |   |
| Equity  securities available-for-sale, at fair value (Note 3)                                                                        |   | 4,537,000         |          | 6,028,000             |   |
| Interest rate  swaps, at fair value (Note 5)                                                                                         |   | —            |          | 4,620,000             |   |
| Accrued interest  receivable                                                                                                         |   | 18,840,000        |          | 8,580,000             |   |
| Principal  payments receivable                                                                                                       |   | 355,000           |          | 485,000               |   |
| Receivable for  unsettled securities                                                                                                 |   | 1,494,000         |          | 5,520,000             |   |
| Other assets                                                                                                                         |   | 194,000           |          | 333,000               |   |
|                                                                                                                                 |   | $                 | 3,536,471,000 |                  | $      | 1,535,425,000 |   |
|                                                                                                                                 |   |              |          |                  |   |
| **Liabilities  and Stockholders’ Equity**                                                                                       |   |              |          |                  |   |
|                                                                                                                                 |   |              |          |                  |   |
| Liabilities                                                                                                                          |   |              |          |                  |   |
|                                                                                                                                 |   |              |          |                  |   |
| Reverse  repurchase agreements (Note 4)                                                                                              |   | $                 | 3,191,797,000 |                  | $      | 1,376,850,000 |   |
| Accrued interest  payable                                                                                                            |   | 2,882,000         |          | 975,000               |   |
| Dividend payable                                                                                                                     |   | 15,011,000        |          | 12,596,000            |   |
| Forward  contracts, at fair value (Note 5)                                                                                           |   | 2,218,000         |          | 3,275,000             |   |
| Interest rate  swaps, at fair value (Note 5)                                                                                         |   | 37,342,000        |          | —                |   |
| Accrued expenses  and other liabilities                                                                                              |   | 13,877,000        |          | 11,699,000            |   |
|                                                                                                                                 |   |              |          |                  |   |
|                                                                                                                                 |   | 3,263,127,000     |          | 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 shares authorized; 29,857,000 (2002)  and 15,555,500 (2001) shares outstanding |   | 299,000           |          | 155,000               |   |
| Additional  paid-in-capital                                                                                                          |   | 331,494,000       |          | 175,802,000           |   |
| Accumulated  other comprehensive loss                                                                                                |   | (18,121,000       | )             | (7,837,000            | )      |
| Accumulated  deficit                                                                                                                 |   | (40,328,000       | )             | (38,090,000           | )      |
|                                                                                                                                 |   |              |          |                  |   |
|                                                                                                                                 |   | 273,344,000       |          | 130,030,000           |   |
|                                                                                                                                 |   |              |          |                  |   |
|                                                                                                                                 |   | $                 | 3,536,471,000 |                  | $      | 1,535,425,000 |   |

 

See accompanying notes to financial statements

 

3

----

 

**Apex Mortgage Capital, Inc.**

** **

**Statements of Operations**

**(Unaudited)**

 
|                                                                                  |   | **Three Months  Ended  June 30, 2002** |       | **Three Months  Ended  June 30, 2001** |   | **Six Months  Ended  June 30, 2002** |   | **Six Months  Ended  June 30, 2001** |       |
|---------------------------------------------------------------------------------------|--------|----------------------------------------|------------|----------------------------------------|--------|--------------------------------------|--------|--------------------------------------|------------|
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Interest  Income:**                                                                 |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Fixed income  securities                                                              |   | $                                      | 45,252,000 |                                   | $      | 9,730,000                            |   | $                                    | 72,506,000 |   | $ | 20,708,000 |   |
| Cash and cash  equivalents                                                            |   | 18,000                                 |       | 34,000                                 |   | 73,000                               |   | 76,000                               |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Total interest  income                                                                |   | 45,270,000                             |       | 9,764,000                              |   | 72,579,000                           |   | 20,784,000                           |       |
| **Interest  Expense**                                                                 |   | 21,390,000                             |       | 4,988,000                              |   | 34,095,000                           |   | 12,064,000                           |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Net  Interest Income**                                                              |   | 23,880,000                             |       | 4,776,000                              |   | 38,484,000                           |   | 8,720,000                            |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Dividend  Income**                                                                  |   | 109,000                                |       | 306,000                                |   | 235,000                              |   | 494,000                              |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Operating  Income Before General and Administrative Expenses**                      |   | 23,989,000                             |       | 5,082,000                              |   | 38,719,000                           |   | 9,214,000                            |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **General  and Administrative Expenses:**                                             |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Management fee                                                                        |   | 503,000                                |       | 84,000                                 |   | 822,000                              |   | 172,000                              |       |
| Incentive fee                                                                         |   | (1,213,000                             | )          | —                                 |   | 1,437,000                            |   | —                               |       |
| Insurance                                                                             |   | 83,000                                 |       | 83,000                                 |   | 167,000                              |   | 167,000                              |       |
| Professional  fees                                                                    |   | 72,000                                 |       | 23,000                                 |   | 99,000                               |   | 46,000                               |       |
| Directors’ fees                                                                  |   | 22,000                                 |       | 15,000                                 |   | 44,000                               |   | 30,000                               |       |
| Non-employee  stock options                                                           |   | 23,000                                 |       | 1,000                                  |   | 50,000                               |   | 2,000                                |       |
| Other                                                                                 |   | 230,000                                |       | 94,000                                 |   | 398,000                              |   | 152,000                              |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Total general  and administrative expense                                             |   | (280,000                               | )          | 300,000                                |   | 3,017,000                            |   | 569,000                              |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Operating  Income, Net of General and Administrative Expenses**                     |   | 24,269,000                             |       | 4,782,000                              |   | 35,702,000                           |   | 8,645,000                            |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Net  (Loss) from Investment and Derivative Activities (Note 3)**                    |   | (8,748,000                             | )          | (4,382,000                             | )      | (10,453,000                          | )      | (6,840,000                           | )          |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Reclassification  of Previously Unrealized Gains**                                  |   | —                                 |       | —                                 |   | —                               |   | 1,742,000                            |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Net  Income Before Cumulative Effect of Change in Accounting Principle**            |   | 15,521,000                             |       | 400,000                                |   | 25,249,000                           |   | 3,547,000                            |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Cumulative  Effect of Change in Accounting Principle (Note 2)**                     |   | —                                 |       | —                                 |   | —                               |   | (2,173,000                           | )          |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Net  Income**                                                                       |   | $                                      | 15,521,000 |                                   | $      | 400,000                              |   | $                                    | 25,249,000 |   | $ | 1,374,000 |   |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Net  Income Per Share Before Cumulative Effect of Change in Accounting Principle:** |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Basic                                                                                 |   | $                                      | 0.58       |                                   | $      | 0.07                                 |   | $                                    | 1.12       |   | $ | 0.62 |   |
| Diluted                                                                               |   | $                                      | 0.58       |                                   | $      | 0.07                                 |   | $                                    | 1.12       |   | $ | 0.61 |   |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Effect  of Accounting Change Per Share:**                                           |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Basic                                                                                 |   | $                                      | —     |                                   | $      | —                               |   | $                                    | —     |   | $ | (0.38 | ) |
| Diluted                                                                               |   | $                                      | —     |                                   | $      | —                               |   | $                                    | —     |   | $ | (0.37 | ) |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Net  Income Per Share:**                                                            |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Basic                                                                                 |   | $                                      | 0.58       |                                   | $      | 0.07                                 |   | $                                    | 1.12       |   | $ | 0.24 |   |
| Diluted                                                                               |   | $                                      | 0.58       |                                   | $      | 0.07                                 |   | $                                    | 1.12       |   | $ | 0.24 |   |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Weighted  Average Number of Shares Outstanding:**                                   |   |                                   |       |                                   |   |                                 |   |                                 |       |
| Basic                                                                                 |   | 26,627,934                             |       | 5,753,000                              |   | 22,494,859                           |   | 5,753,000                            |       |
| Diluted                                                                               |   | 26,796,090                             |       | 5,819,000                              |   | 22,636,070                           |   | 5,819,000                            |       |
|                                                                                  |   |                                   |       |                                   |   |                                 |   |                                 |       |
| **Dividends  Declared Per Share:**                                                    |   | $                                      | 0.50       |                                   | $      | 0.40                                 |   | $                                    | 1.00       |   | $ | 0.75 |   |

 

See accompanying notes to financial statements

 

4

----

 

