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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended September 30, 2003
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Commission file number 1-9819
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4551 Cox Road, Suite 300, Glen Allen, Virginia 23060-6740
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days.
|_| Yes |X| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). |_| Yes |X| No
As of October 31, 2003, the registrant had 10,873,903 shares of common stock
outstanding with a par value of $.01 per share, which is the registrant's only
class of common stock.
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DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2003
and December 31, 2002 (as restated) (unaudited).................................................1
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2003 and 2002 (as restated) (unaudited) ...................................2
Condensed Consolidated Statements of Cash Flows for
the nine months ended September 30, 2003 and 2002 (as restated) (unaudited) ....................3
Notes to Unaudited Condensed Consolidated Financial Statements..................................4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................................................12
Item 3. Quantitative and Qualitative Disclosures about Market Risk.....................................25
Item 4. Controls and Procedures........................................................................26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .............................................................................27
Item 2. Changes in Securities and Use of Proceeds......................................................28
Item 3. Defaults Upon Senior Securities................................................................28
Item 4. Submission of Matters to a Vote of Security Holders............................................28
Item 5. Other Information..............................................................................28
Item 6. Exhibits and Reports on Form 8-K...............................................................28
SIGNATURES ...............................................................................................29
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED
BALANCE SHEETS (UNAUDITED)
(amounts in thousands except share data)
-------------------- ---- ---------------------
September 30, December 31,
2003 2002
-------------------- ---------------------
(As Restated, See
Note 13)
ASSETS
Cash and cash equivalents $ 9,208 $ 15,077
Other assets 3,308 4,912
-------------------- ---------------------
12,516 19,989
-------------------- ---------------------
Investments:
Collateral for collateralized bonds:
Loans, net 1,605,774 1,818,577
Debt securities, available-for-sale 274,589 329,920
Other investments 48,195 54,322
Other loans 9,647 9,288
Securities 2,076 6,208
-------------------- ---------------------
1,940,281 2,218,315
-------------------- ---------------------
$ 1,952,797 $ 2,238,304
==================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Collateralized bonds $ 1,776,110 $ 2,013,271
Senior notes 14,059 -
Accrued expenses and other liabilities 1,200 1,612
-------------------- ---------------------
1,791,369 2,014,883
-------------------- ---------------------
Commitments and contingencies (Note 11) - -
SHAREHOLDERS' EQUITY
Preferred stock, par value $0.01 per share, 50,000,000 shares authorized:
9.75% Cumulative Convertible Series A, 493,595 and 992,038 shares issued and 11,274 22,658
outstanding, respectively ($16,033 and $31,353 aggregate liquidation
preference, respectively)
9.55% Cumulative Convertible Series B, 688,189 and 1,378,707 shares issued 16,109 32,273
and outstanding, respectively ($22,698 and $44,263 aggregate liquidation
preference, respectively)
9.73% Cumulative Convertible Series C, 684,893 and 1,383,532 shares issued 19,630 39,655
and outstanding, respectively ($27,795 and $54,634 aggregate liquidation
preference, respectively)
Common stock, par value $0.01 per share, 100,000,000 shares authorized, 109 109
10,873,903 shares issued and outstanding
Additional paid-in capital 360,684 364,743
Accumulated other comprehensive loss (3,965) (4,832)
Accumulated deficit (242,413) (231,185)
-------------------- ---------------------
161,428 223,421
-------------------- ---------------------
$ 1,952,797 $ 2,238,304
==================== =====================
See notes to unaudited condensed consolidated financial statements.
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS (UNAUDITED)
(amounts in thousands except share and per share data)
------------------------------------- --- -------------------------------------
Three Months Ended September 30, Nine months Ended September 30,
------------------------------------- -------------------------------------
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
Interest income: (As Restated, (As Restated,
See Note 13) See Note 13)
Collateral for collateralized bonds $ 34,457 $ 41,878 $ 107,927 $ 129,066
Other investments 1,018 1,391 3,522 4,288
Other loans 175 109 428 318
Securities 199 289 608 746
---------------- ---------------- ---------------- ----------------
35,849 43,667 112,485 134,418
Interest and related expense:
Collateralized bonds 26,389 31,278 81,609 95,040
Senior notes 556 162 1,540 2,134
Other 72 41 234 462
---------------- ---------------- ---------------- ----------------
27,017 31,481 83,383 97,636
---------------- ---------------- ---------------- ----------------
Net interest margin before provision for loan
losses 8,832 12,186 29,102 36,782
Provision for loan losses (5,831) (5,408) (29,715) (16,292)
---------------- ---------------- ---------------- ----------------
Net interest margin 3,001 6,778 (613) 20,490
Impairment charges (2,277) (2,469) (4,482) (9,553)
Gain (loss) on sale of investments, net 769 (257) 1,779 (84)
Trading losses - (4,035) - (3,307)
Other 130 692 170 1,403
General and administrative expenses (2,124) (2,226) (6,296) (6,744)
---------------- ---------------- ---------------- ----------------
Net (loss) income (501) (1,517) (9,442) 2,205
Preferred stock (charge) benefit (1,191) (2,397) 8,039 (7,189)
---------------- ---------------- ---------------- ----------------
Net loss to common shareholders $ (1,692) $ (3,914) $ (1,403) $ (4,984)
---------------- ---------------- ---------------- ----------------
Change in net unrealized loss during period on:
Investments classified as available-for-sale (2,004) 502 976 (5,396)
Hedge instruments 1,010 (3,952) (109) (3,578)
---------------- ---------------- ---------------- ----------------
Comprehensive loss $ (1,495) $ (4,966) $ (8,575) $ (6,769)
================ ================ ================ ================
Net loss per common share:
Basic and diluted $ (0.16) $ (0.36) $ (0.13) $ (0.46)
================ ================ ================ ================
Weighted average number of common shares
outstanding; basic and diluted 10,873,903 10,873,903 10,873,903 10,873,866
================ ================ ================ ================
See notes to unaudited condensed consolidated financial statements.
DYNEX CAPITAL, INC.
CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS (UNAUDITED)
(amounts in thousands)
-------------------------------------------------
Nine months Ended
September 30,
-------------------------------------------------
2003 2002
---------------------- -----------------------
(As Restated, See
Note 13)
Operating activities:
Net loss $ (9,442) $ 2,205
Adjustments to reconcile net loss to net cash provided by operating
activities:
Provision for loan losses 29,715 16,292
Impairment charges 4,482 9,553
Net (gain) loss on sale of investments (1,779) 84
Amortization and depreciation 947 10,982
Net change in other assets, accrued expenses and other liabilities 1,332 (7,911)
---------------------- -----------------------
Net cash and cash equivalents provided by operating activities 25,255 31,205
---------------------- -----------------------
Investing activities:
Purchase of or advances on investments (1,669) (165,149)
Principal payments on collateral 228,325 338,716
Principal payments on (purchase of, net) loans 1,622 (5,280)
Payments received on securities and other investments 11,537 15,700
Proceeds from sales of securities and other investments 2,536 196
Other 170 (238)
---------------------- -----------------------
Net cash and cash equivalents provided by investing activities 242,521 183,945
---------------------- -----------------------
Financing activities:
Proceeds from issuance of bonds - 605,272
Principal payments on collateralized bonds (234,285) (762,177)
Repayment of senior notes (18,020) (57,890)
Retirement of preferred stock (19,553) -
Dividends paid (1,787) (1,199)
---------------------- -----------------------
---------------------- -----------------------
Net cash and cash equivalents used for financing activities (273,645) (215,994)
---------------------- -----------------------
Net decrease in cash and cash equivalents (5,869) (844)
Cash and cash equivalents at beginning of period 15,077 7,129
---------------------- -----------------------
Cash and cash equivalents at end of period $ 9,208 $ 6,285
====================== =======================
Supplement disclosures of cash flow information:
Cash paid for interest $ 81,610 $ 100,080
====================== =======================
Supplemental disclosure of non-cash financing activities:
9.50% senior unsecured notes due February 2005 issued in connection with
Preferred Stock tender offer $ 32,079 $ -
====================== =======================
See notes to unaudited condensed consolidated financial statements.
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
(amounts in thousands except share and per share data)
NOTE 1 - BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by accounting principles generally accepted in
the United States of America, hereinafter referred to as "generally accepted
accounting principles," for complete financial statements. The condensed
consolidated financial statements include the accounts of Dynex Capital, Inc.
and its qualified real estate investment trust ("REIT") subsidiaries and taxable
REIT subsidiary ("Dynex" or the "Company"). All inter-company balances and
transactions have been eliminated in consolidation of Dynex.
The Company believes it has complied with the requirements for qualification as
a REIT under the Internal Revenue Code (the "Code"). To the extent the Company
qualifies as a REIT, it generally will not be subject to federal income tax on
the amount of its income or gain that is distributed as dividends to
shareholders.
In the opinion of management, all significant adjustments, consisting of normal
recurring accruals, considered necessary for a fair presentation of the
condensed consolidated financial statements have been included. The financial
statements presented are unaudited. Operating results for the three and nine
months ended September 30, 2003 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2003.
The preparation of financial statements, in conformity with generally accepted
accounting principles, 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. The primary estimates inherent in the
accompanying condensed consolidated financial statements are discussed below.
The Company uses estimates in establishing fair value for its financial
instruments as discussed in Note 2.
The Company also has credit risk on certain investments in its portfolio as
discussed in Note 7. An allowance for loan losses has been estimated and
established for current existing losses based on management's judgment. The
allowance for loan losses is evaluated and adjusted periodically by management
based on the actual and projected timing and amount of credit losses. Provisions
made to increase the allowance related to credit risk are presented as provision
for loan losses in the accompanying condensed consolidated statements of
operations. The Company's actual credit losses may differ from those estimates
used to establish the allowance.
Certain reclassifications have been made to the financial statements for 2002 to
conform to the presentation for 2003, including the reclassification of the
extraordinary gain recorded in the three and nine month periods ended September
30, 2002 pursuant to the adoption of SFAS No. 145, "Recission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections".
NOTE 2 - FAIR VALUE
Securities classified as available-for-sale are carried in the accompanying
financial statements at estimated fair value. Estimates of fair value for
securities may be based on market prices provided by certain dealers. Estimates
of fair value for certain other securities are determined by calculating the
present value of the projected cash flows of the instruments using market-based
discount rates, prepayment rates and credit loss assumptions. The estimate of
fair value for securities pledged as collateral for collateralized bonds is
determined by calculating the present value of the projected cash flows of the
instruments using prepayment rate assumptions and credit loss assumptions based
on historical experience and estimated future activity, and using discount rates
commensurate with those the Company believes would be used by third parties.
Such discount rate used in the determination of fair value of securities pledged
as collateral for collateralized bonds was 16% at September 30, 2003 and
December 31, 2002. Prepayment rate assumptions at September 30, 2003, and
December 31, 2002, were generally at a "constant prepayment rate," or CPR
ranging from 35%-40% for 2003 and 30%-45% for 2002 for collateral for
collateralized bonds consisting of securities backed by single-family mortgage
loans and a CPR equivalent of 9%-10% for 2003 and 10%-12% for 2002 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 depending on the collateral pledged.
NOTE 3 - NET LOSS PER COMMON SHARE
Net loss per common share is presented on both a basic net loss per common share
and diluted net loss per common share basis. Diluted net loss per common share
assumes the conversion of the convertible preferred stock into common stock,
using the if-converted method and stock appreciation rights to the extent that
there are rights outstanding, using the treasury stock method, but only if these
items are dilutive. The preferred stock is convertible into one share of common
stock for two shares of preferred stock. Differences between the potentially
dilutive preferred stock charge and preferred stock benefit included in net loss
to common shareholders is discussed in Note 9.
