##### ** **

##### **UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

##### **FORM 10-Q**

 

**ý           ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**                For the quarterly period ended:        SEPTEMBER 30, 2001**

 

#### **OR**

 

**o           ****TRANSITION REPORT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**                For thetransition period from _____ to _____**

 

 

**Commission File Number: 001-13637**

 

**APEX MORTGAGE CAPITAL, INC.**

(Exact name of Registrantas specified in its Charter)

** **

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

 

                                                Registrant’stelephone number, including area code **(213) 244-0440**

 

 

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

                Yesý    No o

 

**APPLICABLE ONLY TO CORPORATE ISSUERS:**

 

 

 

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

 

Common Stock ($0.01 par value)                                                                                      11,848,000 as ofNovember 9, 2001

 

### **APEXMORTGAGE CAPITAL, INC**.

# **FORM 10-Q**

 

**INDEX**

** **
|       |                                                                                        |                                                                                                       |   |
|------------|---------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------|--------|
| PART I.    | FINANCIAL INFORMATION                                                                       |                                                                                                       |   |
|       |                                                                                        |                                                                                                       |   |
| Item 1.    | Financial Statements                                                                        |                                                                                                       |   |
|       |                                                                                        |                                                                                                       |   |
|       |                                                                                        | Balance Sheets at september 30, 2001  (unaudited) and December 31, 2000                                    |   |
|       |                                                                                        |                                                                                                       |   |
|       |                                                                                        | Statements  of Operations for the nine months ended september 30, 2001 and september 30,  2000 (unaudited) |   |
|       |                                                                                        |                                                                                                       |   |
|       |                                                                                        | Statement of  Stockholders’ Equity for the  nine  months ended september 30, 2001 (unaudited)    |   |
|       |                                                                                        |                                                                                                       |   |
|       |                                                                                        | Statements  of Cash Flows for the nine months ended september 30, 2001 and september 30,  2000 (unaudited) |   |
|       |                                                                                        |                                                                                                       |   |
|       |                                                                                        | Notes to Financial  Statements (unaudited)                                                                 |   |
|       |                                                                                        |                                                                                                       |   |
| Item  2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                       |
|       |                                                                                        |                                                                                                       |   |
| Item  3.   | Quantitative  and Qualitative Disclosures About Market Risk                                 |                                                                                                       |
|       |                                                                                        |                                                                                                       |   |
|       |                                                                                        |                                                                                                       |   |
| PART  II.  | OTHER  INFORMATION                                                                          |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Item  1.   | Legal  Proceedings                                                                          |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Item 2.    | Changes in Securities                                                                       |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Item 3.    | Defaults Upon  Senior Securities                                                            |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                        |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Item  5.   | Other  Information                                                                          |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Item 6.    | Exhibits and  Reports on Form 8-K                                                           |                                                                                                       |
|       |                                                                                        |                                                                                                       |
|       |                                                                                        |                                                                                                       |
| Signatures |                                                                                        |
|            |                                                                                             |                                                                                                            |        |  |  |

**PART 1.                FINANCIAL INFORMATION**

 

**Item 1.                    Financial Statements**

 

**Apex Mortgage Capital, Inc.**

 

**Balance Sheets**

**(Unaudited)**

 

|                                                                                                                         |   | **September  30, 2001** |        | **December  31, 2000** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|-------------|------------------------|--------|
| **Assets**                                                                                                                   |   |                    |        |                   |   |
| Cash and cash equivalents                                                                                                    |   | $                       | 1,844,000   |                   | $      | 140,000 |   |
| Fixed income trading  securities, at fair value (Note 3)                                                                     |   | 515,942,000             |        | -                      |   |
| Fixed income securities  available-for-sale, at fair value (Note 3)                                                          |   | 5,722,000               |        | 600,131,000            |   |
| Equity securities  available-for-sale, at fair value (Note 3)                                                                |   | 11,954,000              |        | 9,068,000              |   |
| Accrued interest  receivable                                                                                                 |   | 3,294,000               |        | 3,734,000              |   |
| Principal payments  receivable                                                                                               |   | 127,000                 |        | 288,000                |   |
| Other assets                                                                                                                 |   | 583,000                 |        | 712,000                |   |
|                                                                                                                         |   |                    |        |                   |   |
|                                                                                                                         |   | $                       | 539,466,000 |                   | $      | 614,073,000 |   |
|                                                                                                                         |   |                    |        |                   |   |
| **Liabilities  and Stockholders' Equity**                                                                                    |   |                    |        |                   |   |
|                                                                                                                         |   |                    |        |                   |   |
| Liabilities                                                                                                                  |   |                    |        |                   |   |
|                                                                                                                         |   |                    |        |                   |   |
| Reverse repurchase  agreements (Note 4)                                                                                      |   | $                       | 479,790,000 |                   | $      | 545,434,000 |   |
| Payable for unsettled  securities                                                                                            |   | 354,000                 |        | 14,514,000             |   |
| Accrued interest  payable                                                                                                    |   | 499,000                 |        | 569,000                |   |
| Dividend payable                                                                                                             |   | 2,369,000               |        | 2,073,000              |   |
| Unrealized loss on  forward contracts, at fair value (Note 10)                                                               |   | 987,000                 |        | 3,731,000              |   |
| Deferred gain on  interest rate swap contracts                                                                               |   | -                       |        | 2,546,000              |   |
| Accrued expenses and  other liabilities                                                                                      |   | 3,017,000               |        | 823,000                |   |
|                                                                                                                         |   |                    |        |                   |   |
|                                                                                                                         |   | 487,016,000             |        | 569,690,000            |   |
|                                                                                                                         |   |                    |        |                   |   |
| Commitments and  contingencies (Notes 3, 4, 9, and 10)                                                                       |   |                    |        |                   |   |
|                                                                                                                         |   |                    |        |                   |   |
| Stockholders' Equity                                                                                                         |   |                    |        |                   |   |
|                                                                                                                         |   |                    |        |                   |   |
| Preferred stock, par  value $0.01 per share; 50,000,000 shares authorized;no shares  outstanding                             |   |                    |        |                   |   |
| Common stock, par value  $0.01 per share; 100,000,000 shares  authorized;  5,753,000 shares outstanding (Notes 6 and 8) |   | 58,000                  |        | 58,000                 |   |
| Additional  paid-in-capital                                                                                                  |   | 82,831,000              |        | 82,800,000             |   |
| Accumulated other  comprehensive income (loss)                                                                               |   | 4,559,000               |        | (1,079,000             | )      |
| Accumulated deficit                                                                                                          |   | (34,998,000             | )           | (37,396,000            | )      |
|                                                                                                                         |   |                    |        |                   |   |
|                                                                                                                         |   | 52,450,000              |        | 44,383,000             |   |
|                                                                                                                         |   | $                       | 539,466,000 |                   | $      | 614,073,000 |   |

 

 

See accompanying notes to financial statements

 

**Apex Mortgage Capital, Inc.**

 

**Statements of Operations**

 

**(Unaudited)**

 

 

|                                                                                      |   | **Three  Months  Ended  September 30, 2001** |          | **Three Months  Ended  September 30, 2000** |          | **Nine Months  Ended  September 30, 2001** |          | **Nine Months  Ended  September 30, 2000** | ** **    |
|-------------------------------------------------------------------------------------------|--------|----------------------------------------------|---------------|---------------------------------------------|---------------|--------------------------------------------|---------------|--------------------------------------------|---------------|
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Interest Income:**                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Fixed  income securities                                                                  |   | $                                            | 9,809,000     |                                        | $             | 9,559,000                                  |          | $                                          | 30,517,000    |   | $ | 32,427,000 |   |
| Cash  and cash equivalents                                                                |   | 24,000                                       |          | 21,000                                      |          | 95,000                                     |          | 183,000                                    |          |
|                                                                                      |   | 9,833,000                                    |          | 9,580,000                                   |          | 30,612,000                                 |          | 32,610,000                                 |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Interest Expense**                                                                      |   | 4,201,000                                    |          | 7,600,000                                   |          | 16,260,000                                 |          | 25,878,000                                 |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Net Interest Income**                                                                   |   | 5,632,000                                    |          | 1,980,000                                   |          | 14,352,000                                 |          | 6,732,000                                  |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Dividend Income**                                                                       |   | 162,000                                      |          | 185,000                                     |          | 656,000                                    |          | 909,000                                    |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Total Operating Income**                                                                |   | 5,794,000                                    |          | 2,165,000                                   |          | 15,008,000                                 |          | 7,641,000                                  |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **General and Administrative Expenses:**                                                  |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Management  fee (Note 7)                                                                  |   | 88,000                                       |          | 124,000                                     |          | 260,000                                    |          | 427,000                                    |          |
| Other                                                                                     |   | 279,000                                      |          | 556,000                                     |          | 676,000                                    |          | 1,017,000                                  |          |
|                                                                                      |   | 367,000                                      |          | 680,000                                     |          | 936,000                                    |          | 1,444,000                                  |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Operating Income, net of General and Administrative  Expenses**                         |   | 5,427,000                                    |          | 1,485,000                                   |          | 14,072,000                                 |          | 6,197,000                                  |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Net Gain  (Loss) from Investment Activities**                                           |   | 2,409,000                                    |          | (29,912,000                                 | )             | (4,431,000                                 | )             | (37,444,000                                | )             |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Reclassification of Previously Unrealized Gains (Note 2)**                              |   | -                                            |          | -                                           |          | 1,742,000                                  |          | -                                          |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Net Income (Loss) Before Cumulative Effect of****Change in Accounting Principle**       |   | 7,836,000                                    |          | (28,427,000                                 | )             | 11,383,000                                 |          | (31,247,000                                | )             |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Cumulative Effect of Change in Accounting Principle**                                   |   | -                                            |          | -                                           |          | (2,173,000                                 | )             | -                                          |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| **Net Income (Loss)**                                                                     |   | $                                            | 7,836,000     |                                        | $             | (28,427,000                                | )             | $                                          | 9,210,000     |   | $ | (31,247,000 | ) |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Net  Income (Loss) Per Share Before Cumulative Effect of Change in Accounting  Principle: |   |                                         |     |                                        |     |                                       |     |                                       |     |
| Basic                                                                                     |   | $                                            | 1.36          |                                        | $             | (4.94                                      | )             | $                                          | 1.98          |   | $ | (5.43 | ) |
| Diluted                                                                                   |   | $                                            | 1.34          |                                        | $             | (4.94                                      | )             | $                                          | 1.95          |   | $ | (5.43 | ) |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Effect  of Accounting Change Per Share:                                                   |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Basic                                                                                     |   | $                                            | -             |                                        | $             | -                                          |          | $                                          | (0.38         | ) | $ | - |   |
| Diluted                                                                                   |   | $                                            | -             |                                        | $             | -                                          |          | $                                          | (0.37         | ) | $ | - |   |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Net  Income (Loss) Per Share:                                                             |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Basic                                                                                     |   | $                                            | 1.36          |                                        | $             | (4.94                                      | )             | $                                          | 1.60          |   | $ | (5.43 | ) |
| Diluted                                                                                   |   | $                                            | 1.34          |                                        | $             | (4.94                                      | )             | $                                          | 1.58          |   | $ | (5.43 | ) |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Weighted  Average Number of Shares Outstanding:                                           |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Basic                                                                                     |   | 5,753,000                                    |          | 5,753,000                                   |          | 5,753,000                                  |          | 5,753,000                                  |          |
| Diluted                                                                                   |   | 5,846,000                                    |          | 5,753,000                                   |          | 5,846,000                                  |          | 5,753,000                                  |          |
|                                                                                      |   |                                         |          |                                        |          |                                       |          |                                       |          |
| Dividends  Declared Per Share                                                             |   | $                                            | 0.40          |                                        | $             | 0.35                                       |          | $                                          | 1.15          |   | $ | 1.16 |   |

