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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended September 30, 2001
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(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 ninety days. |_| Yes |X| No
On October 31, 2001, the registrant had 11,446,031 shares of common stock
of $.01 value outstanding, which is the registrant's only class of common stock.
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DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2001
(unaudited) and December 31, 2000 1
Consolidated Statements of Operations for the three and
nine months ended September 30, 2001 and 2000 (unaudited) 2
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2001 and 2000 (unaudited) 3
Notes to Unaudited Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 31
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands except share data)
(Unaudited)
September 30, December 31,
ASSETS 2001 2000
------------------- ------------------
Investments:
Collateral for collateralized bonds $ 2,558,555 $ 3,042,158
Securities 5,163 9,364
Other investments 34,143 42,284
Loans held for sale 2,891 19,102
------------------- ------------------
2,600,752 3,112,908
Cash, including restricted 18,071 26,773
Accrued interest receivable 25 323
Other assets 14,802 19,592
------------------- ------------------
Total Assets $ 2,633,650 $ 3,159,596
=================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt $ 2,384,670 $ 2,856,728
Recourse debt 64,964 134,168
------------------- ------------------
2,449,634 2,990,896
Accrued interest payable 958 3,775
Accrued expenses and other liabilities 1,716 7,794
------------------- ------------------
Total Liabilities 2,452,308 3,002,465
------------------- ------------------
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share, 50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
1,106,971 and 1,309,061 issued and outstanding, respectively
($31,748 and $36,012 aggregate liquidation preference, respectively) 25,284 29,900
9.55% Cumulative Convertible Series B,
1,548,726 and 1,912,434 issued and outstanding, respectively
($45,192 and $53,567 aggregate liquidation preference, respectively) 36,254 44,767
9.73% Cumulative Convertible Series C,
1,585,197 and 1,840,000 issued and outstanding, respectively
($56,813 and $63,259 aggregate liquidation preference, respectively) 45,437 52,740
Common stock, par value $.01 per share,
100,000,000 shares authorized,
11,446,206 issued and outstanding 114 114
Additional paid-in capital 361,469 351,999
Accumulated other comprehensive loss (94,738) (124,589)
Accumulated deficit (192,478) (197,800)
------------------- ------------------
Total Shareholders' Equity 181,342 157,131
------------------- ------------------
Total Liabilities and Shareholders' Equity $ 2,633,350 $ 3,159,596
=================== ==================
See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS, UNAUDITED
(amounts in thousands except share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Interest income:
Collateral for collateralized bonds $ 50,767 $ 68,300 $ 168,358 $ 209,923
Securities 157 301 831 3,303
Other investments 1,373 1,180 4,767 4,216
Loans held for sale or securitization 98 704 431 10,570
------------- ------------- ------------- -------------
52,395 70,485 174,387 225,012
------------- ------------- ------------- -------------
Interest and related expense:
Non-recourse debt 39,192 59,881 132,863 176,577
Recourse debt 1,316 3,492 5,739 18,785
Other 62 590 531 4,417
------------- ------------- ------------- -------------
40,570 63,963 139,133 199,779
------------- ------------- ------------- -------------
Net interest margin before provision for losses 11,825 6,522 35,254 25,233
Provision for losses (14,247) (5,270) (27,424) (16,101)
---------- ------------- ------------- -------------
Net interest margin (2,422) 1,252 7,830 9,132
Net (loss) gain on sales, write-downs,
impairment charges, and litigation (650) (557) 6,893 (85,467)
Trading losses (1,161) -- (2,881) --
Other income 59 42 39 2,619
----------- ------------- ------------- -------------
(4,174) 737 11,881 (73,716)
General and administrative expenses (2,299) (1,573) (6,777) (6,519)
----------- ------------- ------------- -------------
(Loss) income before extraordinary item (6,473) (836) 5,104 (80,235)
Extraordinary item - (loss)/gain on extinguishment of debt (1,010) -- 1,835 --
---------- ------------- ------------- -------------
Net (loss) income (7,483) (836) 6,939 (80,235)
Preferred stock (charges) benefit (1,097) (3,227) 6,053 (9,683)
----------- ------------- ------------- -------------
Net (loss) income to common shareholders $ (8,580) $ (4,063) $ 12,992 $ (89,918)
=========== ============= ============= =============
Net (loss) income per common share before extraordinary item:
Basic $ (0.66) $ (0.35) $ 0.97 $ (7.86)
=========== ============= ============= =============
Diluted $ (0.66) $ (0.35) $ 0.97 $ (7.86)
=========== ============= ============= =============
Net (loss) income per common share after extraordinary item:
Basic $ (0.75) $ (0.35) $ 1.14 $ (7.86)
=========== ============= ============= =============
Diluted $ (0.75) $ (0.35) $ 1.14 $ (7.86)
=========== ============= ============= =============
Weighted average number of common shares outstanding
Basic and diluted 11,446,090 11,446,010 11,446,167 11,444,911
=========== ============= ============= =============
See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, UNAUDITED
Nine Months Ended
(amounts in thousands) September 30,
----------------------------------------
2001 2000
------------------- ------------------
Operating activities:
Net income (loss) $ $
6,939 (80,235)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Provision for losses 27,424 16,101
Net (gain) loss on sales, write-downs, impairment
charges and litigation (6,893) 85,467
Equity in net earnings of Dynex Holding, Inc. - (1,778)
AutoBond related litigation settlement (payment) 7,111 (20,000)
Extraordinary item - net gain on extinguishment of debt (1,835) -
Amortization and depreciation 9,272 12,836
Net change in accrued interest, other assets and
other liabilities (7,288) (18,926)
------------------- ------------------
Net cash provided (used) by operating activities 34,730 (6,535)
------------------- ------------------
Investing activities:
Collateral for collateralized bonds:
Principal payments on collateral 473,917 396,666
Decrease in accrued interest receivable 2,786 1,188
Net (increase) decrease in funds held by trustee (206) 441
Net decrease in loans held for sale or securitization 16,601 203,679
Purchase of other investments (2,838) (1,658)
Payments received on other investments 4,210 3,111
Proceeds from sales of other investments 233 4,468
Decrease in restricted cash 14,361 -
Payments received on securities 1,873 20,060
Proceeds from sales of securities 3,893 20,111
Payment on tax-exempt bond obligations - (30,284)
Investment in and net advances to Dynex Holding, Inc. - 5,414
Proceeds from sale of loan production operations 9,500 9,500
Capital expenditures (212) (81)
------------------- ------------------
Net cash provided by investing activities 524,118 632,615
------------------- ------------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of bonds 507,641 140,724
Principal payments on bonds (979,959) (398,998)
Change in accrued interest payable (958) 1,001
Repayment of recourse debt borrowings, net (67,334) (394,554)
Capital stock transactions (10,963) 4
Dividends paid (1,614) -
------------------- ------------------
Net cash used for financing activities (553,187) (651,823)
------------------- ------------------
Net increase (decrease) in cash 5,661 (25,743)
Cash at beginning of period (unrestricted) 3,485 54,433
------------------- ------------------
Cash at end of period (unrestricted) $ 9,146 $ 28,690
=================== ==================
Cash paid for interest $ 140,180 $ 194,004
=================== ==================
Securities owned subsequently securitized $ - $ 71,209
=================== ==================
Collateral on Collateralized Bonds acquired through litigation settlement $ - $ 60,339
=================== ==================
See notes to unaudited consolidated financial statements.
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(amounts in thousands except share data)
NOTE 1 -- BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. The consolidated financial statements include the
accounts of Dynex Capital, Inc. and its qualified REIT subsidiaries (together,
"Dynex REIT"). Certain of the Company's operations were previously conducted
through Dynex Holding, Inc. ("DHI"), a taxable affiliate of Dynex REIT. During
2000, Dynex REIT owned all of the outstanding non-voting preferred stock of DHI
representing a 99% economic ownership interest in DHI. The common stock of DHI
represented a 1% economic ownership of DHI and was owned by certain officers of
Dynex REIT. For the nine months ended September 30, 2000, DHI was accounted for
under an accounting method similar to the equity method. In November 2000,
certain subsidiaries of DHI were sold to Dynex REIT, and on December 31, 2000,
DHI was liquidated in a taxable transaction into Dynex REIT. As a result of the
liquidation, substantially all of the assets and liabilities of DHI have been
transferred to Dynex REIT as of December 31, 2000. References to the "Company"
mean Dynex Capital, Inc., its consolidated subsidiaries, and, to the extent they
existed, DHI and its consolidated subsidiaries. All significant intercompany
balances and transactions with Dynex REIT's consolidated subsidiaries have been
eliminated in consolidation of Dynex REIT.
In the opinion of management, all material adjustments, consisting of
normal recurring adjustments, considered necessary for a fair presentation of
the consolidated financial statements have been included. The Consolidated
Balance Sheet at September 30, 2001, the Consolidated Statements of Operations
for the three and nine months ended September 30, 2001 and 2000, the
Consolidated Statements of Cash Flows for the nine months ended September 30,
2001 and 2000 and related notes to consolidated financial statements are
unaudited. Operating results for the nine months ended September 30, 2001 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2001. For further information, refer to the audited
consolidated financial statements and footnotes included in the Company's Form
10-K for the year ended December 31, 2000.
Certain reclassifications have been made to the financial statements for 2000 to
conform to presentation for 2001.
Risks and Uncertainties Since early 1999, the Company has focused its
efforts on conserving its capital base and repaying its outstanding recourse
borrowings. On a long-term basis, the Company believes that competitive
pressures, including competing against larger companies which generally have
significantly lower costs of capital and access to both short-term and long-term
financing sources, will generally keep specialty finance companies like Dynex
from earning an adequate risk-adjusted return on its invested capital. The
Company's current business operations are essentially limited to the management
of its investment portfolio and the active collection of its portfolio of
delinquent property tax receivables. The Company currently has no loan
origination operations, and for the foreseeable future does not intend to
purchase loans or securities in the secondary market. However, as a result of a
previously existing contractual obligation, the Company acquired $8,719 in
delinquent property tax receivables during September and October 2001.