The following table reconciles the numerator and denominator for both basic and
diluted net loss per common share for the three and nine months ended September
30, 2003 and 2002.
- ----------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine months Ended September 30,
----------------------------------------------------------------------------------------------
2003 2002 2003 2002
----------------------------------------------------------------------------------------------
Weighted- Loss Weighted- Loss Weighted- Weighted-
Average Average Average Average
Number Number Number Income Number
Loss Of Shares Of Shares Of Shares (loss) Of Shares
----------- ----------------------- ----------------------- ---------------------- -----------
Net (loss) income $ (501) $ (1,517) $ (9,442) $ 2,205
Preferred stock (charge)
benefit (1,191) (2,397) 8,039 (7,189)
------------- ----------- ----------- ----------
Net loss to common
shareholders $ (1,692) 10,873,903 $ (3,914) 10,873,903 $ (1,403) 10,873,903 $(4,984) 10,873,866
=========== =========== ========== =========== ========= ========== ======== ===========
Net loss per share:
Basic and diluted $ (0.16) $ (0.36) $ (0.13) $ (0.46)
=========== =========== =========== ===========
Reconciliation of shares not
included in calculation of
earnings per share due to
antidilutive effect
Series A $ (289) 246,798 $ (580) 496,019 $ (964) 300,659 $(1,741) 496,019
Series B (403) 344,095 (807) 689,354 (1,342) 418,711 (2,419) 689,354
Series C (499) 342,447 (1,010) 691,766 (1,669) 417,940 (3,029) 691,766
Expense and incremental
shares of stock - 19,304 - 16,187 - 19,170 - 16,486
appreciation rights
----------- ----------------------- ----------------------- ---------------------- -----------
$ (1,191) 952,644 $ (2,397) 1,893,326 $ (3,975) 1,156,480 $(7,189) 1,893,625
=========== ======================= ======================= ====================== ===========
NOTE 4 - COLLATERAL FOR COLLATERALIZED BONDS
The following table summarizes the types of collateral for collateralized bonds
as of September 30, 2003 and December 31, 2002:
- ----------------------------------------------------------------------------------- -------------------- -- ----------------
September 30, December 31,
2003 2002
- ----------------------------------------------------------------------------------- -------------------- -- ----------------
Loans, at amortized cost $ 1,646,749 $ 1,844,025
Allowance for loan losses (40,975) (25,448)
- ----------------------------------------------------------------------------------- -------------------- -- ----------------
Loans, net 1,605,774 1,818,577
- ----------------------------------------------------------------------------------- -------------------- -- ----------------
Debt securities, at fair value 274,589 329,920
- ----------------------------------------------------------------------------------- -------------------- -- ----------------
$ 1,880,363 $ 2,148,497
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 September 30, 2003 and December 31, 2002:
- ----------------------------------------------------------------------------- ---------------------- --- -------------------
September 30, December 31, 2002
2003
- ----------------------------------------------------------------------------- ---------------------- --- -------------------
Debt securities, at amortized cost $ 273,986 $ 329,621
Gross unrealized gains 603 322
Gross unrealized losses - (23)
- ----------------------------------------------------------------------------- ---------------------- --- -------------------
Estimated fair value $ 274,589 $ 329,920
- ----------------------------------------------------------------------------- ---------------------- --- -------------------
The components of collateral for collateralized bonds at September 30, 2003 and
December 31, 2002 are as follows:
------------------------------------- ---------------------------------------- -- -----------------------------------------
September 30, 2003 December 31, 2002
---------------------------------------- -----------------------------------------
Loans, Debt Total Loans, Debt Total
net Securities net Securities
------------------------------------- ------------- ------------ ------------- ------------- ------------ --------------
Collateral, net $1,583,674 $271,149 $1,854,823 $1,791,679 $325,819 $2,117,498
Funds held by trustees 130 239 369 140 515 655
Accrued interest receivable 10,250 1,630 11,880 11,741 2,120 13,861
Unamortized premiums and discounts,
net 11,720 968 12,688 15,017 1,167 16,184
Unrealized gain, net - 603 603 - 299 299
------------------------------------- ------------- ------------ ------------- ------------- ------------ --------------
$1,605,774 $274,589 $1,880,363 $1,818,577 $329,920 $2,148,497
------------------------------------- ------------- ------------ ------------- -- ------------- ------------ --------------
NOTE 5 - OTHER INVESTMENTS
The following table summarizes the Company's other investments as of September
30, 2003 and December 31, 2002:
- ---------------------------------------------------------------------------------- ------------------ -- ------------------
September 30, December 31, 2002
2003
- ---------------------------------------------------------------------------------- ------------------ -- ------------------
Delinquent property tax receivables and securities, at amortized cost $ 43,298 $ 48,932
Real estate owned 4,887 5,251
Other 10 139
- ---------------------------------------------------------------------------------- ------------------ ------------------
$ 48,195 $ 54,322
- ---------------------------------------------------------------------------------- ------------------ -- ------------------
During the nine months ended September 30, 2003 and 2002, the Company collected
an aggregate $8,798 and $13,085, respectively, including net sales proceeds from
related real estate owned. The Company also accrued interest income of $3,437
and $4,188, respectively, during such periods, on a level-yield basis. During
the three months ended September 30, 2003, as a result of a change in estimated
collections on a certain delinquent property tax receivable security, the
Company recorded an other-than-temporary impairment charge of $2,219 and ceased
interest accrual on these receivables. This impairment charge was recorded as a
change in estimate, and was based upon collection trends and weakening economic
conditions in the greater Pittsburgh area, where the bulk of the delinquent
property tax receivables collateralizing this security are located. These
weakening economic conditions are expected to slow collections directly, impact
underlying real estate values, and reduce or eliminate government programs that
in the past have been favorable to collection results.
NOTE 6 - SECURITIES
The following table summarizes Dynex's amortized cost basis of securities
classified as held-to-maturity and fair value of securities classified as
available-for-sale, as of September 30, 2003 and December 31, 2002:
- ------------------------------------------------------------------------------------- ------------------ -- ----------------
September 30, December 31,
2003 2002
- ------------------------------------------------------------------------------------- ------------------ -- ----------------
Securities:
Fixed-rate mortgage securities, available-for-sale $ 877 $ 1,268
Mortgage-related securities, available-for-sale 172 3,770
- ------------------------------------------------------------------------------------- ------------------ ----------------
1,049 5,038
Gross unrealized gains 193 935
Gross unrealized losses (92) (1,409)
- ------------------------------------------------------------------------------------- ------------------ -- ----------------
Securities, available-for-sale 1,150 4,564
Asset-backed security, held-to-maturity 926 1,644
- ------------------------------------------------------------------------------------- ------------------ -- ----------------
$ 2,076 $ 6,208
- ------------------------------------------------------------------------------------- ------------------ -- ----------------
NOTE 7 - ALLOWANCE FOR LOAN LOSSES
The Company reserves for credit risk where it has exposure to losses on loans in
its investment portfolio. The following table summarizes the aggregate activity
for the allowance for loan losses on investments for the nine months ended
September 30, 2003 and 2002:
- ------------------------------------------------------------------------- --------------------------------------------------
Nine months Ended September 30,
- ------------------------------------------------------------------------- --------------------------------------------------
2003 2002
- ------------------------------------------------------------------------- -------------------------- -----------------------
Allowance at beginning of period $ 25,472 $ 21,508
Provision for loan losses 29,715 16,292
Credit losses, net of recoveries (14,194) (16,679)
- ------------------------------------------------------------------------- -------------------------- -----------------------
Allowance at end of period $ 40,993 $ 21,121
- ------------------------------------------------------------------------- -------------------------- -----------------------
The Company continues to experience unfavorable results in its manufactured
housing loan portfolio in terms of elevated delinquencies and loss severity on
repossessed units. For the nine months ended September 30, 2003, the Company
added $29,715 in provisions for loan losses, substantially all of which relates
to the manufactured housing loan portfolio. Included in this amount is $14,400
in provision for loan losses recorded in June 2003 specifically for currently
existing credit losses within outstanding manufactured housing loans that are
current as to payment but which the Company has determined to be impaired.
Previously, the Company had not considered current loans to be impaired under
generally accepted accounting principles and therefore had not previously
provided allowances for loan losses with respect to these loans. Continued
worsening trends in both the industry as a whole and the Company's pools of
manufactured housing loans prompted the Company to prepare extensive analysis on
these pools of loans. The Company has not originated any new manufactured
housing loans since 1999, and has extensive empirical data on the historical
performance of this static pool of loans. The Company analyzed performance and
default activity for loans that were current at various points in time over the
last 36 months, and based on that analysis, identified default trends on these
loans. The Company also considered current market conditions in this analysis,
with the expectation that these market conditions would continue for the
foreseeable future. Given this new observable data, the Company now believes the
inclusion of amounts in the provision for loan losses for loans which are
current as to payment is an appropriate application of the definition of
impairment within generally accepted accounting principles, and has accounted
for the amount as a change in accounting estimate and accordingly recorded the
amount as additional provision for loan losses. At September 30, 2003, the
remaining net unreserved principal balance on manufactured housing loans where
the Company has credit risk was $14,490.
NOTE 8 - SENIOR NOTES
The following table summarizes Dynex's recourse debt outstanding at September
30, 2003 and December 31, 2002:
- ----------------------------------------------------------------- -- ----------------------------
September 30, 2003 December 31, 2002
- ----------------------------------------------------------------- -- ----------------------------
9.50% Senior Notes (due 2/28/2005) $ 14,059 $ -
- ----------------------------------------------------------------- -- ----------------------------
During the quarter ended March 31, 2003, the Company issued $32,079 of 9.50%
senior unsecured notes due February 2005 (the "February 2005 Senior Notes") in
connection with a tender offer on the Company's Preferred Stock. The February
2005 Senior Notes were issued in exchange for 1,156,891 shares of Series A,
Series B and Series C Preferred Stock. See Note 9 for further discussion.
Principal payments in the amount of $4,010, along with interest payments at a
rate of 9.50% per annum, are due quarterly beginning May 2003, with final
payment due on February 28, 2005. The Company at its option can prepay the
February 2005 Senior Notes in whole or in part, without penalty, at any time.
The Company redeemed $10,000 of the February 2005 Senior Notes in addition to
the $4,010 most recent required quarterly principal payment. The February 2005
Senior Notes prohibit distributions on the Company's capital stock until they
are fully repaid, except distributions necessary for the Company to maintain
REIT status.
NOTE 9 - PREFERRED STOCK
As of September 30, 2003 and December 31, 2002, the total liquidation preference
on the Preferred Stock was $66,526 and $130,250, respectively, and the total
amount of dividends in arrears on Preferred Stock was $17,273 and $31,157,
respectively. Individually, the amount of dividends in arrears on the Series A,
the Series B, and the Series C Preferred Stock were $4,187 ($8.48 per Series A
share), $5,837 ($8.48 per Series B share), and $7,249 ($10.58 per Series C
share), respectively, at September 30, 2003 and $7,544 ($7.60 per Series A
share), $10,485 ($7.60 per Series B share), and $13,128 ($9.49 per Series C
share), respectively, at December 31, 2002.
