UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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, 1997
|_| Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Commission file number 33-83524
MERIT SECURITIES CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 54-1736551
(State or other jurisdiction (I.R.S. Employer
of incorporation) 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
As of October 31, 1997, the latest practicable date, there were 1,000 shares of
Merit Securities Corporation common stock outstanding.
The registrant meets the conditions set forth in General Instructions H(1)(a)
and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced
disclosure format.
================================================================================
MERIT SECURITIES CORPORATION
FORM 10-Q
INDEX
Page Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets at September 30, 1997 and
December 31, 1996..................................3
Statements of Operations for the three and
nine months ended September 30, 1997 and 1996......4
Statement of Shareholder's Equity for the nine
months ended September 30, 1997....................5
Statements of Cash Flows for the nine months ended
September 30, 1997 and 1996........................6
Notes to Unaudited Financial Statements............7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................9
Item 5. Other Information .................................9
Item 6. Exhibits and Reports on Form 8-K...................9
SIGNATURES................................................12
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERIT SECURITIES CORPORATION
Balance Sheets
(amounts in thousands except share data)
September 30, December 31,
1997 1996
------------ ------------
ASSETS:
Collateral for collateralized bonds $ 2,849,080 $ 2,463,842
Prepaid shelf registration fees 536 849
Cash 10 10
----------- -----------
$ 2,849,626 $ 2,464,701
============ ===========
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES:
Collateralized bonds $ 2,669,580 $ 2,301,598
Due to affiliates 42,941 41,973
------------ -----------
2,712,521 2,343,571
------------ -----------
SHAREHOLDER'S EQUITY:
Common stock, no par value,
10,000 shares authorized,
1,000 shares issued and outstanding 10 10
Additional paid-in capital 104,779 82,136
Net unrealized gain on investments 52,825 60,304
available-for-sale
Retained deficit (20,509) (21,320)
------------ ----------
137,105 121,130
============ ============
$ 2,849,626 $ 2,464,701
============ ============
<FN>
See notes to unaudited financial statements.
</FN>
MERIT SECURITIES CORPORATION
Statements of Operations
(amounts in thousands except
share data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- -----------------------
1997 1996 1997 1996
---------- --------- ---------- ----------
Interest Income:
Collateral for $ 51,097 $ 33,599 $ 133,260 $ 76,381
collateralized bonds
-------- -------- ---------- ---------
Interest and related expense:
Interest expense on 49,577 29,377 126,161 69,308
collateralized bonds
Other collateralized bond 777 717 2,414 1,871
expense
Provision for losses 600 900 1,800 1,700
-------- -------- ---------- ---------
50,954 30,994 130,375 72,879
-------- -------- ---------- ---------
Net interest margin 143 2,605 2,885 3,502
Provision for loss on Dynex's - (1,300) - (29,434)
sale of affiliates
Interest on due to affiliate (780) (602) (2,074) ( 1,182)
-------- -------- ---------- ---------
Net income (loss) $ (637) $ 703 $ 811 $ (27,114)
======== ======== ========== ==========
<FN>
See notes to unaudited financial statements.
</FN>
MERIT SECURITIES CORPORATION
Statement of Shareholder's Equity
(amounts in thousands except share data)
Net
unrealized
Additional gain on Retained
Common paid-in investments earnings
stock capital available-for-sale (deficit) Total
-------- ------------ -------------------- ----------- -------
Balance at December 31, 1996 $ 10 $ 82,136 $ 60,304 $(21,320) $121,130
Contributed capital - 22,643 - - 22,643
Change in net unrealized
gain on investments
available-for-sale - - (7,479) - (7,479)
Net income - - - 811 811
------- -------- ---------------- -------- --------
Balance at September 30, 1997 $ 10 $ 104,779 $ 52,825 $(20,509) $137,105
======== ========= ================ ======== ========
<FN>
See notes to unaudited financial statements.
</FN>
MERIT SECURITIES CORPORATION
Statements of Cash Flows
(amounts in thousands)
Nine Months Ended
September 30,
1997 1996
------------ ------------
Operating activities:
Net income $ 811 $ (27,114)
Adjustments to reconcile net
income to net cash provided
by operating activities:
Amortization, net 14,487 5,323
Provision for losses 1,800 1,700
Provision for loss on Dynex's
sale of affiliates - 29,434
Net change in accrued interest (4,183) (5,986)
Decrease in prepaid shelf
registration fees 313 509
------------ ------------
Net cash provided by
operating activities 13,228 3,866
------------ ------------
Investing activities:
Collateral for collateralized bonds:
Purchase of loans subsequently
securitized (1,024,444) (2,135,510)
Principal payments on collateral 619,061 271,170
Net change in funds held by trustee 251 (198)
------------ -------------
Net cash used for investing activities (405,132) (1,864,538)
------------ -------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of
collateralized bonds 989,797 2,071,285
Principal payments on
collateralized bonds (621,504) (270,707)
Increase in due to affiliate 968 13,180
Proceeds from capital contributions 22,643 46,914
------------ ------------
Net cash provided by financing activities 391,904 1,860,672
------------ ------------
Net decrease in cash - -
Cash at beginning of period 10 10
------------ ------------
Cash at end of period $ 10 $ 10
============ ============
Supplemental disclosure of cash
flow information:
Cash paid for interest $ 126,473 $ 63,507
============ ============
<FN>
See notes to unaudited financial statements.
