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, 1997
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-9819
DYNEX CAPITAL, INC.
(Exact name of registrant as specified in its charter)
Virginia 52-1549373
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer I.D. No.)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of 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:
Title of each class Name of each exchange on which registered
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
<TABLE>
<S><C> <C>
Title of each class Name of each exchange on which registered
Series A 9.75% Cumulative Convertible Preferred Stock, Nasdaq National Market
$.01 par value
Series B 9.55% Cumulative Convertible Preferred Stock, $.01 Nasdaq National Market
par value
Series C 9.73% Cumulative Convertible Preferred Stock, $.01 Nasdaq National Market
par value
</TABLE>
Indicate by check mark whether the registrant(1) has filed all reports
required to be filed by Section 13 or 15(d) of theSecurities 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|
As of February 28, 1998, the aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately $542,631,239
(43,848,989) shares at a closing price on The New York Stock Exchange of
$12.375). Common stock outstanding as of February 28, 1998 was 45,543,182
shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement to be filed pursuant to
Regulation 14A within 120 days from December 31, 1997, are incorporated by
reference into Part III.
<PAGE>
<TABLE>
<CAPTION>
DYNEX CAPITAL, INC.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I PAGE
<S> <C> <C>
Item 1. BUSINESS.................................................. 3
Item 2. PROPERTIES................................................ 15
Item 3. LEGAL PROCEEDINGS......................................... 15
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....... 15
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS........................... 16
Item 6. SELECTED FINANCIAL DATA................................... 17
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............. 18
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............... 35
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE..................... 35
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......... 35
Item 11. EXECUTIVE COMPENSATION..................................... 35
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT...................................... 35
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............. 35
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K..................................... 35
SIGNATURES ........................................................... 38
</TABLE>
<PAGE>
Item 1. BUSINESS
GENERAL
Dynex Capital, Inc. (the "Company") was incorporated in the
Commonwealth of Virginia in 1987. References to the "Company" mean the parent
company, its wholly-owned subsidiaries and certain other affiliated
entities consolidated for financial reporting purposes. The Company has
elected to be treated as a real estate investment trust ("REIT") for federal
income tax purposes and, as such, must distribute substantially all of
its taxable income to shareholders and will generally not be subject to
federal income tax.
The Company is a mortgage and consumer finance company which uses its loan
production operations to create investments for its portfolio. The Company's
primary loan production operations include the origination of mortgage loans
secured by multifamily and commercial real estate properties (hereinafter
referred to as "commercial loans") and the origination of loans secured by
manufactured homes. The Company will generally securitize the loans
funded as collateral for collateralized bonds, limiting its credit risk and
providing long-term financing for its portfolio.
The Company's principal source of earnings is net interest income
on its investment portfolio. The Company's investment portfolio consists
principally of collateral for collateralized bonds, adjustable-rate
mortgage ("ARM") securities and loans held for securitization. The Company
funds its portfolio investments with both borrowings and cash raised from
the issuance of equity. For the portion of the portfolio investments
funded with borrowings, the Company generates net interest income to the
extent that there is a positive spread between the yield on the interest-
earning assets and the cost of borrowed funds. The cost of the Company's
borrowings may be increased or decreased by interest rate swap, cap or floor
agreements. For the portion of the balance sheet that is funded with equity,
net interest income is primarily a function of the yield generated from the
interest-earning asset.
Business Focus and Strategy
The Company'strives to create a diversified portfolio of investments that
in the aggregate generates stable income for the Company in a variety of
interest rate environments and preserves the capital base of the Company.
The Company'seeks to generate growth in earnings and dividends per share in a
variety of ways, including (i) adding investments to its portfolio when
opportunities in the market are favorable; (ii) developing production
capabilities to originate and acquire financial assets in order to create
attractively priced investments for its portfolio, as well as control the
underwriting and servicing of such financial assets and (iii) increasing the
efficiency with which the Company utilizes its equity capital over time.
To increase potential returns to shareholders, the Company also employs
leverage through the use of secured borrowings and repurchase agreements to
fund a portion of its portfolio investments. The Company's specific
strategies for its lending operations and investment portfolio are discussed
below.
Lending Strategies
The Company strives to be a vertically integrated lender by
performing the sourcing, underwriting, funding and servicing of loans to
maximize efficiency and provide superior customer service. The Company
adheres to the following business strategies in its lending operations:
develop loan production capabilities to originate and acquire financial
assets in order to create attractively priced investments for its
portfolio, generally at a lower cost than if investments with
comparable risk profiles were purchased in the secondary market;
focus on loan products that maximize the advantages of the REIT tax
election;
emphasize direct relationships with the borrower and minimize, to the
extent practical, the use of origination intermediaries;
use internally generated guidelines to underwrite loans for all
product types and maintain centralized loan pricing; and
perform the servicing function for loans on which the Company has credit
exposure; emphasizing the use of early intervention, aggressive
collection and loss mitigation techniques in the servicing process to
manage and seek to reduce delinquencies and to minimize losses in its
securitized loan pools.
Investment Portfolio Strategies
The Company adheres to the following business strategies in managing its
investment portfolio:
use its loan origination capabilities to provide assets for it
investment portfolio, generally at a lower effective cost than if
investments of comparable risk profiles were purchased in the secondary
market;
securitize its loan production to provide long-term financing for its
investment portfolio and to reduce the Company's liquidity, interest rate
and credit risk;
utilize leverage to finance purchases of loans and investments in line
with prudent capital allocation guidelines which are designed to balance
the risk in certain assets, thereby increasing potential returns to
shareholders while seeking to protect the Company's equity base;
structure borrowings to have interest rate adjustment indices and
interest rate adjustment periods that, on an aggregate basis,
generally correspond (within a range of one to six months) to the
interest rate adjustment indices and interest rate adjustment periods
of the related asset; and
utilize interest rate caps, swaps and similar instruments and
securitization vehicles with such instruments embodied in the
structure to mitigate the risk of the cost of its variable rate
liabilities increasing at a faster rate than the earnings on its assets
during a period of rising interest rates.
Lending Operations
The Company's primary lending activities include commercial mortgage
lending and manufactured housing lending. The Company will provide mortgage
financing for apartment properties, assisted living and retirement housing,
limited and full service hotels, urban and suburban office buildings, retail
shopping strips and centers, light industrial buildings and manufactured
housing parks. The Company's manufactured housing production includes
installment loans, land/home loans and inventory financing to manufactured
housing dealers. In addition to these primary sources of loan production, the
Company leases and provides financing to builders of single family homes that
serve as model homes for those builders and purchases and manages real estate
property tax portfolios. Additionally, the Company has purchased and may
continue to purchase single family mortgage loans on a "bulk" basis from time
to time.
The main purposes of the Company's production operations are to enhance
the return on shareholders' equity ("ROE") by earning a favorable net interest
spread while loans are being accumulated for securitization and to create
investments for the Company's portfolio at a lower cost than if such
investments were purchased from third parties. The creation of such
investments generally involves the issuance of collateralized bonds or pass-
through securities collateralized by the loans generated from the Company's
production activities, and the retention of one or more classes of the
collateralized bonds or securities relating to such issuance. The
securitization of loans as collateralized bonds and pass-through securities
generally limits the Company's credit and interest rate risk in contrast to
retaining loans in the portfolio in whole-loan form.
<PAGE>
The following table summarizes the production activity for the three years
ended December 31, 1997, 1996 and 1995.
Loan Production Activity
($ in thousands)
<TABLE>
<CAPTION>
- --------------------------------------------------- -- --------------------------------------------------
For the Years Ended December 31,
--------------------------------------------------
<S> <C> <C> <C>
1997 1996 1995
-------------- -------------- --------------
Commercial $ 290,988 (1) $ 201,496 $ 18,432
Manufactured housing 265,906 41,031 -
Single family - 499,288 875,521
Specialty finance 168,965 35,505 184
-- ----------- -- ----------- -- -----------
Total fundings through direct production 725,859 777,320 894,137
Securities acquired through bond calls 493,152 - -
Single family fundings through bulk purchases 1,271,479 731,460 22,433
== =========== == =========== == ===========
Total fundings $ 2,490,490 $ 1,508,780 $ 916,570
== =========== == =========== == ===========
Principal amount of loans and securities
securitized or sold $ 2,278,633 $ 1,357,564 $ 1,172,101
== =========== == =========== == ===========
<FN>
(1) Included in commercial fundings were $49 million of loans funded in
connection with the issuance of tax-exempt bonds. These loans are not
included in the balance of the loans held for securitization, as funding for
these loans was provided by the sale of tax-exempt bonds.
</FN>
</TABLE>
During 1997, the Company funded $291 million of commercial mortgage
loans consisting of $118 million of multifamily loans, $49 million in
construction/permanent loans and $124 million in other types of commercial
loans. The majority of the multifamily loans funded in 1997 consist of
permanent mortgage loans on properties that have been allocated low
income housing tax credits. The Company initiated a construction/permanent
lending program on multifamily properties in the fourth quarter of 1997.
The majority of such construction/permanent loans related to mortgage loans
securing tax-exempt bonds. Other types of commercial loans consist primarily
of loans on hotels, office buildings, light industrial space and
distribution centers. As of December 31, 1997, commitments to fund
commercial loans were approximately $642 million. Additionally, the
Company securitized $314 million of its commercial loan production through a
collateralized bond issuance in October 1997.
During 1997, the Company funded $266 million of manufactured housing
loans and as of December 31, 1997, had commitments outstanding to fund
$56 million of such loans. The Company securitized a total of $235 million of
its manufactured housing production through the issuance of two
collateralized bonds during 1997.
The Company's specialty finance businesses funded $169 million during
1997. Such fundings principally included the purchase and leaseback or
financing of $110 million of model homes and the acquisition of $39 million of
property tax liens.
The Company owns the right to call $1.0 billion of securities previously
issued by the Company once the outstanding value of such securities reaches
35% or less of the original amount issued. During 1997, the Company
exercised its call rights on $493 million of such securities. These securities
were included in new securitizations during 1997.
Additionally, during 1997, the Company purchased $1.3 billion of
single family ARM loans through various bulk purchases. The Company will
continue to purchase single family loans on a bulk basis to the
extent, that upon securitization, such purchases would generate a
favorable return to the Company on a proforma basis. All of the single
family ARM loans purchased were securitized through the issuance of the
collateralized bonds in 1997.
Commercial Lending Operations
The Company originates commercial mortgage loans which are secured
primarily by multifamily properties, as well as limited service hotels,
office buildings, light industrial and warehouse spaces, retirement homes,
distribution centers and retail space. The Company originally entered the
commercial market in 1992 as a multifamily lender focused on multifamily
mortgage loans secured by apartment properties that qualified for low-income
housing tax credits ("LIHTCs") under Section 42 of the Internal Revenue Code.
Since 1992, the Company has funded or provided loan commitments for
approximately $1 billion of LIHTC communities nationwide. The Company
believes that it is one of the country's leading LIHTC lenders, with an
estimated market share of 15%. In 1997, the Company broadened its commercial
mortgage lending beyond LIHTC apartment properties to include apartment
properties that have not received LIHTCs, assisted living and retirement
housing, limited service hotels, office buildings, retail shopping strips and
centers and light industrial buildings.
LIHTC Lending
Approximately one-third of all multifamily housing starts during 1997
were LIHTC properties. For property owners to comply with the LIHTC
regulations, owners must "set aside" at least 20% of the units for rental to
families with income of 50% or less of the median income for the locality as
determined by the Department of Housing and Urban Development (HUD), or at
least 40% of the units to families with income of 60% or less of the HUD
median income. Most owners elect the "40-60 set-aside" and designate 100%
of the units in the project as LIHTC units. Additionally, rents cannot
exceed 30% of the annual HUD median income adjusted for the unit's designated
"family size."
Generally, the LIHTCs are sold by the developers to investors prior to
construction in order to provide additional equity for the project. The sale
of the LIHTCs typically provides funds equal to approximately 50% of the
construction costs of the project. The multifamily loans made by the Company
normally fund the difference between the project cost (including a fee to
the developer) and the funds generated from the sale of the LIHTCs. The
average principal balance of LIHTC loans originated in 1997 was $3.5
million, ranging in size from $1.0 million to $10.0 million. The multifamily
mortgage loans originated by the Company are currently sourced through
direct relationships with the developers and syndicators of LIHTCs.
There are no correspondent or broker relationships.
Multifamily Construction/Permanent Lending
As a part of its product expansion efforts during 1997, the Company began
offering a multifamily construction/permanent loan program for LIHTC
properties. The construction loans range in size from $1 million to
$10 million with a loan-to-value of 80% or less of the appraised property
value. The Company underwrites each property to its required debt service
coverage and loan-to-value levels, and serves as the construction loan
administrator on each property.
Tax-exempt Bonds
The Company facilitates the issuance of tax-exempt multifamily housing
bonds, the proceeds of which are used to fund mortgage loans on multifamily
properties. The Company enters into standby commitment agreements whereby
the Company is required to pay principal and interest to the bondholders
in the event there is a payment shortfall on the underlying mortgage loans.
In addition, the Company is required to purchase the bonds if such bonds
are not able to be remarketed by the remarketing agent. The bonds are
remarketed in the tax-exempt market generally every seven days. The Company
has provided letters of credit to support its obligations in amounts equal
$25.9 million at December 31, 1997. There were nooutstanding letters of credit
at December 31, 1996.
Other Commercial Lending
The Company's expansion into non-multifamily commercial lending during
1997 was due to several factors: (i) to increase volume to expedite
securitizations, (ii) to capitalize on the underwriting, closing and servicing
infrastructure that the Company already had in place, and (iii) to benefit in
the securitization rating levels from a more diversified pool of loans.
The commercial loans are combined with the multifamily loans and securitized
through the issuance of collateralized bonds.
The Company sources these commercial loans through direct relationships
with developers, property owners and on a selected basis from commercial
mortgage bankers. The Company's underwriting guidelines for other commercial
mortgage loans are generally consistent with rating agency and investor
requirements.
The other commercial mortgages primarily have fixed interest rates with
loan sizes that generally vary from $1 million to $20 million. The product
types include mainly limited service hotels, industrial warehouse,
distribution centers, retirement homes, retail and office property.
<PAGE>
Risk Management
Because the Company funds and commits to fund commercial loans at
fixed-interest rates, the Company is exposed to interest rate risk to the
extent that interest rates increase prior to the time such loans are
securitized. The Company'strives to mitigate such risk by the use of futures
contracts and forward contracts of US treasury securities with duration
characteristics similar to such loans and loan commitments.
Manufactured Housing Lending Operations
The Company has been funding manufactured housing loans since 1996.
The Company believes the manufactured housing lending market is growing
as a result of strong customer demand. The market for loans on new
manufactured homes is approximately $14 billion annually, and is expected to
grow as shipments of multi-section homes relative to single-section homes
increases and average loan size increases. The manufactured home is
gaining greater market acceptance as the product's quality improves and its
affordability remains attractive versus site built housing.
A manufactured home is distinguished from a traditional single family home
in that the housing unit is constructed in a plant, transported to the site
and secured to a pier or a foundation, whereas a single family home is built
on the site. The majority of the manufactured housing loans are in the form of
a consumer installment loan (i.e., a personal property loan) in which the
borrower rents or owns the land underlying the manufactured home. However,
an increasing percentage of these loans are in the form of a "land/home"
loan, a first lien mortgage loan. The Company offers both fixed and
adjustable rate loans with terms ranging from 7 to 30 years. The Company
underwrites all loans which it originates. As of December 31, 1997, the
Company had $56 million in principal balance of manufactured housing
loans in inventory and had commitments outstanding of approximately $56
million. As of December 31, 1997, the average funded amount per loan is
approximately $40,000. To date, approximately 96% of the Company's loan
fundings have been fixed interest rate loans.
The Company has two primary distribution channels -- its dealer network
and direct lending. Substantially all new manufactured homes are sold through
manufactured housing dealers. Approximately 90% of these homes are financed.
There are over 7,000 manufactured housing dealers operating in the United
States, many with multiple sales locations. The Company plans to expand
its distribution channels to nearly all sources for manufactured housing
loans by establishing relationships with park owners, developers of
manufactured housing communities, manufacturers of manufactured homes,
brokers and correspondents. As of December 31, 1997, the Company had 1,113
approved dealers with 1,867 sales locations.
