UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
MERIT SECURITIES CORPORATION
(Exact name of registrant as specified in its charter)
33-83524
Commission File No.
Virginia 54-1736551
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060-6740
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|
Aggregate market value of voting stock held by non-affiliates of the registrant
as of the latest practicable date, February 28, 2003:
None
As of February 28, 2002, the latest practicable date, there were 1,000 shares of
Merit Securities Corporation common stock outstanding.
The registrant meets the conditions set forth in General Instruction I(1)(a) and
(b) of Form 10-K and, therefore, is furnishing the abbreviated narrative
disclosure specified in Paragraph (2) of General Instruction I.
(i)
MERIT SECURITIES CORPORATION
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
Number
PART I.
Item 1. Business..................................................................................1
Item 2. Properties................................................................................3
Item 3. Legal Proceedings.........................................................................3
Item 4. Submission of Matters to a Vote of Security Holders.......................................3
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.....................3
Item 6. Selected Financial Data...................................................................3
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.....................................................................3
Item 7A. Quantitative and Qualitative Disclosures about Market Risk................................8
Item 8. Financial Statements and Supplementary Data..............................................11
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.....................................................................24
PART III.
Item 10. Directors and Executive Officers of the Registrant.......................................24
Item 11. Executive Compensation...................................................................24
Item 12. Security Ownership of Certain Beneficial Owners and Management...........................24
Item 13. Certain Relationships and Related Transactions...........................................24
PART IV.
Item 14. Controls and Procedures..................................................................24
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........................25
SIGNATURES .........................................................................................28
PART I
Item 1. BUSINESS
Merit Securities Corporation (the "Company") was incorporated in Virginia on
August 19, 1994. The Company is a wholly-owned, limited-purpose finance
subsidiary of Issuer Holding Corporation ("IHC"), which is a wholly-owned
subsidiary of Dynex Capital, Inc. ("Dynex"), a New York Stock Exchange listed
financial services company (symbol: DX). The financial statements include the
amounts of the Company and its wholly owned subsidiary, Financial Asset
Securitization, Inc. (FASI).
The Company was organized to facilitate the securitization of loans through the
issuance and sale of collateralized bonds (the "Bonds"). The Bonds are secured
by securities and loans backed primarily by: (i) mortgage loans secured by first
or second liens on residential property, and manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title, (ii) other
mortgage pass-through certificates or mortgage-collateralized obligations, and
(iii) consumer installment loans (collectively, the "Collateral"). In the
future, the Company may also securitize other types of loans or securities such
as Federal National Mortgage Association Mortgage-Backed Certificates, Federal
Home Loan Mortgage Corporation Mortgage-Backed Certificates, or Government
National Mortgage Association Mortgage-Backed Certificates.
After payment of the expenses of an offering and certain administrative
expenses, the net proceeds from an offering of Bonds have been used to purchase
Collateral from IHC or various third parties. IHC has used the proceeds to
reduce indebtedness incurred to obtain such loans or to acquire additional
Collateral. After the issuance of a series of Bonds, the Company may sell the
Collateral securing that series of Bonds, subject to the lien of the Bonds.
From the date of its inception to December 31, 2002, the Company has issued
fifteen (15) series of Bonds totaling approximately $9.7 billion aggregate
principal amount. To date, eleven (11) of these series have been called and
collapsed into subsequent issuances or called and re-offered for sale. As of
December 31, 2002 and December 31, 2001, the Company had four (4) series of
Bonds outstanding totaling approximately $1.3 billion and $1.5 billion
respectively.
On April 25, 2002, the Company completed the securitization of $602 million of
single-family mortgage loans and the associated issuance of $605 million of
collateralized bonds. Of the $602 million of single-family mortgage loans
securitized, $447 million were loans which were already owned by the Company and
$155 million represented new loans from the purchase of adjustable-rate and
fixed-rate mortgage backed securities from third parties pursuant to certain
call rights owned by the Company. The securitization was accounted for as a
financing; thus the loans and associated bonds were included in the accompanying
consolidated balance sheet as assets and liabilities of the Company.
Approximately $12 million of delinquent loans were not included in the
securitization and were retained by the Company. These loans were considered
held-for-sale, and accordingly were adjusted to the lower of cost or market. The
Company no longer considers these loans held-for-sale.
At December 31, 2002, the Company had securities of approximately $308.6 million
remaining for issuance under a shelf registration statement filed with the
Securities and Exchange Commission. The Company does not currently anticipate
issuing additional Bonds in the near future, other than the possible call and
re-securitization or re-issuance of previously issued Bonds.
The Company competes in a national market with various financial firms. Economic
conditions, interest rates, regulatory changes and market dynamics all influence
the securities market.
Securitization
The Company's predominate securitization structure is collateralized bonds,
whereby loans and securities are pledged to a trust and the trust issues
non-recourse collateralized bonds pursuant to an indenture. Generally, for
accounting and tax purposes, the loans and securities financed through the
issuance of collateralized bonds are treated as assets of the Company, and the
collateralized bonds are treated as debt of the Company. The Company earns the
1
net interest spread between the interest income on the loans and securities and
the interest and other expenses associated with the collateralized bond
financing. The net interest spread is directly impacted by the credit
performance of the underlying loans and securities, by the level of prepayments
of the underlying loans and securities and, to the extent collateralized bond
classes are variable-rate, may be affected by changes in short-term rates. The
Company's investment in the collateralized bonds is typically referred to as the
"over-collateralization", which is represented by the excess of the collateral
pledged over the associated collateralized bonds.
Investment Portfolio Risks
The Company is exposed to several types of risks inherent in its investment
portfolio. These risks include credit risk (inherent in the loan and/or security
structure) and prepayment/interest rate risk (inherent in the underlying loan).
Credit Risk
Credit risk is the risk of loss to the Company from the failure by a borrower
(or the proceeds from the liquidation of the underlying collateral) to fully
repay the principal balance and interest due on a loan. A borrower's ability to
repay, or the value of the underlying collateral, could be negatively influenced
by economic and market conditions. These conditions could be global, national,
regional or local in nature. Upon securitization of the pool of loans or
securities backed by loans, the credit risk retained by the Company is generally
limited to its net investment in the collateralized bond structure (referred to
as "principal balance of net investment", or as "over-collateralization") and/or
subordinated [securities] that it may retain from a securitization. For
securitized pools of loans, the Company provides for reserves for expected
losses based on the current performance of the respective pool; if losses are
experienced more rapidly due to market conditions than the Company has provided
for in its reserves, the Company may be required to provide for additional
reserves for these losses. The Company also has credit risk related to certain
debt securities, principally on those pledged as collateral for collateralized
bonds, and recognizes losses when incurred or when such security is deemed to be
impaired on an other than temporary basis.
The Company evaluates and monitors its exposure to credit losses and has
established reserves for probable credit losses based upon anticipated future
losses on the loans and securities, general economic conditions and historical
trends in the portfolio. For loans and securities pledged as collateral for
collateralized bonds, the Company considers its credit exposure to include
over-collateralization and retained subordinated securities. As of December 31,
2002, the Company's credit exposure on over-collateralization was $93.6 million.
The Company has reserves of $20.7 million relative to this credit exposure. The
Company also has credit risk on loans that are not securitized amounting to $6.5
million at December 31, 2002.
The Company also has various other forms of credit enhancement which, based upon
the performance of the underlying loans and securities, may provide additional
protection against losses. Specifically $272.0 million of the single family
mortgage loans in various pools are subject to various mortgage pool insurance
policies whereby losses would need to exceed the remaining stop loss of at least
48.4% on such policies before the Company would incur losses; and $94.0 million
of the single family mortgage loans are subject to various loss reimbursement
agreements totaling $30.2 million with a remaining aggregate deductible of
approximately $1.4 million.
