** **

**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D. C.20549**

** **

**FORM 10-Q**

**(mark one)**

| **ý**                                              |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                  |
|---------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------|
|                                                    |   |                                                                                                          |
|                                                    |   | **For the quarter ended: MARCH 31, 2003**                                                                     |
|                                                    |   |                                                                                                          |
|                                                    |   | **OR**                                                                                                        |
|                                                    |   |                                                                                                          |
| **o**                                                   |   | **TRANSITION  REPORT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                          |
|                                                    |   |                                                                                                          |
|                                                    |   | **For the transition period  from            to** |
| **Commission File Number: 001-13637**                   |
|                                                    |
| **APEX  MORTGAGE CAPITAL, INC.**                        |
| (Exact name of Registrant as  specified in its Charter) |

** **

| **Maryland**                                                                |   | **95-4650863**                           |
|-----------------------------------------------------------------------------|--------|------------------------------------------|
|  (State or other jurisdiction  of incorporation or  organization)      |   | (I.R.S. Employer Identification  Number) |
|                                                                        |   |                                     |
| **865 South Figueroa Street  Los Angeles, California**                      |   | **90017**                                |
| (Address of principal executive offices)                                    |   | (Zip Code)                               |
|                                                                        |   |                                     |
| Registrant’s telephone number, including area code **(213)  244-0000** |

 

Securities registered pursuant to Section 12(b) of the Act:

 

| **Title of  Each Class**      |   | **Name of  Exchange Which Registered** |
|-------------------------------|--------|----------------------------------------|
| Common Stock ($.01 par value) |   | American Stock Exchange                |

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

 

Yes ý    No o

 

Indicate by check mark whetherthe Registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).                     Yesý    No o

 

At May 8, 2003, the aggregatemarket value of the voting stock held by non-affiliates was $171,672,844 basedon the closing price of the Common Stock on the American Stock Exchange.

 

Number of shares of CommonStock outstanding at May 8, 2003: 29,857,000

 

 

----

 

**APEX MORTGAGE CAPITAL, INC.**

**FORM 10-Q**

** **

**INDEX**

** **
| **PART I.**    | **FINANCIAL INFORMATION**                                                                           |   |
|----------------|-----------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                |   |
| ITEM 1.        | FINANCIAL STATEMENTS                                                                                |   |
|           |                                                                                                |   |
|           | BALANCE SHEET AT MARCH 31, 2003 AND  DECEMBER 31, 2002 (UNAUDITED)                                  |
|           |                                                                                                |
|           | STATEMENTS OF OPERATIONS FOR THE THREE  MONTHS ENDED  MARCH 31, 2003 AND MARCH 31, 2002 (UNAUDITED) |
|           |                                                                                                |   |
|           | STATEMENT OF STOCKHOLDERS’ EQUITY FOR THE  THREE MONTHS ENDED  MARCH 31, 2003 (UNAUDITED)      |
|           |                                                                                                |   |
|           | STATEMENTS OF CASH FLOWS FOR THE THREE  MONTHS ENDED  MARCH 31, 2003 AND MARCH 31, 2002 (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                                         |
|           |                                                                                                |   |
| ITEM 4.        | CONTROLS  AND PROCEDURES                                                                            |
|           |                                                                                                |   |
| **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     |                                                                                                |
|           |                                                                                                |
| CERTIFICATIONS |                                                                                                |

 

1

----

 

**Apex Mortgage Capital, Inc.**

 

**Balance Sheets**

**(Unaudited)**

** **
|                                                                                                                                                |   | **March 31, 2003** |          | **December 31, 2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|---------------|-----------------------|--------|
| **Assets**                                                                                                                                          |   |               |          |                  |   |
|                                                                                                                                                |   |               |          |                  |   |
| Cash and cash equivalents                                                                                                                           |   | $                  | 3,107,000     |                  | $      | 1,456,000 |   |
| Fixed income trading securities, at fair value                                                                                                      |   | 556,929,000        |          | 606,014,000           |   |
| Fixed income securities available-for-sale, at fair value                                                                                           |   | 1,874,683,000      |          | 1,818,893,000         |   |
| Equity securities available-for-sale, at fair value                                                                                                 |   | 4,184,000          |          | 4,168,000             |   |
| Accrued interest receivable                                                                                                                         |   | 11,759,000         |          | 12,012,000            |   |
| Principal payments receivable                                                                                                                       |   | 127,000            |          | 248,000               |   |
| Other assets                                                                                                                                        |   | 1,135,000          |          | 2,587,000             |   |
|                                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                                |   | $                  | 2,451,924,000 |                  | $      | 2,445,378,000 |   |
|                                                                                                                                                |   |               |          |                  |   |
| **Liabilities and Stockholders’ Equity**                                                                                                       |   |               |          |                  |   |
|                                                                                                                                                |   |               |          |                  |   |
| Liabilities                                                                                                                                         |   |               |          |                  |   |
|                                                                                                                                                |   |               |          |                  |   |
| Reverse repurchase agreements                                                                                                                       |   | $                  | 2,124,312,000 |                  | $      | 2,112,444,000 |   |
| Accrued interest payable                                                                                                                            |   | 2,419,000          |          | 2,444,000             |   |
| Dividend payable                                                                                                                                    |   | 7,557,000          |          | 13,509,000            |   |
| Interest rate swaps, at fair value                                                                                                                  |   | 120,214,000        |          | 120,098,000           |   |
| Accrued expenses and other liabilities                                                                                                              |   | 2,172,000          |          | 2,224,000             |   |
|                                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                                |   | 2,256,674,000      |          | 2,250,719,000         |   |
|                                                                                                                                                |   |               |          |                  |   |
| Commitments and contingencies (Note 6)                                                                                                              |   |               |          |                  |   |
|                                                                                                                                                |   |               |          |                  |   |
| 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 shares outstanding as of March 31, 2003 and Decemeber  31, 2002 |   | 299,000            |          | 299,000               |   |
| Additional paid-in-capital                                                                                                                          |   | 331,507,000        |          | 331,499,000           |   |
| Accumulated other comprehensive loss                                                                                                                |   | (94,091,000        | )             | (95,880,000           | )      |
| Accumulated deficit                                                                                                                                 |   | (42,465,000        | )             | (41,259,000           | )      |
|                                                                                                                                                |   |               |          |                  |   |
|                                                                                                                                                |   | 195,250,000        |          | 194,659,000           |   |
|                                                                                                                                                |   | $                  | 2,451,924,000 |                  | $      | 2,445,378,000 |   |

 

Seeaccompanying notes to financial statements

 

2

----

 

**Apex Mortgage Capital, Inc.**

 

**Statements of Operations**

**(Unaudited)**

 
|                                                                            |   | **Three Months Ended March 31,** |       |
|---------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                            |   | **2003**                         |       | **2002** |   |
|                                                                            |   |                             |       |   |   |
| **Interest Income:**                                                            |   |                             |       |   |   |
| Fixed income securities                                                         |   | $                                | 30,107,000 |   | $ | 27,254,000 |   |
| Cash and cash equivalents                                                       |   | 11,000                           |       | 55,000 |   |
|                                                                            |   | 30,118,000                       |       | 27,309,000 |   |
|                                                                            |   |                             |       |   |   |
| **Interest Expense**                                                            |   | 22,680,000                       |       | 12,705,000 |   |
|                                                                            |   |                             |       |   |   |
| **Net Interest Income**                                                         |   | 7,438,000                        |       | 14,604,000 |   |
|                                                                            |   |                             |       |   |   |
| **Dividend Income**                                                             |   | 101,000                          |       | 126,000 |   |
|                                                                            |   |                             |       |   |   |
| **Net Interest and Dividend Income**                                            |   | 7,539,000                        |       | 14,730,000 |   |
|                                                                            |   |                             |       |   |   |
| **General and Administrative Expenses:**                                        |   |                             |       |   |   |
| Management fee                                                                  |   | 545,000                          |       | 319,000 |   |
| Incentive fee                                                                   |   | 658,000                          |       | 2,650,000 |   |
| Insurance                                                                       |   | 164,000                          |       | 83,000 |   |
| Professional fees                                                               |   | 38,000                           |       | 27,000 |   |
| Directors’ fees                                                            |   | 20,000                           |       | 22,000 |   |
| Non-employee stock options                                                      |   | 8,000                            |       | 27,000 |   |
| Other                                                                           |   | 255,000                          |       | 170,000 |   |
|                                                                            |   | 1,688,000                        |       | 3,298,000 |   |
|                                                                            |   |                             |       |   |   |
| **Net Interest and Dividend Income After General and  Administrative Expenses** |   | 5,851,000                        |       | 11,432,000 |   |
|                                                                            |   |                             |       |   |   |
| **Net Gain (Loss) from Investment and Derivative  Activities**                  |   | 448,000                          |       | (1,704,000 | ) |
|                                                                            |   |                             |       |   |   |
| **Net Income**                                                                  |   | $                                | 6,299,000  |   | $ | 9,728,000 |   |
|                                                                            |   |                             |       |   |   |
| **Net Income Per Share:**                                                       |   |                             |       |   |   |
| Basic                                                                           |   | $                                | 0.21       |   | $ | 0.53 |   |
| Diluted                                                                         |   | $                                | 0.21       |   | $ | 0.53 |   |
|                                                                            |   |                             |       |   |   |
| **Weighted Average Number of Shares Outstanding:**                              |   |                             |       |   |   |
| Basic                                                                           |   | 29,857,000                       |       | 18,316,000 |   |
| Diluted                                                                         |   | 29,857,000                       |       | 18,428,000 |   |
|                                                                            |   |                             |       |   |   |
| **Dividends Declared Per Share:**                                               |   | $                                | 0.25       |   | $ | 0.50 |   |

 

Seeaccompanying notes to financial statements

 

3

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**Apex Mortgage Capital, Inc.**

 

**Statements of Stockholders’ Equity**

**(Unaudited)**

 
|                                                                                 |              |       |       |   |       | **Additional  Paid-in Capital** |       | **Accumulated  Other Comprehensive Income (Loss)** |       | **Accumulated  Deficit** |        | **Total  Stockholders’ Equity** |       | **Comprehensive  Income (Loss)** |       |
|--------------------------------------------------------------------------------------|-------------------|------------|------------|--------|------------|---------------------------------|------------|----------------------------------------------------|------------|--------------------------|-------------|--------------------------------------|------------|----------------------------------|------------|
|                                                                                 |              |       |       |
|                                                                                 | **Common  Stock** |
|                                                                                 | **Shares**        |       | **Amount** |
|                                                                                 |              |       | ** ** |   | ** ** |                            | ** ** |                                               | ** ** |                     | ** **  |                                 | ** ** |                             | ** ** |
| Balance, January 1, 2003                                                             |              | 29,857,000 |       | $      | 299,000    |                            | $          | 331,499,000                                        |       | $                        | (95,880,000 | )                                    | $          | (41,259,000                      | )          | $ | 194,659,000 |   |   |   |
|                                                                                 |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| Amortization of non-employees stock options                                          |              | —     |       | — |       | 8,000                           |       | —                                             |       | —                   |        | 8,000                                |       |                             |       |
|                                                                                 |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| Net income                                                                           |              | —     |       | — |       | —                          |       | —                                             |       | 6,299,000                |        | 6,299,000                            |       | $                                | 6,299,000  |   |
|                                                                                 |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| Other comprehensive income (loss):                                                   |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| Net change in unrealized gain on available-for-sale securities                       |              | —     |       | — |       | —                          |       | 32,000                                             |       | —                   |        | 32,000                               |       | 32,000                           |       |
|                                                                                 |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| Net change in deferred loss on terminated interest rate swaps                        |              | —     |       | — |       | —                          |       | 1,873,000                                          |       | —                   |        | 1,873,000                            |       | 1,873,000                        |       |
|                                                                                 |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| Net change in unrealized loss on interest rate swaps classified as  cash flow hedges |              | —     |       | — |       | —                          |       | (116,000                                           | )          | —                   |        | (116,000                             | )          | (116,000                         | )          |
| **Comprehensive income (loss)**                                                      |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       | $                                | 8,088,000  |   |
|                                                                                 |              |       |       |   |       |                            |       |                                               |       |                     |        |                                 |       |                             |       |
| **Dividends declared**                                                               |              | —     |       | — |       | —                          |       | —                                             |       | (7,505,000               | )           | (7,505,000                           | )          |                             |       |
| **Balance, March 31, 2003**                                                          |              | 29,857,000 |       | $      | 299,000    |                            | $          | 331,507,000                                        |       | $                        | (94,091,000 | )                                    | $          | (42,465,000                      | )          | $ | 195,250,000 |   |   |   |