The Company services its dealer network through its home office in
Virginia and its five regional offices located in North Carolina, Georgia,
Texas, Ohio and Washington. The Company also has three district sales offices.
Each regional office supports three to four district sales managers who
establish and maintain relationships with manufactured housing dealers. By
using the home/regional/district office structure, the Company has created a
decentralized customer service and loan origination organization with
centralized controls and support functions. The Company believes that this
approach also provides the Company with a greater ability to maintain customer
service, to respond to market conditions, to enter and exit local markets
and to test new products.
Inventory Financing.
The Company offers inventory financing, or "lines of credit," to
retail dealers for the purpose of purchasing manufactured housing
inventory to display and sell to customers. Under such arrangements, the
Company will lend against the dealer's line of credit when an invoice
representing the purchase of a manufactured home by a dealer is presented to
the Company by the manufacturer of the manufactured home. Prior to
approval of the line of credit for the dealer, the Company will perform a
financial review of the manufacturer as well as the dealer. The Company
performs monthly inspections of the dealer's inventory financed by the
Company and annual reviews of both the dealer and the manufacturer. The
Company believes that offering this product will increase market presence
and will enable the Company to improve its positioning with the dealers and
manufacturers.
Manufactured housing loans originated by the Company are primarily
fixed-rate loans. To reduce interest rate risk associated with these
fixed-rate loans, the Company utilizes interest rate forwards, futures and
swaps until the pool ofloans is securitized. To date, the loans have been
securitized through the issuance of variable rate bonds, with the interest
on a portion of such bonds swapped to a fixed rate through an interest rate
swap agreement.
<PAGE>
Specialty Finance
Model Home Sales/Leaseback and Lending.
The Company provides financing to single family home builders through a
sale/leaseback program in which the Company purchases single family homes
from builders and the builders simultaneously lease back the homes for use
as models. The Company also provides loans to builders secured by the single
family homes used as models. The Company has an appraisal performed on each
home and limits the amount of the loan or purchase price for the homes to a
predetermined percentage of each home's appraised value. Upon expiration
of the lease period, the Company'sells the home to a third-party buyer. The
lease terms are generally 12-24 months and can be extended at the option of
the builder upon approval of the Company. During 1997, the Company
purchased and subsequently leased back or provided financing to builders
for $116 million of models homes. At December 31, 1997, the Company had
$131 million of model homes on lease or had provided financing to 21 builders
throughout the United States and Mexico.
Property Tax Receivables. Since 1993, the Company has been involved in
the purchase and management of property tax receivables from various state
and local jurisdictions. A property tax receivable is a delinquent tax on
real property that has a lien status superior to any mortgage (and most other
liens) on the property. As a result, the property tax receivables generally
have a very low "lien-to-value". Various jurisdictions sell these property
tax receivables to investors, as the private sector is more efficient and
better equipped to collect the taxes and to get the properties back on the
tax rolls. The Company offers payment plans to taxpayers in order to assist
them in bringing their property taxes current. In the event the taxpayer
does not pay the property tax receivable, the Company has the right to
foreclose on the property to recover the amount of the tax and associated costs.
The Company had $42 million of property tax receivables at December 31,
1997 in five states. Over 80% of the property tax receivables are on single
family residential properties. The Company has established local offices
responsible for collecting the property tax receivables, and if necessary,
foreclosing on the properties in the event that the collection efforts fail.
Due to the short duration of the property tax receivables, the Company holds
such assets in the portfolio with no current plans to securitize them.
Single Family Lending
Pursuant to the terms of the sale of the Company's single family
mortgage operations to a subsidiary of Dominion Resources, Inc. during the
second quarter of 1996, the Company is precluded from originating or purchasing
certain types of single family loans through a wholesale or correspondent
network through April, 2001. However, the Company may purchase any type of
single family loans on a bulk basis, i.e., in blocks of $25 million or more,
and may originate loans on a retail basis. Currently, the Company purchases
"A" quality adjustable-rate, single family loans on a bulk basis to the extent
that the Company can generate a favorable return on investment upon
securitization. Due to the sale of its single family mortgage operations,
the Company does not currently have the internal capability to directly
underwrite single family mortgage loans. In the future, the Company may
re-establish an internal capability for single family mortgage loans. In the
interim, the Company may utilize independent contractors to assist in the
underwriting and servicing of such loans. During 1997, the Company purchased
$1.3 billion of single family, "A" quality loans through such bulk loan
purchases and securitized the entire amount.
Loan Servicing
During 1996, the Company established the capability to service both
commercial and manufactured housing loans funded through its production
operations. The purpose of servicing the loans funded through the production
operations is to manage the Company's credit exposure more effectively while
the loans are held for securitization, as well as to limit the credit exposure
that is usually retained when the Company securitizes the pool of loans. The
commercial servicing function is located in Glen Allen, Virginia and
includes collection and remittance of principal and interest payments,
administration of tax and insurance accounts, management of the replacement
reserve funds, collection of certain insurance claims and, in the event of
default, the workout of such situations through either a modification
of the loan or the foreclosure and sale of the property.
The manufactured housing servicing function is operated in Fort Worth,
Texas. As the servicer of manufactured housing loans, the Company is
responsible for the collection of monthly payments, and if the loan defaults,
the resolution of the defaulted loan through either a modification of the
loan or the repossession and sale of the related property. With manufactured
housing loans, minimizing the time between the date the loan goes in
default and the time that the manufactured home is repossessed and sold is
critical to mitigating losses on these loans.
<PAGE>
Loan Securitization Strategy
The Company primarily uses funds provided by its senior notes, bank
borrowings and equity to finance loan production when loans are initially
funded. When a sufficient volume of loans is accumulated, the loans are
securitized through the issuance of collateralized bonds. As a result of
the reduction in the availability of mortgage pool insurance, and the
Company's desire to reduce both its recourse borrowings as a percentage of its
overall borrowings and the variability of its earnings, the Company has
utilized the collateralized bond structure for securitizing substantially
all of its loan production since the beginning of 1995. Prior to 1995,
the Company issued pass-through securities, in a senior-subordinated
structure or with pool insurance.
The Company believes that securitization is an efficient and cost
effective way to (i) reduce capital otherwise required to own the loans in
whole loan form; (ii) limit the Company's credit exposure on the loans;
(iii)lower the overall cost of financing the loans and (iv) limit the Company's
exposure to interest rate and/or valuation risk, depending on the
securitization structure. The length of time between when the Company funds
the loan and when it securitizes such loan varies depending on certain
factors including the loan volume, fluctuations in the prices of securities
and variations in the securitization process.
The securities are structured by the Company'so that a substantial
portion of the securities are rated in one of the two highest rating categories
(i.e., AAA or AA) by at least one of the nationally recognized rating agencies.
In contrast to mortgage-backed securities in which the principal and interest
payments are guaranteed by the U. S. government or an agency thereof,
securities created by the Company do not benefit from any such guarantee.
The ratings for the Company's collateralized bonds are based on the perceived
credit risk by the applicable rating agency of the underlying mortgage loans,
the structure of the securities and the associated level of credit enhancement.
Credit enhancement is designed to provide protection to one or more
classes of security holders in the event of a borrower default and to protect
against other losses, including those associated with fraud or reductions in
the principal balances or interest rates on mortgage loans as required by
law or a bankruptcy court. Credit enhancement for these securities may
take the form of over-collateralization, subordination, reserve funds,
mortgage pool insurance, bond insurance, third-party limited guaranties
or any combination of the foregoing. The Company'strives to use the most cost
effective security structure and form of credit enhancement available at
the time of securitization. Each series of securities is expected to be
fully payable from the collateral pledged to secure the series.
Master Servicing
The Company performs the function of master servicer for certain of the
securities it has issued, including all of the securities it has issued since
1995. The master servicer's function typically includes monitoring and
reconciling the loan payments remitted by the servicers of the loans,
determining the payments due on the securities and determining that the
funds are correctly sent to a trustee or investors for each series of
securities. Master servicing responsibilities also include monitoring
the servicers' compliance with its servicing guidelines. As master
servicer, the Company is paid a monthly fee based on the outstanding
principal balance of each such loan master serviced or serviced by the
Company as of the last day of each month. As of December 31, 1997, the
Company master serviced $4.0 billion in securities.
Investment Portfolio
The core of the Company's earnings is derived from its investment
portfolio. The Company's strategy for its investment portfolio is to create a
diversified portfolio of high quality assets that in the aggregate generates
stable income in a variety of interest rate and prepayment environments and
preserves the Company's capital base. In many instances, the investment
strategy involves not only the creation of the asset, but also structuring
the related securitization or borrowing to create a stable yield profile and
reduce interest rate and credit risk.
The Company continuously monitors the aggregate cash flow, projected
net yield and market value of its investment portfolio under various interest
rate and prepayment environments. While certain investments may perform
poorly in an increasing or decreasing interest rate environment, certain
investments may perform well, and others may not be impacted at all. Generally,
the Company adds investments to its portfolio which are designed to increase
the diversification and reduce the variability of the yield produced by the
portfolio in different interest rate environments.
Credit Quality. The investment portfolio is of very high credit quality.
Excluding certain securities where the risk is primarily the rate of prepayments
and not credit, 98% of the Company's investments relate to securities rated
AA or AAA by at least one rating agency. These ratings are based on AAA
rated bond insurance, mortgage pool insurance or subordination. On
securities where the Company has retained a portion of the credit risk below
the investment grade level (BBB), the Company's maximum exposure to credit
losses (net of discounts, reserves and third party guarantees) was $87
million as of December 31, 1997.
Composition. The following table presents the balance sheet composition of
the investment portfolio by investment type and the percentage of the total
investments as of December 31, 1997 and 1996.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
As of December 31,
------------------------------------------------------------
1997 1996
- ----------------------------------------------------------------------------------------------------
(amounts in thousands) Balance % of Balance % of
Total Total
<S> <C> <C> <C> <C>
bonds
Mortgage securities:
Adjustable-rate mortgage 386,159 7 758,746 19
securities
Fixed-rate mortgage 23,065 1 32,535 1
securities
Derivative and residual 104,526 2 98,931 3
securities
Other investments 214,120 4 98,943 3
Loans held for securitization 235,023 4 265,537 6
---------------- ------------ ------------- ------------
Total investments $ 5,338,454 100% $ 3,953,034 100 %
================ ============ ============= ============
- ----------------------------------------------------------------------------------------------------
</TABLE>
Collateral for collateralized bonds. Collateral for collateralized
bonds represents the single largest investment in the Company's portfolio.
Interest margin on the net investment in collateralized bonds (defined as the
principal balance of collateral for collateralized bonds less the principal
balance of the collateralized bonds outstanding) is derived primarily from
the difference between (i) the cash flow generated from the collateral pledged
to secure the collateralized bonds and (ii) the amounts required for
payment on the collateralized bonds and related insurance and
administrative expenses. Collateralized bonds are generally non-recourse
to the Company. The Company's yield on its net investment in collateralized
bonds is affected primarily by changes in interest rates and prepayment
rates and, to a lesser extent, credit losses on the underlying loans. The
Company may retain for its investment portfolio certain classes of the
collateralized bonds issued and pledge such classes as collateral for repurchase
agreements. Collateral for collateralized bonds is composed primarily of ARM
securities with indices based on six-month LIBOR and one-year CMT. The
Company's current lending production is predominantly fixed-rate loans, and
accordingly the mix of adjustable-rate versus fixed-rate loans may change in
future periods.
ARM securities. Another segment of the Company's portfolio is the
investments in ARM securities. The interest rates on the majority of the
Company's ARM securities reset every six months and the rates are subject
to both periodic and lifetime limitations. Generally, the Company finances
a portion of its ARM securities with repurchase agreements, which have a fixed
rate of interest over a term that ranges from 30 to 90 days and, therefore,
are not subject to repricing limitations. As a result, the net interest
margin on the ARM securities could decline if the spread between the yield on
the ARM security versus the interest rate on the repurchase agreement was to be
reduced.
Fixed-rate mortgage securities. Fixed-rate mortgage securities consist
of securities that have a fixed-rate of interest for specified periods of
time. Certain fixed-rate mortgage securities have a fixed interest rate for
the first 3, 5 or 7 years and an interest rate that adjusts at six- or
twelve-month intervals thereafter, subject to periodic and lifetime
interest rate caps. The Company's yields on these securities are primarily
affected by changes in prepayment rates. Such yields will decline with an
increase in prepayment rates and will increase with a decrease in prepayment
rates. The Company generally borrows against its fixed-rate mortgage securities
through the use of repurchase agreements.
Derivative and residual securities. Derivative and residual securities
consist primarily of interest-only securities ("I/Os"), principal-only
securities ("P/Os") and residual interests which were either purchased or were
created through the Company's production operations. An I/O is a class of a
collateralized bond or a mortgage pass-through security that pays
to the holder substantially all interest. A P/O is a class of a collateralized
bond or a mortgage pass-through security that pays to the holder substantially
all principal. Residual interests represent the excess cash flows on a
pool of mortgage collateral after payment of principal, interest and expenses
of the related mortgage-backed security or repurchase arrangement. Residual
interests may have little or no principal amount and may not receive
scheduled interest payments. Included in the residual interests at December
31, 1997 was $81 million of equity ownership in residual trusts which own
collateral financed with repurchase agreements. The collateral consists
primarily of agency ARM securities. The Company's borrowings against its
derivative and residual securities is limited by certain loan covenants to
3% of shareholders' equity. The yields on these securities are affected
primarily by changes in prepayment rates and by changes in short-term
interest rates.
Other investments. Other investments consists primarily of single
family homes purchased and simultaneously leased back to home builders.
At the end of each lease, generally after a twelve to eighteen month lease
term, the Company will sell the home. Also included in other investments are
property tax receivables and an installment note received as part of
the consideration for the sale of the single family mortgage operations in 1996.
Loans held for securitization. Loans held for securitization consist
primarily of loans originated or purchased through the Company's production
operations that have not been securitized. During the accumulation period, the
Company is exposed to risks of interest rate fluctuations and may enter into
hedging transactions to reduce the change in value of such loans caused by
changes in interest rates. The Company is also at risk for credit losses
on these loans during accumulation. This risk is managed through the
application of loan underwriting and risk management standards and
procedures and the establishment of reserves.
Hedging and other portfolio transactions. As part of its asset/liability
management process, the Company enters into interest rate agreements such as
interest rate caps and swaps and financial futures contracts ("hedges").
These agreements are used to reduce interest rate risk which arises from
the lifetime interest rate caps on the ARM securities, the mismatched
repricing of portfolio investments versus borrowed funds and assets repricing
on indices such as the prime rate which are different than the related
borrowing indices. The agreements are designed to protect the portfolio's
cash flow and to stabilize the portfolio's yield profile in a variety of
interest rate environments.
Approximately $4.1 billion of the Company's investment portfolio as
of December 31, 1997 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.
Generally, during a period of rising short-term interest rates, the Company's
net interest spread earned on its investment portfolio will decrease. The
decrease of the net interest spread results from (i) the lag in resets of the
ARM loans underlying the ARM securities and collateral for collateralized bonds
relative to the rate resets on the associated borrowings and (ii) rate resets
on the ARM loans which are generally limited to 1% every six 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 cost or proceeds of interest rate
swap, cap or floor agreements.
Because of the 1% periodic cap nature of the ARM loans underlying the ARM
securities, these securities may decline in market value in a rising interest
rate environment. In a rapidly increasing rate environment, as was experienced
in 1994, a decline in value may be significant enough to impact the amount of
funds available under repurchase agreements to borrow against these
securities. In order to maintain liquidity, the Company may be required to
sell certain securities. To mitigate this potential liquidity risk, the
Company strives to maintain excess liquidity to cover any additional margin
required in a rapidly increasing interest rate environment, defined as a 3%
increase in short-term interest rates over a twelve-month time period. The
Company has also entered into an interest rate swap transaction aggregating
$1.02 billion notional amount, which is designed to protect the Company's
cash flow and earnings on the ARM securities and certain collateral on
collateralized bonds in a rapidly rising interest rate environment. Under
the terms of this interest rate swap agreement, the Company receives payment
if one-month LIBOR increases by 1% or more in any six-month period. Finally,
the Company has purchased $1.5 billion notional amount of interest rate cap
agreements to reduce the risk of the lifetime interest rate limitation on the
ARM securities and on certain collateralized bonds owned by the Company.