The Board of the Company initiated a process in the fall of 1999 to
evaluate various courses of action to improve shareholder value given the
depressed prices of the Company's preferred and common stocks. As a result of
this evaluation, the Company entered into a merger agreement in November 2000,
which was subsequently terminated in January 2001 by the Company due to breaches
by the other party. See Note 11 below. In addition, in an effort to improve the
liquidity of the Company's Series A, Series B, and Series C Preferred Stock
(together, the "Preferred Stock"), on June 8, 2001, the Company completed a
tender offer on its Preferred Stock, resulting in the purchase by the Company of
820,601 shares of the Preferred Stock, and on September 6, 2001, the Company
announced a second tender offer on the Preferred Stock for up to 815,320 shares.
This tender offer was completed on November 2, 2001 with the purchase of 486,517
shares of Preferred Stock.
Since December 31, 2000, the Company has repaid $69,204 of on-balance sheet
recourse debt outstanding, and has satisfied off-balance sheet liabilities of
$66,765. While the Company's current business prospects are limited, based on
current projected cash flow estimates on its investment portfolio and estimated
proceeds on the call and subsequent sale or resecuritization of investment
portfolio assets, the Company anticipates that it will be able to repay its
remaining outstanding recourse debts in accordance with their respective terms.
Cash - Restricted. At September 30, 2001 and December 31, 2000, cash in the
aggregate amount of approximately $8,928 and $23,288, respectively, was held in
escrow as collateral for letters of credit, collateral for repurchase
agreements, or to cover losses on securities not otherwise covered by insurance.
NOTE 2 -- NET INCOME PER COMMON SHARE
Net income per common share is presented on both a basic net income per
common share and diluted net income per common share basis. Diluted net income
per common share assumes the conversion of the convertible preferred stock into
common stock, using the if-converted method, and stock appreciation rights to
the extent that there are rights outstanding, using the treasury stock method,
but only if these items are dilutive. As a result of the two-for-one split in
May 1997 and the one-for-four reverse split in July 2000 of Dynex REIT's common
stock, the preferred stock is convertible into one share of common stock for two
shares of preferred stock.
The following table reconciles the numerator and denominator for both the
basic and diluted net income per common share for the three and nine months
ended September 30, 2001 and 2000.
Three months ended Nine months ended
September 30, September 30,
------------------------------- ------------------------------
2001 2000 2001 2000
-------------- -------------- ------------- -------------
Income (loss) before extraordinary item $ (6,473) $ (836) $ 5,104 $ (80,235)
Extraordinary item - net gain on extinguishment of debt (1,010) - - 1,835
-------------- -------------- ------------- -------------
Net income (loss) (7,483) (836) 6,939 (80,235)
Preferred Stock benefits (charges) (1,097) (3,227) 6,053 (9,683)
-------------- -------------- ------------- -------------
Basic and Diluted net income (loss) to common shareholders $ (8,580) $ (4,063) $ 12,992 $ (89,918)
============== ============== ============= =============
Weighted average common shares outstanding
Basic 11,446,090 11,446,010 11,446,167 11,444,911
Diluted 11,446,090 11,446,010 11,446,167 11,444,911
Basic net income (loss) per common share before
extraordinary item:
Basic $ (0.66) (0.35) $ 0.97 $ (7.86)
============== ============== ============= =============
Diluted $ (0.66) (0.35) $ 0.97 $ (7.86)
============== ============== ============= =============
Basic net income (loss) per common share after extraordinary item:
Basic $ (0.75) (0.35) $ 1.14 $ (7.86)
============== ============== ============= =============
Diluted $ (0.75) (0.35) $ 1.14 $ (7.86)$
============== ============== ============= =============
Additional shares of preferred stock
Series A 9.75% cumulative convertible 553,486 654,531 616,407 654,531
Series B 9.55% cumulative convertible 774,363 956,217 887,605 956,217
Series C 9.73% cumulative convertible 792,599 920,000 871,933 920,000
Incremental shares of stock appreciation rights - 24,462 - 24,462
-------------- -------------- ------------- -------------
2,120,448 2,555,372 2,375,945 2,555,372
============== ============== ============= =============
NOTE 3 -- COLLATERAL FOR COLLATERALIZED BONDS AND SECURITIES
The following table summarizes Dynex REIT's amortized cost basis and fair
value of investments classified as available-for-sale, as of September 30, 2001
and December 31, 2000, and the related average effective interest rates:
September 30, 2001 December 31, 2000
- -----------------------------------------------------------------------------------------------------------------
Effective Effective
Fair Value Interest Rate Fair Value Interest Rate
- -------------------------------------------- ---------------- ----------------- ---------------- ----------------
Collateral for collateralized bonds:
Amortized cost $ 2,678,534 7.7% $ 3,189,414 7.8%
Allowance for losses (26,133) (25,314)
- -----------------------------------------------------------------------------------------------------------------
Amortized cost, net 2,652,401 3,164,100
Gross unrealized gains 35,108 37,803
Gross unrealized losses (128,954) (159,745)
- -----------------------------------------------------------------------------------------------------------------
$ 2,558,555 $ 3,042,158
- -----------------------------------------------------------------------------------------------------------------
Securities:
Adjustable-rate mortgage securities 673 13.1% 5,008 10.9%
Fixed-rate mortgage securities 551 10.6% 1,505 9.3%
Derivative and residual securities 4,886 9.1% 5,553 7.9%
- -----------------------------------------------------------------------------------------------------------------
6,110 12,066
Allowance for losses (55) (55)
- -----------------------------------------------------------------------------------------------------------------
Amortized cost, net 6,055 12,011
Gross unrealized gains 1,325 411
Gross unrealized losses (2,217) (3,058)
- -----------------------------------------------------------------------------------------------------------------
$ 5,163 $ 9,364
- -----------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds. Collateral for collateralized bonds
consists primarily of securities backed by adjustable-rate and fixed-rate
mortgage loans secured by first liens on single family housing, fixed-rate loans
on multifamily and commercial properties and manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title. Collateral for
collateralized bonds also includes delinquent property tax receivables. All
collateral for collateralized bonds is pledged to secure repayment of the
related collateralized bonds. All principal and interest (less servicing-related
fees) on the collateral is remitted to a trustee and is available for payment on
the collateralized bonds. Dynex REIT's exposure to loss on collateral for
collateralized bonds is generally limited to the amount of collateral pledged to
the collateralized bonds in excess of the amount of the collateralized bonds
issued, as the collateralized bonds issued by the limited-purpose finance
subsidiaries are non-recourse to Dynex REIT.
Securities. Adjustable-rate mortgage ("ARM") securities consist of mortgage
certificates secured by ARM loans. Fixed-rate mortgage securities consist of
mortgage certificates secured by mortgage loans that have a fixed rate of
interest for at least one year from the balance sheet date. Derivative
securities are classes of collateralized bonds, mortgage pass-through
certificates or mortgage certificates that pay to the holder substantially all
interest (i.e., an interest-only security), or substantially all principal
(i.e., a principal-only security). Residual interests represent the right to
receive the excess of (i) the cash flow from the collateral pledged to secure
related mortgage-backed securities, together with any reinvestment income
thereon, over (ii) the amount required for principal and interest payments on
the mortgage-backed securities or repurchase arrangements, together with any
related administrative expenses.
Sale of Securities. Proceeds from sales of securities totaled $20,111 for
the nine months ended September 30, 2000. Three securities have been sold during
the nine months ended September 30, 2001 for aggregate proceeds of $4,561 and an
aggregate loss of $11. See Note 9, Net Gain (Loss) on Sales, Write-downs,
Impairment Charges and Litigation for further discussion.
NOTE 4 -- USE OF ESTIMATES
Fair Value. Dynex REIT uses estimates in establishing fair value for its
financial instruments. Estimates of fair value for financial instruments may be
based on market prices provided by certain dealers. Estimates of fair value for
certain other financial instruments including collateral for collateralized
bonds, are determined by calculating the present value of the projected cash
flows of the instruments using appropriate discount rates, prepayment rates and
credit loss assumptions. Discount rates used are those management believes would
be used by willing buyers of these financial instruments at prevailing market
rates. The discount rate used in the determination of fair value of the
collateral for collateralized bonds at both September 30, 2001 and December 31,
2000 was 16%. Variations in market discount rates, prepayments rates and credit
loss assumptions may materially impact the resulting fair values of the
Company's financial instruments. In addition to variations in such assumptions,
as discussed further in Note 11, due to an adverse ruling rendered by the
Commonwealth Court of Pennsylvania on July 5, 2001, the Company's ability to
collect certain amounts of interest, fees and costs incurred on its delinquent
property tax receivables pledged as collateral for collateralized bonds may be
adversely impacted. The Company, based on consultation with counsel, reasonably
believes that the Appellate Court's decision will ultimately be reversed or that
the ultimate outcome of the litigation will not result in a material impact on
the carrying value of the related delinquent property tax receivables.
Estimates of fair value for other financial instruments are based primarily
on management's judgment. Since the fair value of Dynex REIT's financial
instruments is based on estimates, actual gains and losses recognized may differ
from those estimates recorded in the consolidated financial statements.
NOTE 5 -- RECOURSE DEBT
Dynex REIT utilizes repurchase agreements, notes payable and secured credit
facilities (together, "recourse debt") to finance certain of its investments.
The following table summarizes Dynex REIT's recourse debt outstanding at
September 30, 2001 and December 31, 2000:
September 30, 2001 December 31, 2000
------------------ -----------------
Repurchase agreements $ 6,823 $ 35,015
Credit facility - 2,000
Capital lease obligations 292 430
------------------ -----------------
7,115 37,445
7.875% July 2002 Senior Notes 57,969 97,250
Net unamortized issuance costs (120) (527)
- --------------------------------------------------------------------------------
$ 64,964 $ 134,168
- --------------------------------------------------------------------------------
At September 30, 2001 and December 31, 2000, recourse debt consisted of
$6,823 and $35,015, respectively, of repurchase agreements secured by cash,
investments and retained collateralized bonds; $0 and $2,000, respectively,
outstanding under a revolving credit facility secured by other investments; and
$292 and $430, respectively, of amounts outstanding under a capital lease. The
secured revolving credit facility was extinguished in January 2001. At September
30, 2001, all recourse debt in the form of repurchase agreements was with Lehman
Brothers, Inc., had overnight or "one-day" maturity, and bears interest at rates
indexed to LIBOR. If Lehman Brothers fails to return the collateral, the
ultimate realization of the security by Dynex REIT may be delayed or limited.
