HANOVER CAPITAL MORTGAGE HOLDINGS INC - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended June 30, 2004

		or

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

		For the transition period from to

Commission file number: 001-13417

Hanover Capital Mortgage Holdings, Inc.

(Exact name of registrant as specified in its charter)


Maryland		13-3950486
(State or other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

379 Thornall Street, Edison, New Jersey 08837

(Address of principal executive offices) (Zip Code)

(732) 548-0101

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The registrant had 8,305,937 shares of common stock outstanding as of August 12, 2004.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) (unaudited)
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
PART II. OTHER INFORMATION
	Item 6. Exhibits and Reports on Form 8-K
	Signatures
EXHIBIT INDEX
Ex-10.25.2 Amend.#2 to Contribution Agreement
Ex-31.1 Section 302 Certification of CEO
Ex-31.2 Section 302 Certification of CFO
Ex-32.1 Section 906 Certification of CEO
Ex-32.2 Section 906 Certification of CFO

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

FORM 10-Q

For the Three and Six Months Ended June 30, 2004

INDEX


		Page No.

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements		2
	Condensed Consolidated Balance Sheets (unaudited) as of June 30, 2004 and December 31, 2003		2
	Condensed Consolidated Statements of Income (unaudited) for the Three and Six Months Ended June 30, 2004 and 2003		3
	Condensed Consolidated Statement of Stockholders’ Equity (unaudited) for the Six Months Ended June 30, 2004		4
	Condensed Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2004 and 2003		5
	Notes to Condensed Consolidated Financial Statements (unaudited)		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		25
Item 4.	Controls and Procedures		27
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		28
Item 2.	Changes in Securities and Use of Proceeds		28
Item 3.	Defaults Upon Senior Securities		28
Item 4.	Submission of Matters to a Vote of Security Holders		28
Item 5.	Other Information		28
Item 6.	Exhibits and Reports on Form 8-K		28
	Signatures		29

PART I. FINANCIAL INFORMATION


Item 1.	Financial Statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(unaudited)


			June 30,			December 31,
			2004			2003

ASSETS
Cash and cash equivalents			$	19,403		$	32,588
Accounts receivable				3,155			2,733
Accrued interest receivable				1,264			1,026
Mortgage loans:
	Held for sale			184			434
	Collateral for CMOs			48,284			58,551
Mortgage securities pledged as collateral for reverse repurchase agreements:
	Available for sale			45,003			29,807
	Trading			96,757			37,882
Mortgage securities, not pledged:
	Available for sale			15,759			13,875
Equity investment in HDMF-I LLC				2,581			2,085
Other assets				8,834			10,010

TOTAL ASSETS			$	241,224		$	188,991

LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES:
Reverse repurchase agreements			$	124,460		$	55,400
CMO borrowing				42,194			52,164
Dividends payable				—			2,458
Accounts payable, accrued expenses and other liabilities				3,064			4,150

		TOTAL LIABILITIES		169,718			114,172

COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock: $0.01 par value, 10 million shares authorized, -0- shares issued and outstanding
Common stock: $0.01 par value, 90 million shares authorized, 8,228,322 and 8,192,903 shares issued and outstanding as of June 30, 2004 and December 31, 2003, respectively				82			82
Additional paid-in capital				102,622			101,279
Notes receivable from related parties				(583	)		(1,167	)
Retained earnings (deficit)				(28,201	)		(25,598	)
Accumulated other comprehensive (loss) income				(2,414	)		223

		TOTAL STOCKHOLDERS’ EQUITY		71,506			74,819

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY			$	241,224		$	188,991

See notes to condensed consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

(unaudited)



			Three Months Ended					Six Months Ended
			June 30,					June 30,

			2004			2003		2004			2003

REVENUES:
	Interest income		$	3,124		$	2,432	$	6,227		$	4,827
	Interest expense			836			989		1,656			2,274

		Net interest income		2,288			1,443		4,571			2,553
	Loan loss provision			9			14		20			30

		Net interest income after loan loss provision		2,279			1,429		4,551			2,523
	Gain on sale of mortgage assets			2,114			2,100		5,572			5,128
	(Loss) gain on mark to market of mortgage assets			(1,226	)		18		(1,283	)		18
	Due diligence fees			1,729			1,433		3,109			2,752
	Assignment fees			710			641		1,295			1,214
	Technology			238			927		626			1,812
	Loan brokering and advisory services			902			948		1,393			1,344
	Other income (loss)			813			58		(161	)		105

		Total revenues		7,559			7,554		15,102			14,896

EXPENSES:
	Personnel			3,709			3,725		6,014			5,903
	Subcontractor			1,128			933		2,177			1,873
	Legal and professional			820			379		1,407			775
	General and administrative			388			437		835			826
	Depreciation and amortization			223			389		439			777
	Other			203			122		349			229
	Travel and entertainment			110			161		250			311
	Occupancy			126			116		244			239
	Technology			141			66		238			121

		Total expenses		6,848			6,328		11,953			11,054

		Operating income		711			1,226		3,149			3,842
Equity in (loss) income of HDMF-I LLC				(64	)		3		(40	)		(40	)

Income before income tax provision (benefit)				647			1,229		3,109			3,802
Income tax provision (benefit)				34			60		(49	)		84

NET INCOME			$	613		$	1,169	$	3,158		$	3,718

BASIC EARNINGS PER SHARE			$	0.07		$	0.26	$	0.38		$	0.83

DILUTED EARNINGS PER SHARE			$	0.07		$	0.25	$	0.38		$	0.81

See notes to condensed consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Six Months Ended June 30, 2004

(in thousands, except share data)

(unaudited)


									Notes
			Common Stock				Additional		Receivable						Retained			Accumulated Other
							Paid-In		from			Comprehensive			Earnings			Comprehensive
			Shares		Amount		Capital		Related Parties			Income			(Deficit)			(Loss) Income			Total

Balance, December 31, 2003				8,192,903	$	82	$	101,279	$	(1,167	)				$	(25,598	)	$	223		$	74,819
Common stock paid for acquisition				35,419		—		494														494
Forgiveness of notes receivable from related parties										584												584
Common stock earned by Principals								849														849
Comprehensive income:
	Net income											$	3,158			3,158						3,158
	Other comprehensive income:
		Net unrealized gain (loss) on available for sale securities											(1,731	)					(1,731	)		(1,731	)
		Reclassification adjustment for net gain (loss) included in net income											(906	)					(906	)		(906	)

Comprehensive income												$	521

Dividends declared																(5,761	)					(5,761	)

Balance, June 30, 2004				8,228,322	$	82	$	102,622	$	(583	)				$	(28,201	)	$	(2,414	)	$	71,506

See notes to condensed consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



				Six Months Ended
				June 30,

				2004			2003

CASH FLOWS FROM OPERATING ACTIVITIES:
	Net income			$	3,158		$	3,718
	Adjustments to reconcile net income to net cash (used in) provided by operating activities:
		Depreciation and amortization			439			777
		Common stock earned by Principals			849			922
		Accretion of net discount			(1,007	)		(382	)
		Loan loss provision			20			30
		Gain on sale of mortgage assets			(5,572	)		(5,128	)
		Loss (gain) on mark to market of mortgage assets			1,283			(7	)
		(Gain) loss on disposition of real estate owned			(27	)		49
		Gain on paid-in-full mortgage loans			(19	)		—
		Purchase of trading securities			(61,977	)		(5,057	)
		Sale of trading securities			—			3,267
		Distributions from HDMF-I LLC in excess of equity (income) loss			40			2,952
		(Increase) decrease in accounts receivable			(422	)		406
		(Increase) decrease in accrued interest receivable			(238	)		11
		Decrease in notes receivable from related parties			—			813
		Decrease (increase) in other assets			1,214			(1,640	)
		(Decrease) increase in accounts payable, accrued expenses and other liabilities			(1,086	)		144

			Net cash (used in) provided by operating activities		(63,345	)		875

CASH FLOWS FROM INVESTING ACTIVITIES:
	Purchase of mortgage loans held for sale				—			(133	)
	Purchase of available for sale mortgage securities				(40,282	)		(60,452	)
	Principal payments received on mortgage securities				3,354			885
	Principal payments received on collateral for CMOs				10,188			14,327
	Principal payments received on mortgage loans held for sale				158			51
	Proceeds from sale of mortgage assets				25,740			40,272
	Proceeds from disposition of real estate owned				44			150
	Cash paid for acquisition				—			(75	)
	Capital contributions to HDMF-I LLC				(536	)		—

			Net cash used in investing activities		(1,334	)		(4,975	)

CASH FLOWS FROM FINANCING ACTIVITIES:
	Net borrowings from reverse repurchase agreements				69,060			48,036
	Repayment of CMOs				(9,931	)		(39,679	)
	Payment of dividends				(8,219	)		(3,125	)
	Repurchase of common stock				—			(252	)
	Decrease in notes receivable from related parties				584			583

			Net cash provided by financing activities		51,494			5,563

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS					(13,185	)		1,463
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD					32,588			10,605

CASH AND CASH EQUIVALENTS, END OF PERIOD				$	19,403		$	12,068

See notes to condensed consolidated financial statements

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)


1.	Organization, Basis of Presentation and Stock-Based Compensation

The interim condensed consolidated financial statements of Hanover Capital Mortgage Holdings, Inc. (“Hanover”) and subsidiaries include the accounts of Hanover and its wholly-owned and equity-owned subsidiaries. These interim condensed consolidated financial statements should be read in conjunction with Hanover’s Annual Report on Form 10-K for the year ended December 31, 2003. The interim condensed consolidated financial statements reflect all normal and recurring adjustments which are, in the opinion of management, considered necessary for a fair presentation of the financial condition and results of operations for the periods presented. There were no adjustments of a non-recurring nature recorded during the three and six months ended June 30, 2004. The interim results of operations presented are not necessarily indicative of the results for the full year. When necessary, reclassifications have been made to conform to current period presentation.