Liquidity risk also exists with all other investments pledged as collateral
for repurchase agreements, but to a lesser extent.
The remaining portion of the Company's investments portfolio as of
December 31, 1997, approximately $1.2 billion, is comprised of loans or
securities 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 investments through (i) the issuance of fixed-rate collateralized bonds
and notes payable, (ii) interest rate swap agreements (Company receives
floating, pays fixed) and (iii) equity, which in the aggregate totals
approximately $1.2 billion as of the same date. 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.
<PAGE>
Risks
The Company is exposed to three types of risks inherent in its investment
portfolio. These risks include credit risk (inherent in the loans before
securitization and the security structure after securitization), prepayment/
interest rate risk (inherent in the underlying loan) and margin call risk
(inherent in the security if it is used as collateral for borrowings).
In general, the Company has developed analytical tools and risk management
strategies to monitor and address these risks, including (i) weekly
mark-to-market of a representative basket of securities within the
portfolio, (ii) monthly analysis using advanced option-adjusted spread
("OAS") methodology to calculate the expected change in the market
value of various assets within the portfolio under various extreme
scenarios; (iii) a monthly static cash flow and yield projection under 49
different scenarios, and (iv) a monthly "Portfolio Committee" meeting to
review the status of the portfolio, changes in the portfolio and any issues
and recommendations. Additionally, the portfolio status is reviewed
with the Board of Directors on a quarterly basis. Such tools allow the
Company 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 risk profile. While the Company may use such tools, there
can be no assurance the Company will accomplish the goal of adequately
managing the risk profile of the investment portfolio.
Credit Risk. When a loan is funded and becomes part of the Company's
investment portfolio, the Company has all of the credit risk on the loan
should it default. Upon securitization of the pool of loans, the credit
risk retained by the Company is generally limited to the net investment in
collateralized bonds and subordinated securities. The Company began to retain
a portion of the credit risk on securitized mortgage loans in 1994 as
mortgage pool insurance became less available in the market and as the
Company diversified into other products. To the extent the Company has
credit exposure on a pool of loans after securitization, the Company will
generally utilize its servicing capabilities in an effort to better manage
its credit exposure. The Company evaluates and monitors its exposure to
credit losses and has established reserves and discounts for anticipated
credit losses based upon estimated future losses on the loans, general
economic conditions and trends in the portfolio. As of December 31, 1997,
the Company's maximum credit exposure (net of discounts, reserves and
guarantees from a third party) on its investment portfolio (excluding loans
held for securitization) is $87 million or less than 16% of total equity.
The reserve relating to loans held for securitization was $2 million or 0.76%
of total loans held for securitization at December 31, 1997.
Prepayment/Interest Rate Risk. The Company strives to structure its
portfolio of investments to provide stable spread income in a variety of
prepayment and interest rate scenarios. To manage prepayment risk (i.e. from a
decline in long-term rates on fixed rate assets, or a flattening or inverse
yield curve as to ARM assets), the Company minimizes the amount of
"interest-only" investments or premium on assets. Thus, in a period of low
interest rates or a flat yield curve, the Company should not have a material
earnings exposure to rapid amortization or write-down of assets due to faster
prepayments. The Company has, in aggregate, less than $69 million of asset
premium and "interest-only" investments. In addition, future earnings may be
lowered as a result of the reduction in the interest earning assets from the
increased prepayment speeds.
The Company also views its hedging activities as a tool to manage interest
rate risk. To manage interest rate spread risk as a result of a rapid increase
in short term rates, the Company has entered into a $1.02 million interest rate
swap agreement which essentially removes the 1% periodic cap on certain
six-month ARM assets. Additionally, if short term rates were to rise
significantly, the Company has over $1 billion in interest rate cap agreements
(with strike prices between 9% and 11%) which would limit the Company's
borrowing cost on its $1.0 billion of short term debt.
Margin Call Risk. The Company uses repurchase agreements to finance a
portion of its investment portfolio. This financing structure exposes the
Company to "margin calls" if the market value of the assets pledged as
collateral for the repurchase agreements declines. The Company has established a
target equity requirement for each type of investment to take into account the
price volatility and liquidity of each such investment. The Company models and
plans for the margin call risk related to its repurchase borrowings through the
use of its OAS model to calculate the projected change in market value of its
investments that are pledged as collateral for repurchase borrowings under
various adverse scenarios. The Company generally maintains enough immediate or
available liquidity to meet margin call requirements if short-term interest
rates increased up to 300 basis points over a one-year period. As of December
31, 1997, the Company had total repurchase agreements outstanding of $889
million, secured by collateralized bonds retained, ARM securities, fixed-rate
mortgage securities and derivative and residual securities at their market
values of $524 million, $389 million, $21 million and $9 million, respectively.
The Company also has liquidity risk inherent to its investment in certain
residual trusts. These trusts are subject to margin calls and the Company, at
its option, may provide additional equity to the trust to meet the margin call.
Should the Company not provide the additional equity, the assets of the trust
could be sold to meet the trusts' obligations, resulting in a potential loss to
the Company.
Since 1996, the Company has structured all of its ARM loan securitizations
as collateralized bonds, with the financing, in effect, incorporated into the
bond structure. This structure eliminates the need for repurchase agreements on
such collateral, and consequently eliminates the margin call risk and to a
lesser degree the interest rate risk. During 1997 and 1996, the Company issued
approximately $2.4 billion and $1.8 billion, respectively in collateralized
bonds. The Company plans to continue to use collateralized bonds as its primary
securitization vehicle.
FEDERAL INCOME TAX CONSIDERATIONS
General
The Company and its qualified REIT subsidiaries (collectively "Dynex REIT")
believes it has complied and, intends to comply in the future, with the
requirements for qualification as a REIT under the Internal Revenue Code (the
Code). To the extent that Dynex REIT qualifies as a REIT for federal income tax
purposes, it generally will not be subject to federal income tax on the amount
of its income or gain that is distributed to shareholders. However, various
affiliated companies, which conduct the production operations and are included
in the Company's consolidated financial statements prepared in accordance with
generally accepted accounting principles ("GAAP"), are not qualified REIT
subsidiaries. Consequently, all of the nonqualified REIT subsidiaries' taxable
income is subject to federal and state income taxes.
The REIT rules generally require that a REIT invest primarily in real
estate-related assets, that its activities be passive rather than active and
that it distribute annually to its shareholders substantially all of its taxable
income. The Company could be subject to income tax if it failed to satisfy those
requirements or if it acquired certain types of income-producing real property.
Although no complete assurances can be given, Dynex REIT does not expect that it
will be subject to material amounts of such taxes.
Dynex REIT's failure to satisfy certain Code requirements could cause the
Company to lose its status as a REIT. If Dynex REIT failed to qualify as a REIT
for any taxable year, it would be subject to federal income tax (including any
applicable minimum tax) at regular corporate rates and would not receive
deductions for dividends paid to shareholders. As a result, the amount of
after-tax earnings available for distribution to shareholders would decrease
substantially. While the Board of Directors intends to cause Dynex REIT to
operate in a manner that will enable it to qualify as a REIT in future taxable
years, there can be no certainty that such intention will be realized.
Qualification of the Company as a REIT
Qualification as a REIT requires that Dynex REIT satisfy a variety of tests
relating to its income, assets, distributions and ownership. The significant
tests are summarized below.
Sources of Income. To continue qualifying as a REIT in any taxable year
beginning 1998, Dynex REIT must satisfy two distinct tests with respect to the
sources of its income: the "75% income test" and the "95% income test". The 75%
income test requires that Dynex REIT derive at least 75% of its gross income
(excluding gross income from prohibited transactions) from certain real
estate-related sources.
In order to satisfy the 95% income test, 95% Dynex REIT's gross income for
the taxable year must consist either of income that qualifies under the 75%
income test or certain other types of passive income.
If Dynex REIT fails to meet either the 75% income test or the 95% income
test, or both, in a taxable year, it might nonetheless continue to qualify as a
REIT, if its failure was due to reasonable cause and not willful neglect and the
nature and amounts of its items of gross income were properly disclosed to the
Internal Revenue Service. However, in such a case Dynex REIT would be required
to pay a tax equal to 100% of any excess non-qualifying income.
Nature and Diversification of Assets. At the end of each calendar quarter,
three asset tests must be met by Dynex REIT. Under the 75% asset test, at least
75% of the value of Dynex REIT's total assets must represent cash or cash items
(including receivables), government securities or real estate assets. Under the
"10% asset test", Dynex REIT may not own more than 10% of the outstanding voting
securities of any single non-governmental issuer, if such securities do not
qualify under the 75% asset test. Under the "5% asset test," ownership of any
stocks or securities that do not qualify under the 75% asset test must be
limited, in respect of any single non-governmental issuer, to an amount not
greater than 5% of the value of the total assets of Dynex REIT.
If Dynex REIT inadvertently fails to satisfy one or more of the asset tests
at the end of a calendar quarter, such failure would not cause it to lose its
REIT status, provided that (i) it satisfied all of the asset tests at the close
of a preceding calendar quarter and (ii) the discrepancy between the values of
Dynex REIT's assets and the standards imposed by the asset tests either did not
exist immediately after the acquisition of any particular asset or was not
wholly or partially caused by such an acquisition. If the condition described in
clause (ii) of the preceding sentence was not satisfied, Dynex REIT still could
avoid disqualification by eliminating any discrepancy within 30 days after the
close of the calendar quarter in which it arose.
Distributions. With respect to each taxable year, in order to maintain its
REIT status, Dynex REIT generally must distribute to its shareholders an amount
at least equal to 95% of the sum of its "REIT taxable income" (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain) and any after-tax net income from certain types of foreclosure
property minus any "excess noncash income." The Code provides that distributions
relating to a particular year may be made in the following year, in certain
circumstances. The Company will balance the benefit to the shareholders of
making these distributions and maintaining REIT status against their impact on
the liquidity of the Company. In an unlikely situation, it may benefit the
shareholders if the Company retained cash to preserve liquidity and thereby lose
REIT status.
For federal income tax purposes, Dynex REIT is required to recognize income
on an accrual basis and to make distributions to its shareholders when income is
recognized. Accordingly, it is possible that income could be recognized and
distributions required to be made in advance of the actual receipt of such funds
by Dynex REIT. The nature of Dynex REIT's investments is such that it expects to
have sufficient cash to meet any federal income tax distribution requirements.
Taxation of Distributions by the Company
Assuming that Dynex REIT maintains its status as a REIT, any distributions
that are properly designated as "capital gain dividends" will generally be taxed
to shareholders as long-term or mid-term capital gains, regardless of how long a
shareholder has owned his shares. Any other distributions out of Dynex REIT's
current or accumulated earnings and profits will be dividends taxable as
ordinary income. Distributions in excess of Dynex REIT's current or accumulated
earnings and profits will be treated as tax-free returns of capital, to the
extent of the shareholder's basis in his shares and, as gain from the
disposition of shares, to the extent they exceed such basis. Shareholders may
not include on their own tax returns any of Dynex REIT ordinary or capital
losses. Distributions to shareholders attributable to "excess inclusion income"'
of Dynex REIT will be characterized as excess inclusion income in the hands of
the shareholders. Excess inclusion income can arise from Dynex REIT's holdings
of residual interests in real estate mortgage investment conduits and in certain
other types of mortgage-backed security structures created after 1991. Excess
inclusion income constitutes unrelated business taxable income ("UBTI") for
tax-exempt entities (including employee benefit plans and individual retirement
accounts) and it may not be offset by current deductions or net operating loss
carryovers. In the unlikely event that the Company's excess inclusion income is
greater than its taxable income, the Company's distribution would be based on
the Company's excess inclusion income.
Dividends paid by Dynex REIT to organizations that generally are exempt
from federal income tax under Section 501(a) of the Code should not be taxable
to them as UBTI except to the extent that (i) purchase of shares of Dynex REIT
was financed by "acquisition indebtedness" or (ii) such dividends constitute
excess inclusion income. In 1997, Dynex REIT's excess inclusion income was de
minimus.
Taxable Income
Dynex REIT uses the calendar year for both tax and financial reporting
purposes. However, there may be differences between taxable income and income
computed in accordance with GAAP. These differences primarily arise from timing
differences in the recognition of revenue and expense for tax and GAAP purposes.
Additionally, Dynex REIT's taxable income does not include the taxable income of
its taxable affiliate, although the affiliates are included in the Company's
GAAP consolidated financial statements. For the year ended December 31, 1997,
Dynex REIT's estimated taxable income was approximately $71.3 million.
<PAGE>
REGULATION
As an approved mortgage and consumer loan originator, the Company is
subject to various federal and state regulations. A violation of such
regulations may result in the Company losing its ability to originate mortgage
and consumer loans in the respective jurisdiction.
The rules and regulations applicable to the production operations, among
other things, prohibit discrimination and establish underwriting guidelines that
include provisions for inspections and appraisals, require credit reports on
prospective borrowers and fix maximum loan amounts. Certain of the Company's
funding activities are subject to, among other laws, the Equal Credit
Opportunity Act, Federal Truth-in-Lending Act and the Real Estate Settlement
Procedures Act and the regulations promulgated thereunder that prohibit
discrimination and require the disclosure of certain basic information to
mortgagors concerning credit terms and settlement costs.
Additionally, there are various state and local laws and regulations
affecting the production operations. The production operations are licensed in
those states requiring such a license. Production operations may also be subject
to applicable state usury statutes. The Company believes that it is in material
compliance with all material rules and regulations to which it is subject.
COMPETITION The Company competes with a number of institutions with greater
financial resources in originating and purchasing loans through their production
operations. In addition, in purchasing portfolio investments and in issuing
securities, the Company competes with investment banking firms, savings and loan
associations, commercial banks, mortgage bankers, insurance companies and
federal agencies and other entities purchasing mortgage assets, many of which
have greater financial resources than the Company. Additionally, securities
issued relative to its production operations will face competition from other
investment opportunities available to prospective purchasers.
EMPLOYEES
As of December 31, 1997, the Company had 231 employees.
Item 2. PROPERTIES
The Company's executive and administrative offices and operations offices
are both located in Glen Allen, Virginia, on properties leased by the Company.
The address is 10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060.
Item 3. LEGAL PROCEEDINGS
On March 20, 1997, American Model Homes ("Plaintiff") filed a complaint
against the Company in Federal District Court in the Central District of
California alleging that the Company, among other things, misappropriated
Plaintiff's trade secrets and confidential information in connection with the
Company's establishment of its model home lending business. The US District
Court for the Eastern District of Virginia dismissed this complaint with
prejudice on February 20, 1998. The plaintiffs have appealed the Court's
decision to the Fourth Circuit Court of Appeals. The Company is subject to
various lawsuits as result of its lending activities. The Company does not
anticipate that the resolution of such lawsuits will have a material impact on
the Company's financial condition. Item 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS No matters were submitted to a vote of the Company's
stockholders during the fourth quarter of 1997.