 

 

See accompanying notes to financial statements

**Apex Mortgage Capital, Inc.**

 

**Statementof Stockholders' Equity**

 

**(Unaudited)**

 

 

|                                                                                                          |   |      |   |   |   | **Common Stock** |   | **Additional  Paid-in  Capital** |   | **Accumulated  OtherComprehensive  Income (Loss)** |       | **Accumulated  Dividend  Distribution  in Excess of  Net Income** |          | **Comprehensive  Income / (Loss)** |          | **Total** |   |
|---------------------------------------------------------------------------------------------------------------|--------|-----------|--------|--------|--------|------------------|--------|----------------------------------|--------|----------------------------------------------------|------------|-------------------------------------------------------------------|---------------|------------------------------------|---------------|-----------|--------|
|                                                                                                          |   |      |   |   |   | **Shares**       |   | **Amount**                       |   |                                               |       |                                                              |          |                               |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Balance, December 31, 2000                                                                                    |   | 5,753,000 |   | $      | 58,000 |             | $      | 82,800,000                       |   | $                                                  | (1,079,000 | )                                                                 | $             | (37,396,000                        | )             |      |   | $ | 44,383,000 |   |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Issuance  of stock options to non-employees (Note 8)                                                     |   |      |   |   |   | 1,000            |   |                             |   |                                               |       |                                                              |          | 1,000                              |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Net income                                                                                                    |   |      |   |   |   |             |   |                             |   | 974,000                                            |       | $                                                                 | 974,000       |                               | 974,000       |      |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Other comprehensive income:                                                                              |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |
| Cumulative effect of change  in accounting principle (Note 2)                                                 |   |      |   |   |   |             |   | 2,173,000                        |   |                                               |       | 2,173,000                                                         |          | 2,173,000                          |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Reclassification of  previously unrealized gains                                                         |   |      |   |   |   |             |   | (1,742,000                       | )      |                                               |       | (1,742,000                                                        | )             | (1,742,000                         | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Change in unrealized gain  on available-for-sale securities                                              |   |      |   |   |   |             |   | 2,450,000                        |   |                                               |       | 2,450,000                                                         |     | 2,450,000                          |     |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Cumulative effect of change  in accounting principle - reclassification of deferred gain on terminated  swaps |   |      |   |   |   |             |   | 2,546,000                        |   |                                               |       | 2,546,000                                                         |          | 2,546,000                          |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Amortization of deferred  gain on terminated swaps                                                       |   |      |   |   |   |             |   | (1,152,000                       | )      |                                               |       | (1,152,000                                                        | )             | (1,152,000                         | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Comprehensive income                                                                                     |   |      |   |   |   |             |   |                             |   |                                               |       | $                                                                 | 5,249,000     |                               |          |      |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Dividends declared                                                                                            |   |      |   |   |   |             |   |                             |   | (2,073,000                                         | )          |                                                              |          | (2,073,000                         | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Balance, March 31, 2001                                                                                       |   | 5,753,000 |   | 58,000 |   | 82,801,000       |   | 3,196,000                        |   | (38,495,000                                        | )          |                                                              |          | 47,560,000                         |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Issuance  of stock options to non-employees (Note 8)                                                     |   |      |   |   |   | 1,000            |   |                             |   |                                               |       |                                                              |          | 1,000                              |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Net income                                                                                                    |   |      |   |   |   |             |   |                             |   | 400,000                                            |       | $                                                                 | 400,000       |                               | 400,000       |      |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Other comprehensive  income:                                                                             |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |
| Change in unrealized gain  on available-for-sale securities                                              |   |      |   |   |   |             |   | 367,000                          |   |                                               |       | 367,000                                                           |          | 367,000                            |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Amortization of deferred  gain on terminated swaps                                                       |   |      |   |   |   |             |   | (946,000                         | )      |                                               |       | (946,000                                                          | )             | (946,000                           | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Comprehensive loss                                                                                       |   |      |   |   |   |             |   |                             |   |                                               |       | $                                                                 | (179,000      | )                                  |          |      |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |
| Dividends declared                                                                                            |   |      |   |   |   |             |   |                             |   | (2,370,000                                         | )          |                                                              |          | (2,370,000                         | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Balance, June 30, 2001                                                                                        |   | 5,753,000 |   | 58,000 |   | 82,802,000       |   | 2,617,000                        |   | (40,465,000                                        | )          |                                                              |          | 45,012,000                         |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Issuance  of stock options to non-employees (Note 8)                                                          |   |      |   |   |   | 1,000            |   |                             |   |                                               |       |                                                              |          | 1,000                              |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Additional paid-in-capital                                                                                    |   |      |   |   |   | 28,000           |   |                             |   |                                               |       |                                                              |          | 28,000                             |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Net income                                                                                                    |   |      |   |   |   |             |   |                             |   | 7,836,000                                          |       | $                                                                 | 7,836,000     |                               | 7,836,000     |      |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Other comprehensive income:                                                                                   |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |
| Change in unrealized gain  on available-for-sale securities                                                   |   |      |   |   |   |             |   | 2,087,000                        |   |                                               |       | 2,087,000                                                         |          | 2,087,000                          |          |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Amortization of deferred  gain on terminated swaps                                                            |   |      |   |   |   |             |   | (145,000                         | )      |                                               |       | (145,000                                                          | )             | (145,000                           | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Comprehensive income                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       | $                                                                 | 9,778,000     |                               |          |      |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Dividends declared                                                                                            |   |      |   |   |   |             |   |                             |   | (2,369,000                                         | )          |                                                              |          | (2,369,000                         | )             |
|                                                                                                          |   |      |   |   |   |             |   |                             |   |                                               |       |                                                              |          |                               |          |      |   |   |   |
| Balance, September 30, 2001                                                                                   |   | 5,753,000 |   | $      | 58,000 |             | $      | 82,831,000                       |   | $                                                  | 4,559,000  |                                                              | $             | (34,998,000                        | )             |      |   | $ | 52,450,000 |   |

 

See accompanying notes tofinancial statments.

**Apex Mortgage Capital, Inc.**

 

**Statements of Cash Flows**

 

**(Unaudited)**

 

 
|                                                                               |   | **Three  Months  Ended  September 30, 2001** |      | **Three  Months  Ended  September 30, 2000** |   | **Nine  Months  Ended  September 30, 2001** |   | **Nine  Months  Ended  September 30, 2000** |        |
|------------------------------------------------------------------------------------|--------|----------------------------------------------|-----------|----------------------------------------------|--------|---------------------------------------------|--------|---------------------------------------------|-------------|
| **Operating  Activities:**                                                         |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Net income (loss)                                                                  |   | $                                            | 7,836,000 |                                         | $      | (28,427,000                                 | )      | $                                           | 9,210,000   |   | $ | (31,247,000 | ) |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Accretion of discount                                                              |   | (786,000                                     | )         | (849,000                                     | )      | (3,730,000                                  | )      | (1,280,000                                  | )           |
| Net (gain) loss on  investing activities                                           |   | (2,409,000                                   | )         | 29,912,000                                   |   | 4,431,000                                   |   | 37,444,000                                  |        |
| Cumulative effect of  change in accounting principle                               |   | -                                            |      | -                                            |   | 2,173,000                                   |   | -                                           |        |
| Reclassification of  previously unrealized gains                                   |   | -                                            |      | -                                            |   | (1,742,000                                  | )      | -                                           |        |
| Change in assets and  liabilities                                                  |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Trading securities                                                                 |   | 16,279,000                                   |      | -                                            |   | 59,088,000                                  |   | -                                           |        |
| Accrued interest  receivable                                                       |   | 115,000                                      |      | 110,000                                      |   | 440,000                                     |   | 2,689,000                                   |        |
| Other assets                                                                       |   | 110,000                                      |      | 224,000                                      |   | 129,000                                     |   | 696,000                                     |        |
| Accrued interest  payable                                                          |   | (73,000                                      | )         | 130,000                                      |   | (70,000                                     | )      | (2,768,000                                  | )           |
| Accrued expenses and  other liabilities                                            |   | 2,647,000                                    |      | 61,000                                       |   | 2,194,000                                   |   | (307,000                                    | )           |
| Net cash provided by  operating activities                                         |   | 23,719,000                                   |      | 1,161,000                                    |   | 72,123,000                                  |   | 5,227,000                                   |        |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Investing  Activities:**                                                         |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Payments on closed  forward contracts                                              |   | -                                            |      | (6,645,000                                   | )      | -                                           |   | (13,107,000                                 | )           |
| Proceeds from sales of  equity securities available-for-sale                       |   | -                                            |      | 1,393,000                                    |   | 1,712,000                                   |   | 6,481,000                                   |        |
| Proceeds from sales of  fixed income securities available-for-sale                 |   | -                                            |      | -                                            |   | -                                           |   | 96,513,000                                  |        |
| Proceeds from closed  forward contracts                                            |   | -                                            |      | 39,000                                       |   | -                                           |   | 5,930,000                                   |        |
| Proceeds from  terminating interest rate swaps                                     |   | -                                            |      | -                                            |   | -                                           |   | 5,554,000                                   |        |
| Principal payments on  fixed income securities available-for-sale                  |   | -                                            |      | 17,448,000                                   |   | -                                           |   | 58,524,000                                  |        |
| Net cash provided by  investing activities                                         |   | -                                            |      | 12,235,000                                   |   | 1,712,000                                   |   | 159,895,000                                 |        |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Financing  Activities:**                                                         |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Net (repayments) on  reverse repurchase agreements                                 |   | (21,814,000                                  | )         | (14,656,000                                  | )      | (65,644,000                                 | )      | (160,125,000                                | )           |
| Dividend distributions                                                             |   | (2,446,000                                   | )         | (2,035,000                                   | )      | (6,515,000                                  | )      | (7,483,000                                  | )           |
| Additional Paid In  Capital                                                        |   | 28,000                                       |      | -                                            |   | 28,000                                      |   | -                                           |        |
| Net cash used in  financing activities                                             |   | (24,232,000                                  | )         | (16,691,000                                  | )      | (72,131,000                                 | )      | (167,608,000                                | )           |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Net  (Decrease) Increase in Cash and Cash Equivalents**                          |   | (513,000                                     | )         | (3,295,000                                   | )      | 1,704,000                                   |   | (2,486,000                                  | )           |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Cash  and Cash Equivalents at Beginning of Period**                              |   | 2,357,000                                    |      | 3,414,000                                    |   | 140,000                                     |   | 2,605,000                                   |        |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Cash  and Cash Equivalents at End of Period**                                    |   | $                                            | 1,844,000 |                                         | $      | 119,000                                     |   | $                                           | 1,844,000   |   | $ | 119,000 |   |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Supplemental  Disclosure of Cash Flow Information:**                             |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Cash paid for interest                                                             |   | $                                            | 4,418,337 |                                         | $      | 8,661,000                                   |   | $                                           | 18,577,337  |   | $ | 30,348,000 |   |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| **Noncash  Investing and Financing Activities:**                                   |   |                                         |      |                                         |   |                                        |   |                                        |        |
|                                                                               |   |                                         |      |                                         |   |                                        |   |                                        |        |
| Change in accumulated  other comprehensive income                                  |   | $                                            | 1,942,000 |                                         | $      | 30,571,000                                  |   | $                                           | 5,638,000   |   | $ | 30,435,000 |   |
| Change in principal  payments, not yet received                                    |   | $                                            | (127,000  | )                                            | $      | -                                           |   | $                                           | 161,000     |   | $ | 3,537,000 |   |
| Change in securities  purchased, not yet settled                                   |   | $                                            | 354,000   |                                         | $      | -                                           |   | $                                           | (14,160,000 | ) | $ | - |   |
| Change in dividends  declared, not yet paid                                        |   | $                                            | (77,000   | )                                            | $      | (2,111,000                                  | )      | $                                           | 296,000     |   | $ | (2,724,000 | ) |