On February 28, 2003, the Company completed a tender offer for shares of its
Series A, Series B and Series C Preferred Stock. The Company purchased for cash
188,940 shares of its Series A Preferred Stock, 272,977 shares of its Series B
Preferred Stock and 268,792 shares of its Series C Preferred Stock for a total
cash payment of $19,286, and incurred $267 of fees and charges to complete the
tender offer. In addition, the Company exchanged $32,079 of February 2005 Senior
Notes for an additional 309,503 shares of Series A Preferred Stock, 417,541
shares of Series B Preferred Stock and 429,847 shares of Series C Preferred
Stock. The tender offer resulted in a Preferred Stock benefit of $12,438
comprised of the elimination of dividends-in-arrears of $16,475 for the shares
tendered, less the premium paid on the Preferred Stock in excess of the book
value of such Preferred Stock of $4,059.
NOTE 10 - DERIVATIVE FINANCIAL INSTRUMENTS
In June 2002, the Company entered into an interest rate swap which matures on
June 28, 2005, to mitigate its interest rate risk exposure on $100,000 in
notional value of its variable rate collateralized bonds, which finance a like
amount of fixed rate assets. Under the agreement, the Company will pay interest
at a fixed rate of 3.73% on the notional amount and will receive interest based
on One-Month LIBOR on the same amount. This contract has been treated as a cash
flow hedge with changes in the value of the hedge being reported as a component
of accumulated other comprehensive income. During the nine months ended
September 30, 2003, the Company recognized $284 in other comprehensive income on
this hedge instrument and incurred $1,870 of interest expense related to net
payments made on this position. At September 30, 2003, the aggregate accumulated
other comprehensive loss on this hedge instrument was $3,700. As the repricing
dates, interest rate indices and formulae for computing net settlements of the
interest rate swap agreement match the corresponding terms of the underlying
collateralized bonds being hedged, no ineffectiveness is assumed on this
agreement and, accordingly, any prospective gains or losses are included in
Other Comprehensive Income until such time as all interest rate swap payments
have been settled. Assuming no change in one-month LIBOR rates from September
30, 2003, over the next twelve months, the Company expects to reclassify $2,467
of this other comprehensive loss to interest expense.
In October 2002, the Company entered into a synthetic three-year amortizing
interest-rate swap with an initial notional balance of approximately $80,000 and
ending in September 2005 to mitigate its exposure to rising interest rates on a
portion of its variable rate collateralized bonds, which finance a like amount
of fixed rate assets. This contract is accounted for as a cash flow hedge with
gains and losses associated with the change in the value of the hedge being
reported as a component of accumulated other comprehensive income. At September
30, 2003, the current notional balance of the amortizing synthetic swap was
$46,000, and the remaining weighted-average fixed-rate payable by the Company
under the terms of the synthetic swap was 2.47%. During the nine months ended
September 30, 2003, the Company recognized $393 in other comprehensive loss for
the synthetic interest-rate swap, which includes unamortized losses, and
incurred $223 of interest expense related to net payments made on this position.
At September 30, 2003 and December 31, 2002, the aggregate accumulated other
comprehensive loss on this hedge instrument was $871 and $477, respectively. The
Company evaluated hedge effectiveness and determined that there was no material
ineffectiveness to reflect in earnings. Assuming no change in Eurodollar rates
from September 30, 2003, over the next twelve months, the Company expects to
reclassify $573 into earnings.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the County
of Allegheny, Pennsylvania ("Allegheny County"), were defendants in a lawsuit in
the Commonwealth Court of Pennsylvania (the "Commonwealth Court"), the appellate
court of the state of Pennsylvania. Plaintiffs were two local businesses seeking
status to represent as a class, delinquent taxpayers in Allegheny County whose
delinquent tax liens had been assigned to GLS. Plaintiffs challenged the right
of Allegheny County and GLS to collect certain interest, costs and expenses
related to delinquent property tax receivables in Allegheny County, and whether
the County had the right to assign the delinquent property tax receivables to
GLS and therefore employ procedures for collection enjoyed by Allegheny County
under state statute. This lawsuit was related to the purchase by GLS of
delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999. In July 2001, the Commonwealth Court issued a ruling that addressed, among
other things, (i) the right of GLS to charge to the delinquent taxpayer a rate
of interest of 12% per annum versus 10% per annum on the collection of its
delinquent property tax receivables, (ii) the charging of a full month's
interest on a partial month's delinquency; (iii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iv)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court in its opinion remanded for further consideration to the
lower trial court items (i), (ii) and (iv) above, and ruled that neither
Allegheny County nor GLS had the right to charge attorney's fees to the
delinquent taxpayer related to the collection of such tax receivables. The
Commonwealth Court further ruled that Allegheny County could assign its rights
in the delinquent property tax receivables to GLS, and that plaintiffs could
maintain equitable class in the action. In October 2001, GLS, along with
Allegheny County, filed an Application for Extraordinary Jurisdiction with the
Supreme Court of Pennsylvania, Western District appealing certain aspects of the
Commonwealth Court's ruling. In March 2003, the Supreme Court issued its opinion
as follows: (i) the Supreme Court determined that GLS can charge delinquent
taxpayers a rate of 12% per annum; (ii) the Supreme Court remanded back to the
lower trial court the charging of a full month's interest on a partial month's
delinquency; (iii) the Supreme Court revised the Commonwealth Court's ruling
regarding recouping attorney fees for collection of the receivables indicating
that the recoupment of fees requires a judicial review of collection procedures
used in each case; and (iv) the Supreme Court upheld the Commonwealth Court's
ruling that GLS can charge certain fees and costs, while remanding back to the
lower trial court for consideration the facts of each individual case. Finally,
the Supreme Court remanded to the lower trial court to determine if the
remaining claims can be resolved as a class action. No hearing date has been set
for the issues remanded back to the lower trial court. In August 2003, the
Pennsylvania legislature signed a bill amending and clarifying certain
provisions of the Pennsylvania statute governing GLS' right to the collection of
certain interest, costs and expenses. If enacted as currently proposed, the law
is retroactive to 1996, and amends and clarifies that as to items (ii)-(iv)
noted above by the Supreme Court, that GLS can charge a full month's interest on
a partial month's delinquency, that GLS can charge the taxpayer for legal fees,
and that GLS can charge certain fees and costs to the taxpayer at redemption.
The Company and Dynex Commercial, Inc. ("DCI"), formerly an affiliate of the
Company and now known as DCI Commercial, Inc., are defendants in state court in
Dallas County, Texas in the matter of Basic Capital Management et al ("BCM")
versus Dynex Commercial, Inc. et al. The suit was filed in April 1999 originally
against DCI, and in March 2000, BCM amended the complaint and added the Company
as a defendant. The current complaint alleges that, among other things, DCI and
the Company failed to fund tenant improvement or other advances allegedly
required on various loans made by DCI to BCM, which loans were subsequently
acquired by the Company; that DCI breached an alleged $160,000 "master" loan
commitment entered into in February 1998 and a second alleged loan commitment of
approximately $9,000; that DCI and the Company made negligent misrepresentations
in connection with the alleged $160,000 commitment; and that DCI and the Company
fraudulently induced BCM into canceling the alleged $160,000 master loan
commitment in January 1999. Plaintiff BCM is seeking damages approximating
$40,000, including approximately $36,500 for DCI's breach of the alleged
$160,000 master loan commitment, approximately $1,600 for alleged failure to
make additional tenant improvement advances, and approximately $1,900 for DCI's
not funding the alleged $9,000 commitment. DCI and the Company are vigorously
defending the claims on several grounds. The Company was not a party to the
alleged $160,000 master commitment or the alleged $9,000 commitment. The Company
has filed a counterclaim for damages approximating $11,000 against BCM.
Commencement of the trial of the case in Dallas, Texas is anticipated in the
first quarter of 2004. During the second quarter 2003, BCM filed suit against
the Company and DCI as third-party defendants in related litigation in the
United States District Court Eastern District of Louisiana in the matter Kelly
Investment, Inc. versus BCM et al. The Company sold certain BCM related loans on
commercial properties located in Louisiana to Kelly Investment, Inc. in 2000,
and Kelly Investment, Inc. subsequently filed suit against BCM in 2001. Claims
made by BCM in the US District Court of Louisiana against the Company and DCI
are substantially similar to those being made in Dallas County, Texas. During
the third quarter 2003, Kelly and BCM entered into a settlement agreement where
BCM paid certain amounts to Kelly. Subsequently, the Louisiana litigation
against the Company and DCI was dismissed. Neither the company nor DCI were
impacted by the settlement.
Although no assurance can be given with respect to the ultimate outcome of the
above litigation, the Company believes the resolution of these lawsuits will not
have a material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
NOTE 12 - RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." Effective after June 30, 2003,
this Statement amends FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities", to provide clarification of financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts. In particular, this
Statement (1) clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative discussed in paragraph 6(b)
of Statement 133, (2) clarifies when a derivative contains a financing
component, (3) amends the definition of an underlying to conform it to language
used in FASB Interpretation (FIN) No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," and (4) amends certain other existing pronouncements. Those changes
will result in more consistent reporting of contracts as either derivatives or
hybrid instruments. The Company's adoption of SFAS No. 149 in June 2003 has not
had a significant impact on its financial position, results of operations, or
cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
is effective for financial instruments entered into or modified after May 31,
2003; and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatorily redeemable financial
instruments of nonpublic entities, which are subject to the provisions of this
Statement for the first fiscal period beginning after December 15, 2003. This
Statement amends SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and SFAS No. 128, "Earnings per Share," to establish
standards outlining how to classify and measure certain financial instruments
with characteristics of both liabilities and equity. It requires that certain
financial instruments that were previously classified as equity now be
classified as a liability (or, in some circumstances, as an asset). The Company
is reviewing the implications of SFAS No. 150 but does not believe that its
adoption will have a significant impact on its financial position, results of
operations, or cash flows.
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 December 31,
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
did not have a material effect on the Company's results of operations, cash
flows or financial position.
NOTE 13 - RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the issuance of its financial statements for the three and six
months ended June 30, 2003 and the year ended December 31, 2002, the Company
determined that declines in the fair value of its delinquent property tax
receivable debt security upon the reclassification from available-for-sale to
held-to-maturity in the fourth quarter of 2001were not accounted for correctly.
As a result, the accompanying condensed consolidated financial statements for
the three and nine month periods ended September 30, 2002 and the condensed
consolidated balance sheet as of December 31, 2002 have been restated from the
amounts previously reported to correct the accounting for these impairment
charges.
In 2001, the Company recorded other-than-temporary impairment charges of $6.3
million in the statement of operations and a reduction in the carrying value of
the delinquent property tax receivable security of $18.1 million as an
adjustment to accumulated other comprehensive loss included in shareholders'
equity. The Company subsequently amortized a portion of this $18.1 million in
2002 and 2003 on a level-yield basis as a reduction in accumulated other
comprehensive loss and as an increase in the carrying value of the tax
receivable security. As a result of the continued decline of the fair value of
this security, in the third quarter of 2003, the Company reconsidered the
accounting treatment afforded to the security in 2001, and determined that the
$18.1 million previously recorded as an adjustment to accumulated other
comprehensive loss should have been recorded as an other-than-temporary
impairment charge in the statement of operations in 2001. The Company has
further determined that interest income should have then been recorded in 2002
and 2003 based on estimated collections on a level-yield basis.