As of September 30, 2001 and December 31, 2000, Dynex REIT had $57,969 and
$97,250, respectively, outstanding of its Senior Unsecured Notes issued in July
1997 and due July 15, 2002 (the "July 2002 Notes"). On March 30, 2001, the
Company entered into an amendment to the related indenture governing the July
2002 Notes whereby the Company pledged to the Trustee of the July 2002 Notes
substantially all of the Company's unencumbered assets in its investment
portfolio and the stock of its subsidiaries. In consideration of this pledge,
the indenture was further amended to provide for the release of the Company from
certain covenant restrictions in the indenture, and specifically provided for
the Company's ability to make distributions on its capital stock in an amount
not to exceed the sum of (i) $26,000, (ii) the cash proceeds of any "permitted
subordinated indebtedness", (iii) the cash proceeds of the issuance of any
"qualified capital stock", and (iv) any distributions required in order for the
Company to maintain its REIT status. In addition, the Company entered into a
Purchase Agreement with holders of 50.1% of the July 2002 Notes which require
the Company to purchase, and such holders to sell, their respective July 2002
Notes at various discounts prior to maturity based on a computation of the
Company's available cash. Through September 30, 2001, the Company has retired
$39,281of July 2002 Notes for $35,549 in cash under the Purchase Agreement. The
discounts provided for under the Purchase Agreement are as follows: by April 15,
2001, 10%; by July 15, 2001, 8%; by October 15, 2001, 6%; by January 15, 2002,
4%; by March 1, 2002, 2%; thereafter until maturity, 0%.
At December 31, 2000, Dynex REIT had a secured non-revolving credit
facility under which $66,765 of letters of credit to support tax-exempt bonds
had been issued. These letters of credit were released during the first quarter
of 2001, as a result of the purchase, sale or transfer of the underlying
tax-exempt bonds, and the facility was extinguished.
NOTE 6 -- ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
Statement of Financial Accounting Standards ("FAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" is effective for all fiscal
years beginning after June 15, 2000. FAS No. 133, as amended, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
The Company adopted FAS No. 133 effective January 1, 2001. The adoption of FAS
No. 133 did not have a significant impact on the financial position, results of
operations, or cash flows of the Company.
In September 2000, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities" ("FAS No.
140"). FAS No. 140 replaces the Statement of Financial Accounting Standards No.
125 "Accounting for the Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("FAS No. 125"). FAS No. 140 revises the
standards for accounting for securitization and other transfers of financial
assets and collateral and requires certain disclosure, but it carries over most
of FAS No. 125 provisions without reconsideration. FAS No. 140 is effective for
transfers and servicing of financial assets and extinguishment of liabilities
occurring after March 31, 2001. FAS No. 140 is effective for recognition and
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000.
Disclosures about securitization and collateral accepted need not be reported
for periods ending on or before December 15, 2000, for which financial
statements are presented for comparative purposes. FAS No. 140 is to be applied
prospectively with certain exceptions. Other than those exceptions, earlier or
retroactive application of its accounting provision is not permitted. The
adoption of FAS No. 140 did not have a material impact on the Company's
financial statements
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations. SFAS No.
141 requires that all business combinations initiated after June 30, 2001 be
accounted for under the purchase method and addresses the initial recognition
and measurement of goodwill and other intangible assets acquired in a business
combination. Business combinations originally accounted for under the pooling of
interest method will not be changed. Management does not expect the adoption of
SFAS 141 to have an impact on the financial position, results of operations or
cash flows of the Company.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination and the accounting
for goodwill and other intangible assets subsequent to their acquisition. SFAS
No. 142 provides that intangible assets with finite useful lives be amortized
and that goodwill and intangible assets with indefinite lives will not be
amortized, but will rather be tested at least annually for impairment. As the
Company has no goodwill or intangible assets that it is amortizing, the adoption
of SFAS No. 142 will have no effect on the financial position, results of
operations or cash flows of the Company.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. The Company is in the process of evaluating the
impact of implementing SFAS No. 143.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets" which supercedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of"
and the accounting and reporting provisions of APB No. 30, "Reporting the
Results of Operations - Reporting and Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" for the disposal of a segment of business. This statement is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
retains many of the provisions of SFAS No. 121, but addresses certain
implementation issues associated with that Statement. The Company is currently
evaluating the impact of implementing SFAS No. 142.
NOTE 7 -- DERIVATIVE FINANCIAL INSTRUMENTS
Dynex REIT may enter into interest rate swap agreements, interest rate cap
agreements, interest rate floor agreements, financial forwards, financial
futures and options on financial futures ("Interest Rate Agreements") to manage
its sensitivity to changes in interest rates. These Interest Rate Agreements are
intended to provide income and cash flow to offset potential reduced net
interest income and cash flow under certain interest rate environments. At the
inception of the hedge, these instruments are designated as either hedge
positions or trade positions using criteria established in FAS No. 133.
For Interest Rate Agreements designated as hedge instruments, Dynex REIT
evaluates the effectiveness of these hedges against the financial instrument
being hedged under various interest rate scenarios. The effective portion of the
gain or loss on an Interest Rate Protection Agreement designated as a hedge is
reported in accumulated other comprehensive income, and the ineffective portion
of such hedge is reported in income.
As a part of Dynex REIT's interest rate risk management process, Dynex REIT
may be required periodically to terminate hedge instruments. Any realized gain
or loss resulting from the termination of a hedge is amortized into income or
expense of the corresponding hedged instrument over the remaining period of the
original hedge or hedged instrument.
If the underlying asset, liability or commitment is sold or matures, the
hedge is deemed partially or wholly ineffective, or the criteria that was
executed at the time the hedge instrument was entered into no longer exists, the
Interest Rate Agreement is no longer accounted for as a hedge. Under these
circumstances, the accumulated change in the market value of the hedge is
recognized in current income to the extent that the effects of interest rate or
price changes of the hedged item have not offset the hedge results or otherwise
previously been recognized in income.
For Interest Rate Agreements entered into for trading purposes, realized
and unrealized changes in fair value of these instruments are recognized in the
consolidated statements of operations as trading activities in the period in
which the changes occur or when such trade instruments are settled. Amounts
payable to or receivable from counterparties, if any, are included on the
consolidated balance sheets in accrued expenses and other liabilities. In March
2001, the Company entered into three separate short positions aggregating
$1,300,000 on the June 2001, September 2001, and December 2001 90-day Eurodollar
Futures Contracts. The Company entered into these positions to, in effect,
lock-in its borrowing costs on a forward basis relative to its floating-rate
liabilities. In addition, in April and May 2001, the Company entered into two
short positions on the one-month LIBOR futures contract, both of which were
settled during the second quarter. These instruments fail to meet the hedge
criteria of FAS No. 133, and therefore are accounted for on a trading basis.
Changes in market value for these contracts, and the gain or loss recognized at
the termination of these contracts, are recognized in current period earnings.
During the nine months ended September 30, 2001, given the continued decline in
one-month LIBOR due to reductions in the targeted Federal Funds Rate, the
Company recognized $2,914 in losses related to these contracts. At September 30,
2001, the aggregate remaining short position was $150,000 relating to the
December 2001 contract.
NOTE 8 -- PREFERRED STOCK
On June 8, 2001, the Company completed a tender offer on its Series A,
Series B, and Series C Preferred Stock (together, the "Preferred Stock"),
resulting in the purchase by the Company of 820,601 shares of the Preferred
Stock, consisting of 202,090 shares of Series A, 363,708 shares of Series B and
254,803 shares of Series C, respectively, for an aggregate $10,918 and which had
an aggregate issue price of $21,405, a book value of $20,503, and including
dividends in arrears, a liquidation preference of $25,110. The difference of
$9,470 between the repurchase price and the book value has been included in the
accompanying Statement of Operations for the three and nine month periods ended
September 30, 2001 as an addition to net income available to common shareholders
in the line item captioned Preferred Stock benefit (charges) as required by
EITF's D-42 and D-53. Also included in Preferred Stock benefit (charges) is the
cumulative dividend in arrears of $3,964 related to those shares tendered on
June 8, 2001, and which was effectively cancelled at such time. In addition,
Preferred Stock benefit (charges) includes the current period dividend amount
for the Preferred Stock outstanding for the three and nine month periods ended
September 30, 2001.
On May 22, 2001, dividends of $0.2925 per share of Series A and Series B
Preferred Stock and $0.3649 per share of Series C Preferred Stock were declared
payable to holders of record as of June 8, 2001. Total dividends of $1,614 were
paid on July 20, 2001.
On September 6, 2001, the Company announced a tender offer on the Preferred
Stock, offering to purchase up to 212,817 shares of its Series A Preferred Stock
for $16.80 per share, up to 297,746 shares of Series B Preferred Stock for
$17.15 per share and up to 304,757 shares of Series C Preferred Stock for $21.00
per share. 486,517 shares were tendered for an aggregate $9,080 and which had an
aggregate issue price of $12,971, and including dividends in arrears, a
liquidation preference of $15,639. The purchase of the 486,517 tendered shares
was completed on November 2, 2001 and as a result will be accounted for in the
fourth quarter of 2001.
As of September 30, 2001 and December 31, 2000, the total amount of
dividends in arrears were $23,042 and $19,367 respectively. Individually, the
amount of dividends in arrears on the Series A, the Series B and the Series C
were $5,505 ($4.97 per Series A share), $7,701 ($4.97 per Series B share) and
$9,836 ($6.21 per Series C share), at September 30, 2001 and $4,595 ($3.51 per
Series A share), $6,713 ($3.51 per Series B share) and $8,059 ($4.38 per Series
C share), at December 31,2000.
NOTE 9 -- NET GAIN (LOSS) ON SALES, WRITE-DOWNS, IMPAIRMENT CHARGES
AND LITIGATION
The following table sets forth the composition of net gain (loss) on sales,
write-downs and impairment charges for the nine months ended September 30, 2001
and 2000.
Nine months ended September 30,
---------------------------------
2001 2000
-------------- ------------
Phase-out of commercial production operations 402 $ (1,482)
Sales of investments 11 (15,639)
Impairment/Writedowns - (63,545)
AutoBond litigation and AutoBond securities 7,111 -
Other (631) (380)
------------- ------------
$ 6,893 $ (81,046)
During the nine months ending September 30, 2001 the Company resolved
litigation related to AutoBond Acceptance Corporation to the mutual satisfaction
of the parties involved. The Company received $7,111 net of legal fees incurred
related to the litigation. During the nine months ended September 30, 2000, the
Company recognized losses of $63,545 related to (i) the permanent impairment in
the carrying value of certain securities, (ii) write-downs to market value of
commercial and multifamily loans held for sale and (iii) the accrual of losses
related to contingent obligations on its off-balance sheet tax-exempt bond
positions. Also, securities with an aggregate principal balance of $34,448 were
sold during the nine months ended September 30, 2000 for an aggregate loss of
$15,639. Loss on sale of investments at September 30, 2000 also includes
realized losses of $1,482 related to the sale of $268,732 of commercial loans
during the nine months ended September 30, 2000.