 

Seeaccompanying notes to financial statements

 

The following is a presentation of the changes in accumulated othercomprehensive income (loss) for the three months ended March 31, 2003.

 
|                                                                                        |   | **Three  Months  Ended March 31,  2003** |        |
|---------------------------------------------------------------------------------------------|--------|------------------------------------------|-------------|
| *Unrealized Gains (Losses) on Available-for-Sale Securities:*                               |   |                                     |        |
|                                                                                        |   |                                     |        |
| Unrealized  gains (losses) arising during the year                                          |   | $                                        | 32,000      |   |
|                                                                                        |   |                                     |        |
| Net change in  unrealized gains (losses) on available-for-sale securities                   |   | $                                        | 32,000      |   |
|                                                                                        |   |                                     |        |
| *Deferred Gain (Loss) on Terminated Interest Rate Swaps:*                                   |   |                                     |        |
|                                                                                        |   |                                     |        |
| Reclassification  for amortization into interest expense                                    |   | $                                        | 1,873,000   |   |
|                                                                                        |   |                                     |        |
| Net change in  deferred gain (loss) on terminated interest rate swaps                       |   | $                                        | 1,873,000   |   |
|                                                                                        |   |                                     |        |
| *Unrealized Gain (Loss) on Interest Rate Swaps Classified as Cash Flow  Hedges:*            |   |                                     |        |
|                                                                                        |   |                                     |        |
| Net unrealized  gain (loss) on interest rate swaps classified as cash flow hedges           |   | $                                        | (13,898,000 | ) |
|                                                                                        |   |                                     |        |
| Reclassification  for adjustments to interest expense                                       |   | 13,782,000                               |        |
|                                                                                        |   |                                     |        |
| Net change in  unrealized gain (loss) on interest rate swaps classified as cash flow hedges |   | $                                        | (116,000    | ) |

 

4

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**Apex Mortgage Capital, Inc.**

 

**Statements of Cash Flows**

**(Unaudited)**

 
|                                                                                         |   | **Three Months Ended March 31,** |       |
|----------------------------------------------------------------------------------------------|--------|----------------------------------|------------|
|                                                                                         |   | **2003**                         |       | **2002** |   |
|                                                                                         |   |                             |       |   |   |
| **Operating Activities:**                                                                    |   |                             |       |   |   |
| Net income                                                                                   |   | $                                | 6,299,000  |   | $ | 9,728,000 |   |
| Adjustments to reconcile net income to net cash provided by (used in)  operating activities: |   |                             |       |   |   |
| Net amortization                                                                             |   | 5,947,000                        |       | (81,000 | ) |
| Net (gain) loss from investment and derivative activities                                    |   | (448,000                         | )          | 1,704,000 |   |
| Trading activities                                                                           |   | 48,987,000                       |       | (273,846,000 | ) |
| Change in assets and liabilities:                                                            |   |                             |       |   |   |
| Accrued interest receivable                                                                  |   | 253,000                          |       | (5,722,000 | ) |
| Other assets                                                                                 |   | 1,452,000                        |       | (109,000 | ) |
| Accrued interest payable                                                                     |   | (25,000                          | )          | 1,699,000 |   |
| Accrued expenses and other liabilities                                                       |   | (52,000                          | )          | 5,215,000 |   |
| Net cash provided by (used in) operating activities                                          |   | 62,413,000                       |       | (261,412,000 | ) |
|                                                                                         |   |                             |       |   |   |
| **Investing Activities:**                                                                    |   |                             |       |   |   |
| Purchase of fixed income securities available-for-sale                                       |   | (245,721,000                     | )          | (810,655,000 | ) |
| Proceeds from sales of fixed income securities available-for-sale                            |   | —                           |       | 5,520,000 |   |
| Proceeds from sales of equity securities                                                     |   | —                           |       | 1,117,000 |   |
| Principal payments on fixed income securities available-for-sale                             |   | 186,548,000                      |       | 14,374,000 |   |
| Net cash used in investing activities                                                        |   | (59,173,000                      | )          | (789,644,000 | ) |
|                                                                                         |   |                             |       |   |   |
| **Financing Activities:**                                                                    |   |                             |       |   |   |
| Net change in reverse repurchase agreements                                                  |   | 11,868,000                       |       | 974,900,000 |   |
| Dividend distributions                                                                       |   | (13,457,000                      | )          | (12,537,000 | ) |
| Issuance of common stock                                                                     |   | —                           |       | 91,795,000 |   |
| Net cash (used in) provided by financing activities                                          |   | (1,589,000                       | )          | 1,054,158,000 |   |
|                                                                                         |   |                             |       |   |   |
| **Net Increase in Cash and Cash Equivalents**                                                |   | 1,651,000                        |       | 3,102,000 |   |
|                                                                                         |   |                             |       |   |   |
| **Cash and Cash Equivalents at Beginning of Period**                                         |   | 1,456,000                        |       | 4,330,000 |   |
|                                                                                         |   |                             |       |   |   |
| **Cash and Cash Equivalents at End of Period**                                               |   | $                                | 3,107,000  |   | $ | 7,432,000 |   |
|                                                                                         |   |                             |       |   |   |
| **Supplemental Disclosure of Cash Flow Information:**                                        |   |                             |       |   |   |
| Cash paid for interest                                                                       |   | $                                | 20,831,000 |   | $ | 11,006,375 |   |
| Noncash Investing and Financing Activities:                                                  |   |                             |       |   |   |
| Change in accumulated other comprehensive loss                                               |   | 1,789,000                        |       | (4,601,000 | ) |
| Change in receivable for unsettled securities                                                |   | —                           |       | (94,679,000 | ) |
| Change in dividends declared, not yet paid                                                   |   | (5,952,000                       | )          | (120,000 | ) |

 

Seeaccompanying notes to financial statements

 

5

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**Apex Mortgage Capital, Inc.**

**Notesto Financial Statements**

**(Unaudited)**

 

# **Note 1 - The Company**

 

Apex MortgageCapital, Inc. (the “Company”) was incorporated in Maryland on September 15,1997. The Company commenced its operations of acquiring and managing aportfolio of mortgage related assets on December 9, 1997, upon receipt of thenet proceeds from the initial public offering of the Company’s Common Stock.The Company uses its equity capital and borrowed funds to seek to generateincome based on the difference between the yield on its investments and thecost of its borrowings.  The Company isstructured for tax purposes as a real estate investment trust (“REIT”) underthe Internal Revenue Code of 1986, as amended (the “Code”).

 

The Company hasentered into a Management Agreement (the “Management Agreement”), as amended,with TCW Investment Management Company (the “Manager”), a wholly ownedsubsidiary of The TCW Group, Inc., pursuant to 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 Policiesand Certain Risks**

## * *

## *Overview*

Certaininformation and note disclosures normally included in annual financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) have been condensed or omitted pursuant tothe rules and regulations of the Securities and Exchange Commission (“SEC”) forinterim financial statements. The unaudited financial statements should be readin conjunction with the audited financial statements and notes thereto includedin the Company’s Annual Report on Form 10-K for the year ended December 31,2002. The accounting policies used in the preparation of these interimfinancial statements were consistent with those used in the preparation of thefinancial statements for the year ended December 31, 2002, unless otherwisenoted. Certain reclassifications may have been made to the prior periodfinancial statements to conform to the current period presentation.

## * *

## *Derivatives and Hedging Transactions*

 

The Company mayenter into interest rate swaps and other financial instruments in order tomitigate the impact of rising interest rates on the cost of its short-termborrowings and market value of its portfolio securities.  The Company may also enter into forwardcontracts to sell U.S. Treasury securities and other financial instruments inorder to mitigate the negative impact of rising interest rates on the fairvalue of its fixed income securities.  Such financial instruments are generally referred to as “derivatives.”

 

The Companyadopted SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*, as amended, on January 1, 2001. Under SFAS No. 133, allderivatives are recorded at fair value and presented as either assets orliabilities on the Company’s balance sheets. If the Company were to change current or anticipated borrowings so thatthey were no longer appropriately matched to the swap agreements, theagreements might no longer qualify for hedge accounting treatment. In thatcase, changes in their fair values would affect net income.

 

Prior to adoptingSFAS No. 133, the Company accounted for changes in fair values of the forwardcontracts through adjustments to accumulated other comprehensive income.Following adoption of 

 

6

----

 

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.

 

At March 31, 2003and December 31, 2002, the Company’s outstanding interest rate swaps qualify ascash flow hedges and are deemed to be fully effective as hedges under SFAS No.133.  Changes in fair values of suchswaps are not reflected in current earnings, but are reflected in othercomprehensive income.  Currently, fairvalue of the interest rate swaps is determined by the average of valuesobtained from two market analytics systems, i.e., The Yield Book and Bloomberg.

 

*Stock-based Compensation*

 

The Company grantsstock options to Directors and to certain directors, officers and employees ofthe Manager. Options granted to Directors of the Company are accounted for usingthe intrinsic-value method, and generally no compensation expense is recognizedin the statements of operations for such options. Options granted to personsother than Directors (i.e., to non-employees) are accounted for using the fairvalue method; such stock options are measured at their fair value when they aregranted and are recognized as general and administrative expense during theperiods when the options are vested and the related services areperformed.  During the quarters endedMarch 31, 2003 and March 31, 2002, the Company did not issue any stock options.The effects of previously issued and unvested stock options to the Company’sdirectors did not have an impact for either of the quarters presented below.

