UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(mark one)
[ X ] Annual Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
Commission File No. 33-83524
MERIT SECURITIES CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 54-1736551
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address or principal executive offices) (Zip Code)
Registrant's telephone number, including area code (804) 217-5800
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes XX No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Aggregate market value of voting stock held by nonaffiliates of the
registrant as of the latest practicable date, February 28, 1999: NONE
As of February 28, 1999, the latest practicable date, there were 1,000
shares of Merit Securities Corporation common stock outstanding.
The registrant meets the conditions set forth in General Instruction
I(1)(a) and (b) of Form 10-K and, therefore, is furnishing the abbreviated
narrative disclosure specified in Paragraph (2) of General Instruction I.
MERIT SECURITIES CORPORATION
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
Number
PART I.
Item 1. Business 3
Item 2. Properties 3
Item 3. Legal Proceedings 3
Item 4. Submission of Matters to a Vote of Security Holders 3
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 3
Item 6. Selected Financial Data 3
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 4
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 7
Item 8. Financial Statements and Supplementary Data 9
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure 21
PART III.
Item 10. Directors and Executive Officers of the Registrant 21
Item 11. Executive Compensation 21
Item 12. Security Ownership of Certain Beneficial Owners and Management 21
Item 13. Certain Relationships and Related Transactions 21
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 21
SIGNATURES 25
PART I
Item 1. BUSINESS
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"), a New York Stock Exchange listed financial
services company (symbol: DX). 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 ("Bonds"). The Bonds will be
secured by securities backed 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, and (v) other mortgage pass-through
certificates or mortgage-collateralized obligations, (vi) property tax
receivables and (vii) 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.
From the date of its inception to December 31, 1998, the Company has issued
eleven (11) series of Bonds totaling approximately $7.0 billion aggregate
principal amount. To date, three of these series have been called and collapsed
into subsequent issuances. As of December 31, 1998, the Company had eight (8)
series of Bonds outstanding totaling approximately $3.2 billion, compared to
seven (7) series at December 31, 1997 totaling $3.6 billion.
At December 31, 1998, the Company had securities of approximately $329
million remaining for issuance under a shelf 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 securities market.
Item 2. PROPERTIES
The Company has no physical properties.
Item 3. LEGAL PROCEEDINGS
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information in response to this Item is omitted pursuant to General
Instruction I.
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
All of the Company's outstanding common stock is owned by IHC. Accordingly,
there is no market for its common stock. The Company has paid no dividends with
respect to its common stock.
Item 6. SELECTED FINANCIAL DATA
Information in response to this Item is omitted pursuant to General
Instruction I.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL CONDITION
December 31,
-------------------------------------------
(amounts in thousands) 1998 1997
- - -----------------------------------------------------------------------------------------------
Collateral for collateralized bonds $ 3,350,344 $ 3,835,289
Non-recourse debt - collateralized bonds 3,153,060 3,622,877
Shareholder's equity 203,310 168,967
Collateralized bond series outstanding 8 7
- - -----------------------------------------------------------------------------------------------
The Company was organized to facilitate the securitization of loans and
securities through the issuance and sale of collateralized bonds. Prior to
September 4, 1996, the Company was a wholly-owned subsidiary of Dynex. On
September 4, 1996, IHC acquired all of the outstanding stock of the Company and
certain other affiliates of Dynex. IHC is a wholly-owned subsidiary of Dynex.
Collateral for collateralized bonds As of December 31, 1998, the Company
had 8 series of collateralized bonds outstanding. The collateral for
collateralized bonds decreased to $3.4 billion at December 31, 1998 compared to
$3.8 billion at December 31, 1997. This decrease of $0.4 billion is the result
of $2.1 billion in paydowns of collateral net of the addition of $1.7 billion of
collateral related to the issuance of one series of collateralized bonds in
1998.
Non-recourse debt - collateralized bonds Collateralized bonds decreased to
$3.2 billion at December 31, 1998 from $3.6 billion at December 31, 1997 as a
result of $2.1 billion in paydowns during 1998 net of the issuance of $1.6
billion of collateralized bonds. The collateralized bonds were collateralized by
securities primarily secured by single-family mortgage loans, consumer
installment loans and property tax receivables. All series of collateralized
bonds, except one class of collateralized bonds issued during 1998, issued by
the Company include provisions to call the outstanding bonds once the remaining
principal amount outstanding is equal to 35% or less of its original balance.
One class of collateralized bonds, with a principal amount outstanding of $34.3
million at December 31, 1998, includes a provision to call the outstanding bond
once the remaining amount outstanding is equal to 10% or less of its original
balance. This class of collateralized bonds was sold during 1998 for proceeds of
$43.8 million. A gain of $7.5 million was recognized from this sale.
Shareholder's Equity Shareholder's equity increased to $203.3 million at
December 31, 1998 from $169.0 million at December 31, 1997. This increase was
primarily the result of a $64.2 million capital contribution from IHC. This
increase was partially offset by the $31.1 decrease in the net unrealized gain
on investments available-for-sale from $64.7 million at December 31, 1997 to
$33.6 million at December 31, 1998, primarily due to the high rate of
prepayments on the portfolio.
RESULTS OF OPERATIONS
- - -------------------------------------------------------------------------------------------------------------------
For the Year Ended December 31,
-----------------------------------------------------
(amounts in thousands) 1998 1997 1996
- - -------------------------------------------------------------------------------------------------------------------
Interest income $ 253,352 $ 181,690 $ 123,089
Interest expense on collateralized bonds (247,380) (173,096) (110,401)
Net interest margin (3,643) 2,363 7,631
Gain on sale of securities 7,500 - -
Provision for loss on Dynex's sale of affiliates - - (29,434)
Net income (loss) 1,272 (382) (23,539)
- - -------------------------------------------------------------------------------------------------------------------
Interest income on the collateral for collateralized bonds increased to
$253.4 million in 1998 from $181.7 million in 1997 and $123.1 in 1996, primarily
as a result of the increased number of series outstanding. One series with
collateral totaling $1.7 billion, was issued during 1998 and two series with
$2.3 billion of collateral, were issued during 1997.