NOTE 10 -- COMMITMENTS
The Company makes various representations and warranties relating to the
sale or securitization of loans. To the extent the Company were to breach any of
these representations or warranties, and such breach could not be cured within
the allowable time period, the Company would be required to repurchase such
loans, and could incur losses. In the opinion of management, no material losses
are expected to result from any such representations and warranties.
The Company has made various representations and warranties relating to the
sale of various production operations. To the extent the Company were to breach
any of these representations or warranties, and such breach could not be cured
within the allowable time period, the Company would be required to cover any
losses and expenses up to certain limits. In the opinion of management, no
material losses are expected to result from any such representations and
warranties.
NOTE 11 -- LITIGATION
On November 7, 2000, the Company entered into an Agreement and Plan of
Merger with California Investment Fund, LLC ("CIF"), for the purchase of all of
the equity securities of the Company for $90,000 (the "Merger Agreement"). The
Merger Agreement was subsequently amended on December 22, 2000 as a result of a
breach of the requirements of the Merger Agreement by CIF in delivering
sufficient evidence of a financing commitment. Among other things, the amendment
to the Merger Agreement obligated CIF to deliver to the Company written binding
financing commitments and evidence of the consent of the holders of the July
2002 Notes to the merger transaction on or before January 25, 2001. On January
25, 2001, CIF failed to meet the requirements as set forth in the Merger
Agreement and the letter of December 22, 2000, and the Company terminated the
Merger Agreement effective January 26, 2001 and requested that the escrow agent
release to the Company the $1,000 and 572,178 shares of common stock of the
Company which CIF placed in escrow under the Merger Agreement (the "Escrow
Amount"). On January 29, 2001, the Company filed for Declaratory Judgment in
United States District Court for the Eastern District of Virginia, Alexandria
Division (the "Court"). CIF filed a counterclaim and demand for jury trial and
asked for damages of $45,000. The Court subsequently capped CIF's damage claim
to $2,000 as set forth in the Merger Agreement and held a jury trial. On October
16, 2001, the jury returned a verdict which would result in (i) the escrow
amount consisting of $1,000 and 572,178 shares of common stock being awarded to
the Company, and (ii) the Company having to pay CIF a termination fee of $2,000.
The Court has yet to enter judgment pending its decision regarding motions filed
by the two parties. Assuming the Court upholds the jury verdict on the $2,000
termination fee the Company will most likely appeal. Neither the receipt of the
escrow amount nor the payment of the $2,000 termination fee has been accrued for
in the accompanying financial statements.
In February 2001, the Company resolved a matter related to AutoBond
Acceptance Corporation to the mutual satisfaction of the parties involved. In
connection with the resolution of this matter, the Company received $7,111, net
of related legal fees.
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the
County of Allegheny, Pennsylvania ("Allegheny County"), were defendants in a
lawsuit in the Commonwealth Court of Pennsylvania (the "Commonwealth Court")
wherein the plaintiffs challenged the right of Allegheny County and GLS to
collect certain interest, costs and expenses related to delinquent property tax
receivables in Allegheny County. This lawsuit was related to the purchase by GLS
of delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999 for approximately $58,258. On July 5, 2001, the Commonwealth Court
ruling addressed, among other things, (i) the right of the Company to charge to
the delinquent taxpayer a rate of interest of 12% versus 10% on the collection
of its delinquent property tax receivables, (ii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iii)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court remanded for further consideration to the Court of Common
Pleas items (i) and (iii), and ruled that neither Allegheny County nor GLS had
the right to charge attorney's fees to the delinquent taxpayer related to the
collection of such tax receivables, reversing the Court of Common Pleas
decision. On September 10th the Commonwealth Court denied the County of
Allegheny and GLS's Application for Re-argument. The Pennsylvania Supreme Court
has accepted the Application for Extraordinary Jurisdiction filed by Allegheny
County and GLS. No damages have been claimed in the action; however, as
discussed in Note 4, the decision may impact the ultimate recoverability of the
delinquent property tax receivables. To date, GLS has incurred attorneys fees of
approximately $2,000 related to foreclosures on such delinquent property tax
receivables, approximately $1,000 of which have been reimbursed to GLS by the
taxpayer or through liquidation of the underlying real property.
On May 4, 2001, ACA Financial Guaranty Corporation ("ACA") commenced an
action in the United States District Court for the Southern District of New York
(the "District Court"), (the "Action"), in which ACA sought injunctive relief as
well as money damages of $25,000 based on causes of action for fraudulent
conveyance and breach of contract. The complaint challenged, among other things,
the validity of the March 30, 2001 Supplemental Indenture to the 1997 Senior
Note Indenture as amended ("1997 Indenture") discussed in Note 5, pursuant to
which in 1997 Dynex issued its 7.875% Senior Notes due July 2002. In particular,
the complaint challenged the validity, among other things, of the Purchase
Agreement, and the Supplemental Indenture and the related amendment to certain
restrictive covenants in the Indenture to allow for certain distributions to
holders of Dynex equity securities, including the Preferred Stock. ACA is a
financial guaranty company who has insured $25,000 of the July 2002 Notes for
repayment at maturity on July 15, 2002, for the benefit of the holder of the
Notes. The Company is not a party to this insurance contract. On October 31,
2001, the Company and ACA settled this matter out of court. The settlement
provides for, among other things, that the Company could complete the tender
offer of Preferred Stock announced on September 6, 2001 (and subsequently funded
on November 2, 2001), but that the Company would generally not be permitted to
make further distributions on its capital stock until the July 2002 Notes are
repaid or defeased.
The Company is also subject to other lawsuits or claims which have arisen
in the ordinary course of its business, some of which seek damages in amounts
which could be material to the financial statements. Although no assurance can
be given with respect to the ultimate outcome of any such litigation or claim,
the Company believes the resolution of such lawsuits or claims will not have a
material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
NOTE 12 -- RELATED PARTY TRANSACTIONS
During 2000, Dynex REIT had a credit arrangement with DHI whereby DHI and
any of DHI's subsidiaries could borrow funds from Dynex REIT to finance its
operations. Under this arrangement, Dynex REIT could also borrow funds from DHI.
The terms of the agreement allowed DHI and its subsidiaries to borrow up to $50
million from Dynex REIT at a rate of Prime plus 1.0%. Dynex REIT could borrow up
to $50 million from DHI at a rate of one-month LIBOR plus 1.0%. Effective with
the liquidation of DHI at December 31, 2000, this credit agreement was
terminated. Net interest expense under this agreement was $1,087 for the nine
months ended September 30, 2000.
Dynex REIT has entered into subservicing agreements with Dynex Commercial
Services, Inc. ("DCSI") and GLS Capital Services, Inc ("GLSCS") to service
commercial loans and property tax receivables, respectively. DCSI and GLSCS were
subsidiaries of DHI in 2000, and are now subsidiaries of Dynex REIT. For
servicing the commercial loans, DCSI receives an annual servicing fee of 0.02%
of the aggregate unpaid principal balance of the loans. For servicing the
property tax receivables, GLSCS receives an annual servicing fee of 0.72% of the
aggregate unpaid principal balance of the property tax receivables. Servicing
fees paid by Dynex REIT under such agreements were $211 during the nine months
ended September 30, 2000 and $57 during the same period ended September 30,
2001.
The Company has made a loan to Thomas H. Potts, president of the Company,
as evidenced by a demand promissory note (the "Potts Note"). Mr. Potts directly
owns 399,502 shares of common stock of the Company, all of which have been
pledged as collateral to secure the Potts Note. Interest is charged on the Potts
Note at the applicable short-term monthly applicable federal rate (commonly
known as the AFR Rate) as published by the Internal Revenue Service. As of
September 30, 2001 and December 31, 2000, the outstanding balance of the Potts
Note was $543 and $687, respectively, and interest was current.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Dynex Capital, Inc. (the "Company") is a financial services company that
invests in a portfolio of securities and investments backed principally by
single family mortgage loans, commercial mortgage loans and manufactured housing
installment loans. Such loans have been funded generally by the Company's loan
production operations or purchased in bulk in the market. Loans funded through
the Company's production operations have generally been pooled and pledged as
collateral using a collateralized bond security structure, which provides
long-term financing for the loans while limiting credit, interest rate and
liquidity risk.
FINANCIAL CONDITION
(amounts in thousands except per share data)
September 30, 2001 December 31, 2000
------------------ -----------------
Investments:
Collateral for collateralized bonds $ 2,558,555 $ 3,042,158
Securities 5,163 9,364
Other investments 34,143 42,284
Loans held for sale 2,891 19,102
Non-recourse debt - collateralized 2,384,670 2,856,728
Recourse debt 64,964 134,168
Shareholders' equity 181,342 157,131
Collateral for collateralized bonds Collateral for collateralized bonds
consists primarily of securities backed by adjustable-rate and fixed-rate
mortgage loans secured by first liens on single family housing, fixed-rate loans
secured by first liens on multifamily and commercial properties, manufactured
housing installment loans secured by either a UCC filing or a motor vehicle
title and delinquent property tax receivables. As of September 30, 2001, the
Company had 24 series of collateralized bonds outstanding. The collateral for
collateralized bonds decreased to $2.56 billion at September 30, 2001 compared
to $3.04 billion at December 31, 2000. This decrease of $0.48 billion is
primarily the result of $473.9 million in paydowns on the collateral.
Securities Securities consist primarily of adjustable-rate and fixed-rate
mortgage-backed securities. Securities also include derivative and residual
securities. Securities decreased during the nine months ended September 30, 2001
by $4.2 million to $5.2 million at September 30, 2001 from $9.4 million at
December 31, 2000 due primarily to the sale of two ARM securities.
