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 March 31, 1997
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(formerly Resource Mortgage Capital, Inc.)
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past ninety days.
|X| Yes |_| No
On April 30, 1997, the registrant had 42,422,208 shares of common stock of $.01
value outstanding, which is the registrant's only class of common stock.
DYNEX CAPITAL, INC.
FORM 10-Q
INDEX
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 1997 and
December 31, 1996...................................................................3
Consolidated Statements of Operations for the three months
ended March 31, 1997 and 1996.......................................................4
Consolidated Statement of Shareholders' Equity for
the three months ended March 31, 1997...............................................5
Consolidated Statements of Cash Flows for
the three months ended March 31, 1997 and 1996......................................6
Notes to Unaudited Consolidated Financial
Statements................................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................................10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................30
Item 2. Changes in Securities........................................................................30
Item 3. Defaults Upon Senior Securities..............................................................30
Item 4. Submission of Matters to a Vote of Security Holders..........................................30
Item 5. Other Information............................................................................30
Item 6. Exhibits and Reports on Form 8-K.............................................................30
SIGNATURES............................................................................................31
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNEX CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands except share data)
March 31, December 31,
1997 1996
------------ ------------
ASSETS
Investments:
Portfolio assets:
Collateral for collateralized bonds $ 2,498,964 $ 2,702,294
Mortgage securities 911,973 892,037
Other 118,628 96,236
Loans held for securitization 388,077 265,537
------------ ------------
3,917,642 3,956,104
Cash 8,415 11,396
Accrued interest receivable 8,643 8,078
Other assets 15,166 11,879
------------ ------------
$ 3,949,866 $ 3,987,457
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Collateralized bonds $ 2,325,372 $ 2,519,708
Repurchase agreements 842,167 756,448
Notes payable 243,153 177,124
Accrued interest payable 3,029 2,717
Other liabilities 31,196 27,843
------------ ------------
3,444,917 3,483,840
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock, par value $.01 per share, 50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
1,499,300 and 1,552,500 issued and 34,245 35,460
outstanding, respectively
9.55% Cumulative Convertible Series B,
2,106,743 and 2,196,824 issued and 49,316 51,425
outstanding, respectively
9.73% Cumulative Convertible Series C,
1,840,000 issued and outstanding, respectively 52,740 52,740
Common stock, par value $.01 per share, 100,000,000
shares authorized,
42,053,042 (1) and 20,653,593 issued and 421 207
outstanding, respectively
Additional paid-in capital 301,045 291,637
Net unrealized gain on investments available-for-sale 58,480 64,402
Retained earnings 8,702 7,746
------------ ------------
504,949 503,617
------------ ------------
$ 3,949,866 $ 3,987,457
============ ============
<FN>
(1)Reflects the two-for-one common stock split which will be distributed on May 23, 1997.
See notes to unaudited consolidated financial statements.
</FN>
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands except share data)
Three Months Ended
March 31,
1997 1996
----------- ----------
Interest income:
Collateral for collateralized $ 48,462 $ 23,509
bonds
Mortgage securities 19,681 36,537
Other portfolio assets 2,362 668
Loans held for securitization 6,556 11,451
----------- ----------
77,061 72,165
----------- ----------
Interest and related expense:
Collateralized bonds 39,352 17,773
Repurchase agreements 12,328 33,104
Notes payable 3,200 2,508
Other 556 561
Provision for losses 995 400
----------- ----------
56,431 54,346
----------- ----------
Net interest margin 20,630 17,819
Gain on sale of assets, net of 2,487 201
associated costs
Other income 412 616
General and administrative expenses (5,219) (5,951)
=========== ==========
Net income $ 18,310 $ 12,685
=========== ==========
Net income 18,310 12,685
Dividends on preferred stock (3,687 ) (2,193)
=========== ==========
Net income available to common $ 14,623 $ 10,492
shareholders
=========== ==========
Net income per common share $ 0.35 $ 0.26
=========== ==========
Weighted average number of common 41,666,720 40,530,398
shares outstanding
=========== ==========
<FN>
See notes to unaudited consolidated financial statements.
</FN>
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(amounts in thousands except share data)
Net
Additional Unrealized Gain
Preferred Common Paid-in on Investments Retained
Stock Stock Capital Available-for Earnings Total
-------- ------- -------- -------------- --------- --------
Balance at December 31, 1996 $139,625 $ 207 $291,637 $ 64,402 $ 7,746 $503,617
Net income - three months ended
March 31, 1997 - - - - 18,310 18,310
Issuance of common stock - 2 6,296 - - 6,298
Conversion of (3,324) 1 3,323 - - -
preferred stock
Two-for-one stock split 211 (211)
Change in net
unrealized gain on - - - (5,922) - (5,922)
investments available-for-sale
Dividends on common stock - - - - (13,667) (13,66)
at $0.325 per share
Dividends on preferred stock - - - - (3,687) (6,687)
-------- --------- ---------- ----------- ---------- ---------
Balance at March 31, 1997 $136,301 $ 421 $301,045 $ 58,480 $ 8,702 $504,949
========= ======== ========= ============ ========== =========
<FN>
See notes to unaudited consolidated financial statements.
</FN>
DYNEX CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended
(amounts in thousands) March 31,
1997 1996
--------------- ---------------
Operating activities:
Net income $ 14,623 $ 10,492
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Provision for losses 995 400
Net gain from sale of portfolio assets (2,487) (201)
Amortization and depreciation 6,101 5,124
Net change in accrued interest, other 7,004 (27,275)
assets and other liabilities
------------- ------------
Net cash provided by (used for) 26,236 (11,460)
operating activities
------------- ------------
Investing activities:
Collateral for collateralized bonds:
Fundings of loans subsequently securitized - (608,084)
Principal payments on collateral 193,514 67,116
Net change in funds held by trustees 751 3,056
------------- ------------
194,265 (537,912)
Net increase in loans held for securitization (122,824) (141,024)
Purchase of other portfolio assets (34,754) -
Payments on other portfolio assets 12,236 2,658
Purchase of mortgage securities (47,407) (22,606)
Payments on mortgage securities 20,094 108,003
Proceeds from sales of mortgage securities 3,454 -
Capital expenditures (1,575) (1,122)
------------- ------------
Net cash provided by (used for) 23,489 (592,003)
investing activities
------------- ------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of securities - 583,023
Principal payments on securities (194,518) (53,032)
------------- ------------
(194,518) 529,991
Proceeds from borrowings, net 151,748 69,323
Proceeds from stock offerings, net 6,298 1,998
Dividends paid (16,234) (11,533)
------------- ------------
Net cash (used for) provided by (52,706) 589,779
financing activities
------------- ------------
Net decrease in cash (2,981) (13,684)
Cash at beginning of period 11,396 22,229
============= ============
Cash at end of period $ 8,415 $ 8,545
============= ============
Cash paid for interest $ 53,329 $ 52,749
============= ============
<FN>
See notes to unaudited consolidated
financial statements.
</FN>
DYNEX CAPITAL, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS March 31, 1997 (amounts in
thousands except share data)
NOTE 1--BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. The consolidated financial statements include the
accounts of Dynex Capital, Inc. (formerly Resource Mortgage Capital, Inc.), its
wholly-owned subsidiaries, and certain other entities. As used herein, the
"Company" refers to Dynex Capital, Inc. (Dynex) and each of the entities that is
consolidated with Dynex for financial reporting purposes. A portion of the
Company's operations are operated by taxable corporations that are consolidated
with Dynex for financial reporting purposes, but are not consolidated for income
tax purposes. All significant intercompany balances and transactions have been
eliminated in consolidation.
In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation of the
consolidated financial statements have been included. The Consolidated Balance
Sheets at March 31, 1997 and December 31, 1996, the Consolidated Statements of
Operations for the three months ended March 31, 1997 and 1996, the Consolidated
Statement of Shareholders' Equity for the three months ended March 31, 1997, the
Consolidated Statements of Cash Flows for the three months ended March 31, 1997
and 1996 and related notes to consolidated financial statements are unaudited.
Operating results for the three months ended March 31, 1997 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997. For further information, refer to the audited consolidated financial
statements and footnotes included in the Company's Form 10-K for the year ended
December 31, 1996.
Certain amounts for 1996 have been reclassified to conform with the presentation
for 1997.
NOTE 2--NET INCOME PER COMMON SHARE
Net income per common share as shown on the consolidated statements of
operations for the three months ended March 31, 1997 and 1996 is primary net
income per common share. Fully diluted net income per common share basis is not
presented as the dilutive effect of the Preferred Stock and Stock Appreciation
Rights was less than 3%. As a result of the two-for-one split of the Company's
common stock discussed in Note 8, the Company's Preferred Stock is convertible
into two shares of common stock for one share of Preferred Stock.