Prepayment/Interest Rate Risk
The interest rate environment may also impact the Company. For example, in a
rising rate environment, the Company's net interest margin may be reduced, as
the interest cost for its funding sources could increase more rapidly than the
interest earned on the associated asset financed. The Company's floating-rate
funding sources are substantially based on the one-month London Inter-Bank
Offered Rate ("LIBOR") and re-price at least monthly, while the associated
assets are principally six-month LIBOR or one-year Constant Maturity Treasury
("CMT") based and generally re-price every six to twelve months. Additionally,
the Company has approximately $254 million of fixed-rate assets financed with
floating-rate collateralized bond liabilities. In a declining rate environment,
net interest margin may be enhanced for the opposite reasons. In a period of
declining interest rates, however, loans and securities in the investment
portfolio will generally prepay more rapidly (to the extent that such loans are
not prohibited from prepayment), which may result in additional amortization of
asset premium. In a flat yield curve environment (i.e., when the spread between
the yield on the one-year Treasury security and the yield on the ten-year
2
Treasury security is less than 1.0%), single-family adjustable rate mortgage
("ARM") loans and securities tend to rapidly prepay, causing additional
amortization of asset premium. In addition, the spread between the Company's
funding costs and asset yields would most likely compress, causing a further
reduction in the Company's net interest margin. Lastly, the Company's investment
portfolio may shrink, or proceeds returned from prepaid assets may be invested
in lower yielding assets. The severity of the impact of a flat yield curve to
the Company would depend on the length of time the yield curve remained flat.
Item 2. PROPERTIES
The Company has no physical properties.
Item 3. LEGAL PROCEEDINGS
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information in response to this Item is omitted pursuant to General Instruction
I.
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
All of the Company's outstanding common stock is owned by IHC. Accordingly,
there is no market for its common stock. The Company has paid no dividends with
respect to its common stock.
Item 6. SELECTED FINANCIAL DATA
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company is a financial services company, which invests in loans and
securities consisting of or secured by, principally single family mortgage loans
and manufactured housing installment loans. The loans and securities in which
the Company invests have generally been pooled and pledged (i.e. securitized) as
collateral for non-recourse bonds ("collateralized bonds"), which provides
long-term financing for such loans while limiting credit, interest rate and
liquidity risk.
On April 25, 2002, the Company completed the securitization of $602 million of
single-family mortgage loans and the associated issuance of $605 million of
collateralized bonds. Of the $602 million of single-family mortgage loans
securitized, $447 million were loans which were already owned by the Company and
$155 million represented new loans from the purchase of adjustable-rate and
fixed-rate mortgage backed securities from third parties pursuant to certain
call rights owned by the Company. The securitization was accounted for as a
financing; thus the loans and associated bonds were included in the accompanying
consolidated balance sheet as assets and liabilities of the Company.
Approximately $12 million of delinquent loans were not included in the
securitization and were retained by the Company. These loans were considered
available-for-sale, and accordingly were adjusted to the lower of cost or
market. The Company no longer considers these loans available-for-sale.
3
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the Company's financial condition and results of
operations are based in large part upon its consolidated financial statements,
which have been prepared in conformity with accounting principles generally
accepted in the United States of America. The preparation of the financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenue and expenses during the reported period. Actual results could differ
from those estimates.
Critical accounting policies are defined as those that are reflective of
significant judgements or uncertainties, and which may result in materially
different results under different assumptions and conditions, or the application
of which may have a material impact on the Company's financial statements. The
following are the Company's critical accounting policies.
Fair Value
The Company 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 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. Collateral for collateralized
bonds make up a significant portion of the Company's investments. The estimate
of fair value for securities within collateral for collateralized bonds is
determined by calculating the present value of the projected net cash flows of
the instruments, using discount rates, prepayment rate assumptions and credit
loss assumptions established by management. The discount rate used in the
determination of fair value of the collateral for collateralized bonds was 16%
at December 31, 2002 and 2001. The Company utilizes a discount rate of 16% in
determining the fair value of its financial instruments when the Company's
ownership interest in such financial instrument is generally represented by
interests rated `BBB' or below, and generally concentrated in the
overcollateralization or residual interest components. Prepayment rate
assumptions at December 31, 2002 and 2001 were generally at a "constant
prepayment rate," or CPR, ranging from 26%-50% for 2002, and 40%-60% for 2001,
for collateral for collateralized bonds consisting of single-family mortgage
loans and securities, and a CPR equivalent of 11%-12% for 2002 and 9%-10% for
2001, for collateral for collateralized bonds consisting of manufactured housing
loans and securities. CPR assumptions for each year are based in part on the
actual prepayment rates experienced for the prior six-month period and in part
on management's estimate of future prepayment activity. The loss assumptions
utilized vary for each series of collateral for collateralized bonds, depending
on the collateral pledged. The cash flows for the collateral for collateralized
bonds were projected to the estimated date that the collateralized bond security
could be called and retired by the Company if there is economic value to the
Company in calling and retiring the collateralized bond security. Such call date
is typically triggered on the earlier of a specified date or when the remaining
collateralized bond security balance equals 35% of the original balance (the
"Call Date"). The Company estimates anticipated market prices of the underlying
collateral at the Call Date.
Allowance for Loan Losses
The Company has credit risk on loans pledged as collateral for collateralized
bonds in its investment portfolio. An allowance for loan losses has been
estimated and established for current existing losses based on certain
performance factors associated with the collateral, including current loan
delinquencies, historical cure rates of delinquent loans, and historical and
anticipated loss severity of the loans as they are liquidated. The allowance for
loan losses is evaluated and adjusted periodically by management based on the
actual and projected timing and amount of probable credit losses, using the
above factors, as well as industry loss experience. The loans are considered
homogeneous and the allowance for loan losses is established and evaluated on a
pool basis. Provisions made to increase the allowance related to credit risk are
presented as provision for loan losses in the accompanying consolidated
statements of operations. The Company's actual credit losses may differ from
those estimates used to record the allowance.
4
FINANCIAL CONDITION
- --------------------------------------------------------------------------------
December 31,
-----------------------
(amounts in thousands except series outstanding) ....... 2002 2001
---------- ----------
Collateral for collateralized bonds .................... $1,341,237 $1,634,460
Loans .................................................. 6,505 906
Asset-backed Securities ................................ 1,644 3,529
Non-recourse debt - collateralized bonds ............... 1,299,113 1,542,924
Shareholder's equity ................................... 61,780 95,971
Collateralized bond series outstanding ................. 4 4
- --------------------------------------------------------------------------------
Collateral for collateralized bonds
Collateral for collateralized bonds includes loans and securities consisting of,
or secured by, adjustable-rate and fixed-rate mortgage loans secured by first
liens on single family properties, fixed-rate loans secured by first liens on
multifamily and manufactured housing installment loans secured by either a UCC
filing or a motor vehicle title. As of December 31, 2002 and 2001, the Company
had four series of collateralized bonds outstanding. The collateral for
collateralized bonds decreased to $1.3 billion at December 31, 2002 compared to
$1.6 billion at December 31, 2001. This decrease of $293.2 million is primarily
the result of $390 million in paydowns on the collateral, $28.5 million of
increased provisions for losses on loans, $15.6 million of impairment losses on
securities, amortization of premiums and discounts of $2.2 million and market
value adjustments of $3.1 million. These decreases were offset by the addition
of $147 million of new collateral purchased in the current year.
Loans
Loans increased to $6.5 million at December 31, 2002 from $0.9 million at
December 31, 2001. In connection with the securitization completed in April 2002
as previously discussed, non-performing loans in the amount of $12.6 million
were reclassified to loans from collateral for collateralized bonds. This
increase was partially offset by paydowns on the loans of $4.2 million,
impairment write-downs of $2.1 million, and $1.0 million of other net decreases.
Asset-backed Securities
Asset-backed securities decreased to $1.6 million at December 31, 2002, compared
to $3.5 million at December 31, 2001, as a result of principal payments of $2.0
million during the year partially offset by $0.1 million in discount
amortization.
Non-recourse debt - collateralized bonds
Collateralized bonds decreased to $1.3 billion at December 31, 2002 from $1.5
billion at December 31, 2001. This decrease was primarily a result of principal
pay-downs of $420.8 million and interest made during the year, from the
principal payments received from the associated collateral for collateralized
bonds and a net decrease of $0.5 million for accrued interest payable. These
decreases were partially offset by a net increase in bonds payable of $174.5
million and amortization of the discount on collateralized bonds of $3.2
million.
Shareholder's Equity
Shareholder's equity decreased to $61.8 million at December 31, 2002, from $96.0
million at December 31, 2001. This decrease was a result of $24.1 million in
dividend and return of capital distributions made by the Company to IHC, a $3.3
million decrease in net unrealized income, and a net loss of $6.8 million during
2002.