Other investments Other investments at September 30, 2001 consist primarily
of delinquent property tax receivables. Other investments decreased from $42.3
million at December 31, 2000 to $34.1 million at September 30, 2001. This
decrease is primarily the result of the receipt of the final $9.5 million annual
principal payment on the note receivable from the 1996 sale of the Company's
single family mortgage operations, offset in part by the purchase of $2.7
million of delinquent property tax receivables.
Loans held for sale Loans held for sale, which consists principally of
commercial mortgage and mezzanine loans on healthcare facilities at September
30, 2001, decreased from $19.1 million at December 31, 2000 to $2.9 million at
September 30, 2001 as the result of the sale of loans during the first nine
months of the year. These loans are currently carried at the lower of cost or
market.
Non-recourse debt Collateralized bonds issued by Dynex REIT are recourse
only to the assets pledged as collateral, and are otherwise non-recourse to
Dynex REIT. Collateralized bonds decreased from $2.9 billion at December 31,
2000 to $2.4 billion at September 30, 2001. This decrease was primarily a result
of principal payments received on the associated collateral pledged which were
used to pay down the collateralized bonds in accordance with the respective
indentures.
Recourse debt Recourse debt decreased to $65.0 million at September 30,
2001 from $134.2 million at December 31, 2000. This decrease was due to $39.3
million of repurchases on the July 2002 Notes, $26.0 million of repayments made
on repurchase agreements and the $2.0 million payoff of a note payable.
Shareholders' equity Shareholders' equity increased to $181.3 million at
September 30, 2001 from $157.1 million at December 31, 2000. This increase was a
combined result of a $29.9 million decrease in the net unrealized loss on
investments available-for-sale from $124.6 million at December 31, 2000 to $94.7
million at September 30, 2001 and net income of $6.9 million during the nine
months ended September 30, 2001. This was partially offset by the completion of
the tender offer on Preferred Stock completed in June 2001, which reduced
shareholders' equity by $11.0 million and the payment of dividends of $1.6
million in July 2001.
RESULTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30, September 30,
(amounts in thousands except per share information) 2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest margin $ (2,422) $ 1,252 $ 7,830 $ 9,132
Net (loss) gain on sales, write-downs, impairment
charges and litigation (650) (557) 6,893 (85,467)
Trading losses (1,161) - (2,881) -
General and administrative expenses 2,299 (1,573) 6,777 6,519
Extraordinary item - (loss) gain on extinguishment of debt (1,010) - 1,835 -
Net (loss) income before preferred stock benefits (charges) (7,483) (836) 6,939 (80,235)
Basic net (loss) income per common share before
extraordinary gain $ (0.66) $ (0.35) $ 0.97 $ (7.86)
Diluted net (loss) income per common share before
extraordinary gain (0.66) (0.35) 0.97 (7.86)
Basic net (loss) income per common share after
extraordinary item $ (0.75) $ (0.35) $ 1.14 $ (7.86)
Diluted net (loss) income per common share after
extraordinary item (0.75) (0.35) 1.14 (7.86)
Three and Nine Months Ended September 30, 2001 Compared to Three and Nine
Months Ended September 30, 2000. The increase in net income and net income per
common share during the nine months ended September 30, 2001 as compared to the
same period in 2000 is primarily the result of several positive non-recurring
items in 2001, including the favorable settlement of litigation, and an
extraordinary gain related to the early extinguishment of $39.3 million of the
Company's July 2002 Notes, versus losses in 2000 resulting from the
sale/write-down of certain securities, the write-down of certain commercial
mortgage loans held for sale, and the accrual of losses on certain off-balance
sheet tax-exempt bond positions. In addition, basic and diluted earnings per
common share for the nine months ended September 2001 reflect the discount to
book value of the purchase price of the Company's Series A, Series B, and Series
C Preferred Stock tendered pursuant to the tender offer for the Preferred Stock
completed on June 8, 2001, and the associated cumulative dividend in arrears on
those tendered shares, which were cancelled.
Net interest margin for the nine months ended September 30, 2001 decreased
to $7.8 million from $9.1 million for the same period for 2000. This decrease
was primarily the result of an increase in provision for losses to $27.4 million
during the nine months ended September 30, 2001 compared to $16.1 million during
the nine months ended September 30, 2000. This increase in provision for losses
was a result of increasing the reserve for probable losses on various
manufactured housing loan pools pledged as collateral for collateralized bonds
where the Company has retained credit risk. In addition, average
interest-earning assets declined from $3.8 billion for the nine months ended
September 30, 2000 to $3.0 billion for the nine months ended September 30, 2001.
These decreases were partially offset by an increase in the net interest spread
from 0.57% for the nine months ending September 30, 2000 to 1.22% for the nine
months ended September 30, 2001.
Net gain (loss) on sales, write-downs, impairment charges and litigation
improved $92.4 million, from a loss of $85.5 million during the nine months
ended September 30, 2000, to a gain of $6.9 million during the nine months ended
September 30, 2001. During 2001, the Company favorably resolved litigation for
$7.1 million, net of legal expenses. During the nine months ended September 30,
2000, the Company recognized losses of $63.5 million related to (i) the
permanent impairment in the carrying value of certain securities, (ii)
write-downs to market value of commercial and multifamily loans held for sale
and (iii) the accrual of losses related to contingent obligations on its
off-balance sheet tax-exempt bond positions. Also, securities with an aggregate
principal balance of $34.4 million were sold during the nine months ended
September 30, 2000 for an aggregate loss of $15.6 million. The Company also
realized losses of $1.5 million related to the sale of $268.7 million of
commercial loans during the nine months ended September 30, 2000.
The following table summarizes the average balances of interest-earning
assets and their average effective yields, along with the average interest-
bearing liabilities and the related average effective interest rates, for each
of the periods presented.
Average Balances and Effective Interest Rates
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------------- ----------------------------------------------
2001 2000 2001 2000
---------------------- --------------------- ----------------------- ---------------------
Average Effective Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate Balance Rate
---------- ---------- ---------- --------- ----------- --------- ---------- ---------
Interest-earning assets:(1)
Collateral for collateralized
bonds(2)(3) $2,722,657 7.46% $3,418,086 7.99% $2,902,187 7.73% $3,530,831 7.81%
Securities 5,558 11.28 12,930 9.32 9,507 10.53 69,777 6.31
Other investments 35,534 14.69 36,271 13.20 35,970 15.08 43,402 13.43
Loans held for sale or
securitization 3,386 11.36 35,765 7.88 4,432 12.74 174,623 8.07
Cash investments 7,642 3.62 - - 16,609 4.68 - -
----------- -------- ------------ -------- ----------- --------- ----------- --------
Total interest-earning assets $2,774,778 7.55% $ 3,503,052 8.05% $2,968,724 7.82% $3,818,634 7.86%
=========== ======== ============ ======== =========== ========= =========== ========
Interest-bearing liabilities:
Non-recourse debt(3) $2,528,348 6.11% $3,101,953 7.61% $2,654,283 6.58% $3,193,760 7.27%
Recourse debt - collateralized
bonds retained 8,364 5.41 41,878 7.54 21,123 6.37 75,223 6.97
----------- -------- ------------ -------- ----------- --------- ----------- --------
2,536,712 6.11% 3,143,831 7.61 2,675,406 6.58 3,268,983 7.27
Credit facilities 702 5.30 2,191 7.01 1,637 6.33 27,506 8.60
Other recourse debt - secured 58,010 8.18 23,704 9.25 73,974 8.33 130,872 6.38
Other recourse debt - unsecured - - 98,309 8.43 - - 102,776 8.62
----------- -------- ------------ -------- ----------- --------- ----------- --------
Total interest-bearing liabilities $2,595,423 6.15% $3,268,035 7.65% $2,751,017 6.63% $3,530,138 7.29%
=========== ======== ============ ======== =========== ========= =========== ========
Net interest spread on all
investments(3) 1.40% 0.40% 1.19% 0.57%
========== ========== ========= ========
Net yield on average interest-earning 1.80% 0.92% 1.68% 1.12%
assets(3) ========== ========== ========= ========
<FN>
(1) _____Average balances exclude adjustments made in accordance with Statement
of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" to record available-for-sale
securities at fair value.
(2) Average balances exclude funds held by trustees of $579 and $698 for the
three months ended September 30, 2001 and 2000, respectively, and $502 and
$932 for the nine months ended September 30, 2001 and 2000, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses. If included,
the net yield on average interest-earning assets would be 0.75% and 0.14%
for the three months ended September 30, 2001 and 2000, respectively, and
0.34% and 0.32% for the nine months ended September 30, 2001 and 2000,
respectively.
</FN>
The net interest spread increased 1.00%, to 1.40% for the three months
ended September 30, 2001 from 0.40% for the same period in 2000. The net
interest spread for the nine months ended September 30, 2001 also improved
relative to the same period in 2000, to 1.68% from 0.57%. The improvement in the
Company's net interest spread can be attributed to a decline in the cost of
interest-bearing liabilities for the respective 2001 periods, which have
declined as a result in the decline of One-Month LIBOR due to the recent
reduction in short-term interest rates by the Federal Reserve. The majority of
the Company's variable-rate interest-bearing liabilities are priced relative to
One-Month LIBOR. Interest-bearing liability costs declined 1.50% and 0.66% for
the three and nine-month periods ended September 30, 2001, compared to the same
periods in 2000. For both the three and nine month periods ended September 30,
2001, there has been a lesser decline in the effective interest-earning yield on
the collateral for collateralized bonds due to the `reset' lag and "floors" (the
loans generally adjust or `reset' every six or twelve months and are generally
limited to maximum adjustments upwards or downwards of 1% each six months) on
the approximate $779 million in single-family ARM loans that comprise a portion
of the collateral for collateralized bonds. The Company would expect its net
interest spread on its interest-earning assets for the balance of 2001 to
improve relative to the first nine-months of 2001 due to further reductions in
short term interest rates since September 30, 2001.
For the three months ended September 30, 2001 compared to the three months
ended September 30, 2000, average interest-earning assets declined $728 million,
or approximately 21%. The decline for the nine-month period was $850 million, or
approximately 22%. A large portion of such reduction relates to paydowns on the
Company's adjustable-rate single-family mortgage loans and the sale of
fixed-rate commercial mortgage loans that were held for sale. The Company's
portfolio now consists of $778.7 million of adjustable rate assets and $1.8
billion of fixed-rate assets. The Company currently finances approximately
$195.5 million of the fixed-rate assets with non-recourse LIBOR based
floating-rate liabilities, and to the extent that short-term rates continue to
decline, the Company's net interest spread should continue to benefit. Once
rates stabilize, however, the remaining single-family ARM loans should continue
to reset downwards in rate (subject to "floors") which will have the impact of
reducing net interest spread in future periods.