NOTE 3--PORTFOLIO ASSETS
The Company has classified collateral for collateralized bonds and all mortgage
securities as available-for-sale. The following table summarizes the Company's
amortized cost basis and fair value of collateral for collateralized bonds and
mortgage securities held at March 31, 1997 and December 31, 1996, and the
related average effective interest rates (calculated excluding unrealized gains
and losses) for the month ended March 31, 1997 and December 31, 1996:
- ----------------------------------------------------------------------------------
March 31, 1997 December 31, 1996
- ---------------------------------------------------------------------------------
Effective Effective
Fair Value Interest Rate Fair Value Interest Rate
- -----------------------------------------------------------------------------------
Collateral for
collateralized bonds:
Amortized cost $ 2,470,073 7.8% $ 2,668,633 7.9%
Allowance for losses (30,707 ) (31,732)
- -----------------------------------------------------------------------------------
Amortized cost, net 2,439,366 2,636,901
Gross unrealized gains 70,739 73,696
Gross unrealized losses (11,141 ) (8,303)
- -----------------------------------------------------------------------------------
$ 2,498,964 $ 2,702,294
- -----------------------------------------------------------------------------------
Mortgage securities:
Adjustable-rate $ 777,173 7.4% $ 780,259 6.9%
mortgage securities
Fixed-rate mortgage 21,609 9.2% 29,505 10.9%
securities
Other mortgage 119,183 17.5% 88,198 16.4%
securities
- -----------------------------------------------------------------------------------
917,965 897,962
Allowance for losses (4,874) (4,934)
- -----------------------------------------------------------------------------------
Amortized cost, net 913,091 893,028
Gross unrealized gains 24,002 23,591
Gross unrealized losses (25,120) (24,582)
- -----------------------------------------------------------------------------------
$ 911,973 $ 892,037
- -----------------------------------------------------------------------------------
NOTE 4--GAIN ON SALE OF ASSETS
Mortgage securities with an aggregate principal balance of $3,284 were sold
during the three months ended March 31, 1997 for an aggregate net gain of $170.
The specific identification method is used to calculate the basis of mortgage
investments sold. Gain on sale of assets also includes premiums received of
$2,438 on $400,000 notional balance of call options written which expired
unexercised during the first quarter.
NOTE 5--ADOPTION OF FINANCIAL ACCOUNTING STANDARDS
In January 1997, the Company adopted the Financial Accounting Standards Board
Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" (FAS No. 125). FAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on consistent application of a
financial components approach that focuses on control of the respective assets
and liabilities. It distinguishes transfers of financial assets that are sales
from transfers that are secured borrowings. FAS No. 125 is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996. The impact of adopting FAS No 125 did not
result in a material change to the Company's financial position and results of
operations.
NOTE 6 -- OTHER MATTERS
During the period from March 12, 1997 through March 31,1997, the Company issued
84,000 shares of its common stock, adjusted for the two-for-one stock split,
pursuant to a registration statement filed with the Securities and Exchange
Commission. The net proceeds from the issuance were approximately $1,256. The
Company also issued 376,314 shares of its common stock, adjusted for the
two-for-one stock split, pursuant to its dividend reinvestment program for net
proceeds of $5,057.
NOTE 7- CHANGE OF COMPANY NAME
Effective April 25, 1997, the Company changed its name from Resource
Mortgage Capital, Inc. to Dynex Capital, Inc.
NOTE 8 -- SUBSEQUENT EVENTS
At the annual meeting of shareholders, held on April 24, 1997, the shareholders
approved an amendment to the Articles of Incorporation to effect a two-for-one
split of the issued and outstanding shares of the Company's $0.01 par value
common stock to holders of record on May 5, 1997 and also to increase the number
of authorized shares of common stock to 100,000,000. As a result of the split,
approximately 21.2 million additional shares were issued. All references in
the accompanying financial statements to the number of shares for 1997 have
been restated to reflect the stock split. All references in the accompanying
financial statements to the per share amounts for 1996 and 1997 have also been
restated to reflect the stock split.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Summary
Dynex Capital, Inc. (the "Company") is a mortgage and consumer finance
company which uses its loan production operations to create investments for its
portfolio. Currently, the Company's primary loan production operations include
the origination of mortgage loans secured by multi-family properties and the
origination of loans secured by manufactured homes. During the first quarter,
the Company expanded its production sources by including other financial
products, such as commercial real estate loans. The Company will generally
securitize the loans funded as collateral for collateralized bonds, limiting its
credit risk and providing long-term financing for its portfolio. The Company has
elected to be treated as a real estate investment trust (REIT) for federal
income tax purposes and, as such, must distribute substantially all of its
taxable income to shareholders and will generally not be subject to federal
income tax.
The Company's principal source of earnings is net interest income on its
investment portfolio. The Company's investment portfolio consists principally of
collateral for collateralized bonds, adjustable-rate mortgage securities (ARM)
and loans held for securitization. The Company funds its portfolio investments
with both borrowings and cash raised from the issuance of equity. For the
portion of the portfolio investments funded with borrowings, the Company
generates net interest income to the extent that there is a positive spread
between the yield on the interest-earning assets and the cost of borrowed funds.
The cost of the Company's borrowings may be increased or decreased by interest
rate swap, cap or floor agreements. For the portion of the balance sheet that is
funded with equity, net interest income is primarily a function of the yield
generated from the interest-earning asset.
Business Focus and Strategy
The Company's overall level of earnings is dependent upon (i) the spread
between interest earned on its investment portfolio, and the cost of borrowed
funds to finance those assets; and (ii) the aggregate amount of interest-earning
assets that the Company has on its balance sheet. The Company strives to create
a diversified portfolio of investments that in the aggregate generates stable
income in a variety of interest rate and prepayment rate environments and
preserves the capital base of the Company. In many instances, the Company's
investment strategy has involved not only the creation or acquisition of the
asset, but also structuring the related borrowings through the securitization
process to create a stable yield profile.
Investment Portfolio Strategies
The Company adheres to the following business strategies in managing its
investment portfolio:
use of its loan origination capabilities to provide assets for its
investment portfolio, generally at a lower effective cost than if
investments of comparable risk profiles where purchased in the secondary
market;
securitization of its loan production to provide long-term financing and
to reduce the Company's liquidity, interest rate and credit risk for these
long-term assets;
utilization of leverage to finance purchases of loans and investments in
line with prudent capital allocation guidelines which are designed to
balance the risk in certain assets, thereby increasing potential returns
to shareholders while seeking to protect the Company's equity base;
structuring borrowings to have interest rate adjustment indices and
interest rate adjustment periods that, on an aggregate basis, generally
correspond (within a range of one to six months) to the interest rate
adjustment indices and interest rate adjustment periods of the related
asset; and
utilization of interest rate caps, swaps and similar instruments and
securitization vehicles with such instruments embodied in the structure to
mitigate the risk of the cost of its variable rate liabilities increasing
at a faster rate than the earnings on its assets during a period of rising
interest rates.
Lending Strategies
The Company generally adheres to the following business strategies in its
lending operations:
developing loan production capabilities to originate and acquire
financial assets in order to create attractively priced investments for its
portfolio, generally at a lower cost than if investments with comparable
risk profiles were purchased in the secondary market;
focusing on loan products that maximize the advantages of the REIT tax
election;
emphasizing direct relationships with the borrower and minimize, to
the extent practical, the use of origination intermediaries; using
internally generated guidelines to underwrite loans for all product types
and maintain centralized loan pricing;
performing the servicing function for loans on which the Company has
credit exposure; emphasize the use of early intervention, aggressive
collection and loss mitigation techniques in the servicing process to
manage and seek to reduce delinquencies and to minimize losses in its
securitized loan pools; and
vertical integration of the loan origination process by performing the
sourcing, underwriting, funding and servicing of loans to maximize
efficiency and provide superior customer service.
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------------
(amounts in thousands except per share 1997 1996
information)
-----------------------
Net interest margin $ 20,630 $ 17,819
Gain on sale of assets, net of associated costs 2,487 201
General and administrative expenses 5,219 5,951
Net income 18,310 12,685
Primary net income per common share (1) 0.35 0.26
Principal balance of fundings through the 175,146 767,630
production operations
Dividends declared per share:
Common (1) $ 0.325 $ 0.255
Series A Preferred 0.650 0.585
Series B Preferred 0.650 0.585
Series C Preferred 0.730 -
- ---------------------------------------------------------------------------
<FN>
(1) Adjusted for two-for-one common stock split.
</FN>
Three Months Ended March 31, 1997 Compared to Three Months Ended March 31, 1996.