 

 

See accompanying notes to financial statements

**ApexMortgage Capital, Inc.**

**Notes to Financial Statements**

# ** **

# **Note 1 - The Company**

 

Apex Mortgage Capital,Inc. (the “Company”) was incorporated in Maryland on September 15, 1997.  The Company commenced its operations ofacquiring and managing a portfolio of mortgage assets on December 9, 1997, uponreceipt of the net proceeds from the initial public offering of the Company’scommon stock.  The Company uses itsequity capital and borrowed funds to seek to generate income based on the differencebetween the yield on its investments and the cost of its borrowings.  The Company is structured for tax purposesas a real estate investment trust (“REIT”) under the Internal Revenue Code of1986, as amended (the “Code”).

 

# **Note 2 - Summary of Significant Accounting Policies**

## *Basis of Presentation*

The accompanyingfinancial statements of Apex Mortgage Capital, Inc. have been prepared inaccordance with the instructions to Form 10-Q. In the opinion of management, all adjustments (consisting of normalrecurring adjustments) considered necessary for a fair presentation have beenincluded.  These statements should beread in conjunction with the consolidated financial statements and notesthereto included in our 2000 Annual Report on Form 10-K filed with theSecurities and Exchange Commission.  Interimresults are not necessarily indicative of results for a full year.

 

Certain balances shown inprior period Balance Sheets and Statements of Operations have been reclassifiedto conform to the current period presentation for comparative purposes.

## *Cash and CashEquivalents*

Cash and cash equivalentsinclude cash and highly liquid investments with original maturities of threemonths or less.  The carrying amount ofcash equivalents approximates their fair value.

## *Fixed Income Securities*

The Company’s fixedincome securities consist primarily of residential mortgage securities andother fixed income securities.  Allfixed income securities are recorded at cost on the date the assets arepurchased.  Realized gains and losses onsales of the securities are determined on an average cost basis.  A majority of the Company's fixed incomesecurities are expected to qualify as real estate assets under the REITProvisions of the Code.

 

Interest income on theCompany’s mortgage securities is accrued based on the actual coupon rate andthe outstanding principal amount. Premiums and discounts are amortized into interest income over the livesof the securities using the effective yield method adjusted for the effects ofestimated prepayments.  When securitiesare deemed to be impaired, an impairment reserve is recorded.  Such reserve is accounted for as anadjustment to the cost of the securities and is accreted into income on thesame basis as the original discount.

 

Interest income on theCompany’s other fixed income securities is accrued using the effective interestmethod applied prospectively based on current market assumptions.

 

Beginning on January 1,2001, the Company's policy is to generally classify its fixed income securitiesthat are subject to a hedging strategy and are generally expected to experiencea higher level of turnover as trading securities.  These fixed income securities are reported at fair value withunrealized gains and losses included in earnings each reporting period.  Fixed income securities that are generallynot subject to hedging and are expected to experience a lower level of turnoverare classified as available-for-sale. These fixed income securities are reported at fair value with unrealizedgains and losses excluded from earnings and reported in accumulated othercomprehensive income.

## *Equity Securities*

The Company’s equitysecurities consist primarily of equity securities issued by other real estateinvestment trusts.

 

Dividend income on equitysecurities is recorded on the declaration date.  Realized gains and losses on sales of the securities aredetermined on an average cost basis.  Amajority of the Company's equity securities are expected to qualify as realestate assets under the REIT Provisions of the Code.

 

The Company’s policy is togenerally classify its equity securities as available-for-sale.  Equity securities are reported at fair valuewith unrealized gains and losses excluded from earnings and reported inaccumulated other comprehensive income.

 

## *Interest Rate Hedging Transactions*

The Company may enterinto interest rate swap and interest rate cap agreements in order to mitigatethe impact of rising interest rates on the cost of its short-termborrowings.  The Company may also enterinto forward contracts to sell U.S. Treasury notes in order to mitigate thenegative impact of rising interest rates on the fair value of certain fixedincome securities.  Prior to December31, 2000, unrealized gains and losses on open forwards were shown as assets andliabilities, respectively, and as accumulated other comprehensive income in thebalance sheets.  Realized gains andlosses on terminated forwards were recorded as deferred gains and losses,included in accumulated other comprehensive income in the balance sheets andwere amortized over the remaining lives of the fixed income securities beinghedged as an adjustment to income in the statements of operations.  Beginning on January 1, 2001, all realizedand unrealized gains and losses on forward contracts are recognized in netgains and losses from trading activities in the statement of operations.

## *Stock Based Compensation*

The Company grants stockoptions to its directors and officers and to certain directors, officers andemployees of its investment manager and the investment manager itself, asdiscussed in Note 8.  Options granted todirectors of the Company are accounted for using the intrinsic value method,and generally no compensation expense is recognized in the statements ofoperations for such options.  Otheroptions are accounted for using the fair value method; such options aremeasured at their fair value when they are granted and are recognized as ageneral and administrative expense during the periods when the options vest andthe related services are performed.

## *Federal and State Income Taxes*

The Company has electedto be taxed as a REIT and generally is not subject to federal and state taxeson its income to the extent it distributes annually 90% of its predistributiontaxable income to stockholders and meets certain other asset, income and stockownership tests.  As such, no accrualfor income taxes has been included in the financial statements.

## *Net Income Per Share*

Basic net income pershare is calculated on the basis of the weighted average number of commonshares outstanding during each period. Diluted net income per share includes the additional dilutive effect ofcommon stock equivalents and outstanding stock options, and is calculated usingthe treasury stock method.

 

570,000 stock optionsthat could potentially dilute net income per share in the future were notincluded in the computation of diluted net income per share in 2000 becausethey would have been antidilutive for the period presented.

## * IncomeRecognition*

Income and expenses arerecorded on the accrual basis of accounting.

## *Credit Risk*

The Company has limitedits exposure to credit losses on its portfolio of fixed income securities bypurchasing securities that are either rated “AAA” by at least one nationallyrecognized rating agency or are issued by the Federal Home Loan MortgageCorporation (“FHLMC”), Fannie Mae (formerly known as the Federal NationalMortgage Corporation) or the Government National Mortgage Association(“GNMA”).  The payment of principal andinterest on the FHLMC, Fannie Mae and GNMA securities are guaranteed by thoserespective agencies.  In addition, theCompany has the ability to purchase up to 10% of the portfolio in belowinvestment grade securities.

## *Use of Estimates*

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from those estimates.

 

*Recently Issued Accounting Standards*

 

The Company adopted SFASNo. 133 and the related amendments on January 1, 2001.  This adoption resulted in a transitionadjustment that reclassified $2,173,000 of net losses on unrealized anddeferred gains and losses on investment securities and forward contracts fromaccumulated other comprehensive income to current income.  Also, deferred gains on interest rate swapspreviously designated as hedges were reclassified from other liabilities toaccumulated other comprehensive income.

 

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

 

In 2001, the Companyadopted the provisions of SFAS No. 140, "Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities."  This statement revises the standards foraccounting for securitizations and other transfers of financial assets andcollateral and requires certain disclosures, but otherwise carries over most ofthe provisions of SFAS No. 125 without reconsideration.  The adoption of SFAS No. 140 had no immediateeffect on the results of operations, financial position or cash flows of theCompany.  The future effect, if any,will depend on whether the Company enters into any securitization transactionsor other financial transactions to which SFAS No. 140 provisions may apply.

 

 

**Note 3 – Fixed Income and EquitySecurities**

 

At September 30, 2001, fixed income and equity securitiesconsisted of the following:

 
| **(in thousands)**             |   | **Fixed  Income  Trading Securities** |    | **Fixed  Income Securities  Available-For-Sale** |   | **Equity  Securities  Available-For-Sale** |   |
|--------------------------------|--------|---------------------------------------|---------|--------------------------------------------------|--------|--------------------------------------------|--------|
| Principal Amount               |   | $                                     | 505,106 |                                             | $      | 10,400                                     |   | $ | 7,042 |   |
| Unamortized Premium (Discount) |   | (9,829                                | )       | (4,022                                           | )      | -                                          |   |
| Adjusted Cost                  |   | 495,277                               |    | 6,378                                            |   | 7,042                                      |   |
| Unrealized Gains               |   | 20,666                                |    | -                                                |   | 5,808                                      |   |
| Unrealized Losses              |   | (1                                    | )       | (656                                             | )      | (896                                       | )      |
| Fair Value                     |   | $                                     | 515,942 |                                             | $      | 5,722                                      |   | $ | 11,954 |   |

 

AtDecember 31, 2000, fixed income and equity securities available-for-saleconsisted of the following:

 
| **(in thousands)**             |   | **Adjustable Rate Mortgage Securities** |   | **Fixed Rate Mortgage Securities** |   | **Other Fixed Income Securities** |   | **Equity Securities** |   |
|--------------------------------|--------|-----------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|-----------------------|--------|
| Principal Amount               |   | $                                       | 39,253 |                               | $      | 557,962                           |   | $                     | 10,400 |   | $ | 8,690 |   |
| Unamortized Premium (Discount) |   | 978                                     |   | (15,529                            | )      | (3,712                            | )      | -                     |   |
| Adjusted Cost                  |   | 40,231                                  |   | 542,433                            |   | 6,688                             |   | 8,690                 |   |
| Unrealized Gains               |   | 46                                      |   | 11,783                             |   | -                                 |   | 1,091                 |   |
| Unrealized Losses              |   | (24                                     | )      | -                                  |   | (1,026                            | )      | (713                  | )      |
| Fair Value                     |   | $                                       | 40,253 |                               | $      | 554,216                           |   | $                     | 5,662  |   | $ | 9,068 |   |

 

A portion of the otherfixed income securities held as available-for-sale generally have an originalmaturity of five years subject to certain acceleration provisions.  The expected average remaining maturity atSeptember 30, 2001 and December 31, 2000 was approximately 1.2 and 2.0 years,respectively.  The remaining portion ofthis category has a fixed remaining maturity of approximately 0.8 years as ofSeptember 30, 2001.