**Apex Mortgage Capital, Inc.**

** **

**Statements of Stockholders’ Equity**

**(Unaudited)**

 

 
|                                                                                  |   | **Common  Stock** |   | **Additional  Paid-in  Capital** |    | **Accumulated  Other  Comprehensive  Income (Loss)** |   | **Accumulated  Deficit** |   | **Total  Stockholders’  Equity** |        | **Comprehensive  Income / (Loss)** |   |
|---------------------------------------------------------------------------------------|--------|-------------------|--------|----------------------------------|---------|------------------------------------------------------|--------|--------------------------|--------|---------------------------------------|-------------|------------------------------------|--------|
| **Shares**                                                                            |   | **Amount**        |
| **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 gain on terminated interest rate swaps                         |   | —            |   | —                           |    | —                                               |   | (121,000                 | )      | —                                |        | (121,000                           | )      | (121,000 | ) |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| Net change in unrealized gain on interest rate swaps classified as  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                        |   |   |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Issuance of common stock**                                                          |   | 5,095,000         |   | 51,000                           |    | 63,940,000                                           |   | —                   |   | —                                |        | 63,991,000                         |   |   |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Issuance of stock options**                                                         |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **to non-employees**                                                                  |   | —            |   | —                           |    | 23,000                                               |   | —                   |   | —                                |        | 23,000                             |   |   |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Net income**                                                                        |   | —            |   | —                           |    | —                                               |   | —                   |   | 15,521,000                            |        | 15,521,000                         |   | $ | 15,521,000 |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Other comprehensive income (loss):**                                                |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| Net change in unrealized income on available-for-sale securities                      |   | —            |   | —                           |    | —                                               |   | 53,825,000               |   | —                                |        | 53,825,000                         |   | 53,825,000 |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| Net change in deferred gain on terminated interest rate swaps                         |   | —            |   | —                           |    | —                                               |   | (59,000                  | )      | —                                |        | (59,000                            | )      | (59,000 | ) |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| Net change in unrealized (loss) on interest rate swaps classifiedas  cash flow hedges |   | —            |   | —                           |    | —                                               |   | (59,449,000              | )      | —                                |        | (59,449,000                        | )      | (59,449,000 | ) |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Comprehensive income**                                                              |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   | $ | 9,838,000 |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Dividends declared**                                                                |   | —            |   | —                           |    | —                                               |   | —                   |   | (15,011,000                           | )           | (15,011,000                        | )      |   |   |
|                                                                                  |   |              |   |                             |    |                                                 |   |                     |   |                                  |        |                               |   |   |   |
| **Balance, June 30, 2002**                                                            |   | 29,857,000        |   | $                                | 299,000 |                                                 | $      | 331,494,000              |   | $                                     | (18,121,000 | )                                  | $      | (40,328,000 | ) | $ | 273,344,000 |   |   |   |

 

See accompanying notes to financial statements

 

5

----

 

**Apex Mortgage Capital, Inc.**

 

**Statements of Cash Flows**

**(Unaudited)**

 
|                                                                               |   | **Six Months********Ended  June 30, 2002** |       | **Six Months  Ended  June 30, 2001** |   |
|------------------------------------------------------------------------------------|--------|--------------------------------------------|------------|--------------------------------------|--------|
|                                                                               |   |                                       |       |                                 |   |
| **Operating  Activities:**                                                         |   |                                       |       |                                 |   |
| Net income                                                                         |   | $                                          | 25,249,000 |                                 | $      | 1,374,000 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                                       |       |                                 |   |
| Amortization                                                                       |   | 14,000                                     |       | (2,944,000                           | )      |
| Net loss on  investment and derivative activities                                  |   | 10,453,000                                 |       | 6,840,000                            |   |
| Cumulative  effect of change in accounting principle                               |   | —                                     |       | 2,173,000                            |   |
| Reclassification  of previously unrealized gains                                   |   | —                                     |       | (1,742,000                           | )      |
| Trading  activities                                                                |   | (765,132,000                               | )          | 42,809,000                           |   |
| Change in assets  and liabilities:                                                 |   |                                       |       |                                 |   |
| Accrued interest  receivable                                                       |   | (10,260,000                                | )          | 325,000                              |   |
| Other assets                                                                       |   | 139,000                                    |       | 19,000                               |   |
| Accrued interest  payable                                                          |   | 1,907,000                                  |       | 3,000                                |   |
| Accrued expenses  and other liabilities                                            |   | 2,178,000                                  |       | (453,000                             | )      |
| Net cash (used  in) provided by operating activities                               |   | (735,452,000                               | )          | 48,404,000                           |   |
|                                                                               |   |                                       |       |                                 |   |
| **Investing  Activities:**                                                         |   |                                       |       |                                 |   |
| Purchase of  fixed income securities available-for-sale                            |   | (1,345,807,000                             | )          | —                               |   |
| Proceeds from  sales of fixed income securities available-for-sale                 |   | 104,153,000                                |       | —                               |   |
| Proceeds from  sales of equity securities                                          |   | 1,695,000                                  |       | 1,712,000                            |   |
| Principal  payments on fixed income securities available-for-sale                  |   | 44,394,000                                 |       | —                               |   |
| Net cash  (used in) provided by investing activities                          |   | (1,195,565,000                             | )          | 1,712,000                            |   |
|                                                                               |   |                                       |       |                                 |   |
| **Financing  Activities:**                                                         |   |                                       |       |                                 |   |
| Net change in  reverse repurchase agreements                                       |   | 1,813,454,000                              |       | (43,830,000                          | )      |
| Dividend  distributions                                                            |   | (25,013,000                                | )          | (4,069,000                           | )      |
| Issuance of  common stock                                                          |   | 155,856,000                                |       | —                               |   |
| Net cash  provided by (used in) financing activities                               |   | 1,944,297,000                              |       | (47,899,000                          | )      |
|                                                                               |   |                                       |       |                                 |   |
| **Net  Increase (Decrease) in Cash and Cash Equivalents**                          |   | 13,280,000                                 |       | 2,217,000                            |   |
|                                                                               |   |                                       |       |                                 |   |
| **Cash  and Cash Equivalents at Beginning of Period**                              |   | 4,330,000                                  |       | 140,000                              |   |
|                                                                               |   |                                       |       |                                 |   |
| **Cash  and Cash Equivalents at End of Period**                                    |   | $                                          | 17,610,000 |                                 | $      | 2,357,000 |   |
|                                                                               |   |                                       |       |                                 |   |
| **Supplemental  Disclosure of Cash Flow Information:**                             |   |                                       |       |                                 |   |
| Cash paid for  interest                                                            |   | $                                          | 32,188,000 |                                 | $      | 14,159,000 |   |
| Noncash  Investing and Financing Activities:                                       |   |                                       |       |                                 |   |
|                                                                               |   |                                       |       |                                 |   |
| Change in  accumulated other comprehensive income                                  |   | (10,284,000                                | )          | 3,696,000                            |   |
|                                                                               |   |                                       |       |                                 |   |
| Change in  principal payments receivable                                           |   | 130,000                                    |       | 288,000                              |   |
|                                                                               |   |                                       |       |                                 |   |
| Change in  receivable for unsettled securities                                     |   | 4,026,000                                  |       | (14,514,000                          | )      |
|                                                                               |   |                                       |       |                                 |   |
| Change in  dividends declared, not yet paid                                        |   | 2,415,000                                  |       | (2,073,000                           | )      |

 

See accompanying notes to financial statements

 

6

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**Apex Mortgage Capital, Inc.**

**Notes to FinancialStatements**

**(Unaudited)**

 

# **NOTE 1 -**       THE COMPANY

 

ApexMortgage Capital, Inc. (the “Company”) was incorporated in Maryland onSeptember 15, 1997.  The Companycommenced its operations of acquiring and managing a portfolio ofmortgage-related assets on December 9, 1997, upon receipt of the net proceedsfrom the initial public offering of the Company’s common stock.  The Company uses its equity capital andborrowed funds to seek to generate income based on the difference between theyield on its investments and the cost of its borrowings.  The Company is structured for tax purposesas a real estate investment trust (“REIT”) under the Internal Revenue Code of1986, as amended (the “Code”).

 

TheCompany has entered into a Management Agreement (the “Management Agreement”),as amended, with TCW Investment Management Company (the “Manager”), a whollyowned subsidiary of The TCW Group, Inc., under which the Manager manages theCompany’s day-to-day operations, subject to the direction and oversight of theCompany’s Board of Directors.

 

 

# **NOTE 2 -**       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND CERTAINRISKS

 

*Overview*

 

Certaininformation and note disclosures normally included in annual financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America (“GAAP”) have been condensed or omittedpursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”) for interim financial statements. The unaudited financial statementsshould be read in conjunction with the audited financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2001.  The accounting policiesused in the preparation of these interim financial statements were consistentwith those used in the preparation of the financial statements for the yearended December 31, 2001, unless otherwise noted.   Certain reclassifications may have been made to the prior periodfinancial statements to conform to the current period presentation.

 

*Derivativesand Hedging Transactions*

 

TheCompany may enter into interest rate swaps and other financial instruments inorder to mitigate the impact of rising interest rates on the cost of itsshort-term borrowings.  The Company mayalso enter into forward contracts to sell U.S. Treasury securities and otherfinancial instruments in order to mitigate the negative impact of rising interestrates on the fair value of its fixed income securities.   Such financial instruments are generallyreferred to as “derivatives.”

 

TheCompany adopted SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*, as amended, on January 1, 2001.  Prior to adopting SFAS No. 133, the Companyaccounted for changes in fair values of the forward contracts throughadjustments to accumulated other comprehensive income (loss).  Following adoption of SFAS No. 133, theCompany recognizes changes in fair values of forward contracts as a componentof net gain (loss) on investment and derivative activities in the statements ofoperations.

 

UnderSFAS No. 133, all derivatives are recorded at fair value and presented aseither assets or liabilities on the Company’s balance sheets.