A summary of the significant effects of the restatement is as follows:
Condensed Consolidated Balance Sheets Data
(amounts in thousands)
- ----------------------------------------------------------------------------- --------------------- ---- ---------------------
December 31, 2002 December 31, 2002
--------------------- ---------------------
(As Previously
Reported) (As Restated)
- ----------------------------------------------------------------------------- --------------------- ---- ---------------------
Accumulated other comprehensive loss $ (17,472) $ (4,832)
Accumulated deficit (218,545) (231,185)
Total stockholders' equity 223,421 223,421
- ----------------------------------------------------------------------------- --------------------- ---- ---------------------
Condensed Consolidated Statements of Operations Data
(amounts in thousands, except share data)
- -------------------------------------------- -------------------------------------- -- --------------------------------------
Three Months Ended September 30 Nine Months Ended September 30
-------------------------------------- --------------------------------------
2002 2002 2002 2002
----------------- ----------------- ----------------- ----------------
(As Previously (As Restated) (As Previously (As Restated)
Reported) Reported)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Interest income - Other Investments $ 45 $ 1,391 $ 100 $ 4,288
Total interest income 42,321 43,667 130,230 134,418
Net interest margin before provision for
loan losses 10,840 12,186 32,594 36,782
Net interest margin 5,432 6,778 16,302 20,490
Net (loss) income (2,862) (1,517) (1,982) 2,205
Net loss to common shareholders (5,259) (3,914) (9,171) (4,984)
Change in net unrealized loss during
period on: Investments classified as
available-for-sale 1,848 503 (1,208) (5,396)
Comprehensive loss (4,966) (4,966) (6,768) (6,768)
Net loss per common share (basic and
diluted) $ (0.48) $ (0.36) $ (0.84) $ (0.46)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
As discussed in Note 13 to the condensed consolidated financial statements
included in Item 1, the Company has restated its financial statements as of
December 31, 2002 and for the three and six-month period ended June 30, 2003.
The following management discussion and analysis takes into account the effects
of the restatement. The Company intends to amend its Annual Report of Form 10-K
for the year ended December 31, 2002 and its quarterly reports on Forms 10-Q for
the quarterly periods ended March 31, 2003 and June 30, 2003 to include the
restated financial statements as soon as practicable. The following tables
summarize the significant effects of such restatements for such periods.
Condensed Consolidated Balance Sheets Data
(amounts in thousands, except share data)
- ----------------------------------------------------------------------------- --------------------- ---- ---------------------
(As Previously
Reported) (As Restated)
- ------------------------------------------------------------------------------------------------------------------------------
June 30, 2003 June 30, 2003
--------------------- ---------------------
Accumulated other comprehensive loss $ (13,166) $ (2,971)
Accumulated deficit (229,931) (240,126)
Total stockholders' equity 164,709 164,709
March 31, 2003 March 31, 2003
--------------------- ---------------------
Accumulated other comprehensive loss $ (15,973) $ (4,646)
Accumulated deficit (217,813) (229,140)
Total stockholders' equity 174,042 174,042
December 31, 2001 December 31, 2001
--------------------- ---------------------
Accumulated other comprehensive loss $ (14,825) $ 3,298
Accumulated deficit (202,502) (220,625)
Total stockholders' equity 242,110 242,110
- ----------------------------------------------------------------------------- --------------------- ---- ---------------------
Condensed Consolidated Statements of Operations Data
(amounts in thousands, except share data)
- -------------------------------------------- -------------------------------------- -- --------------------------------------
Three Months Ended June 30, 2003 Six Months Ended June 30, 2003
-------------------------------------- --------------------------------------
(As Previously (As Restated) (As Previously (As Restated)
Reported) Reported)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Interest income - Other Investments $ 30 $ 1,162 $ 59 $ 2,503
Total interest income 36,010 37,142 74,191 76,635
Net interest margin before provision for
loan losses 7,694 8,826 17,825 20,269
Net interest margin (10,346) (9,214) (6,059) (3,615)
Net loss (12,118) (10,986) (11,386) (8,942)
Net (loss) income to common shareholders (13,332) (12,200) (2,156) 288
Change in net unrealized loss during
period on: Investments classified as
available-for-sale 3,486 2,354 5,425 2,980
Comprehensive loss (9,311) (9,311) (7,080) (7,081)
Net loss per common share (basic and
diluted) $ (1.23) $ (1.12) $ (0.20) $ 0.03
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
- -------------------------------------------- -------------------------------------- -- --------------------------------------
Three Months Ended June 30, 2002 Six Months Ended June 30, 2002
-------------------------------------- --------------------------------------
(As Previously (As Restated) (As Previously (As Restated)
Reported) Reported)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Interest income - Other Investments $ 44 $ 1,441 $ 55 $ 2,896
Total interest income 44,968 46,365 87,909 90,750
Net interest margin before provision for
loan losses 12,254 13,650 21,754 24,595
Net interest margin 7,013 8,409 10,870 13,711
Net income 398 1,796 880 3,721
Net loss to common shareholders (1,998) (601) (3,912) (1,072)
Change in net unrealized loss during
period on: Investments classified as
available-for-sale (4,355) (5,752) (3,057) (5,898)
Comprehensive loss (3,583) (3,582) (1,803) (1,803)
Net loss per common share (basic and
diluted) $ (0.18) $ (0.06) $ (0.36) $ (0.10)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
- -------------------------------------------- -------------------------------------- -- --------------------------------------
Three Months Ended March 31, 2003 Three Months Ended March 31, 2002
-------------------------------------- --------------------------------------
(As Previously (As Restated) (As Previously (As Restated)
Reported) Reported)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Interest income - Other Investments $ 28 $ 1,341 $ 10 $ 1,454
Total interest income 38,181 39,493 42,940 44,385
Net interest margin before provision for
loan losses 10,131 11,443 9,500 10,945
Net interest margin 4,287 5,599 3,857 5,302
Net income 732 2,044 481 1,925
Net income (loss) to common shareholders
11,176 12,488 (1,915) (471)
Change in net unrealized loss during
period on: Investments classified as
available-for-sale 1,939 626 1,299 (146)
Comprehensive income (loss) 12,675 2,230 (616) 1,779
Net income (loss) per common share (basic
and diluted) $ 1.03 $ 1.15 $ (0.18) $ (0.04)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- --------------
- -------------------------------------------- --------------------------------------------------------------------------------
Years ended December 31,
--------------------------------------------------------------------------------
2002 2001
- -------------------------------------------- -------------------------------------- -- --------------------------------------
(As Previously (As Restated) (As Previously (As Restated)
Reported) Reported)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Interest income - Other Investments $ 189 $ 5,674 $ 6,164 $ 6,164
Total interest income 170,883 176,367 222,760 222,760
Net interest margin before provision for
loan losses 43,669 49,153 48,082 48,082
Net interest margin 15,186 20,670 28,410 28,410
Net loss on sales, impairment charges and
litigation (18,299) (18,299) (20,954) (39,078)
Net loss (14,844) (9,360) (3,085) (21,209)
Net (loss) income to common shareholders
(24,430) (18,946) 4,632 (13,492)
Change in net unrealized loss during
period on: Investments classified as
available-for-sale 1,784 (3,669) 29,438 47,561
Comprehensive (loss) income (17,491) (17,491) 26,353 26,352
Net (loss) income per common share (basic
and diluted) $ (2.25) $ (1.74) $ 0.41 $ (1.18)
- -------------------------------------------- ----------------- -- ----------------- -- ----------------- --- ----------------
Dynex Capital, Inc. was incorporated in the Commonwealth of Virginia in 1987.
References to "Dynex" or "the Company" contained herein refer to Dynex Capital,
Inc. together with its qualified real estate investment trust (REIT)
subsidiaries and taxable REIT subsidiary. Dynex is a financial services company,
which invests in loans and securities consisting of or secured by, principally
single family mortgage loans, commercial mortgage loans, manufactured housing
installment loans and delinquent property tax receivables. 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. The Company has elected to be treated
as a REIT for federal income tax purposes under the Internal Revenue Code of
1986, as amended, and, as such, must distribute substantially all of its taxable
income to shareholders. Provided that the Company meets all of the prescribed
Internal Revenue Code requirements for a REIT, the Company will generally not be
subject to federal income tax.
The Company's primary focus in the near term is on maximizing cash flows from
its investment portfolio, opportunistically calling securities pursuant to
clean-up calls if the underlying collateral has value for the Company and
securing third-party servicing contracts to leverage its delinquent property tax
receivables platform. During the first nine months of 2003, the Company's
investment portfolio generated net cash flows to the Company of $43.8 million,
including $14.0 million in the third quarter. Depending on prepayment activity
on the underlying assets in the investment portfolio, collection activity on the
delinquent property tax receivable portfolio and the absolute level of
short-term interest rates which directly impacts the Company's financing costs,
the Company estimates that cash flow for the balance of 2003 will be similar to
amounts generated during the first nine months of the year. In September 2003,
the Company redeemed or otherwise retired $14 million of its 9.50% Senior Notes
due February 2005.
The Company has entered into an agreement to service $7.5 million of liens on
real estate for a regional utility in Pennsylvania. The Company will be
compensated based on the results of its collection efforts. Given the existing
infrastructure now in place to service the Company's investment in property tax
receivables, the incremental cost to service these liens is marginal. The
Company will seek to gain other third-party servicing contracts in the future.
The Company also owns the right to call adjustable-rate and fixed-rate mortgage
pass-through securities previously issued and sold by the Company once the
outstanding balance of such securities reaches a call trigger, generally either
10% or less of the original amount issued or a specified date. During the
quarter ended September 30, 2003, the Company called approximately $23.1 million
of securities, and subsequently sold approximately $20 million of the underlying
seasoned single-family mortgage loan collateral at a gain of $0.8 million. At
September 30, 2003, the callable balance at the time of the projected call of
the one remaining security expected to reach a call trigger this year is
approximately $32.1 million.
The Board of Directors continues to evaluate alternatives for the use of the
Company's cash flow in an effort to improve overall shareholder value. To that
end, the Board has formed a committee to review possible strategic alternatives.
Such review may include a number of alternatives, including the acquisition of a
new business. The Company has a net operating loss carryforward of approximately
$130 million which can be utilized to offset REIT distribution requirements,
other than excess inclusion income, which would allow the Company to retain
capital for investment in a new strategic alternative. In addition, the Company
could use the net operating loss carryforward to shelter taxable income from
income tax for any taxable-REIT subsidiary or for the Company itself if it were
to forego its REIT status. The committee of the Board also continues to review
various alternatives with respect to the Company's capital structure.
FINANCIAL CONDITION
(amounts in thousands except per share data)
- ---------------------------------------------------------------------- -------------------------- --------------------------
September 30, 2003 December 31, 2002
- ---------------------------------------------------------------------- -------------------------- --------------------------
Investments:
Collateral for collateralized bonds $ 1,880,363 $ 2,148,497
Other investments 48,195 54,322
Other loans 9,647 9,288
Securities 2,076 6,208
Collateralized bonds 1,776,110 2,013,271
Senior notes 14,059 -
Shareholders' equity 161,428 223,421
Common book value per share (inclusive of dividends in arrears) 8.73 8.57
- ---------------------------------------------------------------------- -------------------------- --------------------------
Collateral for collateralized bonds. As of September 30, 2003, the Company had
21 series of collateralized bonds outstanding. The collateral for collateralized
bonds decreased to $1.88 billion at September 30, 2003 compared to $2.15 billion
at December 31, 2002. This decrease of $268.1 million is primarily the result of
$228.3 million in principal paydowns on the collateral, $29.7 million of
additions to allowance for loan losses, $4.5 million of impairment charges and
$3.4 million of net premium amortization.
Other investments. Other investments at September 30, 2003 consist primarily of
delinquent property tax receivables and securities. Other investments decreased
from $54.3 million at December 31, 2002 to $48.2 million at September 30, 2003.
This decrease is primarily the result of pay-downs of delinquent property tax
receivables which totaled $7.9 million, sales of real estate owned properties of
$1.0 million and the recognition of a $2.2 million impairment loss on these
delinquent property tax receivables. These decreases were partially offset by
$3.4 million of interest income recorded during the period and additional
advances for collections of $1.7 million.