Hanover was incorporated in Maryland on June 10, 1997. Hanover is a real estate investment trust (“REIT”), formed to operate as a specialty finance company. Hanover has two primary subsidiaries: Hanover Capital Partners Ltd. (“HCP”) and HanoverTrade, Inc. (“HT”). When we refer to the “Company,” we mean Hanover together with its consolidated and equity method investees.

The Company is engaged in three principal businesses, which are conducted through its three primary operating units: Hanover, HCP and HT. The principal business strategy of Hanover is to invest in subordinate mortgage-backed securities (“MBS”) and, to a lesser extent, mortgage loans and to earn net interest income on these investments. The principal business strategy of HCP is to generate non-interest income by providing consulting and advisory services for third parties, including loan sale advisory services, loan file due diligence reviews, staffing solutions and mortgage assignment and collateral rectification services. The principal business activity of HT is to generate non-interest income by providing loan sale advisory and traditional loan brokerage services, technology solutions and valuation services. HT also brokers loan pools, mortgage servicing rights and other similar assets through an Internet-based exchange. Hanover also maintains an equity investment in HDMF-I LLC (“HDMF-I”). HDMF-I was organized in August 2001 to purchase, service, manage and ultimately re-sell or otherwise liquidate pools of primarily sub- and non-performing one-to-four family residential mortgage loans.

The Company’s principal business objective is to generate net interest income on its portfolio of mortgage securities and mortgage loans and to generate non-interest income through HCP, HT and third party asset-management contracts.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-Based Compensation

Hanover applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for its stock option plans. No compensation cost has been recognized for its stock options in the interim condensed consolidated financial statements for 2004 and 2003. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under Statement of Financial Accounting Standards No. 123, Accounting For Stock-Based Compensation, the Company’s net income would have been reduced to the following pro forma amounts for the periods indicated below (dollars in thousands, except per share data):



		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2004			2003			2004			2003

Net income:
	As reported	$	613		$	1,169		$	3,158		$	3,718
	Deduct: Total stock-based employee compensation expense determined under fair value based method		(4	)		(2	)		(4	)		(14	)

	Pro forma	$	609		$	1,167		$	3,154		$	3,704

Basic earnings per share:
	As reported	$	0.07		$	0.26		$	0.38		$	0.83

	Pro forma	$	0.07		$	0.26		$	0.38		$	0.82

Diluted earnings per share:
	As reported	$	0.07		$	0.25		$	0.38		$	0.81

	Pro forma	$	0.07		$	0.25		$	0.38		$	0.80

The per share weighted average fair value of stock options granted was $1.06 for the three and six months ended June 30, 2004 and $0.44 and $0.40 for the three and six months ended June 30, 2003, respectively, as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:



	Three Months Ended						Six Months Ended
	June 30,						June 30,

	2004			2003			2004			2003

Expected life (years)		10			10			10			6
Risk-free interest rate		4.70	%		3.53	%		4.70	%		3.79	%
Volatility		29.51	%		29.54	%		29.51	%		27.85	%
Expected dividend yield		9.41	%		11.70	%		9.41	%		11.03	%

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2. Mortgage Loans

Mortgage Loans Held for Sale

(dollars in thousands)



	June 30, 2004						December 31, 2003

	Fixed		Adjustable				Fixed			Adjustable
	Rate		Rate		Total		Rate			Rate			Total

Principal amount of mortgage loans	$	15	$	169	$	184	$	191		$	359		$	550
Net premium (discount) and deferred costs		—		—		—		(19	)		(77	)		(96	)
Net unrealized loss		—		—		—		(20	)		—			(20	)

Carrying value of mortgage loans	$	15	$	169	$	184	$	152		$	282		$	434

Mortgage Loans Securitized in Collateralized Mortgage Obligations

(dollars in thousands)



	June 30, 2004									December 31, 2003

	Fixed			Adjustable						Fixed			Adjustable
	Rate			Rate			Total			Rate			Rate			Total

Principal amount of mortgage loans	$	28,061		$	20,445		$	48,506		$	34,493		$	24,213		$	58,706
Net premium (discount) and deferred financing costs		305			(113	)		192			376			(124	)		252
Loan loss allowance		(190	)		(224	)		(414	)		(186	)		(221	)		(407	)

Carrying value of mortgage loans	$	28,176		$	20,108		$	48,284		$	34,683		$	23,868		$	58,551

The following table summarizes the activity in the loan loss allowance for mortgage loans securitized in collateralized mortgage obligations (dollars in thousands):



	Three Months Ended				Six Months Ended
	June 30,				June 30,

	2004		2003		2004			2003

Balance, beginning of period	$	405	$	395	$	407		$	571
Loan loss provision		9		14		20			30
Sales		—		—		—			(185	)
Charge-offs		—		—		(13	)		(7	)

Balance, end of period	$	414	$	409	$	414		$	409

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

3. Mortgage Securities

Mortgage Securities Pledged as Collateral for Reverse Repurchase Agreements

(dollars in thousands)



	Available for Sale

	June 30,			December 31,
	2004			2003

Principal balance of mortgage securities	$	76,936		$	60,464
Net discount		(30,691	)		(31,318	)

Total amortized cost of mortgage securities		46,245			29,146
Gross unrealized gain		215			1,369
Gross unrealized loss		(1,457	)		(708	)

Carrying value of mortgage securities	$	45,003		$	29,807

As of June 30, 2004 and December 31, 2003, the Company had approximately $96,757,000 and $37,882,000, respectively, of trading securities pledged as collateral for reverse repurchase agreements.

Mortgage Securities, Not Pledged

(dollars in thousands)



	Available for Sale

	June 30,			December 31,
	2004			2003

Principal balance of mortgage securities	$	30,249		$	26,145
Discount		(13,317	)		(11,832	)

Total amortized cost of mortgage securities		16,932			14,313
Gross unrealized gain		16			25
Gross unrealized loss		(1,189	)		(463	)

Carrying value of mortgage securities	$	15,759		$	13,875

Summary of All Mortgage Securities by Collateral

(dollars in thousands)



	Available for Sale				Trading

	June 30,		December 31,		June 30,		December 31,
	2004		2003		2004		2003

Fixed-Rate Agency Mortgage-Backed Securities	$	—	$	—	$	96,757	$	37,882
Fixed-Rate Subordinate Mortgage-Backed Securities		32,886		30,601		—		—
Adjustable-Rate Subordinate Mortgage-Backed Securities (1)		27,876		13,081		—		—

Carrying value of mortgage securities	$	60,762	$	43,682	$	96,757	$	37,882

(1) Adjustable-Rate Subordinate Mortgage-Backed Securities generally have fixed rates for initial terms of three to ten years.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

4. Notes Receivable from Related Parties and Common Stock Earned by Principals

As of June 30, 2004, Hanover had approximately $583,000 of loans outstanding to four of its executive officers (the “Principals”)(dollars in thousands):


	December 31,							June 30,		Interest
	2003		Repayment		Forgiveness			2004		Rate			Maturity Date

Secured by stock	$	38	$	—	$	(38	)	$	—		6.02	%		September 2007
Secured by stock		1,129		—		(546	)		583		5.70			September 2007

	$	1,167	$	—	$	(584	)	$	583

For the three and six months ended June 30, 2004, approximately $584,000 of outstanding loans were forgiven and 72,222 shares of the Company’s common stock were earned by, and subsequently transferred to, the Principals pursuant to the Contribution Agreement, dated September 19, 1997 (the “1997 Agreement”) as amended by Amendment No. 1 to Contribution Agreement, dated July 1, 2002 (“Amendment No. 1”) and Amendment No. 2 to Contribution Agreement, dated May 20, 2004 (together, the “Contribution Agreement”). The terms of the Contribution Agreement provide for (i) the transfer of up to 216,667 shares of the Company’s common stock to the Principals and (ii) for the forgiveness of certain indebtedness of the Principals to the Company of up to $1,750,000 upon the satisfaction of certain conditions related to the financial performance of the Company as of specified “earn-out measuring dates”. As of July 1, 2004, the second earn-out measuring date, approximately $1,167,000 of loans had been forgiven and 144,444 shares of the Company’s common stock had been earned by the Principals as the return on the Company’s common stock, including dividend distributions, exceeded the target annualized rate of return of 15% for the twenty consecutive trading days immediately preceding each earn-out measuring date (the “Target Rate”). The approximately $583,000 of loans outstanding as of June 30, 2004 could be forgiven and 72,223 shares of the Company’s common stock could be earned by, and subsequently transferred to, the Principals as of any July 1 between 2005 and 2007 if the return on the Company’s common stock exceeds the Target Rate.

Pursuant to the Contribution Agreement, the Company recognized approximately $1,433,000 and $1,505,000 of personnel expense for the three and six months ended June 30, 2004 and 2003, respectively, in the accompanying Condensed Consolidated Statements of Income. The 1997 Agreement had been executed in conjunction with the Company’s initial public offering. Amendment No. 1 changed certain terms of the 1997 Agreement that resulted in the recognition of expense for the loan forgiveness and the transfer of shares.