 

Duringthe six months ended June 30, 2001, the Company adopted SFAS No. 133 and therelated amendments.  This adoptionresulted in a transition adjustment that reclassified $2,173,000 of net losseson unrealized and deferred gains and losses on investment securities andforward contracts from accumulated other comprehensive income to currentincome.  Also, deferred gains oninterest rate swaps previously designated as hedges were reclassified fromother liabilities to accumulated other comprehensive income.

 

7

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Asof June 30, 2002, the Company has interest rate swaps that qualify as cash flowhedges under SFAS No. 133.  Changes infair values of the swaps are not reflected in current earnings, but arereflected in other comprehensive income. To the extent changes in the fair value of the cash flow hedges aredeemed to be due to ineffectiveness of the hedges, such changes are reflectedin net gain (loss) on investment and derivative activities in the statements ofoperations.  However, the Company’sswaps outstanding at June 30, 2002 are deemed to be fully effective as hedges.

 

Alsoduring the six months ended June 30, 2001, the Company reclassified$594,469,000 of its mortgage securities from the available-for-sale category tothe trading category for investments accounted for under SFAS No. 115.  This change resulted in the reclassificationof $1,742,000 net unrealized gains from accumulated other comprehensive incometo current income, in addition to net unrealized gains included in the SFAS No.133 transition adjustment discussed above.

 

Nosuch accounting changes were made during the six months ended June 30, 2002.

 

# **Note 3 -**      Fixed Income and EquitySecurities

 

AtJune 30, 2002, fixed income and equity securities consisted of the following:

 
| **(in thousands)**             |   | **Fixed  Income  Trading Securities** |      | **Fixed Income  Securities  Available-For-Sale** |   | **Equity Securities  Available-For-Sale** |   |
|--------------------------------|--------|--------------------------------------------|-----------|--------------------------------------------------|--------|-------------------------------------------|--------|
| Principal Amount               |   | $                                          | 1,164,865 |                                             | $      | 2,258,070                                 |   | $ | 3,968 |   |
| Unamortized Premium (Discount) |   | 966                                        |      | 25,149                                           |   | (958                                      | )      |
| Adjusted Cost                  |   | 1,165,831                                  |      | 2,283,219                                        |   | 3,010                                     |   |
| Gross Unrealized Gains         |   | 26,700                                     |      | 18,656                                           |   | 1,527                                     |   |
| Gross Unrealized Losses        |   | (3                                         | )         | (962                                             | )      | —                                    |   |
| Fair Value                     |   | $                                          | 1,192,528 |                                             | $      | 2,300,913                                 |   | $ | 4,537 |   |

 

AtDecember 31, 2001, fixed income and equity securities consisted of thefollowing:

 
| **(in thousands)**             |   | **Fixed  Income  Trading Securities** |    | **Fixed Income  Securities  Available-For-Sale** |   | **Equity Securities  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 |   |

 

Thecontractual final maturity of the mortgage loans supporting fixed incomemortgage securities is generally between 15 and 30 years at origination.  Because of prepayments on the underlyingmortgage loans, the actual weighted-average maturity is expected to besubstantially less.  Fixed-rate mortgagesecurities composed over 96% and 98% of the Company’s portfolio of fixed incomesecurities at June 30, 2002 and December 31, 2001, respectively.  The expected average remaining maturity ofthe Company’s other fixed income securities at June 30, 2002 and December 31,2001 was less than one year.

 

Adjustable-ratemortgage securities composed approximately 3.1% and 1.1% of the Company’sportfolio of fixed income securities at June 30, 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.  

 

8

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AtJune 30, 2002, the portion of adjustable-rate mortgage securities subject toperiodic and lifetime caps had an average periodic cap equal to 1.1% per annumand an average lifetime cap equal to 10.2%. At December 31, 2001, the portionof adjustable-rate mortgage securities subject to periodic and lifetime capshad an average periodic cap equal to 2.0 % per annum and an average lifetimecap equal to 11.3 %.

 

Duringthe quarter ended June 30, 2002, the Company reported a net loss on investmentand derivative activities of $8,748,000 in the statement of operations.  This loss consisted of a net loss of$23,441,000 on closed forward contracts, a gain of $3,000 on the sale of $1,248,000of fixed income securities classified as available-for-sale, a gain of $177,000on the sale of $578,000 of equity securities available-for-sale, and anunrealized gain of $14,513,000 on fixed income trading securities.

 

Duringthe quarter ended June 30, 2001, the Company reported a net loss on investmentand derivative activities of $4,382,000 in the statement of operations.  This loss consisted of $65,000 in gains onthe sale of $1,712,000 of equity securities that were available-for-sale,$866,000 in gains on the sale of $59,109,000 of fixed income securitiesheld-for-trading, $6,115,000 loss from the net decrease in fair market value offixed income securities held-for-trading, $2,974,000 gain from the net decreasein unrealized loss on forward contracts, and $2,172,000 in net losses on closedforward contracts.

 

# **NOTE 4 -**       Reverse Repurchase Agreements

 

TheCompany has entered into reverse repurchase agreements to finance certain ofits investments.  These agreements aresecured by a portion of the Company’s investments and bear interest rates thathave historically moved in close relationship to LIBOR.

 

AtJune 30, 2002, the Company had outstanding $3,191,797,000 of reverse repurchaseagreements with a weighted average current borrowing rate of 1.81% and amaturity of 1.0 month.  The reverserepurchase agreements were collateralized by securities with an estimated fairvalue of $3,303,657,000.

 

AtDecember 31, 2001, the Company had outstanding $1,376,850,000 of reverserepurchase agreements with a weighted average current borrowing rate of 1.89%and a maturity of 1.0 month.  Thereverse repurchase agreements were collateralized by securities with anestimated fair value of $1,440,014,000.

 

# **NOTE 5 -**       Derivative Financial Instruments and HedgingActivities

 

TheCompany has entered into interest rate swap agreements as summarizedbelow.  Under these agreements, theCompany receives a floating rate and pays a fixed rate.  The swaps qualify as cash flow hedges foraccounting purposes, and effectively fix the interest rate paid on$2,223,000,000, as of June 30, 2002, of current and anticipated futureborrowings under reverse repurchase agreements.

 

InterestRate Swaps at June 30, 2002:

 
| **Current  Notional Amount  (000)** |      | **Average  Fixed Rate** |   | **Floating  Rate** |      | **Average  Termination  Date** |      | **Unrealized  Losses  (000)** |   |
|------------------------------------------|-----------|-------------------------|--------|--------------------|-----------|--------------------------------|-----------|-------------------------------|--------|
|                                     |      |                    |   |               |      |                           |      |                          |   |
| $                                        | 2,223,000 |                    | 4.380  | %                  | 1Mo LIBOR |                           | 2/25/2008 |                          | $      | (37,342 | ) |
|                                          |           |                         |        |                    |           |                                |           |                               |        |  |  |

 

9

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InterestRate Swaps at December 31, 2001:

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

 

Duringthe year ended December 31, 2000, the Company terminated outstanding interestrate swap agreements with a combined notional amount of $386,213,000, whichresulted in a deferred gain of $5,554,000. The deferred gain is being amortized as an adjustment to interestexpense over the remaining lives of the original swap agreements, and theremaining unamortized amount is included in accumulated other comprehensiveincome (loss) as of December 31, 2001.  During the quarters ended June 30, 2002 and 2001, $59,000 and $946,000,respectively, of the deferred gain were amortized.  The remaining deferred gain was fully amortized in May 31, 2002.

 

AtDecember 31, 2001, the Company held $2,500,000 in cash as collateral from aswap counterparty. At June 30, 2002, there was no cash collateral held from aswap counterparty.

 

AtJune 30, 2002, the Company had open forward contracts to sell U.S. Treasurynotes with terms stated below:

 

 
| **Current  Notional Amount ($000)** |    | **Average  Termination  Date** |     | **Net  Unrealized  Losses  ($000)** |   | **Average  Maturity of  Underlying  Securities** |   |
|-------------------------------------|---------|--------------------------------|----------|-------------------------------------|--------|--------------------------------------------------|--------|
|                                |    |                           |     |                                |   |                                             |   |
| $                                   | 605,000 |                           | 7/2/2002 |                                | $      | (2,218                                           | )      | 4.23 Years |   |
|                                     |         |                                |          |                                     |        |                                                  |        |  |  |

 

AtDecember 31, 2001, the Company had open forward contracts to sell U.S. Treasurynotes with terms stated below:

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

 

 

# **ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL 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.*

 

**SAFEHARBOR/FORWARD LOOKING STATEMENTS**

 

Certain information contained in this Quarterly Reporton Form 10-Q constitutes “forward-looking statements” which can be identifiedby the use of forward-looking terminology such as “may,” “will,” “should,”“expect,” “anticipate,” “estimate,” “intend,” “continue,” or “believes” or thenegatives thereof or other variations thereon or comparable terminology.  Discussed below are some important factorsthat would cause actual results to differ materially from those in any forward-lookingstatements, including changes in interest rates; domestic and foreign business,market, financial or 

 

10

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legal conditions; differences in the actual allocation of the assets ofthe Company from those assumed; and the degree to which assets are hedged andthe effectiveness of the hedge, among others. In addition, the degree of risk is increased by the Company’s leveragingof its assets.  For additional discussionof factors that could cause actual results to differ from those contained insuch 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. The Company does not undertake, andspecifically disclaims any obligation, to update any forward-looking statementsto reflect occurrences or unanticipated events or circumstances after the dateof such statements.