Other loans. Other loans increased by $0.3 million from $9.3 million at December
31, 2002 to $9.6 million at September 30, 2003 principally as the result the
call and purchase of two pools of loans for $3.4 million. This was partially
offset by $3.0 million of pay-downs during the quarter.
Securities. Securities decreased during the nine months ended September 30, 2003
by $4.2 million, to $2.0 million at September 30, 2003 from $6.2 million at
December 31, 2002 due primarily to principal payments of $4.1 million and the
sale of six securities with a book value of $1.2 million, partially offset by
$1.1 million of net discount amortization.
Collateralized bonds. Collateralized bonds decreased $237.2 million, from $2.0
billion at December 31, 2002 to $1.8 billion at September 30, 2003. This
decrease was primarily a result of principal payments received of $228.3 million
on the associated collateral pledged which were used to pay down the
collateralized bonds in accordance with the respective indentures. Additionally,
for certain securitizations, surplus cash in the amount of $4.5 million was
retained within the security structure and used to repay collateralized bonds
outstanding, instead of being released to the Company. For certain other
securitizations, surplus cash in the amount of $3.8 million was retained to
cover losses, as certain performance triggers were not met in such
securitizations.
Senior Notes. Senior Notes increased $14.1 million as a result of the issuance
of February 2005 Senior Notes issued in exchange for Preferred Stock in February
2003. Since their issuance, the Company has repaid $8.0 million of the Senior
Notes in accordance with their contractual terms and redeemed early $10.0
million of the notes.
Shareholders' equity. Shareholders' equity decreased to $161.4 million at
September 30, 2003 from $223.4 million at December 31, 2002. This decrease was
primarily the result of a $51.6 million retirement of preferred shares in
connection with the tender offer completed in February 2003, net loss of $9.4
million, a $1.8 million dividend paid on preferred shares and $0.1 million of
deferred losses on hedging instruments during the period. This decrease was
partially offset by a net decrease in accumulated other comprehensive loss due
to an unrealized gain on investments available-for-sale of $0.9 million.
RESULTS OF OPERATIONS
- ----------------------------------------- --- ------------------------------------- --- ------------------------------------
(amounts in thousands except per share Three months ended September 30, Nine months ended September 30,
information)
- ----------------------------------------- ------------------------------------- ------------------------------------
2003 2002 2003 2002
- ----------------------------------------- ---------------- ---------------- ---------------- ---------------
Net interest margin before provision
for loan losses $ 8,832 $12,186 $29,102 $36,782
Provision for loan losses (5,831) (5,408) (29,715) (16,292)
Net interest margin 3,001 6,778 (613) 20,490
Impairment charges (2,277) (2,469) (4,482) (9,553)
Gain (loss) on sales of investments, net 769 (257) 1,779 (84)
Trading losses - (4,035) - (3,307)
General and administrative expenses (2,124) (2,226) (6,296) (6,744)
Net (loss) income (501) (1,517) (9,442) 2,205
Preferred stock (charge) benefit (1,191) (2,397) 8,039 (7,189)
Net loss to common shareholders
(1,692) (3,914) (1,403) (4,984)
Basic and diluted net loss per common
share $(0.16) $(0.36) $(0.13) $(0.46)
- ----------------------------------------- --- ---------------- --- ---------------- --- ---------------- --- ---------------
Three Months Ended September 30, 2003 Compared to Three Months Ended September
30, 2002. Net loss and net loss per common share decreased during the three
months ended September 30, 2003 as compared to the same period in 2002. The
decrease in net loss for the three months ended September 30, 2003 is primarily
attributable to a $4.0 non-recurring trading loss incurred during the three
months ended September 30, 2002, and a $1.0 million increase in gain on sale of
investments, offset by a reduction in net interest margin of $3.8 million. Net
loss to common shareholders declined for the same reasons, in addition to a $1.2
million decrease in dividends in arrears accruals.
Net interest margin declined as a result of a decline in average
interest-earning assets of approximately $350 million, and a decline in the net
interest spread earned on these assets of 0.23%. The decline in the net interest
spread resulted principally from the prepayment of higher coupon loans and
securities.
The Company incurred trading losses of $4.0 million during the three months
ended September 30, 2002 related to a short position in the 5-Year Treasury
futures contract which was terminated during the third quarter 2002. Income of
$0.7 million earned in the three months ended June 30, 2002 resulted in a net
loss on this trading position of $3.3 million.
Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30,
2002. The increase in net loss during the nine months ended September 30, 2003
as compared to the same period in 2002 is primarily the result of a reduction in
net interest margin by $21.0 resulting primarily from additions of $29.7 million
to provisions for loan losses. Included in this amount is $14.4 million in
provision for loan losses recorded in June 2003 specifically for currently
existing credit losses within outstanding manufactured housing loans that are
current as to payment but which the Company has determined to be impaired.
Offsetting this decline was decreased impairment charges of approximately $5.1
million and incremental net gains on sales of investments of $1.9 million for
the nine months ended September 30, 2003 compared to the same periods in 2002.
Net loss to common shareholders decreased by $3.6 million or $0.33 per common
share, mostly due to preferred stock benefits from the tender offer completed in
February 2003.
Impairment charges decreased by $5.1 million for the nine months ended September
30, 2003 from the same period last year. This decrease was primarily a result of
a decrease of $5.4 million related to other-than-temporary impairment charges on
a debt security comprised largely of manufactured housing loans. In addition,
losses were recorded in the amount of $1.9 million in 2002 on valuation
adjustments on loans held-for-sale which were not included in the SASCO 2002-9
securitization completed in April 2002.
General and administrative expense decreased by $0.4 million to $6.3 million for
the nine months ended September 30, 2003 compared to the same period in 2002.
Decreased personnel, independent contractor and legal expenses are the primary
reason for the reduction in general and administrative expense.
The following table summarizes the average balances of interest-earning assets
and their average effective yields, along with the average interest-bearing
liabilities and the related average effective interest rates, for each of the
periods presented.
Average Balances and Effective Interest Rates
- --------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine months Ended September 30,
---------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------------------------------------------------
(amounts in thousands) Average Effective Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate Balance Rate
---------------------------------------------------------------------------------------------------
Interest-earning
assets: (1)
Collateral for
collateralized
bonds (2) (3) $1,936,461 7.12% $2,286,048 7.31% $2,017,936 7.13% $2,344,608 7.33%
Other loans 10,374 6.75% 11,320 3.82% 9,142 6.25% 9,630 4.39%
Securities 2,167 36.77% 3,499 33.07% 3,738 21.70% 4,222 23.57%
Cash and other
investments 63,104 6.46% 66,740 8.37% 62,845 7.47% 75,632 7.65%
---------------------------------------------------------------------------------------------------
Total interest-
earning assets $2,012,106 7.13% $2,367,607 7.36% $2,093,661 7.16% $2,434,092 7.36%
===================================================================================================
Interest-bearing
liabilities:
Collateralized
bonds (3) $1,816,494 5.68% $2,137,737 5.72% $1,889,262 5.64% $2,188,094 5.67%
Senior notes 23,248 9.56% 7,463 8.62% 21,547 9.53% 34,816 8.15%
---------------------------------------------------------------------------------------------------
Total
interest-bearing $1,839,742 5.73% $2,145,200 5.73% $1,910,809 5.68% $2,222,910 5.71%
liabilities
===================================================================================================
Net interest spread on
all investments (3) 1.39% 1.64% 1.48% 1.65%
=========== ============ =========== ============
Net yield on average
interest-earning 1.88% 2.18% 1.98% 2.15%
assets (3)
============ ============ =========== ============
- --------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Average balances exclude adjustments made in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" to record available-for-sale securities at
fair value.
(2) Average balances exclude funds held by trustees of $347 and $500 for the
three months ended September 30, 2003 and 2002, respectively, and $406 and
$544 for the nine months ended September 30, 2003 and 2002, respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses. If included, the effective rate on
interest-bearing liabilities would be 5.87% for both the three month
periods ended September 30, 2003 and 2002, respectively, and 5.82% and
5.86% for the nine months ended September 30, 2003 and 2002, respectively,
while the net yield on average interest-earning assets would be 1.76% and
2.06% for the three months ended September 30, 2003 and 2002, respectively,
and 1.85% and 2.01% for the nine months ended September 30, 2003 and 2002,
respectively.
</FN>
The net interest spread decreased 25 basis points, to 139 basis points for the
three months ended September 30, 2003 from 164 basis points for the same period
in 2002 (each basis point is 0.01%). The net interest spread for the nine months
ended September 30, 2003 also decreased relative to the same period in 2002, to
148 basis points from 165 basis points. The decrease in the Company's net
interest spread for both periods can be generally attributed to the resetting of
interest rates on adjustable rate mortgage loans in the Company's investment
portfolio and the prepayment of higher rate loans in that portfolio which
together caused a decline in interest earning asset yield of 23 basis points and
20 basis points for the three and nine month comparative periods, respectively.
Interest-bearing liability costs were unchanged for the three month period and
decreased 3 basis points for the nine-month period ended September 30, 2003,
respectively, compared to the same period in 2002. The Company currently
finances approximately $198 million of the fixed-rate assets with non-recourse
LIBOR based floating-rate liabilities. In June 2002, the Company, through the
use of an interest-rate swap, converted $100 million of such floating-rate
liabilities into fixed rate, in effect locking the spread in for that portion of
fixed rate assets financed with floating rate liabilities. Under the swap, the
Company pays a fixed rate of 3.73% and receives one-month LIBOR. In October
2002, the Company created an amortizing synthetic swap through the short sale of
a string of Eurodollar futures contracts, with an initial effective notional
balance of approximately $80 million, amortizing over a three-year period. At
September 30, 2003, the notional amount of this synthetic amortizing swap was
$46 million.
The Company would expect its net interest spread on its interest-earning assets
for the balance of 2003 to continue to decrease, on a seasonal basis, as higher
coupon loans and securities prepay, and rates on adjustable-rate assets in the
investment portfolio continue to adjust downward. The average One-Month LIBOR
rate declined to 1.11% and 1.23% for the three and nine month periods ended
September 30, 2003, respectively from 1.82% and 1.84%, respectively, for the
three and nine month periods ended September 30, 2002.
Interest Income and Interest-Earning Assets. At September 30, 2003, $1.5 billion
of the investment portfolio consists of loans and securities which pay a
fixed-rate of interest, and approximately $390.4 million of the investment
portfolio is comprised of loans and 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. The Company finances its
investment portfolio with principally non-recourse collateralized bonds. At
September 30, 2003, approximately $1.2 billion of fixed-rate bonds and $587
million of adjustable rate bonds were outstanding. The following table presents
a breakdown, by principal balance, of the Company's collateral for
collateralized bonds and ARM and fixed mortgage securities by type of underlying
loan. This table excludes mortgage-related securities, other investments and
other loans.
Investment Portfolio Composition (1)
($ in millions)
- ---------------------------- ------------------ ----------------- ------------------ ------------------- ------------------
Other Indices
LIBOR Based ARM CMT Based ARM Based ARM Loans Fixed-Rate Loans
Loans Loans Total
- ---------------------------- ------------------ ----------------- ------------------ ------------------- ------------------
2002, Quarter 3 $ 414.4 $ 80.8 $ 59.9 $ 1,698.4 $ 2,253.5
2002, Quarter 4 384.6 73.2 57.0 1,647.0 2,161.8
2003, Quarter 1 352.5 66.3 52.8 1,605.3 2,076.9
2003, Quarter 2 316.9 59.6 49.9 1,564.9 1,991.3
2003, Quarter 3 288.8 53.4 48.2 1,519.2 1,909.6
- ---------------------------- ------------------ ----------------- ------------------ ------------------- ------------------
<FN>
(1) Includes only the principal amount of collateral for collateralized bonds, ARM securities and fixed-rate mortgage
securities.