 

During the quarter endedSeptember 30, 2001, the Company reported a net gain on investment transactionsof $2,409,000 which is included in the Statement of Operations.  This gain consisted of $2,107,000 in gainson the sale of $130,456,000 of fixed income trading securities, $11,566,000gain from the net increase in fair market value of fixed income tradingsecurities, and $11,264,000 in net losses on closed forward contracts.  For the quarter ended September 30, 2000,the Company reported a net loss on investment transactions of $29,912,000.  The loss consisted of an impairment chargeon certain fixed-rate mortgage securities that may be sold prior to maturity of$21,652,000, the recognition of the associated unrealized loss and deferredhedging losses on the impaired assets of $8,425,000, and $165,000 of net gainson the sale of $1,393,000 equity securities that were classified asavailable-for-sale.

 

 

At September 30, 2001,the Company held equity securities and senior unsecured notes issued by DynexCapital, Inc. (“Dynex”) with fair market values of $5,774,000 and $4,500,000,respectively.  During the year endedDecember 31, 1999, Dynex suspended the payment of dividends on its preferredstock.  Accordingly, the Company is nolonger recognizing dividend income on its equity investments in Dynex.  Dynex is currently paying interest on itssenior notes.  Accordingly, the Companyis recognizing interest income on the senior note investments issued byDynex.  If Dynex were to suspend paymentof interest on its senior notes, interest income recognized by the Companywould be negatively impacted.

 

# ** **

# **Note 4 - ReverseRepurchase Agreements**

 

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

 

At September 30, 2001,the Company had outstanding $479,790,000 of reverse repurchase agreements witha weighted average current borrowing rate of 2.99% and a maturity of 1.0month.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$500,783,000.

 

At December 31, 2000, theCompany had outstanding $545,434,000 of reverse repurchase agreements with aweighted average current borrowing rate of 6.61% and a maturity of 1.1months.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$564,274,000.

 

For the quarter endedSeptember 30, 2001, the average reverse repurchase agreement balance was$491,563,000 with a weighted average interest cost of 3.46%.

 

For the year endedDecember 31, 2000, the average reverse repurchase agreement balance was$576,190,000 with a weighted average interest cost of 6.33%.

 

 

 

 

**Note 5 - Fair Value of FinancialInstruments**

** **

The following tablepresents the amortized cost and estimated fair values of the Company’sfinancial instruments.  SFAS No. 107,“Disclosures About Fair Value of Financial Instruments,” defines the fair valueof a financial instrument as the amount at which the instrument could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale (dollars in thousands):

 
|                                                                         |   | **At September 30, 2001** |       | **At December 31, 2000** |       |
|------------------------------------------------------------------------------|--------|---------------------------|------------|--------------------------|------------|
|                                                                         |   |                      |       |                     |       |   |   |   |   |
|                                                                         |   | **Adjusted  Cost**        | ** ** | **Fair Value**           | ** ** | **Adjusted Cost** | ** ** | **Fair Value** |   |
|                                                                         |   |                      |       |                     |       |   |   |   |   |
| Trading securities                                                           |   | $                         | 495,277    |                     | $          | 515,942 |   | - |   | - |   |
| Available-for-sale securities:Mortgage  related securitiesavailable-for-sale |   | -                         |       | -                        |       | $ | 582,664 |   | $ | 594,469 |   |
| Equity securities                                                            |   | 7,042                     |       | 11,954                   |       | 8,690 |   | 9,068 |   |
| Other fixed incomesecurities                                                 |   | 6,378                     |       | 5,722                    |       | 6,688 |   | 5,662 |   |
| Forward contracts                                                            |   | -                         |       | (987                     | )          | - |   | (3,731 | ) |
|                                                                              |        |                           |            |                          |            |  |  |  |  |  |  |  |  |

 

The Company bases itsfair value estimates for mortgage-related securities, equity securities, otherfixed income securities, and forward contracts primarily on third party priceindications provided by dealers who make markets in these financial instrumentswhen such indications are available. However, the fair value reported reflects estimates and may notnecessarily be indicative of the amounts the Company could realize in a currentmarket exchange.  Cash and cashequivalents, interest receivable and reverse repurchase agreements arereflected in the financial statements at their costs, which approximates theirfair values because of the short-term nature of these instruments.

 

 

# **Note 6 – Stock Repurchase Program**

 

The Company’s Board ofDirectors has authorized a program to repurchase shares of the Company’s commonstock. At September 30, 2001 and December 31, 2000, the Company was authorizedto repurchase an additional 552,900 shares of the Company’s common stockpursuant to the repurchase program.

 

 

# **Note 7 - Transactions with Affiliates**

 

The Company has enteredinto a Management Agreement (the “Management Agreement”), as amended, with TCWInvestment Management Company (the “Manager”), a wholly owned subsidiary of TheTCW Group, Inc., under which the Manager will manage its day-to-day operations,subject to the direction and oversight of the Company’s Board ofDirectors.  The Company will pay theManager annual base management compensation, payable monthly in arrears, equalto 3/4 of 1% of the average net invested capital as further defined in theManagement Agreement.

 

The Company recordedexpenses of $88,000 and $124,000 in base management compensation to the Managerduring the quarters ended September 30, 2001 and 2000, respectively.

 

The accrued liability forbase management compensation was $144,000 and $85,000 at September 30, 2001 andDecember 31, 2000, respectively.

 

The Company also pays theManager, as incentive compensation, an amount equal to 30% of the Net Income ofthe Company, as defined in the Management Agreement, before incentivecompensation, in excess of the amount that would produce an annualized returnon equity equal to the ten-year US Treasury rate plus 1%, as further defined inthe Management Agreement.

 

The Company may alsogrant stock options to directors, officers and key employees of the Company, theManager, its directors, officers and key employees (see Note 8).

 

The Management Agreementmay be renewed each year at the discretion of the Company’s Board of Directors,unless previously terminated by the Company or the Manager upon written notice.Except in the case of a termination or non-renewal by the Company for cause,upon termination or non-renewal of the Management Agreement by the Company, theCompany is obligated to pay the Manager a termination or non-renewal fee, whichmay be significant. The termination or non-renewal fee shall be equal to thefair market value of the Management Agreement without regard to the Company'stermination right, as determined by an independent appraisal.  Neither the fair market value of theManagement Agreement nor the various factors that an appraiser may findrelevant in its determination of the fair market value can be determined atthis time.  The fair market value of theManagement Agreement will be affected by significant variables, including (i)the historical management fees paid to the Manager, (ii) any projections offuture management fees to be paid to the Manager determined by the independentappraiser, (iii) the relative valuations of agreements similar to theManagement Agreement and (iv) other factors, all of which may be unrelated tothe performance of the Manager.  Similarmanagement agreements have been valued at as much as eight times the historicalannual fees paid under such agreements. Any termination or non-renewal fee paid may be materially greater thaneight times historical fees and the Company can provide no assurance at thistime as to the amount of any such fee.

 

The Company’s other fixedincome investments held as available-for-sale include securities that areissued by special purpose companies that invest primarily in mortgage-relatedassets.  The Manager serves as theinvestment manager to these companies and is paid fees in connection with suchservices.  The Company does notanticipate paying any management fees directly to the Manager in connectionwith these investments.

 

 

# **Note 8 - Stock Options**

 

The Company has adopted astock option plan (the ''Amended and Restated 1997 Stock Option Plan'') thatprovides for the grant of both qualified incentive stock options that meet therequirements of Section 422 of the Code, and non-qualified stock options, stockappreciation rights and dividend equivalent rights.  Stock options may be granted to directors of the Company(“employees”), and to the Manager and the directors, officers and key employeesof the Manager (“non-employees”).

 

The exercise price forany stock option granted under the Amended and Restated 1997 Stock Option Planmay not be less than 100% of the fair market value of the shares of commonstock at the time the option is granted. Each option must terminate no more than ten years from the date it isgranted.  Subject to anti-dilutionprovisions for stock splits, stock dividends and similar events, the Amendedand Restated 1997 Stock Option Plan authorizes the grant of options to purchasean aggregate of 1,000,000 shares of common stock.

 

The Company recognizedstock option expense relating to the options granted to the non-employees of$1,000 and $23,000 during the quarters ended September 30, 2001 and 2000,respectively.

 

For stock optionsoutstanding at September 30, 2001, the range of exercise prices is $6.98 to$15.00 per share and the weighted-average remaining contractual life is 7.44years.

 

For the year endedDecember 31, 2000, options to purchase 180,000 shares of the Company’s commonstock were granted to directors of the Company and options to purchase 125,000shares were granted to officers of the Company and officers and key employeesof the Manager.  The exercise price ofthe options granted during 2000 was $6.98 per share.  None of the options granted during 2000 include dividendequivalent rights.

 

The fair value of eachoption granted during 2000 was estimated to be $0.04 as of the grant date usingthe Black-Scholes option pricing model with the following assumptions: dividendyield of 20% per annum; expected volatility of 30%; risk free interest rate of5.22% per annum; and an expected life of 10 years.

 

The options grantedduring 2000 expire in December 2010 and vest in two equal installments duringthe month of December in 2001 and 2002.

 

For the year endedDecember 31, 1998, options to purchase 112,000 shares of the Company’s commonstock were granted to directors of the Company and options to purchase 58,000shares were granted to officers of the Company and officers and key employeesof the Manager.  The exercise price ofthe options granted during 1998 was $10.38 per share.  All of the options granted during 1998 include dividendequivalent rights that entitle the option holder to receive a cash payment equalto the dividends declared on the Company’s common stock multiplied by thenumber of options held until the options are exercised or expire.

 

The fair value of eachoption granted during 1998 was estimated to be $5.32 as of the grant date usingthe Black-Scholes option pricing model with the following assumptions: dividendyield of 0% per annum (to account for the dividend equivalent rights); expectedvolatility of 30%; risk free interest rate of 4.57% per annum; and an expectedlife of 10 years.

 

The options grantedduring 1998 expire in December 2008 and vested in two equal installments duringthe month of December in 1999 and 2000.

 

For the year endedDecember 31, 1997, options to purchase 210,000 shares of the Company’s commonstock were granted to directors of the Company and options to purchase 190,000shares were granted to officers of the Company and officers and key employeesof the Manager.  The exercise price ofthe options granted during 1997 was $15 per share.

 

The fair value of eachoption granted during 1997 was estimated to be $1.05 as of the grant date usingthe Black-Scholes option pricing model with the following assumptions: dividendyield of 11% per annum; expected volatility of 30%; risk free interest rate of5.82% per annum; and an expected life of 10 years.

 

The options grantedduring 1997 expire in December 2007 and vest in three equal installments duringthe month of February in 1999, 2000 and 2001.