 

**GENERAL**

 

Apex Mortgage Capital, Inc.  (the ‘‘Company’’), a Maryland corporation, was formed onSeptember 15, 1997, primarily to acquire United States agency and other highlyrated, single-family real estate adjustable and fixed rate mortgage relatedassets.  The Company commencedoperations on December 9, 1997 following the initial public offering of theCompany’s Common Stock.  The Company’sprincipal executive offices are located at 865 South Figueroa Street, Suite1800, Los Angeles, California 90017, and its telephone number is (213)244-0000.

 

The Company uses its equity capital and borrowed fundsto seek 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 managedby an external 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 June 20, 2002, the Company’s Board ofDirectors declared a dividend distribution of $0.50 per common share.  The dividend was paid on July 26, 2002, tostockholders of record on June 28, 2002.

 

*Followon Public Offering*.  On May 29, 2002, the Company issued5,060,000 shares of common stock in a follow on public offering.  The Company received proceeds (net ofunderwriting discounts, commissions and other expenses) of $63,659,000 fromthis offering.  The Company leveragedthe new equity by entering into additional reverse repurchase agreements, andused the combined proceeds from the offering and the new borrowings primarilyto purchase additional mortgage-related securities.

 

*ReportingPeriod*.  Unless otherwise noted, this reportdescribes the Company’s operations and developments through the date hereof.

 

**STRATEGY**

 

To achieve its businessobjective and generate dividend yields that provide a competitive rate ofreturn for its stockholders, the Company’s strategy is to:

 

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

 

11

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•                  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 through borrowings(primarily reverse repurchase agreements) with interest rates that will alsoreflect 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,interest rate caps and similar financial instruments to mitigate interest raterisks;

 

•                  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.

 

There can be no assurancethat the Company will be able to generate competitive earnings and dividendswhile holding primarily high quality mortgage related assets and maintaining adisciplined risk-control profile.

 

The Company may attemptto increase the return to stockholders over time by: (i) raising additionalcapital in order to increase its ability to invest in additional mortgagerelated assets; (ii) lowering its effective borrowing costs through directfunding with collateralized lenders, in addition to using Wall Streetintermediaries, and investigating the possibility of using collateralizedcommercial paper and medium-term note programs; and (iii) improving theefficiency of its balance sheet structure by issuing uncollateralizedsubordinated debt and other forms of capital.

 

**THEMANAGEMENT AGREEMENT**

 

The Company has renewedits Management Agreement with the Manager for a one year term ending onDecember 31, 2002.  The Manager isprimarily 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 all times, the Manageris subject to the direction and oversight of the Company’s Board of Directorsand has only such functions and authority as the Company delegates to it.  The Manager is responsible for theday-to-day operations of the Company.

 

The Management Agreementmay be renewed for additional one-year terms at the discretion of theunaffiliated directors, unless previously terminated by the Company or theManager upon written notice.  Except inthe case of a termination or non-renewal by the Company for cause, upontermination or non-renewal of the Management Agreement by the Company, theCompany is obligated to pay the Manager a termination or non-renewal fee, whichmay be significant.  The termination ornon-renewal fee shall be equal to the fair market value of the ManagementAgreement without regard to the Company’s termination right, as determined byan independent appraisal.  The selectionof the independent appraiser shall be subject to the approval of the unaffiliateddirectors.  Neither the fair marketvalue of the Management Agreement 

 

12

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nor the various factors which the appraiser may findrelevant in its determination of the fair market value can be determined atthis time.

 

The fair market value of theManagement Agreement will be affected by significant variables, including (i)the historical management fees paid to the Manager, (ii) any projections offuture management fees to be paid to the Manager determined by the independentappraiser, (iii) the relative valuations of agreements similar to theManagement Agreement and (iv) other factors, all of which may be unrelated tothe performance of the Manager.

 

The Management Agreementmay be assigned by the Manager to an affiliate of TCW without the consent ofthe Company.  The Management Agreementmay be assigned to a non-affiliate of TCW only with the approval of a majorityof the unaffiliated directors.

 

**Manager Compensation**

 

The Manager will receiveannual base management compensation based on the Average Net Invested Capitalof the Company, payable monthly in arrears, equal to 3/4 of 1% of Average NetInvested 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 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 debtto finance specific investment purchases does not ordinarily increase AverageNet Invested Capital.

 

The Manager shall also beentitled to receive as incentive compensation for each fiscal quarter, anamount equal to 30% of the Net Income of the Company, before incentivecompensation, in excess of the amount that would produce an annualized Returnon 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 calculating theincentive 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.

 

The ability of theCompany to achieve an annualized Return on Equity in excess of the Ten-YearU.S.  Treasury Rate plus 1%, and of theManager to earn the incentive compensation described in the precedingparagraph, is dependent upon the level and volatility of interest rates, theCompany’s ability to react to changes in interest rates and to utilizesuccessfully the operating strategies described herein, and other factors, manyof which are not within the Company’s or the Manager’s control.  The Manager’s base compensation shall becalculated by the Manager within 15 days after the end of each month, and suchcalculation shall be promptly delivered to the Company.  The Company is obligated to pay the basecompensation 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.

 

13

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#### **POLICIES**

 

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

 

**FINANCIAL CONDITION**

 

**Fixed Income Securities**

 

At June 30, 2002 andDecember 31, 2001, the Company held $3,493,441,000 and $1,505,529,000 of fixedincome securities, respectively.  Theincrease in fixed income securities held at June 30, 2002 is primarily theresult of two successful follow-on equity offerings during the six monthsperiod ended June 30, 2002. With the net proceeds from the offerings and theuse of leverage, The Company increased its investments in fixed income securities.The original 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):

 
|                          |   | **June 30, 2002**   |      | **December 31, 2001**      |   |
|-------------------------------|--------|---------------------|-----------|----------------------------|--------|
| **Fixed Income Securities**   |   | **Carrying  Value** |      | **Percent of   Portfolio** |   | **Carrying  Value** |   | **Percent of  Portfolio** |   |
|                          |   |                |      |                       |   |   |   |   |   |
| Mortgage Securities:          |   |                |      |                       |   |   |   |   |   |
| Adjustable Rate (1)           |   | $                   | 109,005   |                       | 3.12   | % | $ | 16,196 |   | 1.08 | % |
| Fixed Rate                    |   | 3,379,495           |      | 96.74                      | %      | 1,483,881 |   | 98.56 | % |
| Other Fixed Income Securities |   | 4,941               |      | 0.14                       | %      | 5,452 |   | 0.36 | % |
| Totals                        |   | $                   | 3,493,441 |                       | 100.00 | % | $ | 1,505,529 |   | 100.00 | % |

 

----

(1)          At June 30, 2002,  the interest rate indices for 99.8% and 0.2%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.

 

At December 31,2001, the interest rate indices for 98.0% and 2% of the adjustable ratemortgage securities were based on the one-year U.S. Treasury rate and thesix-month London Inter-Bank Offered Rate, respectively.

 

The following table showsvarious weighted average characteristics of the fixed income securities held bythe Company at June 30, 2002 (dollars in thousands):

 
| **Security Type**             |   | **Par Amount** |      | **Par as a  Percent of  Category** |   | **Adjusted  Cost Basis** |   | **Market  Price** |   | **Current  Coupon** |   | **Weighted  Average  Life (1)** |   |
|-------------------------------|--------|----------------|-----------|------------------------------------|--------|--------------------------|--------|-------------------|--------|---------------------|--------|---------------------------------|--------|
|                          |   |           |      |                               |   |                     |   |              |   |                |   |                            |   |
| 20 Year Agency Pass-throughs  |   | $              | 157,487   |                               | 4.60   | %                        | 96.90  | %                 | 103.61 | %                   | 6.50   | %                               | 3.3    |   |
| 30 Year Agency Pass-throughs  |   | 3,085,970      |      | 90.16                              | %      | 101.22                   | %      | 102.17            | %      | 6.50                | %      | 5.6                             |   |
| AAA CMOs                      |   | 61,864         |      | 1.81                               | %      | 95.98                    | %      | 102.70            | %      | 6.68                | %      | 1.6                             |   |
| Total Fixed Rate Holdings     |   | 3,305,321      |      | 96.57                              | %      | 100.92                   | %      | 102.24            | %      | 6.50                | %      | 5.4                             |   |
|                          |   |           |      |                               |   |                     |   |              |   |                |   |                            |   |
| Other Fixed Income Securities |   | 10,400         |      | 0.30                               | %      | 55.71                    | %      | 47.51             | %      | 13.40               | %      | 0.3                             |   |
| Adjustable Rate Holdings      |   | 107,214        |      | 3.13                               | %      | 100.39                   | %      | 101.67            | %      | 5.06                | %      | 1.0                             |   |
|                          |   |           |      |                               |   |                     |   |              |   |                |   |                            |   |
| Category Total                |   | $              | 3,422,935 |                               | 100.00 | %                        | 100.76 | %                 | 102.06 | %                   | 6.48   | %                               | 5.3    |   |
|                               |        |                |           |                                    |        |                          |        |                   |        |                     |        |                                 |        |  |  |

 

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):

 
| **Security Type**             |   | **Par Amount** |      | **Percent of   Total Par  Amount** |   | **Adjusted  Cost Basis** |   | **Market  Price** |   | **Current  Coupon** |   | **Weighted  Average  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 fixedrate mortgage 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.