 

The followingtable represents the pro forma effects on net income (loss) and net income(loss) per share if compensation costs related to the director stock optionswere measured using the fair value method as prescribed under SFAS No. 123, *Accounting for Stock-based compensation:*

** **
|                                                                                                                                          |   | **Three Months Ended March 31,** |      |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|-----------|
|                                                                                                                                          |   | **2003**                         |      | **2002** |   |
| Reported net  income                                                                                                                          |   | $                                | 6,299,000 |   | $ | 9,728,000 |   |
| Deduct: Total  stock-based employee Compensation expense determined under fair value based  method for all awards, net of related tax effects |   | —                           |      | — |   |
|                                                                                                                                          |   |                             |      |   |   |
| Pro forma net  income                                                                                                                         |   | $                                | 6,299,000 |   | $ | 9,728,000 |   |
|                                                                                                                                          |   |                             |      |   |   |
| Earnings per  share:                                                                                                                          |   |                             |      |   |   |
| Basic - as  reported                                                                                                                          |   | $                                | 0.21      |   | $ | 0.53 |   |
| Basic - pro  forma                                                                                                                            |   | $                                | 0.21      |   | $ | 0.53 |   |
|                                                                                                                                          |   |                             |      |   |   |
| Diluted - as  reported                                                                                                                        |   | $                                | 0.21      |   | $ | 0.53 |   |
| Diluted - pro  forma                                                                                                                          |   | $                                | 0.21      |   | $ | 0.53 |   |

 

7

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**Note 3 – Fixed Income and EquitySecurities**

 

At March 31, 2003,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               |   | $                                    | 536,951 |                                             | $      | 1,818,563                                 |   |   |   |
| Unamortized  Premium (Discount) |   | 12,171                               |    | 23,030                                           |   |                                      |   |
| Adjusted Cost                   |   | 549,122                              |    | 1,841,593                                        |   | $                                         | 2,844  |   |
| Gross  Unrealized Gains         |   | 7,807                                |    | 33,706                                           |   | 1,340                                     |   |
| Gross  Unrealized Losses        |   | —                               |    | (616                                             | )      | —                                    |   |
| Fair Value                      |   | $                                    | 556,929 |                                             | $      | 1,874,683                                 |   | $ | 4,184 |   |

 

At December 31,2002, 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               |   | $                                    | 585,817 |                                               | $      | 1,765,448                                 |   |   |   |
| Unamortized  Premium (Discount) |   | 12,838                               |    | 20,371                                             |   |                                      |   |
| Adjusted Cost                   |   | 598,655                              |    | 1,785,819                                          |   | $                                         | 2,844  |   |
| Gross  Unrealized Gains         |   | 7,359                                |    | 33,225                                             |   | 1,324                                     |   |
| Gross Unrealized  Losses        |   | —                               |    | (151                                               | )      | —                                    |   |
| Fair Value                      |   | $                                    | 606,014 |                                               | $      | 1,818,893                                 |   | $ | 4,168 |   |

 

The contractualfinal maturity of the mortgage loans supporting fixed income mortgagesecurities 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-ratemortgage securities composed approximately 95% and 99% of the Company’sportfolio of fixed income securities at March 31, 2003 and December 31, 2002,respectively.  The expected averageremaining maturity of the Company’s other fixed income securities as of March31, 2003 and December 31, 2002 was less than one year.

 

Adjustable-ratemortgage securities composed approximately 4.6% and 0.4% of the Company’sportfolio of fixed income securities at March 31, 2003 and December 31, 2002,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.  Both atMarch 31, 2003 and December 31, 2002, the portion of adjustable-rate mortgagesecurities subject to periodic cap had an average periodic cap equal to 2.0%.At March 31, 2003 and December 31, 2002, the portion of adjustable-ratemortgage securities subject to a lifetime cap had an average lifetime cap equalto 10.3% and 11.3%, respectively.

 

During the quarterended March 31, 2003, the Company reported a gain on investment and derivativeactivities of $448,000 in the statement of operations.  The gain was the unrealized gain on fixedincome trading securities.

 

8

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

 

# ** **

# **Note 4 - Reverse Repurchase Agreements**

 

The Company hasentered into reverse repurchase agreements to finance certain of itsinvestments.  These agreements aresecured by a portion of the Company’s investments and bear interest rates thathave historically moved in close relationship to LIBOR. Reverse repurchaseagreements are accounted for as short-term borrowings and recorded as aliability on the balance sheet.

 

At March 31, 2003,the Company had outstanding $2,124,312,000 of reverse repurchase agreementswith a weighted average current borrowing rate of 1.28% and a weighted averagematurity of one month.  The reverserepurchase agreements were collateralized by securities with an estimated fairvalue of $2,213,442,000.

 

At December 31,2002, the Company had outstanding $2,112,444,000 of reverse repurchaseagreements with a weighted average current borrowing rate of 1.40% and aweighted average maturity of one month. The reverse repurchase agreements were collateralized by securities withan estimated fair value of $2,199,852,000.

 

# ** **

# **Note 5 – Derivative Financial Instruments and HedgingActivities**

 

The Company hasentered into interest rate swap agreements as summarized below.  Under these agreements, the Company receivesa floating rate and pays a fixed rate. The swaps qualify as cash flow hedges for accounting purposes, andeffectively fix the interest rate paid on $1,678,500,000, as of March 31, 2003,of current and anticipated future borrowings under reverse repurchaseagreements. The Company estimates that approximately $42,676,000 of unrealizedand deferred realized losses on interest rate swaps currently included inaccumulated other comprehensive loss will be reclassified into interest expensewithin the next twelve months as net settlements occur. As of March 31, 2003,the maximum length of time over which the Company is hedging its exposure tothe variability in future cash flows for current and anticipated futuretransactions is approximately 9.3 years.

 

Interest RateSwaps at March 31, 2003:

 

(Dollars in thousands)

 
| **Current  Notional Amount** |   | **Average  Fixed Rate** |   | **Floating  Rate** |   | **Par Weighted  Average  Maturity** |   | **Unrealized  Losses** |    |
|------------------------------|--------|-------------------------|--------|--------------------|--------|-------------------------------------|--------|------------------------|---------|
|                         |   |                    |   |               |   |                                |   |                   |    |
| $1,678,500                   |   | 4.643                   | %      | 1 Month LIBOR      |   | 4.2 years                           |   | $                      | 120,214 |   |
|                              |        |                         |        |                    |        |                                     |        |                        |         |  |

 

9

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Interest RateSwaps at December 31, 2002:

 

(Dollars in thousands)

 
| **Current  Notional Amount** |   | **Average  Fixed Rate** |   | **Floating  Rate** |   | **Par Weighted  Average  Maturity** |   | **Unrealized  Losses** |    |
|------------------------------|--------|-------------------------|--------|--------------------|--------|-------------------------------------|--------|------------------------|---------|
|                         |   |                    |   |               |   |                                |   |                   |    |
| $ 1,678,500                  |   | 4.643                   | %      | 1 Month LIBOR      |   | 4.4 years                           |   | $                      | 120,098 |   |
|                              |        |                         |        |                    |        |                                     |        |                        |         |  |

 

During the fourthquarter of 2002, the Company terminated a portion of the outstanding interestrate swap agreements with a combined notional amount of $544,500,000, whichresulted in a deferred loss of approximately $13,872,000 with an average termof 1.3 years and an average rate of 3.57%. The deferred loss is being amortizedas an adjustment to interest expense over the remaining lives of the originalswap agreements. However, the Company may be required to accelerate thedeferred loss recognition if the general level of reverse repurchase agreementsmaintained by the Company declines in the future.

 

During the quarterended March 31, 2003, interest expense was increased by $13,782,000 paid toswap counterparties and $1,873,000 from amortization of deferred losses onterminated swap contracts. During the quarter ended March 31, 2002, interestexpense was increased by $5,691,000 paid to swap counterparties and decreasedby $121,000 from amortization of deferred gains on terminated swap contracts.

 

# ** **

# **Note 6 – Commitments and Contingencies**

# ** **

There have been no material changes to the matters disclosed in “Note10 - Commitments and Contingencies” on the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2002.

 

# **Note 7 – Subsequent Events**

 

On March 13, 2003, the Board of Directors authorized management toconsider a full range of strategic alternatives for the Company in order tomaximize shareholder value, including the potential sale of the Company. Inthis context, the Board of Directors has appointed a special committeeconsisting of the independent directors. The Company has engaged an investmentbank, UBS Warburg LLC as its financial advisor to assist in the evaluation ofstrategic alternatives.  In the event ofa sale of the Company, the Manager is entitled to receive a termination feeunder the terms of the Management Agreement. In the event of a termination, the Manager and the Board of Directorshave agreed to limit the termination fee to an amount less than the fair marketvalue contemplated to be paid under the Management Agreement. In the event of asale of the Company, the termination fee will be an amount up to fifty percentof the premium over book value, not to exceed $10 million.

 

10

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**ITEM 2.          MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The followingdiscussion of our financial condition and results of operations should be readin conjunction with the financial statements and the notes to those statementsincluded elsewhere in this Quarterly Report on Form 10-Q and our auditedfinancial statements for the year ended December 31, 2002 included in ourAnnual Report on Form 10-K previously filed with the SEC.*

 

 

**SAFEHARBOR/FORWARD LOOKING STATEMENTS**

 

Certain information contained in this Quarterly Report on Form 10-Qconstitutes “forward-looking statements” which can be identified by the use offorward-looking terminology such as “may,” “will,” “should,” “anticipate,”“estimate,” “intend,” “continue” or “believes” or the negatives thereof orother variations thereon or comparable terminology. Some important factors thatwould cause actual results to differ materially from those in anyforward-looking statements include changes in interest rates; domestic andforeign business, market, financial or legal conditions; differences in theactual allocation of the assets of the company from those assumed; and thedegree to which assets are hedged and the effectiveness of the hedge, amongother factors. In addition, the degree of risk in the company’s investments isincreased by the company’s leveraging of 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, 2002. 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 on September 15,1997, primarily to acquire United States agency and other highly rated,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 funds to seek togenerate income based on the difference between the yield on its mortgagerelated assets and the cost of its borrowings. The Company has elected to be taxed as a real estate investment trust(“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”).  The Company will not generally be subject tofederal taxes on its income to the extent that it distributes its net income toits stockholders and maintains its qualification as a REIT.

 

The day-to-day operations of the Company are managed by an externalmanagement company, TCW Investment Management Company (the “Manager”), subjectto the direction and oversight of the Company’s Board of Directors.  A majority of the Board of Directors areunaffiliated with the TCW Group, Inc. (“TCW” and, together with itssubsidiaries and affiliates, the “TCW Group”), or the Manager.  The Manager is a wholly-owned subsidiary ofTCW.  The Manager was established in1987, and the TCW Group began operations in 1971 through one of itsaffiliates.  The Company’s investmentmanagement team are selected members of the TCW Group’s Mortgage-BackedSecurities Group (the “MBS Group”), all of whom have over thirteen years ofexperience in raising and managing mortgage capital.  The Company has elected to be externally managed by the Managerto take advantage of the existing operational systems, expertise and economiesof scale associated with the Manager’s current business operations, among otherreasons. The 

 

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Manager’s key officers have experience in raising and managing mortgagecapital, mortgage finance and the purchase and administration of mortgagerelated assets.

 

###### **Website Access to Our Periodic SEC Reports**

 

Our internet address is www.apexreit.com.  We make our periodic SEC reports (Form 10-Q and Form 10-K) andcurrent reports (Form 8-K) available free of charge through our website as soonas reasonably practicable after they are filed electronically with theSEC.  We may from time to time provideimportant disclosures to investors by posting them in the investor relationssection of our website, as allowed by SEC rules.

 

Materials we file with the SEC may be read and copied at the SEC’sPublic Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.  Information on the operation of the PublicReference Room may be obtained by calling the SEC at 1-800-SEC-0330.  The SEC also maintains an Internet Website atwww.sec.gov that contains reports, proxy and information statements, and otherinformation regarding our company that we file electronically with the SEC.