Interest expense on collateralized bonds also increased to $247.4 million
in 1998 from $173.1 million and $110.4 million in 1997 and 1996, respectively,
primarily due to the additional series outstanding. During 1998, one series of
bonds was issued, totaling $1.6 billion while two series of bonds, totaling $2.2
billion, were issued during 1997.
Net interest margin in 1998 decreased to a negative $3.6 million from a
positive $2.4 million in 1997. This decrease was primarily the result of higher
premium amortization caused by higher prepayments during 1998 than during 1997.
Net interest margin decreased to $2.4 million in 1997 from $7.6 million in 1996.
This decrease was 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.
Gain on sale of securities is the result of the sale of the Merit 11B A-1
class, with a principal balance of $44.0 million during 1998, for a gain of $7.5
million.
As a result of Dynex's sale of Meritech Mortgage Services, Inc.
("Meritech"), the servicer for a significant portion of the Company's collateral
for collateralized bonds, the Company recorded during 1996 a $29.4 million
provision for probable losses for those loans pledged as collateral for
collateralized bonds which were serviced by Meritech, and where the Company has
retained the credit risk.
During 1998, the Company redeemed five series of previously issued
collateralized bonds, which resulted in $571 of additional costs related to such
redemptions. The Company simultaneously sold these bonds to an affiliated
company, MSC I LP, but retained the right to call the bonds in March 1999,
therefore the Company recorded the transaction as a financing transaction.
Credit Exposures 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 December 31, 1998, the Company retained $144.4 million
in aggregate principal amount of overcollateralization compared to $112.9
million at December 31, 1997. The Company had reserves, or otherwise had
provided coverage on $47.4 million and $55.1 million of this potential credit
loss exposure at December 31, 1998 and 1997, respectively. $30.3 million of this
reserve amount is in the form of a loss reimbursement guarantee from an A rated
third-party.
Year 2000 The Company relies upon its ultimate parent company, Dynex, for
all computer systems operations. Dynex is dependent upon purchased, leased, and
internally-developed software to conduct certain operations. In addition, the
Company relies upon certain counterparties such as banks and loan servicers who
are also highly dependent upon computer systems. The Company recognizes that
some computer software may incorrectly recognize dates beyond December 31, 1999.
The ability of the Company and its counterparties to correctly operate computer
software in the Year 2000 is critical to the Company's viability.
The Dynex computer systems that the Company relies upon to conduct its
business operations are as follows:
- The internally-developed investment portfolio analytics,
securitization, and securities administration software
- The purchased servicing system for single family and manufactured
housing loans
- The purchased general ledger accounting system
In addition, Dynex is involved in data interchange with a number of
counterparties in the normal course of business. Each system or interface that
Dynex relies on is being tested and evaluated for Year 2000 compliance.
Dynex has contacted all of its key software vendors to determine their Year
2000 readiness. We have received documentation from each of the vendors
providing assurances of Year 2000 compliance:
- Baan/CODA, vendor of the general ledger accounting system, has
provided confirmation that their current software release is fully
Year 2000 compliant. Dynex plans to apply this release in the first
half of 1999.
- Interlinq Software, vendor of the single-family and manufactured
housing loan servicing software, has provided assurance that their
software is Year 2000 compliant.
All software developed internally by Dynex was designed to be Year 2000
compliant. Nevertheless, Dynex has established a Year 2000 test-bed to ensure
that there were no design or development oversights that could lead to a Year
2000 problem. Initial testing of all key applications was completed in January
of 1999, with only minor issues discovered and remedied. Continued testing of
certain applications will continue through June of 1999.
Dynex has reviewed or is reviewing the Year 2000 progress of its primary
financial counterparties. Based on initial reviews, these counterparties are
expected to be in compliance. Dynex, as master servicer of certain securities
including those held on the Company's books, is in the process of assessing the
Year 2000 readiness of its external servicers, to ensure that these parties will
be able to correctly remit loan information and payments after December 31,
1999.
Dynex believes that, other than its exposure to financial counterparties,
its most significant risk with respect to internal or purchased software is the
software systems used to service single family loans. Dynex will not be able to
service these loans without the automated system. Should these loans go
unattended for a period greater than three months, the result could have a
material adverse impact on the Company as Dynex services the manufactured
housing loans which are included in the Company's collateral for collateralized
bonds.
Dynex is also at significant risk if the systems of the financial
institutions that provide Dynex software for cash management services should
fail. In a worst case scenario, Dynex would be unable to fund its operations or
pay on its obligations for an unknown period of failure. This would have
material adverse impact on the Company.
Dynex is also at significant risk if the voice and data communications
network supplied by its provider should fail. In such an instance Dynex would be
unable to efficiently service its Manufactured Housing loans until the problem
is remedied. Dynex is closely monitoring the Year 2000 efforts of its
telecommunications provider and is developing contingency plans in the event
that the provider does not give sufficient assurance of compliance by June 30,
1999.
Dynex uses many other purchased and internally developed systems, including
non-IT, that could fail to perform accurately after December 31, 1999.
Management believes that the functions performed by these systems are either
non-critical or could be performed manually in the event of failure.
Dynex will complete its Year 2000 test plan and remediation efforts in the
second quarter of 1999. Management believes that there is little possibility of
a significant disruption in business. The major risks are those related to the
ability of vendors and business partners to complete Year 2000 plans. Dynex
expects that those vendors and counterparties will complete their Year 2000
compliance programs before January 1, 2000.
The Company will not incur any costs related to Year 2000 as all costs will
be paid by Dynex. Dynex has incurred less than $50,000 in costs to date in
carrying out its Year 2000 compliance program. Dynex estimates that it will
spend less than $100,000 to complete the plan. Costs could increase in the event
that Dynex determines that a counter-party will not be Year 2000 compliant.
Dynex is still developing contingency plans in the event that a system or
counterparty is not Year 2000 compliant. These plans will be developed prior to
June 30, 1999.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in the value of a financial instrument due to fluctuations in
interest and foreign exchange rates and in equity and commodity prices. Market
risk is inherent to both derivative and non-derivative financial instruments,
and accordingly, the scope of the Company's market risk management extends
beyond derivatives to include all market risk sensitive financial instruments.