 

### **Equity Securities**

 

At June 30, 2002 andDecember 31, 2001 the Company held $4,537,000 and $6,028,000 of equitysecurities, respectively.  The decreasein the value of equity securities at June 30, 2002 is primarily due to the saleof Capstead convertible preferred stock during the six months period ended June30, 2002. Equity securities consist primarily of investment in equities issuedby other real estate investment trusts.

 

At June 30, 2002, equity securities consisted of the following:

                
| **(In thousands)**                      |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |   |
|-----------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|--------|
|                                    |   |            |   |              |   |           |   |
| Common Stock:                           |   |            |   |              |   |           |   |
| Dynex Capital, Inc.                     |   | 75              |   | $                 | 122    |           | $      | 364 |   |
| Total Common Stock                      |   |            |   | 122               |   | 364            |   |
|                                    |   |            |   |              |   |           |   |
| Convertible Preferred Stock:            |   |            |   |              |   |           |   |
| Capstead Mortgage Corporation, Series B |   | 341             |   | 2,888             |   | 4,173          |   |
| Total Convertible Preferred Stock       |   |            |   | 2,888             |   | 4,173          |   |
|                                    |   |            |   |              |   |           |   |
| Total Equity Securities                 |   |            |   | $                 | 3,010  |           | $      | 4,537 |   |

 

15

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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 |   |

 

**PRINCIPALRISKS AND SPECIAL CONSIDERATIONS**

 

***Leverage Risk****.* The Company employs a leveraging strategy of generally borrowing up to92% of its total assets to finance the acquisition of additional mortgagerelated assets.  The Company’s borrowingmay, at times, exceed 92% of its total assets. In the event borrowing costs exceed the income on its mortgage relatedassets, the Company will experience negative cash flow and incur losses.Another risk of leverage is the possibility that the value of the collateralsecuring the borrowings will decline. In such event, additional collateral or repayment of borrowings would berequired.  The Company could be requiredto sell mortgage related assets under adverse market conditions in order tomaintain liquidity.  If these sales weremade at prices lower than the carrying value of the mortgage related assets,the Company would experience losses.

 

***Interest Rate Risk.***  There is thepossibility that the value of the Company’s mortgage related assets may fallsince fixed income securities generally fall when interest rates rise.  The longer the term of a fixed incomeinstrument, the more sensitive it will be to fluctuations in value frominterest rate changes.  Changes ininterest rates may have a significant effect on the Company’s operations,because it may hold mortgage related assets with long terms to maturity.  Rising interest rates will negatively impactthe Company’s borrowings since the value of the collateral securing theborrowing will decline in value, requiring additional collateral or repaymentsof borrowing.  This could reduce thelevel of borrowings and reduce returns. Also, when interest rates rise, the Company’s holding of mortgagerelated assets can reduce returns if the owners of the underlying mortgagespay-off their mortgages later than anticipated.  This is known as *extension risk*.  When interest rates drop, the Company’s holdings of the mortgagerelated assets can reduce returns if the owners of the underlying mortgages payoff their mortgages sooner than anticipated since the funds prepaid will haveto be invested at the then lower prevailing rate.  This is known as *prepayment risk*.  In addition, when interest rates drop, not only can the value ofmortgage related assets drop, but the yield can drop, particularly where theyield on the security is tied to interest rates, such as adjustable mortgages.

 

***Liquidity Risk****.* There is the possibility that the Company may lose money or be preventedfrom earning capital gains if it cannot sell a mortgage related asset at a timeand price that is most beneficial to the Company.  The Company is subject to liquidity risk because it invests inmortgage securities which have experienced periods of illiquidity.

 

***Credit Risk****.* Credit risk is the possibility that the Company could lose money if anissuer is unable to meet its financial obligations, such as the payment ofprincipal and/or interest on an instrument, or goes bankrupt.  The Company may invest a portion of itsassets in mortgage related assets which are not guaranteed by the 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 andlitigation.  This is especially trueduring periods of economic uncertainties and economic downturns.

 

16

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***Failure to Maintain REIT Status Risk****.*  Failure to maintain REIT status risk refersto the possibility that the Company may become subject to federal income tax asa regular corporation.  The Companyintends at all times to maintain substantially all of its investments in, andotherwise conduct its business in a manner consistent with, the REIT Provisionsof the Code.  If the Company fails toqualify as a REIT, it would be treated as a regular corporation for federal taxpurposes.  This would result in theCompany being subject to federal income tax that would further result in asubstantial reduction of cash available for distribution to stockholders.

 

***Failure to Maintain Investment Company Act Exemption Risk****.*  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 assets may be limited by the InvestmentCompany Act.  This could have the effectof  adversely affecting the Company’soperations and returns to stockholders. In addition, if the Company fails to qualify for  the exemption from registration as aninvestment company, its ability to use leverage would be substantiallyreduced.  This could reduce income tothe Company and returns to stockholders.

 

**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 intends generallyto hedge as much of the interest rate risk as the Manager determines is in thebest interest of the stockholders of the Company given the cost of such hedgingtransactions and the Company’s desire to maintain its status as a REIT.  The Company’s policies do not containspecific requirements as to the percentages or amount of interest rate riskthat 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.

 

Borrowings hedged by interest rate swaps are usedprimarily to acquire and hold fixed income securities available-for-sale.  Changes in the fair values of securitiesavailable-for-sale are also reported in accumulated other comprehensive income,a component of stockholders’ equity. Changes in fair values of the securities only affect periodic earningswhen they are sold or if they have an other-than-temporary impairment.   Therefore, earnings volatility is reducedby the use of the swap agreements as cash flow hedges and the acquisition ofavailable-for-sale securities with the borrowings hedged by theagreements.  Impairment of theavailable-for-sale securities or decisions to sell the securities prior totheir expected maturities could result in unanticipated earnings volatility.

 

17

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At June 30, 2002, the Company had entered intointerest rate swap agreements summarized below.

 
| **Current  Notional Amount  (000)** |      | **Weighted  Average Life** |     | **Average  Fixed Rate** |   | **Floating  Rate** |      | **Average  Termination  Date** |      | **Unrealized  Losses  (000)** |   |
|-------------------------------------|-----------|----------------------------|----------|-------------------------|--------|--------------------|-----------|--------------------------------|-----------|-------------------------------|--------|
|                                |      |                       |     |                    |   |               |      |                           |      |                          |   |
| $                                   | 2,223,000 |                       | 4.2years |                    | 4.380  | %                  | 1Mo LIBOR |                           | 2/25/2008 |                          | $      | (37,342 | ) |
|                                     |           |                            |          |                         |        |                    |           |                                |           |                               |        |  |  |

 

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

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

 

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.

 

TheCompany’s forward contracts do not meet the criteria for hedge accounting underSFAS No. 133.  Therefore, changes intheir fair values affect current earnings, as do changes in the fair values ofthe securities to which they are matched – such securities are classified astrading securities.  Although thechanges in the fair values of the forward contracts and the trading securitiesare offsetting, the contracts are not fully effective as hedges, and there canbe significant volatility in periodic earnings to the extent they are not.

 

At June 30, 2002,the Company had open forward contracts to sell U.S. Treasury notes with termsstated below.

 
| **Current  Notional Amount  (000)** |    | **Average  Contract  Price** |    | **Fair Value  of  Contracts  (000)** |   | **Average  Termination  Date** |   | **Unrealized  Gains (Losses)  (000)** |   |
|-------------------------------------|---------|------------------------------|---------|--------------------------------------|--------|--------------------------------|--------|---------------------------------------|--------|
|                                |    |                         |    |                                 |   |                           |   |                                  |   |
| $                                   | 605,000 |                         | 105.733 |                                 | $      | 641,902                        |   | 7/2/2002                              |   | $ | (2,218 | ) |
|                                     |         |                              |         |                                      |        |                                |        |                                       |        |  |  |  |

 

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

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

 

18

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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 June 30, 2002, theCompany had outstanding $3,191,797,000 of reverse repurchase agreements with aweighted average current borrowing rate of 1.81% and a maturity of 1.0month.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$3,303,657,000.

 

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 1.0month.  The reverse repurchaseagreements were collateralized by mortgage-backed securities with an estimatedfair value of $1,440,014,000.

 

The increase inoutstanding reverse repurchase agreements at June 30, 2002 is the result of thefollow-on equity offerings during the six months period ended June 30, 2002.The Company utilized the net proceeds of the follow-on equity offerings toincrease leverage which is used to take advantage of market opportunities andto invest the portfolio as fully as possible in anticipation of any futureacceleration in prepayment rates, which would reduce leverage over time.