5
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
For the Year Ended December 31,
-------------------------------------
(amounts in thousands) 2002 2001 2000
- --------------------------------------------------------------------------------
Interest income $ 105,217 $ 150,372 $ 201,317
Interest expense 65,432 109,863 176,918
Provision for losses 28,559 18,670 28,585
Net interest margin 11,226 21,839 (4,186)
Loss on termination of interest rate caps - - (2,440)
Impairment charges (17,617) (15,840) (5,523)
Extraordinary loss - extinguishment of debt (379) (1,013) -
-------------------------------------
Net (loss) income (6,770) 4,986 (12,714)
- --------------------------------------------------------------------------------
Interest income on the collateral for collateralized bonds decreased to $105.2
million in 2002 from $150.4 million in 2001. This decrease was primarily a
result of the continued impact of prepayments on interest income, as average
collateral for collateralized bonds declined from $2.0 billion to $1.5 billion
for the years ended December 31, 2001 and 2002, respectively, coupled with the
overall decline in interest rates during 2002. Interest income on the collateral
for collateralized bonds decreased to $150.4 million in 2001 from $201.3 million
in 2000. This decrease was primarily a result of the continued impact of
prepayments on interest income, as average collateral for collateralized bonds
declined from $2.6 billion to $2.0 billion for the years ended December 31, 2000
and 2001, respectively, coupled with the overall decline in interest rates
during 2001.
Interest expense on collateralized bonds decreased to $65.4 million in 2002 from
$109.9 million in 2001, primarily due to the decrease in one-month London
InterBank Offered Rate ("LIBOR") during 2002 and the decline in average
collateralized bonds due to paydowns on the related collateral for
collateralized bonds. The one-month LIBOR decreased from 1.87% at December 31,
2001 to 1.38% at December 31, 2002. Interest expense on collateralized bonds
decreased to $109.9 million in 2001 from $176.9 million in 2000, primarily due
to the decrease in one-month London InterBank Offered Rate ("LIBOR") during 2001
and the decline in average collateralized bonds due to prepayments on the
related collateral for collateralized bonds.
The Company provides for losses on its loans where it has retained credit risk.
The Company provides for losses on its loans through a provision for loan
losses. Provision for loan losses increased to $28.6 million in 2002 from $18.7
million in 2001. The continuing under-performance of the Company's manufactured
housing loan and securities portfolio prompted the company to revise its
estimate of losses to include a percentage of all loans with delinquencies
greater than 30 days. Defaults in 2002 averaged 4.3% versus 4.2% in 2001, and
loss severity remained at 77% during the year. "Loss Severity" is the cumulative
loss incurred on a loan, or sub-set of loans, divided by the unpaid principal
balance of such loan(s). Should these trends continue, the Company will likely
need to increase the provision for loan losses and will likely have increased
other-than-temporary impairment charges on its manufactured housing debt
securities portfolio. Provision for losses for loans decreased to $18.7 million
in 2001 from $28.5 million in 2000 and impairment charges increased to $15.8
million in 2001 from $5.5 million in 2000. Provision for losses and
other-than-temporary impairment losses remained high in 2001 due to the
under-performance of the Company's manufactured housing loan portfolio. The
increase in severe loan losses is a result of the saturation in the market place
with both new and used (repossessed) manufactured housing units. In addition,
the Company has seen some increase in overall default rates on its manufactured
housing loans. Defaults in 2001 averaged 4.2% versus 3.4% in 2000, and loss
severity increased from 70% to 77% during the year.
Net interest margin in 2002 decreased to $11.2 million from $21.8 million in
2001. This decrease was the result of an increase in provision for losses and
reduced borrowing costs on collateralized bonds outstanding partially offset by
a decline in interest earning assets during these periods. Net interest margin
in 2001 increased to $21.8 million from $(4.2) million in 2000. This increase
was the result of the reduction in the Company's average cost of funds as a
result of the overall decline in interest rates during 2001. Due to the mismatch
in the re-pricing of the Company's assets and liabilities (the adjustable rate
portion of the Company's assets resets generally every six months and the
adjustable rate portion of the Company's collateralized bonds resets generally
every month), the decrease in overall rates benefited the Company's net interest
margin.
6
The Company recognizes other than temporary impairment charges on its debt
securities. Impairment charges increased from $15.8 million in 2001 to $17.6
million in 2002. Impairment charges increased to $15.8 million in 2001 compared
to $5.5 million in 2000. These increases resulted from the continued
under-performance of the Company's manufactured housing loan portfolio in debt
securities as discussed above.
Loss on termination of interest rate caps of $2.4 million during 2000 is the
result of the liquidation of the Company's interest rate cap agreements, which
had a notional balance of $351 million.
The extraordinary loss of $0.4 million in 2002 was a result of the write-off of
bond issuance costs relating to the securitization completed in April 2002. The
extraordinary loss of $1.0 million in 2001 was a result of the call and
re-issuance of $503.8 million of collateralized bonds related to its Series 11A
bonds.
Credit Exposures
With collateralized bond structures, the Company retains credit risk relative to
the amount of over-collateralization required in conjunction with the bond
insurance. Losses are generally first applied to the over-collateralized amount,
with any losses in excess of that amount borne by the holders of the
collateralized bonds. Generally, surplus cash that would otherwise be released
to the Company is retained within the securitization structure if losses exceed
a certain threshold. The Company only incurs credit losses to the extent that
losses are incurred in the repossession, foreclosure and sale of the underlying
collateral. Such losses generally equal the excess of the principal amount
outstanding, less any proceeds from mortgage or hazard insurance, over the
liquidation value of the collateral. To compensate the Company for retaining
this loss exposure, the Company generally receives an excess yield on the
collateralized loans relative to the yield on the collateralized bonds. At
December 31, 2002, the Company retained $93.6 million in aggregate principal
amount of over-collateralization compared to $102.7 million at December 31,
2001. During 2002, surplus cash retained to cover losses aggregated $6.7
million.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("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 No.143 is effective for fiscal years
beginning after June 15, 2002. The Company does not believe the adoption of SFAS
No. 143 will have a significant impact on the financial position, results of
operations or cash flows of the Company.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections".
Effective January 1, 2003, SFAS No. 145 requires gains and losses from the
extinguishment or repurchase of debt to be classified as extraordinary items
only if they meet the criteria for such classification in APB 30. Until January
1, 2003, gains and losses from the extinguishment or repurchase of debt must be
classified as extraordinary items, as Dynex has done. After January 1, 2003, any
gain or loss resulting from the extinguishment or repurchase of debt classified
as an extraordinary item in a prior period that does not meet the criteria for
such classification under APB 30 must be reclassified. The Company is in the
process of assessing the impact of this statement but does not believe the
adoption of SFAS No. 145 will have any material impact on its financial position
or results of operations. The Company is reviewing its tranactions to determine
if there may be instances that require reclassification of some amounts from
extraordinary items to operting income which will not have an impact on income
(loss) available to common shareholders.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Effective January 1, 2003, SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This SFAS applies to activities that are initiated after
December 31, 2002. The Company does not believe the adoption of SFAS No. 146
will have a significant impact on the financial position, results of operations
or cash flows of the Company.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions," which amends SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," and FASB Interpretation No. 9,
"Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a
Similar Institution is Acquired in a Business Combination Accounted for by the
Purchase Method." With the exception of transactions between two or more mutual
enterprises, this Statement removes acquisitions of financial institutions from
the scope of both SFAS No. 72 and Interpretation 9 and requires that those
7
transactions be accounted for in accordance with SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." In
addition, the carrying amount of an unidentifiable intangible asset shall
continue to be amortized as required in SFAS No. 72, unless the transaction to
which that asset arose was a business combination. In that case, the carrying
amount of that asset is to be reclassified to goodwill as of the later of the
date of acquisition or the date SFAS No. 142 is applied in its entirety. Thus,
those intangible assets are subject to the same undiscounted cash flow
recoverability test and impairment loss recognition and measurement provisions
that SFAS No. 144 requires for other long-lived assets that are held and used.
Also, this Statement amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions. The effective
date for this provision is on October 1, 2002, with earlier application
permitted. The adoption of SFAS No. 147 has not had an impact on the financial
position, results of operations, or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." Effective after December 15, 2003,
this Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has not yet assessed the impact of this statement on its financial position or
results of operations.