</FN>
The average asset yield is reduced for the amortization of premiums, net of
discounts on the investment portfolio. As indicated in the table below, net
premium on the collateral for collateralized bonds, ARM securities, and
fixed-rate mortgage securities at September 30, 2002, was $12.7 million, or
approximately 0.67% of the aggregate balance of collateral for collateralized
bonds, ARM securities and fixed-rate securities. The $12.7 million net premium
consists of gross collateral premiums of $33.1 million, less gross collateral
discounts of $20.4 million. Of the $33.1 million in gross premiums on
collateral, $24.8 million relates to the premium on multifamily and commercial
mortgage loans with a principal balance of $763.4 million at September 30, 2003,
and that have average prepayment lockouts or yield maintenance to 2008. The net
premium (i.e., gross premium less gross discount) on such multifamily and
commercial loans is $20.2 million. Amortization expense as a percentage of
principal pay-downs has decreased from 1.84% for the three months ended
September 30, 2002 to 1.27% for the same period in 2003. The principal
prepayment rate for the Company (indicated in the table below as "CPR Annualized
Rate") was approximately 22% for the three months ended September 30, 2003. CPR
or "constant prepayment rate" is a measure of the annual prepayment rate on a
pool of loans.
Premium Basis and Amortization
($ in millions)
- --------------------------------------------------------------------------------------------------------------------------
Amortization
CPR Annualized Expense as a %
Amortization Rate Principal of Principal
Net Premium Expense Paydowns Paydowns
- --------------------------------------------------------------------------------------------------------------------------
2002, Quarter 3 $ 16.7 $ 1.6 21% $ 94.5 1.70%
2002, Quarter 4 16.2 0.5 19% 95.5 0.57%
2003, Quarter 1 15.1 1.1 24% 85.4 1.32%
2003, Quarter 2 13.7 1.3 22% 81.8 1.64%
2003, Quarter 2 12.7 1.0 22% 80.4 1.27%
- --------------------------------------------------------------------------------------------------------------------------
Credit Exposures. The Company invests in collateralized bonds or pass-through
securitization structures. Generally these securitization structures use
over-collateralization, subordination, third-party guarantees, reserve funds,
bond insurance, mortgage pool insurance or any combination of the foregoing as a
form of credit enhancement. The Company generally has retained a limited portion
of the direct credit risk in these securities. In most instances, the Company
retained the "first-loss" credit risk on pools of loans that it has securitized.
The following table summarizes the aggregate principal amount of collateral for
collateralized bonds and securities outstanding, the direct credit exposure
retained by the Company (represented by the amount of over-collateralization
pledged and subordinated securities owned by the Company), net of the credit
reserves and discounts maintained by the Company for such exposure, and the
actual credit losses incurred for each quarter presented.
The table excludes other forms of credit enhancement from which the Company
benefits, and based upon the performance of the underlying loans, may provide
additional protection against losses. These additional protections include loss
reimbursement guarantees with a remaining balance of $27.5 million and a
remaining deductible aggregating $0.9 million on $57.1 million of securitized
single family mortgage loans which are subject to such reimbursement agreements;
guarantees aggregating $28.7 million on $299.7 million of securitized commercial
mortgage loans, whereby losses on such loans would need to exceed the respective
guarantee amount before the Company would incur credit losses; and $193.5
million of securitized single family mortgage loans which are subject to various
mortgage pool insurance policies whereby losses would need to exceed the
remaining stop loss of at least 65% on such policies before the Company would
incur losses.
Credit Reserves and Actual Credit Losses
($ in millions)
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding Loan Credit Exposure, Net Actual Credit Credit Exposure, Net to
Principal Balance of Credit Reserves Losses Outstanding Loan Balance
- ---------------------------------------------------------------------------------------------------------------------------
2002, Quarter 3 $ 2,340.5 $ 110.2 $ 8.3 4.71%
2002, Quarter 4 2,246.9 91.9 7.7 4.09%
2003, Quarter 1 2,082.3 90.1 6.2 4.33%
2003, Quarter 2 1,997.1 72.8 6.4 3.65%
2003, Quarter 3 1,903.7 67.6 5.7 3.55%
- ---------------------------------------------------------------------------------------------------------------------------
The following table summarizes single family mortgage loan, manufactured housing
loan and commercial mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities in which the Company has
retained a portion of the direct credit risk. The delinquencies as a percentage
of the outstanding collateral balance have increased to 4.68% at September 30,
2003 from 4.47% at September 30, 2002 primarily due to two commercial loans
which have become delinquent and increased percentage of delinquencies on single
family mortgage loans and manufactured housing loans due primarily to the
declining balance of these loans outstanding. The Company monitors and evaluates
its exposure to credit losses and has established reserves based upon
anticipated losses, general economic conditions and trends in the investment
portfolio. As of September 30, 2003, management believes the level of credit
reserves is appropriate for currently existing losses.
Delinquency Statistics (1)
- ----------------------------------------------------------------------------------------------------------------------------
30 to 60 days delinquent 60 to 90 days 90 days and over
delinquent delinquent (2) Total
- ----------------------------------------------------------------------------------------------------------------------------
2002, Quarter 3 1.99% 0.34% 2.14% 4.47%
2002, Quarter 4 1.78% 0.64% 2.07% 4.49%
2003, Quarter 1 1.79% 0.51% 2.20% 4.50%
2003, Quarter 2 1.68% 0.50% 2.58% 4.76%
2003, Quarter 3 1.59% 0.56% 2.53% 4.68%
- ----------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Excludes other investments and loans held for sale or securitization.
(2) Includes foreclosures, repossessions and REO.
</FN>
General and Administrative Expense. The following tables present a breakdown of
general and administrative expense.
- -------------------------------- ------------------------------ ------------------------------ ---------------------------
Servicing Corporate/Investment Total
Portfolio Management
- -------------------------------- ------------------------------ ------------------------------ ---------------------------
2002, Quarter 3 $ 1,122.2 $ 1,103.7 $ 2,225.9
2002, Quarter 4 1,221.5 1,526.9 2,748.4
2003, Quarter 1 1,146.6 874.2 2,020.8
2003, Quarter 2 1,262.3 888.3 2,150.6
2003, Quarter 3 1,240.6 884.1 2,124.7
- -------------------------------- ------------------------------ ------------------------------ ---------------------------
Recent Accounting Pronouncements. In April 2003, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." Effective after June 30, 2003, this Statement amends FASB Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities", to
provide clarification of financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts. In particular, this Statement (1) clarifies under what circumstances
a contract with an initial net investment meets the characteristic of a
derivative discussed in paragraph 6(b) of Statement 133, (2) clarifies when a
derivative contains a financing component, (3) amends the definition of an
underlying to conform it to language used in FASB Interpretation (FIN) No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," and (4) amends certain other
existing pronouncements. Those changes will result in more consistent reporting
of contracts as either derivatives or hybrid instruments. The Company's adoption
of SFAS No. 149 in June 2003 has not had a significant impact on its financial
position, results of operations, or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
is effective for financial instruments entered into or modified after May 31,
2003; and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003, except for mandatorily redeemable financial
instruments of nonpublic entities, which are subject to the provisions of this
Statement for the first fiscal period beginning after December 15, 2003. This
Statement amends SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and SFAS No. 128, "Earnings per Share," to establish
standards outlining how to classify and measure certain financial instruments
with characteristics of both liabilities and equity. It requires that certain
financial instruments that were previously classified as equity now be
classified as a liability (or, in some circumstances, as an asset). The Company
is reviewing the implications of SFAS No. 150 but does not believe that its
adoption will have a significant impact on its financial position, results of
operations, or cash flows.
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 December 31,
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
did not have a material effect on the Company's results of operations, cash
flows or financial position.
Supplemental Information for Collateralized Bond Securities
The Company, through its subsidiaries, pledges collateral (i.e., single-family
mortgage loans and securities, manufactured housing mortgage loans and
securities, or commercial mortgage loans) for collateralized bond obligations
that are issued based on the pledge of such collateral. These collateralized
bonds are recourse only to the collateral pledged, and not to the Company. The
structure created by the pledge of collateral and sale of the associated
collateralized bonds is referred to hereafter as a "collateralized bond
security". The "principal balance of net investment" in a collateralized bond
security represents the principal balance of the collateral pledged less the
outstanding balance of the associated collateralized bonds owned by third
parties. This net investment is also commonly referred to as
"over-collateralization". The "amortized cost basis of net investment" is the
over-collateralization amount plus or minus collateral and collateralized bond
premiums and discounts and related costs. The Company generally has sold the
investment grade classes of the collateralized bonds to third parties, and has
retained the portion of the collateralized bond security that is below
investment grade.
The Company analyzes and values its investment in collateral for collateralized
bonds on a net investment basis. The Company estimates the fair value of its net
investment in collateralized bond securities as the present value of the
projected cash flow from the collateral, adjusted for the impact of and assumed
level of future prepayments and credit losses, less the projected principal and
interest due on the bonds owned by third parties. Below is a summary as of
September 30, 2003, by each series where the fair value exceeds $0.5 million of
the Company's net investment in collateralized bond securities. The Company
master services four of its collateral for collateralized bond securities.
Structured Asset Securitization Corporation (SASCO) Series 2002-9 is
master-serviced by Wells Fargo Bank. CCA One Series 2 and Series 3 are
master-serviced by Bank of New York. Monthly payment reports for those
securities master-serviced by the Company may be found on the Company's website
at www.dynexcapital.com.
The following tables show the Company's net investment in each of the securities
presented below on both a principal balance and amortized cost basis, as those
terms are defined above. The accompanying consolidated financial statements of
the Company present the collateral for collateralized bonds as an asset, and
presents the associated collateralized bond obligation as a non-recourse
liability. In addition, the Company carries only its investment in MERIT Series
11 at fair value. As a result, the table below is not meant to present the
Company's investment in collateral for collateralized bonds or collateralized
bonds in accordance with generally accepted accounting principles applicable to
the Company's transactions. See below for a reconciliation of the amounts
included in the table to the Company's consolidated financial statements.
- --------------------------------------------------------------------------------------------------------------------------------
(amounts in thousands) Principal balance
Principal balance of collateralized Amortized Cost
Collateralized Bond of collateral bonds outstanding Principal balance Basis of Net
Series (1) Collateral Type pledged to third parties of Net Investment Investment
- ---------------------------------------------------------------------------------------------------------------------------
MERIT Series 11A Debt securities backed by
Single-family loans and
Manufactured housing loans $ 277,835 $ 241,394 $ 36,441 $ 28,266
MERIT Series 12-1 Manufactured housing loans 230,807 210,139 20,668 18,319
MERIT Series 13 Manufactured housing loans 276,192 248,708 27,484 21,679
SASCO 2002-9 Single family loans 355,277 345,880 9,397 17,160
MCA One Series 1 Commercial mortgage loans 80,471 75,752 4,719 -
CCA One Series 2 Commercial mortgage loans 290,478 268,374 22,104 8,712
CCA One Series 3 Commercial mortgage loans 391,423 350,477 40,946 50,335
- ---------------------------------------------------------------------------------------------------------------------------
$ 1,902,483 $ 1,740,724 $ 161,759 $ 144,471
- ---------------------------------------------------------------------------------------------------------------------------
<FN>
(1) MERIT stands for MERIT Securities Corporation; MCA stands for Multifamily
Capital Access One, Inc. (now known as Commercial Capital Access One,
Inc.); and CCA stands for Commercial Capital Access One, Inc. Each such
entity is a wholly owned limited purpose subsidiary of the Company. SASCO
stands for Structured Asset Securitization Corporation.