 

#### **RECENT EVENTS**

 

*Exploration of Strategic*Alternatives*.* On March 13, 2003, we announced that ourBoard of Directors has authorized our management to consider a full range ofstrategic alternatives for our Company in order to maximize stockholder value,including, but not limited to, the potential sale of the Company. In thiscontext, our Board of Directors has appointed a special committee consisting ofour independent directors. The Company has engaged an investment bank, UBSWarburg LLC as its financial advisor to assist in the evaluation of strategicalternatives.  In the event of a sale ofthe Company, the Manager is entitled to receive a termination fee under theterms of our management agreement. For this purpose, in the event of atermination, the Manager and our Board of Directors have agreed to limit thetermination fee to an amount less than the fair market value contemplated to bepaid under the management agreement. In the event of a sale of the Company, thetermination fee will be an amount up to 50% of the premium over book value ofthe management agreement, not to exceed $10 million.

 

*Reporting Period*.  Unless otherwise noted, this report describes the Company’soperations and developments through the date hereof.

 

**STRATEGY**

 

In order to achieve its business objective and generate dividend yieldsthat provide a competitive rate of return for its stockholders, the Company’sstrategy is to seek to:

 

•                  purchaseprimarily single-family real estate adjustable and fixed rate mortgage relatedassets;

 

•                  manage thecredit risk of its mortgage related assets through, among other activities; (i)carefully selecting mortgage related assets to be acquired; (ii) complying withthe Company’s investment policy; (iii) actively monitoring the ongoing creditquality and servicing of its mortgage related assets; and (iv) maintainingappropriate capital levels and allowances for possible credit losses;

 

•                  financepurchases of mortgage related assets with the net proceeds of equity offeringsand, to the extent permitted by the Company’s leverage policy, to utilizeleverage 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 tostructure its borrowings in accordance with its interest rate risk managementpolicy;

 

12

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

 

•                  seek to minimizeprepayment risk primarily by structuring a diversified portfolio with a varietyof prepayment characteristics; and

 

•                  purchase equityand other securities issued by financial entities on an opportunistic basis.

 

There can be no assurance that the Company will be able to generatecompetitive earnings and dividends while holding primarily high qualitymortgage related assets and maintaining a disciplined risk-control profile.

 

The Company may attempt to increase the return to stockholders over timeby: (i) raising additional capital in order to increase its ability to investin additional mortgage related assets; (ii) lowering its effective borrowingcosts through direct funding with collateralized lenders, in addition to usingWall Street intermediaries, and investigating the possibility of usingcollateralized commercial paper and medium-term note programs; and (iii)improving the efficiency of its balance sheet structure by issuinguncollateralized subordinated debt and other forms of capital.

 

### **THE MANAGEMENTAGREEMENT**

 

The Company has renewed its Management Agreement with the Manager for aone-year term ending on December 31, 2003. The Manager is primarily involved in two activities: (i) asset/liabilitymanagement—acquisition, financing, hedging, management and disposition ofmortgage related assets, including credit and prepayment risk management; and(ii) capital management—oversight of the Company’s structuring, analysis,capital raising and investor relations activities.  In conducting these activities, the Manager formulates operatingstrategies for the Company, arranges for the acquisition of mortgage relatedassets by the Company, arranges for various types of financing for the Company,monitors the performance of the Company’s mortgage related assets and providescertain administrative and managerial services in connection with the operationof the Company.  The Manager is requiredto manage the business affairs of the Company in conformity with the policiesthat are approved and monitored by the Company’s Board of Directors.  The Manager is required to prepare regularreports for the Company’s Board of Directors that will review the Company’sacquisitions of mortgage related assets, portfolio composition andcharacteristics, credit quality, performance and compliance with the policiesapproved by the Company’s Board of Directors.

 

At all times, the Manager is subject to the direction and oversight ofthe Company’s Board of Directors and has only such functions and authority asthe Company delegates to it.  TheManager is responsible for the day-to-day operations of the Company.

 

The Management Agreement may be renewed for additional one-year termsat the discretion of the unaffiliated directors, unless previously terminatedby the Company or the Manager upon written notice.  Except in the case of a termination or non-renewal by the Companyfor cause, upon termination or non-renewal of the Management Agreement by theCompany, the Company is obligated to pay the Manager a termination or non-renewalfee, which may be significant.  Thetermination or non-renewal fee shall be equal to the fair market value of theManagement Agreement without regard to the Company’s termination right, asdetermined by an independent appraisal. The selection of the independent appraiser shall be subject to theapproval of the unaffiliated directors. Neither the fair market value of the Management Agreement nor thevarious factors which the appraiser may find relevant in its determination ofthe fair market value can be determined at this time.

 

The fair market value of the Management Agreement will be affected bysignificant variables, including (i) the historical management fees paid to theManager, (ii) any projections of future management fees to be 

 

13

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paid to the Manager determined by the independent appraiser, (iii) therelative valuations of agreements similar to the Management Agreement, and (iv)other factors, all of which may be unrelated to the performance of the Manager.

 

The Management Agreement may be assigned by the Manager to an affiliateof TCW without the consent of the Company. The Management Agreement may be assigned to a non-affiliate of TCW onlywith the approval of a majority of the unaffiliated directors.

 

###### **Manager Compensation**

 

The Manager will receive annual base management compensation based onthe Average Net Invested Capital of the Company, payable monthly in arrears,equal to 3/4 of 1% of Average Net Invested Capital.  The term “Average NetInvested Capital” means the month end sum of (1) the Company’s totalstockholders’ equity computed in accordance with accounting principlesgenerally accepted in the United States of America, plus (2) any unsecured debtthat has been approved for inclusion by the unaffiliated directors at issuance,plus or minus (3) an adjustment to exclude the impact of any unrealized gains, losses or other items that do not affectrealized net income. Accordingly, incurring collateralized debt to finance specific investmentpurchases does not ordinarily increase Average Net Invested Capital.

 

The Manager shall also be entitled to receive as incentive compensationfor each fiscal quarter, an amount equal to 30% of the Net Income of theCompany, before incentive compensation, in excess of the amount that wouldproduce an annualized Return on Equity equal to the Ten-Year U.S. Treasury Rateplus 1%.  The incentive compensationcalculation and payment will be made quarterly in arrears.  The term “Return on Equity” is calculatedfor any quarter by dividing the Company’s Net Income for the quarter by itsAverage Net Worth for the quarter.  Forpurposes of calculating the incentive compensation payable, the definition“Return on Equity” is not related to the actual distributions received bystockholders or to an individual investor’s actual return on investment.  For such calculations, the “Net Income” ofthe Company means the taxable income of the Company (including net capitalgains, if any) before the Manager’s incentive compensation, net operating lossdeductions arising from losses in prior periods and deductions permitted by theCode in calculating taxable income for a REIT plus the effects of adjustments,if any, necessary to record hedging and interest transactions in accordancewith accounting principles generally accepted in the United States ofAmerica.  A deduction for all of theCompany’s interest expenses for borrowed funds is taken into account incalculating Net Income. “Average Net Worth” for any period means the arithmeticaverage of the sum of the gross proceeds from any offering of its equitysecurities by the Company, before deducting any underwriting discounts andcommissions and other expenses and costs relating to the offerings, plus theCompany’s retained earnings (without taking into account any losses incurred inprior periods) computed by taking the average of such values at the end of eachmonth during such period, minus the cumulative amounts paid by the Company torepurchase its shares.

 

The ability of the Company to achieve an annualized Return on Equity inexcess of the Ten-Year U.S.  TreasuryRate plus 1%, and of the Manager to earn the incentive compensation describedin the preceding paragraph, is dependent upon the level and volatility ofinterest rates, the Company’s ability to react to changes in interest rates andto utilize successfully the operating strategies described herein, and otherfactors, many of 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.  Quarterly incentivecompensation is subject to an annual adjustment so that the incentivecompensation is based on earnings for the entire year. The Company believesthat this compensation arrangement benefits its stockholders because it 

 

14

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ties the Manager’s compensation to Return on Equity and, in periods oflow earnings, the Manager’s incentive compensation is reduced or eliminated,thereby lowering the Company’s operating expenses.

 

**POLICIES**

 

The Company’s current investment policies are set forth in its AnnualReport on Form 10-K for the year ended December 31, 2002.

### ** **

### **PRINCIPAL RISKSAND SPECIAL CONSIDERATIONS**

# ** **

***Leverage Risk****.*  The Company employs a leveraging strategy ofgenerally borrowing up to 92% of its total assets, less any assets that arefunded with committed secured borrowings, plus the market value of any relatedhedging transactions to finance the acquisition of additional mortgage relatedassets.  The Company’s borrowings may,from time to time, exceed 92% of its total assets.  In the event borrowing costs exceed the income on its mortgagerelated assets, the Company will experience negative cash flow and incurlosses. Another risk of leverage is the possibility that the value of thecollateral securing the borrowings will decline.  In such event, additional collateral or repayment of borrowingswould be required.  The Company could berequired to sell mortgage related assets under adverse market conditions inorder to maintain liquidity.  If thesesales were made at prices lower than the carrying value of the mortgage relatedassets, the Company would experience losses.

 

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

 

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

 

***Credit Risk****.*  Credit risk is the possibility that theCompany could lose money if an issuer is unable to meet its financialobligations, such as the payment of principal and/or interest on an instrument,or goes bankrupt.  The Company mayinvest a portion of its assets in mortgage related assets which are notguaranteed by the U.S. Government or investment grade, which may make theCompany subject to substantial credit risk. This is especially true during periods of economic uncertainty or duringeconomic downturns.

 

***Equity Risk.***  Equity risk is the possibility that theCompany could lose money if its equity investments decline in value.  Such a decline could be caused by a numberof factors, including, but not limited to, overall market conditions,suspension or omission of dividends, bankruptcies and litigation.  This is especially true during periods ofeconomic uncertainty or during economic downturns.

 

15

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***Failure to MaintainREIT Status Risk****.*  Failure to maintain REIT status risk refers to the possibilitythat the Company may become subject to federal income tax as a regularcorporation.  The Company intends at alltimes to maintain substantially all of its investments in, and otherwiseconduct its business in a manner consistent with, the REIT Provisions of theCode.  If the Company fails to qualifyas 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 MaintainInvestment 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 harming the Company’s operations and returns to stockholders.  In addition, if the Company fails to qualifyfor the exemption from registration as an investment company, its ability touse leverage would be substantially reduced. This could reduce income to the Company and returns to stockholders.

 

***Risks Relating toExploration of Strategic Alternatives.***  On March 13, 2003, we announced that ourBoard of Directors has authorized management to consider a full range ofstrategic alternatives for the Company in order to maximize stockholder value,including, without limitation, the potential sale of the Company. We areuncertain as to what strategic alternatives may be available to the Company orwhat impact any particular strategic alternative will have on our stock priceif accomplished. Uncertainties and risks relating to our exploration ofstrategic alternatives include:

 

•                  the explorationof strategic alternatives may disrupt our operations and distract management,which could harm our operating results and the market price of our commonstock;

 

•                  the process ofexploring strategic alternatives may be more time-consuming and expensive thanwe anticipate;

 

•                  we may not beable to identify any strategic alternatives that we believe are worthundertaking;

 

•                  we may not beable to successfully execute or achieve the benefits of a strategic alternativewhich is approved by the Board or the independent committee thereof formed forthat purpose;

 

•                  we may incursignificant financial advisory fees, legal and accounting fees and othergeneral and administrative expenses associated with exploring and/orimplementing various strategic alternatives, including possible termination orbreak-up fees with counterparties; and

 

•                  we may terminateour management agreement with the Manager upon the consummation of any sale ofthe Company and, in such event, we will be obligated to pay the Manager atermination fee which could be substantial.