The increase in the Company's earnings during the three months ended March 31,
1997 as compared to the same period in 1996 is primarily the result of the
increase in net interest margin. In addition, the increase can also be partially
attributed to the increased gain on sale of assets and reduction in general and
administrative expenses.
Net interest margin for the three months ended March 31, 1997 increased to
$20.6 million, or 16%, over the $17.8 million for the same period for 1996. This
increase was the result of the increased contribution from the net investment in
collateralized bonds issued during 1996 and the increase in other mortgage
securities during the past several quarters. These increases were partially
offset by a decrease in the contribution from ARM securities as a result
of securitizing several of the ARM securities in a collateralized bond issued
in September 1996.
The gain on sale of assets increased to a net $2.5 million for the three
months ended March 31, 1997, from $0.2 million for the three months ended March
31, 1996. The increase in the net gain is primarily the result of premiums
received of $2.4 million on $400 million notional call options which expired
unexercised during the first quarter. In addition, the Company sold certain
investments during the three months ended March 31, 1997, which generated a gain
of $0.2 million. During the three months ended March 31, 1996, the Company did
not sell any of its investments.
General and administrative expenses decreased $0.7 million, or 12%, to $5.2
million for the three months ended March 31, 1997 as compared to the same period
for 1996. The decrease is a result of the sale of single-family operations on
May 13, 1996 offset partially by the growth in the current production
operations. General and administrative expenses should increase on a quarter by
quarter basis during 1997 as the Company continues to build its production
infrastructure.
The following table summarizes the average balances of the Company's
interest-earning assets and their average effective yields, along with the
Company's 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 March 31,
--------------------------------------------------
(amounts in thousands) 1997 1996
------------------------- ------------------------
Average Effective Average Effective
Balance Rate Balance Rate
------------------------- ------------------------
Interest-earning assets : (1)
Collateral for collateralized 2,500,179 7.75 % $ 1,079,600 8.71 %
bonds (2) (3)
Adjustable-rate mortgage 774,059 7.36 1,987,569 6.83
securities
Fixed-rate mortgage securities 27,231 9.22 39,855 9.68
Other mortgage securities 111,575 17.22 62,418 10.63
Other portfolio assets 99,010 9.54 25,680 10.43
Loans held for securitization 310,424 8.45 551,227 8.30
------------ ------- ----------- -------
Total interest-earning 3,822,478 8.06 % $ 3,746,349 7.70 %
============= ======= ============= =======
Interest-bearing liabilities:
Collateralized bonds (3) 2,382,985 6.43 % $ 1,028,572 6.57 %
Repurchase agreements:
Adjustable-rate mortgage 718,665 6.15 1,917,513 5.65
securities
Fixed-rate mortgage 26,471 5.72 25,528 5.77
securities
Other mortgage securities 10,428 5.83 7,382 5.74
Loans held for 31,561 5.95 362,231 6.10
securitization
Notes payable:
Other portfolio assets 13,776 7.93 547 5.85
Loans held for 156,740 5.11 84,027 6.03
securitization
============= ====== ============= =======
Total interest-bearing 3,340,626 6.30 % $ 3,425,800 5.99 %
liabilities
============= ======= ============= =======
Net interest spread on all investments 1.76 % 1.71 %
======= =======
Net yield on average 2.56 % 2.23 %
interest-earning assets
======= =======
--------------------------------------------------------------------------------------
<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 $2,285 and
$3,168 for the three months ended March 31, 1997 and March 31, 1996,
respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses.
</FN>
The slight increase in net interest spread for the three months ended March
31, 1997 relative to the same period in 1996 is primarily the result of the
increased spread on the other mortgage securities and to a lesser extent ARM
securities, offset by a decrease in the net spread on both net investment in
collateralized bonds (defined as collateral for collateralized bonds less
collateralized bonds) and other portfolio assets. The Company's overall yield on
interest-earning assets increased to 8.06% for the three months ended March 31,
1997 from 7.70% for the same period in 1996. The weighted average borrowing
costs also increased to 6.30% for the three months ended March 31, 1997 from
5.99% for the three months ended March 31, 1996. During the first part of 1996,
the net interest spread temporarily benefited by the declining short-term
interest rate environment, which had the impact of reducing the Company's
borrowing costs faster than it reduced the yields on the Company's
interest-earning assets. After remaining fairly stable during most of the first
quarter 1997, short-term interest rates rose by approximately 25 basis points at
the end of the quarter.
Individually, the net interest spread on collateralized bonds decreased 82
basis points, from 214 basis points for the three months ended March 31, 1996,
to 132 basis points for the three months ended March 31, 1997. This decline was
primarily due to the securitization of lower coupon collateral, principally A+
quality single-family mortgage loans. In addition, the spread on the net
investment in collateralized bonds decreased due to higher premium amortization
during the first quarter 1997 due to higher prepayments. The net interest spread
on ARM securities increased 3 basis points, from 118 basis points for the three
months ended March 31, 1996, to 121 basis points during the same period in 1997.
The net interest spread on other mortgage securities increased to 1,139 basis
points for the three months ended March 31, 1997 from 489 basis points for the
three months ended March 31, 1996. This increase is due to the purchase of $38
million of residual trusts during the three months ended March 31, 1997. The net
interest spread on other portfolio assets decreased 297 basis points, from 458
basis points from the three months ended March 31, 1996, to 161 basis points for
the three months ended March 31, 1997. This decrease in net interest spread is
due to the inclusion in 1997 of the $38 million note receivable from the 1996
sale of the Company's single-family operations which has a 6.5% fixed interest
rate, plus higher borrowing costs associated with the Company's model home
purchase and lending business.
PORTFOLIO RESULTS
The core of the earnings is derived from its investment portfolio. The
Company's investment strategy is to create a diversified portfolio of securities
that in the aggregate generate stable income in a variety of interest rate and
prepayment rate environments and preserves the capital base of the Company. The
Company has pursued its strategy of concentrating on its production activities
to create investments with attractive yields. In many instances, the Company's
investment strategy has involved not only the creation or acquisition of the
asset, but also structuring the related borrowings through the securitization
process to create a stable yield profile.
Approximately $3.2 billion of the Company's investment portfolio as of March
31, 1997 are 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. Generally, during a
period of rising interest rates, the Company's net interest spread earned on its
investment portfolio will decrease. The decrease of the net interest spread
results from (i) the lag in resets of the ARM loans underlying the ARM
securities and collateral for collateralized bonds relative to the rate resets
on the associated borrowings and (ii) rate resets on the ARM loans which are
generally limited to 1% every six months, while the associated borrowings have
no such limitation. As interest rates stabilize and the ARM loans reset, the net
interest margin may be restored to its former level as the yields on the ARM
loans adjust to market conditions. Conversely, net interest margin may increase
following a fall in short-term interest rates. This increase may be temporary as
the yields on the ARM loans adjust to the new market conditions after a lag
period. In each case, however, the Company expects that the increase or decrease
in the net interest spread due to changes in the short-term interest rates to be
temporary. The net interest spread may also be increased or decreased by the
cost or proceeds of interest rate swap, cap or floor agreements.
Interest Income and Interest-Earning Assets
The Company's average interest-earning assets were $3.8 billion during the
three months ended March 31, 1997, an increase of 2% from $3.7 billion of
average interest-earning assets during the same period of 1996. Total interest
income rose 7%, from $72.2 million for the three months ended March 31, 1996 to
$77.1 million for the same period of 1997. Overall, the yield on
interest-earning assets rose to 8.06% for the three months ended March 31, 1997
from 7.70% for the three months ended March 31, 1996, as the investment in
higher yielding assets grew. On a quarter to quarter basis, average
interest-earning assets for the quarter ended December, 1996 were $4.3 billion
versus $3.8 billion for the quarter ended March 31, 1997. This decrease in
average interest-earnings assets was the result of higher prepayments speeds
during the first quarter of 1997 in the investment portfolio and the sale of
approximately $400 million of ARM securities in December 1996. Total interest
income for the quarter ended December 31, 1996 was $83.2 million versus $77.1
million for the quarter ended March 31, 1997. The decrease was due to the lower
average interest-earning assets. As indicated in the table below, average yields
for these periods were 7.72% and 8.06%, respectively, which were 2.12% and 2.37%
higher than the average daily London InterBank Offered Rate (LIBOR) for
six-month deposits (six-month LIBOR) during those periods. The majority of the
ARM loans underlying the Company's ARM securities and collateral for
collateralized bonds are indexed to and reset based upon the level of six-month
LIBOR. As a result of the six-month LIBOR daily average increasing during the
first quarter of 1997, the Company expects that the yield on the ARM loans
underlying the ARM securities and certain collateral for collateralized bonds
will trend upward during the second and third quarter since the majority of the
ARM loans underlying the Company's ARM securities and collateral for
collateralized bonds reset generally every six months and on a one-to-two month
lag.