The loans to Principals of approximately $583,000 as of June 30, 2004, recorded as deduction from stockholders’ equity, are secured solely by an aggregate of 38,889 shares of Hanover’s common stock owned by the Principals and are otherwise nonrecourse to the Principals.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5. Reverse Repurchase Agreements

Information pertaining to individual reverse repurchase agreement lenders as of June 30, 2004 is summarized as follows (dollars in thousands):


			December 31,		Net			June 30,
	Maximum		2003		(Paydown)			2004		Underlying
Lender	Borrowing		Balance		Advance			Balance		Collateral		Type of Collateral

Lender A (committed)	$	20,000	$	5,358	$	2,210		$	7,568	$	11,839	Retained CMO Securities, Mortgage Securities
Lender B				4,680		(1,626	)		3,054		5,835		Mortgage Securities
Lender C				2,266		824			3,090		4,373		Mortgage Securities
Lender D				39,925		60,075			100,000		105,014		Mortgage Securities
Lender E				225		356			581		899		Mortgage Securities
Lender F				2,013		2,659			4,672		6,397		Mortgage Securities
Lender G				933		2,030			2,963		5,476		Mortgage Securities
Lender H				—		929			929		1,223		Mortgage Securities
Lender I				—		1,603			1,603		2,677		Mortgage Securities

Total			$	55,400	$	69,060		$	124,460	$	143,733

As of June 30, 2004, the weighted-average borrowing rate on the Company’s reverse repurchase agreements was 1.64%. With the exception of the first facility listed, all of the reverse repurchase borrowings are pursuant to uncommitted financing arrangements which are typically renewed monthly. The first facility listed matures on April 25, 2005.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6. Derivative Instruments

Interest Rate Caps (Freestanding Derivatives)

From time to time the Company buys interest rate caps when it finances fixed-rate assets with floating-rate reverse repurchase agreements and CMOs. As of June 30, 2004, the Company had three interest rate caps designated as freestanding derivatives. The objective in entering into these instruments is to protect the net interest margin, which represents the difference between the interest earned on assets and the interest paid on debt. Payments received on the interest rate caps are expected to partially offset increases in interest expense that could result from increases in interest rates. Currently, all three interest rate caps are indexed to LIBOR. The Company considers its interest rate caps designated as freestanding derivatives additional protection against the net interest margin although they have not been specifically designated hedging instruments for accounting purposes. The Company recognized approximately $5,000 and $171,000 of losses for the three and six months ended June 30, 2004, respectively, in the accompanying Condensed Consolidated Statements of Income for changes in the fair value of interest rate caps designated as freestanding derivatives. All of these interest rate caps relate to the payment of variable interest on existing financial instruments. As of June 30, 2004, the fair value of the Company’s interest rate caps, recorded as a component of other assets in the accompanying Condensed Consolidated Balance Sheet, was approximately $272,000.

Forward Sales of Agency Securities (Freestanding Derivatives)

For the six months ended June 30, 2004, the Company entered into forward sales of government agency guaranteed securities, known as Agency securities, to manage the exposure to changes in the value of securities classified as trading securities. The Company considers these forward sales to be freestanding derivatives. The objective is to offset gains or losses on the trading securities with comparable losses or gains on the forward sales. Generally, changes in the value of the trading securities are caused by changes in interest rates, changes in the market for mortgage-backed securities, and changes in the credit quality of the asset. Changes in interest rates and changes in the market for mortgage-backed securities will also affect the value of the forward sales of Agency securities. The Company does not attempt to hedge changes in the credit quality of individual assets. The Company calculates the expected impact that changes in interest rates and the market will have on the price of the trading securities and the forward sales. Using this information, the Company determines the amount of forward sales that it needs so that the expected gains or losses on trading securities will be offset by comparable losses or gains on the forward sales. The Company marks to market the gain or loss on all of the trading securities and all of the freestanding derivatives in each reporting period. The mark to market on the trading securities is reported as a component of gain (loss) on mark to market of mortgage assets in the accompanying Condensed Consolidated Statements of Income. The mark to market on the freestanding derivatives is reported as a component of other income (loss) in the accompanying Condensed Consolidated Statements of Income. The Company realized net losses on these freestanding derivatives of approximately $1,022,000 and $858,000, respectively, for the three and six months ended June 30, 2004. As of June 30, 2004, the Company had a liability of approximately $916,000, recorded as a component of other assets in the accompanying Condensed Consolidated Balance Sheet.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

7. Stockholders’ Equity and Earnings Per Share

Common Stock Issued and Outstanding

The activity in common stock issued and outstanding is summarized as follows:



			Three Months Ended					Six Months Ended
			June 30,					June 30,

			2004		2003			2004		2003

Beginning of period
	Issued and outstanding			8,228,322		4,532,402			8,192,903		4,474,222

Activity
	Shares repurchased			—		(29,276	)		—		(31,276	)
	Shares issued:
		Common stock paid for acquisition		—		—			35,419		60,180

	Net Activity			—		(29,276	)		35,419		28,904
End of period
	Issued and outstanding			8,228,322		4,503,126			8,228,322		4,503,126

Earnings Per Share

(dollars in thousands, except per share data)



		Three Months Ended				Six Months Ended
		June 30,				June 30,

		2004		2003		2004		2003

Basic earnings per share:
	Net income (numerator)	$	613	$	1,169	$	3,158	$	3,718

	Weighted-average common shares outstanding (denominator)		8,228,322		4,504,091		8,218,786		4,500,965

	Basic earnings per share	$	0.07	$	0.26	$	0.38	$	0.83

Diluted earnings per share:
	Net income (numerator)	$	613	$	1,169	$	3,158	$	3,718

	Weighted-average common shares outstanding		8,228,322		4,504,091		8,218,786		4,500,965
	Add: Incremental shares from assumed conversion of stock options		70,405		131,208		74,348		102,882

	Diluted weighted-average shares outstanding (denominator)		8,298,727		4,635,299		8,293,134		4,603,847

	Diluted earnings per share	$	0.07	$	0.25	$	0.38	$	0.81

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

8. Supplemental Disclosures for Statements of Cash Flows
(dollars in thousands, except share data)



			Six Months Ended
			June 30,

			2004		2003

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
	Cash paid during the period for:
		Income taxes	$	281	$	129

		Interest	$	1,634	$	2,435

SUPPLEMENTAL SCHEDULE OF NON-CASH ACTIVITIES
	35,419 shares of common stock paid for acquisition		$	494	$	—

	60,180 shares of common stock paid for acquisition		$	—	$	458

	Transfer of mortgage loans to real estate owned, net		$	—	$	75

9. Segment Reporting

As discussed in Note 1, the Company is engaged in three principal businesses which are conducted through its three primary operating units, each a reportable segment: Hanover, HCP and HT. Segment information is prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America. All significant intercompany accounts and transactions are eliminated in consolidation. In general, intercompany transactions are recorded on an arms-length basis. However, the interest rate on the notes receivable from HCP and HT to Hanover is determined on an incremental cost basis, which may be less than the interest rate HCP and HT would pay to a third party.

The principal business strategy of Hanover is to invest in subordinate mortgage-backed securities and, to a lesser extent, mortgage loans and to earn net investment income on these investments. The principal business strategy of HCP is to generate non-interest income by providing consulting and advisory services for third parties, including loan sale advisory services, loan file due diligence reviews, staffing solutions and mortgage assignment and collateral rectification services. HCP also owns an inactive mortgage banking entity and a registered broker/dealer; these two activities are not material and are combined with HCP for purposes of segment reporting. The principal business activity of HT is to generate non-interest income by providing loan sale advisory and traditional loan brokerage services, technology solutions and valuation services. HT also brokers loan pools, mortgage servicing rights and other similar assets through an Internet-based exchange. HT also owns an inactive broker/dealer whose activities are not material and are

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

combined with HT for segment reporting purposes. All of the Company’s revenues are attributed to activities conducted within the United States of America and its territories.



			Three Months Ended June 30, 2004 (dollars in thousands)

			Hanover Capital			Hanover Capital
			Mortgage Holdings, Inc.			Partners Ltd.			HanoverTrade, Inc.			Eliminations			Consolidated

REVENUES:
	Interest income		$	3,208		$	2		$	—		$	(86	)	$	3,124
	Interest expense			836			17			69			(86	)		836

		Net interest income		2,372			(15	)		(69	)		—			2,288
	Loan loss provision			9			—			—			—			9

		Net interest income after loan loss provision		2,363			(15	)		(69	)		—			2,279
	Gain on sale of mortgage assets			2,114			—			—			—			2,114
	Loss on mark to market of mortgage assets			(1,226	)		—			—			—			(1,226	)
	Due diligence fees			—			1,729			—			—			1,729
	Assignment fees			—			710			—			—			710
	Technology			—			—			238			—			238
	Loan brokering and advisory services			—			—			907			(5	)		902
	Other income			735			6			95			(23	)		813

		Total revenues		3,986			2,430			1,171			(28	)		7,559

		Total expenses		2,767			2,345			1,764			(28	)		6,848

		Operating income		1,219			85			(593	)		—			711
Equity in loss of HDMF-I LLC				(64	)		—			—			—			(64	)

Income before income tax provision				1,155			85			(593	)		—			647
Income tax provision				—			34			—			—			34

NET INCOME			$	1,155		$	51		$	(593	)	$	—		$	613



			Three Months Ended June 30, 2003 (dollars in thousands)