<PAGE>
PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS The Company's common stock is traded on the New York Stock
Exchange under the trading symbol DX. The Company's common stock was held by
approximately 4,422 holders of record as of February 28, 1998. During the last
two years, the high and low closing stock prices and cash dividends declared on
common stock, adjusted for the two-for-one stock split effective May 5, 1997,
were as follows:cash dividends declared on common stock, adjusted for the
two-for-one stock split effective May 5, 1997, were as follows:
<TABLE>
<CAPTION>
Cash Dividends
High Low Declared
1997
<S> <C> <C> <C>
First quarter $ 15 11/16 $ 12 3/4 $ 0.325
Second quarter 15 1/2 12 13/16 0.335
Third quarter 15 5/16 13 1/8 0.345
Fourth quarter 14 13/16 13 1/16 0.350
1996
First quarter $ 11 $ 9 3/8 $ 0.255
Second quarter 12 9/16 9 3/4 0.275
Third quarter 12 3/4 10 5/8 0.293
Fourth quarter 14 13/16 11 15/16 0.310
</TABLE>
<PAGE>
Item 6. SELECTED FINANCIAL DATA
(amounts in thousands except share data)
<TABLE>
<CAPTION>
Years ended December 31, 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net interest margin $ 84,737 $ 75,141 $ 43,791 $ 44,978 45,019
Gain on sale of single family mortgage - 17,285 - - -
operations
Gain on sale of assets, net 10,254 503 9,651 27,723 23,585
Other income 3,604 882 1,591 840 734
General and administrative expenses 24,597 20,763 18,123 21,284 15,211
------ ------ ------ ------ ------
Net income $ 73,998 $ 73,048 $ 36,910 $ 52,257 54,127
============== ============= ============= ============= =============
Total revenue $ 350,762 $ 330,971 $ 266,496 $ 256,483 196,575
============== ============= ============= ============= =============
Total expenses $ 276,764 $ 257,923 $ 229,586 $ 204,226 142,448
============== ============= ============= ============= =============
Net income per common share
Basic(1) $ 1.38 $ 1.54 $ 0.85 $ 1.32 1.56
Diluted (1) 1.37 1.49 0.85 1.32 1.56
Dividends declared per share:
Common (1) $ 1.355 $ 1.133 $ 0.84 $ 1.38 1.53
Series A Preferred 2.710 2.375 1.17 - -
Series B Preferred 2.710 2.375 0.42 - -
Series C Preferred 2.920 0.600 - $ -
-
Return on average common shareholders' equity 17.9% 21.6% 12.5% 19.2% 25.8%
(2)
Total fundings $ 2,490,490 $ 1,508,780 $ 916,570 $ 2,861,443 4,093,714
As of December 31, 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------
Investments (3) $ 5,338,454 $ 3,953,034 $ 3,426,413 $ 3,539,778 $ 3,513,416
Total assets 5,378,172 3,983,122 3,486,288 3,590,383 3,724,554
Non-recourse debt 3,632,079 2,147,384 843,856 351,406 430,470
Recourse debt 1,145,695 1,299,876 2,238,931 3,010,372 2,990,289
Total liabilities 4,817,263 3,479,505 3,131,465 3,400,350 3,471,522
Shareholders' equity 560,909 503,617 354,823 190,033 253,032
Number of common shares outstanding 45,146,242 20,653,593 20,198,654 20,078,013 19,331,932
Average number of common shares 43,031,381 20,444,790 20,122,722 19,829,609 17,364,309
Book value per common share (1) $ 9.53 $ 8.81 $ 6.63 $ 4.73 $ 6.54
- --------------------------------------------------------------------------------
<FN>
(2) Excludes unrealized gain/loss on investments available-for-sale.
(3) Investments classified as available-for-sale are shown at fair value
as of December 31, 1997, 1996, 1995, and 1994 and at amortized cost as
of December 31, 1993
</FN>
</TABLE>
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
FINANCIAL CONDITION
- -------------------------------------------------- -----------------------------
December 31,
---------------------------
(amounts in thousands
except per share data) 1997 1996
- -------------------------------------------------- ---------------------
<S> <C> <C>
Investments:
Collateral for collateralized bonds $4,375,561 $2,698,342
Mortgage securities 513,750 890,212
Other investments 214,120 98,943
Loans held for securitization 235,023 265,537
Non-recourse debt - collateralized bonds 3,632,079 2,147,384
Recourse debt 1,145,695 1,299,876
Shareholders' equity 560,909 503,617
Book value per common share 9.53 8.81
- -------------------------------------------------- -- ------------------ --- --
</TABLE>
Dynex Capital, Inc. (the "Company") is a mortgage and consumer finance
company which uses its loan production operations to create investments for its
portfolio. Currently, the Company's primary loan production operations include
the origination of mortgage loans secured by multifamily and commercial
properties and the origination of loans secured by manufactured homes. The
Company will generally securitize the loans funded as collateral for
collateralized bonds, limiting its credit risk and providing long-term financing
for its portfolio.
Collateral for collateralized bonds As of December 31, 1997, the Company
had 33 series of collateralized bonds outstanding. The collateral for
collateralized bonds increased to $4.4 billion at December 31, 1997 compared to
$2.7 billion at December 31, 1996. This increase of $1.7 billion is primarily
the result of the addition of $2.7 billion of collateral related to the issuance
of three series of collateralized bonds in 1997, net of $0.9 billion in paydowns
on collateral.
Mortgage securities
Mortgage securities decreased to $513.8 million at December 31, 1997
compared to $890.2 million at December 31, 1996. The decrease was primarily the
result of the Company pledging $311.1 million of mortgage securities as part of
the collateral for two series of collateralized bonds issued during 1997.
Additionally, the Company purchased $848.7 million of primarily fixed-rate
mortgage securities and sold $847.3 million of primarily fixed-rate mortgage
securities during 1997.
Other investments
Other investments increased from $98.9 million at December 31, 1996 to
$214.1 million at December 31, 1997. The increase is primarily the result of
additional purchases or financing of $116.0 million of model homes and the
purchase of $38.7 million of property tax receivables in 1997. These increases
were partially offset by the sale of $15.3 million in model homes and the
receipt of the $9.5 million annual principal payment on the note receivable from
the 1996 sale of the single family mortgage operations.
Loans held for securitization
Loans held for securitization decreased from $265.5 million at December 31,
1996 to $235.0 million at December 31, 1997. The decrease resulted from the
securitization of $1.8 billion of loans as collateral for collateralized bonds
during 1997. This decrease was principally offset with new loan fundings from
the Company's production operations, totaling $565.1 million and bulk purchases
of single family loans, totaling $1.3 billion.
<PAGE>
Non-recourse debt
Collateralized bonds increased to $3.6 billion at December 31, 1997 from
$2.1 billion at December 31, 1996 as a result of the issuance of $2.6 billion of
collateralized bonds during 1997. Two series of collateralized bonds, totaling
$2.3 billion, were collateralized by securities secured by single family
mortgage loans and manufactured housing loans. One series, totaling $313.5
million was collateralized by securities secured by commercial and multifamily
mortgage loans.
Recourse debt
Recourse debt decreased to $1.1 billion at December 31, 1997 from $1.3
billion at December 31, 1996. This decrease was primarily due to securitizing
$311.1 of mortgage securities as collateral for collateralized bonds, offset by
the addition of $144.9 million of repurchase agreements secured by
collateralized bonds retained by the Company as a result of securitizations
during 1997 and the issuance of $100 million of senior unsecured notes during
1997.
Shareholders' Equity
Shareholders' equity increased to $560.9 million at December 31, 1997 from
$503.6 million at December 31, 1996. This increase was primarily the result of
$42 million of common stock proceeds received, principally through the dividend
reinvestment program. In addition, the net unrealized gain on investments
available-for-sale increased $15.0 million from $64.4 million at December 31,
1996 to $79.4 million at December 31, 1997 primarily due to the issuance of the
three series of collateralized bonds during 1997.
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Year Ended December 31,
----------------------------------------------------------
(amounts in thousands except per share information) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net interest margin $ 84,737 $ 75,141 $ 43,791
Gain on sale of single family mortgage operations - 17,285 -
Gain on sale of assets, net 10,254 503 9,651
General and administrative expenses 24,597 20,763 18,123
Net income 73,998 73,048 36,910
Basic net income per common share(1) 1.38 1.54 0.85
Diluted net income per common share(1) 1.37 1.49 0.85
Total fundings 2,490,490 1,508,780 916,570
Dividends declared per share:
Common(1) $ 1.355 $ 1.1325 0.840
Series A Preferred 2.710 2.3750 1.170
Series B Preferred 2.710 2.3750 0.423
Series C Preferred 2.920 0.6000 -
<FN>
- --------------------------------------------------------------------------------
(1) 1996 and 1995 have been adjusted for two-for-one common stock split
effective May 5, 1997.
</FN>
</TABLE>
1997 Compared to 1996. The increase in the Company's net income during 1997
as compared to 1996 is primarily the result of an increase in both net interest
margin and gain on sale of assets. These increases were offset partially by an
increase in general and administrative expenses and no comparable gain to the
gain on sale of the single family mortgage operations in 1996. The decrease in
the Company's net income per common share during 1997 as compared to 1996 is
primarily the result of an increase in the average number of common shares
outstanding due to the issuance of new common stock and the partial conversion
of outstanding preferred stock.
Net interest margin for the year ended December 31, 1997 increased to $84.7
million, or 12.8%, over net interest margin of $75.1 million for the same period
in 1996. This increase in net interest margin was a result of an overall growth
in average interest-earning assets which increased to $4.5 billion during 1997
as compared to $4.1 billion for 1996. Additionally, the increase in net interest
margin was due to the additional common stock issued during 1997, the proceeds
from which was initially used to pay short-term borrowings.
The gain on the sale of the single family mortgage operations in 1996 was a
one-time gain related to the sale of the Company's single family correspondent,
wholesale and servicing business on May 13, 1996. The gain on sale of assets,
net for 1997 increased to $10.3 million, as compared to a $0.5 million gain for
1996. The gain on sale of assets during 1997 is primarily the result of premiums
received of $9.9 million on covered call options and put options written during
1997 and gains generated of $0.6 million on the sale of certain investments.
During 1996, the Company sold certain investments in its portfolio which
resulted in a $2.0 million net gain. The Company also wrote down, by $1.5
million, the carrying value of certain mortgage derivative securities as
anticipated future prepayment rates were expected to result in the Company
receiving less cash than its remaining basis in those investments.
General and administrative expenses increased $3.8 million, or 18.5%, to
$24.6 million in 1997. This increase is primarily a result of the growth in the
Company's current production operations offset partially by the expense
reductions resulting from the sale of the single family mortgage operations in
May 1996. In 1997, the Company opened one regional office and three district
offices to support its manufactured housing lending operations. General and
administrative expenses should continue increasing during 1998 as the Company
continues to build its production infrastructure, including a retail
manufactured housing loan origination effort.
1996 Compared to 1995. The increase in the Company's net income and net
income per common share during 1996 as compared to 1995 was primarily the result
of the increase in net interest margin and the gain on the sale of the single
family mortgage operations. These increases were offset partially by a decline
in the gain on sale of assets and an increase in general and administrative
expenses.
Net interest margin for 1996 increased to $75.1 million, or 71.5%, over net
interest margin of $43.8 million for 1995. This increase was a result of an
overall increase in the net interest spread on all interest-earning assets,
which increased to 1.52% for 1996 versus 1.04% for 1995, as well as the
increased contribution from the net investment in collateralized bonds. The
increase in the net interest spread was attributable to the ARM securities being
fully-indexed during 1996, and to the more favorable interest rate environment
on both collateralized bonds and recourse borrowings related to the ARM
securities. During 1995, as a result of rising short-term rates during both 1994
and early 1995, the Company's ARM securities were generally not fully-indexed
throughout the year.
Prior to the sale of the Company's single family mortgage operations on May
13, 1996, the single family mortgage operations had contributed to the Company's
earnings through the securitization and sale of loans funded through its
production activities, recorded as gain on sale of assets. During 1995, the
Company recorded a $4.7 million net gain on sale of assets related to the
securitization and sale of loans. No gain on securitization or sale of loans was
recorded during 1996. During 1996, the Company'sold certain investments in its
portfolio which resulted in a $2.0 million gain. The Company also wrote down by
$1.5 million the carrying value of certain mortgage derivative securities as
anticipated future prepayment rates were expected to result in the Company
receiving less cash than its remaining basis in those investments. In
comparison, during 1995, the Company'sold investments for a net gain of $3.8
million and recorded no write-downs. The Company also sold previously purchased
mortgage servicing rights in 1995 for a gain of $1.2 million.
General and administrative expenses increased $2.6 million, or 14.6%, to
$20.8 million in 1996, as the Company continued to build its infrastructure for
its manufactured housing lending operations. General and administrative expenses
also increased from 1995 as a result of the Company's continued expansion of its
wholesale origination capabilities for its single family mortgage operations
prior to their sale. The Company continued to expand its manufactured housing
lending operations, and in August 1996, acquired Multi-Family Capital Markets,
Inc. to expand its multifamily and commercial real estate lending businesses.
<PAGE>
The following table summarizes the average balances of the Company's
interest-earning assets and their average effective yields, along with the
Company's average interest-bearing liabilities and the related average effective
interest rates, for each of the periods presented.
Average Balances and Effective Interest Rates
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
(amounts in thousands) Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------- --------------------------- ------------------------
Average Effective Average Effective Average Effective
Balance Rate Balance Rate Balance Rate
-------------- -------- -------------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets: (1)
Collateral for collateralized $ 2,775,494 7.53 % 1,832,141 8.11 % $ 711,316 8.58 %
bonds(2) (3)
Mortgage securities 1,110,646 8.36 1,831,621 7.01 2,277,906 7.05
Other investments 136,932 10.00 62,484 9.18 35,413 14.97
Loans held for securitization 502,677 7.98 355,326 8.29 331,995 8.54
------- ---- ------- ---- ------- ----
Total interest-earning assets $ 4,525,749 7.86 % 4,081,572 7.65 % $ 3,356,630 7.60 %
============== ====== ============== ======== ============ ========
Interest-bearing liabilities:
Non-recourse debt - collateralized $ 2,226,894 6.67 % 1,493,397 6.63 % 530,616 7.52 %
bonds (3)
Recourse debt - collateralized 419,621 5.74 248,657 5.60 148,935 6.01
bonds retained
-------------- ------ -------------- -------- ------------ --------
2,646,515 6.53 1,742,054 6.50 679,551 7.21
Recourse debt secured by
investments:
Mortgage securities 931,334 5.74 1,691,629 5.55 2,071,750 6.07
Other investments 31,372 7.74 1,241 9.59 11,329 8.64
Loans held for securitization 354,116 5.83 229,494 5.90 274,686 7.05
Recourse debt - unsecured 88,059 9.01 46,375 10.01 49,375 9.97
------ ---- ------ ----- ------ ----
Total interest-bearing $ 4,051,396 6.38 % 3,710,793 6.13 % $ 3,086,691 6.56 %
liabilities
============== ====== ============== ======== ============ ========
Net interest spread on all investments 1.48 % 1.52 % 1.04 %
(3)
====== ======== ========
Net yield on average interest-earning 2.15 % 2.08 % 1.57 %
assets
====== ======== ========
- --------------------------------------------------------------------------------------------------------------------------
<FN>
___________________________
(1) Average balances exclude adjustments made in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities", to record available for sale securities at
fair
value.
(2) Average balances exclude funds held by trustees of $2,481, $2,839 and
$3,815 for the years ended December 31, 1997, 1996 and 1995,
respectively.
(3) Effective rates are calculated excluding non-interest related
collateralized bond expenses and provision for credit losses.
</FN>
</TABLE>
1997 compared to 1996 The net interest spread decreased to 1.48% for the
year ended December 31, 1997 from 1.52% for the same period in 1996. This
decrease was primarily the result of the decline in the spread on the
collateralized bonds, which for 1997 constituted the largest portion of the
Company's investment portfolio on a weighted-average basis. In addition,
short-term interest rates increased 0.25% during March 1997, which raised the
Company's weighted-average borrowing costs to 6.38% for the year ended December
31, 1997, from 6.13% for the year ended December 31, 1996. The overall yield on
interest-earning assets increased to 7.86% for year ended December 31, 1997,
from 7.65% for the same period in 1996. This increase is primarily due to the
ARM assets in the Company's portfolio resetting upwards during 1997 and the
purchase of higher yielding ARM residual trusts during the latter part of 1996
and during the first three quarters of 1997.
Individually, the net interest spread on collateralized bonds decreased 61
basis points, from 161 basis points for the year ended December 31, 1996 to 100
basis points for the same period in 1997. This decline was primarily due to the
securitization of lower coupon collateral, principally A+ quality single family
ARM loans during 1997 coupled with the prepayments of seasoned, higher coupon
single family collateral during 1997. In addition, the spread on the net
investment in collateralized bonds decreased due to higher premium amortization
caused by increased prepayments during the latter part of 1997. The net interest
spread on mortgage securities increased 116 basis points, from 146 basis points
for the year ended December 31, 1996 to 262 basis points for the year ended
December 31, 1997. This increase is primarily attributed to the ARM securities
in the Company's portfolio during 1997 having a higher margin than those ARM
securities in the Company's portfolio in 1996. In addition, the Company
purchased higher yielding ARM residual trusts during the latter part of 1996 and
during the first three quarters of 1997. The net interest spread on other
investments increased 267 basis points, from a negative 41 basis points for the
year ended December 31, 1996, to 226 basis points for the year ended December
31, 1997, due primarily to lower borrowing costs associated with the Company's
single family model home purchase and leaseback business during 1997. The net
interest spread on loans held for securitization decreased 24 basis points, from
239 basis points from the year ended December 31, 1996, to 215 basis points for
the same period in 1997. This decrease is primarily attributable to the purchase
of lower coupon loans, principally A+ quality single family ARM loans during
1997.