 

If the Company hadrecorded stock option grants to Company directors at fair value and relatedcompensation expense, the pro forma effect on the Company’s net income (loss)and earnings (loss) per share would have been as follows:

 
|                                             |   | **Quarter Ended  September 30, 2001** |      | **Quarter Ended  September 30, 2000** |   |
|--------------------------------------------------|--------|---------------------------------------|-----------|---------------------------------------|--------|
|                                             |   |                                  |      |                                  |   |
| Net income (loss) - as reported                  |   | $                                     | 7,836,000 |                                  | $      | (28,427,000 | ) |
| Net income (loss) - pro forma                    |   | $                                     | 7,835,000 |                                  | $      | (28,450,000 | ) |
|                                             |   |                                  |      |                                  |   |
| Basic earnings (loss) per share - as  reported   |   | $                                     | 1.36      |                                  | $      | (4.94 | ) |
| Diluted earnings (loss) per share - as  reported |   | $                                     | 1.34      |                                  | $      | (4.94 | ) |
| Basic earnings (loss) per share - pro  forma     |   | $                                     | 1.36      |                                  | $      | (4.95 | ) |
| Diluted earnings (loss) per share - pro  forma   |   | $                                     | 1.34      |                                  | $      | (4.95 | ) |

 

 

Information regardingstock option activity during the nine months ended September 30, 2001 is asfollows:

 
|                                      |   | **Shares** |   | **Weighted Average  Exercise Price** |   |
|-------------------------------------------|--------|------------|--------|--------------------------------------|--------|
| Options Outstanding at January 1, 2001    |   | 878,000    |   | $                                    | 11.29  |   |
| Exercised                                 |   | -          |   | -                                    |   |
| Expired                                   |   | -          |   | -                                    |   |
| Options Outstanding at September 30, 2001 |   | 878,000    |   | $                                    | 11.29  |   |

# ** **

# **Note 9 –Contractual Commitments**

 

The Company from time totime may enter into interest rate swap agreements in order to mitigate theimpact of rising interest rates on the cost of its short-term borrowings.  There were no interest rate swap agreementsopen at September 30, 2001 and December 31, 2000.

 

During the year endedDecember 31, 2000, the Company terminated all outstanding interest rate swapagreements with a combined notional amount of $386,213,000 which resulted in adeferred gain of $5,554,000 that is being amortized over the remaining life ofthe original swap agreements.  Thedeferred gain is included in accumulated other comprehensive income on thebalance sheet and the amortization expense is included in interest expense inthe statements of operations.   Duringthe quarter ended September 30, 2001, $145,000 of the deferred gain wasamortized.  Approximately 97% of thedeferred gain will be amortized by December 31, 2001.  The remaining deferred gain will be fully amortized by May 31,2002.

 

 

**Note 10 -  Forward Contracts**

 

At September 30, 2001,the Company had open forward contracts to sell U.S. Treasury notes with termsstated below.

 
| **Current  Notional Amount  (000)** |    | **Average  Termination Date** |       | **Net Unrealized Losses  (000)** |   | **Average Maturity of  Underlying Securities** |   |
|-------------------------------------|---------|-------------------------------|------------|----------------------------------|--------|------------------------------------------------|--------|
|                                |    |                          |       |                             |   |                                           |   |
| $                                   | 288,000 |                          | 10/22/2001 |                             | $      | (987)                                          |   | 4.23 Years |   |
|                                     |         |                               |            |                                  |        |                                                |        |  |  |

 

 

At December 31, 2000, theCompany had open forward contracts to sell U.S. Treasury notes with termsstated below.

 
| **Current  Notional Amount  (000)** |    | **Average  Termination Date** |      | **Net Unrealized Losses  (000)** |   | **Average Maturity of  Underlying Securities** |   |
|-------------------------------------|---------|-------------------------------|-----------|----------------------------------|--------|------------------------------------------------|--------|
|                                |    |                          |      |                             |   |                                           |   |
| $                                   | 575,000 |                          | 1/19/2001 |                             | $      | (3,731)                                        |   | 2.99 Years |   |
|                                     |         |                               |           |                                  |        |                                                |        |  |  |

 

During the ninemonths ended September 30, 2001, a transition adjustment, in connection withthe adoption of Statement of Financial Accounting Standards ("SFAS")No. 133, was recorded to reclassify $2,173,000 from accumulated othercomprehensive income to net loss on investment transactions on the statementsof operations.  This reclassificationconsists of $8,505,000 net deferred losses on closed forward contracts,$3,731,000 net unrealized losses on open forward contracts, and $10,063,000 netunrealized gains on securities hedged by open forward contracts at December 31,2000.  Also, during the nine monthsended September 30, 2001, $22,518,000 of net loss was realized on closedforward contracts and is included in net loss from trading activities on thestatements of operations.

 

 

# **Note 11 – Adoption of Shareholder Rights Plan**

 

On June 30, 1999, the Board of Directors of ApexMortgage Capital, Inc. (the “Company”) declared a dividend distribution of oneRight for each outstanding share of Company Common Stock to stockholders ofrecord at the close of business on July 30, 1999 (the “Record Date”).  Each Right entitles the registered holder topurchase from the Company one one-hundredth of a share of Series A JuniorParticipating Preferred Stock, par value $0.01 per share (the “PreferredStock”), at a Purchase Price of $50, subject to adjustment.  The description and terms of the Rights areset forth in a Shareholder Rights Agreement (the “Rights Agreement”) betweenthe Company and The Bank of New York, as Rights Agent.

 

Initially, the Rights will be attached to all CommonStock certificates representing shares then outstanding, and no separate RightsCertificates will be distributed. Subject to certain exceptions specified in the Rights Agreement, theRights will separate from the Common Stock and a Distribution Date will occurupon the earlier of (i) 10 business days following a public announcement that aperson or group of affiliated or associated persons (an “Acquiring Person”) hasacquired, or obtained the right to acquire, beneficial ownership of 15% or moreof the outstanding shares of Common Stock (the “Stock Acquisition Date”), otherthan as a result of repurchases of stock by the Company or certain inadvertentactions by institutional or certain other stockholders or (ii) 10 business days(or such later date as the Board shall determine) following the commencement ofa tender offer or exchange offer that would result in a person or groupbecoming an Acquiring Person.  Until theDistribution Date, (i) the Rights will be evidenced by the Common Stockcertificates and will be transferred with and only with such Common Stockcertificates, (ii) new Common Stock certificates issued after the Record Datewill contain a notation incorporating the Rights Agreement by reference and(iii) the surrender for transfer of any certificates for Common Stockoutstanding will also constitute the transfer of the Rights associated with theCommon Stock represented by such certificate. Pursuant to the Rights Agreement, the Company reserves the right torequire that, prior to the occurrence of a triggering event, upon any exerciseof Rights, a number of Rights be exercised so that only whole shares ofPreferred Stock will be issued.

 

The Rights are notexercisable until the Distribution Date and will expire on July 30, 2009,unless earlier redeemed or exchanged by the Company.

 

 

# **Note 12 –Subsequent Event**

 

During October 2001, theCompany completed a secondary offering of 6.095 million shares of common stockat $10.00 per share.  The size of theoffering was increased over the initially filed 4.0 million shares.  The aggregate net proceeds to the Companyafter deducting expenses were used to purchase mortgage related assets consistentwith the Company's investment policy.

 

 

# **ITEM 2. **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

 

**SAFE HARBOR/FORWARD LOOKINGSTATEMENTS**

 

Certain informationcontained in this Quarterly Report on Form 10-Q constitutes “forward-lookingstatements” which can be identified by the use of forward-looking terminologysuch as “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “intend,”“continue,” or “believes” or the negatives thereof or other variations thereonor comparable terminology.  Discussedbelow are some important factors that would cause actual results to differmaterially from those in any forward-looking statements, including changes ininterest rates; domestic and foreign business, market, financial or legalconditions; differences in the actual allocation of the assets of the Companyfrom those assumed; and the degree to which assets are hedged and theeffectiveness of the hedge, among others. In addition, the degree of risk is increased by the Company’s leveragingof its assets.  For additionaldiscussion of factors that could cause actual results to differ from thosecontained in such forward-looking statements, see “Principal Risks and SpecialConsiderations”, “Item 7 Management's Discussion and Analysis of FinancialConditions and Results of Operations” and “Item 7A Quantitative and QualitativeDisclosures About Market Risk” in the Company’s annual report on Form 10-K forthe year ended December 31, 2000.  TheCompany does not undertake, and specifically disclaims any obligation, toupdate any forward-looking statements to reflect occurrences or unanticipatedevents or circumstances after the date of such statements.

 

 

**GENERAL**

 

         ApexMortgage Capital, Inc.  (the''Company''), a Maryland corporation, was formed on September 15, 1997,primarily to acquire United States agency and other highly rated, single-familyreal estate adjustable and fixed rate Mortgage Related Assets.  The Company commenced operations on December9, 1997 following the initial public offering of the Company’s CommonStock.  The Company's principalexecutive offices are located at 865 South Figueroa Street, Suite 1800, LosAngeles, California 90017, and its telephone number is (213) 244-0440.

 

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

 

         The day-to-day operations of the Company are managed by anexternal management company, TCW Investment Management Company (the"Manager"), subject to the direction and oversight of the Company'sBoard of Directors.  A majority of theBoard of Directors are unaffiliated with The TCW Group, Inc.  (''TCW'' and, together with its subsidiariesand Affiliates, the ''TCW Group'') or the Manager.  The Manager is a wholly-owned subsidiary of TCW.  The Manager was established in 1992 and theTCW Group began operations in 1971 through one of its affiliates.  The Company's investment management team areselected members of the TCW Group's Mortgage-Backed Securities Group (the ''MBSGroup''), all of whom have over twelve years of experience in raising andmanaging mortgage capital.  The Companyhas elected to be externally managed by the Manager to take advantage of theexisting operational systems, expertise and economies of scale associated withthe Manager's current business operations, among other reasons. The Manager'skey officers have experience in raising and managing mortgage capital, mortgagefinance and the purchase and administration of Mortgage Related Assets.

 

 

**RECENT EVENTS**

 

*Recently Issued Accounting Standards –*TheCompany adopted SFAS No. 133 and the related amendments on January 1,2001.  This adoption resulted in atransition adjustment that reclassified $2,173,000 of net losses on unrealizedand deferred gains and losses on investment securities and forward contractsfrom accumulated other comprehensive income to current income.  Also, deferred gains on interest rate swapspreviously designated as hedges were reclassified from other liabilities toaccumulated other comprehensive income.

 

In conjunction with theadoption of SFAS No. 133, the Company reclassified $594,469,000 of its mortgagesecurities from the available-for-sale category to the trading category forinvestments accounted for under SFAS No. 115. This change resulted in the reclassification of $1,742,000 netunrealized gains from accumulated other comprehensive income to current income,in addition to net unrealized gains included in the SFAS No. 133 transitionadjustment discussed above. This change is also expected to increase thevolatility of net income as both changes in the fair market value and actual realizedgains and losses of the fixed income securities and the related hedginginstruments will now flow through net income each reporting period.