			Hanover Capital			Hanover Capital
			Mortgage Holdings, Inc.			Partners Ltd.			HanoverTrade, Inc.			Eliminations			Consolidated

REVENUES:
	Interest income		$	2,491		$	4		$	9		$	(72	)	$	2,432
	Interest expense			989			7			65			(72	)		989

		Net interest income		1,502			(3	)		(56	)		—			1,443
	Loan loss provision			14			—			—			—			14

		Net interest income after loan loss provision		1,488			(3	)		(56	)		—			1,429
	Gain on sale of mortgage assets			2,097			—			—			3			2,100
	Gain on mark to market of mortgage assets			8			10			—			—			18
	Due diligence fees			—			1,433			—			—			1,433
	Assignment fees			—			644			—			(3	)		641
	Technology			—			—			927			—			927
	Loan brokering and advisory services			—			283			939			(274	)		948
	Other income			(2	)		10			50			—			58

		Total revenues		3,591			2,377			1,860			(274	)		7,554

		Total expenses		2,567			2,279			1,756			(274	)		6,328

		Operating income		1,024			98			104			—			1,226
Equity in income of HDMF-I LLC				3			—			—			—			3

Income before income tax provision				1,027			98			104			—			1,229
Income tax provision				4			54			2			—			60

NET INCOME			$	1,023		$	44		$	102		$	—		$	1,169

HANOVER CAPITAL MORTGAGE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)



			Six Months Ended June 30, 2004 (dollars in thousands)

			Hanover Capital			Hanover Capital
			Mortgage Holdings, Inc.			Partners Ltd.			HanoverTrade, Inc.			Eliminations			Consolidated

REVENUES:
	Interest income		$	6,393		$	4		$	—		$	(170	)	$	6,227
	Interest expense			1,656			34			136			(170	)		1,656

		Net interest income		4,737			(30	)		(136	)		—			4,571
	Loan loss provision			20			—			—			—			20

		Net interest income after loan loss provision		4,717			(30	)		(136	)		—			4,551
	Gain on sale of mortgage assets			5,572			—			—			—			5,572
	Loss on mark to market of mortgage assets			(1,283	)		—			—			—			(1,283	)
	Due diligence fees			—			3,109			—			—			3,109
	Assignment fees			—			1,295			—			—			1,295
	Technology			—			—			626			—			626
	Loan brokering and advisory services			—			—			1,398			(5	)		1,393
	Other loss			(304	)		13			163			(33	)		(161	)

		Total revenues		8,702			4,387			2,051			(38	)		15,102

		Total expenses		4,093			4,560			3,338			(38	)		11,953

		Operating income		4,609			(173	)		(1,287	)		—			3,149
Equity in loss of HDMF-I LLC				(40	)		—			—			—			(40	)

Income before income tax benefit				4,569			(173	)		(1,287	)		—			3,109
Income tax benefit				—			(49	)		—			—			(49	)

NET INCOME			$	4,569		$	(124	)	$	(1,287	)	$	—		$	3,158



			Six Months Ended June 30, 2003 (dollars in thousands)

			Hanover Capital			Hanover Capital
			Mortgage Holdings, Inc.			Partners Ltd.			HanoverTrade, Inc.			Eliminations			Consolidated

REVENUES:
	Interest income		$	4,943		$	9		$	18		$	(143	)	$	4,827
	Interest expense			2,274			14			129			(143	)		2,274

		Net interest income		2,669			(5	)		(111	)		—			2,553
	Loan loss provision			30			—			—			—			30

		Net interest income after loan loss provision		2,639			(5	)		(111	)		—			2,523
	Gain on sale of mortgage assets			4,759			—			—			369			5,128
	Gain on mark to market of mortgage assets			8			10			—			—			18
	Due diligence fees			—			2,752			—			—			2,752
	Assignment fees			—			1,244			—			(30	)		1,214
	Technology			—			—			1,812			—			1,812
	Loan brokering and advisory services			—			284			1,673			(613	)		1,344
	Other income			(21	)		35			91			—			105

		Total revenues		7,385			4,320			3,465			(274	)		14,896

		Total expenses		3,605			4,291			3,432			(274	)		11,054

		Operating income		3,780			29			33			—			3,842
Equity in loss of HDMF-I LLC				(40	)		—			—			—			(40	)

Income before income tax provision				3,740			29			33			—			3,802
Income tax provision				45			37			2			—			84

NET INCOME			$	3,695		$	(8	)	$	31		$	—		$	3,718

10. Subsequent Events

On August 10, 2004, the Board of Directors declared a $0.30 per share cash dividend for the quarter ended June 30, 2004 to be paid on August 24, 2004 to stockholders of record as of August 17, 2004.


Item 2.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*

Important Factors Related to Forward-Looking Statements and Associated Risks

The following section, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” should be read in conjunction with the financial statements, related notes, and other detailed information included elsewhere in this Quarterly Report on Form 10-Q. This report contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our current expectations, intentions or beliefs regarding future events or trends, including, without limitation, statements containing the words “believes,” “anticipates,” “expects,” “intends,” “assumes,” “will,” or other similar expressions; and also including, without limitation, the following: statements regarding our continuing ability to target, price and acquire mortgage-backed securities, which we refer to as MBS, or mortgage loans; our estimated loan loss reserves; our ability to manage and hedge the risks associated with our investments; assumptions regarding interest rates and their effect on our hedging strategies; assumptions regarding prepayment and default rates on the mortgage loans securing our MBS and their effect on our hedging strategies; the liquidity of our portfolios and our ability to invest currently liquid assets; the expected future performance of Hanover Capital Partners and HanoverTrade, which we refer to as HCP and HT, and their need for additional capital; continuing availability of the master reverse repurchase agreement financing or other financing; the sufficiency of our working capital, cash flows and financing to support our future operating and capital requirements; results of operations and overall financial performance; the expected dividend distribution rate; our ability to enter into additional asset management contracts with third parties; our expectations regarding the effects of accounting rules and changes thereto; changes in government regulations affecting our business; and the expected tax treatment of our operations. Such forward-looking statements relate to future events and our future financial performance and involve known and unknown risks, uncertainties and other important factors, many of which are beyond our control, which could cause actual results, performance or achievements to differ materially from those expressed or implied by such forward-looking statements.

In light of the risks and uncertainties inherent in all such projected operational matters, the inclusion of forward-looking statements in this report should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that any of our operating expectations will be realized. Our revenues and results of operations are difficult to forecast and could differ materially from those projected in the forward-looking statements contained in this report as a result of certain risks and uncertainties including, but not limited to: changes in interest rates and the yield curve; management of growth; changes in prepayment rates or default rates on our mortgage assets; our ability to borrow at favorable rates and terms; changes in business conditions and the general economy; our dependence on effective information-systems technology; potential declines in our ability to locate and acquire desirable investments; changes in the real estate market both locally and nationally; the effectiveness of our hedging and other efforts to mitigate the risks of our investments; the effects of default, bankruptcy and severe weather or natural disasters on the ability of borrowers to repay mortgages included in our asset pools; enforceability and collectibility of non-standard single-family mortgage loans; our ability to retain key employees; our ability to maintain our qualification for exemption from registration as an investment company; our ability to obtain and maintain all licenses necessary to our business; competition from other financial institutions, including other mortgage real estate investment trusts, or REITs; and the possible changes in tax and other laws applicable to REITs or our inability to maintain compliance with such rules and to continue to qualify as a REIT. Investors should carefully consider the various factors identified in “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2003 that could cause actual results to differ materially from the results predicted in the forward-looking statements. These factors should not be considered exhaustive; we undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview

We are a specialty finance company organized in June 1997 as a REIT. As of June 30, 2004, we had two principal consolidated subsidiaries, HCP and HT.

Hanover’s principal business strategy is to invest in subordinate mortgage-backed securities, which we refer to as MBS, and, to a lesser extent, mortgage loans and to earn net interest income on these investments. HCP’s principal business strategy is to generate consulting and other non-interest income by performing loan sale advisory services, loan file due diligence reviews, staffing solutions and mortgage assignment and collateral rectification services. HT’s principal business strategy is to generate non-interest income by providing loan sale advisory and traditional loan brokerage services, technology solutions and valuation services. HT also brokers loan pools, mortgage servicing rights and other similar assets through an Internet-based exchange. In addition, Hanover has an equity interest in HDMF-I LLC, a limited liability company formed to purchase, service, manage or otherwise liquidate pools of primarily sub- and non-performing one-to-four family residential mortgage loans.

Hanover operates as a tax-advantaged REIT and is generally not subject to Federal and state income tax to the extent that it distributes its taxable earnings to its stockholders and maintains its qualification as a REIT. Hanover’s taxable affiliates, however, are subject to Federal and state income tax.

In conducting our business, we retain credit risk primarily through (i) the purchase of subordinate mortgage-backed securities, (ii) the retention of subordinate securities from our own securitization transactions, (iii) the direct investment in mortgage loans on our own behalf and (iv) investment in HDMF-I LLC. Through these investing activities, we generally bear the credit losses on the related pools of mortgage loans up to their carrying value. During the time we hold mortgage assets for investment, we are subject to the risks of borrower defaults and bankruptcies and hazard losses (such as those occurring from earthquakes or floods) that are not covered by insurance. If a default occurs on any mortgage loan held by us or on any mortgage loan collateralizing below-investment-grade MBS held by us, we will bear the risk of loss of principal to the extent of any deficiency between the value of the mortgaged property, plus any payments from an insurer or guarantor, and the amount owing on the mortgage loan.