Interest Income and Interest-Earning Assets. At September 30, 2001, $1.80
billion of the investment portfolio consists of loans which pay a fixed-rate of
interest. Also at September 30, 2001, approximately $800 million of the
investment portfolio is comprised of loans or securities that have coupon rates
which adjust over time (subject to certain periodic and lifetime limitations) in
conjunction with changes in short-term interest rates. Approximately 66% of the
ARM loans underlying the ARM securities and collateral for collateralized bonds
are indexed to and reset based upon the level of six-month LIBOR; approximately
22% of the ARM loans are indexed to and reset based upon the level of the
one-year Constant Maturity Treasury (CMT) index. The following table presents a
breakdown, by principal balance, of the Company's collateral for collateralized
bonds and ARM and fixed mortgage securities by type of underlying loan. This
table excludes derivative and residual securities, other investments and loans
held for sale.
Investment Portfolio Composition(1)
($ in millions)
LIBOR Based CMT Based Other Indices Fixed-Rate
ARM Loans ARM Loans Based ARM Loans Loans Total
- ----------------------------------------------------------------------------------------------------
1999, Quarter 4 $1,048.5 $430.8 $121.1 $2,061.5 $3,661.9
2000, Quarter 1 976.7 362.6 117.4 2,029.4 3,486.1
2000, Quarter 2 902.5 375.8 110.8 1,998.2 3,387.3
2000, Quarter 3 830.1 348.9 103.2 1,960.8 3,243.0
2000, Quarter 4 758.6 309.9 97.4 1,926.3 3,092.2
2001, Quarter 1 688.4 271.6 91.3 1,892.8 2,944.1
2001, Quarter 2 604.4 224.0 81.3 1,852.7 2,762.4
2001, Quarter 3 527.4 173.2 78.2 1,802.4 2,581.2
- ----------------------------------------------------------------------------------------------------
<FN>
(1) Includes only the principal amount of collateral for collateralized bonds,
ARM securities and fixed-rate mortgage securities.
</FN>
The average asset yield is reduced for the amortization of premiums, net of
discounts on the investment portfolio. As indicated in the table below, net
premium on the collateral for collateralized bonds, ARM securities, fixed-rate
mortgage securities at September 30, 2001 was $23.7 million, or approximately
0.90% of the aggregate balance of collateral for collateralized bonds, ARM
securities and fixed-rate securities. The $23.7 million net premium consists of
gross collateral premiums of $51.0 million, less gross collateral discounts of
$27.3 million. Of the $51.0 million in gross premiums on collateral, $34.2
million relates to the premium on multifamily and commercial mortgage loans with
a principal balance of $807.9 million at September 30, 2001, and that have
average initial prepayment lockouts or yield maintenance for at least ten years.
Net premium on such multifamily and commercial loans is $27.8 million.
Amortization expense as a percentage of principal paydowns has decreased from
1.59% for the three months ended September 30, 2000 to 1.30% for the same period
in 2001. The principal prepayment rate for the Company (indicated in the table
below as "CPR Annualized Rate") was approximately 28% for the three months ended
September 30, 2001. CPR or "constant prepayment rate" is a measure of the annual
prepayment rate on a pool of loans.
Premium Basis and Amortization
($ in millions)
Amortization
CPR Expense as a % of
Amortization Annualized Principal Principal Paydowns
Net Premium Expense Rate Paydowns
----------------------------------------------------------------------------------------------------------------------
1999, Quarter 4 $ 38.3 $ 2.2 20% $ 165.0 1.41%
2000, Quarter 1 36.2 2.0 18% 122.6 1.64%
2000, Quarter 2 34.1 2.1 18% 131.6 1.56%
2000, Quarter 3 32.0 2.1 18% 134.1 1.59%
2000, Quarter 4 30.1 1.9 20% 134.7 1.41%
2001, Quarter 1 28.0 2.0 23% 142.6 1.43%
2001, Quarter 2 25.7 2.3 28% 174.6 1.31%
2001, Quarter 3 23.7 2.1 28% 162.9 1.30%
- ---------------------------------------------------------------------------------------------------------------------------
Credit Exposures. The Company securitizes its loans into collateralized
bonds or pass-through securitization structures. With either structure, the
Company may use overcollateralization, subordination, third-party guarantees,
reserve funds, bond insurance, mortgage pool insurance or any combination of the
foregoing as a form of credit enhancement. With all forms of credit enhancement,
the Company may retain a limited portion of the direct credit risk after
securitization.
The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and ARM and fixed-rate mortgage pass-through securities
outstanding; the direct credit exposure retained by the Company (represented by
the amount of overcollateralization pledged and subordinated securities owned by
the Company and rated below BBB by one of the nationally recognized rating
agencies), net of the credit reserves maintained by the Company for such
exposure; and the actual credit losses incurred for each year. Credit reserves
maintained by the Company and included in the table below includes third-party
reimbursement guarantees of $30.3 million. The table excludes any risks related
to representations and warranties made on loans funded by the Company and
securitized in mortgage pass-through securities generally funded prior to 1995.
This table also excludes any credit exposure on loans held for sale or
securitization, and other investments, including delinquent property tax
receivables. The Company's credit exposure declines principally as a result of
charge-offs against the Company's investment in the respective security
structure, and the amount of provision for losses that the Company records
during the period relative to such charge-offs.
The Company is currently engaged in a dispute with the counterparty to the
$30.3 million in reimbursement guarantees. Such guarantees are payable when
cumulative loss trigger levels are reached on certain of the Company's
single-family mortgage loan securitizations. Currently, these trigger levels
have been reached on four of the Company's securities, and the Company has made
claims under the reimbursement guarantees in amounts approximating $1.7 million.
The counterparty has denied payment on these claims, citing various deficiencies
in loan underwriting which would render these loans and corresponding claims
ineligible under the reimbursement agreements. The Company disputes this
classification and is pursuing this matter through court-ordered arbitration.
Credit Reserves and Actual Credit Losses
($ in millions)
Outstanding Loan Credit Exposure, Net Actual Credit Credit Exposure, Net of Credit
Principal Balance of Credit Reserves Losses Reserves to Outstanding Loan
Balance
- ----------------------------------------------------------------------------------------------------------------------
1999, Quarter 4 $ 3,770.3 $ 183.2 $ 5.5 4.86%
2000, Quarter 1 3,679.6 136.0 4.8 3.70%
2000, Quarter 2 3,677.3 165.2 5.4 4.49%
2000, Quarter 3 3,503.1 142.4 6.8 4.06%
2000, Quarter 4 3,245.3 119.1 9.6 3.67%
2001, Quarter 1 3,137.0 111.7 8.1 3.56%
2001, Quarter 2 2,948.0 105.5 8.2 3.58%
2001, Quarter 3 2,771.2 100.1 9.2 3.61%
- ----------------------------------------------------------------------------------------------------------------------
The following table summarizes single family mortgage loan, manufactured
housing loan and commercial mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities in which Dynex REIT has
retained a portion of the direct credit risk. The delinquencies as a percentage
of the outstanding collateral balance have decreased to 1.75% at September 30,
2001 from 1.96% at September 30, 2000. The Company monitors and evaluates its
exposure to credit losses and has established reserves based upon anticipated
losses, general economic conditions and trends in the investment portfolio. As
of September 30, 2001, management believes the credit reserves are sufficient to
cover anticipated losses that may occur as a result of current delinquencies
presented in the table below.
Delinquency Statistics(1)
60 to 90 days 90 days and over
delinquent delinquent (2) Total
- -------------------------------------------------------------------------------------------------------------------------
1999, Quarter 4 0.27% 1.37% 1.64%
2000, Quarter 1 0.26% 1.46% 1.72%
2000, Quarter 2 0.34% 1.52% 1.86%
2000, Quarter 3 0.35% 1.61% 1.96%
2000, Quarter 4 0.37% 1.59% 1.96%
2001, Quarter 1 0.20% 1.55% 1.75%
2001, Quarter 2 0.29% 1.45% 1.74%
2001, Quarter 3 0.33% 1.42% 1.75%
- -------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Excludes other investments and loans held for sale or securitization.
(2) Includes foreclosures, repossessions and REO.
</FN>
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("FAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities" is effective for all fiscal
years beginning after June 15, 2000. FAS No. 133, as amended, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
The Company adopted FAS No. 133 effective January 1, 2001. The adoption of FAS
No. 133 did not have a significant impact on the financial position, results of
operations, or cash flows of the Company.
In September 2000, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities" ("FAS No.
140"). FAS No. 140 replaces the Statement of Financial Accounting Standards No.
125 "Accounting for the Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("FAS No. 125"). FAS No. 140 revises the
standards for accounting for securitization and other transfers of financial
assets and collateral and requires certain disclosure, but it carries over most
of FAS No. 125 provisions without reconsideration. FAS No. 140 is effective for
transfers and servicing of financial assets and extinguishment of liabilities
occurring after March 31, 2001. FAS No. 140 is effective for recognition and
reclassification of collateral and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000.
Disclosures about securitization and collateral accepted need not be reported
for periods ending on or before December 15, 2000, for which financial
statements are presented for comparative purposes. FAS No. 140 is to be applied
prospectively with certain exceptions. Other than those exceptions, earlier or
retroactive application of its accounting provision is not permitted. The
adoption of FAS No. 140 did not have a material impact on the Company's
financial statements.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 141, Business Combinations. SFAS No.
141 requires that all business combinations initiated after June 30, 2001 be
accounted for under the purchase method and addresses the initial recognition
and measurement of goodwill and other intangible assets acquired in a business
combination. Business combinations originally accounted for under the pooling of
interest method will not be changed. Management does not expect the adoption of
SFAS 141 to have an impact on the financial position, results of operations or
cash flows of the Company.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination and the accounting
for goodwill and other intangible assets subsequent to their acquisition. SFAS
No. 142 provides that intangible assets with finite useful lives be amortized
and that goodwill and intangible assets with indefinite lives will not be
amortized, but will rather be tested at least annually for impairment. As the
company has no goodwill or intangible assets which it is amortizing, the
adoption of SFAS No. 142 will have no effect on the financial position, results
of operations or cash flows of the Company.