 

During October 2001, the Company completed a secondaryoffering of 6.095 million shares of common stock at $10.00 per share.  The size of the offering was increased overthe initially filed 4.0 million shares. The aggregate net proceeds to the Company after deducting expenses wereused to purchase mortgage related assets consistent with the Company'sinvestment policy.

 

**STRATEGY**

 

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

 

•      purchaseprimarily single-family fixed and adjustable rate Mortgage Related Assets;

 

•      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;

 

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

 

•      seek tominimize prepayment risk primarily by structuring a diversified portfolio witha variety of prepayment characteristics;

•      purchaseequity and other securities issued by financial entities on an opportunisticbasis.

 

 

         Therecan be no assurance that the Company will be able to generate competitiveearnings and dividends while holding primarily High Quality Mortgage RelatedAssets and maintaining a disciplined risk-control profile.

 

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

 

 

#### **POLICIES**

 

The Company’s currentinvestment policies are set forth in its Annual Report on form 10-K for theyear ended December 31, 2000.

 

**FINANCIALCONDITION**

**FixedIncome Securities**

 

At September 30, 2001 andDecember 31, 2000, the Company held $521,663,000 and $600,131,000 of FixedIncome Securities, respectively.  Theoriginal maturity of a significant portion of the Fixed Income Securitiesranges from fifteen to thirty years; the actual maturity is subject to changebased on the prepayments of the underlying mortgage loans.

 

The following table is aschedule of Fixed Income Securities held as available for sale listed bysecurity type (dollars in thousands):

 
|                          |   | **September 30, 2001** |       | **December 31, 2000**                                |       |
|-------------------------------|--------|------------------------|------------|------------------------------------------------------|------------|
|                          |   |                   |       |                                                 |       |   |   |   |   |
| **Fixed Income Securities**   |   | **Carrying Value**     | ** ** | **Percent of Total  Available-for-sale  Securities** | ** ** | **Carrying Value** | ** ** | **Percent of Total  Available-for-sale  Securities** |   |
|                          |   |                   |       |                                                 |       |   |   |   |   |
| Mortgage Securities:          |   |                   |       |                                                 |       |   |   |   |   |
| Adjustable Rate (1)           |   | -                      |       | 0.00                                                 | %          | $ | 40,253 |   | 6.71 | % |
| Fixed Rate                    |   | -                      |       | 0.00                                                 | %          | 554,216 |   | 92.35 | % |
| Other Fixed Income Securities |   | $                      | 5,722      |                                                 | 100.00     | % | 5,662 |   | 0.94 | % |
| Totals                        |   | $                      | 5,722      |                                                 | 100.00     | % | $ | 600,131 |   | 100.00 | % |

----

 (1) At December 31, 2000, the interest rateindices for 98% and 2% 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 is aschedule of Fixed Income Securities held for trading at September 30, 2001listed by security type (dollars in thousands):

 
|                        |   | **September 30, 2001** |       |
|-----------------------------|--------|------------------------|------------|
|                        |   |                   |       |   |   |
| **Fixed Income Securities** |   | **Carrying Value**     | ** ** | **Percent of Total Securities  Held for Trading** |   |
|                        |   |                   |       |   |   |
| Mortgage Securities:        |   |                   |       |   |   |
| Adjustable Rate             |   | $                      | 17,269     |   | 3.35 | % |
| Fixed Rate                  |   | 498,673                |       | 96.65 | % |
| Totals                      |   | $                      | 515,942    |   | 100.00 | % |

 

 

The following table showsvarious weighted average characteristics of the Fixed Income Securities held asavailable-for-sale by the Company at September 30, 2001 (dollars in thousands):

 
| **Security Type**             |   | **Par Amount** |   | **Par as a  Percent of Category** |   | **Adjusted Cost Basis** |   | **Market Price** |   | **Current Coupon** |   | **Weighted Average Life** |   |
|-------------------------------|--------|----------------|--------|-----------------------------------|--------|-------------------------|--------|------------------|--------|--------------------|--------|---------------------------|--------|
|                          |   |           |   |                              |   |                    |   |             |   |               |   |                      |   |
| Other Fixed Income Securities |   | $              | 10,400 |                              | 100.00 | %                       | 61.33  | %                | 55.02  | %                  | 14.32  | %                         | 1.0    |   |
|                               |        |                |        |                                   |        |                         |        |                  |        |                    |        |                           |        |  |

 

 

The following table showsvarious weighted average characteristics of the fixed income trading securitiesby the Company at September 30, 2001 (dollars in thousands):

 
| **Security Type**            |   | **Par Amount** |    | **Par as a Percent of Category** |   | **Adjusted Cost Basis** |   | **Market Price** |   | **Current Coupon** |   | **Weighted Average Life (1)** |   |
|------------------------------|--------|----------------|---------|----------------------------------|--------|-------------------------|--------|------------------|--------|--------------------|--------|-------------------------------|--------|
|                         |   |           |    |                             |   |                    |   |             |   |               |   |                          |   |
| 20 Year Agency Pass-throughs |   | $              | 202,334 |                             | 40.06  | %                       | 97.28  | %                | 102.59 | %                  | 6.50   | %                             | 2.5    |   |
| 30 Year Agency Pass-throughs |   | 192,228        |    | 38.06                            | %      | 99.96                   | %      | 101.66           | %      | 6.54               | %      | 3.6                           |   |
| AAA CMOs                     |   | 93,638         |    | 18.54                            | %      | 95.36                   | %      | 102.18           | %      | 6.69               | %      | 1.0                           |   |
| Total Fixed Rate Holdings    |   | 488,200        |    | 96.66                            | %      | 97.97                   | %      | 102.15           | %      | 6.55               | %      | 2.7                           |   |
|                         |   |           |    |                             |   |                    |   |             |   |               |   |                          |   |
| Adjustable Rate Holdings     |   | 16,906         |    | 3.34                             | %      | 100.56                  | %      | 102.15           | %      | 7.35               | %      | 1.0                           |   |
|                         |   |           |    |                             |   |                    |   |             |   |               |   |                          |   |
| Category Total               |   | $              | 505,106 |                             | 100.00 | %                       | 98.05  | %                | 102.15 | %                  | 6.58   | %                             | 2.6    |   |

 

 

The following table showsvarious weighted average characteristics of the Fixed Income Securities held asavailable-for-sale by the Company at December 31, 2000 (dollars in thousands):

 
| **Security Type**                |   | **Par Amount** |    | **Percent of Total Par Amount** |   | **Adjusted Cost Basis** |   | **Market Price** |   | **Current Coupon** |   | **Weighted Average Life (1)** |   |
|----------------------------------|--------|----------------|---------|---------------------------------|--------|-------------------------|--------|------------------|--------|--------------------|--------|-------------------------------|--------|
|                             |   |           |    |                            |   |                    |   |             |   |               |   |                          |   |
| 15 Year Agency/AAA Pass-throughs |   | $              | 145,251 |                            | 23.90  | %                       | 98.00  | %                | 99.90  | %                  | 6.50   | %                             | 4.5    |   |
| 20 Year Agency Pass-throughs     |   | 230,193        |    | 37.90                           | %      | 97.00                   | %      | 99.30            | %      | 6.50               | %      | 5.6                           |   |
| 30 Year Agency Pass-throughs     |   | 54,759         |    | 9.00                            | %      | 99.65                   | %      | 101.23           | %      | 7.41               | %      | 5.0                           |   |
| AAA CMOs                         |   | 127,759        |    | 21.00                           | %      | 95.68                   | %      | 97.92            | %      | 6.80               | %      | 6.4                           |   |
| Total Fixed Rate Holdings        |   | 557,962        |    | 91.80                           | %      | 97.22                   | %      | 99.33            | %      | 6.80               | %      | 5.4                           |   |
|                             |   |           |    |                            |   |                    |   |             |   |               |   |                          |   |
| Other Fixed Income Securities    |   | 10,400         |    | 1.70                            | %      | 64.31                   | %      | 54.44            | %      | 15.89              | %      | 1.8                           |   |
| Adjustable Rate Holdings         |   | 39,253         |    | 6.50                            | %      | 102.49                  | %      | 102.55           | %      | 8.00               | %      | 0.6                           |   |
|                             |   |           |    |                            |   |                    |   |             |   |               |   |                          |   |
| Total Portfolio                  |   | $              | 607,615 |                            | 100.00 | %                       | 96.99  | %                | 98.77  | %                  | 6.90   | %                             | 5.1    |   |

 

----

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

 

 

### **Equity Securities**

 

At  September 30, 2001 and December 31, 2000 theCompany held $11,954,000 and $9,068,000 of equity securities held asavailable-for-sale, respectively. Equity securities consist primarily of investments in equities issued byother real estate investment trusts.

 

At September 30, 2001, equity securities consisted of the following:

                
| **(In thousands)**                      |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |   |
|-----------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|--------|
|                                    |   |            |   |              |   |           |   |
| Common Stock:                           |   |            |   |              |   |           |   |
| Dynex Capital, Inc.                     |   | 75              |   | $                 | 122    |           | $      | 184 |   |
| Total Common Stock                      |   |            |   | 122               |   | 184            |   |
|                                    |   |            |   |              |   |           |   |
| Convertible Preferred Stock:            |   |            |   |              |   |           |   |
| Capstead Mortgage Corporation, Series B |   | 515             |   | 3,407             |   | 6,180          |   |
| Dynex Capital, Inc., Series A           |   | 53              |   | 420               |   | 866            |   |
| Dynex Capital, Inc., Series B           |   | 150             |   | 1,167             |   | 2,520          |   |
| Dynex Capital, Inc., Series C           |   | 108             |   | 968               |   | 2,204          |   |
| Total Convertible Preferred Stock       |   |            |   | 5,962             |   | 11,770         |   |
|                                    |   |            |   |              |   |           |   |
| Total Equity Securities                 |   |            |   | $                 | 7,042  |           | $      | 11,954 |   |
|                                         |        |                 |        |                   |        |                |        |  |  |  |

 

At December 31, 2000, equity securities consisted of the following:

                
| **(In thousands)**                           |   | **Shares Held** |   | **Adjusted Cost** |   | **Fair Value** |   |
|----------------------------------------------|--------|-----------------|--------|-------------------|--------|----------------|--------|
|                                         |   |            |   |              |   |           |   |
| Common Stock:                                |   |            |   |              |   |           |   |
| American Residential Investment Trust,  Inc. |   | 109             |   | $                 | 611    |           | $      | 238 |   |
| Anworth Mortgage Asset Corporation           |   | 222             |   | 994               |   | 900            |   |
| Dynex Capital, Inc.                          |   | 75              |   | 122               |   | 75             |   |
| Total Common Stock                           |   |            |   | 1,727             |   | 1,213          |   |
|                                         |   |            |   |              |   |           |   |
| Convertible Preferred Stock:                 |   |            |   |              |   |           |   |
| Capstead Mortgage Corporation, Series B      |   | 520             |   | 4,408             |   | 5,492          |   |
| Dynex Capital, Inc., Series A                |   | 53              |   | 420               |   | 427            |   |
| Dynex Capital, Inc., Series B                |   | 150             |   | 1,167             |   | 1,088          |   |
| Dynex Capital, Inc.,  Series C          |   | 108             |   | 968               |   | 848            |   |
| Total Convertible Preferred Stock            |   |            |   | 6,963             |   | 7,855          |   |
|                                         |   |            |   |              |   |           |   |
| Total Equity Securities                      |   |            |   | $                 | 8,690  |           | $      | 9,068 |   |
|                                              |        |                 |        |                   |        |                |        |  |  |  |