 

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**FINANCIAL CONDITION**

 

# **Fixed Income Securities**

 

At March 31, 2003 and December 31, 2002, the Company held$2,431,612,000 and $2,424,907,000 of fixed income securities, respectively. Theoriginal maturity of a significant portion of the fixed income securitiesranges from fifteen to thirty years; the actual maturity is subject to changebased on the prepayments of the underlying mortgage loans.

 

The following table is a schedule of fixed income securities held andlisted by security type (dollars in thousands):

 
|                           |   | **March 31, 2003** |      | **December 31, 2002**    |   |
|--------------------------------|--------|--------------------|-----------|--------------------------|--------|
| **Fixed Income Securities**    |   | **Carrying Value** |      | **Percent of Portfolio** |   | **Carrying Value** |   | **Percent of Portfolio** |   |
|                           |   |               |      |                     |   |   |   |   |   |
| Mortgage  Securities:          |   |               |      |                     |   |   |   |   |   |
| Adjustable  Rate (1)           |   | $                  | 109,864   |                     | 4.52   | % | $ | 9,173 |   | 0.38 | % |
| Fixed Rate                     |   | 2,320,998          |      | 95.45                    | %      | 2,415,484 |   | 99.61 | % |
| Other Fixed  Income Securities |   | 750                |      | 0.03                     | %      | 250 |   | 0.01 | % |
| Totals                         |   | $                  | 2,431,612 |                     | 100.00 | % | $ | 2,424,907 |   | 100.00 | % |

 

----

(1)          At March 31, 2003, the interest rate indicesfor 90% and 10% of the adjustable rate mortgage securities were based on theone-year U.S. Treasury rate and the six-month London Inter-Bank Offered Rate,respectively.

 

At December 31, 2002, the interest rateindices for 99% and 1% of the adjustable rate mortgage securities were based onthe one-year U.S. Treasury rate and the six-month London Inter-Bank OfferedRate, respectively.

 

The following table shows various weightedaverage characteristics of the fixed income securities held by the Company atMarch 31, 2003 (dollars in thousands):

 
| **Security Type**              |   | **Par Amount** |      | **Par as a  Percent of  Category** |   | **Adjusted  Cost Basis** |   | **Market  Price** |   | **Current  Coupon** |   | **Weighted  Average  Life (1)** |   |
|--------------------------------|--------|----------------|-----------|------------------------------------|--------|--------------------------|--------|-------------------|--------|---------------------|--------|---------------------------------|--------|
|                           |   |           |      |                               |   |                     |   |              |   |                |   |                            |   |
| 15 Year Agency  Pass-throughs  |   | $              | 139,524   |                               | 5.92   | %                        | 102.20 | %                 | 102.90 | %                   | 5.05   | %                               | 4.1    |   |
| 30 Year Agency  Pass-throughs  |   | 2,098,546      |      | 89.09                              | %      | 101.52                   | %      | 103.40            | %      | 6.04                | %      | 2.6                             |   |
| AAA CMOs                       |   | 7,527          |      | 0.32                               | %      | 98.39                    | %      | 101.50            | %      | 7.25                | %      | 1.4                             |   |
| Total Fixed  Rate Holdings     |   | 2,245,597      |      | 95.33                              | %      | 101.55                   | %      | 103.36            | %      | 6.02                | %      | 2.7                             |   |
|                           |   |           |      |                               |   |                     |   |              |   |                |   |                            |   |
| Other Fixed  Income Securities |   | 2,500          |      | 0.11                               | %      | 11.83                    | %      | 30.00             | %      | 17.88               | %      | —                          |   |
| Adjustable Rate  Holdings      |   | 107,417        |      | 4.56                               | %      | 102.44                   | %      | 102.28            | %      | 5.24                | %      | 5.0                             |   |
|                           |   |           |      |                               |   |                     |   |              |   |                |   |                            |   |
| Category Total                 |   | $              | 2,355,514 |                               | 100.00 | %                        | 101.49 | %                 | 103.23 | %                   | 6.00   | %                               | 2.8    |   |

 

17

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The following table shows various weightedaverage characteristics of the fixed income securities held by the Company atDecember 31, 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)** |   |
|--------------------------------|--------|----------------|-----------|----------------------------------|--------|--------------------------|--------|-------------------|--------|---------------------|--------|---------------------------------|--------|
|                           |   |           |      |                             |   |                     |   |              |   |                |   |                            |   |
| 30 Year Agency  Pass-throughs  |   | 2,327,391      |      | 98.98                            | %      | 101.54                   | %      | 103.24            | %      | 6.07                | %      | 2.7                             |   |
| AAA CMOs                       |   | 12,409         |      | 0.53                             | %      | 97.54                    | %      | 101.91            | %      | 7.10                | %      | 1.0                             |   |
| Total Fixed  Rate Holdings     |   | 2,339,800      |      | 99.51                            | %      | 101.52                   | %      | 103.23            | %      | 6.08                | %      | 2.7                             |   |
|                           |   |           |      |                             |   |                     |   |              |   |                |   |                            |   |
| Other Fixed  Income Securities |   | 2,500          |      | 0.11                             | %      | 16.04                    | %      | 10.00             | %      | 18.28               | %      | 0.3                             |   |
| Adjustable  Rate Holdings      |   | 8,965          |      | 0.38                             | %      | 97.42                    | %      | 102.32            | %      | 5.12                | %      | 1.0                             |   |
|                           |   |           |      |                             |   |                     |   |              |   |                |   |                            |   |
| Category Total                 |   | $              | 2,351,265 |                             | 100.00 | %                        | 101.41 | %                 | 103.13 | %                   | 6.09   | %                               | 2.7    |   |
|                                |        |                |           |                                  |        |                          |        |                   |        |                     |        |                                 |        |  |

 

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(1)   The weighted average life of the fixed ratemortgage securities is based upon market prepayment expectations as of thedates shown.  The actual weightedaverage life could be longer or shorter depending on the actual prepaymentrates experienced over the life of the securities and is sensitive to changesin both prepayment rates and interest rates. The weighted average life shownfor the adjustable rate mortgage assets represents the average time until thenext coupon reset date.  All averagesare shown in years.

 

### **Equity Securities**

 

At March 31, 2003 and December 31, 2002, theCompany held $4,184,000 and $4,168,000 of equity securities, respectively.Equity securities consist primarily of investment in equities issued by otherreal estate investment trusts.

 

At March 31, 2003, equity securities consisted of the following:

 
| **(In thousands)**                       |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |   |
|------------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|--------|
|                                     |   |            |   |              |   |           |   |
| Common Stock:                            |   |            |   |              |   |           |   |
|                                     |   |            |   |              |   |           |   |
| Dynex Capital,  Inc.                     |   | 75              |   | $                 | 122    |           | $      | 366 |   |
| Total Common  Stock                      |   |            |   | 122               |   | 366            |   |
|                                     |   |            |   |              |   |           |   |
| Convertible  Preferred Stock:            |   |            |   |              |   |           |   |
|                                     |   |            |   |              |   |           |   |
| Capstead  Mortgage Corporation, Series B |   | 321             |   | 2,722             |   | 3,818          |   |
| Total  Convertible Preferred Stock       |   |            |   | 2,722             |   | 3,818          |   |
|                                     |   |            |   |              |   |           |   |
| Total Equity  Securities                 |   |            |   | $                 | 2,844  |           | $      | 4,184 |   |

 

18

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

 
| **(In thousands)**                       |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |
|------------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|
|                                     |   |            |   |              |   |           |
| Common Stock:                            |   |            |   |              |   |           |
|                                     |   |            |   |              |   |           |
| Dynex Capital,  Inc.                     |   | 75              |   | $                 | 122    |           | $ | 363 |
| Total Common  Stock                      |   |            |   | 122               |   | 363            |
|                                     |   |            |   |              |   |           |
| Convertible  Preferred Stock:            |   |            |   |              |   |           |
|                                     |   |            |   |              |   |           |
| Capstead  Mortgage Corporation, Series B |   | 321             |   | 2,722             |   | 3,805          |
| Total  Convertible Preferred Stock       |   |            |   | 2,722             |   | 3,805          |
|                                     |   |            |   |              |   |           |
| Total Equity  Securities                 |   |            |   | $                 | 2,844  |           | $ | 4,168 |

 

**Other Assets**

 

The Company had other assets of $13,021,000 and $14,847,000 at March31, 2003 and December 31, 2002, respectively. Other assets consist of accruedinterest receivable, principal payments receivable, deferred insurance expense,deferred shareholder rights expense and other prepaid expenses.

# ** **

# **Stockholders’ Equity**

 

The Company had stockholders’ equity of$195,250,000 and $194,659,000 at March 31, 2003 and December 31, 2002,respectively. The increase in stockholders’ equity at March 31, 2003 wasprimarily due to a decrease in accumulated other comprehensive loss during thequarter ended March 31, 2003. The decrease in accumulated other comprehensiveloss included an increase in unrealized gains on available-for-sale securities,a decrease in unrealized losses on interest rate swaps, and a decrease indeferred loss on terminated interest rate swaps. The increase in accumulateddeficit included net income less dividends declared for the quarter ended March31, 2003.

 

**Hedging Instruments**

 

There can be no assurance that the Company will enter into hedgingactivities or that, if entered into, such activities will have the desiredbeneficial impact on the Company’s results of operations or financialcondition.  Moreover, no hedging activitycan completely insulate the Company from the risks associated with changes ininterest rates and prepayment rates.

 

Hedging involves risk and typically involves costs, includingtransaction costs.  Such costs increasedramatically as the period covered by the hedging increases and during periodsof rising and volatile interest rates. The Company may increase its hedging activity and, thus, increase itshedging costs during such periods when interest rates are volatile or risingand hedging costs have increased.  TheCompany intends generally to hedge as much of the interest rate risk as theManager determines is in the best interest of the Company’s stockholders giventhe cost of such hedging transactions and the Company’s desire to maintain itsstatus as a REIT.  The Company’spolicies do not contain specific requirements as to the percentages or amountof interest rate risk that the Manager is required to hedge.

 

The Company utilizes interest rate swap agreements as a tool to manageinterest rate risk. Under the swap agreements, the Company receives a floatingrate and pays a fixed rate. The notional amount of each

 

19

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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 the contract.In the absence of such financial instruments, interest expense on reverse repurchaseagreements and similar short-term borrowings, which mature and repricefrequently, can increase faster than the Company can adjust itsinterest-earning assets and increase interest income, because the Company’smortgage related securities generally have much longer maturities and havefixed rates of interest.

 

The interest rate swap agreements entered into by the Company areclassified as cash flow hedges for accounting purposes and meet therequirements of SFAS No. 133 for such classification.  Therefore, changes in the fair value of the agreements arereported in accumulated other comprehensive income, a component ofstockholders’ 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 not qualifyfor hedge accounting treatment.  In thatcase, changes in their fair values would affect net income.

 

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

 

During the fourth quarter of 2002, the Company terminated a portion ofthe outstanding interest rate swap agreements with a combined notional amountof $544,500,000, which resulted in a deferred loss of approximately $13,872,000with an average term of 1.3 years and an average rate of 3.57%. The deferredloss is being amortized as an adjustment to interest expense over the remaininglives of the original swap agreements. However, the Company may be required to accelerate the deferred lossrecognition if the general level of reverse repurchase agreements maintained bythe Company declines in the future.