As of June 30, 2004, we retain the aggregate credit risk on approximately $28.3 billion of mortgage loans relating to (dollars in thousands):


		Principal		Carrying
		Balance		Value		Financing

Mortgage loans:
	Held for sale	$	184	$	184	$	—
	Collateral for CMOs		48,506		48,284		43,535
Mortgage securities pledged as collateral for reverse repurchase agreements:
	Available for sale		76,936		45,003		29,716
	Trading		97,371		96,757		93,403
Mortgage securities, not pledged:
	Available for sale		30,249		15,759		—

		$	253,246	$	205,987	$	166,654

Critical Accounting Policies

The significant accounting policies used in preparation of our financial statements are more fully described in Note 2 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2003. Certain critical accounting policies are complex and involve significant judgment by our management, including the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. As a result, changes in these estimates and assumptions could significantly affect our financial position or our results of operations. We base our estimates on historical

experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe that of our significant accounting policies, the following involve a high degree of judgment and complexity in the preparation of our consolidated financial statements:

Mortgage Securities — Our mortgage securities are designated as either available for sale, trading or held to maturity. Mortgage securities designated as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. Mortgage securities designated as trading are reported at estimated fair value. Gains and losses resulting from changes in fair value are recorded as income or expense and included in earnings. Mortgage securities classified as held to maturity are carried at amortized cost unless a decline in value is deemed other-than-temporary, in which case the carrying value is reduced. Because our assets are generally not traded on a national securities exchange or national automated quotation system and prices are therefore not readily ascertainable, complex cash flow modeling is performed in determining their estimated fair value. Several of the assumptions used by management are confirmed by independent third parties on at least a quarterly basis. In using cash-flow analysis to determine fair value, future cash flows are based on estimates of prepayments, the impact of interest rate movements on yields, delinquency of the underlying loans and estimated probable losses based on historical experience and estimates of expected future performance. As a result, a high degree of judgment is required in estimating the assumptions used in the cash flow analysis. Assumptions are reviewed in light of market expectations adjusted for our experience. Such assumptions directly impact the fair values of our securities and their effective yields. To the extent that management’s assumptions do not reflect market expectations, the value of our portfolio may be adversely impacted.

Revenue Recognition — We recognize revenue from due diligence contracts in progress and long-term technology consulting contracts as they are earned. To calculate what percentage of the total revenue of a contract has been earned, management must make estimates. As the majority of these revenues relate to services performed, such estimates may include the amount of time spent by individuals in consideration of the aggregate amount of time required to complete the contract, the evaluation of both quantitative and qualitative criteria as agreed to and maintained in the contract and possibly regulations set forth by the government should the contract be with an agency of the Federal government.

We recognize revenue from loan brokering and advisory services when the transactions close and fund, at which time fees are earned. At the time of closing a transaction, the number of loans, loan principal balance and purchase price in the transaction are agreed upon, documentation is signed and the sale is funded.

Results of Operations

The following table presents the unaudited condensed consolidated results of operations for the three and six months ended June 30, 2004 and 2003 (dollars in thousands, except per share data):



		Three Months Ended						Six Months Ended
		June 30,						June 30,

		2004			2003			2004			2003

Net interest income		$	2,288		$	1,443		$	4,571		$	2,553
Loan loss provision			(9	)		(14	)		(20	)		(30	)
Gain on sale of mortgage assets			2,114			2,100			5,572			5,128
(Loss) gain on mark to market of mortgage assets			(1,226	)		18			(1,283	)		18
Due diligence fees			1,729			1,433			3,109			2,752
Assignment fees			710			641			1,295			1,214
Technology			238			927			626			1,812
Loan brokering and advisory services			902			948			1,393			1,344
Other income (loss)			813			58			(161	)		105

	Total revenues		7,559			7,554			15,102			14,896
	Total expenses		6,848			6,328			11,953			11,054

	Operating income		711			1,226			3,149			3,842
Equity in (loss) income HDMF-I LLC			(64	)		3			(40	)		(40	)

Income before income tax provision (benefit)			647			1,229			3,109			3,802
Income tax provision (benefit)			34			60			(49	)		84

Net income		$	613		$	1,169		$	3,158		$	3,718

Basic earnings per share		$	0.07		$	0.26		$	0.38		$	0.83

Diluted earnings per share		$	0.07		$	0.25		$	0.38		$	0.81

Dividends declared per share		$	0.30		$	0.30		$	0.70	(1)	$	0.45	(2)

(1) Includes $0.40 special dividend declared, paid and taxable in the first quarter of 2004.

(2) Includes $0.15 special dividend declared, paid and taxable in the first quarter of 2003.


	*Net Income, Diluted Earnings Per Share and Total Revenues*

We recorded net income of approximately $613,000 or $0.07 per share based on 8,298,727 diluted weighted-average shares of common stock outstanding for the three months ended June 30, 2004 compared to net income of approximately $1,169,000 or $0.25 per share based on 4,635,299 diluted weighted-average common shares outstanding for the three months ended June 30, 2003. We recorded net income of approximately $3,158,000 or $0.38 per share based on 8,293,134 diluted weighted-average shares of common stock outstanding for the six months ended June 30, 2004 compared to net income of approximately $3,718,000 or $0.81 per share based on 4,603,847 diluted weighted-average common shares outstanding for the six months ended June 30, 2003. Total revenues for the three months ended June 30, 2004 was approximately $7,559,000 compared to approximately $7,554,000 previously reported for the same period in 2003. Total revenues for the six months ended June 30, 2004 was approximately $15,102,000 compared to approximately $14,896,000 previously reported for the same period in 2003.

Included in net income for the three and six months ended June 30, 2004 was approximately $1,433,000 or $0.17 per share of expense for the forgiveness of loans from, and the transfer of shares to, four executive officers. For the same periods in 2003 we recorded approximately $1,505,000 or $0.32 and $0.33 per share for the first of such loan forgiveness and shares transfer. A third and final forgiveness of loans and transfer of shares could occur on any July 1 between 2005 and 2007 if the compound rate of return on our common stock, including dividend distributions, exceeds 15% per year over a base stock price established in 2002.


	*Net Interest Income*

The following table provides details of net interest income and loan loss provision for interest earning assets as follows (dollars in thousands):

Net Interest Income



	Three Months Ended June 30,										Six Months Ended June 30,


	2004					2003					2004					2003

	Net		Loan			Net		Loan			Net		Loan			Net		Loan
	Interest		Loss			Interest		Loss			Interest		Loss			Interest		Loss
	Income		Provision			Income		Provision			Income		Provision			Income		Provision

Mortgage loans	$	3	$	—		$	37	$	—		$	17	$	—		$	53	$	—
CMO collateral		211		(9	)		382		(14	)		481		(20	)		780		(30	)
Agency-issued MBS		443		—			168		—			777		—			174		—
Subordinate MBS		1,575		—			788		—			3,159		—			1,412		—
Other		56		—			68		—			137		—			134		—

Total net interest income	$	2,288	$	(9	)	$	1,443	$	(14	)	$	4,571	$	(20	)	$	2,553	$	(30	)

Net interest income increased to approximately $2,288,000, or $0.28 per share, for the three months ended June 30, 2004 from approximately $1,443,000, or $0.31 per share, as previously reported for the same period in 2003. The increase in net interest income of approximately $845,000 was primarily due to:

• the decrease in the average balance of our mortgage loans held as collateral for collateralized mortgage obligations, called CMOs, offset by decreased borrowing costs on our corresponding CMO liabilities and reverse repurchase agreements;

• the purchase of Agency-issued MBS; and

• the increase in the average balance of our purchased subordinate MBS portfolio.

Agency-issued MBS net interest income increased primarily due to the purchase of Agency-issued MBS during the second quarter of 2004. The average balance of our Agency-issued MBS portfolio increased to approximately $49,319,000 for the second quarter 2004 from approximately $18,402,000 for the second quarter 2003.

Subordinate MBS net interest income increased primarily due to the purchase of subordinate MBS during the second quarter of 2004. The average balance of our subordinate MBS portfolio increased to approximately $53,140,000 for the second quarter 2004 from approximately $20,274,000 for the second quarter 2003.

Net interest income increased to approximately $4,571,000, or $0.55 per share, for the six months ended June 30, 2004 from approximately $2,553,000, or $0.55 per share, as previously reported for the same period in 2003. The increase in net interest income of approximately $2,018,000 was primarily due to:

• the decrease in the average balance of our mortgage loans held as collateral for CMOs offset by decreased borrowing costs on our corresponding CMO liabilities and reverse repurchase agreements;

• the increase in the average balance of our Agency-issued MBS portfolio; and

• the increase in the average balance of our purchased subordinate MBS portfolio.

Agency-issued MBS net interest income increased primarily due to the purchase of Agency-issued MBS during the six months ended June 30, 2004. The average balance of our Agency-issued MBS portfolio increased to approximately $43,801,000 for the six months ended June 30, 2004 from approximately $9,662,000 for the six months ended June 30, 2003.

Subordinate MBS net interest income increased primarily due to the purchase of subordinate MBS during the six months ended June 30, 2004. The average balance of our subordinate MBS portfolio increased to approximately $49,271,000 for the six months ended June 30, 2004 from approximately $17,578,000 for the six months ended June 30, 2003.