 

The Company had interestrate swaps with an unrealized loss of $37,342,000 and an unrealized gain of$4,620,000 at June 30, 2002 and December 31, 2001, respectively. The $41,962,000decrease in unrealized value on interest rate swaps is due to an increase innotional amount of $850,000,000 to $2,223,000,000 at December 31, 2001 and June30, 2002, respectively, combined with a decrease in the one-month LIBOR rate.Under the swap agreements, the Company receives a floating rate and pays afixed rate.

 

TheCompany had $33,988,000 and $28,545,000 of other liabilities at June 30, 2002and December 31, 2001, respectively. The increase of other liabilities at June30, 2002 is primarily due to the increase of dividend payable, which is theresult of the follow-on equity offerings during the six months period endedJune 30, 2002. Other liabilities consist primarily of accrued interest payable,dividend payable, unrealized loss on forward contracts, and accrued expense andother liabilities. The Company anticipates settling all other liabilitieswithin one year.

 

**Results of Operations forthe Three Months Ended June 30, 2002**

 

*Overview*

 

For the three months ended June 30, 2002, theCompany’s net income was $15,521,000, or 0.58 per common share on a basic anddiluted basis, based on a weighted average of 26,627,934 and 26,796,090 sharesoutstanding, respectively.  Thatcompares to net income of $400,000, or $0.07 per common share on both a basicbasis and diluted basis, based on a weighted average of 5,753,000 and 5,819,000shares outstanding for the three months ended June 30, 2001.  The weighted average number of shares usedto calculate net income per diluted share includes the effect of the assumedexercise of outstanding stock options.

 

*Net Interest Income*

 

Net interest income forthe three months ended June 30, 2002 was $23,880,000 consisting of interestincome on fixed income securities and cash balances less interest expense onreverse repurchase agreements compared to $4,776,000 for the three months endedJune 30, 2001. The increase in net interest income for the three months endedJune 30, 2002 is primarily due to an increase in investments in fixed incomesecurities with a net interest margin of approximately 3.17%.  The Company reported dividend income of$109,000 from dividends on equity investments for the three months ended June30, 2002 compared to $306,000 for the three months ended June 30, 2001.

 

19

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The following tablereflects the average balances for each category of the Company’s interestearning assets as well as the Company’s interest bearing liabilities, with thecorresponding effective rate of interest annualized (dollars in thousands):

 

#### **AVERAGE BALANCE AND RATE TABLE**

#### (Dollars in thousands)

 
|                                    |   | **For the Quarter Ended  June 30, 2002** |      | **For the Quarter Ended  June 30, 2001** |   |
|-----------------------------------------|--------|------------------------------------------|-----------|------------------------------------------|--------|
|                                    |   | **Average Balance**                      |      | **Effective Rate**                       |   | **Average Balance** |   | **Effective Rate** |   |
| Interest  Earning Assets:               |   |                                     |      |                                     |   |   |   |   |   |
| Mortgage  Securities                    |   | $                                        | 2,788,814 |                                     | 6.48   | % | $ | 536,103 |   | 7.05 | % |
| Other  Fixed Income Assets              |   | 5,888                                    |      | 4.68                                     | %      | 6,532 |   | 17.34 | % |
| Cash  and Cash Equivalents              |   | 7,946                                    |      | 0.91                                     | %      | 4,017 |   | 3.39 | % |
| Total  Interest Earning Assets          |   | 2,802,648                                |      | 6.46                                     | %      | 546,652 |   | 7.14 | % |
|                                    |   |                                     |      |                                     |   |   |   |   |   |
| Interest  Bearing Liabilities:          |   |                                     |      |                                     |   |   |   |   |   |
| Reverse  Repurchase Agreements          |   | 2,597,048                                |      | 3.29                                     | %      | 527,693 |   | 3.78 | % |
|                                    |   |                                     |      |                                     |   |   |   |   |   |
| Net  Interest Earning Assets and Spread |   | $                                        | 205,600   |                                     | 3.17   | % | $ | 18,959 |   | 3.36 | % |

 

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

 

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

 

#### **AVERAGE BALANCE AND RATE TABLE**

#### (Dollars in thousands)

 
|               |   | **For the Quarter Ended  June 30, 2002** |   | **For the Quarter Ended  June 30, 2001** |   |
|--------------------|--------|------------------------------------------|--------|------------------------------------------|--------|
|               |   | **Average  Balance**                     |   | **Effective  Dividend  Yield**           |   | **Average  Balance** |   | **Effective  Dividend  Yield** |   |
|               |   |                                     |   |                                     |   |   |   |   |   |
| Equity  securities |   | $                                        | 4,033  |                                     | 10.81  | % | $ | 12,535 |   | 9.76 | % |
|                    |        |                                          |        |                                          |        |  |  |  |  |  |  |

 

20

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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****June 30****,  2002 compared to 2001** |   |
|                          |   | **Total  Change**                                              |   | **Changes Due  to** |   |
| **Volume (1)**                |   | **Rates (1)**                                                  |
| Interest-Earning Assets       |   |                                                           |   |   |   |   |   |
| Fixed income securities       |   | $                                                              | 35,522 |   | $ | 40,365 |   | $ | (4,843 | ) |
| Cash and cash equivalents     |   | (16                                                            | )      | 34 |   | (50 | ) |
|                          |   |                                                           |   |   |   |   |   |
| Total interest income         |   | $                                                              | 35,506 |   | $ | 40,399 |   | $ | (4,893 | ) |
|                          |   |                                                           |   |   |   |   |   |
| Interest-Bearing Liabilities  |   |                                                           |   |   |   |   |   |
| Reverse repurchase agreements |   | $                                                              | 16,402 |   | $ | 19,778 |   | $ | (3,376 | ) |
|                          |   |                                                           |   |   |   |   |   |
| Total interest expense        |   | $                                                              | 16,402 |   | $ | 19,778 |   | $ | (3,376 | ) |
|                          |   |                                                           |   |   |   |   |   |
| Change In Net Interest Income |   | $                                                              | 19,104 |   | $ | 20,621 |   | $ | (1,517 | ) |

 

----

(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 June 30, 2001,interest expense was decreased by $946,000 from amortization of deferred gainson terminated swap contracts.  Duringthe quarter ended June 30, 2002, interest expense was increased by $9,463,000paid to swap counterparties and decreased by $59,000 from amortization ofdeferred gains on terminated swap contracts.

 

*General and Administrative Expenses*

 

The Company incurredoperating expenses of ($280,000) for the three months ended June 30, 2002consisting of management fees, professional, printing, insurance and otherexpenses aggregating  $933,000 offset bya $1,213,000 reversal of annual incentive fee expense.  For the three months ended June 30, 2001,the Company incurred operating expenses of $300,000 consisting of managementfees, professional, printing, insurance and other expenses.  The primary reason for lower operating expensesin the three months ended June 30, 2002 compared to the same period in 2001 isdue to the reversal of the annual incentive fee.

 

In the quarter ended June30, 2002, the Company reversed a portion of the incentive fee recorded asexpense in the first quarter.  Incentive fees are calculated based onyear-to-date book earnings adjusted for certain items not subject to taxcurrently and return on equity relative to certain benchmarks.  Becausethe Company had realized losses on terminated forward contracts, which reduceddistributable income, and offsetting unrealized gains on investment securities,which do not increase distributable income, distributable income year-to-datethrough June 30, 2002 did not exceed the benchmark and accordingly the Company wasnot required to pay the Manager an incentive fee for the quarter ended June 30,2002.

 

*Net Gain (Loss) on Investment andDerivative Activities*

 

During the quarter endedJune 30, 2002, the Company reported a net loss on investment and derivativeactivities of $8,748,000 in the statement of operations.  This loss consisted of a net loss of$23,441,000 on closed forward contracts, a 

 

21

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gain of $3,000 on the sale of $1,248,000 of fixed income securities available-for-sale,a gain of $177,000 on the sale of $578,000 of equity securitiesavailable-for-sale, and an unrealized gain of $14,513,000 on tradingsecurities.

 

During the quarter endedJune 30, 2001, the Company reported a net loss on investment and derivativeactivities of $4,382,000 in the statement of operations.  This loss consisted of $65,000 in gains onthe sale of $1,712,000 of equity securities that were available-for-sale,$866,000 in gains on the sale of $59,109,000 of fixed income securities held-for-trading,$6,115,000 loss from the net decrease in fair market value of fixed incomesecurities held-for-trading, $2,974,000 gain from the net decrease inunrealized loss on forward contracts, and $2,172,000 in net losses on closedforward contracts.

 

 

**Results of Operations for the Six Months Ended June 30, 2002**

 

*Overview*

 

For the six months endedJune 30, 2002, the Company’s net income was $25,249,000, or $1.12 per share ona basic and diluted basis, based on a weighted average of 22,494,859 and 22,636,070shares outstanding, respectively.  Thatcompares to net income of $1,374,000 or $0.24 per share, both on a basic anddiluted basis, based on a weighted average of 5,753,000 and 5,819,000 sharesoutstanding, respectively, for the six months ended June 30, 2001.