</FN>
The following table reconciles the balances presented in the table above with
the amounts included for collateral for collateralized bonds and collateralized
bonds in the accompanying consolidated financial statements.
- ----------------------------------------------------------------------------------------------------------------------------
(amounts in thousands) Collateral
For Collateralized Collateralized Net
Bonds Bonds Investment
- ----------------------------------------------------------------------------------------------------------------------------
Principal balances per the above table $ 1,902,483 $ 1,740,724 $ 161,759
Principal balance of security excluded from above table 4,007 4,132 (125)
Recorded impairments on debt securities (10,692) - (10,692)
Premiums and discounts 12,688 23,695 (11,007)
Unrealized gain/loss 603 _ 603
Accrued interest and other 12,249 7,559 4,690
Allowance for loan losses (40,975) - (40,975)
- ----------------------------------------------------------------------------------------------------------------------------
Balance per consolidated financial statements $ 1,880,363 $ 1,776,110 $ 104,253
- ----------------------------------------------------------------------------------------------------------------------------
The following table summarizes the fair value of the Company's net investment in
collateralized bond securities, the various assumptions made in estimating value
and the cash flow received from such net investment during the nine months ended
September 30, 2003. As the Company does not present its investment in
collateralized bonds on a net investment basis and carries only its investment
in MERIT Series 11 at fair value, the table below is not meant to present the
Company's investment in collateral for collateralized bonds or collateralized
bonds in accordance with generally accepted accounting principles applicable to
the Company's transactions.
- ----------------------------------------------------------------------------------------------------------------------------
Fair Value Assumptions ($ in thousands)
-------------------------------------------------------------------------------------------------------
Cash flows
Collateralized Weighted-average Projected cash flow Fair value of received
Bond Series prepayment speeds Losses termination date net in 2003,
investment (1) net (2)
- ----------------------------------------------------------------------------------------------------------------------------
MERIT Series 11 35%-40% CPR on SF 3.0% annually on Anticipated final maturity $ 28,736 $ 11,953
securities; 10% CPR MH securities in 2025
on MH securities
MERIT Series 12-1 9% CPR 3.1% annually on Anticipated final maturity 1,707 935
MH Loans in 2027
MERIT Series 13 10% CPR 3.5% annually Anticipated final maturity 1,366 1,051
in 2026
SASCO 2002-9 30% CPR 0.20% annually Anticipated call date in 23,158 11,778
2005
MCA One Series 1 (3) 0.8% annually Anticipated final maturity 2,469 349
in 2018
CCA One Series 2 (4) 0.80% annually Anticipated call date in 10,732 1,292
beginning in 2004 2012
CCA One Series 3 (4) 1.2% annually Anticipated call date in 17,623 1,393
beginning in 2004 2009
- ----------------------------------------------------------------------------------------------------------------------------
$ 85,791 $28,751
- ----------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Calculated as the net present value of expected future cash flows,
discounted at 16%. Expected cash flows were based on the forward LIBOR
curve as of September 30, 2003, and incorporates the resetting of the
interest rates on the adjustable rate assets and variable-rate
collateralized bonds to a level consistent with projected prevailing rates.
Increases or decreases in interest rates and index levels from those used
in the projection would impact the calculation of fair value, as would
differences in actual prepayment speeds and credit losses versus the
assumptions set forth above.
(2) Cash flows received by the Company during the nine months ended September
30, 2003, equal to the excess of the cash flows received on the collateral
pledged, over the cash flow requirements of the collateralized bond
security
(3) Computed at 0% CPR until maturity
(4) Computed at 0% CPR until the respective call date
</FN>
The above tables illustrate the Company's estimated fair value of its net
investment in certain collateralized bond securities. In its consolidated
financial statements, the Company carries its investments at amortized cost,
except for its investment in MERIT Series 11, which it carries at estimated fair
value. Including the recorded allowance for loan losses of $41.0 million, the
Company's net investment in collateralized bond securities is approximately
$104.3 million as set forth in the table on page 21. This amount compares to an
estimated fair value, utilizing a discount rate of 16%, of approximately $85.8
million, as set forth in the table above. The difference between the $104.3
million in net investment as included in the consolidated financial statements
and the $85.8 million of estimated fair value, is due to the differences between
the estimated fair value of such net investment and amortized cost.
The following table compares the fair value of these investments at various
discount rates, but otherwise using the same assumptions as set forth for the
two immediately preceding tables:
- -----------------------------------------------------------------------------------------------------------------------------
Fair Value of Net Investment
- -----------------------------------------------------------------------------------------------------------------------------
Collateralized Bond Series 12% 16% 20% 25%
- ---------------------------------------------------------- -------------------------------------------- ---------------------
MERIT Series 11 $ 32,046 $ 28,736 $ 26,190 $ 23,709
MERIT Series 12-1 1,574 1,707 1,769 1,784
MERIT Series 13 1,153 1,366 1,491 1,570
SASCO 2002-9 24,064 23,158 22,298 21,282
MCA One Series 1 3,088 2,469 2,012 1,598
CCA One Series 2 13,295 10,732 8,824 7,087
CCA One Series 3 20,954 17,623 14,897 12,166
- ------------------------------------- --------------------- --------------------- --------------------- ---------------------
$ 96,174 $ 85,791 $ 77,481 $ 69,196
- ------------------------------------- --------------------- --------------------- --------------------- ---------------------
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations from a variety of sources.
These sources have included cash flow generated from the investment portfolio,
including net interest income and principal payments and prepayments. In
addition, while the Company was actively originating loans for its investment
portfolio, the Company funded these operations through short-term warehouse
lines of credit with commercial and investment banks, repurchase agreements and
the capital markets via the asset-backed securities market (which provides
long-term non-recourse funding of the investment portfolio via the issuance of
collateralized bonds). Should the Company's future operations require access to
sources of capital such as lines of credit and repurchase agreements, the
Company believes that it would be able to access such sources.
The Company's cash flow from its investment portfolio for the three months and
nine months ended September 30, 2003 was approximately $14.0 million and $43.8
million, respectively. Such cash flow is after payment of principal and interest
on the associated collateralized bonds (i.e., non-recourse debt) outstanding.
From the cash flow on its investment portfolio, the Company funds its operating
overhead costs, including the servicing of its delinquent property tax
receivables, and repays any remaining recourse debt.
The Company's cash flow from its investment portfolio is subject to fluctuation
due to changes in interest rates, repayment rates and default rates and related
losses. In a period of rapidly rising interest rates, the Company's net interest
margin and cash flow from the investment portfolio is likely to be significantly
impacted due to increased borrowing costs on variable-rate non-recourse
collateralized bonds. The Company anticipates, however, that it will have
sufficient cash flow from its investment portfolio to meet all of its
obligations.
Collateralized Bonds. Dynex, through limited-purpose finance subsidiaries, has
issued non-recourse debt in the form of collateralized bonds to fund the
majority of its investment portfolio. The obligations under the collateralized
bonds are payable solely from the collateral for collateralized bonds and are
otherwise non-recourse to Dynex. Collateral for collateralized bonds is not
subject to margin calls. The maturity of each class of collateralized bonds is
directly affected by the rate of principal prepayments on the related
collateral. Each series is also subject to redemption according to specific
terms of the respective indentures, generally on the earlier of a specified date
or when the remaining balance of the bonds equals 35% or less of the original
principal balance of the bonds. At September 30, 2003, Dynex had $1.8 billion of
collateralized bonds outstanding. Approximately $1.2 billion of the
collateralized bonds carry a fixed rate of interest, and approximately $0.6
billion carries a rate of interest which adjusts monthly based on One-Month
LIBOR.
Senior notes. On February 28, 2003, the Company issued $32.1 million of 9.50%
senior unsecured notes due February 2005 (the "February 2005 Senior Notes") in
connection with a tender offer on the Company's preferred stock. The February
2005 Senior Notes were issued in exchange for 1,156,891 shares of Series A,
Series B and Series C preferred stock. Principal payments in the amount of $4.0
million, along with interest payments at a rate of 9.50% per annum, are due
quarterly beginning May 2003, with final payment due on February 28, 2005. The
Company at its option can prepay the February 2005 Senior Notes in whole or in
part, without penalty, at any time. The February 2005 Senior Notes prohibit
distributions on the Company's capital stock until they are fully repaid, except
distributions necessary for the Company to maintain REIT status. At September
30, 2003, the outstanding balance of the Senior Notes was $14.1 million. In
September 2003, the Company redeemed, early, $10 million of the Senior Notes.
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-Q made by the Company, that are not
historical fact constitute "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or from
any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by general economic conditions. The
risk of defaults and credit losses could increase during an economic slowdown or
recession. This could have an adverse effect on the performance of the Company's
securitized loan pools and on the Company's overall financial performance.
Capital Resources. Cash flows from the investment portfolio fund the Company's
operations and repayments of recourse debt, and are subject to fluctuation due
to changes in interest rates, repayment rates and default rates and related
losses.
Interest Rate Fluctuations. The Company's income and cash flow depends on its
ability to earn greater interest on its investments than the interest cost to
finance these investments. Interest rates in the markets served by the Company
generally rise or fall with interest rates as a whole. A majority of the loans
currently pledged as collateral for collateralized bonds by the Company are
fixed-rate. The Company currently finances these fixed-rate assets through
non-recourse collateralized bonds, approximately $198 million of which is
variable rate which resets monthly. Financing fixed rate assets with variable
rate bonds exposes the Company to reductions in income and cash flow in a period
of rising interest rates. Through the use of interest rate swaps and synthetic
swaps, the Company has reduced this exposure by approximately $146 million at
September 30, 2003 on an amortizing basis through approximately June 2005. In
addition, a significant amount of the investments held by the Company is
adjustable-rate collateral for collateralized bonds, which generally reset on a
delayed basis and have periodic interest rate caps. These investments are
financed through non-recourse long-term collateralized bonds which reset monthly
and which have no periodic caps. In total at September 30, 2003, the Company has
approximately $587 million of variable-rate collateralized bonds.
The net interest spread and cash flow for the Company could decrease materially
during a period of rapidly rising short-term interest rates, despite the use of
interest-rate swaps and synthetic swaps, as a result of the monthly reset in the
rate on the adjustable-rate collateralized bonds issued by the Company.
Defaults. Defaults by borrowers on loans securitized by the Company may have an
adverse impact on the Company's financial performance, if actual credit losses
differ materially from estimates made by the Company or exceed reserves for loss
recorded in the financial statements. The allowance for losses is calculated on
the basis of historical experience and management's best estimates. Actual
default rates or loss severity may differ from the Company's estimate as a
result of economic conditions. In particular, the default rate and loss severity
on the Company's portfolio of manufactured housing loans and securities has been
higher than initially estimated. Actual defaults on ARM loans may increase
during a rising interest rate environment. In addition, commercial mortgage
loans are generally large dollar balance loans, and a significant loan default
may have an adverse impact on the Company's financial results. The Company
believes that its reserves are adequate for such risks on loans as of September
30, 2003.
Third-party Servicers. Third-party servicers service the majority of the
Company's investment portfolio. To the extent that these servicers are
financially impaired, the performance of the Company's investment portfolio may
deteriorate, and defaults and credit losses may be greater than estimated.