Earning Asset Yield
($ in millions)
- --------------------- --------------- - ------------ -- -------------- --- ---------------- -----------------
Average Daily Asset
Interest- Average Average Yield versus
Earning Interest Asset Month Six Month
Assets Income Yield LIBOR LIBOR
- --------------------- --------------- - ------------ -- -------------- --- ---------------- -----------------
1995, Quarter 1 $ 3,406.9 $ 60.8 7.14% 6.60% 0.54%
1995, Quarter 2 3,181.4 61.3 7.71% 6.14% 1.57%
1995, Quarter 3 3,450.4 66.8 7.74% 5.89% 1.85%
1995, Quarter 4 3,360.8 64.5 7.67% 5.75% 1.92%
1996, Quarter 1 3,746.3 72.1 7.70% 5.34% 2.36%
1996, Quarter 2 4,164.8 78.3 7.52% 5.64% 1.88%
1996, Quarter 3 4,106.5 78.4 7.64% 5.80% 1.84%
1996, Quarter 4 4,308.6 83.2 7.72% 5.60% 2.12%
1997, Quarter 1 3,822.5 77.1 8.06% 5.69% 2.37%
- --------------------- --- ----------- -- ----------- -- -------------- --- ---------------- -----------------
The net yield on average interest-earning assets increased to 2.56% for the
three months ended March 31, 1997, compared to 2.25% for the three months ended
December 31, 1996 and 2.23% for the three months ended March 31, 1996. The
increase from the three months ended December 31, 1996 is principally due to the
increase in the spread earned on the interest-earning assets. The increase from
the three months ended March 31, 1996 is due to the increased investment in
higher yielding assets. The net yield percentages presented below exclude
non-interest collateralized bonds expenses such as provision for credit losses,
and interest on senior notes payable. For the three months ended March 31, 1997,
if these expenses were included, the net yield on average interest-earning
assets would be 2.16%.
Net Yield on Average Interest-Earning Assets
($ in millions)
- -------------------------- ---------------------- -- -------------------- -- -----------------
Net Yield
Average Interest- Average Interest- Net Average
Earning Assets Earning Assets Assets (1)
- -------------------------- ---------------------- -- -------------------- -- -----------------
1995, Quarter 1 $ 3,406.9 1.23% $ 3,259.8
1995, Quarter 2 3,181.4 1.60% 3,036.6
1995, Quarter 3 3,450.4 1.74% 3,031.5
1995, Quarter 4 3,360.8 2.00% 2,800.4
1996, Quarter 1 3,746.3 2.23% 2,757.5
1996, Quarter 2 4,164.8 2.11% 2,937.9
1996, Quarter 3 4,106.5 2.21% 2,734.3
1996, Quarter 4 4,308.6 2.25% 2,333.5
1997, Quarter 1 3,822.5 2.56% 2,033.9
- -------------------------- -- ------------------- -- -------------------- -- -----------------
<FN>
(1) Average interest-earning assets less non-recourse collateralized bonds.
</FN>
The average asset yield is reduced for the amortization of premium on the
Company's investment portfolio. By creating its investments through its
production operations, the Company believes that premium amounts are less than
if the investments were acquired in the market. As indicated in the table below,
premiums on the Company's ARM securities, fixed-rate securities and collateral
for collateralized bonds at March 31, 1997 were $50.2 million, or approximately
1.58% of the aggregate investment portfolio balance. The mortgage principal
repayment rate for the Company (indicated in the table below as "CPR Annualized
Rate") was 29% for the three months ended March 31, 1997. The Company expects
that the long-term prepayment speeds will range between 24% and 28%. The CPR for
the first quarter of 1997 is currently within this range and the Company expects
it will remain within this range for the second quarter of 1997. CPR stands for
"constant prepayment rate" and is a measure of the annual prepayment rate on a
pool of loans.
Premium Basis and Amortization
($ in millions)
- ---------------------------------------------------------------------------------------------------------------------
Ending Amortization
CPR Investment Expense as a %
Net Premium Amortization Annualized Principal of Average
(Discount) Expense Rate Balance (2) Assets
- ---------------------------------------------------------------------------------------------------------------------
1995, Quarter 1 $ 26.6 $ 1.0 (1) $ 2,454.2 0.12%
1995, Quarter 2 23.7 1.6 (1) 2,432.5 0.21%
1995, Quarter 3 35.3 2.5 (1) 2,705.0 0.30%
1995, Quarter 4 39.3 2.8 (1) 2,772.9 0.33%
1996, Quarter 1 49.3 3.2 30% 3,214.4 0.34%
1996, Quarter 2 56.0 4.0 28% 3,557.7 0.38%
1996, Quarter 3 60.8 2.8 19% 3,808.3 0.28%
1996, Quarter 4 54.1 3.7 24% 3,379.0 0.34%
1997, Quarter 1 50.2 3.8 29% 3,176.9 0.40%
- ---------------------------------------------------------------------------------------------------------------------
<FN>
(1) CPR rates were not available for those periods.
(2) Includes only collateral for collateralized bonds, ARM securities and fixed-rate securities.
</FN>
Interest Expense and Cost of Funds
The Company's largest expense is the interest cost on borrowed funds. Funds
to finance the investment portfolio are generally borrowed in the form of
collateralized bonds or repurchase agreements, both of which are primarily
indexed to one-month LIBOR. For the three-month period ended March 31, 1997 as
compared to the same period in 1996, interest expense increased to $52.6 million
from $51.3 million while the average cost of funds increased to 6.30% compared
to 5.99%. The increased cost of funds for the first quarter of 1997 compared to
the first quarter of 1996 was due primarily to increased cost of funds for both
other portfolio assets and ARM securities. On a quarter to quarter basis, the
cost of funds rose from 6.16% for the three months ended December 31, 1996, to
6.30% for the three months ended March 31, 1997, which was due primarily to the
increased cost of funds on collateralized bonds. The Company may use interest
rate swaps, caps and financial futures to manage its interest rate risk. The net
cost of these instruments is included in the cost of funds table below as a
component of interest expense for the period to which it relates.
Cost of Funds
($ in millions)
- ----------------------------------------------------------------------------------------
Average Cost Average
Borrowed Interest of One-month
Funds Expense (1) Funds LIBOR
- ----------------------------------------------------------------------------------------
1995, Quarter 1 $ 3,058.1 $ 50.3 6.58% 6.06%
1995, Quarter 2 2,906.1 48.5 6.68% 6.08%
1995, Quarter 3 3,159.7 51.0 6.46% 5.88%
1995, Quarter 4 3,025.3 47.6 6.30% 5.86%
1996, Quarter 1 3,425.8 51.3 5.99% 5.43%
1996, Quarter 2 3,735.8 56.4 6.04% 5.45%
1996, Quarter 3 3,667.9 55.7 6.07% 5.46%
1996, Quarter 4 3,825.1 59.0 6.16% 5.46%
1997, Quarter 1 3,340.6 52.6 6.30% 5.46%
- ----------------------------------------------------------------------------------------
<FN>
(1) Excludes non-interest collateralized bond-related expenses and interest on
non-portfolio related notes payable
</FN>
Interest Rate Agreements
As part of its asset/liability management process, the Company enters into
interest rate agreements such as interest rate caps and swaps and financial
futures contracts. These agreements are used to reduce interest rate risk which
arises from the lifetime yield caps on the ARM securities, the mismatched
repricing of portfolio investments versus borrowed funds, and finally, assets
repricing on indices such as the prime rate which differ from the related
borrowing indices. The agreements are designed to protect the portfolio's cash
flow, and to provide income and capital appreciation to the Company in the event
that short-term interest rates rise quickly.
The following table includes all interest rate agreements in effect as of the
various quarter ends for asset/liability management of the investment portfolio.
This table excludes all interest rate agreements in effect for the Company's
production operations. Generally, interest rate swaps and caps are used to
manage the interest rate risk associated with assets that have periodic and
annual interest rate reset limitations financed with borrowings that have no
such limitations. Financial futures contracts and options on futures are used to
lengthen the terms of repurchase agreement financing, generally from one month
to three and six months. Amounts presented are aggregate notional amounts. To
the extent any of these agreements are terminated, gains and losses are
generally amortized over the remaining period of the original agreement.