 

 

**Hedging Instruments**

 

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

 

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

 

At September 30,2001, the Company had open forward contracts to sell U.S. Treasury notes withterms stated below.

 
| **Current  Notional Amount(000)** |    | **Average Contract Price** |    | **Fair value of contracts (000)** |   | **Average Termination Date** |   | **Unrealized Gains (Losses) (000)** |   |
|-----------------------------------|---------|----------------------------|---------|-----------------------------------|--------|------------------------------|--------|-------------------------------------|--------|
|                              |    |                       |    |                              |   |                         |   |                                |   |
|                              |    |                       |    |                              |   |                         |   |                                |   |
| $                                 | 288,000 |                       | 102.281 |                              | $      | 295,557                      |   | 10/22/2001                          |   | $ | (987) |   |
|                                   |         |                            |         |                                   |        |                              |        |                                     |        |  |  |  |

 

 

At December 31,2000, the Company had open forward contracts to sell U.S. Treasury notes withterms stated below.

 
| **Current  Notional Amount(000)** |    | **Average Contract Price** |    | **Fair value of contracts (000)** |   | **Average Termination Date** |   | **Unrealized Gains (Losses) (000)** |   |
|-----------------------------------|---------|----------------------------|---------|-----------------------------------|--------|------------------------------|--------|-------------------------------------|--------|
|                              |    |                       |    |                              |   |                         |   |                                |   |
|                              |    |                       |    |                              |   |                         |   |                                |   |
| $                                 | 575,000 |                       | 101.099 |                              | $      | 585,048                      |   | 1/19/2001                           |   | $ | (3,731) |   |
|                                   |         |                            |         |                                   |        |                              |        |                                     |        |  |  |  |

 

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

 

 

**Liabilities**

 

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

 

At September 30, 2001,the Company had outstanding $479,790,000 of reverse repurchase agreements witha weighted average current borrowing rate of 2.99% and a maturity of 1.0month.  The reverse repurchaseagreements were collateralized by securities with an estimated fair value of$500,783,000.

 

At December 31, 2000, theCompany had outstanding $545,434,000 of reverse repurchase agreements with aweighted average current borrowing rate of 6.61% and a maturity of 1.1months.  The reverse repurchaseagreements were collateralized by mortgage-backed securities with an estimatedfair value of $564,274,000.

 

The Company had$7,226,000 and $24,256,000 of other liabilities at September 30, 2001 andDecember 31, 2000, respectively, consisting primarily of accrued interestpayable, unrealized loss on forward contracts and payables for unsettledsecurities at September 30, 2001 and deferred gain on interest rate swaps,accrued interest payable and payables for unsettled securities at December 31,2000.  The Company anticipates settlingall other liabilities within one year.

 

# ** **

# **Other Matters**

 

AtSeptember 30, 2001, the Company held equity securities and senior unsecurednotes issued by Dynex Capital, Inc. (“Dynex”) with fair market values of$5,774,000 and $4,500,000, respectively. During the year ended December 31, 1999, Dynex suspended the payment ofdividends on its preferred stock. Accordingly, the Company is no longer recognizing dividend income on itsequity investments in Dynex.  Dynex iscurrently paying interest on its senior notes. Accordingly, the Company is recognizing interest income on the seniornote investments issued by Dynex.  IfDynex were to suspend payment of interest on its senior notes, interest incomerecognized by the Company would be negatively impacted.

 

 

**Results of Operations for the Quarter Ended September 30,2001**

 

For the quarter endedSeptember 30, 2001, the Company’s net income was $7,836,000, or $1.36 per shareon a basic basis and $1.34 per share on a diluted basis, based on a weightedaverage of 5,753,000 and 5,846,000 shares outstanding, respectively.  That compares to a net loss of $28,427,000,or $4.94 per share both on basic and diluted basis, based on a weighted averageof 5,753,000 shares outstanding for the quarter ended September 30, 2000.  Net interest income for the quarter endedSeptember 30, 2001 was $5,632,000 consisting of interest income on mortgageassets and cash balances less interest expense on reverse repurchase agreementscompared to $1,980,000 for the quarter ended September 30, 2000.  The Company reported dividend income of$162,000 from dividends on equity investments for the quarter ended September30, 2001.  The Company reported dividendincome of $185,000 from dividends on equity investments for the quarter endedSeptember 30, 2000.

 

During the quarter endedSeptember 30, 2001, the Company incurred a net gain on investment transactionsof $2,409,000 which is reported in the Statement of Operations.  This gain consisted of $2,107,000 in gainson the sale of $130,456,000 of fixed income trading securities, $11,566,000gain from the net increase in fair market value of fixed income securitiesheld-for-trading, and $11,264,000 in net losses on closed forwardcontracts.  The Company reported a netloss on investment transactions of $29,912,000 for the quarter ended September30, 2000.  The loss consisted of animpairment charge on certain fixed-rate mortgage securities that may be soldprior to maturity of $21,652,000, the recognition of the associated unrealizedloss and deferred hedging losses on the impaired assets of $8,425,000 and again of $165,000 on the sale of equity securities.

 

The Company incurredoperating expenses of $367,000 for the quarter ended September 30, 2001consisting of management fees, audit, tax, legal, printing, insurance and otherexpenses compared to $680,000 for the quarter ended September 30, 2000.

 

                Thefollowing table reflects the average balances for each category of theCompany’s interest earning assets as well as the Company’s interest bearingliabilities, with the corresponding effective rate of interest annualized:

 

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

(Dollarsin thousands)

 
|                                         |   | **For  the Quarter Ended  September 30, 2001** |    | **For  the Quarter Ended  September 30, 2000** |   |
|----------------------------------------------|--------|------------------------------------------------|---------|------------------------------------------------|--------|
|                                         |   | **Average  Balance**                           |    | **Effective  Rate**                            |   | **Average  Balance** |   | **Effective  Rate** |   |
| Interest  Earning Assets:                    |   |                                           |    |                                           |   |   |   |   |   |
| Mortgage  Securities                         |   | $                                              | 501,366 |                                           | 7.62   | % | $ | 570,523 |   | 6.52 | % |
| Other  Fixed Income Assets                   |   | 6,418                                          |    | 16.24                                          | %      | 6,881 |   | 14.94 | % |
| Cash  and Cash Equivalents                   |   | 2,173                                          |    | 4.42                                           | %      | 1,510 |   | 5.56 | % |
|                                         |   |                                           |    |                                           |   |   |   |   |   |
| Total  Interest Earning Assets               |   | 509,957                                        |    | 7.71                                           | %      | 578,914 |   | 6.62 | % |
|                                         |   |                                           |    |                                           |   |   |   |   |   |
| Interest  Bearing Liabilities:               |   |                                           |    |                                           |   |   |   |   |   |
| Reverse  Repurchase Agreements               |   | 491,563                                        |    | 3.42                                           | %      | 522,145 |   | 5.82 | % |
|                                         |   |                                           |    |                                           |   |   |   |   |   |
| Net  Interest Bearing Liabilities and Spread |   | $                                              | 18,394  |                                           | 4.29   | % | $ | 56,769 |   | 0.80 | % |

 

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

 

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

 

 

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

(Dollarsin thousands)

 

 
|               |   | **For  the Quarter Ended  September 30, 2001** |   | **For  the Quarter Ended  September 30, 2000** |   |
|--------------------|--------|------------------------------------------------|--------|------------------------------------------------|--------|
|               |   | **Average  Balance**                           |   | **Effective  Dividend Yield**                  |   | **Average  Balance** |   | **Effective  Dividend Yield** |   |
|               |   |                                           |   |                                           |   |   |   |   |   |
| Equity  securities |   | $                                              | 11,368 |                                           | 5.70   | % | $ | 13,354 |   | 5.54 | % |
|                    |        |                                                |        |                                                |        |  |  |  |  |  |  |

 

 

 

**Results of Operations for the Nine Months Ended September 30,2001**

 

For the nine months endedSeptember 30, 2001, the Company’s net income was $9,210,000, or $1.98 per shareon a basic basis and $1.95 per share on a diluted basis, based on a weightedaverage of 5,753,000 and 5,846,000 shares outstanding, respectively.  That compares to a net loss of $31,247,000or $5.43 per share on both a basic and diluted basis, based on a weightedaverage of 5,753,000 shares outstanding for the nine months ended September 30,2000.  Net interest income for the ninemonths ended September 30, 2001 was $14,352,000 consisting of interest incomeon fixed income securities and cash balances less interest expense on reverserepurchase agreements compared to $6,732,000 for the nine months endedSeptember 30, 2000.  The Companyreported dividend income of $656,000 from dividends on equity investments forthe nine months ended September 30, 2001 compared to $909,000 for the ninemonths ended September 30, 2000.

 

The Company incurredoperating expenses of $936,000 for the nine months ended September 30, 2001consisting of management fees, professional, printing, insurance and otherexpenses.  For the nine months endedSeptember 30, 2000, the Company incurred operating expenses of $1,444,000consisting of management fees, professional, printing, insurance and otherexpenses.

 

During the nine monthsended September 30, 2001, the Company incurred a net loss on investmenttransactions of $4,431,000 which is reported in the Statement ofOperations.  The loss consisted of a$65,000 gain on the sale of $1,712,000 of equity securities, a realized$6,418,000 gain on the sale of $332,373,000 of fixed income trading securities, a reported gain of$11,603,000 from the net increase in fair market value of fixed income securitiesheld for trading and a realized $22,517,000 net loss on closed forwardcontracts.  The Company realized a netloss of $37,444,000 on investment transactions for the nine months endedSeptember 30, 2000. The loss consisted of an impairment charge on certainfixed-rate mortgage securities that may be sold prior to maturity of$21,652,000, the recognition of the associated unrealized loss and deferredhedging losses on the impaired assets of $8,425,000 and a net loss of$7,367,000 on the sale of mortgage and equity securities.

 

On January 1, 2001, theCompany adopted SFAS No. 133 and the related amendments.  This adoption resulted in a transitionadjustment that reclassified $2,173,000 of net losses on unrealized anddeferred gains and losses on investment securities and forward contracts fromaccumulated other comprehensive income to current income.  Also, deferred gains on interest rate swapspreviously designated as hedges were reclassified from other liabilities toaccumulated other comprehensive income.

 

Also on January 1, 2001,the Company reclassified $594,469,000 of its mortgage securities from theavailable-for-sale category to the trading category for investments accountedfor under SFAS No. 115.  This change resultedin the reclassification of $1,742,000 net unrealized gains from accumulatedother comprehensive income to current income, in addition to net unrealizedgains included in the SFAS No. 133 transition adjustment discussed above.

 

No such accountingchanges were made during the nine months ended September 30, 2000.