 

At March 31, 2003, the Company had entered into interest rate swapagreements summarized below:

 

(Dollars inthousands)

 
| **Current  Notional Amount** |   | **Average  Fixed Rate** |   | **Floating  Rate** |   | **Par Weighted  Average  Maturity** |   | **Unrealized  Losses** |    |
|------------------------------|--------|-------------------------|--------|--------------------|--------|-------------------------------------|--------|------------------------|---------|
|                         |   |                    |   |               |   |                                |   |                   |    |
| $ 1,678,500                  |   | 4.643                   | %      | 1 Month LIBOR      |   | 4.2 years                           |   | $                      | 120,214 |   |
|                              |        |                         |        |                    |        |                                     |        |                        |         |  |

 

 

20

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At December 31, 2002, the Company had enteredinto interest rate swap agreements summarized below:

 

(Dollars inthousands)

 
| **Current  Notional Amount** |   | **Average  Fixed Rate** |   | **Floating  Rate** |   | **Par Weighted  Average  Maturity** |   | **Unrealized  Losses** |    |
|------------------------------|--------|-------------------------|--------|--------------------|--------|-------------------------------------|--------|------------------------|---------|
|                         |   |                    |   |               |   |                                |   |                   |    |
| $ 1,678,500                  |   | 4.643                   | %      | 1 Month LIBOR      |   | 4.4 years                           |   | $                      | 120,098 |   |
|                              |        |                         |        |                    |        |                                     |        |                        |         |  |

 

At various times the Company has used forward contractsto sell U.S. Treasury securities as a means to seek to mitigate the effect ofrising interest rates on the fair value of its mortgage relatedsecurities.   The fair values of theseforward contracts generally move in the opposite direction of the fair valuesof the mortgage related securities, and approximately in the same proportionwhen the maturities and other terms are appropriately matched.   When interest rates rise, the fair value ofthe mortgage related securities declines, but the increasing fair values of theforward contracts help to preserve net asset value relative to the changingfair value of the short-term borrowings used to fund them.

 

The Company’s forward contracts do not meet the criteria for hedgeaccounting under SFAS No. 133.  Therefore,changes in their fair values affect current earnings, as do changes in the fairvalues of the securities to which they are matched — such securities areclassified as trading securities. Although the changes in the fair values of the forward contracts and thetrading securities are offsetting, the contracts are not fully effective ashedges and, therefore, there can be volatility in periodic earnings to theextent they are not effective.

 

At March 31, 2003 and December 31, 2002, the Company had no openforward contracts to sell U.S. Treasury notes.

 

# **Liabilities**

 

The Company has entered into reverse repurchase agreements to financecertain of its mortgage-backed securities. These agreements are secured by a portion of the Company’smortgage-backed securities and bear interest rates that have historically movedin close relationship to LIBOR.

 

At March 31, 2003, the Company had outstanding $2,124,312,000 ofreverse repurchase agreements with a weighted average current borrowing rate of1.28% and a maturity of one month. The reverse repurchase agreements werecollateralized by mortgage-backed securities with an estimated fair value of$2,213,442,000.

 

At December 31, 2002, the Company had outstanding $2,112,444,000 ofreverse repurchase agreements with a weighted average current borrowing rate of1.40% and a maturity of one month.  Thereverse repurchase agreements were collateralized by mortgage-backed securitieswith an estimated fair value of $2,199,852,000.

 

The Company had interest rate swaps with an unrealized loss of$120,214,000 and $120,098,000 at March 31, 2003 and December 31, 2002,respectively. Under the swap agreements, the Company receives a floating rateand pays a fixed rate.

 

The Company had $12,148,000 and $18,177,000 of other liabilities atMarch 31, 2003 and December 31, 2002, respectively. The decrease in otherliabilities at March 31, 2003 was primarily due to a decrease of dividendpayable during the quarter ended March 31, 2003. Other liabilities also consistof accrued interest payable and accrued expenses and other liabilities. TheCompany anticipates settling all other liabilities within one year.

 

21

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**RESULTS OF OPERATIONS**

 

**Three Months Ended March 31, 2003 Compared To Three MonthsEnded March 31, 2002**

 

##### *Overview*

 

For the quarter ended March 31, 2003, theCompany’s net income was $6,299,000, or $0.21 per common share on a basic anddiluted basis, based on a weighted average of 29,857,000 shares outstanding.This compares to net income of $9,728,000, or $0.53 per common share on a basicand diluted basis, based on a weighted average of 18,316,000 and 18,428,000shares outstanding, respectively, for the three months ended March 31, 2002.The weighted average number of shares used to calculate net income per dilutedshare includes the effect of the assumed exercise of outstanding stock options.

 

The primary reasons for the change inoperating results for the three months ended March 31, 2003 compared to 2002are:  (1) changes in interest rates andmarket conditions affecting the fair values of the Company’s Mortgage RelatedSecurities and related derivative financial instruments and net interestincome, and (2) related changes in investment and hedging strategies.

 

##### *Net Interest Income*

 

  Netinterest income for the quarter ended March 31, 2003 was $7,438,000, consistingof interest income on fixed income securities and cash balances less interestexpense on reverse repurchase agreements and interest rate swaps, compared to$14,604,000 for the quarter ended March 31, 2002, or a decrease of 49%. Thedecrease in net interest income was primarily due to a decrease in net interestmargin, from 3.23% for the quarter ended March 31, 2002 to 0.89% for thequarter ended March 31, 2003. Changes in interest income and expense areprimarily a function of changes in average effective interest rates on theCompany’s fixed income securities, reverse repurchase agreements and interestrate swaps, and changes in the average amount of those assets and liabilitiesoutstanding during each year.

 

The following table reflects the averagebalances for each category of the Company’s interest earning assets as well asthe Company’s interest bearing liabilities, with the corresponding effectiverate of interest annualized:

 

22

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

(Dollars in thousands)

 
|                                   |   | **For the  Quarter Ended  March 31, 2003** |      | **For the  Quarter Ended  March 31, 2002** |   |
|----------------------------------------|--------|--------------------------------------------|-----------|--------------------------------------------|--------|
|                                   |   | **Average  Balance**                       |      | **Effective  Rate**                        |   | **Average  Balance** |   | **Effective  Rate** |   |
| Interest-Earning Assets:               |   |                                       |      |                                       |   |   |   |   |   |
| Mortgage Securities                    |   | $                                          | 2,300,350 |                                       | 5.24   | % | $ | 1,679,584 |   | 6.49 | % |
| Cash and Cash Equivalents              |   | 6,616                                      |      | 0.67                                       | %      | 9,273 |   | 2.37 | % |
| Total Interest-Earning Assets          |   | 2,306,966                                  |      | 5.22                                       | %      | 1,688,857 |   | 6.47 | % |
|                                   |   |                                       |      |                                       |   |   |   |   |   |
| Interest-Bearing Liabilities:          |   |                                       |      |                                       |   |   |   |   |   |
| Reverse Repurchase Agreements          |   | 2,095,587                                  |      | 4.33                                       | %      | 1,570,692 |   | 3.24 | % |
|                                   |   |                                       |      |                                       |   |   |   |   |   |
| Net Interest-Earning Assets and Spread |   | $                                          | 211,379   |                                       | 0.89   | % | $ | 118,165 |   | 3.23 | % |

 

The effective yield data is computed by dividingthe annualized net interest income or expense, including the effect on interestexpense of hedging transactions as applicable into the average daily balanceshown.

 

The following table reflects the averagebalances for the Company’s equity securities, with the corresponding effectivedividend yield annualized:

 

AVERAGEBALANCE AND RATE TABLE

(Dollars inthousands)

 
|              |   | **For the  Quarter Ended   March 31, 2003** |   | **For the  Quarter Ended   March 31, 2002** |   |
|-------------------|--------|---------------------------------------------|--------|---------------------------------------------|--------|
|              |   | **Average   Balance**                       |   | **Effective   Dividend   Yield**            |   | **Average   Balance** |   | **Effective   Dividend   Yield** |   |
|              |   |                                        |   |                                        |   |   |   |   |   |
| Equity securities |   | $                                           | 3,802  |                                        | 10.63  | % | $ | 4,519 |   | 4.07 | % |
|                   |        |                                             |        |                                             |        |  |  |  |  |  |  |

 

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The following table shows the approximate amounts of the change ininterest income and expense between 2003 and 2002 that was a function of rateand volume changes, and the amount of the change that cannot be ascribedspecifically to either rate or volume changes:

 

**RATE/ VOLUME TABLE**

(Dollars inthousands)

 
|                          |   | **Three  Months Ended March 31,  2003 compared to 2002** |   |
|-------------------------------|--------|----------------------------------------------------------|--------|
|                          |   | **Total**                                                |   | **Changes Due  to** |   |
|                          |   | **Change**                                               |   | **Volume (1)** |   | **Rates (1)** |   |
| Interest-Earning Assets       |   |                                                     |   |   |   |   |   |
| Fixed income securities       |   | $                                                        | 2,853  |   | $ | 10,074 |   | ($7,221 | ) |
| Cash and cash equivalents     |   | (44                                                      | )      | (16 | ) | (28 | ) |
|                          |   |                                                     |   |   |   |   |   |
| Total interest income         |   | 2,809                                                    |   | 10,058 |   | (7,249 | ) |
|                          |   |                                                     |   |   |   |   |   |
| Interest-Bearing Liabilities  |   |                                                     |   |   |   |   |   |
| Reverse repurchase agreements |   | 9,975                                                    |   | 4,246 |   | 5,729 |   |
|                          |   |                                                     |   |   |   |   |   |
| Total interest expense        |   | 9,975                                                    |   | 4,246 |   | 5,729 |   |
|                          |   |                                                     |   |   |   |   |   |
| Change In Net Interest Income |   | $                                                        | (7,166 | ) | $ | 5,812 |   | $ | (12,978 | ) |
|                               |        |                                                          |        |  |  |  |  |  |  |  |

 

----

(1)  Changesin interest income/expense not arising from volume or rate variances areallocated proportionately to rate and volume.

 

A portion of the change in interest expensein the table 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 quarter ended March 31, 2003,interest expense was increased by $13,782,000 paid to swap counterparties and$1,873,000 from amortization of deferred losses on terminated swapcontracts.  During the quarter endedMarch 31, 2002, interest expense was increased by $5,691,000 paid to swapcounterparties and decreased by $121,000 from amortization of deferred gains onterminated swap contracts.

 

Low interest rates have continued to increasemortgage prepayments and this in turn has continued to adversly affect theCompany’ earnings.  For the past threequarters, the average constant prepayment rate (CPR) for the portfolio hascontinued to rise with the CPR for the first quarter of 2003 increasing to 31CPR, up 28% from the 24 CPR rate in the fourth quarter of 2002.

 

##### *Dividend Income*

 

The Company reported dividend income of$101,000 from dividends on equity investments for the quarter ended March 31,2003, compared to $126,000 for the quarter ended March 31, 2002.

 

*Net Gain (Loss) onInvestment and Derivative Activities*

 

Duringthe quarter ended March 31, 2003, the Company reported net gains on investmentand derivative activities of $448,000 in the statement of operations. This gainwas an unrealized gain on fixed income trading securities.