Instruments Used for Interest Rate Risk Management Purposes (1)
($ in millions)
- ---------------------------------------------------------------------------------------------------
Interest Interest Financial Options
Notional Amounts Rate Caps Rate Swaps Futures on Futures
- ---------------------------------------------------------------------------------------------------
1995, Quarter 1 $ 1,475 $ 200 $ - $ -
1995, Quarter 2 1,475 200 1,000 500
1995, Quarter 3 1,475 220 1,000 500
1995, Quarter 4 1,575 1,227 1,000 2,130
1996, Quarter 1 1,575 1,631 1,000 1,250
1996, Quarter 2 1,575 1,559 400 880
1996, Quarter 3 1,499 1,480 1,550 -
1996, Quarter 4 1,499 1,453 - -
1997, Quarter 1 1,499 1,427 - -
- ---------------------------------------------------------------------------------------------------
<FN>
(1) Excludes all interest rate agreements in effect for the Company's production operations.
</FN>
Net Interest Rate Agreement Expense
The net interest rate agreement expense, or hedging expense, equals the cost
of the agreements, net of any benefits received from these agreements. For the
quarter ended March 31, 1997, net hedging expense amounted to $2.65 million
versus $2.67 million and $1.63 million for the quarters ended December 31, 1996
and March 31, 1996, respectively. The increase in hedging expense for the
quarter ended March 31, 1997 compared to March 31, 1996, relates to costs on
financial futures used to lengthen repurchase agreement maturities during the
quarter. Such amounts exclude the hedging costs and benefits associated with the
Company's production activities as these amounts are deferred as additional
premium or discount on the loans funded and amortized over the life of the loans
as an adjustment to their yield.
Net Interest Rate Agreement Expense
($ in millions)
- ---------------------------------------------------------------------------------------------------
Net Expense as
Net Expense Percentage of
Net Interest as Percentage Average
Rate Agreement of Average Borrowings
Expense Assets (annualized) (annualized)
- ---------------------------------------------------------------------------------------------------
1995, Quarter 1 $ 1.38 0.160% 0.180%
1995, Quarter 2 1.30 0.163% 0.179%
1995, Quarter 3 0.86 0.100% 0.109%
1995, Quarter 4 0.16 0.018% 0.020%
1996, Quarter 1 1.63 0.174% 0.191%
1996, Quarter 2 1.02 0.100% 0.110%
1996, Quarter 3 1.29 0.126% 0.141%
1996, Quarter 4 2.67 0.248% 0.280%
1997, Quarter 1 2.65 0.277% 0.317%
- ---------------------------------------------------------------------------------------------------
Fair Value
The fair value of the available-for-sale portion of the Company's investment
portfolio as of March 31, 1997, as measured by the net unrealized gain on
investments available-for-sale, was $58.5 million above its cost basis, which
represents a $44.9 million improvement from March 31, 1996. At March 31, 1996,
the fair value of the available-for-sale portion of the Company's investment
portfolio was above its amortized cost by $13.6 million. This increase in the
portfolio's value is primarily attributable to the increase in the value of the
collateral for collateralized bonds relative to the collateralized bonds issued
during the last twelve months, as well as an increase in value of the Company's
ARM securities due principally to the ARM securities becoming fully indexed
during 1996. The portfolio also benefited from the reduction in amortized cost
basis of its investments through additional provision for losses. The fair value
of the available-for-sale portion of the Company's investment portfolio at March
31, 1997, decreased $5.9 million from the fair value at December 31, 1996, which
was $64.4 million above the amortized cost of its investment portfolio. This
decrease was primarily the result of the increase in interest rates during the
quarter and the increase in prepayment speeds for the Company's collateral for
collateralized bonds.
Credit Exposures
The Company has historically securitized its loan production in
collateralized bonds or pass-through securitization structures. With either
structure, the Company may use overcollateralization, subordination, reserve
funds, bond insurance, mortgage pool insurance or any combination of the
foregoing for credit enhancement. Regardless of the form of credit enhancement,
the Company may retain a limited portion of the direct credit risk after
securitization. This risk can include risk of loss related to hazards not
covered under standard hazard insurance policies and credit risks on loans not
covered by standard borrower mortgage insurance, or pool insurance.
Beginning in 1994, the Company issued pass-through securities which used
subordination structures as their form of credit enhancement. The credit risk of
subordinated pass-through securities is concentrated in the subordinated classes
(which may themselves partially be credit enhanced with reserve funds or pool
insurance) of the securities, thus allowing the senior classes of the securities
to receive the higher credit rating. To the extent credit losses are greater
than expected (or exceed the protection provided by any reserve funds or pool
insurance), the holders of the subordinated securities will experience a lower
yield (which may be negative) than expected on their investments. At March 31,
1997, the Company retained $18.4 million in aggregate principal amount of
subordinated securities, which are carried at a book value of $1.7 million,
reflecting such potential credit loss exposure.
With collateralized bond structures, the Company also retains credit risk
relative to the amount of overcollateralization required in conjunction with the
bond insurance. Losses are generally first applied to the overcollateralization
amount, with any losses in excess of that amount borne by the bond insurer or
the holders of the collateralized bonds. The Company only incurs credit losses
to the extent that losses are incurred in the repossession, foreclosure and sale
of the underlying collateral. Such losses generally equal the excess of the
principal amount outstanding, less any proceeds from mortgage or hazard
insurance, over the liquidation value of the collateral. To compensate the
Company for retaining this loss exposure, the Company generally receives an
excess yield on the collateralized loans relative to the yield on the
collateralized bonds. At March 31, 1997, the Company retained $87.2 million in
aggregate principal amount of overcollateralization, and had reserves, or
otherwise had provided coverage on $61.0 million of the potential credit loss
exposure. This reserve includes a provision recorded as a result of the sale of
the single-family operations of approximately $31.0 million for possible losses
on securitized single-family loans where the Company, which performed the
servicing of such loans prior to the sale, has retained a portion of the credit
risk on these loans. Also, as a result from the sale of the single-family
operations, a $30.3 million loss reimbursement guarantee from Dominion Mortgage
Services, Inc. has been included in the reserves at March 31, 1997.
The Company principally used pool insurance as its means of credit
enhancement for years prior to 1994. Pool insurance has generally been
unavailable as a means of credit enhancement since the beginning of 1994. Pool
insurance covered substantially all credit risk for the security with the
exception of fraud in the origination or certain special hazard risks. Loss
exposure due to special hazards is generally limited to an amount equal to a
fixed percentage of the principal balance of the pool of mortgage loans at the
time of securitization. Fraud in the origination exposure is generally limited
to those loans which default within one year of origination. The reserve for
potential losses on these risks was $6.5 million at March 31, 1997, which the
Company believes represents its maximum exposure from these risks.
The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and pass-through securities outstanding which are
subject to credit exposure; the maximum credit exposure held by the Company
represented by the amount of overcollateralization and first loss securities
owned by the Company; the credit reserves available to the Company for such
exposure through provision for losses; indemnifications or insurance and the
actual credit losses incurred. The table excludes reserves and losses due to
fraud and special hazard exposure. Additionally, for purposes of this table, the
aggregate principal amount of subordinated securities held by the Company are
included in the Maximum Credit Exposure column, with the difference between this
amount and the carrying amount of these securities as reported in the Company's
consolidated financial statements included in Credit Reserves.
Credit Reserves and Actual Credit Losses
($ in millions)
- -----------------------------------------------------------------------------------------------------------------
Credit Credit Reserves
Outstanding Maximum Credit Actual Credit Reserves to to Maximum
Loan Balance Exposure Credit Losses Average Assets Credit Exposure
- -----------------------------------------------------------------------------------------------------------------
1995, Quarter 2 $ 2,435 $ 49.6 $ 14.6 $ - 0.46% 29.44%
1995, Quarter 3 2,462 51.3 16.4 - 0.48% 31.97%
1995, Quarter 4 2,504 65.9 18.5 - 0.55% 28.07%
1996, Quarter 1 2,888 79.2 19.3 - 0.52% 24.37%
1996, Quarter 2 3,131 106.7 79.0 1.1 1.90% 74.04%
1996, Quarter 3 3,919 109.5 80.0 2.0 1.95% 73.06%
1996, Quarter 4 3,848 116.0 86.0 2.1 2.00% 74.14%
1997, Quarter 1 3,583 114.0 84.4 2.6 2.21% 74.01%
- -----------------------------------------------------------------------------------------------------------------
The following table summarizes the single-family mortgage loan delinquencies
as a percentage of the outstanding loan balance for the total collateral for
collateralized bonds and pass-through securities outstanding where the Company
has retained a portion of the credit risk either through holding a subordinated
security or through overcollateralization. There were no delinquencies on any
multi-family loans where the Company has retained a portion of the credit risk
either through holding a subordinated security or through overcollateralization.
As of March 31, 1997, the Company believes that its credit reserves are
sufficient to cover any losses which may occur as a result of current
delinquencies presented in the table below.