Prepayments. Prepayments by borrowers on loans securitized by the Company may
have an adverse impact on the Company's financial performance. Prepayments are
expected to increase during a declining interest rate or flat yield curve
environment. The Company's exposure to rapid prepayments is primarily (i) the
faster amortization of premium on the investments and, to the extent applicable,
amortization of bond discount, and (ii) the replacement of investments in its
portfolio with lower yield securities.
Competition. The financial services industry is a highly competitive market.
Increased competition in the market has adversely affected the Company, and may
continue to do so.
Regulatory Changes. The Company's businesses as of September 30, 2003 are not
subject to any material federal or state regulation or licensing requirements.
However, changes in existing laws and regulations or in the interpretation
thereof, or the introduction of new laws and regulations, could adversely affect
the Company and the performance of the Company's securitized loan pools or its
ability to collect on its delinquent property tax receivables.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest 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. 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 following the forward LIBOR
curve (based on 90-day Eurodollar futures contracts) as of September 30, 2003.
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 September 30, 2003. This analysis represents
management's estimate of the percentage change in net interest margin cash flow
given a shift in interest rates, as discussed above. Other investments are
excluded from this analysis because they are generally not considered interest
rate sensitive. The "Base" case represents the interest rate environment as it
existed as of September 30, 2003. At September 30, 2003, one-month LIBOR was
1.12% and six-month LIBOR was 1.18%. The analysis is heavily dependent upon the
assumptions used in the model. The effect of changes in future interest rates,
the shape of the yield curve or the mix of assets and liabilities may cause
actual results to differ significantly from the modeled results. In addition,
certain financial instruments provide a degree of "optionality." The most
significant option affecting the Company's portfolio is the borrowers' option to
prepay the loans. The model applies prepayment rate assumptions representing
management's estimate of prepayment activity on a projected basis for each
collateral pool in the investment portfolio. The model applies the same
prepayment rate assumptions for all five cases indicated below. The extent to
which borrowers utilize the ability to exercise their option may cause actual
results to significantly differ from the analysis. Furthermore, the 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 investment portfolio and the liabilities
incurred by the Company, including collateralized bonds, to finance their
investments. As a result of anticipated prepayments on assets in the investment
portfolio, there are likely to be such changes in the future.
- ------------------------------ ---------- ---------------------------
% Change in Net
Basis Point Interest Margin
Increase (Decrease) Cash Flow From
in Interest Rates Base Case
- ------------------------------ ---------------------------
+200 (17.0)%
+100 (8.9)%
Base -
-100 9.5%
-200 12.5%
- ------------------------------ ---------- ---------------------------
Approximately $390.4 million of the Company's investment portfolio as of
September 30, 2003 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 underlying the Company's ARM securities and collateral for
collateralized bonds are indexed to and reset based upon the level of six-month
LIBOR and one-year CMT, respectively.
Generally, during a period of rising short-term interest rates, the Company's
net interest spread earned on its investment portfolio will decrease. The
decrease of the net interest spread results from (i) the lag in resets of the
ARM loans underlying the ARM securities and collateral for collateralized bonds
relative to the rate resets on the associated borrowings (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 and (iii) any unhedged difference in fixed rate assets which are
financed with variable rate liabilities. As short-term interest rates stabilize
and the ARM loans reset, the net interest margin may be partially restored 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.
Approximately $1.5 billion of the Company's investment portfolio as of September
30, 2003 is comprised of loans or securities that have coupon rates that are
fixed. The Company has substantially limited its interest rate risk on such
investments through (i) the issuance of fixed-rate collateralized bonds which
approximated $1.2 billion as of September 30, 2003, and (ii) shareholders'
equity, which was $161.4 million. Overall, the Company's interest rate risk is
related both to the rate of change in short term interest rates, and to the
level of short-term interest rates.
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. As required by
Rule 13a-15 under the Exchange Act, as of the end of the period covered by this
quarterly report (the "Evaluation Date"), the Company carried out an evaluation
of the effectiveness of the design and operation of the Company's 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 materially
affect, or are reasonably likely to materially 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.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
GLS Capital, Inc. ("GLS"), a subsidiary of the Company, together with the County
of Allegheny, Pennsylvania ("Allegheny County"), were defendants in a lawsuit in
the Commonwealth Court of Pennsylvania (the "Commonwealth Court"), the appellate
court of the state of Pennsylvania. Plaintiffs were two local businesses seeking
status to represent as a class, delinquent taxpayers in Allegheny County whose
delinquent tax liens had been assigned to GLS. Plaintiffs challenged the right
of Allegheny County and GLS to collect certain interest, costs and expenses
related to delinquent property tax receivables in Allegheny County, and whether
the County had the right to assign the delinquent property tax receivables to
GLS and therefore employ procedures for collection enjoyed by Allegheny County
under state statute. This lawsuit was related to the purchase by GLS of
delinquent property tax receivables from Allegheny County in 1997, 1998, and
1999. In July 2001, the Commonwealth Court issued a ruling that addressed, among
other things, (i) the right of GLS to charge to the delinquent taxpayer a rate
of interest of 12% per annum versus 10% per annum on the collection of its
delinquent property tax receivables, (ii) the charging of a full month's
interest on a partial month's delinquency; (iii) the charging of attorney's fees
to the delinquent taxpayer for the collection of such tax receivables, and (iv)
the charging to the delinquent taxpayer of certain other fees and costs. The
Commonwealth Court in its opinion remanded for further consideration to the
lower trial court items (i), (ii) and (iv) above, and ruled that neither
Allegheny County nor GLS had the right to charge attorney's fees to the
delinquent taxpayer related to the collection of such tax receivables. The
Commonwealth Court further ruled that Allegheny County could assign its rights
in the delinquent property tax receivables to GLS, and that plaintiffs could
maintain equitable class in the action. In October 2001, GLS, along with
Allegheny County, filed an Application for Extraordinary Jurisdiction with the
Supreme Court of Pennsylvania, Western District appealing certain aspects of the
Commonwealth Court's ruling. In March 2003, the Supreme Court issued its opinion
as follows: (i) the Supreme Court determined that GLS can charge delinquent
taxpayers a rate of 12% per annum; (ii) the Supreme Court remanded back to the
lower trial court the charging of a full month's interest on a partial month's
delinquency; (iii) the Supreme Court revised the Commonwealth Court's ruling
regarding recouping attorney fees for collection of the receivables indicating
that the recoupment of fees requires a judicial review of collection procedures
used in each case; and (iv) the Supreme Court upheld the Commonwealth Court's
ruling that GLS can charge certain fees and costs, while remanding back to the
lower trial court for consideration the facts of each individual case. Finally,
the Supreme Court remanded to the lower trial court to determine if the
remaining claims can be resolved as a class action. No hearing date has been set
for the issues remanded back to the lower trial court. In August 2003, the
Pennsylvania legislature signed a bill amending and clarifying certain
provisions of the Pennsylvania statute governing GLS' right to the collection of
certain interest, costs and expenses. If enacted as currently proposed, the law
is retroactive to 1996, and amends and clarifies that as to items (ii)-(iv)
noted above by the Supreme Court, that GLS can charge a full month's interest on
a partial month's delinquency, that GLS can charge the taxpayer for legal fees,
and that GLS can charge certain fees and costs to the taxpayer at redemption.
The Company and Dynex Commercial, Inc. ("DCI"), formerly an affiliate of the
Company and now known as DCI Commercial, Inc., are defendants in state court in
Dallas County, Texas in the matter of Basic Capital Management et al ("BCM")
versus Dynex Commercial, Inc. et al. The suit was filed in April 1999 originally
against DCI, and in March 2000, BCM amended the complaint and added the Company
as a defendant. The current complaint alleges that, among other things, DCI and
the Company failed to fund tenant improvement or other advances allegedly
required on various loans made by DCI to BCM, which loans were subsequently
acquired by the Company; that DCI breached an alleged $160 million "master" loan
commitment entered into in February 1998 and a second alleged loan commitment of
approximately $9 million; that DCI and the Company made negligent
misrepresentations in connection with the alleged $160 million commitment; and
that DCI and the Company fraudulently induced BCM into canceling the alleged
$160 million master loan commitment in January 1999. Plaintiff BCM is seeking
damages approximating $40 million, including approximately $37 million for DCI's
breach of the alleged $160 million master loan commitment, approximately $1.6
million for alleged failure to make additional tenant improvement advances, and
approximately $1.9 million for DCI's not funding the alleged $9 million
commitment. DCI and the Company are vigorously defending the claims on several
grounds. The Company was not a party to the alleged $160 million master
commitment or the alleged $9 million commitment. The Company has filed a
counterclaim for damages approximating $11 million against BCM. Commencement of
the trial of the case in Dallas, Texas is anticipated in the first quarter of
2004. During the second quarter 2003, BCM filed suit against the Company and DCI
as third-party defendants in related litigation in the United States District
Court Eastern District of Louisiana in the matter Kelly Investment, Inc. versus
BCM et al. The Company sold certain BCM related loans on commercial properties
located in Louisiana to Kelly Investment, Inc. in 2000, and Kelly Investment,
Inc. subsequently filed suit against BCM in 2001. Claims made by BCM in the US
District Court of Louisiana against the Company and DCI are substantially
similar to those being made in Dallas County, Texas. During the third quarter
2003, Kelly and BCM entered into a settlement agreement where BCM paid certain
amounts to Kelly. Subsequently, the Louisiana litigation against the Company and
DCI was dismissed. Neither the Company nor DCI were impacted by the settlement.
Although no assurance can be given with respect to the ultimate outcome of the
above litigation, the Company believes the resolution of these lawsuits will not
have a material effect on the Company's consolidated balance sheet, but could
materially affect consolidated results of operations in a given year.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
See Note 9 to accompanying condensed consolidated financial statements in Part I
Item 1.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Principal Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer and
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
August 11, 2003 providing a copy of the Dynex Capital, Inc.
Press Release dated August 11, 2003.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEX CAPITAL, INC.
Dated: November 25, 2003 By: /s/ Stephen J. Benedetti
------------------------------------
Stephen J. Benedetti
Executive Vice President
(authorized officer of registrant,
principal accounting officer)
Exhibit 31.1
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 quarterly report on Form 10-Q of Dynex Capital,
Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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
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-15(e) and 15d-15(e) for the
registrant and have:
(a) designed such disclosure controls and procedures, or caused such
disclosure controls to be designed under our supervision, 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
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures as of the end
of the period covered by this report based on such evaluation; and
(c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control of financial reporting; and
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, 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 and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting; and
Date: November 25, 2003 /s/ Stephen J. Benedetti
------------------------------------------
Stephen J. Benedetti
Principal Executive Officer
Exhibit 31.2
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 quarterly report on Form 10-Q of Dynex Capital,
Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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
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-15(e) and 15d-15(e) for the
registrant and have:
(a) designed such disclosure controls and procedures, or caused such
disclosure controls to be designed under our supervision, 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
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures as of the end
of the period covered by this report based on such evaluation; and
(c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control of financial reporting; and
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, 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 and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting; and
Date: November 25, 2003 /s/ Stephen J. Benedetti
-------------------------------------
Stephen J. Benedetti
Chief Financial Officer
Exhibit 32.1
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 Quarterly Report of Dynex Capital, Inc. (the "Company")
on Form 10-Q for the quarter ended September 30, 2003, as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen
J. Benedetti, the Principal Executive Officer and the Chief 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.
November 25, 2003 /s/ Stephen J. Benedetti
---------------------------------------
Stephen J. Benedetti
Principal Executive Officer
Chief Financial Officer