As a financial services company, net interest income comprises the primary
component of the Company's earnings. As a result, the Company is subject to risk
resulting from interest rate fluctuations to the extent that there is a gap
between the amount of the Company's interest-earning assets and the amount of
interest-bearing liabilities that are prepaid, mature or reprice within
specified periods.
As the Company's parent, Dynex continuously monitors the aggregate cash
flow, projected net yield and market value of the collateral for collateralized
bonds under various interest rate and prepayment assumptions. Dynex has a
Portfolio Executive Committee ("PEC"), which includes executive management
representatives, and monitors and manages the interest rate sensitivity and
repricing characteristics of the balance sheet components consistent with
maintaining acceptable levels of change in both the net portfolio value and net
interest income. Dynex's exposure to interest rate risk is reviewed on a monthly
basis by the PEC and quarterly by the Board of Directors.
Dynex utilizes several tools and risk management strategies to monitor and
address interest rate risk, including (i) a quarterly sensitivity analysis using
option-adjusted spread ("OAS") methodology to calculate the expected change in
net interest margin as well as the change in the market value of various assets
within the portfolio under various extreme scenarios; and (ii) a monthly static
cash flow and yield projection under 49 different scenarios. Such tools allow
Dynex to continually monitor and evaluate its exposure to these risks and to
manage the risk profile of the investment portfolio in response to changes in
the market risk. While Dynex may use such tools, there can be no assurance Dynex
will accomplish the goal of adequately managing the risk profile of the
investment portfolio.
Dynex measures the sensitivity of its net interest income to changes in
interest rates. Changes in interest rates are defined as instantaneous,
parallel, and sustained interest rate movements in 100 basis point increments.
Dynex estimates its interest income for the next twelve months assuming no
changes in interest rates from those at period end. Once the base case has been
estimated, cash flows are projected for each of the defined interest rate
scenarios. Those scenario results are then compared against the base case to
determine the estimated change to net interest income.
The following table summarizes the Company's net interest margin
sensitivity analysis as of December 31, 1998. This analysis represents
management's estimate of the percentage change in net interest margin given a
parallel shift in interest rates. The "Base" case represents the interest rate
environment as it existed as of December 31, 1998. The analysis is heavily
dependent upon the assumptions used in the model. The effect of changes in
future interest rates on the mix of assets and liabilities may cause actual
results to differ from the modeled results. In addition, certain financial
instruments provide a degree of "optionality." The model considers the effects
of these embedded options when projecting cash flows and earnings. The most
significant option affecting the Company's portfolio is the borrowers' option to
prepay the loans. The model uses a dynamic prepayment model that applies a
Constant Prepayment Rate ranging from 5.5% to 70.1% based on the projected
incentive to refinance for each loan type in any given period. While Dynex's
model considers these factors, the extent to which borrowers utilize the ability
to exercise their option may cause actual results to significantly differ from
the analysis. Furthermore, its projected results assume no additions or
subtractions to the Company's portfolio, and no change to the Company's
liability structure. Historically, the Company has made significant changes to
its assets and liabilities, and is likely to do so in the future.
Basis Point % Change in Net
Increase (Decrease) Interest Margin from
in Interest Rates Base Case
----------------------- -----------------------
+200 (16.02)%
+100 (13.20)%
Base 41%
-100 13.96%
-200 31.03%
Approximately $2.6 billion of the Company's investment portfolio as of
December 31, 1998 is comprised of loans or securities that have coupon rates
which adjust over time (subject to certain periodic and lifetime limitations) in
conjunction with changes in short-term interest rates. Approximately 60% and 29%
of the ARM loans underlying the Company's collateral for collateralized bonds
are indexed to and reset based upon the level of six-month LIBOR and one-year
CMT, respectively.
Generally, during a period of rising short-term interest rates, the
Company's net interest spread earned on its collateralized bonds will decrease.
The decrease of the net interest spread results from (i) the lag in resets of
the ARM loans underlying the collateral for collateralized bonds relative to the
rate resets on the collateralized bonds and (ii) rate resets on the ARM loans
which are generally limited to 1% every six months or 2% every twelve months and
subject to lifetime caps, while the associated borrowings have no such
limitation. As short-term interest rates stabilize and the ARM loans reset, the
net interest margin may be restored to its former level as the yields on the ARM
loans adjust to market conditions. Conversely, net interest margin may increase
following a fall in short-term interest rates. This increase may be temporary as
the yields on the ARM loans adjust to the new market conditions after a lag
period. In each case, however, the Company expects that the increase or decrease
in the net interest spread due to changes in the short-term interest rates to be
temporary. The net interest spread may also be increased or decreased by the
proceeds or costs of interest rate swap and cap agreements.
As part of its asset/liability management process, the Company has entered
into interest rate caps and swaps agreements. These interest rate agreements are
used by the Company to help mitigate the risk related to the collateral for
collateralized bonds for fluctuations in interest rates that would ultimately
impact net interest income. To help protect the Company's net interest income in
a rising interest rate environment, the Company has purchased interest rate caps
with a notional amount of $351 million, which help reduce the Company's exposure
to interest rate risk rising above the lifetime interest rate caps on ARM loans
underlying the collateral for collateralized bonds. These interest rate caps
provide the Company with additional cash flow should the related index increase
above the contracted rates. The contracted rates on these interest rate caps are
based on one-month LIBOR, six-month LIBOR or one-year CMT. The Company has also
utilized interest rate swaps to convert floating rate borrowings to fixed rate
where the associated collateral financed is fixed rate.
The interest rate cap agreements represent protection for the earnings and
cashflow of the net collateral for collateralized bonds in adverse markets. To
date, market conditions have not been adverse such that the caps have been
utilized.