Our provision for loan losses decreased to approximately $9,000 for the three months ended June 30, 2004 from approximately $14,000 for the same period in 2003 and approximately $20,000 for the six months ended June 30, 2004 from approximately $30,000 for the same period in 2003. The decreases for the three and six months ended June 30, 2004 compared to similar periods last year were primarily the result of a reduction in the average balance of collateral for CMOs.


	*Gain on Sale and Mark to Market of Mortgage Assets*

Our results for the three months ended June 30, 2004 include a gain on sale of mortgage assets of approximately $2,114,000 compared to approximately $2,100,000 for the same period in 2003. During the three months ended June 30, 2004, we sold approximately $16,002,000 principal balance of subordinate MBS as compared to sales of approximately $8,084,000 principal balance of subordinate MBS during the same period in 2003.

Our results for the six months ended June 30, 2004 include a gain on sale of mortgage assets of approximately $5,572,000 compared to approximately $5,128,000 for the same period in 2003. The gain on sale for the six months ended June 30, 2003 primarily represents the sales of mortgage loans that supported certain CMOs, which we referred to as Hanover 1998-A and Hanover 1998-B. These sales resulted in a gain of approximately $2,810,000. During the six months ended June 30, 2004, we sold approximately $44,941,000 principal balance of subordinate MBS as compared to sales of approximately $12,520,000 principal balance of subordinate MBS during the same period in 2003. We cannot assure you that we will be able to recognize gain on sale in the future.

Our purchased subordinate MBS portfolio is primarily comprised of non-investment-grade securities. These securities are generally purchased at a substantial discount to their principal balance to reflect their inherent credit risk. To the extent that actual losses on the mortgage asset are less than the discount, the discount provides a yield enhancement. We seek to reduce credit risk by actively monitoring our portfolio for delinquency trends and due to such monitoring we may, from time to time, decide to sell a security in order to mitigate potential losses.

For the three and six months ended June 30, 2004, we recognized mark to market losses on mortgage assets classified as trading securities through the accompanying Condensed Consolidated Statements of Income of approximately $1,170,000 and $591,000, respectively. However, these mark to market losses on trading securities are substantially economically offset by the net interest income from these investments as well as other income from forward sales of like kind securities classified as freestanding derivatives used to manage the exposure to changes in the value of such trading securities. We attempt to fully economically hedge our trading securities portfolio to potentially offset any gains or losses in our portfolio with losses or gains from our freestanding derivatives. Our trading securities are utilized for certain balance sheet requirements. For the three and six months ended June 30, 2004, we recognized approximately $443,000 and $777,000, respectively, of net interest income on such trading securities. For the same periods, we recognized $722,000 of gains and $178,000 of losses on these forward sales. As a result of our trading securities portfolio and economically related forward sales, the total impact in our Condensed Consolidated Statements of Income for the three and six months ended June 30, 2004 was an economic loss of approximately $5,000 and an economic gain of approximately $7,000, respectively.


	*Other Revenue*

Revenues from technology decreased to approximately $238,000 for the three months ended June 30, 2004 from approximately $927,000 for the same period in 2003. Revenues from technology decreased to approximately $626,000 for the six months ended June 30, 2004 from $1,812,000 for the same period in 2003. Technology revenue is derived from the licensing of our proprietary software and consulting services

performed in connection with such licenses. Our technology revenue for the three and six months ended June 30, 2003 primarily consisted of large contracts from two and three customers, respectively, that were substantially completed in 2003 for which no corresponding contracts existed during the same periods in 2004. In general, the sales cycle for our technology contracts has been between twelve to eighteen months. Accordingly, as we continue to sign new contracts we expect our technology revenue to vary significantly.


	*Operating Expenses*

Operating expenses for the three months ended June 30, 2004 were approximately $6,848,000 compared to approximately $6,328,000 for the same period in 2003. Our most significant operating expenses were personnel, subcontractor and legal and professional.

Personnel expense was $3,709,000 for the three months ended June 30, 2004 compared to $3,725,000 for the same period last year. Personnel expense included compensation expense of approximately $1,433,000 and $1,505,000 for the three month periods ended June 30, 2004 and 2003, respectively, related to the forgiveness of loans from, and the transfer of shares to, four executive officers. Such loan forgiveness and transfer of shares were made pursuant to an amended Contribution Agreement that had been executed in conjunction with our initial public offering in 1997.

Subcontractor expense for the three months ended June 30, 2004 increased to approximately $1,128,000 compared to approximately $933,000 for the same period last year. The increase in subcontractor expense is primarily due to an increase in the number of due diligence projects in the second quarter of 2004 as compared to the same period in 2003. In addition, the mix of due diligence projects have continued to require an increase in the use of subcontractors for the second quarter 2004 as compared to the second quarter 2003.

Legal and professional expense increased to approximately $820,000 for the three months ended June 30, 2004 compared to $379,000 for the same period last year. The increase in legal and professional expense is primarily due to additional legal and accounting costs incurred as a result of our former independent auditors’ decision not to stand for re-election and the subsequent appointment of Grant Thornton LLP as our new independent auditor. In addition, we have incurred professional expense relating to our plan to achieve compliance under Section 404 of the Sarbanes-Oxley Act of 2002 as of December 31, 2004.

Operating expenses for the six months ended June 30, 2004 were approximately $11,953,000 compared to approximately $11,054,000 for the same period in 2003. Our most significant operating expenses were personnel, subcontractor and legal and professional.

Personnel expense was $6,014,000 for the six months ended June 30, 2004 compared to $5,903,000 for the same period last year. Personnel expense included compensation expense of approximately $1,433,000 and $1,505,000 for the six month periods ended June 30, 2004 and 2003, respectively, related to the forgiveness of loans from, and the transfer of shares to, four executive officers. Such loan forgiveness and transfer of shares were made pursuant to an amended Contribution Agreement that had been executed in conjunction with our initial public offering in 1997.

Subcontractor expense for the six months ended June 30, 2004 increased to approximately $2,177,000 compared to approximately $1,873,000 for the same period last year. The increase in subcontractor expense is primarily due to an increase in the number of due diligence projects in the first six months of 2004 as compared to the same period in 2003. In addition, the mix of due diligence projects have continued to require an increase in the use of subcontractors for the first six months of 2004 as compared to the first six months of 2003.

Legal and professional expense increased to approximately $1,407,000 for the six months ended June 30, 2004 compared to $775,000 for the same period last year. The increase in legal and professional expense is primarily due to additional legal and accounting costs incurred as a result of our former independent auditors’ decision not to stand for re-election and the subsequent appointment of Grant Thornton LLP as our new independent auditor. In addition, we have incurred professional expense relating to our plan to achieve compliance under Section 404 of the Sarbanes-Oxley Act of 2002 as of December 31, 2004.

Taxable Income

Our taxable income for the quarter ended June 30, 2004 is estimated at approximately $1,279,000. Taxable income differs from GAAP net income due to various recurring and one-time book/tax differences. The following table details the major book/tax differences in arriving at the estimated taxable income (dollars in thousands):


GAAP net income		$	613
	GAAP gain on sale of mortgage securities		(1,619	)
	Tax gain on sale of mortgage securities		1,894
	Loan loss provision, net of realized losses		9
	Loss in subsidiaries not included in taxable income		542
	Bonus expense, net of payments		(115	)
	Other		(45	)

Estimated taxable income		$	1,279

We believe that estimated taxable income provides useful information to investors because it provides information relating to our dividends and REIT status.

As a REIT, we are required to pay dividends amounting to 85% of each year’s taxable ordinary income and 95% of the portion of each year’s capital gain net income that is not taxed at the REIT level, by the end of each calendar year and to have declared dividends amounting to 90% of our REIT taxable income for each year by the time we file our Federal tax return. Therefore, a REIT generally passes through substantially all of its earnings to shareholders without paying Federal income tax at the corporate level.

If we fail to qualify as a REIT in any taxable year and certain relief provisions of the Code do not apply, we will be subject to Federal income tax as a regular, domestic corporation, and our stockholders will be subject to tax in the same manner as stockholders of a regular corporation. Distributions to our stockholders in any year in which we fail to qualify as a REIT would not be deductible by us in computing our taxable income. As a result, we could be subject to income tax liability, thereby significantly reducing or eliminating the amount of cash available for distribution to our stockholders. Further, we could also be disqualified from re-electing REIT status for the four taxable years following the year during which we became disqualified. At the same time, complying with REIT requirements may limit our ability to hedge our risks, or enter into otherwise attractive investments.

Liquidity and Capital Resources

We expect to meet our future short-term and long-term liquidity requirements generally from our existing working capital, cash flow provided by operations, reverse repurchase agreements and other possible sources of longer-term financing, including CMOs and REMICs. We consider our ability to generate cash to be adequate to meet operating requirements both in the short-term and the long-term. However, we have exposure to market-driven liquidity events due to the short-term reverse repurchase financing we have in place against our MBS. If a significant decline in the market value of our portfolio should occur, our available liquidity from existing sources and ability to access additional sources of credit could be reduced. As a result of such a reduction in liquidity, we may be forced to sell certain investments or incur debt to maintain liquidity. If required, these sales could be made at prices lower than the carrying value of such assets, which could result in losses. As of June 30, 2004, we had one $20 million committed reverse repurchase line of credit with approximately $12.4 million available and eight uncommitted lines of credit. We may seek to establish additional committed and uncommitted lines of credit in the future. We cannot assure you that we will be successful in obtaining such additional financing on favorable terms, if at all.