On November 25, 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN
No. 45 clarifies the requirements of FASB Statement No. 5, "Accounting for
Contingencies," relating to the guarantor's accounting for, and disclosure of,
the issuance of certain types of guarantees. The disclosure requirements of FIN
No. 45 are effective for financial statements of interim or annual periods that
end after December 15, 2002. The disclosure provisions have been implemented and
no disclosures were required at year-end 2002. The provisions for initial
recognition and measurement are effective on a prospective basis for guarantees
that are issued or modified after December 31, 2002, irrespective of the
guarantor's year-end. FIN No. 45 requires that upon issuance of a guarantee, the
entity must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The Company's adoption of FIN 45 in 2003 has not
and is not expected to have a material effect on the Company's results of
operations, cash flows or financial position.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities - an interpretation of ARB No. 51," which addresses consolidation of
variable interest entities. FIN No. 46 expands the criteria for consideration in
determining whether a variable interest entity should be consolidated by a
business entity, and requires existing unconsolidated variable interest entities
(which include, but are not limited to, Special Purpose Entities, or SPEs) to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse risks among parties involved. This interpretation applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The adoption of FIN No. 46 is
not expected to have a material effect on the Company's results of operations,
cash flows or financial position.
Item 7A. 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 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 margin comprises the primary component of the Company's
earnings. Additionally, cash flow from the investment portfolio represents the
primary component of the Company's incoming cash flow. 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
8
risk through the creation of a diversified investment portfolio that generates
stable income and cash flow 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 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 focuses on the sensitivity of its cash flow, and measures such
sensitivity 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 net interest margin cash flow for
the next twenty-four months assuming interest rates over such time period follow
the forward LIBOR curve (based on the 90-day Eurodollar futures contract) as of
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 cash flow.
The following table summarizes the Company's net interest margin cash flow
sensitivity analysis as of December 31, 2002. This analysis represents
management's estimate of the percentage change in net interest margin cash flow
given a parallel shift in interest rates, as discussed above. The "Base" case
represents the interest rate environment as it existed as of December 31, 2002.
As December 31, 2002, one-month LIBOR and six-month LIBOR were both 1.38%. The
analysis is heavily dependent upon the assumptions used in the model. Prepayment
rate assumptions used were estimates and were generally at a "constant
prepayment rate", or CPR, ranging from 26%-50%, for collateral for
collateralized bonds consisting of single-family mortgage loans and securities,
and a CPR equivalent ranging from 11%-12% for collateral for collateralized
bonds consisting of manufactured housing loans and securities.
The effect of changes in future interest rates, the shape of the yield curve,
actual credit losses experienced, 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. Given the current composition and
performance of the investment portfolio, and the limitation to estimating
twenty-four months of net interest margin cash flows, variations in prepayment
rate assumptions are not expected to have a material impact on the net interest
margin cash flows. 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.
% Change in Net
Basis Point Interest Margin Cash
Increase (Decrease) in Flow From
Interest Rates Base Case
- ----------------------------- ---------------------------
+200 (19.5)%
+100 (9.7)%
Base
-100 11.4%
-200 23.9%
Approximately $515 million of the Company's investment portfolio as of December
31, 2002 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 73% and 14% of the ARM
loans or securities underlying the Company's collateral for collateralized bonds
are indexed to and reset based upon the level of six-month LIBOR and one-year
CMT, respectively. These ARM assets are financed with adjustable-rate
collateralized bond borrowings.
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
9
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 collateral for collateralized bonds as of
December 31, 2002, approximately $859 million, is comprised of loans that have
coupon rates that are fixed. The Company has limited its interest rate risk on
such collateral primarily through (i) the issuance of fixed-rate collateralized
bonds which approximated $518.7 million as of December 31, 2002, and (ii)
equity, which was $61.8 million. Overall, the Company's interest rate risk is
primarily related to the rate of change in short-term interest rates, not the
level of short-term interest rates.
10
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AUDITED FINANCIAL STATEMENTS
MERIT SECURITIES CORPORATION
Independent Auditors' Report ...........................................................................12
Balance Sheets - December 31, 2002 and 2001.............................................................13
Statements of Operations - For the years ended December 31, 2002, 2001 and 2000.........................14
Statements of Shareholder's Equity - For the years ended December 31, 2002, 2001 and 2000...............15
Statements of Cash Flows - For the years ended December 31, 2002, 2001 and 2000.........................16
Notes to Financial Statements - For the years ended December 31, 2002, 2001 and 2000....................17
11
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Merit Securities Corporation
We have audited the accompanying consolidated balance sheets of Merit Securities
Corporation and subsidiaries (the "Corporation"), as of December 31, 2002 and
2001 and the related consolidated statements of operations, shareholder's
equity, and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Merit Securities Corporation and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002 in conformity with accounting principles generally accepted in
the United States of America.
DELOITTE & TOUCHE LLP
Richmond, Virginia
March 20, 2003
12
BALANCE SHEETS
MERIT SECURITIES CORPORATION
December 31, 2002 and 2001
(amounts in thousands except share data)
2002 2001
--------------- ---------------
Assets:
Collateral for collateralized bonds $ 1,341,237 $ 1,634,460
Loans 6,505 906
Asset-backed Securities, held-to-maturity 1,644 3,529
Due from affiliates, net 11,507 -
--------------- ---------------
$ 1,360,893 $ 1,638,895
=============== ===============
Liabilities and Shareholder's Equity:
Liabilities:
Non-recourse debt - collateralized bonds $ 1,299,113 $ 1,542,924
--------------- ---------------
1,299,113 1,542,924
--------------- ---------------
Shareholder's Equity:
Common stock, no par value
10,000 shares authorized,
1,000 issued and outstanding 10 10
Additional paid-in capital 68,674 92,774
Accumulated other comprehensive (loss) income (134) 3,187
Retained earnings (6,770) -
--------------- ---------------
61,780 95,971
--------------- ---------------
$ 1,360,893 $ 1,638,895
=============== ===============
See accompanying notes to financial statements.
13
STATEMENTS OF OPERATIONS
MERIT SECURITIES CORPORATION
For the years ended December 31, 2002, 2001 and 2000
(amounts in thousands)
2002 2001 2000
------------------------------
Interest income:
Collateral for collateralized bonds .........$ 105,139 $ 150,372 $ 201,317
Loans ..................................... 78 -- --
------- ------- -------
105,217 150,372 201,317
------- ------- -------
Interest and related expense:
Interest expense on collateralized bonds .... 63,441 108,135 175,306
Other collateralized bond expense ........... 1,991 1,728 1,612
------- ------- -------
65,432 109,863 176,918
------- ------- -------
Net interest margin before provision for losses 39,785 40,509 24,399
Provision for loan losses ..................... (28,559) (18,670) (28,585)
------- ------- -------
Net interest margin ........................... 11,226 21,839 (4,186)
Loss on termination of interest rate caps ....... -- -- (2,440)
Impairment charges .............................. (17,617) (15,840) (5,523)
Other expense ................................... -- -- (565)
------- ------- -------
(Loss) income before extraordinary item ......... (6,391) 5,999 (12,714)
Extraordinary loss - extinguishment of debt ..... (379) (1,013) --
------- ------- -------
Net (loss) income ...............................$ (6,770) $ 4,986 $ (12,714)
======== ======= ========
See accompanying notes to financial statements.
14
STATEMENTS OF SHAREHOLDER'S EQUITY
MERIT SECURITIES CORPORATION
For the years ended December 31, 2002, 2001 and 2000 (amounts in thousands
except share data)
Accumulated Retained
Common Additional Other Earnings
Stock Shares Common paid-in comprehensive (accumulated
Outstanding Stock capital income (loss) deficit) Total
----------- ----- ------- ------------- -------- -----
Balance at January 1, 2000 1,000 $ 10 $125,997 $ (11,946) $ 24,757 $ 138,818
Comprehensive loss:
Net loss - - - - (12,714) (12,714)
Change in net unrealized loss on
investments available-for-sale - - - (31,127) - (31,127)
---------------
Total comprehensive loss (43,841)
Capital contributions
- - 21,243 - - 21,243
--------------- ---------- ------------- ------------------ ---------------- ---------------
Balance at December 31, 2000 1,000 10 147,240 (43,073) 12,043 116,220
Comprehensive loss:
Net income - - - - 4,986 4,986
Change in net unrealized loss on
investments available-for-sale - - - 46,260 - 46,260
---------------
Total comprehensive income 51,246
Dividends and capital
distributions - - (54,466) - (17,029) (71,495)
--------------- ---------- ------------- ------------------ ---------------- ---------------
Balance at December 31, 2001 1,000 10 92,774 3,187 - 95,971
Comprehensive loss:
Net loss - - - - (6,770) (6,770)
Change in net unrealized loss on
investments available-for-sale - - - (3,321) - (3,321)
---------------
Total comprehensive income (10,091)
Capital distributions
- - (24,100) - - (24,100)
--------------- ---------- ------------- ------------------ ---------------- ---------------
Balance at December 31, 2002 1,000 $ 10 $ 68,674 $ (134) $ (6,770) $ 61,780
=============== ========== ============= ================== ================ ===============
See accompanying notes to financial statements.