The remaining portion of the Company's collateral for collateralized bonds
as of December 31, 1998, approximately $0.8 billion, is comprised of loans that
have coupon rates that are either fixed or do not reset within the next 15
months. The Company has limited its interest rate risk on such collateral
primarily through the issuance of fixed-rate collateralized bonds. Overall, the
Company's interest rate risk is primarily related to the rate of change in
short-term interest rates, not the level of short-term interest rates.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AUDITED FINANCIAL STATEMENTS
MERIT SECURITIES CORPORATION
Independent Auditors' Report for the year ended December 31, 1998.............................10
Independent Auditors' Report for the years ended December 31, 1997 and 1996...................11
Balance Sheets - December 31, 1998 and 1997...................................................12
Statements of Operations - For the years ended December 31, 1998, 1997 and 1996...............13
Statements of Shareholder's Equity - For the years ended December 31, 1998, 1997 and 1996.....14
Statements of Cash Flows - For the years ended December 31, 1998, 1997 and 1996...............15
Notes to Financial Statements - For the years ended December 31, 1998, 1997 and 1996..........16
Independent Auditors' Report
The Board of Directors
Merit Securities Corporation:
We have audited the accompanying balance sheet of Merit Securities
Corporation (a wholly-owned subsidiary of Issuer Holding Corporation, Inc.) as
of December 31, 1998 and the related statements of operations, shareholder's
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such 1998 consolidated financial statements present fairly,
in all material respects, the financial position of Merit Securities Corporation
as of December 31, 1998, and the results of its operations and its cash flows
for the year then ended in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
Richmond, Virginia
March 26, 1999
Independent Auditors' Report
The Board of Directors
Merit Securities Corporation:
We have audited the accompanying balance sheet of Merit Securities Corporation
as of December 31, 1997 and the related statements of operations, shareholder's
equity and cash flows for each of the years in the two year period ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements present fairly, in all material
respects, the financial position of Merit Securities Corporation as of December
31, 1997, and the results of its operations and its cash flows for each of the
years in the two year period ended December 31, 1997 in conformity with
generally accepted accounting principles.
KPMG LLP
March 24, 1998
MERIT SECURITIES CORPORATION
Balance Sheets
December 31, 1998 and 1997
(amounts in thousands except share data)
1998 1997
------------------ -----------------
Assets:
Collateral for collateralized bonds $ 3,350,344 $ 3,835,289
Due from affiliates, net 5,611 -
Prepaid shelf registration fees 406 334
Cash 10 10
================== =================
$ 3,356,371 $ 3,835,633
================== =================
Liabilities and Shareholder's Equity
Liabilities:
Non-recourse debt - collateralized bonds $ 3,153,060 $ 3,622,877
Due to affiliates, net - 43,789
------------------ -----------------
3,153,060 3,666,666
------------------ -----------------
Shareholder's Equity:
Common stock, no par value, $1 stated value
10,000 shares authorized, 1,000 issued and outstanding 10 10
Additional paid-in capital 190,156 125,952
Accumulated other comprehensive income 33,575 64,707
Accumulated deficit (20,430) (21,702)
------------------
-----------------
203,311 168,967
================== =================
$ 3,356,371 $ 3,835,633
================== =================
See accompanying notes to financial statements.
MERIT SECURITIES CORPORATION
Statements of Operations
For the years ended December 31, 1998, 1997 and 1996
(amounts in thousands)
1998 1997 1996
------------------------------------------------------
Interest income:
Collateral for collateralized bonds $ 253,352 $ 181,690 $ 123,089
------------------------------------------------------
Interest and related expense:
Interest expense on collateralized bonds 247,380 173,096 110,401
Other collateralized bond expense 3,379 3,431 2,757
------------------------------------------------------
250,759 176,527 113,158
------------------------------------------------------
Net interest margin before provision for losses 2,593 5,163 9,931
Provision for losses (6,236) (2,800) (2,300)
------------------------------------------------------
Net interest margin (3,643) 2,363 7,631
Other income (expenses):
Gain on sale of securities 7,500 - -
Provision for loss on Dynex's sale of affiliates - - (29,434)
Interest on due to affiliates, net (2,014) (2,745) (1,736)
------------------------------------------------------
Income (loss) before extraordinary item 1,843 (382) (23,539)
Extraordinary item - loss on extinguishment of (571) - -
debt
------------------------------------------------------
Net income (loss) $ 1,272 $ (382) $ (23,539)
======================================================
See accompanying notes to financial statements.
MERIT SECURITIES CORPORATION
Statements of Shareholder's Equity
For the years ended December 31, 1998, 1997 and 1996
(amount in thousands)
Accumulated other Retained
Additional Accumulated other earnings
paid-in comprehensive (accumulated
Common Stock capital income deficit) Total
--------------- -------------- -------------------- --------------- ---------------
Balance at January 1, 1996 $ 10 $ 35,222 $ 10,313 $ 2,219 $ 47,764
Comprehensive income:
Net loss - - - (23,539) (23,539)
Change in net unrealized gain on
investments available-for-sale - - 49,991 - 49,991
--------------- -------------- -------------------- --------------- ---------------
Total comprehensive income 49,991 (23,539) 26,452
Contributed capital - 46,914 - - 46,914
--------------- -------------- -------------------- --------------- ---------------
Balance at December 31, 1996 10 82,136 60,304 (21,320) 121,130
Comprehensive income:
Net loss - - - (382) (382)
Change in net unrealized gain on
investments available-for-sale - - 4,403 - 4,403
--------------- -------------- -------------------- --------------- ---------------
Total comprehensive income 4,403 (382) 4,021
Contributed capital - 43,816 - - 43,816
--------------- -------------- -------------------- --------------- ---------------
Balance at December 31, 1997 10 125,952 64,707 (21,702) 168,967
Comprehensive income:
Net income - - - 1,272 1,272
Change in net unrealized gain on
investments available-for-sale - - (31,132) - (31,132)
--------------- -------------- -------------------- --------------- ---------------
Total comprehensive income - - (31,132) 1,272 (29,860)
Contributed capital - 64,204 - - 64,204
--------------- -------------- -------------------- --------------- ---------------
Balance at December 31, 1998 $ 10 $ 190,156 $ 33,575 $ (20,430) $ 203,311
=============== ============== ==================== =============== ===============
See accompanying notes to financial statements.