</FN>
MERIT SECURITIES CORPORATION
Notes to Unaudited Financial Statements September 30, 1997 (amounts in thousands
except share data)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 financial statements include the accounts of
Merit Securities Corporation (the Company). The Company is a wholly-owned,
limited-purpose finance subsidiary of Issuer Holding Corporation (IHC). IHC was
formed on September 4, 1996 to acquire all of the outstanding stock of the
Company and certain other affiliates of Dynex Capital, Inc. (Dynex). IHC is a
wholly-owned subsidiary of Dynex. The Company was organized to facilitate the
securitization of loans through the issuance and sale of collateralized bonds
(the Bonds).
In the opinion of management, all material adjustments, consisting of normal
recurring adjustments, considered necessary for a fair presentation of the
financial statements have been included. The Balance Sheet at September 30,
1997, the Statements of Operations for the three and nine months ended September
30, 1997 and 1996, the Statement of Shareholder's Equity for the nine months
ended September 30, 1997, the Statements of Cash Flows for the nine months ended
September 30, 1997 and 1996, and the related notes to financial statements are
unaudited. Operating results for the nine months ended September 30, 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
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--COLLATERAL FOR COLLATERALIZED BONDS
In accordance with the provisions of Statement of Financial Accounting Standards
No. 115, Accounting for Certain Investments in Debt and Equity Securities, the
Company has classified collateral for collateralized bonds as
available-for-sale. The following table summarizes the Company's amortized cost
basis and fair value of collateral for collateralized bonds at September 30,
1997 and December 31, 1996, and the related average effective interest rates
(calculated for the month ended September 30, 1997 and December 31, 1996, and
excluding unrealized gains and losses):
- --------------------------------------------------------------------------------
September 30, 1997 December 31, 1996
- --------------------------------------------------------------------------------
Effective Effective
Interest Interest
Fair Value Rate Fair Value Rate
- --------------------------------------------------------------------------------
Collateral for
collateralized bonds:
Amortized cost $ 2,823,217 7.1% $ 2,435,270 7.5%
Allowance for losses (26,962) (31,732)
- --------------------------------------------------------------------------------
Amortized cost, net 2,796,255 2,403,538
Gross unrealized gains 63,135 68,557
Gross unrealized losses (10,310) (8,253)
- --------------------------------------------------------------------------------
$ 2,849,080 $ 2,463,842
- --------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Merit Securities Corporation (the Company) was incorporated in Virginia on
August 19, 1994 as a wholly-owned, limited-purpose finance subsidiary of Dynex
Capital, Inc. (Dynex), formerly known as Resource Mortgage Capital, Inc. On
September 4, 1996, Issuer Holding Corporation, Inc. (IHC), a wholly-owned
subsidiary of Dynex, acquired all of the outstanding stock of the Company and
certain other affiliates of Dynex.
The Company was organized to facilitate the securitization of loans through the
issuance and sale of collateralized bonds (the Bonds). The Bonds will be secured
primarily by: (i) mortgage loans secured by first or second liens on residential
property, (ii) Federal National Mortgage Association Mortgage-Backed
Certificates, (iii) Federal Home Loan Mortgage Corporation Mortgage-Backed
Certificates, (iv) Government National Mortgage Association Mortgage-Backed
Certificates, (v) any other mortgage pass-through certificates or
mortgage-collateralized obligations and (vi) consumer installment loans
(collectively, the Collateral). In the future, the Company may also securitize
other types of loans.
After payment of the expenses of an offering and certain administrative
expenses, the net proceeds from an offering of Bonds will be used to purchase
Collateral from IHC or various third parties. IHC can be expected to use the
proceeds to reduce indebtedness incurred to obtain such loans or to acquire
additional Collateral. After the issuance of a series of Bonds, the Company may
sell the Collateral securing that series of Bonds, subject to the lien of the
Bonds.
The Company did not issue any Bonds during the three months ended September,
1997. As of September 30, 1997, the Company had seven (7) series of
collateralized bonds outstanding totaling approximately $2.7 billion, compared
to $2.3 billion at December 31, 1996, and $2.5 billion at September 30, 1996.