15
MERIT SECURITIES CORPORATION
STATEMENTS OF CASH FLOWS
For the years ended December 31, 2002, 2001 and 2000
(amounts in thousands)
2002 2001 2000
---- ---- ----
Operating activities:
Net (loss) income $ (6,770) $ 4,986 $ (12,714)
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Impairment charges 17,617 15,840 5,523
Provision for losses 28,559 18,670 28,585
Amortization, net 6,901 9,264 9,971
Loss on termination of interest rate caps - - 2,440
Other (1,529) 1,210 2,316
-------------------------------------------------------
Net cash provided by operating activities 44,778 49,970 36,121
-------------------------------------------------------
Investing activities:
Purchase of loans and debt securities (157,097) - -
Principal payments on collateral 395,717 577,625 507,521
Proceeds from sale of collateral for collateralized bonds - 48,710 -
-------------------------------------------------------
Net cash provided by investing activities 238,620 626,335 507,521
-------------------------------------------------------
Financing activities:
Proceeds from issuance of bonds 172,653 503,914 657
Principal payments on collateralized bonds (420,775) (1,108,734) (523,198)
Increase in due from affiliates (11,176) - (42,344)
Dividends and capital (distributions) contributions (24,100) (71,495) 21,243
-------------------------------------------------------
Net cash used for financing activities (283,398) (676,315) (543,642)
-------------------------------------------------------
Net change in cash - (10) -
Cash at beginning of year - 10 10
-------------------------------------------------------
Cash at end of year $ - $ - $ 10
=======================================================
Supplemental disclosure of cash flow information:
Cash paid for interest $ 60,870 $ 105,654 $ 171,906
=======================================================
See accompanying notes to financial statements.
16
NOTES TO FINANCIAL STATEMENTS
MERIT SECURITIES CORPORATION
For the years ended December 31, 2002, 2001 and 2000
(dollar amounts in thousands)
NOTE 1 - THE COMPANY
Merit Securities Corporation (the "Company") is a wholly owned,
limited-purpose finance subsidiary of Issuer Holding Corporation, Inc. ("IHC").
The Company was organized to facilitate the securitization of loans through the
issuance and sale of collateralized bonds. IHC is a wholly-owned subsidiary of
Dynex Capital, Inc. ("Dynex"), a New York Stock Exchange listed financial
services company (symbol: DX). The financial statements include the amounts of
the Company and its wholly owned subsidiary, Financial Asset Securitization,
Inc. (FASI).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Federal Income Taxes
As a subsidiary of IHC, which is a subsidiary of Dynex, the Company is a
qualified real estate investment trust (REIT) subsidiary under the Internal
Revenue Code. As a qualified REIT subsidiary, the Company is not subject to tax
so long as Dynex maintains its REIT status. Accordingly, no provision has been
made for income taxes for the Company in the accompanying financial statements,
as Dynex believes it has met the prescribed distribution requirements. Should
the Company not maintain its qualified REIT subsidiary status in the future, or
if Dynex does not maintain its REIT status, it may be subject to income taxes.
Collateral for Collateralized Bonds
Collateral for collateralized bonds consists of debt securities and loans, which
have been pledged to secure collateralized bonds. These debt securities and
loans are backed primarily by adjustable-rate and fixed-rate mortgage loans
secured by first liens on single family residential properties and manufactured
housing installment loans secured by either a UCC filing or a motor vehicle
title.
The Company has classified all of its debt securities included in collateral for
collateralized bonds as available-for-sale. As such, debt securities included in
collateral for collateralized bonds at December 31, 2002 and 2001 are reported
at fair value, with unrealized gains and losses excluded from earnings and
reported as accumulated other comprehensive income.
Deferred Issuance Costs
Costs incurred in connection with the issuance of collateralized bonds are
deferred and amortized over the estimated lives of the collateralized bonds
using a method that approximates the effective yield method. These costs are
included in the carrying value of the collateralized bonds.
Price Premiums and Discounts
Price premiums and discounts on the collateral for collateralized bonds and the
collateralized bonds are amortized into interest income or expense,
respectively, over the life of the related investment or obligation using the
effective yield method, or a method that approximates the effective yield
method. Hedging basis adjustments on associated investments and obligations are
included in premiums and discounts.
Loans Not Pledged
The Company holds loans which are not pledged to a trust and are carried at
amortized cost.
17
Interest Income
Interest income is recognized when earned according to the terms of the
underlying investment and when, in the opinion of management, it is collectible.
For loans, the accrual of interest is discontinued when, in the opinion of
management, the interest is not collectible in the normal course of business,
when the loan is past due and when the primary servicer of the loan fails to
advance the interest and/or principal due on the loan. For securities and other
investments, the accrual of interest is discontinued when, in the opinion of
management, it is possible that all amounts contractually due will not be
collected. Loans are considered past due when the borrower fails to make a
timely payment in accordance with the underlying loan agreement, inclusive of
all applicable cure periods. All interest accrued but not collected for
investments that are placed on non-accrual status or charged-off is reversed
against interest income. Interest on these investments is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual.
Investments are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured.
Asset-backed Securities
Asset-backed securities are debt securities which are classified as
held-to-maturity and are carried at amortized cost pursuant to SFAS 115.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates. The
primary estimates inherent in the accompanying financial statements are
discussed below.
Fair Value. The Company 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 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. Collateral for
collateralized bonds make up a significant portion of the Company's investments.
The estimate of fair value for securities within collateral for collateralized
bonds is determined by calculating the present value of the projected net cash
flows of the instruments, using discount rates, prepayment rate assumptions and
credit loss assumptions established by management. The discount rate used in the
determination of fair value of the collateral for collateralized bonds was 16%
at December 31, 2002 and 2001. The Company utilizes a discount rate of 16% in
determining the fair value of its financial instruments when the Company's
ownership interest in such financial instrument is generally represented by
interests rated `BBB' or below, and generally concentrated in the
overcollateralization or residual interest components. Prepayment rate
assumptions at December 31, 2002 and 2001 were generally at a "constant
prepayment rate," or CPR, ranging from 30%-45% for 2002, and 40%-60% for 2001,
for collateral for collateralized bonds consisting of securities backed by
single-family mortgage loans, and a CPR equivalent of 11% for 2002 and 10% for
2001, for collateral for collateralized bonds consisting of securities backed by
manufactured housing loans. CPR assumptions for each year are based in part on
the actual prepayment rates experienced for the prior six-month period and in
part on management's estimate of future prepayment activity. The loss
assumptions utilized vary for each series of collateral for collateralized
bonds, depending on the collateral pledged. The cash flows for the collateral
for collateralized bonds were projected to the estimated date that the
collateralized bond security could be called and retired by the Company if there
is economic value to the Company in calling and retiring the collateralized bond
security. Such call date is typically triggered on the earlier of a specified
date or when the remaining collateralized bond security balance equals 35% of
the original balance (the "Call Date"). The Company estimates anticipated market
prices of the underlying collateral at the Call Date.
Estimates of fair value for other financial instruments are based primarily on
management's judgment. Since the fair value of Company's financial instruments
is based on estimates, actual gains and losses recognized may differ from those
estimates recorded in the consolidated financial statements. The fair value of
all balance sheet financial instruments is presented in Note 6.
18
Allowance for Loan Losses. The Company has credit risk on loans pledged as
collateral for collateralized bonds in its investment portfolio. An allowance
for loan losses has been estimated and established for current expected losses
based on certain performance factors associated with the collateral, including
current loan delinquencies, historical cure rates of delinquent loans, and
historical and anticipated loss severity of the loans as they are liquidated.