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS 143 is effective for fiscal years
beginning after June 15, 2002. The Company is in the process of evaluating the
impact of implementing SFAS No. 143.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets" which supercedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be disposed of"
and the accounting and reporting provisions of APB No. 30, "Reporting the
Results of Operations - Reporting and Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" for the disposal of a segment of business. This statement is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
retains many of the provisions of SFAS No. 121, but addresses certain
implementation issues associated with that Statement. The Company is currently
evaluating the impact of implementing SFAS No. 142.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations from a variety of
sources. These sources have included cash flow generated from the investment
portfolio, including net interest income and principal payments and prepayments,
common stock offerings through the dividend reinvestment plan, short-term
warehouse lines of credit with commercial and investment banks, repurchase
agreements and the capital markets via the asset-backed securities market (which
provides long-term non-recourse funding of the investment portfolio via the
issuance of collateralized bonds). Historically, cash flow generated from the
investment portfolio has satisfied its working capital needs, and the Company
has had sufficient access to capital to fund its loan production operations, on
both a short-term (prior to securitization, and recourse) and long-term (after
securitization, and non-recourse) basis. However, market conditions since
October 1998 have substantially reduced the Company's access to capital. The
Company has been unable to access short-term warehouse lines of credit, and,
with the exception for the resecuritization of seasoned loans in its investment
portfolio, has been unable to efficiently access the asset-backed securities
market to meet its long-term funding needs. Largely as a result of its inability
to access additional capital, the Company sold its manufactured housing and
model home purchase/leaseback operations in 1999, and ceased issuing new
commitments in its commercial lending operations. Since 1999, the Company has
focused on substantially reducing its recourse debt and minimizing its capital
requirements. The Company has made substantial progress in both areas since
1999, and based upon its expected investment portfolio cash flows, and
anticipated proceeds from the sale or resecuritization of assets, the Company
anticipates that it will repay all of its recourse debt obligations in
accordance with their respective terms.
Non-recourse Debt. Dynex REIT, through limited-purpose finance
subsidiaries, has issued non-recourse debt in the form of collateralized bonds
to fund the majority of its investment portfolio. The obligations under the
collateralized bonds are payable solely from the collateral for collateralized
bonds and are otherwise non-recourse to Dynex REIT. Collateral for
collateralized bonds is not subject to margin calls. The maturity of each class
of collateralized bonds is directly affected by the rate of principal
prepayments on the related collateral. Each series is also subject to redemption
according to specific terms of the respective indentures, generally when the
remaining balance of the bonds equals 35% or less of the original principal
balance of the bonds. At September 30, 2001, Dynex REIT had $2.4 billion of
collateralized bonds outstanding.
Recourse Debt. The Company also uses repurchase agreements to finance a
portion of its investments. Repurchase agreements allow the Company to sell
investments for cash together with a simultaneous agreement to repurchase the
same investments on a specified date for a price that is equal to the original
sales price plus an interest component. At September 30, 2001, the Company had
repurchase agreements outstanding of $6.8 million, all with Lehman Brothers,
Inc. (Lehman). These repurchase agreements remain on an "overnight" or one-day
basis, and were secured by cash in escrow of $5.8 million, and securities with
an unpaid principal balance of approximately $88 million, and an estimated fair
value of approximately $62 million. The majority of these securities are rated
investment grade. The Company expects to repay all outstanding repurchase
agreements by the end of 2001.
As of September 30, 2001, the Company has $58.0 million outstanding of its
senior notes issued in July 1997 and due July 15, 2002 (the "July 2002 Notes").
On March 30, 2001, the Company entered into an amendment to the related
indenture governing the July 2002 Notes (the "Supplemental Indenture") whereby
the Company pledged to the Trustee of the July 2002 Notes substantially all of
the Company's unencumbered assets and the stock of its subsidiaries. In
consideration of this pledge, the indenture was further amended to provide for
the release of the Company from certain covenant restrictions in the indenture,
and specifically provided for the Company's ability to make distributions on its
capital stock in an amount not to exceed the sum of (a) $26 million, (b) the
cash proceeds of any "permitted subordinated indebtedness", (c) the cash
proceeds of the issuance of any "qualified capital stock", and (d) any
distributions required in order for the Company to maintain its REIT status.
Pursuant to its settlement with ACA (see Item 1 below), the Company is not
permitted to make any further distributions on its capital stock pursuant to
clause (a) above. In addition, the Company entered into a Purchase Agreement
with holders of 50.1% of the July 2002 Notes which require the Company to
purchase, and such holders to sell, their respective July 2002 Notes at various
discounts based on a computation of the Company's available cash. The discounts
provided for under the Purchase Agreement are as follows: by April 15, 2001,
10%; by July 15, 2001, 8%; by October 15, 2001, 6%; by January 15, 2002, 4%; by
March 1, 2002, 2%; thereafter until maturity, 0%. Through September 30, 2001,
the Company has retired $39,281 of July 2002 Notes for $35,549 in cash under the
Purchase Agreement.
The Company's ability to incur additional indebtedness has been
substantially limited by the Supplemental Indenture. After the repayment of its
repurchase agreement obligations, the only remaining recourse debt of the
Company will be the July 2002 Notes. Based on a pro forma analysis of cash flows
from its investment portfolio and proceeds from the call and resecuritization of
certain of its collateralized bond securities, the Company anticipates that the
July 2002 Notes will be repaid in accordance with their contractual terms,
although no assurances can be given of such repayment. A portion of the proceeds
for repayment of the July 2002 Notes will result from proceeds received from the
call and resecuritization of one series of collateralized bond obligations
currently outstanding. Such series is collateralized primarily by seasoned
single-family ARM loans. To the extent that there are significant disruptions in
the capital markets, the Company's ability to call such series and resecuritize
the underlying loans may be inhibited.
During the quarter ending September 30, 2001 the Company called and resold
one series of collateralized bonds. This series of collateralized bonds is
collateralized principally by adjustable-rate single-family mortgage loans and
securities. As a result of this call and resale the Company incurred an
extraordinary loss of $1.0 million related to the write-off of unamortized bond
issue costs and discounts on the called series.
Table 1
Net Balance Sheet(1)
($ in thousands)
September 30,
2001
-------------
ASSETS
Investments:
Collateral for collateralized bonds $ 2,558,555
Less: Collateralized bonds issued (2,460,584)
-------------
Net investment in collateralized bonds 97,971
Collateralized bonds retained 75,647
Securities 5,162
Other investments 34,143
Loans held for sale 2,891
-------------
215,814
Cash, including restricted 18,071
Accrued interest receivable 292
Other assets 14,802
-------------
Total Assets $ 248,979
=============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Repurchase agreements $ 6,823
Notes payable 58,141
Accrued interest payable 958
Other liabilities 1,715
-------------
Total Liabilities 67,637
-------------
Shareholders' Equity:
Preferred stock, par value $.01 per share 106,975
Common stock, par value $.01 per share, 114
Additional paid-in capital 361,469
Accumulated other comprehensive loss (94,738)
Accumulated deficit (192,478)
-------------
Total Shareholders' Equity 181,342
-------------
Total Liabilities and Shareholders' Equity $ 248,979
=============
<FN>
(1) This presents the balance sheet where the collateralized bonds are "netted"
against the collateral for collateralized bonds. This presentation better
illustrates the Company's net investment in the collateralized bonds and
the collateralized bonds retained in its investment portfolio.
</FN>
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-Q made by the Company, that are
not historical fact constitute "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. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or
from any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by general economic
conditions. The risk of defaults and credit losses could increase during an
economic slowdown or recession. This could have an adverse effect on the
Company's financial performance and the performance on the Company's securitized
loan pools.
Capital Resources. The Company relies on a repurchase facility with an
investment-banking firm to meet its remaining short-term funding needs. This
repurchase facility is currently on an overnight maturity basis. The Company's
access to alternative or additional sources of financing has been significantly
reduced.
Capital Markets. The Company relies on the capital markets for the sale
upon securitization of its collateralized bonds or other types of securities.
While the Company has historically been able to sell such collateralized bonds
and securities into the capital markets, the Company's access to capital markets
has been substantially reduced, which may impair the Company's ability to
re-securitize its existing securitizations in the future.
Interest Rate Fluctuations. The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
pledged as collateral for collateralized bonds by the Company are fixed-rate.
The Company currently finances these fixed-rate assets through non-recourse
debt, $195.5 million of which is variable rate. In addition, a significant
amount of the investments held by the Company are variable rate collateral for
collateralized bonds. These investments are financed through non-recourse
long-term collateralized bonds and, to a lesser extent, recourse short-term
repurchase agreements. The net interest spread for these investments could
decrease during a period of rapidly rising short-term interest rates, since the
investments generally have periodic interest rate caps and the related borrowing
have no such interest rate caps.
Defaults. Defaults by borrowers on loans included in the Company's
investment portfolio may have an adverse impact on the Company's financial
performance, if actual credit losses differ materially from estimates made by
the Company. The Company's allowance for losses is calculated on the basis of
historical experience, industry data, and management's estimates. Actual default
rates or loss severities may differ from the Company's estimate for a variety of
reasons, including economic conditions. Defaults on the Company's manufactured
housing loans have been higher than the Company's prior estimates. Actual
defaults on ARM loans may increase during a rising interest rate environment.
The Company believes that its reserves are adequate for such risks on loans that
were delinquent as of September 30, 2001.
Prepayments. Prepayments by borrowers on loans securitized by the Company
may have an adverse impact on the Company's financial performance. Prepayments
are expected to increase during a declining interest rate or flat yield curve
environment. The Company's exposure to rapid prepayments is primarily (i) the
faster amortization of premium on the investments and, to the extent applicable,
amortization of bond discounts, and (ii) the more rapid decline in its portfolio
of earning assets.
Competition. The financial services industry is a highly competitive
market. Increased competition in the market has adversely affected the Company,
and may continue to do so.
Regulatory Changes. The Company's businesses as of September 30, 2001 are
not subject to any material federal or state regulation or licensing
requirements. However, changes in existing laws and regulations or in the
interpretation thereof, or the introduction of new laws and regulations, could
adversely affect the Company and the performance of the Company's securitized
loan pools or its ability to collect on its delinquent property tax receivables.