1996 compared to 1995. The increase in net interest spread for 1996
relative to 1995 is primarily the result of the increase in the spread on ARM
securities and an increase in the average balance and spread on the net
investment in collateralized bonds, which for 1996, constituted the largest
portion of the Company's investment portfolio on a weighted-average basis. The
net interest spread benefited as a result of the declining short-term interest
rate environment during the first part of 1996, which had the impact of reducing
the Company's borrowing costs faster than reducing the yields on the Company's
interest-earning assets. The Company's overall weighted-average borrowing costs
decreased to 6.13% for 1996 from 6.56% for 1995. The overall yield on
interest-earning assets increased to 7.65% from 7.60% as the Company's portfolio
became more heavily weighted in collateral for collateralized bonds which have
higher effective rates than ARM securities. Collateral for collateralized bonds
increased to an average $1.8 billion for the year ended December 31, 1996, or
158%, from an average $711.3 million for the year ended December 31, 1995.
Individually, the net interest spread on the net investment in
collateralized bonds increased 24 basis points, from 137 basis points for the
year ended December 31, 1995, to 161 basis points for the same period in 1996.
This increase is partially attributable to the declining short-term interest
rate environment, which had the impact of reducing the collateralized bonds
borrowing costs faster than reducing the yield on the collateral for
collateralized bonds. The net interest spread on mortgage securities increased
48 basis points, from 98 basis points for the year ended December 31, 1995 to
146 basis points for the year ended December 31, 1996. During 1995, the ARM
securities were "teased" during the first nine months of 1995. Subsequently, the
ARM securities became fully-indexed as short-term rates stabilized and then
declined during the latter half of 1995 and through the first quarter of 1996.
In addition, the Company purchased higher yielding fixed-rate securities during
1996. The net interest spread on other investments decreased 674 basis points,
from 633 basis points from the year ended December 31, 1995, to negative 41
basis points for the year ended December 31, 1996, due primarily to higher
borrowing costs associated with the Company's single family model home purchase
and leaseback business during 1996. The net interest spread on loans held for
securitization increased 90 basis points, from 149 basis points for the year
ended December 31, 1995, to 239 basis points for the same period in 1996. This
increase is primarily attributed to the reduced borrowing costs associated with
the decline in short-term interest rates during the first part of 1996.
The following tables summarize the amount of change in interest income
and interest expense due to changes in interest rates versus changes in volume:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
1997 to 1996 1996 to 1995
------------------------------------- ------------------------------------
(amounts in thousands) Rate Volume Total Rate Volume Total
------------ ----------- ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Collateral for collateralized bonds $ (11,428) $ 71,699 $ 60,271 $ (3,456 ) $ 91,124 $ 87,668
Mortgage securities 21,435 (57,076) (35,641) (844 ) (31,302 ) (32,146)
Other investments 556 7,405 7,961 (2,577 ) 3,012 435
Loans held for securitization (1,122) 11,795 10,673 (861 ) 1,951 1,090
------------ ------------------------ ------------ ----------- -----------
Total interest income 9,441 33,823 43,264 (7,738 ) 64,785 57,047
------------ ------------------------ ------------ ----------- -----------
Non-recourse debt - collateralized 472 48,887 49,359 (5,200 ) 64,385 59,185
bonds
Recourse debt - collateralized bonds 329 9,939 10,268 (668 ) 5,712 5,044
retained
------------ ------------------------ ------------ ----------- -----------
Total collateralized bonds 801 58,826 59,627 (5,868 ) 70,097 64,229
Recourse debt secured by investments:
Mortgage securities 2,845 (44,158) (41,313) (10,296 ) (22,099 ) (32,395)
Other investments (28) 2,369 2,341 99 (973 ) (874)
Loans held for securitization (169) 7,370 7,201 (2,940 ) (2,967 ) (5,907)
Recourse debt - unsecured (529) 3,852 3,323 20 (305 ) (285)
------------ ------------------------ ------------ ----------- -----------
Total interest expense 2,920 28,259 31,179 (18,985 ) 43,753 24,768
------------ ------------ ---------- ----------- --------- ---------
Net interest on mortgage assets $ 6,521 $ 5,564 $ 12,085 $ 11,247 $ 21,032 $ 32,279
============ ======================== ============ =========== ===========
- -----------------------------------------------------------------------------------------------------------------
<FN>
Note: The change in interest income and interest expense due to changes
in both volume and rate, which cannot be segregated, has been allocated
proportionately to the change due to volume and the change due to rate. This
table excludes other interest expense and provision for credit losses.
</FN>
</TABLE>
<PAGE>
Interest Income and Interest-Earning Assets
The Company's average interest-earning assets grew to $4.5 billion during
1997, an increase of 11% from $4.1 billion of average interest-earning assets
during 1996. This increase in average interest-earnings assets was primarily the
result of the addition of $2.7 billion of collateral for collateralized bonds
during 1997. Of this amount, $0.3 billion resulted from the pledge of ARM
securities already owned by the Company as collateral for collateralized bonds.
This was offset by $1.1 billion of principal paydowns on securities and loans
during 1997. Average interest-earning assets increased to $4.1 billion during
1996, from $3.4 billion during 1995. This increase in interest-earnings assets
from 1995 to 1996 was primarily a result of the addition of $2.1 billion of
collateral for collateralized bonds during 1996, net of $0.8 billion of
principal paydowns on securities and loans during 1996. Total interest income
rose 14% during 1997, from $312.3 million for the year ended December 31, 1996,
to $355.6 million for the same period of 1997. This increase in total interest
income was due to the growth in average interest-earning assets during 1997.
Total interest income also rose 22% during 1996 from $255.3 million for the year
ended December 31, 1995 to $312.3 million for the same period in 1996. Overall,
the yield on average interest-earning assets rose to 7.86% for the year ended
December 31, 1997, from 7.65% and 7.60% for the years ended December 31, 1996
and 1995, respectively. These increases resulted from increased yields on ARM
loans included in the Company's investment portfolio for collateral for
collateralized bonds, ARM securities and ARM residual trusts. As indicated in
the table below, the average yields were 2.02%, 2.06% and 1.50% higher than the
average daily six-month LIBOR interest rate during 1997, 1996 and 1995,
respectively. While a majority of the ARM loans underlying the Company's ARM
securities and collateral for collateralized bonds are indexed to and reset
based upon the level of the London InterBank Offered Rate (LIBOR) for six-month
deposits (six-month LIBOR), approximately one-third are indexed to and reset
based upon the level of the Constant Maturity Treasury Index (CMT).
Earning Asset Yield
($ in millions)
<TABLE>
<CAPTION>
- -------------- --------------- -- ------------- --- -------------- ---- ------------------ ---------------
Average Asset
Interest-Earning Daily Average Yield versus
Assets Interest Average Six Month LIBOR Six Month
Income(1) Asset Yield LIBOR
- -------------- --------------- -- ------------- --- -------------- ---- ------------------ ---------------
<S> <C> <C> <C> <C> <C>
1995 $ 3,356.6 $ 255.3 7.60% 6.10% 1.50%
1996 4,081.6 312.3 7.65% 5.59% 2.06%
1997 4,525.7 355.6 7.86% 5.84% 2.02%
- -------------- -- ------------ --- ------------ --- -------------- ---- ------------------ ---------------
<FN>
(1) Interest income includes amounts related to the gross interest
income on securities which are accounted for on a net basis.
</FN>
</TABLE>
The average asset yield is reduced for the amortization of premiums, net of
discounts on the Company's investment portfolio. By creating its investments
through its production operations, the Company believes that premium amounts are
less than if the investments were acquired in the market. As indicated in the
table below, premiums on the Company's collateral for collateralized bonds, ARM
securities and fixed-rate securities at December 31, 1997 were $56.9 million, or
approximately 1.23% of the aggregate investment portfolio balance. The principal
repayment rate for the Company (indicated in the table below as "CPR Annualized
Rate") was 37% for the year ended December 31, 1997. CPR or "constant prepayment
rate" and is a measure of the annual prepayment rate on a pool of loans.
Premium Basis and Amortization
($ in millions)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Amortization
CPR Expense as a %
Net Amortization Annualized Principal of Principal
Premium Expense Rate Paydowns Paydowns
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1995 $ 46.6 $ 7.9 (1) $ 462.3 1.71%
1996 54.1 13.8 24% 752.5 1.84%
1997 56.9 18.4 37% 993.2 1.85%
- ---------------------------------------------------------------------------------------------------------------------
<FN>
(1) CPR rate was not available for the period.
</FN>
</TABLE>
<PAGE>
Interest Expense and Cost of Funds
The Company's largest expense is the interest cost on borrowed funds. Funds
to finance the investment portfolio are borrowed primarily in the form of
collateralized bonds and repurchase agreements, both of which are primarily
indexed to LIBOR, principally one-month LIBOR. The Company may use interest rate
swaps, caps and financial futures to manage its interest rate risk. The net cost
of these instruments is included in the cost of funds table below as a component
of interest expense for the period to which it relates. The Company's average
borrowed funds increased from $3.7 billion during 1996 to $4.1 billion during
1997. The increase resulted primarily from the issuance of $2.6 billion of
collateralized bonds during 1997. This increase was partially offset by a
reduction of repurchase agreements primarily as a result of the Company
securitizing $311.1 million of ARM securities previously financed with
repurchase agreements as collateral for collateralized bonds. For the year ended
December 31, 1997, interest expense also increased to $258.5 million from $227.3
million for the year ended 1996, while the average cost of funds increased to
6.38% for 1997 compared to 6.13% for 1996. The increase in the cost of funds was
a result of an increase in the one-month LIBOR rates during the first quarter of
1997. The cost of funds for the year ended December 31, 1996, compared to
December 31, 1995, decreased to 6.13% from 6.56 %, respectively as a result of
the decline of the one-month LIBOR rate during 1996.
Cost of Funds
($ in millions)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Average Cost of Funds
Average Borrowed Interest Cost One-month versus
Funds Expense (1)(2) of Funds LIBOR One-month LIBOR
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1995 $ 3,086.7 $ 202.5 6.56% 5.97% 0.59%
1996 3,710.8 227.3 6.13% 5.45% 0.68%
1997 4,051.4 258.5 6.38% 5.64% 0.74%
- -----------------------------------------------------------------------------------------------------------
<FN>
(1) Excludes non-interest related expenses.
(2) Includes the net amortization expense of bond discounts and bond premiums
of $2.4 million, ($0.2) million and ($0.3) million for the years ended
December 31, 1997, 1996 and 1995, respectively.
</FN>
</TABLE>
Interest Rate Agreements
As part of the Company's asset/liability management process for its
investment portfolio, the Company enters into interest rate agreements such as
interest rate caps, swaps and financial futures contracts. These agreements are
used to reduce interest rate risk which arises from the lifetime yield caps on
the ARM securities, the mismatched repricing of portfolio investments versus
borrowed funds, and finally, assets repricing on indices such as the prime rate
which differ from the related borrowing indices. The agreements are designed to
protect the portfolio's cash flow and to provide income and capital appreciation
to the Company in the event that short-term interest rates rise quickly.
The following table includes all interest rate agreements in effect as of
each year end for asset/liability management of the investment portfolio.
Interest rate agreements used by the Company for asset/liability management
include interest rate swap, cap, futures and forward agreements and options on
interest rate futures. This table excludes all interest rate agreements in
effect for the Company's loan production operations. Generally, interest rate
swaps and caps are used to manage the interest rate risk associated with assets
that have periodic and annual interest rate reset limitations financed with
borrowings that have no such limitations. Financial futures contracts and
options on futures may be used to lengthen the terms of repurchase agreement
financing, generally from one month to three and six months. Amounts presented
are aggregate notional amounts. To the extent any of these agreements are
terminated, gains and losses are generally amortized over the remaining period
of the original agreement. Interest rate caps included $425 million of forward
start caps beginning in 2001.
<PAGE>
<TABLE>
<CAPTION>
Instruments Used for Interest Rate Risk Management Purposes(1)
(Notional amounts in millions)
- --------------------------------------------------------------------------------
Interest Rate Interest Rate Financial Options on
December 31, Caps Swaps Futures Futures
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995 $ 1,575 $ 1,227 $ 1,000 $ 2,130
1996 1,499 1,453 - -
1997 1,499 1,354 - -
- --------------------------------------------------------------------------------
<FN>
(1) Excludes all hedge agreements in effect for the Company's production
operations.
</FN>
</TABLE>
Net Interest Rate Agreement Expense
The net interest rate agreement expense, or hedging expense, equals the
expenses, net of any benefits received, from these agreements. For the year
ended December 31, 1997, net hedging expense amounted to $6.61 million versus
$6.62 million and $3.70 million for the years ended December 31, 1996 and 1995,
respectively. Such amounts exclude the hedging costs and benefits associated
with the Company's production activities as these amounts are deferred as
additional premium or discount on the loan funded and amortized over the life of
the loan as an adjustment to its yield. The net interest rate agreement expense
declined slightly for the year ended December 31, 1997 compared to the same
period in 1996. This slight decrease was the result of the amortization of
existing interest rate agreements and no new interest rate agreements being
entered into during 1997. The increase in the net interest rate agreement
expense for 1996 compared to 1995 is primarily the result of the addition of an
interest rate swap agreements to reduce the Company's exposure to basis risk for
certain collateral for collateralized bonds and to cap the borrowing costs
during any six-month period for a portion of the short-term borrowings.
<TABLE>
<CAPTION>
Net Interest Rate Agreement Expense
($ in millions)
- --------------------------------------------------------------------------------
Net Expense Net Expense as
Net Interest as Percentage Percentage of Average
Rate Agreement of Average Borrowings
Expense Assets (annualized) (annualized)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
1995 $ 3.70 0.11% 0.12%
1996 6.62 0.16% 0.18%
1997 6.61 0.15% 0.16%
- --------------------------------------------------------------------------------
</TABLE>
Fair value
The fair value of the available-for-sale portion of the Company's
investment portfolio as of December 31, 1997, as measured by the net unrealized
gain on investments available-for-sale, was $79.4 million above its amortized
cost basis, which represents a $15.0 million increase from December 31, 1996. At
December 31, 1996, the fair value of the Company's investment portfolio was
$64.4 million above its amortized cost basis. This increase in the portfolio's
value is primarily attributable to the increase in the value of the collateral
for collateralized bonds relative to the collateralized bonds issued during
1997.
All of the collateral pledged to secure collateralized bonds has been
securitized, and, therefore, is considered to be debt securities according to
Statement of Financial Accounting Standard No. 115 "Accounting for Certain
Investments in Debt and Equity Securities". As such, the collateral pledged is
considered available-for-sale subject to the lien of the collateralized bond
indenture. The unrealized gains and losses for these investments are included in
the Company's net unrealized gain on investments available-for-sale.
<PAGE>
Credit Exposures
The Company securitizes its loan production into collateralized bonds or
pass-through securitization structures. With either structure, the Company may
use overcollateralization, subordination, reserve funds, bond insurance,
mortgage pool insurance or any combination of the foregoing as a form of credit
enhancement. With all forms of credit enhancement, the Company may retain a
limited portion of the direct credit risk after securitization.
The following table summarizes the aggregate principal amount of collateral
for collateralized bonds and pass-through securities outstanding; the maximum
direct credit exposure retained by the Company (represented by the amount of
overcollateralization pledged and subordinated securities rated below BBB owned
by the Company), net of the credit reserves maintained by the Company for such
exposure; and the actual credit losses incurred for each year. The table
excludes any risks related to representations and warranties made on loans
funded by the Company and securitized in mortgage pass-through securities
generally funded through 1994. The increase during 1997 is related to the credit
exposure retained by the Company on its $2.7 billion in securitizations during
1997. The net credit exposure in the table below includes $22 million of credit
exposure from the Company's commercial loan securitization in October 1997.The
Company anticipates that such exposure will be substantially eliminated during
the first six months of 1998 through the sale of currently retained classes from
that securitization though no assurance can be given that these retained classes
will be sold. There were no delinquencies for loans included in this securities
at December 31, 1997.