The allowance for loan losses is evaluated and adjusted periodically by
management based on the actual and projected timing and amount of probable
credit losses, using the above factors, as well as industry loss experience. The
loans are considered homogeneous and the allowance for loan losses is
established and evaluated on a pool basis. Provisions made to increase the
allowance related to credit risk are presented as provision for loan losses in
the accompanying consolidated statements of operations. The Company's actual
credit losses may differ from those estimates used to establish the allowance.
Prepaid Shelf Registration Fees
Fees incurred in connection with filing a shelf registration for the issuance of
collateralized bonds are deferred and recognized with each securitization
prorata to the size of the issuance.
Securitization Transactions
The Company follows the provisions of SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities," in
determining whether securitizations of financial instruments should be accounted
for as a financing or as a sale transaction. The Company securitizes loans and
securities by transferring these assets to a wholly owned trust, and the trust
issues non-recourse collateralized bonds pursuant to an indenture. Generally,
the Company retains some form of control over the transferred assets, and/or the
trust is not deemed to be a qualified special purpose entity. In instances where
the trust is deemed not to be a qualified special purpose entity, the trust is
included in the consolidated financial statements of the Company. For accounting
and tax purposes, the loans and securities financed through the issuance of
collateralized bonds are treated as assets of the Company, and the
collateralized bonds are treated as debt of the Company. The Company may retain
certain of the bonds issued by the trust, and the Company generally will
transfer collateral in excess of the bonds issued. This excess is typically
referred to as over-collateralization.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.
The Company does not believe the adoption of SFAS No. 143 will have a
significant impact on the financial position, results of operations or cash
flows of the Company.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections".
Effective January 1, 2003, SFAS No. 145 requires gains and losses from the
extinguishment or repurchase of debt to be classified as extraordinary items
only if they meet the criteria for such classification in APB 30. Until January
1, 2003, gains and losses from the extinguishment or repurchase of debt were
required to be classified as extraordinary items, as Dynex has done. After
January 1, 2003, any gain or loss resulting from the extinguishment or
repurchase of debt classified as an extraordinary item in a prior period that
does not meet the criteria for such classification under APB 30 must be
reclassified. The Company is in the process of assessing the impact of this
statement but does not believe the adoption of SFAS No. 145 will have any
material impact on its financial position or results of operations. The Company
is reviewing its tranactions to determine if there may be instances that require
reclassification of some amounts from extraordinary items to operting income
which will not have an impact on income (loss) available to common shareholders.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Effective January 1, 2003, SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan. This SFAS applies to activities that are initiated after
December 31, 2002. The Company does not believe the adoption of SFAS No. 146
will have a significant impact on the financial position, results of operations
or cash flows of the Company.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions," which amends SFAS No. 72, "Accounting for Certain
Acquisitions of Banking or Thrift Institutions," SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets," and FASB Interpretation No. 9,
"Applying APB Opinions No. 16 and 17 When a Savings and Loan Association or a
19
Similar Institution is Acquired in a Business Combination Accounted for by the
Purchase Method." With the exception of transactions between two or more mutual
enterprises, this Statement removes acquisitions of financial institutions from
the scope of both SFAS No. 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." In
addition, the carrying amount of an unidentifiable intangible asset shall
continue to be amortized as required in SFAS No. 72, unless the transaction to
which that asset arose was a business combination. In that case, the carrying
amount of that asset is to be reclassified to goodwill as of the later of the
date of acquisition or the date SFAS No. 142 is applied in its entirety. Thus,
those intangible assets are subject to the same undiscounted cash flow
recoverability test and impairment loss recognition and measurement provisions
that SFAS No. 144 requires for other long-lived assets that are held and used.
Also, this Statement amends SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," to include in its scope long-term
customer-relationship intangible assets of financial institutions. The effective
date for this provision is on October 1, 2002, with earlier application
permitted. The adoption of SFAS No. 147 has not had an impact on the financial
position, results of operations, or cash flows of the Company.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." Effective after December 15, 2003,
this Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has not yet assessed the impact of this statement on its financial position or
results of operations.
On November 25, 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34." FIN
45 clarifies the requirements of FASB Statement No. 5, "Accounting for
Contingencies," relating to the guarantor's accounting for, and disclosure of,
the issuance of certain types of guarantees. The disclosure requirements of FIN
45 are effective for financial statements of interim or annual periods that end
after December 15, 2002. The disclosure provisions have been implemented and no
disclosures were required at year-end 2002. The provisions for initial
recognition and measurement are effective on a prospective basis for guarantees
that are issued or modified after December 31, 2002, irrespective of the
guarantor's year-end. FIN 45 requires that upon issuance of a guarantee, the
entity must recognize a liability for the fair value of the obligation it
assumes under that guarantee. The Company's adoption of FIN 45 in 2003 has not
and is not expected to have a material effect on the Company's results of
operations, cash flows or financial position.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities - an interpretation of ARB No. 51," which addresses consolidation of
variable interest entities. FIN 46 expands the criteria for consideration in
determining whether a variable interest entity should be consolidated by a
business entity, and requires existing unconsolidated variable interest entities
(which include, but are not limited to, Special Purpose Entities, or SPEs) to be
consolidated by their primary beneficiaries if the entities do not effectively
disperse risks among parties involved. This interpretation applies immediately
to variable interest entities created after January 31, 2003, and to variable
interest entities in which an enterprise obtains an interest after that date. It
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The adoption of FIN 46 is not
expected to have a material effect on the Company's results of operations, cash
flows or financial position.
Basis of Presentation
Certain amounts for 2001 and 2000 have been reclassified to conform to the
presentation for 2002.
20
NOTE 3 - COLLATERAL FOR COLLATERALIZED BONDS
Collateral for collateralized bonds consists of loans and debt securities backed
primarily by adjustable-rate and fixed-rate mortgage loans secured by first
liens on single family residential housing and manufactured housing installment
loans secured by a UCC filing. 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. The Company's
exposure to loss on collateral for collateralized bonds is generally limited to
the amount of collateral pledged in excess of the related collateralized bonds
issued, as the collateralized bonds issued are non-recourse to the Company. The
collateral for collateralized bonds can be sold by the Company, but only subject
to the lien of the collateralized bond indenture.
The following table summarizes the components of collateral for collateralized
bonds as of December 31, 2002 and December 31, 2001. Debt securities pledged as
collateral for collateralized bonds are considered available-for-sale, and are
therefore recorded at fair value.
---------------------------------------- --------------- --- ----------------
2002 2001
---------------------------------------- --------------- ----------------
Loans, at amortized cost $ 1,038,146 $ 1,192,109
Allowance for loan losses (20,700) (15,364)
---------------------------------------- --------------- --- ----------------
1,017,446 1,176,745
Debt Securities, at fair value 323,791 457,715
---------------------------------------- --------------- --- ----------------
$ 1,341,237 $ 1,634,460
---------------------------------------- --------------- --- ----------------
The following table summarizes the amortized cost basis, gross unrealized gains
and losses and estimated fair value of debt securities pledged as collateral for
collateralized bonds as of December 31, 2002 and December 31, 2001:
---------------------------------------- --------------- --- ----------------
2002 2001
---------------------------------------- --------------- ----------------
Debt securities, at amortized cost $ 323,728 $ 454,528
Gross unrealized gains 63 3,187
----------------------------------------
--------------- --- ----------------
Estimated fair value $ 323,791 $ 457,715
---------------------------------------- --------------- --- ----------------
The components of collateral for collateralized bonds at December 31, 2002 and
2001 are as follows:
- -------------------------------- ----------------------------------------- -----------------------------------------
2002 2001
- -------------------------------- ----------------------------------------- -----------------------------------------
Loans, net Debt Total Loans, net Debt Total
Securities Securities
- -------------------------------- ------------- ------------ -------------- -------------- ----------- --------------
Collateral $ 1,018,917 $ 320,501 $1,339,418 $1,174,684 $ 449,273 $1,623,957
Funds held by trustees 12 - 12 5 - 5
Accrued interest receivable 6,559 2,080 8,639 8,155 3,010 11,165
Unamortized premiums and
(discounts), net (8,042) 1,147 (6,895) (6,099) 2,245 (3,854)
Unrealized gain, net - 63 63 - 3,187 3,187
- -------------------------------- ------------- ------------ -------------- -------------- ----------- --------------
$ 1,017,446 $ 323,791 $ 1,341,237 $1,176,745 $457,715 $1,634,460
- -------------------------------- ------------- ------------ -------------- -------------- ----------- --------------
21
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
The following table summarizes the activity for the allowance for loan losses on
collateral for collateralized bonds for the years ended December 31, 2002, 2001
and 2000:
- ---------------------------------------------- -------- -------- --------
2002 2001 2000
- ---------------------------------------------- -------- -------- --------
Beginning balance ............................ $ 15,364 $ 21,401 $ 11,399
Provision for losses ......................... 28,559 18,670 28,585
Losses charged-off, net of recoveries ........ (23,223) (24,707) (18,583)
- ---------------------------------------------- -------- -------- --------
Ending balance ............................... $ 20,700 $ 15,364 $ 21,401
- ---------------------------------------------- -------- -------- --------
The Company has limited exposure to credit risk retained on loans, which it has
securitized through the issuance of collateralized bonds. The aggregate loss
exposure is generally limited to the amount of collateral in excess of the
related investment-grade collateralized bonds issued (commonly referred to as
"overcollateralization") and retained subordinate securities. The allowance for
loan losses on the overcollateralization totaled $20,700 and $15,364 at December
31, 2002 and 2001 respectively, and are included in collateral for
collateralized bonds in the accompanying balance sheets. Overcollateralization
at December 31, 2002 and 2001 totaled $93,625 and $93,468 respectively.