Interest income on the Collateral increased $56.9 million to $133.3 million for
the nine months ended September 30, 1997 compared to $76.4 million for the nine
months ended September 30, 1996, primarily as a result of the increased number
of series outstanding. Interest expense on Bonds increased $56.9 million from
$69.3 million for the nine months ended September 30, 1996 to $126.2 million for
the nine months ended September 30, 1997, primarily due to the additional series
outstanding.
Net interest margin for the nine months ended September 30, 1997 decreased to
$2.9 million, or 17%, over the $3.5 million for the same period for 1996. Net
interest margin for the three months ended September 30, 1997 decreased to $0.1
million, or 96%, over $2.6 million for the same period in 1996. These decreases
were primarily the result of the securitization of lower coupon collateral,
principally A+ quality single-family ARM loans during 1997 coupled with the
prepayments of higher coupon collateral during 1997. In addition, the spread on
the net investment in collateralized bonds decreased due to higher premium
amortization caused by higher prepayments during the three and nine months ended
September 30, 1997 than during the same period in 1996.
With collateralized bond structures, the Company retains credit risk relative to
the amount of overcollateralization required in conjunction with the bond
insurance. Losses are generally first applied to the overcollateralized 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 September 30, 1997, the Company retained $105.5 million
in aggregate principal amount of overcollateralization, and had reserves, or
otherwise had provided coverage on $57.3 million of this potential credit loss
exposure. $30.3 million of this reserve amount is in the form of a loss
reimbursement guarantee from a third-party rated A by Standards & Poors Ratings
Services, Inc.
At September 30, 1997, the Company had securities of approximately $1.2 billion
remaining for issuance under a registration statement filed with the Securities
and Exchange Commission. The Company anticipates issuing additional Bonds in the
future.
The Company competes in a national market with other private conduits and
various financial firms. Economic conditions, interest rates, regulatory changes
and market dynamics all influence the mortgage securities market.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings:
None
Item 5. Other Information:
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
3.2 Bylaws of the Registrant (Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement No. 33-83524 on Form
S-3 filed August 31, 1994).
3.3 Amended and Restated Articles of Incorporation of the Registrant,
effective April 19, 1995 (Incorporated herein by reference to Exhibit to
the Registrant's Current Report on Form 8-K, filed April 21, 1995).
4.1 Indenture between Registrant and Trustee, dated as of August 1, 1994
(Incorporated herein by reference to the Exhibits to Registrant's
Registration Statement No. 33-83524 on Form S-3 filed August 31, 1994).
4.2 Form of Supplement Indenture between Registrant and Trustee (Incorporated
herein by reference to the Exhibits to Registrant's Registration Statement
No. 33-83524 on Form S-3 filed August 31, 1994).
4.3 Copy of the Indenture, dated as of November 1, 1994, by and between the
Registrant and Texas Commerce Bank National Association, as Trustee
(Incorporated herein by reference to Exhibit to the Registrant's Current
Report on Form 8-K, filed December 19, 1994).
4.4 Copy of the Series 1 Indenture Supplement, dated as of November 1, 1994,
by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (including schedules and exhibits) (Incorporated
herein by reference to Exhibit to the Registrant's Current Report on Form
8-K, filed December 19, 1994).
4.5 Copy of the Series 2 Indenture Supplement, dated as of February 1, 1995,
by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (including schedules and exhibits) (Incorporated
herein by reference to Exhibit to the Registrant's Current Report on Form
8-K, filed March 8, 1995).
4.6 Copy of the Series 3 Indenture Supplement, dated as of March 1, 1995, by
and between the Registrant and Texas Commerce Bank National Association,
as Trustee (including schedules and exhibits) (Incorporated herein by
reference to Exhibit to the Registrant's Current Report on Form 8-K, filed
April 21, 1995).
4.7 Copy of the Series 4 Indenture Supplement, dated as of June 1, 1995, by
and between the Registrant and Texas Commerce Bank National Association,
as Trustee (including schedules and exhibits) (Incorporated herein by
reference to Exhibit to the Registrant's Current Report on Form 8-K, filed
July 10, 1995).
4.8 Copy of the Series 5 Indenture Supplement, dated as of October 1, 1995, to
Indenture, dated as of November 1, 1994, by and between the Registrant and
Texas Commerce Bank National Association, as Trustee (related exhibits
available upon request to the Trustee). (Incorporated herein by reference
to Exhibit to the Registrant's Current Report on Form 8-K, filed November
15, 1995).