Risks and Uncertainties. See Note 1 to the Company's audited financial
statements for the year ended December 31, 2000.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest income comprises the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting from interest rate fluctuations to the extent that there is a gap
between the amount of the Company's interest-earning assets and the amount of
interest-bearing liabilities that are prepaid, mature or re-price within
specified periods. The Company's strategy has been to mitigate interest rate
risk through the creation of a diversified investment portfolio of high quality
assets that, in the aggregate, preserves the Company's capital base while
generating stable income in a variety of interest rate and prepayment
environments.
The Company monitors the aggregate cash flow, projected net yield and
market value of its investment portfolio under various interest rate and
prepayment assumptions. While certain investments may perform poorly in an
increasing or decreasing interest rate environment, other investments may
perform well, and others may not be impacted at all.
The Company measures the sensitivity of its net interest income, excluding
various accounting adjustments including provision for losses, and premium and
discount amortization, to changes in interest rates. Changes in interest rates
are defined as instantaneous, parallel, and sustained interest rate movements in
100 basis point increments. The Company estimates its interest income for the
next twenty-four months assuming no changes in interest rates from those at
period end. Once the base case has been estimated, cash flows are projected for
each of the defined interest rate scenarios. Those scenario results are then
compared against the base case to determine the estimated change to net interest
income, excluding various accounting adjustments as set forth above.
The following table summarizes the Company's net interest margin
sensitivity analysis as of September 30, 2001. This analysis represents
management's estimate of the percentage change in net interest margin given a
parallel shift in interest rates. The "Base" case represents the interest rate
environment as it existed as of September 30, 2001. The analysis is heavily
dependent upon the assumptions used in the model. The effect of changes in
future interest rates, the shape of the yield curve or the mix of assets and
liabilities may cause actual results to differ from the modeled results. In
addition, certain financial instruments provide a degree of "optionality." The
most significant option affecting the Company's portfolio is the borrowers'
option to prepay the loans. The model applies prepayment rate assumptions
representing management's estimate of prepayment activity on a projected basis
for each collateral pool in the investment portfolio. The model applies the same
prepayment rate assumptions for all five cases indicated below. The extent to
which borrowers utilize the ability to exercise their option may cause actual
results to significantly differ from the analysis. Furthermore, its projected
results assume no additions or subtractions to the Company's portfolio, and no
change to the Company's liability structure. Historically, there have been
significant changes in the Company's assets and liabilities, and there are
likely to be such changes in the future.
Basis Point Increase (Decrease) % Change in Net Interest
In Interest Rates Margin from Base Case
------------------------------- ------------------------
+200 (7.6)%
+100 (3.8)%
Base
-100 3.8%
-200 7.6%
The Company's investment policy sets forth guidelines for assuming interest
rate risk. The investment policy stipulates that given a 200 basis point
increase or decrease in interest rates over a twelve month period, the estimated
net interest margin may not change by more than 25% of current net interest
margin during the subsequent one year period. The Company is in compliance with
such investment policy.
Approximately $779 million of the Company's investment portfolio as of
September 30, 2001 is comprised of loans or securities that have coupon rates
which adjust over time (subject to certain periodic and lifetime limitations) in
conjunction with changes in short-term interest rates. Approximately 66% and 22%
of the ARM loans underlying the Company's ARM securities and collateral for
collateralized bonds are indexed to and reset based upon the level of six-month
LIBOR and one-year CMT, respectively.
Generally, during a period of rising short-term interest rates, the
Company's net interest spread earned on its investment portfolio will decrease.
The decrease of the net interest spread results from (i) the lag in resets of
the ARM loans underlying the ARM securities and collateral for collateralized
bonds relative to the rate resets on the associated borrowings and (ii) rate
resets on the ARM loans which are generally limited to 1% every six months or 2%
every twelve months and subject to lifetime caps, while the associated
borrowings have no such limitation. As short-term interest rates stabilize and
the ARM loans reset, the net interest margin may be restored to its former level
as the yields on the ARM loans adjust to market conditions. Conversely, net
interest margin may increase following a fall in short-term interest rates. This
increase may be temporary as the yields on the ARM loans adjust to the new
market conditions after a lag period. In each case, however, the Company expects
that the increase or decrease in the net interest spread due to changes in the
short-term interest rates to be temporary. The net interest spread may also be
increased or decreased by the proceeds or costs of interest rate swap, cap or
floor agreements, to the extent that the Company has entered into such
agreements.
The remaining portion of the Company's investments portfolio as of
September 30, 2001, approximately $1.80 billion, is comprised of loans or
securities that have coupon rates that are fixed. The Company has substantially
limited its interest rate risk on such investments through (i) the issuance of
fixed-rate collateralized bonds and notes payable which approximated $1.4
billion as of September 30, 2001, and (ii) equity, which was $181.3 million.
Overall, the Company's interest rate risk is related both to the rate of change
in short term interest rates, and to the level of short-term interest rates.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On November 7, 2000, the Company entered into an Agreement and Plan of
Merger with California Investment Fund, LLC ("CIF"), for the purchase of all of
the equity securities of the Company for $90 million (the "Merger Agreement").
The Merger Agreement was subsequently amended on December 22, 2000 as a result
of a breach of the requirements of the Merger Agreement by CIF in delivering
sufficient evidence of a financing commitment. Among other things, the amendment
to the Merger Agreement obligated CIF to deliver to the Company written binding
financing commitments and evidence of the consent of the holders of the July
2002 Notes to the merger transaction on or before January 25, 2001. On January
25, 2001, CIF failed to meet the requirements as set forth in the Merger
Agreement and the letter of December 22, 2000, and the Company terminated the
Merger Agreement effective January 26, 2001 and requested that the escrow agent
release to the Company the $1 million and 572,178 shares of common stock of the
Company which CIF placed in escrow under the Merger Agreement (the "Escrow
Amount"). On January 29, 2001, the Company filed for Declaratory Judgment in
United States District Court for the Eastern District of Virginia, Alexandria
Division (the "Court"). CIF filed a counterclaim and demand for jury trial and
asked for damages of $45 million. The Court subsequently capped CIF's damage
claim to $2 million as set forth in the Merger Agreement and held a jury trial.
On October 16, 2001, the jury returned a verdict whwhich would result in (i) the
escrow amount consisting of $1 million and 572,178 shares of common stock being
awarded to the Company, and (ii) the Company having to pay CIF a termination fee
of $2 million. The Court has yet to enter judgment pending its decision
regarding motions filed by the two parties. Assuming the Court upholds the jury
verdict on the $2 million termination fee the Company will most likely appeal.
Neither the receipt of the escrow amount nor the payment of the $2 million
termination fee has been accrued for in the accompanying financial statements.
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the
County of Allegheny, Pennsylvania ("Allegheny County"), were defendants in a
lawsuit in the Commonwealth Court of Pennsylvania (the "Commonwealth Court")
wherein the plaintiffs challenged the right of Allegheny County and GLS to
collect certain interest, costs and expenses related to delinquent property tax
receivables in Allegheny County. This lawsuit was related to the purchase by GLS
of delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999 for approximately $58.3 million. On July 5, 2001, the Commonwealth Court
ruling addressed, among other things, (i) the right of the Company to charge to
the delinquent taxpayer a rate of interest of 12% versus 10% on the collection
of its delinquent property tax receivables, (ii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iii)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court remanded for further consideration to the Court of Common
Pleas items (i) and (iii), and ruled that neither Allegheny County nor GLS had
the right to charge attorney's fees to the delinquent taxpayer related to the
collection of such tax receivables, reversing the Court of Common Pleas
decision. On September 10th the Commonwealth Court denied the County of
Allegheny and GLS's Application for Re-argument. The Pennsylvania Supreme Court
has accepted the Application for Extraordinary Jurisdiction filed by Allegheny
County and GLS. No damages have been claimed in the action; however, as
discussed in Note 4, the decision may impact the ultimate recoverability of the
delinquent property tax receivables. To date, GLS has incurred attorneys fees of
approximately $2,000 related to foreclosures on such delinquent property tax
receivables, approximately $1,000 of which have been reimbursed to GLS by the
taxpayer or through liquidation of the underlying real property.
On May 4, 2001, ACA Financial Guaranty Corporation ("ACA") commenced an
action in the United States District Court for the Southern District of New York
(the "District Court"), (the "Action"), in which ACA sought injunctive relief as
well as money damages of $25 million based on causes of action for fraudulent
conveyance and breach of contract. The complaint challenged, among other things,
the validity of the March 30, 2001 Supplemental Indenture to the 1997 Senior
Note Indenture as amended ("1997 Indenture") discussed in Note 5, pursuant to
which in 1997 Dynex issued its 7.875% Senior Notes due July 2002. In particular,
the complaint challenged the validity, among other things, of the Purchase
Agreement, and the Supplemental Indenture and the related amendment to certain
restrictive covenants in the Indenture to allow for certain distributions to
holders of Dynex equity securities, including the Preferred Stock. ACA is a
financial guaranty company who has insured $25 million of the July 2002 Notes
for repayment at maturity on July 15, 2002, for the benefit of the holder of the
Notes. The Company is not a party to this insurance contract. On October 31,
2001, the Company and ACA settled this matter out of court. The settlement
provides for, among other things, that the Company could complete the tender
offer of Preferred Stock announced on September 6, 2001 (and subsequently funded
on November 2, 2001), but that the Company would generally not be permitted to
make further distributions on its capital stock until the July 2002 Notes are
repaid or defeased.
The Company is also subject to other lawsuits or claims which have arisen
in the ordinary course of its business, some of which seek damages in amounts
which could be material to the financial statements. Although no assurance can
be given with respect to the ultimate outcome of any such litigation or claim,
the Company believes the resolution of such lawsuits or claims will not have a
material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
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
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 10.8. Terms of Employment between Dynex Capital, Inc. and
Mr. Thomas H. Potts, dated September 4, 2001.
Exhibit 10.9. Terms of Employment between Dynex Capital, Inc. and
Mr. Stephen J. Benedetti, dated September 4, 2001.
(b) Reports on Form 8-K
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.
DYNEX CAPITAL, INC.
By: /s/ Thomas H. Potts
------------------------------------
Thomas H. Potts, President
(authorized officer of registrant)
/s/ Stephen J. Benedetti
------------------------------------
Stephen J. Benedetti, Chief Financial
Officer, Executive Vice President,
and Treasurer
(principal accounting officer)
Dated: November 14, 2001