 

*Net Interest Income*

 

Net interest income forthe six months ended June 30, 2002 was $38,484,000 consisting of interestincome on fixed income securities and cash balances less interest expense onreverse repurchase agreements compared to $8,720,000 for the six months endedJune 30, 2001.  The increase in netinterest income for the six months ended June 30, 2002 is primarily due to anincrease in investments in fixed income securities with a net interest marginof approximately 3.19%.  The Companyreported dividend income of $235,000 from dividends on equity investments forthe six months ended June 30, 2002 compared to $494,000 for the six monthsended June 30, 2001.

 

The following table reflects the average balances foreach category of the Company’s interest earning assets as well as the Company’sinterest bearing liabilities, with the corresponding effective rate of interestannualized:

 

** **

**AVERAGEBALANCE AND RATE TABLE**

(Dollarsin thousands)

 
|                                    |   | **For the Six Months Ended  June 30, 2002** |      | **For the Six Months Ended  June 30, 2001** |   |
|-----------------------------------------|--------|---------------------------------------------|-----------|---------------------------------------------|--------|
|                                    |   | **Average  Balance**                        |      | **Effective  Rate**                         |   | **Average  Balance** |   | **Effective  Rate** |   |
| Interest  Earning Assets:               |   |                                        |      |                                        |   |   |   |   |   |
| Mortgage  Securities                    |   | $                                           | 2,231,121 |                                        | 6.48   | % | $ | 556,667 |   | 7.22 | % |
| Other  Fixed Income Assets              |   | 6,022                                       |      | 7.21                                        | %      | 6,615 |   | 18.17 | % |
| Cash  and Cash Equivalents              |   | 8,605                                       |      | 1.70                                        | %      | 3,682 |   | 4.13 | % |
|                                    |   |                                        |      |                                        |   |   |   |   |   |
| Total  Interest Earning Assets          |   | 2,245,748                                   |      | 6.46                                        | %      | 566,964 |   | 7.33 | % |
|                                    |   |                                        |      |                                        |   |   |   |   |   |
| Interest  Bearing Liabilities:          |   |                                        |      |                                        |   |   |   |   |   |
| Reverse  Repurchase Agreements          |   | 2,086,705                                   |      | 3.27                                        | %      | 545,055 |   | 4.43 | % |
|                                    |   |                                        |      |                                        |   |   |   |   |   |
| Net  Interest Earning Assets and Spread |   | $                                           | 159,043   |                                        | 3.19   | % | $ | 21,909 |   | 2.90 | % |

 

The effective yield datais computed by dividing the annualized net interest income or expense includingcertain hedging transactions as applicable into the average daily balanceshown.

 

22

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The followingtable reflects the average balances for the Company’s equity securities:

 

#### **AVERAGE BALANCE AND RATE TABLE**

#### (Dollars in thousands)

 
|               |   | **For the Six Months Ended  June 30, 2002** |   | **For the Six Months Ended  June 30, 2001** |   |
|--------------------|--------|---------------------------------------------|--------|---------------------------------------------|--------|
|               |   | **Average  Balance**                        |   | **Effective  Dividend  Yield**              |   | **Average  Balance** |   | **Effective  Dividend  Yield** |   |
|               |   |                                        |   |                                        |   |   |   |   |   |
| Equity  securities |   | $                                           | 4,275  |                                        | 10.99  | % | $ | 12,774 |   | 7.73 | % |
|                    |        |                                             |        |                                             |        |  |  |  |  |  |  |

 

 

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 in thousands)

 
|                          |   | **Six Months  Ended****June 30****,  2002 compared to 2001** |   |
|-------------------------------|--------|--------------------------------------------------------------|--------|
|                          |   | **Total  Change**                                            |   | **Changes Due  to** |   |
| **Volume (1)**                |   | **Rates (1)**                                                |
| Interest-Earning Assets       |   |                                                         |   |   |   |   |   |
| Fixed income securities       |   | $                                                            | 51,798 |   | $ | 61,507 |   | $ | (9,709 | ) |
| Cash and cash equivalents     |   | (3                                                           | )      | 102 |   | (105 | ) |
|                          |   |                                                         |   |   |   |   |   |
| Total interest income         |   | $                                                            | 51,795 |   | $ | 61,609 |   | $ | (9,814 | ) |
|                          |   |                                                         |   |   |   |   |   |
| Interest-Bearing Liabilities  |   |                                                         |   |   |   |   |   |
| Reverse repurchase agreements |   | $                                                            | 22,031 |   | $ | 34,342 |   | $ | (12,311 | ) |
|                          |   |                                                         |   |   |   |   |   |
| Total interest expense        |   | $                                                            | 22,031 |   | $ | 34,342 |   | $ | (12,311 | ) |
|                          |   |                                                         |   |   |   |   |   |
| Change In Net Interest Income |   | $                                                            | 29,764 |   | $ | 27,267 |   | $ | 2,497 |   |

 

----

(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 counterparties result in adjustments to interest expense associatedwith the reverse repurchase agreements hedged by the swaps.  During the six months ended June 30, 2001,interest expense was decreased by $2,098,000 from amortization of deferredgains on terminated swap contracts. During the six months ended June 30, 2002, interest expense was increasedby $15,153,000 paid to swap counterparties and decreased by $180,000 fromamortization of deferred gains on terminated swap contracts.

 

23

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*General and Administrative Expenses*

 

The Company incurred operatingexpenses of $3,017,000 for the six months ended June 30, 2002 consisting ofmanagement fees, incentive fees, professional, printing, insurance and otherexpenses.  For the six months ended June30, 2001, the Company incurred operating expenses of $569,000 consisting ofmanagement fees, professional, printing, insurance and other expenses. Theprimary reasons for the higher operating expenses in first six months of 2002compared to first six months of 2001 were that management fees, especially incentivefees, were much higher because of substantially improved operating income.

 

*Net Gain (Loss) on Investment andDerivative Activities*

 

During the six monthsended June 30, 2002, the Company incurred a net loss on investment transactionsof $10,453,000 which is reported in the Statement of Operations.  The loss consisted of a $518,000 gain on thesale of $1,695,000 of equity securities, a realized $17,000 gain on the saleof  $6,535,000 of fixed incomesecurities held for trading, a loss of $229,000 on the sale of $98,634,000 offixed income securities classified as available-for-sale, a unrealized gain of$13,163,000 on fixed income securities held for trading, and a realized$23,922,000 loss on closed forward contracts. The company realized a net loss of $6,840,000 primarily from the loss onclosed forward contracts for the six months ended June 30, 2001.

 

**Liquidity and Capital Resources**

 

The Company’s primarysources of funds as of June 30, 2002 and December 31, 2001, consisted ofreverse repurchase agreements totaling $3,191,797,000 and $1,376,850,000,respectively.  The Company expects tocontinue to borrow funds in the form of reverse repurchase agreements.  At June 30, 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 theCompany’s cash resources are at any time insufficient to satisfy the Company’sliquidity requirements, the Company may be required to liquidate mortgageassets or sell debt or additional equity securities.  If required, the sale of mortgage assets at prices lower than thecarrying value of such assets would result in losses.

 

The Company may in thefuture increase its capital resources by making additional offerings of equityand debt securities, including classes of preferred stock, common stock,commercial paper, medium-term notes, CMOs and senior or subordinatednotes.  All debt securities, otherborrowings, and classes of preferred stock will be senior to the Common Stockin a liquidation of the Company.  Theeffect of additional equity offerings may be the dilution of stockholders’equity of the Company or the reduction of the price of shares of the CommonStock, or both.  The Company is unableto estimate the amount, timing or nature of additional offerings as they willdepend upon market conditions and other factors.

 

**Inflation**

 

Virtually all of theCompany’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 without consideringinflation.

 

24

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# **ITEM 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

**MARKET RISK**

 

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

 

### **Interest Rate Risk**

 

*Effecton Net Interest Income. *The Company invests in fixed-ratemortgage assets that are expected to be funded with short-term borrowings.  During periods of rising interest rates, theborrowing costs associated with funding such fixed-rate assets are subject toincrease while the income earned on such assets may remain substantiallyunchanged.  This would result in anarrowing of the net interest spread between the related assets and borrowingsand may even result in losses. The Company may enter into derivativetransactions seeking to mitigate the negative impact of a rising interest rateenvironment. Hedging techniques will be based, in part, on assumed levels ofprepayments of the Company’s mortgage assets. If prepayments are slower or faster than assumed, the life of themortgage assets will be longer or shorter which would reduce the effectivenessof the Company’s hedging techniques and may result in losses on suchtransactions.  Hedging techniquesinvolving the use of derivative securities are highly complex and may producevolatile returns. The hedging activity of the Company will also be limited bythe asset and sources of income requirements applicable to the Company as aREIT.