4.9 Copy of the Series 6 Indenture Supplement, dated as of March 1, 1996, by
and between the Registrant and Texas Commerce Bank National Association,
as Trustee (including schedules and exhibits) (Incorporated herein by
reference to Exhibit to the Registrant's Current Report on Form 8-K, filed
March 21, 1996).
4.10 Copy of the Series 7 Indenture Supplement, dated as of May 1, 1996, by and
between the Registrant and Texas Commerce Bank National Association, as
Trustee (related schedules and exhibits available upon request of the
Trustee). (Incorporated herein by reference to Exhibit to Registrant's
Current Report on Form 8-K, filed June 19, 1996).
4.11 Copy of the Series 8 Indenture Supplement, dated as of September 1, 1996,
by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (related schedules and exhibits available upon
request of the Trustee). (Incorporates herein by reference to Exhibit of
Registrant's Current Report on Form 8-K, filed October 9, 1996).
4.12 Copy of the Series 9 Indenture Supplement, dated as of June 1, 1997, by
and between the Registrant and Texas Commerce Bank National Association,
as Trustee (related schedules and exhibits available upon request of the
Trustee). (Incorporates herein by reference to Exhibit of Registrant's
Current Report on Form 8-K, filed July 11, 1997).
99.1 Standard Provisions to Servicing Agreement (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
99.2 Form of Servicing Agreement (Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement No. 33-83524 on Form
S-3 filed August 31, 1994).
99.3 Standard Terms to Master Servicing Agreement (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
99.4 Form of Master Servicing Agreement (Incorporated herein by reference to
the Exhibits to Registrant's Registration Statement No. 33-83524 on Form
S-3 filed August 31, 1994).
99.5 Form of Prospectus Supplement of Bonds secured by adjustable-rate mortgage
loans (Incorporated herein by reference to Exhibits to Registrant's
Pre-Effective Amendment No. 4 to Registration Statement
No. 33-83524 on Form S-3 filed December 5, 1994).
99.6 Form of Financial Guaranty Assurance Policy (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
99.7 Form of GEMICO Mortgage Pool Insurance Policy (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
99.8 Form of PMI Mortgage Insurance Co. Pool Insurance Policy (Incorporated
herein by reference to the Exhibits to Registrant's Registration Statement
No. 33-83524 on Form S-3 filed August 31, 1994).
99.9 Form of Prospectus Supplement of Bonds secured by fixed-rate mortgage
loans (Incorporated herein by reference to Exhibits to Registrant's
Pre-Effective Amendment No. 4 to Registration Statement No. 33-83524 on
Form S-3 filed December 5, 1994).
99.10 Copy of Financial Guaranty Insurance Policy No. 50331-N issued by
Financial Security Assurance Inc., dated December 7, 1994, with respect to
the Series 1 Bonds (Incorporated herein by reference to the Exhibit to
Registrant's 1994 Form 10-K, dated and filed March 31, 1995).
99.11 Copy of Financial Guaranty Insurance Policy No. 95010074 issued by
Financial Guaranty Insurance Company, dated February 23, 1995, with
respect to the Series 2 Bonds (Incorporated herein by reference to Exhibit
to the Registrant's Current Report on Form 8-K, filed March 8, 1995).
99.12 Copy of the Saxon Mortgage Funding Corporation Servicing Guide for Credit
Sensitive Loans, February 1, 1995 Edition (Incorporated herein by
reference to Exhibit to the Registrant's Current Report on Form 8-K, filed
March 8, 1995).
99.13 Copy of Financial Guaranty Insurance Policy No. 50364-N issued by
Financial Guaranty Assurance Inc., dated April 7, 1995, with respect to
the Series 3 Bonds (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed April 21, 1995).
99.14 Copy of Financial Guaranty Insurance Policy No. 50382-N issued by
Financial Guaranty Assurance Inc., dated June 29, 1995, with respect to
the Series 4 Bonds (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed July 10, 1995).
99.15 Copy of the Standard Terms to Master Servicing Agreement, June 1, 1995
Edition (incorporated herein by reference to Exhibit to the Registrant's
Current Report on Form 8-K, filed July 10, 1995).
99.16 Copy of Financial Guaranty Insurance Policy No. 19804 issued by MBIA
Insurance Corporation (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed November 15, 1995).
99.17 Copy of Financial Guaranty Insurance Policy No. 20596 issued by MBIA
Insurance Corporation (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed March 21, 1996).
99.18 Copy of Financial Guaranty Insurance Policy No. 21296 issued by MBIA
Insurance Corporation (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed June 19, 1996).
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MERIT SECURITIES CORPORATION
By: /s/ Lynn K. Geurin
Lynn K. Geurin
(Principal Executive Officer)
/s/ Stephen J. Benedetti
Stephen J. Benedetti
(Principal Financial &
Accounting Officer)
Dated: November 14, 1997