MERIT SECURITIES CORPORATION
Statements of Cash Flows
For the years ended December 31, 1998, 1997 and 1996
(amounts in thousands)
1998 1997 1996
-----------------------------------------------------
Operating activities:
Net income (loss) $ 1,272 $ (382) $ (23,539)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Gain on sale of securities (7,500) - -
Provision for losses 6,236 2,800 2,300
Provision for loss on Dynex's sale of affiliates - - 29,434
Amortization, net 35,589 20,440 8,407
Net change in prepaid shelf registration fees (72) 515 (97)
Other (515) 368 1,125
-----------------------------------------------------
Net cash provided by operating activities 35,010 23,741 17,630
-----------------------------------------------------
Investing activities:
Collateral for collateralized bonds:
Purchase of loans subsequently securitized (1,696,198) (2,300,444) (2,135,796)
Principal payments on collateral 2,074,578 916,580 433,484
Proceeds from sale of collateral for collateralized bonds 43,391 - -
Net decrease (increase) in accrued interest receivable
and funds held by trustee 3,511 (7,981) (11,414)
-----------------------------------------------------
Net cash provided by (used for) investing activities 425,282 (1,391,845) (1,713,726)
-----------------------------------------------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of collateralized bonds 1,589,198 2,243,324 2,071,285
Principal payments on collateralized bonds (2,063,058) (919,370) (437,509)
(Decrease) increase in accrued interest payable (1,236) 1,758 3,381
(Decrease) increase in due to affiliates (49,400) (1,424) 12,025
Proceeds from capital contributions 64,204 43,816 46,914
-----------------------------------------------------
Net cash (used for) provided by financing activities (460,292) 1,368,104 1,696,096
-----------------------------------------------------
Net change in cash - - -
Cash at beginning of year 10 10 10
-----------------------------------------------------
Cash at end of year $ 10 $ 10 $ 10
=====================================================
Supplemental disclosure of cash flow information:
Cash paid for interest $ 245,860 $ 172,853 $ 107,819
=====================================================
Supplemental disclosure of non-cash activities:
Purchase of interest rate agreements from affiliate $ - $ - $ 11,452
=====================================================
See accompanying notes to financial statements.
MERIT SECURITIES CORPORATION
Notes to Financial Statements
For the years ended December 31, 1998, 1997 and 1996
(amounts in thousands)
NOTE 1 - THE COMPANY
Merit Securities Corporation (the "Company") is a wholly-owned,
limited-purpose finance subsidiary of Issuer Holding Corporation, Inc. ("IHC").
The Company was organized to facilitate the securitization of loans through the
issuance and sale of collateralized bonds. Prior to September 4, 1996, the
Company was a wholly-owned subsidiary of Dynex Capital, Inc. ("Dynex"), a New
York Stock Exchange listed financial services company (symbol: DX). On September
4, 1996, IHC acquired all of the outstanding stock of the Company and certain
other affiliates of Dynex. IHC is a wholly-owned subsidiary of Dynex.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Federal Income Taxes
Dynex and its wholly-owned subsidiaries, including the Company, (together,
"Dynex Capital") have elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code. As a result, Dynex Capital generally
will not be subject to federal income taxation at the corporate level to the
extent that it distributes at least 95 percent of its taxable income to its
shareholders and complies with certain other requirements. Accordingly, no
provision has been made for income taxes for the Company in the accompanying
financial statements, as Dynex Capital believes it has met the prescribed
distribution requirements.
Collateral for Collateralized Bonds
Collateral for collateralized bonds consists of debt securities which have been
pledged to secure collateralized bonds. These debt securities are backed
primarily by adjustable-rate and fixed-rate mortgage loans secured by first
liens on single family residential properties, manufactured housing installment
loans secured by either a UCC filing or a motor vehicle title, and property tax
receivables.
Pursuant to the requirements of Statement of Financial Accounting Standards No.
115, Accounting for Certain Investments in Debt and Equity Securities, the
Company has classified all of its collateral for collateralized bonds as
available-for-sale. As such, the collateral for collateralized bonds at December
31, 1998 and 1997 is reported at fair value, with unrealized gains and losses
excluded from earnings and reported as accumulated other comprehensive income.
Deferred Issuance Costs
Costs incurred in connection with the issuance of collateralized bonds are
deferred and amortized over the estimated lives of the collateralized bonds
using a method that approximates the effective yield method. These costs are
included in the carrying value of the collateralized bonds.
Price Premiums and Discounts
Price premiums and discounts on the collateral for collateralized bonds and the
collateralized bonds are amortized into interest income or expense,
respectively, over the life of the related investment or obligation using a
method that approximates the effective yield method.
Derivative Financial Instruments
The Company enters into interest rate swap agreements and interest rate cap
agreements ("Interest Rate Agreements") to manage its sensitivity to changes in
interest rates. These Interest Rate Agreements are intended to provide income
and cash flow to offset potential reduced net interest income and cash flow
under certain interest rate environments. The Company has designated these
instruments as hedge positions.
The Company evaluates the effectiveness of these hedges against the financial
instrument being hedged under various interest rate scenarios. The revenues and
costs associated with interest rate swap agreements are recorded as adjustments
to interest expense on the collateralized bonds being hedged. For interest rate
cap agreements, the amortization of the cost of the agreements is recorded as a
reduction in the net interest margin on the collateral for collateralized bonds.
The unamortized cost is included in the carrying amount of the collateral for
collateralized bonds. These Interest Rate Agreements are carried at fair value,
with unrealized gains and losses reported as accumulated other comprehensive
income.
As a part of Dynex REIT's interest rate risk management process, Dynex REIT may
be required periodically to terminate hedge instruments. Any realized gain or
loss resulting from the termination of a hedge is amortized into income or
expense of the corresponding hedged instrument over the remaining period of the
original hedge or hedged instrument as a yield adjustment.