Delinquency Statistics
- -----------------------------------------------------------------------------------------------------
60 to 90 days 90 days and over delinquent
days delinquent (includes REO and foreclosures) Total
- -----------------------------------------------------------------------------------------------------
1995, Quarter 2 0.54% 1.24% 1.78%
1995, Quarter 3 0.78% 1.77% 2.55%
1995, Quarter 4 2.50% 3.23% 5.73%
1996, Quarter 1 0.90% 2.95% 3.85%
1996, Quarter 2 1.91% 3.47% 5.38%
1996, Quarter 3 0.73% 3.01% 3.74%
1996, Quarter 4 0.88% 3.40% 4.28%
1997, Quarter 1 0.95% 4.16% 5.11%
- -----------------------------------------------------------------------------------------------------
The following table summarizes the credit rating for investments held in the
Company's portfolio assets. This table excludes the Company's other mortgage
securities (as the risk on such securities is prepayment-related, not
credit-related) and other portfolio assets. In preparing the table, the carrying
balances of the investments rated below A are net of credit reserves and
discounts. The average credit rating of the Company's mortgage investments at
the end of the first quarter of 1997 was AAA. At March 31, 1997, securities with
a credit rating of AA or better were $3.2 billion, or 99.1% of the Company's
total mortgage investments compared to 99.1% and 96.5% at December 31, 1996 and
March 31, 1996, respectively. At the end of the first quarter 1997, $469.7
million of all mortgage investments were split rated between rating agencies.
Where investments were split-rated, for purposes of this table, the Company
classified such investments based on the higher credit rating.
Portfolio Assets by Credit Rating (1)
($ in millions)
- -------------------- -- ---------- --- ---------- -- ---------- --- ---------- ----------- ----------- --------- -----------
AAA AA A Carrying Below A AAA Percent AA Percent A Percent Below A
Carrying Carrying Value Carrying of Total of Total of Total Percent
Value Value Value of Total
- -------------------- -- ---------- --- ---------- -- ---------- --- ---------- ----------- ----------- --------- -----------
1996, Quarter 1 $ 2,487.3 $ 943.1 $ 64.2 $ 60.6 70.0% 26.5% 1.8% 1.7%
1996, Quarter 2 2,935.2 914.0 63.6 28.7 74.5% 23.2% 1.6% 0.7%
1996, Quarter 3 3,333.3 766.4 17.1 31.1 80.3% 18.5% 0.4% 0.8%
1996, Quarter 4 2,708.4 752.8 - 29.9 77.5% 21.6% - 0.9%
1997, Quarter 1 2,504.1 739.4 - 29.4 76.5% 22.6% - 0.9%
- -------------------- -- ---------- --- ---------- -- ---------- --- ---------- ----------- ----------- --------- -----------
<FN>
(1) Excludes other mortgage securities and other portfolio assets.
</FN>
Purchase, Securitization and Sale of Portfolio Assets
During the three months ended March 31, 1997, the Company sold various
portfolio investments due to favorable market conditions. The aggregate
principal amount of investments sold during the three months ended March 31,
1997 was $3.3 million, consisting primarily of other mortgage securities, which
resulted in gains of $0.2 million. Also during the three months ended March 31,
1997, the Company exercised its call right or otherwise purchased $7.8 million
of ARM securities, $1.4 million of fixed-rate mortgage securities and $38.1
million of other mortgage securities.
PRODUCTION ACTIVITIES
Since the sale of its single-family mortgage operations to Dominion in 1996,
the Company's primary production operations have been focused on multi-family
and manufactured housing lending. During the first quarter of 1997, the Company
broadened its multi-family lending capabilities to include other types of
commercial real estate loans including commercial industrial warehouse
properties. Future commercial lending efforts may include apartment properties
which have not received low-income housing tax credits, assisted living and
retirement housing, limited and full service hotels, urban and suburban office
buildings, retail shopping strips and centers, other light industrial buildings
and manufactured housing parks. The Company has also expanded its manufactured
housing lending during the first quarter of 1997 to include inventory financing
to manufactured housing dealers. In addition to these production sources, the
Company may also purchase single-family loans on a "bulk" basis from time to
time and may originate such loans on a retail basis.
The purpose of the Company's production operations is to enhance the return
on shareholders' equity (ROE) by earning a favorable net interest spread while
loans are being accumulated for securitization or sale and creating investments
for its portfolio through the securitization process at a lower cost than if
such investments were purchased from third parties. The creation of such
investments generally involves the issuance of collateralized bonds or
pass-through securities collateralized by the loans generated from the Company's
production activities, and the retention of one or more classes of the
securities or collateralized bonds relating to such issuance. The issuance of
collateralized bonds and pass-through securities generally limits the Company's
credit and interest rate risk in contrast to retaining loans in its portfolio in
whole-loan form.
When a sufficient volume of loans is accumulated, the Company generally
securitizes the loans through the issuance of collateralized bonds or
pass-through securities. The Company believes that securitization is an
efficient and cost effective way for the Company to (i) reduce capital otherwise
required to own the loans in whole loan form; (ii) limit the Company's exposure
to credit risk on the loans; (iii) lower the overall cost of financing the
loans; and (iv) depending on the securitization structure, limit the Company's
exposure to interest rate and/or valuation risk. As a result of the reduction in
the availability of mortgage pool insurance, and the Company's desire to both
reduce its recourse borrowings as a percentage of its overall borrowings, as
well as the variability of its earnings, the Company has utilized the
collateralized bond structure for securitizing substantially all of its loan
production since the beginning of 1995.
The following table summarizes the production activity for the three month
periods ended March 31, 1997 and 1996.
Production Activity
($ in thousands)
- -------------------------------------------------------------
Three Months Ended
March 31,
---------------------------
1997 1996
---------- ---------------
Multi-family $ 8,063 $ 11,121
Commercial 4,613 -
Manufactured housing 29,240 -
Single-family 98,144 756,431
Specialty finance 35,086 78
======== ============
Total principal amount of
fundings through the $ 175,146 $ 767,630
production operations
======== ============
Principal amount securitized $ - $ 595,387
or sold
======== ============
- -------------------------------------------------------------
Manufactured housing lending commenced during the second quarter of 1996.
Since commencement, the Company has opened five regional offices in North
Carolina, Georgia, Texas, Michigan and Washington. As of March 31, 1997, the
Company had $67.1 million in principal balance of manufactured housing loans in
inventory, and had commitments outstanding of approximately $71.6 million.
Principally all funding volume to date has been obtained through relationships
with manufactured housing dealers and, to a lesser extent, through direct
marketing to consumers. In the future, the Company plans to expand its sources
of origination to nearly all sources for manufactured housing loans by
establishing relationships with park owners, developers of manufactured housing
communities, manufacturers of manufactured homes, brokers and correspondents.
Once certain volume levels are achieved at a particular region, district offices
may be opened in an effort to further market penetration. The first district
office is expected to be opened in the third quarter of 1997.
As of March 31, 1997, the Company had $220.5 million in principal balance
of multi-family loans held for securitization. The Company funded $8.1 million
in multi-family loans during the three months ended March 31, 1997 compared to
$60.4 million for the three months ended December 31, 1996 and $11.1 million for
the three months ended March 31, 1996. The lower funding volume for the first
quarter of 1997 compared to the fourth quarter of 1996 is due to longer than
expected lease-up periods and construction delays. Principally all fundings are
under the Company's lending programs for properties that have been allocated low
income housing tax credits. As of March 31, 1997 commitments to fund
multi-family loans over the next 20 months were approximately $516.6 million.
The Company expects that it will have funded volume sufficient enough to
securitize a portion of its multi-family loans in the second half of 1997
through the issuance of collateralized bonds. The Company will retain a portion
of the credit risk after securitization and intends to continue servicing the
loans.
As previously mentioned, during the first quarter of 1997 the Company
expanded its production operations to include commercial loans. The Company
funded $4.6 million of commercial loans during the first quarter. These
commercial loans will be securitized with the Company's multi-family production.
Included in the first quarter specialty finance fundings are $33.1 million
of model homes purchased from home builders which were simultaneously leased
back to the builders. The terms of these leases are generally twelve to eighteen
months at lease rates of typically one-month LIBOR plus a spread. At the end of
each lease, the Company will sell the home. As of March 31, 1997, the Company
had leases on $66.3 million of model homes, and had otherwise provided financing
to home builders for model homes for an additional $13.0 million.
Additionally, during the first quarter of 1997, the Company purchased $98
million of single-family loans through two bulk purchases. This is compared to
$409 million purchased during the first quarter of 1996. The Company will
continue to purchase single-family loans on a bulk basis to the extent, upon
securitization, such purchases would generate a favorable return on a proforma
basis.