Credit Reserves and Actual Credit Losses
($ in millions)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
Maximum
Credit Maximum Credit Exposure, Net
Exposure, net Actual of Credit Reserves to
Outstanding of Credit Credit Losses Outstanding Loan Balance
December 31, Loan Balance Reserves
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1995 $ 2,405.0 $ 47.4 $ - 1.97%
1996 3,848.1 30.0 5.2 0.78%
1997 5,153.1 86.6 19.9 1.68%
- ------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes single family mortgage loan, manufactured
housing loan and multifamily mortgage loan delinquencies as a percentage of the
outstanding collateral balance for those securities mentioned above in which the
Company has retained a portion of the direct credit risk. Multifamily and
commercial loan collateral related to the Company's two commercial
securitizations are not included as there were no delinquencies as of December
31, 1997. As of December 31, 1997, the Company believes that its credit reserves
are sufficient to cover any losses which may occur as a result of current
delinquencies presented in the table below.
<TABLE>
<CAPTION>
Delinquency Statistics
- --------------------------------------------------------------------------------
60 to 90 days delinquent 90 days and over delinquent
(includes REO and foreclosures) Total
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
1995 2.50% 3.23% 5.73%
1996 0.88% 3.40% 4.28%
1997 0.52% 2.78% 3.30%
- --------------------------------------------------------------------------------
</TABLE>
<PAGE>
The following table summarizes the credit rating for securities held in the
Company's investment portfolio. This table excludes the Company's mortgage
derivatives and residual securities (as the risk on such securities is primarily
prepayment-related, not credit-related), other investments and loans held for
securitization. The carrying balances of the investments rated below A are net
of credit reserves and discounts. The average credit rating of the Company's
investments at the end 1997 was AAA. At December 31, 1997, securities with a
credit rating of AA or better were $4.7 billion, or 98.3% of the Company's total
investments compared to 99.1% and 97.7% at December 31, 1996 and December 31,
1995, respectively. At the end of 1997, $352.0 million of investments were
split-rated between rating agencies. Where investments were split-rated, for
purposes of this table, the Company classified such investments based on the
higher credit rating.
Investments by Credit Rating (1)
($ in millions)
<TABLE>
<CAPTION>
- ---------- --- ----------- -- ----------- -- ----------- --- ----------- ---------- ------------ ---------- ----------
AAA AA A Below A AAA AA Percent A Below A
Carrying Carrying Carrying Carrying Percent of Total Percent Percent
Value Value Value Value of Total of Total of Total
- ---------- --- ----------- -- ----------- -- ----------- --- ----------- ---------- ------------ ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995 $ 2,039.9 $ 1,010.3 $ 23.7 $ 46.8 65.3% 32.4% 0.8% 1.5%
1996 2,708.4 752.8 - 29.9 77.5% 21.6% - 0.9%
1997 4,346.3 358.8 - 82.9 90.8% 7.5% - 1.7%
- ---------- --- ----------- -- ----------- -- ----------- --- ----------- ---------- ------------ ---------- ----------
<FN>
(1) Carrying value does not include mortgage derivatives and residual
securities, other investments and loans held for securitization.
</FN>
</TABLE>
General and Administrative Expenses
General and administrative expenses ("G&A expense") consist of expenses
incurred in conducting the Company's production activities and managing the
investment portfolio, as well as various other corporate expenses. G&A expense
increased for 1997 as compared to 1996, primarily as a result of continued costs
in connection with the building of the production infrastructure for the
manufacturing housing, commercial lending, and specialty finance businesses. G&A
expense related to the production operations is likely to increase over time as
the Company expands its production activities with current and new product
types. G&A expense increased for the year ended December 31, 1996 as compared to
the same period in 1995 primarily due to the expansion of the single family
wholesale operations and the start up costs related to the manufactured housing
lending operations.
The following table summarizes the Company's efficiency, the ratio
of G&A expense to average interest- earning assets, and the ratio of G&A
expense to average total equity.
<TABLE>
<CAPTION>
Operating Expense Ratios
- --------------------------------------------------------------------------------
G&A G&A Expense/Average G&A Expense/Average
Efficiency Interest-earning Total Equity (2)
Ratio (1) Assets
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
1995 7.10% 0.54% 5.92%
1996 6.65% 0.51% 5.28%
1997 6.92% 0.54% 5.29%
- --------------------------------------------------------------------------------
<FN>
(1) G&A expense as a percentage of interest income.
(2) Average total equity excludes net unrealized gain (loss) on investments
available-for-sale.
</FN>
</TABLE>
<PAGE>
Net Income and Return on Equity
Net income increased from $73.0 million for the year ended December 31,
1996 to $74.0 million for the same period in 1997. Net income available to
common shareholders decreased from $63.0 million to $59.2 million for the same
periods, respectively. Return on common equity (equity excludes net unrealized
gain on investments available-for-sale) decreased from 21.6% for 1996 to 17.9%
1997. The decrease in the return on common equity is a result of the decline in
net income available to common shareholders from 1996 to 1997 and the issuance
of new common shares.
Components of Return on Common Equity
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Gains and
Net Interest Provision Other G&A Preferred
Margin/ for Losses Income Expense/ Dividend/ Return on Net Income
Average /Average Common /Average Average Average Common Average Available to
Common Equity Equity Common Equity Common Equity Common Common
Equity Equity Shareholders
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1995 17.1% 1.1% 4.1% 6.6% 1.0% 12.5% $ 34,164
1996 26.8% 1.1% 6.4% 7.1% 3.4% 21.6% 63,039
1997 27.4% 1.8% 4.2% 7.4% 4.5% 17.9% 59,178
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
Dividends and Taxable Income
The Company and its qualified REIT subsidiaries (collectively "Dynex REIT")
have elected to be treated as a real estate investment trust for federal income
tax purposes. The REIT provisions of the Internal Revenue Code require Dynex
REIT to distribute to shareholders substantially all of its taxable income,
thereby restricting its ability to retain earnings. The Company may issue
additional common stock, preferred stock or other securities in the future in
order to fund growth in its operations, growth in its investment portfolio or
for other purposes.
The Company intends to declare and pay out as dividends 100% of its taxable
income over time. The Company's current practice is to declare quarterly
dividends. Generally, the Company'strives to declare a quarterly dividend which
will result in the distribution of most or all of the taxable income earned
during the quarter. At the time of the dividend announcement, however, the total
level of taxable income for the quarter is unknown. Additionally, the Company
has considerations other than the desire to pay out most of the taxable earnings
for the quarter, which may take precedence when determining the level of
dividends.
Dividend Summary
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Taxable Net Taxable Net Dividend
Income Income Per Declared
Available to Common Share Per Common Dividend Cumulative
Common Share Pay-out Undistributed
Shareholders Ratio Taxable Income
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1995 $ 32,438 $ 0.805 $ 0.8400 104% $ 3,204
1996 51,419 1.260 1.1325 90% 8,210
1997 56,528 1.331 1.3550 102% 3,949
- --------------------------------------------------------------------------------
</TABLE>
Taxable income for 1997 is estimated as the Company has not filed its 1997
federal income tax returns. Taxable income differs from the financial statement
net income, which is determined in accordance with generally accepted accounting
principles (GAAP). For the year ended December 31, 1997, GAAP net income per
common share exceeded taxable income per common share principally due to
differences related to the sale of the single family mortgage operations during
1996. For tax purposes, the sale is being accounted for on an installment sale
basis with annual taxable income of approximately $10 million through the year
2001. Cumulative undistributed taxable income represents timing differences in
the amounts earned for tax purposes versus the amounts distributed. Such amounts
can be distributed for tax purposes in the subsequent year as a portion of the
normal quarterly dividend.
Recent Accounting Pronouncements
In January 1997, the Company adopted the Statement of Financial Accounting
Standard No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" ("FAS No. 125"). FAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities based on a financial components
approach that focuses on control of the respective assets and liabilities. It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. The impact of adopting FAS No. 125 did not result in a
material change to the Company's financial position and results of operations.
The Company also adopted Financial Accounting Standard No. 128, "Earnings
Per Share" ("FAS No. 128") in 1997. FAS No. 128 replaced Primary EPS and Fully
Diluted EPS with Basic EPS and Diluted EPS, respectively.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 129, "Disclosure of Information about
Capital Structure" ("FAS No. 129"). FAS No. 129 summarizes previously issued
disclosure guidance contained within APB Opinions No. 10 and 15, as well as
Statement of Financial Accounting Standard No. 47, "Disclosure of Long-Term
Obligations". This statement is effective for financial statements for periods
ending after December 15, 1997. There are no significant changes to the
Company's disclosures pursuant to the adoption of FAS No. 129.
In June 1997, the Financial Accounting Standards Board issued 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 by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately. This statement is
effective for financial statements issued for fiscal years beginning after
December 15, 1997. There will be no significant changes to the Company's
financial statements pursuant to the adoption of FAS No. 130.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("FAS No. 131"). FAS No. 131 establishes
standard for reporting information about operating segments and is effective for
financial statements issued for fiscal years beginning after December 15, 1997.
There will be no significant changes to the Company's disclosures pursuant to
the adoption of FAS No. 131.
In January 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 132, "Employers' Disclosure about Pensions
and Other Postretirement Benefits" ("FAS No. 132"). FAS No. 132 revises
employers' disclosures about pension and other postretirement benefit plans and
is effective for financial statements issued for fiscal years beginning after
December 15, 1997. There will be no significant changes to the Company's
disclosures pursuant to the adoption of FAS No. 132.
Year 2000
The Year 2000 issue affects virtually all companies and organizations. Many
companies have existing computer applications which use only two digits to
identify a year in the date field. These applications were designed and
developed without considering the impact of the change of the century. If not
corrected these computer applications may fail or create erroneous results by
the year 2000.
The majority of the Company's information critical systems have been
developed internally since 1992. The development of these systems was undertaken
with full awareness of issues involving the Year 2000, and consequently the
Company does not expect to encounter any significant Year 2000 problems with
these systems.
The Company relies upon a small number of third party software vendors for
certain information systems. Testing of these vendors' systems is expected to be
completed by the end of 1998, and the Company does not expect to see any
significant impact to the operations supported by these vendors as a result of
Year 2000 problems.
The Company does not expect that any expenses incurred as a result of any
necessary modifications will be material to the results if operations.
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has various sources of cash flow upon which it relies for its
working capital needs. Sources of cash flow from operations include primarily
net interest margin and the return of principal on the portfolio of investments.
The Company's primary source of borrowings is through the issuance of
collateralized bonds. Other borrowings such as repurchase agreements and
warehouse lines of credit provide the Company with additional cash flow in the
event that it is necessary. Historically, these sources have provided sufficient
liquidity for the conduct of the Company's operations. However, if a significant
decline in the market value of the Company's investment portfolio that is funded
with recourse debt should occur, the Company's available liquidity from these
other borrowings may be reduced. As a result of such a reduction in liquidity,
the Company may be forced to sell certain investments in order to maintain
liquidity. If required, these sales could be made at prices lower than the
carrying value of such assets, which could result in losses.
In order to grow its equity base, the Company may issue additional capital
stock. Management strives to issue such additional shares when it believes
existing shareholders are likely to benefit from such offerings through higher
earnings and dividends per share than as compared to the level of earnings and
dividends the Company would likely generate without such offerings. During 1997,
the Company issued 826,900 shares of its common stock pursuant to a registration
statement filed with the Securities and Exchange Commission for net proceeds of
$11.4 million. The Company also issued 2,224,530 shares of its common stock
during 1997 pursuant to its dividend reinvestment program for net proceeds of
$30.6 million.
The Company borrows funds on a short-term basis to support the accumulation
of loans prior to the issuance of collateralized bonds. These borrowings may
bear fixed or variable interest rates, may require additional collateral in the
event that the value of the existing collateral declines, and may be due on
demand or upon the occurrence of certain events. If borrowing costs are higher
than the yields on the assets financed with such funds, the Company's ability to
acquire or fund additional assets may be substantially reduced and it may
experience losses. These short-term borrowings consist of the Company's lines of
credit and repurchase agreements. These borrowings are paid down as the Company
securitizes or sells loans.
A substantial portion of the assets of the Company are pledged to secure
indebtedness incurred by the Company. Accordingly, those assets would not be
available for distribution to any general creditors or the stockholders of the
Company in the event of the Company's liquidation, except to the extent that the
value of such assets exceeds the amount of the indebtedness they secure.
Non-recourse Debt
The Company, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds to fund its investment
growth. The obligations under the collateralized bonds are payable solely from
the collateral for collateralized bonds and are otherwise non-recourse to the
Company. Collateral for collateralized bonds are not subject to margin calls.
The maturity of each class is directly affected by the rate of principal
prepayments on the related collateral. Each series is also subject to redemption
according to specific terms of the respective indentures, generally when the
remaining balance of the bonds equals 35% or less of the original principal
balance of the bonds. At December 31, 1997, the Company has $3.6 billion of
collateralized bonds outstanding as compared to $2.1 billion at December 31,
1996.
Recourse Debt
Secured. At December 31, 1997, the Company had three credit facilities
aggregating $600 million to finance loan fundings of which $300 million expires
in 1998 and $300 million expires in 1999. One of these facilities includes
several sublines aggregating $200 million to serve various purposes, such as
multifamily loan fundings, working capital, and manufactured housing loan
fundings. Unsecured working capital borrowings under this facility are limited
to $30 million. The Company expects these credit facilities will be renewed, if
necessary, at their respective expiration dates, although there can be no
assurance of such renewal. The lines of credit contain certain financial
covenants which the Company met as of December 31, 1997. However, changes in
asset levels or results of operations could result in the violation of one or
more covenants in the future. At December 31, 1997, the Company had $102.0
million outstanding under its credit facilities.
The Company finances a portion of its investments through repurchase
agreements. Repurchase agreements allow the Company to sell investments for cash
together with a simultaneous agreement to repurchase the same investments on a
specified date for a price which is equal to the original sales price plus an
interest component. At December 31, 1997, the Company had outstanding
obligations of $889.0 million under such repurchase agreements compared to
$1,123.1 million at December 31, 1996.
Increases in either short-term interest rates or long-term interest rates
could negatively impact the valuation of mortgage securities and may limit the
Company's borrowing ability or cause various lenders to initiate margin calls
for mortgage securities financed using repurchase agreements. Additionally,
certain of the Company's ARM securities are AAA or AA rated classes that are
subordinate to related AAA rated classes from the same series of securities.
Such AAA or AA rated classes may have less liquidity than securities that are
not subordinated and the value of such classes is more dependent on the credit
rating of the related insurer or the credit performance of the underlying
mortgage loans. In instances of a downgrade of an insurer or the deterioration
of the credit quality of the underlying mortgage collateral, the Company may be
required to sell certain investments in order to maintain liquidity. If
required, these sales could be made at prices lower than the carrying value of
the assets, which could result in losses.
To reduce the Company's exposure to changes in short-term interest rates on
its repurchase agreements, the Company may lengthen the duration of its
repurchase agreements secured by investments by entering into certain interest
rate futures and/or option contracts. As of December 31, 1997, the Company had
no such financial futures or option contracts outstanding.
Unsecured
Since 1994, the Company has issued three series of unsecured notes payable
totaling $150 million. The proceeds from these issuances have been used to
reduce short-term debt related to financing loans held for securitization during
the accumulation period as well as for general corporate purposes. These notes
payable have an outstanding balance at December 31, 1997 of $141 million. The
Company also has various acquisition notes payable totaling $1.6 million at
December 31, 1997. The above note agreements contain certain financial covenants
which the Company met as of December 31, 1997. However, changes in asset levels
or results of operations could result in the violation of one or more covenants
in the future.
Total recourse debt decreased from $1.3 billion for December 31, 1996 to
$1.1 billion for December 31, 1997. This decrease is primarily a result of the
securitization of $311.1 million of mortgage securities, which previously were
financed through repurchase agreement and notes payable, as collateral for
collateralized bonds. Total recourse debt should continue to decline during 1998
as the Company continues to finance on a long-term basis the loans held for
securitization and mortgage securities through the issuance of collateralized
bonds.
Total Recourse Debt
($ in millions)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Total Recourse Debt to Recourse Interest
December 31, Total Recourse Debt Equity Coverage Ratio
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1996 $ 1,299.9 3.04 1.55
1997 1,145.7 2.15 1.72
- -----------------------------------------------------------------------------------------------------------
</TABLE>
Potential immediate sources of liquidity for the Company include cash
balances and unused availability on the credit facilities described above. The
potential immediate sources of liquidity increased 21% at December 31, 1997 in
comparison to December 31, 1996. This increase in potential immediate sources of
liquidity was due primarily to the issuance of $2.6 billion of collateralized
bonds during 1997 and the issuance of $100 million of senior notes during July
1997, which were used to pay down short-term borrowings related to financing
loans held for securitization during the accumulation period.