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

 

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

(Dollarsin thousands)

 
|                                    |   | **For  the Nine Months Ended  September 30, 2001** |    | **For  the Nine Months Ended  September 30, 2000** |   |
|-----------------------------------------|--------|----------------------------------------------------|---------|----------------------------------------------------|--------|
|                                    |   | **Average  Balance**                               |    | **Effective  Rate**                                |   | **Average  Balance** |   | **Effective  Rate** |   |
| Interest  Earning Assets:               |   |                                               |    |                                               |   |   |   |   |   |
| Mortgage  Securities                    |   | $                                                  | 538,233 |                                               | 7.35   | % | $ | 637,532 |   | 6.61 | % |
| Other  Fixed Income Assets              |   | 6,549                                              |    | 17.54                                              | %      | 7,015 |   | 15.89 | % |
| Cash  and Cash Equivalents              |   | 3,173                                              |    | 3.99                                               | %      | 4,129 |   | 5.91 | % |
|                                    |   |                                               |    |                                               |   |   |   |   |   |
| Total  Interest Earning Assets          |   | 547,955                                            |    | 7.45                                               | %      | 648,676 |   | 6.70 | % |
|                                    |   |                                               |    |                                               |   |   |   |   |   |
| Interest  Bearing Liabilities:          |   |                                               |    |                                               |   |   |   |   |   |
| Reverse  Repurchase Agreements          |   | 527,028                                            |    | 4.11                                               | %      | 589,618 |   | 5.85 | % |
|                                    |   |                                               |    |                                               |   |   |   |   |   |
| Net  Interest Earning Assets and Spread |   | $                                                  | 20,927  |                                               | 3.34   | % | $ | 59,058 |   | 0.85 | % |

 

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

 

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

 

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

(Dollarsin thousands)

 

 
|               |   | **For  the Nine Months Ended  September 30, 2001** |   | **For  the Nine Months Ended  September 30, 2000** |   |
|--------------------|--------|----------------------------------------------------|--------|----------------------------------------------------|--------|
|               |   | **Average  Balance**                               |   | **Effective  Dividend Yield**                      |   | **Average  Balance** |   | **Effective  Dividend Yield** |   |
|               |   |                                               |   |                                               |   |   |   |   |   |
| Equity  securities |   | $                                                  | 12,300 |                                               | 7.11   | % | $ | 16,438 |   | 7.37 | % |
|                    |        |                                                    |        |                                                    |        |  |  |  |  |  |  |

 

 

**Liquidity and Capital Resources**

 

The Company’s primarysources of funds as of September 30, 2001 and December 31, 2000, consisted ofreverse repurchase agreements totaling $479,790,000 and $545,434,000,respectively.  The Company expects tocontinue to borrow funds in the form of reverse repurchase agreements.  At September 30, 2001, the Company hadborrowing arrangements with over twenty different investment bankingfirms.  Increases in short-term interestrates could negatively impact the valuation of the Company’s mortgage assetswhich could limit the Company’s borrowing ability or cause its lenders toinitiate margin calls.

 

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

 

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

 

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

 

 

# **ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**MARKET RISK**

 

The Company’s twoprimary components of market risk are interest rate risk and equity price riskas discussed below.

### **Interest Rate Risk**

 

*                Effecton 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 to maintain adequate liquidity.

 

                *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 into 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 interest rate spread betweenmortgage securities and U.S. Treasury notes were to widen, the fair value ofthe Company'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-rate mortgageassets that are typically subject to periodic and lifetime interest rate capsthat limit the amount an adjustable-rate mortgage asset's interest rate canchange 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 asubstantial portion of its acquisitions of adjustable-rate mortgage assets withborrowings that have interest rates based on indices and repricing termssimilar to, but of somewhat shorter maturities than, the interest rate indicesand repricing terms of the mortgage assets. Thus, the Company anticipates that in most cases the interest rateindices and repricing terms of its mortgage assets and its funding sources willnot be identical, thereby creating an interest rate mismatch between assets andliabilities.  While the historicalspread between relevant short-term interest rate indices has been relativelystable, there have been periods, especially during the 1979-1982 and 1994interest rate environments, when the spread between such indices wasvolatile.  During periods of changinginterest rates, such interest rate mismatches could negatively impact theCompany's financial condition, cash flows and results of operations.

 

         Prepayment rates generally increasewhen prevailing interest rates fall below the interest rates on existingmortgage assets.  In addition,prepayment rates generally increase when the difference between long-term andshort-term interest rates declines. Prepayments of mortgage assets could adversely affect the Company'sresults of operations in several ways. The Company anticipates that a substantial portion of itsadjustable-rate mortgage assets may bear initial ''teaser'' interest rates thatare lower than their ''fully indexed'' rates (the applicable index plus amargin).  In the event that such anadjustable-rate mortgage asset is prepaid prior to or soon after the time ofadjustment to a fully indexed rate, the Company will have held the mortgageasset while it was less profitable and lost the opportunity to receive interestat the fully indexed rate over the expected life of the adjustable-ratemortgage asset.  In addition, theprepayment of any mortgage asset that had been purchased at a premium by theCompany would result in the immediate write-off of any remaining capitalizedpremium amount and consequent reduction of the Company's net interest income bysuch amount.  Finally, in the event thatthe Company is unable to acquire new mortgage assets to replace the prepaidmortgage assets, its financial condition, cash flow and results of operationscould be materially adversely affected.

 

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

 

         The Company primarily assesses itsinterest rate risk by estimating the duration of its assets and the duration ofits liabilities 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.

 

 

The followingsensitivity analysis table shows the estimated impact on the fair value of theCompany’s interest rate sensitive investments net of its hedging instrumentsand reverse repurchase agreement liabilities assuming rates instantaneouslyfall one hundred basis points and rise one hundred basis points.  (Dollars are in thousands except per shareamounts.)

 
|                                             |   | **Fair  Value for Scenario Shown**         |   |
|--------------------------------------------------|--------|--------------------------------------------|--------|
|                                             |   | **Interest  Rates Fall  100 Basis Points** |   | **Unchanged** |   | **Interest  Rates Rise  100 Basis Points** |   |
|                                             |   |                                       |   |   |   |   |   |
| Interest Rate Sensitive Instruments              |   | $                                          | 41,051 |   | $ | 40,886 |   | $ | 37,714 |   |
|                                             |   |                                       |   |   |   |   |   |
| Change in Fair Value                             |   | $                                          | 165    |   | - |   | $ | (3,172 | ) |
| Change as a Percent of Fair Value                |   | 0.03                                       | %      | - |   | (0.61 | )% |
| Change as a Percent of Stockholders’ Equity |   | 0.31                                       | %      | - |   | (6.05 | )% |
| Change on a Per Share Basis                      |   | $                                          | 0.03   |   | - |   | $ | (0.55 | ) |
|                                                  |        |                                            |        |  |  |  |  |  |  |  |  |

 

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

 

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

 

There can be noassurance that the Company will be able to limit such duration differences andthere may be periods of time when the duration difference will be greater thanone year.

 

Beginning with thequarter ended March 31, 2001, the Company reclassified its fixed incomesecurities that are generally subject to a hedging strategy from theavailable-for-sale category to the held-for-trading category of SFASNo.115.  This change is expected toincrease the volatility of net income as both changes in the fair market valueand actual realized gains and losses of the fixed income securities and therelated hedging instruments will now flow through net income each reportingperiod.

 

 

**EquityPrice Risk**

 

Another componentof market risk for the Company is equity price risk.  This is the risk that the market value of the Company’s equityinvestments will decrease.  The followingtable shows the impact on the Company’s fair value as the price of its equitysecurities change assuming price decreases of 10% and 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                                |   | $                                 | 10,759 |   | $ | 11,954 |   | $ | 13,149 |   |
|                                              |   |                              |   |   |   |   |   |
| Change in Fair Value                              |   | (1,195                            | )      | - |   | 1,195 |   |
|                                              |   |                              |   |   |   |   |   |
| Change as a Percent of  Stockholders’ Equity |   | (2.3                              | )%     | - |   | 2.3 | % |
| Change on a Per Share  Basis                      |   | (0.21                             | )      | - |   | 0.21 |   |
|                                                   |        |                                   |        |  |  |  |  |  |  |  |

 

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

 

If the fair marketvalue of the Company’s portfolio were to decline significantly, the Company’soverall liquidity may be impaired which could result in the Company beingrequired to sell assets at losses.

 

The Company’sanalysis of risks is based on management's experience, estimates, models andassumptions.  These analyses rely onmodels of financial information which utilize estimates of fair value andinterest 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 subjectto the Safe Harbor contained in the Private Securities Litigation Reform Act of1995.

# ** **

**PART 2.                OTHERINFORMATION**

 

Item 1.    Legal Proceedings

 

None.

 

Item 2.    Changesin Securities

 

         None.

 

Item 3.    DefaultsUpon Senior Securities

 

         Not Applicable.

 

Item 4.    Submissionof Matters to a Vote of Security Holders

 

         (a)    On the June 26, 2001, the Annual Meeting ofStockholders of the Company was held for the purpose of voting on:

 

         (i)   The election oftwo Directors to the Board of Directors; and

         (ii)  Ratification ofthe appointment of Deloitte & Touche LLP as independent auditor for 2001.

 

         (b)    The stockholders of the Company approved thefollowing matters, with the following votes cast with respect to each proposal:

 

         (i)     Election of two Directors to the Board ofDirectors:

 
| **Director**   |   | **Shares  Voted For:** |   | **Share  Votes Withheld:** |   |
|----------------|--------|------------------------|--------|----------------------------|--------|
|           |   |                   |   |                       |   |
| John  A. Gavin |   | 5,590,274              |   | 40,124                     |   |
|           |   |                   |   |                       |   |
| Marc  I. Stern |   | 5,595,484              |   | 34,924                     |   |

 

 

       The other directors whose terms continued after the AnnualMeeting are: John C, Argue, Carl C. Gregory, III, Jeffrey E. Gundlach, Peter G.Allen and Philip A. Barach.

 

 

         (ii)  Ratification of Deloitte & Touche LLP asIndependent Auditors for 2001:

 
| **Shares  Voted For:** |   | **Share Votes Withheld** |   | **Share Votes Abstained** |   |
|------------------------|--------|--------------------------|--------|---------------------------|--------|
|                   |   |                     |   |                      |   |
| 5,585,908              |   | 27,200                   |   | 17,300                    |   |

 

 

 

Item 5.    Other Information

 

                None.

 

Item 6.    Exhibits and Reports on Form 8-K:

 

 None

The followingexhibits are part of this quarterly report on Form 10-Q and are numbered inaccordance with Item 601 of Regulation S-K.

 

 

None.

**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: November 13, 2001 |   | /s/ Philip A. Barach                  |
|                     |   | Philip A. Barach                      |
|                     |   | President and Chief Executive Officer |
|                     |   | (Principal Executive Officer)         |
|                     |   |                                  |
|                     |   |                                  |
| Dated: November 13, 2001 |   | /s/ David S. DeVito                   |
|                     |   | David S. DeVito                       |
|                     |   | Chief Financial Officer               |
|                     |   | (Principal Accounting Officer)        |