If the underlying asset or liability is sold or matures, or the criteria that
was executed at the time the hedge instrument was entered into no longer exists,
the Interest Rate Agreement is no longer accounted for as a hedge. Under these
circumstances, the accumulated change in the market value of the hedge is
recognized in current income to the extent that the effects of interest rate or
price changes of the hedged item have not offset the hedge results.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
Fair Value. The Company uses estimates in establishing fair value for its
collateral for collateralized bonds. Fair value estimates are determined by
calculating the present value of the projected cash flows of the instruments
using appropriate discount rates and credit loss assumptions. The discount rates
used are based on management's estimates of market rates, and the cash flows are
projected utilizing the current interest rate environment and forecasted
prepayment rates. Since the fair value of the Company's collateral for
collateralized bonds is based on estimates, actual gains and losses recognized
may differ from those estimates recorded in the financial statements. The fair
value of all on- and off- balance sheet financial instruments is presented in
Notes 3 and 6.
Allowance for losses. As discussed in Note 4, the Company has retained credit
risk on certain collateral for collateralized bonds. The Company has established
an allowance for losses for the estimated credit risk retained based on
management's judgment. The allowance for losses is evaluated and adjusted
periodically by management based on the actual and projected timing and amount
of the potential credit losses, as well as industry loss experience. Provisions
made to increase the allowance related to the credit risk retained is presented
as provision for losses in the accompanying financial statements. The Company's
actual credit losses may differ from those estimates used to establish the
allowance.
Prepaid Shelf Registration Fees
Fees incurred in connection with filing a shelf for the issuance of
collateralized bonds are deferred and recognized with each securitization
prorata to the size of the issuance.
Recent Accounting Pronouncements
In January 1998, the Company adopted the Statement of Financial Accounting
Standard No.130, "Reporting Comprehensive Income" ("FAS No. 130"). FAS No. 130
requires companies to classify items of other comprehensive income separately,
either in a separate statement of comprehensive income, in the statement of
shareholders' equity, or in the statement of operations.
Basis of Presentation
Certain amounts for 1997 and 1996 have been reclassified to conform to the
presentation for 1998.
NOTE 3 - COLLATERAL FOR COLLATERALIZED BONDS
The following table summarizes the Company's amortized cost basis and fair value
of collateral for collateralized bonds classified as available-for-sale at
December 31, 1998 and 1997, and the related average effective interest rates
(calculated for the month ended December 31, 1998 and 1997, and excluding
unrealized gains and losses):
- - --------------------------------------------------------------------------------------------------------------
1998 1997
Effective Effective
Fair Value Interest Rate Fair Value Interest Rate
- - --------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds:
Amortized cost $ 3,333,362 7.3% $ 3,795,393 7.2%
Allowance for losses (16,593) (24,811)
----------------- -----------------
Amortized cost, net 3,316,769 3,770,582
Gross unrealized gains 47,244 77,973
Gross unrealized losses (13,669) (13,266)
- - --------------------------------------------------------------------------------------------------------------
$ 3,350,344 $ 3,835,289
- - --------------------------------------------------------------------------------------------------------------
Collateral for collateralized bonds consists of debt securities backed primarily
by adjustable-rate and fixed-rate mortgage loans secured by first liens on
single family residential housing, manufactured housing installment loans
secured by either a UCC filing or a motor vehicle title and property tax
receivables. All collateral for collateralized bonds is pledged to secure
repayment of the related collateralized bonds. All principal and interest (less
servicing-related fees) on the collateral is remitted to a trustee and is
available for payment on the collateralized bonds. The Company's exposure to
loss on collateral for collateralized bonds is generally limited to the amount
of collateral pledged in excess of the related collateralized bonds issued, as
the collateralized bonds issued are non-recourse to the Company. The collateral
for collateralized bonds can be sold by the Company, but only subject to the
lien of the collateralized bond indenture.
The components of collateral for collateralized bonds at December 31, 1998 and
1997 are as follows:
- - --------------------------------------------------------------------------------------
1998 1997
- - --------------------------------------------------------------------------------------
Collateral, net of allowance $ 3,251,003 $ 3,681,789
Accrued interest receivable 21,723 25,235
Unamortized premiums and discounts, net 44,043 63,558
Unrealized gain, net 33,575 64,707
- - --------------------------------------------------------------------------------------
$ 3,350,344 $ 3,835,289
- - --------------------------------------------------------------------------------------
During 1998, the Company securitized $1.7 billion of collateral, through the
issuance of one series of collateralized bonds. The collateral securitized
primarily included single-family mortgage loans and manufactured housing loans.
The securitization was accounted for as part financing and part sale of the
underlying collateral pursuant to Statement of Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("FAS No. 125"). Under FAS No. 125, if an entity retains a call
provision on the bonds in excess of a "clean-up" call, usually defined as 10% of
the initial principal amount of the bond, the entity is precluded from
accounting for the securitization of the collateral and the issuance of the
bonds as a sale. The call provision is considered individually for each bond
issued. On all but one class of bonds issued in this securitization, the Company
retained call rights that are substantially in excess of a clean-up call. For
the one class of bonds with an original principal amount totaling $55,007, the
Company retained only a clean-up call provision of 10%. The Company therefore
treated the issuance of this class as a sale and recognized a gain of $7,500 in
connection with the sale of that class of bonds. The issuance of the remaining
classes of bonds was considered a financing transaction.
The fair value for the Company's residual interest in the securitization
discussed in the previous paragraph is determined by discounting estimated net
future cash flows, using discount rates that approximate current market rates
and using current expected prepayment rates. Estimated net future cash flows
include assumptions related to expected credit losses. As of December 31, 1998
the Company used a discount rate of 16% and an average constant prepayment rate
of 35%.