 

24

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Duringthe quarter ended March 31, 2002, the Company reported net losses on investmentand derivative activities of $1,704,000 in the statement of operations. Thisloss consisted of a net loss of $481,000 on closed forward contracts, a loss of$232,000 on the sale of $99,881,000 of fixed income securitiesavailable-for-sale, a gain of $17,000 on the sale of $6,535,000 of fixed incometrading securities, a gain of $341,000 on the sale of $1,117,000 of equitysecurities available-for-sale, and an unrealized loss of $1,349,000 on tradingsecurities.

 

##### *General and Administrative Expenses*

 

General and administrative expenses decreasedto $1,688,000 for the quarter ended March 31, 2003 from $3,298,000 for thequarter ended March 31, 2002. The primary reason for the decrease was adecrease in incentive fee expenses in the quarter ended March 31, 2003 comparedto the quarter ended March 31, 2002. The decrease in incentive fee expenses was primarily due to interestrate swap agreeements that increased borrowing costs in the quarter ended March31, 2003 compared to the quarter ended March 31, 2002.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

The Company’s primary sources of funds as ofMarch 31, 2003 and December 31, 2002, consisted of reverse repurchaseagreements totaling $2,124,312,000 and $2,112,444,000, respectively.  The Company expects to continue to borrowfunds in the form of reverse repurchase agreements.  At March 31, 2003, the Company had borrowing arrangements withapproximately 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.

 

For liquidity, the Company will also rely onthe cash flow from operations, primarily monthly principal and interestpayments to be received on the mortgage assets.

 

The Company believes that equity capital,combined with the cash flow from operations and the utilization of borrowings,will be sufficient to enable the Company to meet anticipated liquidityrequirements.  However, an increase inprepayment rates substantially above the Company’s expectations could cause aliquidity shortfall.  If the Company’scash resources are at any time insufficient to satisfy the Company’s liquidityrequirements, the Company may be required to liquidate mortgage assets, selldebt or additional equity securities or borrow money to meet itsobligations.  If required, the sale ofmortgage assets at prices lower than the carrying value of such assets wouldresult in losses and reduced income.

 

The Company may in the future increase itscapital resources by making additional offerings of equity and debt securities,including classes of preferred stock, common stock, commercial paper, medium-termnotes, collateralized mortgage obligations 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 in 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 any additional offerings as theywill depend upon market conditions and other factors.

 

**INFLATION**

 

Virtually all of the Company’s assets andliabilities are financial in nature.  Asa result, interest rates and other factors drive the Company’s performance farmore so than does inflation.  Changes ininterest rates do not necessarily correlate with inflation rates or changes ininflation rates.  The Company’sfinancial statements are prepared in accordance with accounting principlesgenerally accepted in the United States of America and the Company’s dividendsare determined by the Company’s net income as calculated for tax purposes; ineach 

 

25

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case, the Company’s activities and balance sheet are measured withreference to historical cost and or fair market value without consideringinflation.

 

**CRITICAL ACCOUNTING POLICIES**

 

The Company’s financial statements areprepared in accordance with accounting principles generally accepted in theUnited States of America. The financial information contained within thesefinancial statements is, to a significant extent, financial information that isbased on approximate measures of the financial effects of transactions andevents that have already occurred. Based on its consideration of accountingpolicies that involve complex and subjective decisions and assessments,management has identified its most critical accounting policies to be thefollowing:

 

##### *Classifications of Investment Securities*

 

The Company’s investment securities areclassified as either trading securities or available-for-sale securities, asdiscussed in Note 2 to the financial statements. Although all of the Company’sinvestment securities are carried on the balance sheets at fair value, theclassification of the securities as trading or as available-for-sale determineswhether changes in fair value are recorded immediately through currentearnings, as they are for trading securities, or as adjustments to accumulatedother comprehensive income (loss), which is a component of stockholders’equity, as they are for available-for-sale securities. If available-for-salesecurities were classified as trading securities, there could be substantiallygreater volatility in earnings from period-to-period.

 

##### *Valuations of Investment Securities*

 

As noted above, all investment securities arecarried on the balance sheets at fair value. Some of the Company’s securities,particularly the equity securities, have readily determinable fair values basedon quotes provided from recognized securities exchanges. However, most of theCompany’s fixed income securities have fair values determined by managementwith reference to price estimates provided by dealers in the securities,independent pricing services, and other sources. Because the price estimatesmay vary to some degree between sources, management must make certain judgmentsand assumptions about the appropriate price to use to calculate the fair valuesfor financial reporting purposes. Different judgments and assumptions couldresult in different presentations of value.

 

When the fairvalue of an available-for-sale security is less than amortized cost, managementconsiders whether there is an other-than-temporary impairment in the value ofthe security (e.g., whether the security will be sold prior to the recovery offair value).  If, in management’sjudgment, an other-than-temporary impairment exists, the cost basis of thesecurity is written down to the then-current fair value, and the unrealizedloss is transferred from accumulated other comprehensive income as an immediatereduction of current earnings (i.e., as if the loss had been realized in theperiod of impairment).

 

*Interest Income and Dividend Recognition*

 

Interestincome on the Company’s mortgage securities and other fixed income securitiesis accrued based on the actual coupon rate and the outstanding principalamount.  Premiums and discounts areamortized or accreted into interest income over the lives of the securitiesusing the effective yield method adjusted for the effects of estimatedprepayments.  In the event that the costbasis of a security has been reduced below par because of another-than-temporary impairment in value, the difference is treated like adiscount in determining the appropriate amount of accretion to recognize asinterest income between the date when the cost is adjusted and when thesecurity is ultimately sold.  Also,dividends on equity securities are recognized as income on their declarationdates.

 

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##### *Accounting for Derivative Financial Instruments andHedging Activities*

 

The Company currently uses two types ofderivative financial instruments, as discussed in Notes 2 and 5 to thefinancial statements. Both types are used fundamentally for the purpose ofhedging the Company’s exposure to interest rate risk, and both are carried atfair value on the balance sheets. Forward contracts to sell U.S. Treasurysecurities are matched against a portion of the Company’s fixed income tradingsecurities. These contracts do not qualify for hedge accounting and, therefore,changes in fair values of these instruments are recorded immediately throughcurrent earnings. Such changes tend to offset fair value changes in theopposite direction for the fixed income trading securities and help to reducethe volatility of periodic earnings. Interest rate swap agreements are matchedagainst a portion of the Company’s current and anticipated reverse repurchaseagreements (borrowings), effectively fixing the rate of interest paid on thoseborrowings for longer durations. These instruments qualify for hedge accountingand are considered to be cash flow hedges. To the extent that periodic changesin fair values of the swap agreements are deemed to be the result of theireffectiveness as hedges, such changes are recorded as adjustments toaccumulated other comprehensive income, a component of stockholders’ equity,rather than to current earnings. If the swaps no longer qualified as cash flowhedges (for example, if the terms of the swaps were not matched appropriatelyto the terms of the borrowings, or if anticipated borrowings matched to theswaps were not in fact made) all or a portion of the swaps’ fair values couldbecome adjustments to current earnings.

 

##### *Accounting for Stock Options*

 

The Company issues stock options to itsDirectors and to certain employees of the Manager. The stock options issued toDirectors are accounted for using the intrinsic-value method. Because theoptions were issued with exercise prices no less than the market price of theCommon Stock on the dates of grant, and because the stock options key terms arefixed, use of the intrinsic-value method results in the Company not recognizingcompensation expense for these stock options. Note 6 to the financialstatements discloses the effects on recent earnings if these stock options wereaccounted for at fair value when granted and if compensation expense wererecognized in periodic earnings over the vesting periods of the options. If theterms of the options were to be changed, variable accounting might need to beused, and the Company might then need to begin recognizing compensation expensefor these options.  Options granted topersons other than Directors (i.e., to non-employees) are accounted for usingthe fair value method; such stock options are measured at their fair value whenthey are granted and are recognized as general and administrative expenseduring the periods when the options are vested and the related services areperformed.

 

*Off Balance Sheet Arrangements*

 

Subsequent to January 1, 2002, the Companydid not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance orspecial purpose entities, which would have been established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes.  Further, the Companyhas not guaranteed any obligations of unconsolidated entities nor does it haveany commitment or intent to provide additional funding to any suchentities.  As such, the Company is notmaterially exposed to any market, credit, liquidity or financing risk thatcould arise if the Company had engaged in such relationships.

 

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# **ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

 

**MARKETRISK**

 

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

 

### **Interest Rate Risk**

 

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

 

*Extension Risk*.  Fixed-rate assets are generally acquired with a projectedweighted average life based on certain assumptions regarding prepayments.  In general, when a fixed-rate mortgage assetis acquired with borrowings, the Company may, but is not required to, enterinto an interest rate swap agreement or other hedging instrument thateffectively fixes the Company’s borrowing costs for a period close to theanticipated average life of the related asset. This strategy is designed to protect the Company from rising interestrates because the borrowing costs are fixed for the duration of the asset.  However, if prepayment rates decrease in arising interest rate environment, the life of the mortgage asset could extendbeyond the term of the swap agreement or other hedging instrument.  This situation could negatively impact theCompany as borrowing costs would no longer be fixed after the end of thehedging instrument while the income earned on the asset would remainfixed.  This situation may also causethe market value of the Company’s mortgage assets to decline with little or nooffsetting gain from the related hedging transactions.  In certain situations, the Company may beforced to sell assets and incur losses or borrow money to maintain adequateliquidity.

 

*Prepayment Risk*.  Fixed-rate assets in combination with hedging instruments arealso subject to prepayment risk.  Infalling interest rate scenarios, the fixed-rate mortgage assets may prepayfaster such that the average life becomes shorter than its related hedginginstrument.  If this were to happen, theCompany would potentially need to reinvest at rates lower than that of therelated hedging instrument.  Thissituation may result in the narrowing of interest rate spreads or may causelosses.

 

*Forward Contract Risk*.  The Company may also enter in forwardcontracts to sell U.S. Treasury notes in addition to or instead of interestrate swap agreements.  These forwardcontracts are generally expected to mitigate the impact of rising interestrates on the fair value of the Company’s fixed income securities.  However, if the duration mismatch betweenmortgage securities and U.S. Treasury notes were to widen, which could occur inboth a rising and falling interest rate environment, the fair value of theCompany’s portfolio would generally be expected to decline.  In addition, the use of forward contracts tosell U.S. Treasury notes generally does not directly impact borrowing costs inthe same manner as interest rate swap agreements.  Therefore, the use of such forward contracts could result in netincome volatility during periods of interest rate volatility.

 

The Company also invests in adjustable-ratemortgage assets that are typically subject to periodic and lifetime interestrate caps that limit the amount an adjustable-rate mortgage asset’s interestrate can change 

 

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during any given period, as well as the minimum rate payable.  The Company’s borrowings will not be subjectto similar restrictions.  Hence, in aperiod of increasing interest rates, interest rates on its borrowings couldincrease without limitation by caps, while the interest rates on its mortgageassets are generally limited by caps. This problem will be magnified to the extent the Company acquiresmortgage assets that are not fully indexed. Further, some adjustable-rate mortgage assets may be subject to periodicpayment caps that result in some portion of the interest being deferred andadded to the principal outstanding. This could result in receipt by the Company of less cash income on itsadjustable-rate mortgage assets than is required to pay interest on the relatedborrowings.  These factors could lowerthe Company’s net interest income or cause a net loss during periods of risinginterest rates, which would negatively impact the Company’s financialcondition, cash flows and results of operations.