NOTE 5 - COLLATERALIZED BONDS
The Company, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds. Each series of
collateralized bonds may consist of various classes of bonds, either at fixed or
variable rates of interest. Payments received on the collateral for
collateralized bonds and any reinvestment income thereon are used to make
payments on the collateralized bonds (see Note 3). The obligations under the
collateralized bonds are payable solely from the collateral for collateralized
bonds and are otherwise non-recourse to the Company. The stated maturity date
for each class of bonds is generally calculated based on the final scheduled
payment date of the underlying collateral pledged. The actual maturity of each
class will be 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, or on a specific date. As a result, the actual maturity of any class of a
series of collateralized bonds is likely to occur earlier than its stated
maturity.
The components of collateralized bonds along with certain other information at
December 31, 2002 and 2001 are summarized below:
- ---------------------------- ------------------------------- --------------------------
2002 2001
----------------------------- ----------------------------
Bonds Range of Bonds Range of
Outstanding Interest Rates Outstanding Interest Rates
-------------- -------------- ------------- --------------
Variable-rate classes $ 786,503 1.7%-3.0% $ 979,174 2.5%-5.6%
Fixed-rate classes 518,734 6.2%-9.0% 572,390 6.2%-8.0%
Accrued interest payable 3,234 3,744
Deferred bond issuance costs (4,197) (4,003)
Unamortized premiums and
(discounts), net (5,161) (8,381)
-------------- -------------
$ 1,299,113 $ 1,542,924
============== =============
Range of stated maturities 2015-2033 2015-2033
Number of series 4 4
- ---------------------------- -------------- -------------- ------------- --------------
Each series of collateralized bonds may consist of various classes of bonds,
either at fixed or variable rates of interest. Payments received on the loans
pledged as collateral for collateralized bonds and any reinvestment income
thereon are used to make payments on the collateralized bonds (see Note 3). The
obligations under the collateralized bonds are payable solely from the
collateral for collateralized bonds and are otherwise non-recourse to the
22
Company. The maturity of each class is directly affected by the rate of
principal prepayments on the related mortgage collateral. In determining average
prepayment speed assumptions, the Company utilizes the last six month's
prepayment experience, market, and Company expectations of prepayment speeds
based on the forward LIBOR curve. Each series is also subject to redemption
according to specific terms of the respective indentures. As a result, the
actual maturity of any class of a collateralized bond series is likely to occur
earlier than its stated maturity. Collateralized bonds are carried at their
outstanding principal balance, net of unamortized premiums and discounts.
The variable rate classes are based on one-month London InterBank Offered Rate
("LIBOR"). The average effective rate of interest expense for collateralized
bonds was 4.6%, 6.1%, and 7.6% for the years ended December 31, 2002, 2001 and
2000, respectively.
NOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's recorded financial instruments as of December 31, 2002 and 2001:
- --------------------------------------------------------------------------------
2002 2001
----------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- --------------------------------------------------------------------------------
Recorded financial instruments:
Assets:
Collateral for collateralized bonds:
Loans ................ $1,038,146 $1,017,446 $1,192,109 $1,176,745
Debt securities ...... 323,791 323,791 457,715 457,715
Loans ................... 6,505 6,727 906 906
Asset-backed Securities.... 1,644 2,073 3,529 3,529
Liabilities:
Collateralized bonds 1,299,113 1,261,450 1,542,924 1,485,756
- --------------------------------------------------------------------------------
Carrying amount excludes the allowance for loan losses. The estimated fair
values of financial instruments have been determined using available market
information or by determining the present value of the projected future cash
flows using appropriate discount rates, credit losses and prepayment
assumptions. However, a degree of judgment is necessary in evaluating market
data and forming these projected future cash flows.
Recorded Financial Instruments. The fair value of the collateral for
collateralized bonds is based on the present value of the projected cash flows
using appropriate discount rates, credit loss and prepayment assumptions. The
Company utilizes a discount rate of 16% in determining the fair value of its
financial instruments when the Company's ownership interest in such financial
instrument is generally represented by interests rated `BBB' or below, and
generally concentrated in the overcollateralization or residual interest
components. The fair value of loans was based on management's estimate.
Non-recourse debt is both floating, fixed, and is considered within the security
structure along with the associated collateral for collateralized bonds.
NOTE 7 - NET LOSS ON WRITE-DOWNS AND IMPAIRMENT CHARGES
Impairment charges include other-than-temporary impairment of debt securities
pledged as collateral for collateralized bonds of $15,563, $15,840 and $5,523
for 2002, 2001 and 2000, respectively. Impairment charges for 2002 also included
$2,054 for the adjustment to the lower of cost or market for certain delinquent
single-family mortgage loans acquired in 2002 which at that time were considered
as held-for-sale.
23
NOTE 8 - OTHER MATTERS
At both December 31, 2002 and 2001, the Company had remaining $308,602 for
issuance under shelf registration statements filed with the Securities and
Exchange Commission.
NOTE 9 - SECURITIZATION
On April 25, 2002, the Company completed the securitization of $602,000 of
single-family mortgage loans and the associated issuance of $605,000 of
collateralized bonds. Of the $602,000 of single-family mortgage loans
securitized, $447,000 million were loans which were already owned by the Company
and $155,000 represented new loans from the purchase of adjustable-rate and
fixed-rate mortgage backed securities from third parties pursuant to certain
call rights owned by the Company. The Trust used to facilitate this
securitization was not deemed to be a qualified special purpose entity because
after the loans were securitized, the trust may acquire derivatives relating to
beneficial interests retained by the certificateholders, who are not independent
third parties. Thus, the securitization was accounted for as a financing and the
loans and associated bonds were included in the accompanying consolidated
balance sheet as assets and liabilities of the Company. Net cash proceeds to the
Company from the securitization were approximately $24,000. Approximately
$12,000 of delinquent loans were not included in the securitization and were
retained by the Company. As the residual interest holder in the collateral, the
Company has the option to redeem the collateral at the earlier of April 2007 or
the month when the principal balance reaches 35% of the original balance of the
loans at the time of closing. The Company retains an interest in a servicing
strip in exchange for advancing responsibilities on a balance of $88,567 as of
December 31, 2002.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 11. EXECUTIVE COMPENSATION
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to this Item is omitted pursuant to General Instruction
I.
PART IV
Item 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
------------------------------------------------
As required by Rule 13a-15 under the Exchange Act, within 90
days prior to the filing date of this annual report (the
"Evaluation Date"), the Company carried out an evaluation of
the effectiveness of the design and operation of the Company's
24
disclosure controls and procedures. This evaluation was
carried out under the supervision and with the participation
of the Company's management. Based upon that evaluation, the
Company's management concluded that the Company's disclosure
controls and procedures are effective. Disclosure controls and
procedures are controls and other procedures that are designed
to ensure that information required to be disclosed in the
Company's reports filed or submitted under the Exchange Act is
recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. Disclosure
controls and procedures include, without limitation, controls
and procedures designed to ensure that information required to
be disclosed in the Company's reports filed under the Exchange
Act is accumulated and communicated to management, including
the Company's management, as appropriate, to allow timely
decisions regarding required disclosures.