OTHER ITEMS
General and Administrative Expenses
General and administrative expenses (G&A expense) consist of expenses
incurred in conducting the Company's production activities and managing the
investment portfolio, as well as various other corporate expenses. G&A expense
decreased for the three-month period ended March 31, 1997 as compared to the
same period in 1996 primarily as a result of the sale of the Company's
single-family mortgage operations during the second quarter of 1996. Offsetting
a portion of this decrease is the addition of G&A expenses resulting from the
current production operations. G&A related to the production operations will
continue to increase over time as the Company expands its production activities
with current and new product types.
The following table summarizes the Company's efficiency, the ratio of G&A
expense to average interest- earning assets, and the ratio of G&A expense to
average total equity.
Operating Expense Ratios
- ---------------------------------------------------------------------
G&A G&A
G&A Expense/Average Expense/Average
Efficiency Interest-Earning Total Equity
Ratio (1) Assets (2)
(Annualized) (Annualized)
- ---------------------------------------------------------------------
1995, Quarter 1 7.26% 0.52% 6.48%
1995, Quarter 2 7.07% 0.54% 6.13%
1995, Quarter 3 6.68% 0.51% 5.71%
1995, Quarter 4 7.51% 0.59% 5.50%
1996, Quarter 1 8.25% 0.64% 6.53%
1996, Quarter 2 6.77% 0.51% 5.60%
1996, Quarter 3 5.67% 0.43% 4.60%
1996, Quarter 4 6.09% 0.47% 4.57%
1997, Quarter 1 6.77% 0.55% 4.65%
- ---------------------------------------------------------------------
<FN>
(1) G&A expense as a percentage of interest income.
(2) Average total equity excludes net unrealized gain (loss) on investments
available-for-sale.
</FN>
Net Income and Return on Equity
Net income increased from $12.7 million for the three months ended March 31,
1996 to $18.3 million for the three months ended March 31, 1997. Return on
common equity (excluding the impact of the net unrealized gain on investments
available-for-sale) also increased from 15.12% for the three months ended March
31, 1996 to 18.82% for the three months ended March 31, 1997. The majority of
the increase in both the net income and the return on common equity is due
mostly to the increased net interest margin related to an increased level of
interest-earning assets and, to a lesser extent, the increase in the net
interest spread on interest-earning assets.
Components of Return on Equity
- --------------------------------------------------------------------------------------------------------------------------
Gains and G&A Preferred
Net Interest Provision Other Expense/ Dividend/ Return on
Margin/ for Losses Income Average Average Average Net Income
Average /Average Common /Average Common Common Common Available to
Common Equity Equity Common Equity Equity Equity Equity Common
(annualized) (annualized) (annualized) (annualized) (annualized) (annualized) Shareholders
- ----------------------------------------------------------------------------------------------------------------------------
1995, Quarter 1 11.17% 0.31% 5.30% 6.48% N/A 9.68% $ 6,596
1995, Quarter 2 13.91% 0.37% 4.64% 6.36% N/A 11.81% 8,041
1995, Quarter 3 19.19% 1.72% 3.85% 6.45% 1.33% 13.53% 10,128
1995, Quarter 4 21.99% 1.82% 4.68% 7.22% 2.67% 14.96% 12,145
1996, Quarter 1 26.26% 0.58% 1.18% 8.58% 3.16% 15.12% 10,492
1996, Quarter 2 25.59% 0.55% 17.67% 7.26% 3.00% 32.45% 23,704
1996, Quarter 3 26.56% 1.20% 2.67% 5.93% 2.93% 19.17% 14,363
1996, Quarter 4 28.26% 1.87% 4.24% 6.75% 4.57% 19.31% 14,480
1997, Quarter 1 27.85% 1.28% 3.73% 6.72% 4.76% 18.82% 14,623
- --------------------------------------------------------------------------------------------------------------------------
Dividends and Taxable Income
The Company and its qualified REIT subsidiaries (collectively "Dynex REIT")
have elected to be treated as a real estate investment trust for federal income
tax purposes. The REIT provisions of the Internal Revenue Code require Dynex
REIT to distribute to shareholders substantially all of its taxable income,
thereby restricting its ability to retain earnings. The Company may issue
additional common stock, preferred stock or other securities in the future in
order to fund growth in its operations, growth in its portfolio of mortgage
investments, or for other purposes.
The Company intends to declare and pay out as dividends 100% of its taxable
income over time. The Company's current practice is to declare quarterly
dividends per share. Generally, the Company strives to declare a quarterly
dividend per share which, in conjunction with the other quarterly dividends,
will result in the distribution of most or all of the taxable income earned
during the calendar year. At the time of the dividend announcement, however, the
total level of taxable income for the quarter is unknown. Additionally, the
Company has considerations other than the desire to pay out most of its taxable
earnings, which may take precedence when determining the level of dividends.
Dividend Summary
($ in thousands, except per share amounts)
- ---------------------------------------------------------------------------------------------
Taxable Net
Income Income Dividend
Available to
Common
- ---------------------------------------------------------------------------------------------
1995, Quarter 1 $ 5,070 $ 0.126 $ 0.180 144% $ 1,507
1995, Quarter 2 5,577 0.139 0.200 143% (956)
1995, Quarter 3 11,223 0.279 0.220 79% 1,410
1995, Quarter 4 13,176 0.325 0.240 74% 4,882
1996, Quarter 1 12,719 0.314 0.255 81% 7,249
1996, Quarter 2 13,359 0.328 0.275 84% 9,376
1996, Quarter 3 13,973 0.341 0.293 86% 11,194
1996, Quarter 4 8,831 0.214 0.310 145% 5,672
1997, Quarter 1 23,849 0.572 0.325 57% 15,854
- ---------------------------------------------------------------------------------------------
<FN>
(1) Adjusted for two-for-one common stock split.
</FN>
Taxable income differs from the financial statement net income which is
determined in accordance with generally accepted accounting principles (GAAP).
For the three months ended March 31, 1997, the Company's taxable earnings per
share of $0.572 were higher than the Company's declared dividend per share of
$0.325. The majority of the difference was caused by GAAP and tax differences
related to the sale of the single-family operations. For tax purposes, the sale
is accounted for on an installment sale basis with annual taxable income of
approximately $10 million from 1996 through 2001. Cumulative undistributed
taxable income represents timing differences in the amounts earned for tax
purposes versus the amounts distributed. Such amounts can be distributed for tax
purposes in the subsequent year as a portion of the normal quarterly dividend.
Such amounts also include certain estimates of taxable income until such time
the company files its federal income tax returns for each year.
LIQUIDITY AND CAPITAL RESOURCES
The Company has various sources of cash flow upon which it relies for its
working capital needs. Sources of cash flow from operations include primarily
the return of principal on its portfolio of investments and the issuance of
collateralized bonds. Other borrowings provide the Company with additional cash
flow in the event that it is necessary. Historically, these sources have
provided sufficient liquidity for the conduct of the Company's operations.
However, if a significant decline in the market value of the Company's
investment portfolio should occur, the Company's available liquidity from these
other borrowings may be reduced. As a result of such a reduction in liquidity,
the Company may be forced to sell certain investments in order to maintain
liquidity. If required, these sales could be made at prices lower than the
carrying value of such assets, which could result in losses.
In order to grow its equity base, the Company may issue additional capital
stock. Management strives to issue such additional shares when it
believes existing shareholders are likely to benefit from such offerings through
higher earnings and dividends per share than as compared to the level of
earnings and dividends the Company would likely generate without such offerings.
The Company borrows funds on a short-term basis to support the accumulation
of loans prior to the sale of such loans or the issuance of collateralized bonds
and mortgage- or asset-backed securities. These borrowings may bear fixed or
variable interest rates, may require additional collateral in the event that the
value of the existing collateral declines, and may be due on demand or upon the
occurrence of certain events. If borrowing costs are higher than the yields on
the assets financed with such funds, the Company's ability to acquire or fund
additional assets may be substantially reduced and it may experience losses.
These short-term borrowings consist of the Company's lines of credit and
repurchase agreements. These borrowings are paid down as the Company securitizes
or sells loans.
A substantial portion of the assets of the Company are pledged to secure
indebtedness incurred by the Company. Accordingly, those assets would not be
available for distribution to any general creditors or the stockholders of the
Company in the event of the Company's liquidation, except to the extent that the
value of such assets exceeds the amount of the indebtedness they secure.
Lines of Credit
At March 31, 1997, the Company has three credit facilities aggregating $500
million to finance loan fundings and for working capital purposes of which $300
million expires in 1997 and $200 million expires in 1998. One of these
facilities includes several sublines aggregating $300 million to serve various
purposes, such as multi-family loan fundings, working capital, and manufactured
housing loan fundings, which may not, in the aggregate, exceed the overall
facility commitment of $150 million at any time. Working capital borrowings
under this facility are limited to $30 million. The Company expects that these
credit facilities will be renewed, if necessary, at their respective expiration
dates, although there can be no assurance of such renewal. The lines of credit
contain certain financial covenants which the Company met as of March 31, 1997.