We intend to access the capital markets in 2004 to raise additional capital. Any new capital raised will be used primarily to invest in subordinate MBS.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*

We use certain derivative financial instruments as economic hedges of anticipated transactions relating to our mortgage loans and mortgage securities.

From time to time, we enter into forward sales of mortgage securities issued by Federal agencies to manage our exposure to market pricing changes in connection with the purchase, holding, securitization and sale of our fixed-rate mortgage loan portfolio and other mortgage securities. We generally close out the forward sale to coincide with the related sale or securitization transaction. As such economic hedges are considered freestanding derivatives for accounting purposes, we recognize changes in the fair value of such derivatives in earnings in the period of change. As of June 30, 2004, the Company had a liability of approximately $916,000, representing the fair value of its six forward commitments to sell or buy Agency-issued mortgage securities.

The primary risk associated with short-selling Agency-issued mortgage securities relates to changes in interest rates. Generally, as market interest rates increase, the market value of the economically hedged asset (fixed-rate mortgage loans) will decrease. The net effect of increasing interest rates will generally be a favorable or gain settlement on the forward sale of the Agency-issued security; this gain should offset a corresponding decline in the value of the economically hedged assets. Conversely, if interest rates decrease, the market value of the economically hedged asset will generally increase. The net effect of decreasing interest rates will generally be an unfavorable or loss settlement on the forward sale of the Agency-issued security; this loss should be offset by a corresponding gain in value of the economically hedged assets. To mitigate interest rate risk, an effective matching of Agency-issued securities with the economically hedged assets needs to be monitored closely. Senior management monitors the changes in weighted average duration and coupons of the economically hedged assets and will appropriately adjust the amount, duration and coupon of future forward sales of Agency-issued securities.

We also enter into interest rate caps to manage our interest rate exposure on certain reverse repurchase agreement financing and floating rate CMOs. Interest rate caps are designated as freestanding derivatives for accounting purposes, and accordingly, changes in fair value are recognized in earnings in the period of change.

As of June 30, 2004, we had the following interest rate caps in effect (dollars in thousands):


Notional
Amount	Index	Strike %			Maturity Date	Accounting Designation

$15,000	1 Month LIBOR		7.75	%	August 2004	Freestanding Derivative
27,500	1 Month LIBOR		5.00	%	October 2006	Freestanding Derivative
20,000	1 Month LIBOR		6.00	%	November 2008	Freestanding Derivative

$62,500

The interest rate caps provide an economic hedge of our cost of funds for interest rates that exceed the strike rate, subject to the limitation of the notional amount of financing. The primary risk associated with interest rate caps relates to interest rate increases. As of June 30, 2004, the fair value of our interest rate caps was approximately $272,000, which is also the maximum potential loss exposure due to unfavorable market movements.

Interest Rate Sensitivity

Interest Rate Mismatch Risk — Reverse Repurchase Financing

As of June 30, 2004, we owned approximately $184,000 of mortgage loans held for sale. In the future, if we resume our strategy of purchasing mortgage loans for our own account, we would finance these assets during the initial period (the time period during which management analyzes the loans in detail and corrects deficiencies where possible before securitizing the loans) with reverse repurchase agreement financing or with equity. In this scenario, we would be exposed to the mismatch between the cost of funds on our reverse repurchase agreement financing and the yield on the mortgage loans as in many cases, the income from our assets would respond more slowly to interest rate fluctuations than the cost of our

borrowings. Our reverse repurchase agreement financing as of June 30, 2004 was indexed to LIBOR plus a spread of 40 to 200 basis points. This financing generally is rolled and matures every 30 days.

Accordingly, any increases in LIBOR will tend to reduce net interest income and any decreases in LIBOR will tend to increase net interest income.

Price Risk

The market value of mortgage loans and mortgage securities will fluctuate with changes in interest rates. In the case of mortgage loans held for sale and mortgage securities available for sale or held for trading, we will be required to record changes in the market value of such assets. In the case of mortgage loans held for sale and mortgage securities held for trading, we generally attempt to economically hedge these changes through the short sale of mortgage securities, described above. As of June 30, 2004, we did not have any significant mortgage loans held for sale. We attempt to mitigate price risk related to our mortgage securities held for trading with the short sale of mortgage securities described above.

Prepayment Risk

Interest income on the mortgage loan and mortgage securities portfolio is also negatively affected by prepayments on mortgage loan pools or MBS purchased at a premium and positively impacted by prepayments on mortgage loan pools or MBS purchased at a discount. We assign an anticipated prepayment speed to each mortgage pool and MBS at the time of purchase and record the appropriate amortization of the premium or discount over the estimated life of the mortgage loan pool or MBS. To the extent the actual prepayment speeds vary significantly from the anticipated prepayment speeds for an extended period of time, we will adjust the anticipated prepayment speeds and amortization of the premium or discount accordingly. This will negatively (in the case of accelerated amortization of premiums or decelerated amortization of discounts) or positively (in the case of decelerated amortization of premiums or accelerated amortization of discounts) impact net interest income.

Securitized Mortgage Loan Assets

With respect to the matched funding of assets and liabilities, the CMO collateral relating to the 1999-A, 1999-B and 2000-A securitizations reflect approximately $28,176,000 of fixed-rate mortgage loans and approximately $20,108,000 of adjustable-rate mortgage loans. The primary financing for this asset category is the CMO debt of approximately $42,194,000 and reverse repurchase agreements of approximately $1,341,000. The reverse repurchase agreement financing, which is indexed to LIBOR, is subject to interest rate volatility as the reverse repurchase agreement matures and is extended. The financing provided by the CMOs for the 1999-A and 2000-A securitizations lock in long-term fixed financing and thereby eliminates most interest rate risk. The financing for the 1999-B securitization is indexed to LIBOR. Accordingly, we have hedged this interest rate risk through the purchase of an interest rate cap. We own an interest rate cap with a notional balance of $27.5 million until October 2004, $23.5 million until October 2005 and $20 million until October 2006.

Mortgage Securities

As of June 30, 2004, we owned certain fixed-rate and adjustable-rate subordinated MBS with an aggregate carrying value of approximately $60,762,000. The coupon interest rates on the fixed-rate mortgage securities would not be affected by changes in interest rates. Net interest income on the mortgage securities portfolio would be negatively affected by prepayments on mortgage loans underlying the mortgage securities and would further be negatively affected to the extent that higher rated coupon mortgage loans paid off more rapidly than lower rated coupon mortgage loans.

The coupon interest rates on the adjustable-rate mortgage securities would be affected by changes in interest rates that would directly affect the amount of interest income we recognize in earnings. However, increases or decreases in the interest rates on the mortgage loans underlying our subordinate MBS may be limited to between 1% and 5% per adjustment period.

Item 4. Controls and Procedures

(a) As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC filings.

(b) During the second quarter of 2004 we revised our existing policy that requires us to obtain our independent auditors’ acknowledgement of their understanding of and agreement with our application of accounting principles generally accepted in the United States of America to complex issues prior to such application. The revision adds the requirement that we obtain our independent auditors’ written acknowledgement thereof prior to such application. There have been no other changes in our internal control over financial reporting that occurred during the second quarter of 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION


Item 1.	*Legal Proceedings*

From time to time, we are involved in litigation incidental to the conduct of our business. We are not currently a party to any lawsuit or proceeding which, in the opinion of management, is likely to have a material adverse effect on our business, financial condition or results of operations.


Item 2.	*Changes in Securities and Use of Proceeds*

Not applicable.


Item 3.	*Defaults Upon Senior Securities*

Not applicable.


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

We held our annual meeting of stockholders on May 20, 2004. 8,228,322 shares of our common stock were outstanding and entitled to vote at the annual meeting, and 7,834,389 shares were represented at the annual meeting in person or by proxy. The following matters were voted upon at the annual meeting:

(a) The following members were re-elected to the Board of Directors:


Terms Expiring in 2007	Votes For		Votes Withheld

Joseph J. Freeman		7,153,871		680,518
Douglas L. Jacobs		7,710,922		123,467
George J. Ostendorf		7,161,559		672,830
John N. Rees		7,157,960		676,429

The six other members of the Board of Directors will continue in office after the annual meeting for the following terms:

Terms expiring in 2005: James F. Stone, Joyce S. Mizerak and Irma N. Tavares.

Terms expiring in 2006: John A. Burchett, John A. Clymer and Saiyid T. Naqvi.

(b) The appointment of Grant Thornton LLP as independent accountants to audit and report on our financial statements for fiscal year 2004 was ratified by the stockholders with the following vote:


Votes For		Votes Against		Abstentions

	7,776,758		39,096		18,535

There were no broker non-votes.


Item 5.	*Other Information*

Not applicable.


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

(a) Exhibits

The exhibits listed on the Exhibit Index, which appears immediately following the signature page below, are included or incorporated by reference herein.

(b) Reports on Form 8-K

On May 26, 2004, we furnished on Form 8-K a press release relating to our financial performance for the first quarter 2004 and other matters.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

HANOVER CAPITAL MORTGAGE HOLDINGS, INC.