Potential Immediate Sources of Liquidity
($ in millions)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Potential Potential Immediate Sources
Cash Balance(1) Estimated Unused Immediate Sources of of Liquidity as a % of
December 31, Borrowing Capacity Liquidity Total Recourse Debt
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996 $ 4.8 $ 131.8 $ 136.6 10.53%
1997 5.8 154.8 160.6 14.02%
- --------------------------------------------------------------------------------------------------------------------
<FN>
(1) Cash balance excludes restricted cash in the amount of $12.5 million
and $6.6 million at December 31, 1997 and 1996,
respectively.
</FN>
</TABLE>
<PAGE>
FOURTH QUARTER REVIEW
The Company reported net income of $17.8 million for the fourth quarter of
1997 and earnings per common share of $0.32. These results were a slight
decrease from the fourth quarter of 1996 net income of $17.9 million and
earnings per common share of $0.35. Compared with the fourth quarter of 1996,
the Company's fourth quarter 1997 results reflect mainly an increase in the
general and administrative expenses, offset partially by an increase in net
interest margin.
Net interest margin totaled $21.9 million for the fourth quarter of 1997
compared with $19.8 million for the fourth quarter of 1996. The increase
resulted primarily from an increase in average interest-earning assets to $5.1
billion for the fourth quarter of 1997 compared to $4.3 billion for the fourth
quarter of 1996. The increase in the average interest-earning assets was
primarily due to the addition of $2.7 billion in collateral for collateralized
bonds during 1997, net of $0.9 billion of paydowns. This increase in
interest-earnings assets was offset by the decline in the net interest spread on
collateralized bonds which decreased from 1.51% for the fourth quarter of 1996
to 0.80% for the fourth quarter of 1997. This decline was primarily due to the
securitization of lower coupon collateral, principally A+ quality single family
ARM loans during 1997 coupled with the prepayments of higher coupon collateral
during the fourth quarter 1997. The spread on the net investment in
collateralized bonds was also effected by higher premium amortization caused by
the increased prepayments during the fourth quarter of 1997. These factors were
the major contributors to the overall decrease in the net interest spread on all
interest-earning assets from 1.51% in the fourth quarter of 1996 to 1.29% for
the fourth quarter of 1997.
Annualized return on common shareholders' equity was 15.96% in the fourth
quarter of 1997 compared to 19.31% for the fourth quarter of 1995.
The average borrowed funds increased $0.7 billion to $4.6 billion for the
fourth quarter of 1997 compared to $3.9 billion for the fourth quarter of 1996.
This increase was directly related to the increase in the average
interest-earning assets, primarily collateral for collateralized bonds. The
average cost of funds also increased from 6.21% for the fourth quarter of 1996
to 6.49% for the fourth quarter of 1997. The increase in the cost of funds was
due primarily to the increase in the average one-month LIBOR rate in the fourth
quarter of 1997 in comparison to the fourth quarter of 1996.
Loan production from all sources for the fourth quarter of 1997 increased
to $465.3 million from $125.0 million for the fourth quarter of 1996 primarily
as a result of an increase in purchases of A+ quality single family loans as
well as an increase in multifamily and manufactured housing fundings during the
fourth quarter of 1997. In addition, the Company'started funding commercial and
multifamily construction/permanent loans during 1997.
<PAGE>
Summary of Selected Quarterly Results (unaudited)
(amounts in thousands except share data)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Year ended December 31, 1997 Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating results:
Total revenues $ 79,960 $ 83,805 $ 92,606 $ 94,391
Net interest margin 20,591 21,463 20,822 21,861
Net income 18,310 18,384 19,512 17,792
Basic net income per common share (2) 0.35 0.35 0.36 0.32
Diluted net income per common share (2) 0.35 0.34 0.36 0.32
Cash dividends declared per common share (2) 0.325 0.335 0.345 0.35
Annualized return on
common 18.83% 18.23% 18.83% 15.96%
shareholders' equity
- ------------------------------------------------------------------------------------------------------------------------
Average interest-earning assets 3,822,478 4,326,438 4,806,525 5,147,551
Average borrowed funds 3,384,627 3,876,080 4,365,282 4,579,595
- ------------------------------------------------------------------------------------------------------------------------
Net interest spread on interest-earning assets 1.71% 1.59% 1.39% 1.29%
Average asset yield 8.06% 7.93% 7.71% 7.78%
Net yield on average interest-earning assets 2.44% 2.25% 1.97% 2.00%
(1)
Cost of funds 6.35% 6.34% 6.32% 6.49%
- ------------------------------------------------------------------------------------------------------------------------
Loans funded 182,976 873,637 528,244 905,633
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Year ended December 31, 1996 Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------------------------------------------------
Operating results:
Total revenues $ 72,982 $ 91,236 $ 80,414 $ 86,339
Net interest margin 18,127 18,278 18,965 19,771
Net income 12,685 25,897 16,558 17,908
Basic net income per common share (2) 0.26 0.58 0.35 0.35
Diluted net income per common share (2) 0.26 0.54 0.34 0.34
Cash dividends declared per common share (2) 0.255 0.275 0.2925 0.31
Annualized return on common
shareholders' equity 15.12% 32.45% 19.17% 19.31%
- ------------------------------------------------------------------------------------------------------------------------
Average interest-earning assets 3,746,349 4,164,848 4,106,537 4,308,551
Average borrowed funds 3,472,800 3,782,776 3,717,976 3,869,616
- ------------------------------------------------------------------------------------------------------------------------
Net interest spread on interest-earning assets 1.70% 1.43% 1.48% 1.51%
Average asset yield 7.74% 7.52% 7.63% 7.72%
Net yield on average interest-earning assets (1) 2.14% 1.99% 2.07% 2.14%
Cost of funds 6.04% 6.09% 6.15% 6.21%
- ------------------------------------------------------------------------------------------------------------------------
Loans funded 767,630 337,230 278,926 124,994
- ------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Computed as net interest margin excluding non-interest collateralized bond
expenses.
(2) Adjusted for two-for-one common stock split effective May 5, 1997.
</FN>
</TABLE>
<PAGE>
FORWARD-LOOKING STATEMENTS
Certain written statements in this Form 10-K made by the Company, that are
not historical fact constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Such forward-looking statements may
involve factors that could cause the actual results of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. The Company cautions the public not to place
undue reliance on forward-looking statements, which may be based on assumptions
and anticipated events that do not materialize. The Company does not undertake,
and the Securities Litigation Reform Act specifically relieves the Company from,
any obligation to update any forward-looking statements.
Factors that may cause actual results to differ from historical results or
from any results expressed or implied by forward-looking statements include the
following:
Economic Conditions. The Company is affected by consumer demand for
manufactured housing, multifamily housing and other products which it finances.
A material decline in demand for these products and services would result in a
reduction in the volume of loans originated by the Company. The risk of defaults
and credit losses could increase during an economic slowdown or recession. This
could have an adverse effect on the Company's financial performance and the
performance on the Company's securitized loan pools.
Capital Resources. The Company relies on various credit facilities and
repurchase agreements with certain investment banking firms to help meet the
Company's short-term funding needs. The Company believes that as these
agreements expire, they will continue to be available or will be able to be
replaced; however no assurance can be given as to such availability or the
prospective terms and conditions of such agreements or replacements.
Interest Rate Fluctuations. The Company's income depends on its ability to
earn greater interest on its investments than the interest cost to finance these
investments. Interest rates in the markets served by the Company generally rise
or fall with interest rates as a whole. A majority of the loans currently
originated by the Company are fixed-rate. The profitability of a particular
securitization may be reduced if interest rates increase substantially before
these loans are securitized. In addition, the majority of the investments held
by the Company are variable rate collateral for collateralized bonds and
adjustable-rate investments. These investments are financed through non-recourse
long-term collateralized bonds and recourse short-term repurchase agreements.
The net interest spread for these investments could decrease during a period of
rapidly rising short-term interest rates, since the investments generally have
periodic interest rate caps and the related borrowing have no such interest rate
caps.
Defaults. Defaults by borrowers on loans retained by the Company may have
an adverse impact on the Company's financial performance, if actual credit
losses differ materially from estimates made by the Company at the time of
securitization. The allowance for losses is calculated on the basis of
historical experience and management's best estimates. Actual defaults may
differ from the Company's estimate as a result of economic conditions. Actual
defaults on ARM loans may increase during a rising interest rate environment.
The Company believes that its reserves are adequate for such risks.
Prepayments. Prepayments by borrowers on loans securitized by the Company
may have an adverse impact on the Company's financial performance. Prepayments
are expected to increase during a declining interest rate or flat yield curve
environment. The Company's exposure to rapid prepayments is primarily (i) the
faster amortization of premium on the investments and, to the extent applicable,
amortization of bond discount, and (ii) the replacement of investments in its
portfolio with lower yield securities. At December 31, 1997, the yield curve was
considered flat relative to its normal shape, and as a result, the Company
expects some prepayment acceleration during the first six months in 1998.
Competition. The financial services industry is a highly competitive
market. Increased competition in the market could adversely affect the Company's
market share within the industry and hamper the Company's efforts to expand its
production sources.
Regulatory Changes. The Company's business is subject to federal and state
regulation which, among other things require the Company to maintain various
licenses and qualifications and require specific disclosures to borrowers.
Changes in existing laws and regulations or in the interpretation thereof, or
the introduction of new laws and regulations, could adversely affect the
Company's operation and the performance of the Company's securitized loan pools.
New Production Sources. The Company has expanded both its manufactured
housing and commercial lending businesses. The Company is incurring or will
incur expenditures related to the start-up of these businesses, with no
guarantee that production targets set by the Company will be met or that these
businesses will be profitable. Various factors such as economic conditions,
interest rates, competition and the lack of the Company's prior experience in
these businesses could all impact these new production sources.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company and the related notes,
together with the Independent Auditors' Report thereon are set forth on pages
F-1 through F-23 of this Form 10-K.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive officers
of the Company is included in the Company's proxy statement for its 1998 Annual
Meeting of Stockholders (the 1998 Proxy Statement) in the Election of Directors
and Management of the Company sections on pages 4 and 6 and is incorporated
herein by reference.
Item 11. EXECUTIVE COMPENSATION
The information required by Item 11 is included in the 1998 Proxy Statement
in the Management of the Company section on pages 6 through 10 and is
incorporated herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is included in the 1998 Proxy Statement
in the Ownership of Common Stock section on page 5 and is incorporated herein by
reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is included in the 1998 Proxy Statement
in the Compensation Committee Interlocks and Insider Participation section on
page 10 and is incorporated herein by reference.
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. and 2. Financial Statements and Financial Statement Schedule
The information required by this section of Item 14 is set forth in the
Consolidated Financial Statements and Independent Auditors' Report beginning at
page F-1 of this Form 10-K. The index to the Financial Statements and Schedule
is set forth at page F-2 of this Form 10-K.
<PAGE>
3. Exhibits
Exhibit Number Exhibit 3.1 Articles of Incorporation of the Registrant, as
amended, effective as of February 4, 1988. (Incorporated herein by reference to
the Company's Amendment No. 1 to the Registration Statement on Form S-3 (No.
333-10783) filed March 21, 1997.)
3.2 Amended Bylaws of the Registrant (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31, 1992, as
amended.)
3.3 Amendment to the Articles of Incorporation, effective December 29, 1989
(Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333-10783) filed March 21, 1997.)
3.4 Amendment to Articles of Incorporation, effective June 27, 1995
(Incorporated herein by reference to the Company's Current Report on Form
8-K (File No. 1-9819), dated June 26,1995.)
3.5 Amendment to Articles of Incorporation, effective October 23,
1995 (Incorporated herein by reference to the Company's Current Report on Form
8-K (File No. 1-9819), dated October 19, 1995.)
3.6 Amendment to the Articles of Incorporation, effective October 9, 1996
(Incorporated herein by reference to the Registrant's Current Report on Form
8-K, filed October 15, 1996.)
3.7 Amendment to the Articles of Incorporation, effective October 10, 1996
(Incorporated herein by reference to the Registrant's Current Report on Form
8-K, filed October 15, 1996.)
3.8 Amendment to the Articles of Incorporation, effective October 19, 1992.
(Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333- 10783) filed March 21, 1997.)
3.9 Amendment to the Articles of Incorporation, effective August 17, 1992.
(Incorporated herein by reference to the Company's Amendment No. 1 to the
Registration Statement on Form S-3 (No. 333- 10783) filed March 21, 1997.)
3.10 Amendment to Articles of Incorporation, effective April 25, 1997.
(Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997.)
3.11 Amendment to Articles of Incorporation, effective May 5, 1997.
(Incorporated herein by reference to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.)
10.1 Dividend Reinvestment and Stock Purchase Plan (Incorporated herein by
reference to the Company's Registration Statement on Form S-3 (No. 33-52071).)
10.2 Executive Deferred Compensation Plan (Incorporated by reference to
the Company's Annual Report on Form 10-K for the year ended December 31, 1993
(File No. 1-9819) dated March 21, 1994.)
10.3 Employment Agreement: Thomas H. Potts (Incorporated by reference to
Exhibits to the Company's Annual Report filed on Form 10-K for the year ended
December 31, 1994 (File No. 1-9819) dated March 31, 1995.)
10.4 Promissory Note, dated as of May 13, 1996, between the Registrant
(as Lender) and Dominion Mortgage Services, Inc. (as Borrower) (Incorporated
herein by reference to Exhibits to the Company's Form 10-Q for the quarter
ended June 30, 1996 (File No. 1-9819) dated August 14, 1996.)
10.5 Employment Agreement: William J. Moore dated August 31, 1996
(Incorporated by reference to Exhibits to the Company's Annual Report filed
on Form 10-K for the year ended December 31, 1996 (File No. 1-9819) dated
March 31, 1997.)
10.6 The Registrant's. Bonus Plan (Incorporated by reference to Exhibits
to the Company's Annual Report filed on Form 10-K for the year ended December
31, 1996 (File No. 1-9819) dated March 31, 1997.)
10.7 The Directors Stock Appreciation Rights Plan (Incorporated herein by
reference to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1997.)
10.8 1992 Stock Incentive Plan as amended (Incorporated herein by reference
to the Company's Quarterly Report on Form 10-Q for the quarter ended March
31, 1997.)
21.1 List of consolidated entities of the Company (filed
herewith)
23.1 Consent of KPMG Peat Marwick LLP (filed herewith)
(b) Reports on Form 8-K
None.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DYNEX CAPITAL, INC.
(Registrant)
March 25, 1998 /s/ Thomas H. Potts
- -------------- -------------------
Thomas H. Potts
President
(Principal Executive Officer)
March 25, 1998 /s/ Lynn K. Geurin
- -------------- ------------------
Lynn K. Geurin
Executive Vice President and
Chief Financial Officer
(Principal Accounting and
Financial Officer)
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 25, 1998
- -------------------
Thomas H. Potts
/s/ J. Sidney Davenport, IV Director March 25, 1998
- ---------------------------
J. Sidney Davenport, IV
/s/ Richard C. Leone Director March 25, 1998
- --------------------
Richard C. Leone
/s/ Paul S. Reid Director March 25, 1998
- ----------------
Paul S. Reid
/s/ Donald B. Vaden Director March 25, 1998
- -------------------
Donald B. Vaden
<PAGE>
DYNEX CAPITAL, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
INDEPENDENT AUDITORS' REPORT
For Inclusion in Form 10-K
Annual Report Filed with
Securities and Exchange Commission
December 31, 1997
<PAGE>
DYNEX CAPITAL, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
<TABLE>
<CAPTION>
<S> <C> <C>
Financial Statements: Page
Independent Auditors' Report F-3
Consolidated Balance Sheets -- December 31, 1997 and 1996 F-4
Consolidated Statements of Operations -- For the years ended
December 31, 1997, 1996 and 1995 F-5
Consolidated Statements of Shareholders' Equity -- For the
years ended December 31, 1997, 1996 and 1995 F-6
Consolidated Statements of Cash Flows -- For the years ended
December 31, 1997, 1996 and 1995 F-7
Notes to Consolidated Financial Statements --
December 31, 1997, 1996 and 1995 F-8
Schedule IV - Mortgage Loans on Real Estate F-21
All other schedules are omitted because they are not applicable or not required.