NOTE 4 - ALLOWANCE FOR LOSSES ON COLLATERAL FOR COLLATERALIZED BONDS
The following table summarizes the activity for the allowance for losses on
collateral for collateralized bonds for the years ended December 31, 1998, 1997
and 1996:
- - --------------------------------------------------------------------------------------------------------
1998 1997 1996
- - --------------------------------------------------------------------------------------------------------
Beginning balance $ 24,811 $ 31,732 $ 1,800
Provision for losses 6,236 2,800 2,300
Losses charged-off, net of recoveries (14,454) (9,721) (1,802)
- - --------------------------------------------------------------------------------------------------------
$ 16,593 $ 24,811 $ 31,732
- - --------------------------------------------------------------------------------------------------------
The Company has limited exposure to credit risk retained on loans which it has
securitized through the issuance of collateralized bonds. The aggregate loss
exposure is generally limited to the amount of collateral in excess of the
related investment-grade collateralized bonds issued (commonly referred to as
"overcollateralization"), excluding price premiums and discounts and hedge gains
and losses. The allowance for losses on the overcollateralization totaled
$16,593 and $24,811 at December 31, 1998 and 1997 respectively, and is included
in collateral for collateralized bonds in the accompanying consolidated balance
sheets. Overcollateralization at December 31, 1998 and 1997 totaled $144,359 and
$112,875, respectively.
On May 13, 1996, Dynex completed the sale of various Dynex affiliates to
Dominion Mortgage Services, Inc. (Dominion), a wholly-owned subsidiary of
Dominion Resources, Inc. Included in the affiliates sold was Meritech Mortgage
Services, Inc. (Meritech), the servicer for a significant portion of the
Company's collateral for collateralized bonds. As a result of this sale, the
Company recorded a $29.4 million provision for probable losses for those loans
pledged as collateral for collateralized bonds which were serviced by Meritech,
and where the Company has retained the credit risk. As part of the terms of the
sale, Dominion has provided for reimbursement of losses incurred by the Company
pursuant to various loss reimbursement guaranty agreements for actual losses
incurred on loans pledged as collateral for collateralized bonds and serviced by
Meritech which exceed the above reserve recorded by the Company, up to an
additional $30 million. Such guaranty agreements apply only to loans serviced by
Meritech and is specific to each collateralized bond issued by the Company.
NOTE 5 - COLLATERALIZED BONDS
The components of collateralized bonds along with certain other information at
December 31, 1998 and 1997 are summarized below:
- - --------------------------------------------------------------------------------------------------
1998 1997
Bonds Range of Bonds Range of
Outstanding Interest Rates Outstanding Interest Rates
- - --------------------------------------------------------------------------------------------------
Variable-rate classes $ 2,568,506 5.3%-6.8% $ 3,192,049 5.9%-7.7%
Fixed-rate classes 555,842 6.2%-15.0% 401,893 6.2%-15.0%
Accrued interest payable 5,202 6,438
Deferred bond issuance costs (2,081) (2,918)
Unamortized premium 25,591 25,415
- - ---------------------------------------------------------------------------------------------------
$ 3,153,060 $ 3,622,877
- - ---------------------------------------------------------------------------------------------------
Range of stated maturities 2016-2032 2016-2031
Number of series 8 7
- - ---------------------------------------------------------------------------------------------------
Each series of collateralized bonds may consist of various classes of bonds,
either at fixed or variable rates of interest. Payments received on the loans
pledged as collateral for collateralized bonds and any reinvestment income
thereon are used to make payments on the collateralized bonds (see Note 3). The
obligations under the collateralized bonds are payable solely from the
collateral for collateralized bonds and are otherwise non-recourse to the
Company. The maturity of each class is directly affected by the rate of
principal prepayments on the related mortgage collateral. Each series is also
subject to redemption according to specific terms of the respective indentures.
As a result, the actual maturity of any class of a collateralized bonds series
is likely to occur earlier than its stated maturity. Collateralized bonds are
carried at their outstanding principal balance, net of unamortized premiums and
discounts.
The variable rate classes are based on one-month London InterBank Offered Rate
("LIBOR"). The average effective rate of interest expense for collateralized
bonds was 6.8%, 7.2%, and 7.3% for the years ended December 31, 1998, 1997 and
1996, respectively.
During 1998, the Company redeemed five series of previously issued
collateralized bonds, which resulted in $571 of additional costs related to such
redemptions. The Company simultaneously sold these bonds to an affiliated
company, MSC I LP, but retained the right to call the bonds in March 1999,
therefore the Company recorded the transaction as a financing transaction.
NOTE 6 - ADDITIONAL INFORMATION ABOUT FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's recorded financial instruments, as well as information about
certain specific off-balance sheet financial instruments as of December 31, 1998
and 1997:
- - ---------------------------------------------------------------------------------------------------------------------------
1998 1997
Notional Amortized Notional Amortized
Amount Amount Fair Value Amount Amount Fair Value
- - ---------------------------------------------------------------------------------------------------------------------------
Recorded financial instruments:
Assets:
Collateral for collaterized
bonds $ - $3,311,548 $3,349,975 $ - $3,761,518 $3,834,465
Interest rate cap agreements 351,000 5,222 369 351,000 9,064 824
Cash - 10 10 - 10 10
Liabilities:
Collateralized bonds - 3,153,060 3,107,262 - 3,622,877 3,605,158
Off-balance sheet financial
instruments:
Interest rate swap agreements:
Collateralized bonds 123,883 - (1,282) 333,644 - (870)
- - ---------------------------------------------------------------------------------------------------------------------------
The estimated fair values of financial instruments have been determined using
available market information and appropriate valuation methodologies. However, a
degree of judgment is necessary in evaluating market data and forming these
estimates.
Recorded Financial Instruments. The fair value of the collateral for
collateralized bonds is based on the present value of the projected cash flows
using appropriate discount rates, credit loss and prepayment assumptions. The
fair value of the interest rate cap and swap agreements was determined using
market quotes and the fair value of the collateralized bonds was estimated to be
the carrying value as they reprice frequently.
During 1996, the Company purchased LIBOR-based interest rate cap agreements to
limit its exposure to the lifetime interest rate caps on certain of its
collateral for collateralized bonds. Under these agreements, the Company will
receive additional cash flow should the related index increase above the
contracted rates. Contract rates on these cap agreements range from 8.0% to
9.5%, with expiration dates ranging from 1999 to 2003.