By: /s/ JOHN A. BURCHETT

John A. Burchett

President and Chief Executive Officer

Chairman of the Board of Directors

(Principal Executive Officer)

Dated: August 12, 2004

By: /s/ J. HOLLY LOUX

J. Holly Loux

Chief Financial Officer

(Principal Financial and

Accounting Officer)

Dated: August 12, 2004

EXHIBIT INDEX


Exhibit		Description

2.1(7)		Stock Purchase Agreement dated as of July 1, 2002 by and between Registrant, John A. Burchett, Joyce S. Mizerak, George J. Ostendorf and Irma N. Tavares
3.1(8)		Amended Articles of Incorporation of Registrant, as amended
3.2(1)		Bylaws of Registrant
4.1(1)		Specimen Common Stock Certificate of Registrant
10.3(1)		Registration Rights Agreement
10.5(1)		Agreement and Plan of Recapitalization
10.6(1)		Bonus Incentive Compensation Plan
10.7(1)		1997 Executive and Non-Employee Director Stock Option Plan
10.7.1(3)		1999 Equity Incentive Plan
10.8(7)		Amended and Restated Employment Agreement effective as of July 1, 2002, by and between Registrant and John A. Burchett
10.8.1(7)		Stock Option Agreement effective as of July 1, 2002 between Registrant and John A. Burchett
10.9(7)		Amended and Restated Employment Agreement effective as of July 1, 2002, by and between Registrant and Irma N. Tavares
10.9.1(7)		Stock Option Agreement effective as of July 1, 2002 between Registrant and Irma N. Tavares
10.10(7)		Amended and Restated Employment Agreement effective as of July 1, 2002, by and between Registrant and Joyce S. Mizerak
10.10.1(7)		Stock Option Agreement effective as of July 1, 2002 between Registrant and Joyce S. Mizerak
10.11(7)		Amended and Restated Employment Agreement effective as of July 1, 2002, by and between Registrant and George J. Ostendorf
10.11.1(7)		Stock Option Agreement effective as of July 1, 2002 between Registrant and George J. Ostendorf
10.11.2(6)		Employment Agreement by and between Registrant and Thomas P. Kaplan
10.11.3(9)		Stock Purchase Agreement as of December 13, 2002 between Thomas P. Kaplan and Hanover Capital Mortgage Holdings, Inc.
10.11.4(10)		Stock Purchase Agreement as of March 31, 2003 between John A. Burchett and Hanover Capital Mortgage Holdings, Inc.
10.11.5(10)		Stock Purchase Agreement as of March 31, 2003 between George J. Ostendorf and Hanover Capital Mortgage Holdings, Inc.
10.13(1)		Office Lease Agreement, dated as of March 1, 1994, by and between Metroplex Associates and Hanover Capital Mortgage Corporation, as amended by the First Modification and Extension of Lease Amendment dated as of February 28, 1997
10.13.1(9)		Second Modification and Extension of Lease Agreement dated April 22, 2002
10.13.2(9)		Third Modification of Lease Agreement dated May 8, 2002
10.13.3(9)		Fourth Modification of Lease Agreement dated November 2002
10.13.4(12)		Fifth Modification of Lease Agreement dated October 9, 2003
10.14(3)		Office Lease Agreement, dated as of February 1, 1999, between LaSalle-Adams, L.L.C. and Hanover Capital Partners Ltd.
10.14.1(12)		First Amendment to Lease dated January 5, 2004
10.15(9)		Office Lease Agreement, dated as of September 3, 1997, between Metro Four Associates Limited Partnership and Pamex Capital Partners, L.L.C., as amended by the First Amendment to Lease dated May 2000
10.15.1(12)		Sublease Agreement dated as of April 2004
10.16(10)		Office Lease Agreement, dated as of July 10, 2002, between 233 Broadway Owners, LLC and Hanover Capital Mortgage Holdings, Inc.


Exhibit		Description

10.25(1)		Contribution Agreement by and among Registrant, John A. Burchett, Joyce S. Mizerak, George J. Ostendorf and Irma N. Tavares
10.25.1(8)		Amendment No. 1 to Contribution Agreement entered into as of July 1, 2002 by and between Registrant, John A. Burchett, Joyce S. Mizerak, George J. Ostendorf and Irma N. Tavares
10.25.2*		Amendment No. 2 to Contribution Agreement entered into as of May 20, 2004 by and between Registrant, John A. Burchett, Joyce S. Mizerak, George J. Ostendorf and Irma N. Tavares
10.26(1)		Participation Agreement by and among Registrant, John A. Burchett, Joyce S. Mizerak, George J. Ostendorf and Irma N. Tavares
10.27(1)		Loan Agreement
10.29(2)		Management Agreement, dated as of January 1, 1998, by and between Registrant and Hanover Capital Partners Ltd.
10.30(3)		Amendment Number One to Management Agreement, dated as of September 30, 1999
10.31(4)		Amended and Restated Master Loan and Security Agreement by and between Greenwich Capital Financial Products, Inc., Registrant and Hanover Capital Partners Ltd. dated March 27, 2000
10.31.3(9)		Amendment Number Six dated as of March 27, 2003 to the Amended and Restated Master Loan and Security Agreement dated as of March 27, 2000 by and among Registrant, Hanover Capital Partners, Ltd. and Greenwich Capital Financial Products, Inc.
10.31.4(10)		Amendment Number Seven dated as of April 27, 2003 to the Amended and Restated Master Loan and Security Agreement dated as of March 27, 2000 by and among Registrant, Hanover Capital Partners, Ltd. and Greenwich Capital Financial Products, Inc.
10.31.5(12)		Amendment Number Eight dated as of April 26, 2004 to the Amended and Restated Master Loan and Security Agreement dated as of March 27, 2000 by and among Registrant, Hanover Capital Partners, Ltd. and Greenwich Capital Financial Products, Inc.
10.33(5)		Stockholder Protection Rights Agreement
10.33.1(7)		Amendment to Stockholder Protection Rights Agreement effective as of September 26, 2001, by and among Registrant, State Street Bank and Trust Company and EquiServe Trust Company, N.A.
10.33.2(7)		Second Amendment to Stockholder Protection Rights Agreement dated as of June 10, 2002 by and between Registrant and EquiServe Trust Company, N.A.
10.34(6)		Asset Purchase Agreement, dated as of January 19, 2001 by and among HanoverTrade.com, Inc., Registrant, Pamex Capital Partners, L.L.C. and the members of Pamex Capital Partners, L.L.C.
10.35(9)		Amended and Restated Limited Liability Agreement as of November 21, 2002 by and among BTD 2001 HDMF-1 Corp., Hanover Capital Mortgage Holdings, Inc. and Provident Financial Group, Inc.
16.1(11)		Letter from Deloitte & Touche LLP, dated February 23, 2004
31.1*		Certification by John A. Burchett pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*		Certification by J. Holly Loux pursuant to Securities Exchange Act Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1**		Certification by John A. Burchett pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2**		Certification by J. Holly Loux pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith.

** Furnished herewith.

(1) Incorporated herein by reference to Registrant’s Registration Statement on Form S-11, Registration No. 333-29261, as amended, which became effective under the Securities Act of 1933, as amended, on September 15, 1997.

(2) Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 1997, as filed with the Securities and Exchange Commission on March 31, 1998.

(3) Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 1999, as filed with the Securities and Exchange Commission on March 30, 2000.

(4) Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2000, as filed with the Securities and Exchange Commission on May 15, 2000.

(5) Incorporated herein by reference to Registrant’s report on Form 8-K filed with the Securities and Exchange Commission on April 24, 2000.

(6) Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 2000, as filed with the Securities and Exchange Commission on April 2, 2001.

(7) Incorporated herein by reference to Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 16, 2002.

(8) Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002.

(9) Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on March 28, 2003.

(10) Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2003, as filed with the Securities and Exchange Commission on May 15, 2003.

(11) Incorporated herein by reference to Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 23, 2004.

(12) Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2004, as filed with the Securities and Exchange Commission on May 24, 2004.

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(1)	Includes $0.40 special dividend declared, paid and taxable in the first quarter of 2004.

(2)	Includes $0.15 special dividend declared, paid and taxable in the first quarter of 2003.


•	the decrease in the average balance of our mortgage loans held as collateral for collateralized mortgage obligations, called CMOs, offset by decreased borrowing costs on our corresponding CMO liabilities and reverse repurchase agreements;

•	the purchase of Agency-issued MBS; and

•	the increase in the average balance of our purchased subordinate MBS portfolio.



	John A. Burchett
	President and Chief Executive Officer
	Chairman of the Board of Directors
	(Principal Executive Officer)



	J. Holly Loux
	Chief Financial Officer
	(Principal Financial and
	Accounting Officer)


(1)	Incorporated herein by reference to Registrant’s Registration Statement on Form S-11, Registration No. 333-29261, as amended, which became effective under the Securities Act of 1933, as amended, on September 15, 1997.

(2)	Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 1997, as filed with the Securities and Exchange Commission on March 31, 1998.

(3)	Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 1999, as filed with the Securities and Exchange Commission on March 30, 2000.

(4)	Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2000, as filed with the Securities and Exchange Commission on May 15, 2000.

(5)	Incorporated herein by reference to Registrant’s report on Form 8-K filed with the Securities and Exchange Commission on April 24, 2000.

(6)	Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 2000, as filed with the Securities and Exchange Commission on April 2, 2001.

(7)	Incorporated herein by reference to Registrant’s Form 8-K filed with the Securities and Exchange Commission on July 16, 2002.

(8)	Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended June 30, 2002, as filed with the Securities and Exchange Commission on August 14, 2002.

(9)	Incorporated herein by reference to Registrant’s Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission on March 28, 2003.


(10)	Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2003, as filed with the Securities and Exchange Commission on May 15, 2003.

(11)	Incorporated herein by reference to Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 23, 2004.

(12)	Incorporated herein by reference to Registrant’s Form 10-Q for the quarter ended March 31, 2004, as filed with the Securities and Exchange Commission on May 24, 2004.