 

*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 hedginginstrument that effectively fixes the Company’s borrowing costs for a periodclose to the anticipated average life of the related asset.  This strategy is designed to protect theCompany from rising interest rates because the borrowing costs are fixed forthe duration of the asset.  However, ifprepayment rates decrease in a rising interest rate environment, the life ofthe mortgage asset could extend beyond the term of the swap agreement or otherhedging instrument.  This situationcould negatively impact the Company as borrowing costs would no longer be fixedafter the end of the hedging instrument while the income earned on the assetwould remain fixed.  This situation mayalso cause the market value of the Company’s mortgage assets to decline withlittle or no offsetting 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.

 

The Company also investsin adjustable-rate mortgage assets that are typically subject to periodic andlifetime interest rate caps that limit the amount an adjustable-rate mortgageasset’s interest rate can change during any given period, as well as theminimum rate payable.  The Company’sborrowings will not be subject to similar restrictions.  Hence, in a period of increasing interestrates, interest rates on its borrowings could increase without limitation bycaps, while the interest rates on its mortgage assets are generally limited bycaps.  This problem will be magnified tothe extent the Company acquires mortgage assets that are not fullyindexed.  Further, some adjustable-ratemortgage assets may be subject to periodic payment caps that result in someportion of the interest being deferred and added to the principaloutstanding.  This could result inreceipt by the Company of less cash income on its adjustable-rate mortgageassets 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 

25

----

 

of rising interest rates, which would negatively impact the Company’sfinancial condition, cash flows and results of operations.

 

The Company intends tofund a substantial portion of its acquisitions of adjustable-rate mortgageassets with borrowings that have interest rates based on indices and repricingterms similar to, but of somewhat shorter maturities than, the interest rateindices and repricing terms of the mortgage assets.  Thus, the Company anticipates that in most cases the interestrate indices and repricing terms of its mortgage assets and its funding sourceswill not be identical, thereby creating an interest rate mismatch betweenassets and liabilities.  While thehistorical spread between relevant short-term interest rate indices has beenrelatively stable, there have been periods, especially during the 1979-1982 and1994 interest rate environments, when the spread between such indices wasvolatile.  During periods of changinginterest rates, such interest rate mismatches could negatively impact theCompany’s financial condition, cash flows and results of operations.

 

Prepayment ratesgenerally increase when prevailing interest rates fall below the interest rateson 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 anadjustable-rate mortgage asset is prepaid prior to or soon after the time ofadjustment to a fully indexed rate, the Company will have held the mortgageasset while it was less profitable and lost the opportunity to receive interestat the fully indexed rate over the expected life of the adjustable-ratemortgage asset.  In addition, theprepayment of any mortgage asset that had been purchased at a premium by theCompany would result in the immediate write-off of any remaining capitalizedpremium amount and consequent reduction of the Company’s net interest income bysuch amount.  Finally, in the event thatthe Company is unable to acquire new mortgage assets to replace the prepaidmortgage assets, its financial condition, cash flow and results of operationscould be materially adversely affected.

 

*Effect on Fair Value.* Another component of interest rate risk is the effect changes ininterest rates will have on the market value of the Company’s assets*. *This is the risk that the marketvalue of the Company’s assets will increase or decrease at different rates thanthat of the Company’s liabilities including its hedging instruments.

 

The Company primarilyassesses its interest rate risk by estimating the duration of its assets andthe duration of its liabilities including all hedging instruments.  Duration essentially measures the marketprice volatility of financial instruments as interest rates change.  The Company generally calculates durationusing various financial models and empirical data.

 

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 agreementliabilities assuming rates instantaneously fall one hundred basis points andrise one hundred basis points. Interest rate sensitive investments currentlyinclude fixed income trading and available-for-sale securities. (Dollars are inthousands except per share amounts.)

 

|                                                                      |   | **Fair Value  for Scenario Shown**          |    |
|---------------------------------------------------------------------------|--------|---------------------------------------------|---------|
|                                                                      |   | **Interest  Rates Fall  100 Basis  Points** |    | **Unchanged** |   | **Interest  Rates Rise  100 Basis  Points** |   |
|                                                                      |   |                                        |    |   |   |   |   |
| Interest Rate  Sensitive Instruments                                      |   | $                                           | 262,321 |   | $ | 262,085 |   | $ | 226,973 |   |
|                                                                      |   |                                        |    |   |   |   |   |
| Change in Fair  Value                                                     |   | $                                           | 236     |   | — |   | $ | (35,112 | ) |
| Change as a  Percent of Fair Value of Interest Rate Sensitive Investments |   | 0.01                                        | %       | — |   | (1.01 | )% |
| Change as a  Percent of Stockholders’ Equity                         |   | 0.09                                        | %       | — |   | (12.84 | )% |
| Change on a Per  Share Basis                                              |   | $                                           | 0.01    |   | — |   | $ | (1.18 | ) |
|                                                                           |        |                                             |         |  |  |  |  |  |  |  |

 

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 

 

26

----

 

be differences between the fair value changes shown above and actualchanges in fair value as interest rates change and those differences may bematerial.

 

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 for the Company is equity pricerisk.  This is the risk that the marketvalue of the Company’s equity investments will decrease.  The following table shows the impact on theCompany’s fair value as the price of its equity securities change assumingprice decreases of 10% and increases of 10%. Actual price decreases or increases may be greater or smaller.  (Dollars are in thousands except per shareamounts.)

 

|                                              |   | **Fair Value for Scenario Shown** |   |
|---------------------------------------------------|--------|-----------------------------------|--------|
|                                              |   | **Prices  Decrease  10%**         |   | **Unchanged** |   | **Prices  Increase  10%** |   |
|                                              |   |                              |   |   |   |   |   |
| Equity  Investments                               |   | $                                 | 4,083  |   | $ | 4,537 |   | $ | 4,991 |   |
|                                              |   |                              |   |   |   |   |   |
| Change  in Fair Value                             |   | (454                              | )      | — |   | 454 |   |
| 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 |   |
|                                                   |        |                                   |        |  |  |  |  |  |  |  |

 

 

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.**

 

27

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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

 

NotApplicable.

 

Item 4.   Submission of Matters to a Vote of Security Holders

 

Submissionof Matters to a Vote of Security Holders

 

(a)                                        On the June 20, 2002, the Annual Meetingof Stockholders of the Company was held for the purpose of voting on:

 

(i)                                           The election of three Directors to theBoard of Directors; and

(ii)                                        Ratification of the appointment ofDeloitte & Touche LLP as independent auditor for 2002.

 

(b)                                       The stockholders of the Company approvedthe following matters, with the following votes cast with respect to eachproposal:

 

(i)                                         Election of three Directors to the Boardof Directors:

 
| **Director**          |   | **Shares Voted For:** |   | **Share Votes Withheld:** |   |
|-----------------------|--------|-----------------------|--------|---------------------------|--------|
|                  |   |                  |   |                      |   |
| John  C. Argue        |   | 23,444,397            |   | 134,725                   |   |
|                  |   |                  |   |                      |   |
| Carl  C. Gregory, III |   | 23,455,506            |   | 123,616                   |   |
|                  |   |                  |   |                      |   |
| Jeffrey  E. Gundlach  |   | 22,985,739            |   | 593,383                   |   |

 

 The other directors whose terms continued afterthe Annual Meeting are:  Peter G. Allen,Philip A. Barach., John A. Gavin and Marc I. Stern.

 

 

(ii)                                        Ratification of Deloitte & Touche LLPas Independent Auditors for 2002:

 
| **Shares Voted For:** |   | **Share  Votes Withheld** |   | **Share  Votes Abstained** |   |
|-----------------------|--------|---------------------------|--------|----------------------------|--------|
|                  |   |                      |   |                       |   |
| 23,400,987            |   | 137,909                   |   | 40,226                     |   |

 

28

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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 followingthe signature page, are included or incorporated by reference in this QuarterlyReport.

 

 

*Reports on Form 8-K*

 

OnMay 29, 2002, we filed a current report on Form 8-K dated May 23, 2002,attaching (i) a form of underwriting agreement by and between the Company andCredit Suisse First Boston, (ii) an opinion and consent of Ballard SpahrAndrews & Ingersoll, LLP dated May 23, 2002, as to the legality of theshares being offered, and (iii) our press release dated May 23, 2002,announcing the public offering of 4,400,000 shares of our common stock, throughCredit Suisse First Boston as the underwriter, at a price to the public of$13.00 per share and the granting to Credit Suisse First Boston of a 30-dayoption to purchase up to 660,000 additional shares to cover over-allotments, ifany.

 

29

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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: | August  14, 2002 |   | /s/ Philip A. Barach                                                                   |   |
|   |             |   | Philip A. Barach  President and Chief Executive Officer  (Principal Executive Officer) |
|   |             |   |                                                                                   |
|   |             |   |                                                                                   |
| Dated: | August  14, 2002 |   | /s/ David S. DeVito                                                                    |   |
|   |             |   | David S. DeVito  Chief Financial Officer  (Principal Accounting Officer)               |

 

 

**EXHIBITINDEX**

 

Pursuant to Item601(a)(2) of Regulation S-K, this exhibit index immediately precedes theexhibits.

 

The following exhibitsare part of this Quarterly Report of Form 10-Q (and are numbered in accordancewith Item 601 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).                                                             |
| 99.1               |   | Section 906 Certification (filed herewith).                                                                                                                                                                                                                                                                                                                                               |

 

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