(b) Changes in internal controls.
----------------------------
There were no significant changes in the Company's internal
controls or in other factors that could significantly affect
the Company's internal controls subsequent to the Evaluation
Date, nor any significant deficiencies or material weaknesses
in such internal controls requiring corrective actions.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits
---------
3.1 Articles of Incorporation of the Registrant
(Incorporated herein by reference to the Exhibits
to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
3.2 Bylaws of the Registrant (Incorporated herein by
reference to the Exhibits to Registrant's
Registration Statement No. 33-83524 on Form S-3
filed August 31, 1994).
3.3 Amended and Restated Articles of Incorporation of
the Registrant, effective April 19, 1995
(Incorporated herein by reference to Exhibit to
the Registrant's Current Report on Form 8-K, filed
April 21, 1995).
4.1 Indenture between Registrant and Trustee, dated as
of August 1, 1994 (Incorporated herein by
reference to the Exhibits to Registrant's
Registration Statement No. 33-83524 on Form S-3
filed August 31, 1994).
4.2 Form of Supplement Indenture between Registrant
and Trustee (Incorporated herein by reference to
the Exhibits to Registrant's Registration
Statement No. 33-83524 on Form S-3 filed
August 31, 1994).
4.3 Copy of the Indenture, dated as of November 1,
1994, by and between the Registrant and Texas
Commerce Bank National Association, as Trustee
(Incorporated herein by reference to Exhibit to
the Registrant's Current Report on Form 8-K, filed
December 19, 1994).
4.4 Copy of the Series 11 Indenture Supplement, dated
as of March 1, 1998, by and between Registrant and
Texas Commerce Bank National Association, as
Trustee (related schedules and exhibits available
upon request of the Trustee). (Incorporated herein
by reference to Exhibit of Registrant's Current
Report on Form 8-K, filed June 12, 1998).
25
4.5 Copy of the Series 12 Indenture Supplement, dated
as of March 1, 1999, by and between the Registrant
and Texas Commerce Bank National Association, as
Trustee (related schedules and exhibits available
upon request of the Trustee). (Incorporated herein
by reference to Exhibit of Registrant's Current
Report on Form 8-K, filed April 12, 1999).
4.6 Copy of the Series 13 Indenture Supplement, dated
as of August 1, 1999, by and between the
Registrant and Texas Commerce Bank National
Association, as Trustee (related schedules and
exhibits available upon request of the Trustee).
(Incorporated herein by reference to Exhibit of
Registrant's Current Report on Form 8-K, filed
September 13, 1999).
4.7 Copy of the Structured Asset Securitization
Corporation Series 2002-9 Indenture Supplement,
dated as of April 1, 2002, by and between
Structured Asset Securitization Corporation and J.
P. Morgan Chase, as Trustee (related schedules and
exhibits available upon request of the Trustee).
(Incorporated herein by reference to Exhibit of
Structured Asset Securitization Corporation's
Current Report on Form 8-K, filed April 25, 2002).
99.1 Standard Provisions to Servicing Agreement
(Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement
No. 33-83524 on Form S-3 filed August 31, 1994).
99.2 Form of Servicing Agreement (Incorporated
herein by reference to the Exhibits to
Registrant's Registration Statement No. 33-83524
on Form S-3 filed August 31, 1994).
99.3 Standard Terms to Master Servicing Agreement
(Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement
No. 33-83524 on Form S-3 filed August 31, 1994).
99.4 Form of Master Servicing Agreement (Incorporated
herein by reference to the Exhibits to
Registrant's Registration Statement No. 33-83524
on Form S-3 filed August 31, 1994).
99.5 Form of Prospectus Supplement of Bonds secured by
adjustable-rate mortgage loans (Incorporated
herein by reference to Exhibits to Registrant's
Pre-Effective Amendment No. 4 to Registration
Statement No. 33-83524 on Form S-3 filed December
5, 1994).
99.6 Form of Financial Guaranty Assurance Policy
(Incorporated herein by reference to the Exhibits
to Registrant's Registration Statement No. 33-
83524 on Form S-3 filed August 31, 1994).
99.7 Form of GEMICO Mortgage Pool Insurance Policy
(Incorporated herein by reference to the Exhibits
to Registrant's Registration Statement No. 33-
83524 on Form S-3 filed August 31, 1994).
99.8 Form of PMI Mortgage Insurance Co. Pool Insurance
Policy (Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement
No. 33-83524 on Form S-3 filed August 31, 1994).
99.9 Form of Prospectus Supplement of Bonds secured by
fixed-rate mortgage loans (Incorporated herein
by reference to Exhibits to Registrant's Pre-
Effective Amendment No. 4 to Registration
Statement No. 33-83524 on Form S-3 filed December
5, 1994).
26
99.10 Copy of the Saxon Mortgage Funding Corporation
Servicing Guide for Credit Sensitive Loans,
February 1, 1995 Edition (Incorporated herein by
reference to Exhibit to the Registrant's Current
Report on Form 8-K, filed March 8, 1995).
99.11 Copy of the Standard Terms to Master Servicing
Agreement, June 1, 1995 Edition (Incorporated
herein by reference to Exhibit to the Registrant's
Current Report on Form 8-K, filed July 10, 1995).
99.12 Copy of Certification of Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (Incorporated herein by reference to
Exhibit to the Registrant's Current Report on Form
8-K, filed August 28, 2002).
99.13 Certification of Principal Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
99.14 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current report on Form 8-K as filed with the Commission on
October 4, 2002, regarding Certification of Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 Item 9 Regulation FD disclosure for in connection with
the Quarterly Report of Merit Securities Corporation on Form
10-Q/A for the quarter ended March 31, 2002.
27
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.
MERIT SECURITIES CORPORATION
Dated: April 15, 2003 By: /s/ Stephen J. Benedetti
-----------------------------------------
Stephen J. Benedetti
(Principal Executive Officer)
Dated: April 15, 2003 By: /s/ Kevin J. Sciuk
-----------------------------------------
Kevin J. Sciuk
(Principal Financial Officer/Controller)
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Capacity Date
/s/ J. Thomas O'Brien, Jr. Director April 15, 2003
- ------------------------------ --------
J. Thomas O'Brien, Jr.
/s/ Christopher T. Bennett Director April 15, 2003
- ------------------------------ --------
Christopher T. Bennett
28
CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Stephen J. Benedetti, certify that:
1. I have reviewed this annual report on Form 10-K of Merit Securities
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation
Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: April 15, 2003 By: /s/ Stephen J. Benedetti
-----------------------------------
Stephen J. Benedetti
Principal Executive Officer
29
CERTIFICATION
PURSUANT TO 17 CFR 240.13a-14
PROMULGATED UNDER
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Kevin J. Sciuk, certify that:
1. I have reviewed this annual report on Form 10-K of Merit
Securities Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation
Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: April 15, 2003 By: /s/ Kevin J. Sciuk
-----------------------------------
Kevin J. Sciuk
Principal Financial Officer
EXHIBIT INDEX
Sequentially
Exhibit Numbered Page
- ------- ---------------
23.1 Consent of DELOITTE & TOUCHE LLP I
III
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to incorporation by reference in Registration Statement No. 333-64385
of Merit Securities Corporation and its subsidiaries on Form S-3 of our report
dated March 20, 2003, appearing in this Annual Report on Form 10-K of Merit
Securities Corporation for the year ended December 31, 2002.
/s/ DELOITTE & TOUCHE LLP
Richmond, Virginia
April 14, 2003
I
Exhibit 99.13
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Merit Securities Corporation (the
"Company") on Form 10-K for the year ending December 31, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen
J. Benedetti, the Principal Executive Officer of the Company, certify, pursuant
to and for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in
all material respects, the financial condition and results of
operations of the Company.
Dated: April 15, 2003 By: /s/ Stephen J. Benedetti
---------------------------------
Stephen J. Benedetti
Principal Executive Officer
II
Exhibit 99.14
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Merit Securities Corporation (the
"Company") on Form 10-K for the year ending December 31, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Kevin
J. Sciuk, the Principal Financial Officer of the Company, certify, pursuant to
and for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in
all material respects, the financial condition and results of
operations of the Company.
Dated: April 15, 2003 By: /s/ Kevin J. Sciuk
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Kevin J. Sciuk
Principal Financial Officer
III