However, changes in asset levels or results of operations could result in the
violation of one or more covenants in the future.
Repurchase Agreements
The Company finances the majority of its portfolio assets through
collateralized bonds and repurchase agreements. Collateralized bonds are
non-recourse to the Company. Repurchase agreements allow the Company to sell
portfolio assets for cash together with a simultaneous agreement to repurchase
the same portfolio assets on a specified date for a price which is equal to the
original sales price plus an interest component. At March 31, 1997, the Company
had outstanding obligations of $1.1 billion under such repurchase agreements. As
of March 31, 1997, $350 million of various classes of collateralized bonds
issued by the Company have been retained by the Company and have been pledged as
security for $365 million of repurchase agreements. For financial statement
presentation purposes, the Company classified the $365 million of repurchase
agreements, secured by collateralized bonds, as collateralized bonds
outstanding. The remainder of the repurchase agreements were secured by ARM
securities -- $716.3 million, fixed-rate securities -- $20.5 million and other
mortgage securities -- $9.7 million.
Increases in either short-term interest rates or long-term interest rates
could negatively impact the valuation of these mortgage securities and may limit
the Company's borrowing ability or cause various lenders to initiate margin
calls. Additionally, certain of the Company's ARM securities are AAA or AA rated
classes that are subordinate to related AAA rated classes from the same series
of securities. Such AAA or AA rated classes have less liquidity than securities
that are not subordinated and the value of such classes is more dependent on the
credit rating of the related insurer or the credit performance of the underlying
mortgage loans. In instances of a downgrade of an insurer or the deterioration
of the credit quality of the underlying mortgage collateral, the Company may be
required to sell certain portfolio assets in order to maintain liquidity. If
required, these sales could be made at prices lower than the carrying value of
the assets, which could result in losses.
In addition to the lines of credit, the Company also may finance a portion of
its loans held for securitization with repurchase agreements on an uncommitted
basis. At March 31, 1997, the Company had $95.7 million outstanding obligations
under such repurchase agreements.
To reduce the Company's exposure to changes in short-term interest rates on
its repurchase agreements, the Company may lengthen the duration of its
repurchase agreements secured by mortgage securities by entering into certain
futures and/or option contracts. As of March 31, 1997, the Company had no such
financial futures or option contracts outstanding. During the quarter, however,
the Company settled several such positions, which have effectively extended the
duration of approximately $500 million notional amount of repurchases agreements
through the first half of 1998.
Potential immediate sources of liquidity for the Company include cash
balances and unused availability on the credit facilities described above.
Potential Immediate Sources of Liquidity
($ in millions)
- --------------------------------------------------------------------------------------------------------------------
Potential Immediate Sources
Estimated Unused Potential of Liquidity as a % of
Borrowing Capacity Immediate Sources of Recourse Borrowings (1)
Cash Balance Liquidity
- --------------------------------------------------------------------------------------------------------------------
1996, Quarter 1 $ 8.5 $ 32.6 $ 41.1 1.79%
1996, Quarter 2 20.9 102.8 123.7 6.56%
1996, Quarter 3 13.8 118.7 132.5 10.13%
1996, Quarter 4 11.4 131.8 143.2 10.16%
1997, Quarter 1 8.4 139.9 148.3 10.26%
- --------------------------------------------------------------------------------------------------------------------
<FN>
(1) Excludes borrowings, such as collateralized bonds, that are non-recourse to the Company.
</FN>
Unsecured Borrowings
The Company issued two series of unsecured notes payable totaling $50 million
in 1994. The proceeds from this issuance were used for general corporate
purposes. These notes payable have an outstanding balance at March 31, 1997 of
$44 million. The first principal repayment on one of the series of notes payable
was due October 1995 and annually thereafter, with quarterly interest payments
due. Principal repayment on the second note payable is contracted to begin in
October 1998. The notes mature between 1999 and 2001 and bear fixed interest
rates of 9.56% and 10.03%, respectively. The note agreements contain certain
financial covenants which the Company met as of March 31, 1997. However, changes
in asset levels or results of operations could result in the violation of one or
more covenants in the future. The Company also has various acquisition notes
payable totaling $2.0 million at March 31, 1997.
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 causes 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 consumer demand for
manufactured housing, multi-family housing and other products which it finances.
A material decline in demand for these goods and services would result in a
reduction in the volume of loans originated by the Company. The risk of defaults
and credit losses could increase during an economic slowdown or recession. This
could have an adverse effect on the Company's financial performance and the
performance on the Company's securitized loan pools.
Capital Resources. The Company relies on various credit facilities and
repurchase agreements with certain investment banking firms to help meet the
Company's short-term funding needs. The Company believes that as these
agreements expire, they will continue to be available or will be able to be
replaced; however no assurance can be given as to such availability or the
prospective terms and conditions of such agreements or replacements.
Interest Rate Fluctuations. The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
originated by the Company are fixed-rate. The profitability of a particular
securitization may be reduced if interest rates increase substantially before
these loans are securitized. In addition, the majority of the investments held
by the Company are variable rate collateral for collateralized bonds and
adjustable-rate investments. These investments are financed through non-recourse
long-term collateralized bonds and recourse short-term repurchase agreements.
The net interest spread for these investments could decrease during a period of
rapidly rising interest rates, since the investments generally have periodic
interest rate caps and the related borrowing have no such interest rate caps.
Defaults. Defaults may have an adverse impact on the Company's financial
performance, if actual credit losses differ materially from estimates made by
the Company at the time of securitization. The allowance for losses is
calculated on the basis of historical experience and management's best
estimates. Actual defaults may differ from the Company's estimate as a result of
economic conditions. Actual defaults on ARM loans may increase during a rising
interest rate environment. The Company believes that its reserves are adequate
for such risks.
Prepayments. Prepayments may have an adverse impact on the Company's
financial performance, if prepayments differ materially from estimates made by
the Company. The prepayment rate is calculated on the basis of historical
experience and management's best estimates. Actual rates of prepayment may vary
as a result of the prevailing interest rate. Prepayments are expected to
increase during a declining interest rate environment. The Company's exposure to
more rapid prepayments is (i) the faster amortization of premium on the
investments 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 could adversely affect the Company's market
share within the industry and hamper the Company's efforts to expand its
production sources.
Regulatory Changes. The Company's business is subject to federal and state
regulation which, among other things require the Company to maintain various
licenses and qualifications and require specific disclosures to borrowers.
Changes in existing laws and regulations or in the interpretation thereof, or
the introduction of new laws and regulations, could adversely affect the
Company's operation and the performance of the Company's securitized loan pools.
New Production Sources. The Company has expanded both its manufactured
housing and commercial lending businesses. The Company is incurring or will
incur expenditures related to the start-up of these businesses, with no
guarantee that production targets set by the Company will be met or that these
businesses will be profitable. Various factors such as economic conditions,
interest rates, competition and the lack of the Company's prior experience in
these businesses could all impact these new production sources.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On March 20, 1997, American Model Homes ("Plaintiff") filed a
complaint against the Company in Federal District Court in the
Central District of California alleging that the Company, among
other things, misappropriated Plaintiff's trade secrets and
confidential information in connection with the Company's
establishment of its model home lending business. The Plaintiff
seeks injunctive relief and money damages. The Company believes the
claims are without merit and will vigorously defend against such
claims.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
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
3.10 Amendment to Articles of Incorporation, effective April 25, 1997 (filed herewith.)
3.11 Amendment to Articles of Incorporation, effective May 5, 1997 (filed herewith.)
10.10 Directors Stock Appreciation Rights Plan (filed herewith.)
10.11 1992 Stock Incentive Plan as amended (filed herewith.)
(b)Reports on Form 8-K
Current Report on Form 8-K filed with the Commission on February 27,
1997, regarding the consolidated financial statements of Resource
Mortgage Capital, Inc. and the independent auditor's report thereon,
for the year ended December 31, 1996.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEX CAPITAL, INC.
By:/s/ Thomas H. Potts
Thomas H. Potts, President
authorized officer of registrant)
/s/ Lynn K. Geurin
Lynn K. Geurin, Executive Vice
President and Chief Financial Officer
(principal accounting officer)
Dated: May 15, 1997
EXHIBIT INDEX
Sequentially
Exhibit Numbered
Page
3.10 Amendment to Articles of Incorporation, effective I
April 25, 1997
3.11 Amendment to Articles of Incorporation, effective May II
5, 1997
10.10 Directors Stock Appreciation Rights Plan III
10.11 1992 Stock Incentive Plan as amended IV