 

The Company intends to fund a substantialportion of its acquisitions of adjustable-rate mortgage assets with borrowingsthat have interest rates based on indices and repricing terms similar to, butof somewhat shorter maturities than, the interest rate indices and repricing termsof the mortgage assets.  Thus, theCompany anticipates that in most cases the interest rate indices and repricingterms of its mortgage assets and its funding sources will not be identical,thereby creating an interest rate mismatch between assets and liabilities.  While the historical spread between relevantshort-term interest rate indices has been relatively stable, there have beenperiods, especially during the 1979-1982 and 1994 interest rate environments,when the spread between such indices was volatile.  During periods of changing interest rates, such interest ratemismatches could negatively impact the Company’s financial condition, cashflows and results of operations.

 

Prepayment rates generally increase whenprevailing interest rates fall below the interest rates on existing mortgageassets.  In addition, prepayment ratesgenerally increase when the difference between long-term and short-terminterest rates declines.  Prepayments ofmortgage assets could harm the Company’s results of operations in severalways.  The Company anticipates that asubstantial portion of its adjustable-rate mortgage assets may bear initial“teaser” interest rates that are lower than their “fully indexed” rates (theapplicable index plus a margin).  In theevent that such an adjustable-rate mortgage asset is prepaid prior to or soonafter the time of adjustment to a fully indexed rate, the Company will haveheld the mortgage asset while it was less profitable and lost the opportunityto receive interest at the fully indexed rate over the expected life of theadjustable-rate mortgage asset.  Inaddition, the prepayment of any mortgage asset that had been purchased at apremium by the Company would result in the immediate write-off of any remainingcapitalized premium amount and consequent reduction of the Company’s netinterest income by such amount. Finally, in the event that the Company is unable to acquire new mortgageassets to replace the prepaid mortgage assets, its financial condition, cashflow and results of operations could be harmed.

 

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

 

The Company primarily assesses its interestrate risk by estimating the duration of its assets and the duration of itsliabilities, including all hedging instruments.  Duration essentially measures the market price volatility offinancial instruments as interest rates change.  The Company generally calculates duration using various financialmodels and empirical data and different models and methodologies can producedifferent duration numbers for the same securities.

 

The following sensitivity analysis tableshows the estimated impact on the fair value of the Company’s interest ratesensitive investments, net of its hedging instruments and reverse repurchaseagreement liabilities, assuming rates instantaneously rise and fall onehundred, two hundred, and three hundred basis points. Interest rate sensitiveinvestments currently include fixed income trading and available-for-salesecurities. (Dollars are in thousands except per share amounts.)

 

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|                                                                      |   | **Fair Value  for Scenario Shown**             |     |
|---------------------------------------------------------------------------|--------|------------------------------------------------|----------|
|                                                                      |   | **Interest   Rates Fall   300 Basis   Points** |     | **Interest  Rates Fall   200 Basis   Points** |   | **Interest  Rates Fall   100 Basis   Points** |   | **Unchanged** |   | **Interest  Rates Rise   100 Basis   Points** |   | **Interest   Rates Rise   200 Basis   Points** |   | **Interest   Rates Rise   300 Basis   Points** |   |
|                                                                      |   |                                           |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Rate Sensitive Instruments After  Hedging Instruments            |   | $                                              | 54,719   |   | $ | 100,564 |   | $ | 148,250 |   | $ | 187,086 |   | $ | 179,874 |   | $ | 126,194 |   | $ | 63,831 |   |
|                                                                      |   |                                           |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Change in Fair Value                                                      |   | $                                              | (132,367 | ) | $ | (86,522 | ) | $ | (38,836 | ) | — |   | $ | (7,212 | ) | $ | (60,892 | ) | $ | (123,255 | ) |
|                                                                      |   |                                           |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Change as a Percent of Fair Value of  Interest Rate Sensitive Investments |   | (5.44                                          | )%       | (3.56 | )% | (1.60 | )% | — |   | (0.30 | )% | (2.50 | )% | (5.07 | )% |
|                                                                      |   |                                           |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Change as a Percent of Stockholders’ Equity                          |   | (67.79                                         | )%       | (44.31 | )% | (19.89 | )% | — |   | (3.69 | )% | (31.19 | )% | (63.13 | )% |
|                                                                      |   |                                           |     |   |   |   |   |   |   |   |   |   |   |   |   |
| Change on a Per Share Basis                                               |   | $                                              | (4.43    | ) | $ | (2.90 | ) | $ | (1.30 | ) | — |   | $ | (0.24 | ) | $ | (2.04 | ) | $ | (4.13 | ) |
|                                                                           |        |                                                |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

It is important to note that the impact ofchanging interest rates on fair value can change significantly when interestrates change beyond one hundred basis points from current levels.  Therefore, the volatility in fair value forthe Company could increase significantly when interest rates change beyond onehundred basis points.  In addition,there are other factors that impact the fair value of the Company’s interestrate sensitive investments and hedging instruments, such as the shape of theyield curve, market expectations as to future interest rate changes and othermarket conditions.  Accordingly, theremay be differences between the fair value changes shown above and actualchanges in fair value as interest rates change, and those differences may bematerial and adverse.

 

The Company has established an interest raterisk management policy that is intended to mitigate the negative impact ofchanging interest rates.  The Companygenerally intends to mitigate interest rate risk by targeting the differencebetween the market weighted average duration on its mortgage related assetsfunded with secured borrowings to the market weighted average duration of suchborrowings to plus or minus one year or less, taking into account all hedgingtransactions.  The Company generallydoes not intend to have any specific duration target for the portion of itsmortgage related assets that are not funded by secured borrowings.

 

There can be no assurance that the Companywill be able to limit such duration differences and there may be periods oftime when the duration difference will be greater than one year.

 

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**Equity Price Risk**

 

Another component of market risk for theCompany is equity price risk.  This isthe risk that the market value of the Company’s equity investments willdecrease.  The following table shows theimpact on the Company’s fair value as the price of its equity securitieschange, assuming price decreases of 10% and price increases of 10%.  Actual price decreases or increases may begreater or smaller.  (Dollars are inthousands except per share amounts.)

** **
|                                             |   | **Fair Value  for Scenario Shown** |   |
|--------------------------------------------------|--------|------------------------------------|--------|
|                                             |   | **Prices  Decrease  10%**          |   | **Unchanged** |   | **Prices  Increase  10%** |   |
|                                             |   |                               |   |   |   |   |   |
| Equity Investments                               |   | $                                  | 3,766  |   | $ | 4,184 |   | $ | 4,602 |   |
|                                             |   |                               |   |   |   |   |   |
| Change in Fair Value                             |   | (418                               | )      | — |   | 418 |   |
| 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                      |   | $                                  | (0.01  | ) | — |   | $ | 0.01 |   |
|                                                  |        |                                    |        |  |  |  |  |  |  |  |

 

Although there is no direct link betweenchanges in fair value and changes in earnings in many cases, a decline in fairvalue for the Company may translate into decreased earnings over the remaininglife of the investment portfolio.

 

If the fair market value of the Company’sportfolio were to decline significantly, the Company’s overall liquidity may beimpaired which could result in the Company being required to sell assets atlosses.

 

**TheCompany’s analysis of risks is based on management’s experience, estimates,models and assumptions.  These analysesrely on models of financial information which utilize estimates of fair valueand interest rate sensitivity.  Actualeconomic conditions or implementation of investment decisions by the Managermay produce results that differ significantly from the estimates andassumptions used in the Company’s models and the projected results shown in theabove tables and in this report.  Theseanalyses contain certain “forward-looking statements” and are subject to theSafe Harbor contained in the Private Securities Litigation Reform Act of 1995.**

 

 

# **ITEM 4**.  CONTROLSAND PROCEDURES

 

(a)          Evaluation of disclosure controls andprocedures.

 

Under the supervision and withthe participation of our management, including the Company’s Chief ExecutiveOfficer and Chief Financial Officer, we evaluated the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined inRule 13a-14(c) under the Exchange Act) as of a date (the “Evaluation Date”)within 90 days prior to the filing date of this quarter report on Form 10Q.Based upon that evaluation, the Chief Executive Officer and Chief FinancialOfficer concluded that, as of the Evaluation Date, our disclosure controls andprocedures are effective in timely alerting them to the material informationrelating to us required to be included in our periodic filings.

 

 

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(b)         Changes in disclosure controls andprocedures.

 

There were no significant changes made in our internal controls duringthe period covered by this report or, to our knowledge, in other factors thatcould significantly affect these internal controls subsequent to March 31,2003.

# ** **

# **PART II.**                OTHERINFORMATION

# ** **

# ** **

# **ITEM 1.**  LEGALPROCEEDINGS

 

None.

 

# **ITEM 2.**  CHANGESIN SECURITIES

 

None.

 

# **ITEM 3**.  DEFAULTSUPON SENIOR SECURITIES

 

Not applicable.

 

# **ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

# **ITEM 5.**  OTHERINFORMATION

 

None.

 

# **ITEM 6.**  EXHIBITSAND REPORTS ON FORM 8-K

 

*a)**            Exhibits*

 

The exhibits listed on the Exhibit List, which appears below followingthe signature page, are included or incorporated by reference in this QuarterlyReport.

 

*b)**            Reports on Form 8-K*

 

None.

 

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**SIGNATURES**

 

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

 

 
|                |   | Apex Mortgage Capital, Inc.              |
|---------------------|--------|------------------------------------------|
|                |   | (Registrant)                             |
|                |   |                                     |
|                |   |                                     |
| Dated: May 15, 2003 |   | /s/ Philip A. Barach                     |   |
|                |   | Philip A. Barach                         |
|                |   | President and Chief Executive Officer    |
|                |   | (Principal Executive Officer)            |
|                |   |                                     |
|                |   |                                     |
| Dated: May 15, 2003 |   | /s/ David S. DeVito                      |   |
|                |   | David S. DeVito  Chief Financial Officer |
|                |   | (Principal Accounting Officer)           |
|                     |        |                                          |  |  |

 

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#### **EXHIBIT INDEX**

 

Pursuant to Item 601 (a)(2) of Regulation S-K, this exhibit indeximmediately precedes the exhibits.

 

The following exhibits are part of this Quarterly Report on Form 10-Qand are numbered in accordance with Item 601 of Regulation S-K.

 
| **Exhibit  No.** |   | **Description**                                                 |   |
|-----------------------|--------|-----------------------------------------------------------------|--------|
|                  |   |                                                            |   |
| 99.1                  |   | Section 906 Certification (filed herewith) by Philip A. Barach. |   |
| 99.2                  |   | Section 906 Certification (filed herewith) by David S. DeVito.  |   |

 

 

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CERTIFICATIONS

 

I, Philip A. Barach, certify that:

 

1.              I have reviewedthis quarterly report on Form 10-Q of Apex Mortgage Capital, Inc.;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a)             designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)            evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)             presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of  the Evaluation Date;

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (and persons performing the equivalentfunction):

 

a)             all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)            any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetherthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date: May 15, 2003 | /s/ Philip A. Barach                     |   |
|--------------------|------------------------------------------|--------|
|               | Philip A. Barach                         |
|               | *President  and Chief Executive Officer* |

 

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I, David S. DeVito, certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of Apex Mortgage Capital, Inc.;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and have:

 

a)             designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)            evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)             presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of  the Evaluation Date;

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (and persons performing the equivalentfunction):

 

a)             all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)            any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetherthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date: May 15, 2003 | /s/ David S. DeVito                      |   |
|--------------------|------------------------------------------|--------|
|               | David S. DeVito                          |
|               | *Chief Financial Officer and Controller* |

 

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