Off-Balance Sheet Financial Instruments. The Company may enter into various
interest rate swap agreements to limit its exposure to changes in financing
rates of certain collateralized bonds. The Company entered into a 7-year
amortizing interest rate swap agreement with remaining notional of $123,883
related to prime-based loans financed with LIBOR-based variable-rate
collateralized bonds. Under the terms of the agreement, the Company receives
one-month LIBOR plus 2.65% and pays one-month average prime in effect 3 months
prior.
NOTE 7 - DUE FROM AFFILIATES
At December 31, 1998 , amounts due from affiliates consisted of amounts loaned
to Dynex net of amounts borrowed from IHC under demand promissory notes. Amounts
due to IHC totaled $43,107 and amounts due from Dynex totaled $48,718 at
December 31, 1998, respectively. At December 31, 1997 amounts due to affiliates
consisted of amounts borrowed from IHC and Dynex under demand promissory notes.
At December 31, 1997, amounts due to IHC and Dynex totaled $40,457 and $3,332
respectively. The Company had net interest expense related to these demand
promissory notes of $2,014, $2,745 and $1,736 during 1998, 1997 and 1996,
respectively.
NOTE 8 - CONTRIBUTED CAPITAL
Contributed capital represents IHC's net contribution of collateral for
collateralized bonds in excess of the related collateralized bonds issued.
During 1998 and 1997, capital contributions totaled $64,204 and $43,816,
respectively.
NOTE 9 - OTHER MATTERS
At December 31, 1998 and 1997, the Company had remaining $0.3 billion and $0.9
billion respectively, for issuance under shelf registration statements filed
with the Securities and Exchange Commission. In April 1998, the Company filed a
shelf registration statement for an additional $1.0 billion in securities which
was effective April 29, 1998. The Company also filed for an additional $1.0
billion shelf, which was not effective as of December 31, 1998.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 21, 1998, the Audit Committee of Dynex Capital, Inc. approved the
appointment of the accounting firm of Deloitte & Touche LLP ("D&T") as the
independent accountants for the year ending December 31, 1998 to replace KPMG
Peat Marwick LLP ("KPMG"), who were dismissed as the independent accountants
effective with such appointment.
The reports of KPMG on the Company's consolidated financial statements for each
of the two years ended December 31, 1997 and 1996 did not contain an adverse
opinion or a disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles.
In connection with the audits of the Company's consolidated financial statements
for the two years ended December 31, 1997 and 1996, and through July 21, 1998,
there have been no disagreements between the Company and KPMG on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope and procedures which, if not resolved to the satisfaction of KPMG, would
have caused them to make reference thereto in their report on the financial
statements for such years.
During the two years ended December 31, 1997 and 1996, and through July 21,
1998, the Company had not consulted with D&T regarding either (i) the
application of accounting principles to a specified transaction, either
completed or proposed; or the type of audit opinion that might be rendered on
the Company's financial statements, and either a written report was provided to
the Company or oral advice was provided that D&T concluded was an important
factor considered by the Company in reaching a decision as to the accounting,
auditing or financial reporting issue; or (ii) any matter that was either the
subject of a disagreement, as that term is defined in Item 304 (a) (1) (iv) of
Regulation S-K and the related instructions to Item 304 of Regulation S-K, or a
reportable event, as that term is defined in Item 304 (a) (1) (v) of Regulation
S-K.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 11. EXECUTIVE COMPENSATION
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information in response to this Item is omitted pursuant to General Instruction
I.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information in response to this Item is omitted pursuant to General Instruction
I.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (Incorporated
herein by reference to the Exhibits to Registrant's
Registration Statement No. 33-83524 on Form S-3 filed August 31, 1994).
3.2 Bylaws of the Registrant (Incorporated herein by reference to
the Exhibits to Registrant's Registration Statement No. 33-83524
on Form S-3 filed August 31, 1994).
3.3 Amended and Restated Articles of Incorporation of the Registrant,
effective April 19, 1995 (Incorporated herein by reference to Exhibit
to the Registrant's Current Report on Form 8-K, filed April 21, 1995).
4.1 Indenture between Registrant and Trustee, dated as of August 1, 1994
(Incorporated herein by reference to the Exhibits to Registrant's
Registration Statement No. 33-83524 on Form S-3 filed August 31, 1994).
4.2 Form of Supplement Indenture between Registrant and Trustee
(Incorporated herein by reference to the Exhibits to Registrant's
Registration Statement No. 33-83524 on Form S-3 filed August 31, 1994).
4.3 Copy of the Indenture, dated as of November 1, 1994, by and between
the Registrant and Texas Commerce Bank National Association, as
Trustee (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed December 19, 1994).
4.4 Copy of the Series 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). (Incorporated 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). (Incorporated herein by reference to
Exhibit of Registrant's Current Report on Form 8-K, filed July
11, 1997).
4.13 Copy of the Series 10 Indenture Supplement, dated as of December 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). (Incorporated herein by reference to
Exhibit of Registrant's Current Report on Form 8-K, filed
January 6, 1998).
4.14 Copy of the Series 11 Indenture Supplement, dated as of March 1, 1998,
by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (related schedules and exhibits available
upon request of the Trustee). (Incorporated herein by reference to
Exhibit of Registrant's Current Report on Form 8-K, filed June
12, 1998).
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
Current Report on Form 8-K as filed with the Commission on February 2,
1999, relating to the Registrant's Series 8 Bonds.
Current Report on Form 8-K as filed with the Commission on February 3,
1999, relating to the Registrant's Series 11 Bonds.
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)
By: /s/ Stephen J. Benedetti
Stephen J. Benedetti
(Principal Financial & Accounting Officer)
Dated: March 31, 1999
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Capacity Date
/s/ Thomas H. Potts Director March 31, 1999
Thomas H. Potts
/s/ J. Thomas O'Brien, Jr. Director March 31, 1999
J. Thomas O'Brien, Jr.
/s/ William H. West, Jr. Director March 31, 1999
William H. West, Jr.
/s/ John C. Stevenson, Jr. Director March 31, 1999
John C. Stevenson, Jr.
EXHIBIT INDEX
Sequentially
Exhibit Numbered Page
23.1 Consent of DELOITTE & TOUCHE LLP I
23.2 Consent of KPMG LLP II