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Dynex Capital, Inc.:
We have audited the consolidated financial statements of Dynex Capital,
Inc. and subsidiaries as listed in the accompanying index. In connection with
our audits of the consolidated financial statements, we also have audited the
financial statement schedule as listed in the accompanying index. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Dynex
Capital, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole presents fairly, in all material respects, the information set forth
therein.
KPMG PEAT MARWICK LLP
Richmond, Virginia
February 4, 1998
<PAGE>
CONSOLIDATED BALANCE SHEETS
DYNEX CAPITAL, INC.
December 31, 1997 and 1996
(amounts in thousands except share data)
<TABLE>
<CAPTION>
ASSETS 1997 1996
---------- ----------
<S> <C> <C>
Investments:
Collateral for collateralized bonds $ 4,375,561 $ 2,698,342
Mortgage securities 513,750 890,212
Other investments 214,120 98,943
Loans held for securitization 235,023 265,537
----------------- ----------------
5,338,454 3,953,034
Cash 18,329 11,396
Accrued interest receivable 5,628 8,078
Other assets 15,761 10,614
------ ------
$ 5,378,172 $ 3,983,122
================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Non-recourse debt - collateralized bonds $ 3,632,079 $ 2,147,384
Recourse debt:
Secured by collateralized bonds retained 494,493 366,688
Secured by investments 510,491 887,530
Unsecured 140,711 45,658
Accrued interest payable 7,240 4,401
Accrued expenses and other liabilities 12,756 11,610
Dividends payable 19,493 16,234
------------- -------------
4,817,263 3,479,505
----------------- ----------------
SHAREHOLDERS' EQUITY
Preferred stock, par value $.01 per share,
50,000,000 shares authorized:
9.75% Cumulative Convertible Series A,
1,397,511 and 1,552,500 issued and outstanding, respectively 31,920 35,460
9.55% Cumulative Convertible Series B,
1,957,490 and 2,196,824 issued and outstanding, respectively 45,822 51,425
9.73% Cumulative Convertible Series C,
1,840,000 and 1,840,000 issued and outstanding, respectively 52,740 52,740
Common stock, par value $.01 per share,
100,000,000 and 50,000,000 shares authorized, respectively,
45,146,242 and 20,653,593 issued and outstanding, respectively 451 207
Additional paid-in capital 342,570 291,637
Net unrealized gain on investments available-for-sale 79,441 64,402
Retained earnings 7,965 7,746
-------------
-----------------
560,909 503,617
------------- -------------
$ 5,378,172 $ 3,983,122
================= ================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
DYNEX CAPITAL, INC.
<TABLE>
<CAPTION>
Years ended December 31, 1997, 1996 and 1995
(amounts in thousands except share data)
1997 1996 1995
------------------- ------------------ -------------------
<S> <C> <C> <C>
Interest income:
Collateral for collateralized bonds $ 208,946 $ 148,675 $ 61,007
Mortgage securities 79,714 128,450 160,597
Other investments 13,730 5,737 5,301
Loans held for securitization 34,514 29,439 28,349
------------------- ------------------ -------------------
336,904 312,301 255,254
------------------- ------------------ -------------------
Interest and related expense:
Non-recourse debt 152,678 102,925 41,883
Recourse debt 91,674 128,310 162,761
Other 1,982 2,819 3,931
------------------- ------------------ -------------------
246,334 234,054 208,575
------------------- ------------------ -------------------
Net interest margin before provision for losses 90,570 78,247 46,679
Provision for losses (5,833 ) (3,106 ) (2,888 )
------------------- ------------------ -------------------
Net interest margin 84,737 75,141 43,791
Gain on sale of single family mortgage operations - 17,285 -
Gain on sale of assets, net 10,254 503 9,651
Other income 3,604 882 1,591
General and administrative expenses (24,597 ) (20,763 ) (18,123 )
---------------- --------------- ----------------
Net income $ 73,998 $ 73,048 $ 36,910
=================== ================== ===================
Net income $ 73,998 $ 73,048 $ 36,910
Dividends on preferred stock (14,820 ) (10,009 ) (2,746 )
------- ------- ------
Net income available to common shareholders $ 59,178 $ 63,039 $ 34,164
=================== ================== ===================
Per common share:
Basic $ 1.38 $ 1.54 $ 0.85
=================== ================== ===================
Diluted $ 1.37 $ 1.49 $ 0.85
=================== ================== ===================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
DYNEX CAPITAL, INC.
Years ended December 31, 1997, 1996 and 1995
(amounts in thousands except share data)
<TABLE>
<CAPTION>
Net Unrealized
Additional Gain (Loss) Retained
Preferred Common Paid-in on Investments Earnings
Stock Stock Capital Available-for-Sale (Deficit) Total
---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ - $ 201 279,296 $ (72,678 ) $ (9,348) $ $197,471
Issuance of common stock 1 2,212 - - 2,213
-
Series A preferred stock issued,
net of issuance costs 35,460 - - - - 35,460
Series B preferred stock issued,
net of issuance costs 51,425 - - - - 51,425
Net income - 1995 - - - 36,910 36,910
-
Change in net unrealized loss
on investments - - 67,919 - 67,919
available-for-sale -
Dividends on common stock
at $0.84 per share - - - (33,829) (33,829)
-
Dividends on preferred stock - - - (2,746) (2,746)
-
---------------------------------------------------------------------------------------------
Balance at December 31, 1995 86,885 202 281,508 (4,759) (9,013) 354,823
Issuance of common stock 5 10,129 - - 10,134
-
Series C preferred stock issued,
net of issuance costs 52,740 - - - - 52,740
Net income - 1996 - - - 73,048 73,048
-
Change in net unrealized loss
on investments - - 69,161 - 69,161
available-for-sale -
Dividends on common stock
at $1.1325 per share - - - (46,280) (46,280)
-
Dividends on preferred stock - - - (10,009) (10,009)
-
---------------------------------------------------------------------------------------------
Balance at December 31, 1996 139,625 207 291,637 64,402 7,746 503,617
Issuance of common stock 25 42,009 - 42,034
- -
Conversion of preferred stock (9,143) 6 9,137 -
- -
Two-for-one common stock split 213 (213) -
- - -
Net income - 1997 - - 73,998 73,998
- -
Change in net unrealized gain
on investments - 15,039 15,039
available-for-sale - - -
Dividends on common stock
at $1.355 per share - - (58,959) (58,959)
- -
Dividends on preferred stock - - (14,820) (14,820)
- -
-----------------------------------------------------------------------------------------------
Balance at December 31, 1997 $ 130,482 $ 451 342,570 $ 79,441 $ 7,965 $ 560,909
===============================================================================================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
DYNEX CAPITAL, INC.
<TABLE>
<CAPTION>
Years ended December 31, 1997, 1996 and 1995
(amounts in thousands)
1997 1996 1995
----------------- ------------------ -----------------
<S> <C> <C> <C>
Operating activities:
Net income $ 73,998 $ 73,048 $ 36,910
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for losses 5,833 3,106 2,888
Net gain from sale of investments (10,254 ) (503 ) (2,276 )
Gain on sale of single family operations - (17,285 ) -
Amortization and depreciation 26,670 23,068 14,091
Net increase (decrease) in accrued interest, other
assets and other liabilities 14,385 (12,583 ) (4,931 )
Other - - (2,639 )
--------------- ---------------- ---------------
Net cash provided by operating activities 110,632 68,851 44,043
----------------- ------------------ -----------------
Investing activities:
Collateral for collateralized bonds:
Fundings of loans subsequently securitized (2,302,831 ) (1,571,955 ) (708,954 )
Principal payments on collateral 940,613 464,478 205,150
Increase in accrued interest receivable (10,316 ) (10,775 ) (4,562 )
Net change in funds held by trustees 544 419 952
Net decrease (increase) in loans held for securitization 28,542 (48,166 ) 307,019
Purchase of other investments (160,800 ) (35,570 ) (15,665 )
Payments on other investments 18,547 12,655 4,939
Proceeds from sale of other investments 15,544 - -
Purchase of mortgage securities (848,663 ) (113,196 ) (432,885 )
Payments on mortgage securities 62,184 304,551 260,850
Proceeds from sales of mortgage securities 847,339 505,708 634,364
Proceeds from sale of single family operations 9,500 20,413 -
Capital expenditures (2,921 ) (3,162 ) (911 )
--------------- ---------------- ---------------
Net cash (used for) provided by investing activities (1,402,718 ) (474,600 ) 250,297
--------------- ---------------- ---------------
Financing activities:
Collateralized bonds:
Proceeds from issuance of securities 2,400,191 1,770,965 602,049
Principal payments on securities (919,885 ) (448,238 ) (174,150 )
Increase (decrease) in accrued interest payable 2,945 91 (427 )
Proceeds from issuance of senior notes 98,223 - -
Repayments on senior unsecured notes (3,000 ) (3,000 ) (3,000 )
Repayments on borrowings, net (250,969 ) (936,055 ) (768,552 )
Proceeds from stock offerings, net 42,034 62,874 89,097
Dividends paid (70,520 ) (51,721 ) (25,042 )
----------------- ------------------ -----------------
Net cash provided by (used for) financing activities 1,299,019 394,916 (280,025 )
----------------- ------------------ -----------------
Net increase (decrease) in cash 6,933 (10,833 ) 14,315
Cash at beginning of year 11,396 22,229 7,914
------ ------ -----
Cash at end of year $ 18,329 $ 11,396 $ 22,229
================= ================== =================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEX CAPITAL, INC.
December 31, 1997, 1996 and 1995
(amounts in thousands except share data)
NOTE 1 - THE COMPANY
The Company originates and purchases mortgage loans and consumer
installment loans throughout the United States. Currently, the Company's primary
production operations include the origination of mortgage loans secured by
multifamily and commercial properties and the origination of loans secured by
manufactured homes. The Company will securitize the loans funded principally as
collateral for collateralized bonds, limiting its credit risk and providing
long-term financing for those loans securitized.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The consolidated financial statements include the
accounts of Dynex Capital, Inc., (formerly, Resource Mortgage Capital, Inc.) its
wholly-owned subsidiaries (together, "Dynex") and certain other affiliated
entities (collectively, the "Company"). All intercompany balances and
transactions have been eliminated in consolidation. Substantially all of the
collateral for collateralized bonds is pledged to secure non-recourse debt in
the form of collateralized bonds issued by limited-purpose finance subsidiaries
and is not available for the satisfaction of general claims of the Company. As
the collateralized bonds are non-recourse to the Company, the Company's exposure
to loss on the assets pledged as collateral for collateralized bonds is
generally limited to the amount of collateral pledged to the collateralized
bonds in excess of the amount of the collateralized bonds issued.
Reclassification and Stock Split Certain amounts for prior years have been
reclassified to conform to the presentation for 1997. On May 5, 1997, the
Company completed a two-for-one common stock split. All references to the per
share amounts in the accompanying consolidated financial statements and related
notes have been restated to reflect the stock split.
Federal Income Taxes Dynex has elected to be taxed as a real estate
investment trust ("REIT") under the Internal Revenue Code. As a result, Dynex
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. No provision has
been made for income taxes for Dynex and its qualified REIT subsidiaries in the
accompanying consolidated financial statements, as Dynex believes it has met the
prescribed requirements.
Investments Pursuant to the requirements of Statement of Financial
Accounting Standards No. 115 ("FAS No. 115"), "Accounting for Certain
Investments in Debt and Equity Securities", the Company is required to classify
certain of its investments as either trading, available-for-sale or
held-to-maturity. The Company has classified collateral for collateralized bonds
and mortgage securities as available-for-sale. These investments are therefore
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of shareholders' equity. The basis of any
securities sold is computed using the specific identification method. Collateral
for collateralized bonds can be sold only subject to the lien of the respective
collateralized bond indenture so long as the related bonds have not been
redeemed.
Collateral for Collateralized Bonds. Collateral for collateralized bonds
consists of securities which have been pledged to secure collateralized bonds.
These securities are backed by single family, multifamily and commercial
mortgage loans, as well as manufactured housing installment loans.
Mortgage Securities. Mortgage securities consist of adjustable-rate
mortgage ("ARM") securities, fixed-rate mortgage securities, mortgage derivative
securities and mortgage residual interests.
Other Investments. Other investments consists primarily of single family
homes leased to home builders, property tax receivables and a note receivable
received in connection with the sale of the Company's single family mortgage
operations in May 1996 (see Note 9). Other investments are not considered
securities pursuant to FAS No. 115, and therefore are reported at their
amortized cost basis.
<PAGE>
Loans Held for Securitization Loans held for securitization primarily
include mortgage loans secured by commercial, multifamily and single family
residential properties and installment loans secured by manufactured homes.
These loans will generally be securitized as collateral for collateralized
bonds. These loans are carried at the lower of cost or market. Premiums paid or
discounts obtained on these loans are deferred as an adjustment to the carrying
value of the loans. Deferred hedging gains or losses, if any, are netted against
the outstanding loan balances.
Price Premiums and Discounts Price premiums and discounts on investments
and obligations 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.
Deferred Issuance Costs Costs incurred in connection with the issuance of
collateralized bonds and unsecured notes are deferred and amortized over the
estimated lives of their respective debt obligations using a method that
approximates the effective yield method.
Derivative Financial Instruments The Company enters into interest rate swap
agreements, interest rate cap agreements, financial forwards, financial futures
and options on financial futures ("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. At trade
date, these instruments are designated as either hedge positions or trade
positions.
For Interest Rate Agreements designated as hedge instruments, the Company
evaluates the effectiveness of these hedges periodically 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 income or expense on the asset or liability 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 related investment.
The unamortized cost is included in the carrying amount of the related
investment. Revenues or cost associated with futures and option contracts are
recognized in income or expense in a manner consistent with the accounting for
the asset or liability being hedged. Amounts payable to or receivable from
counterparties are included in the financial statement line of the item being
hedged. Interest Rate Agreements that are hedge instruments are also carried at
fair value, with unrealized gains and losses reported as a separate component of
shareholders' equity.
The Company may also enter into forward delivery contracts and interest
rate futures and options contracts for hedging interest rate risk associated
with commitments made to fund loans. Gains and losses on such contracts are
either (i) deferred as an adjustment to the carrying value of the related loans
until the loan has been funded and securitized, after which the gains or losses
will be amortized into income over the remaining life of the loan using a method
that approximates the effective yield method, or (ii) deferred until such time
as the related loans are funded and sold.
If a hedged instrument 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.
For Interest Rate Agreements entered into for trading purposes, realized
and unrealized changes in fair value of these instruments are recognized in the
consolidated statements of operations in gain on sale of assets in the period in
which the changes occur or when such trade instruments are settled. Amounts
payable to or receivable from counterparties, if any, are included on the
consolidated balance sheets in accrued expenses and other liabilities.
Cash Approximately $12,500 and $6,600 of cash at December 31, 1997 and
1996, respectively, is restricted for the payment of premiums on various
insurance policies related to certain mortgage securities, or is held in trust
to cover losses not otherwise covered by insurance.
Net Income Per Common Share Net income per common share is presented on
both a basic net income per common share and diluted net income per common share
basis. Diluted net income per common share assumes the conversion of the
convertible preferred stock into common stock, using the if-converted method,
and stock appreciation rights, using the treasury stock method. As a result of
the two-for-one split of the Company's common stock in May 1997, the preferred
stock is convertible into two shares of common stock for one share of preferred
stock.
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
financial instruments. Estimates of fair value for financial instruments may be
based on market prices provided by certain dealers. Estimates of fair value for
certain other financial instruments are determined by calculating the present
value of the projected cash flows of the instruments using appropriate discount
rates, prepayment rates and credit loss assumptions. 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. Estimates of fair value for other financial instruments are
based primarily on management's judgment. Since the fair value of the Company's
financial instruments is based on estimates, actual gains and losses recognized
may differ from those estimates recorded in the consolidated financial
statements. The fair value of all on- and off-balance sheet financial
instruments is presented in Note 8.
Allowance for Losses. As discussed in Note 5, the Company has credit risk
on certain investments. An allowance for losses has been estimated and
established for that credit risk 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 potential credit losses, as well as
industry loss experience. Provisions made to increase the allowance related to
credit risk are presented as provision for losses in the accompanying
consolidated statements of operations. The Company's actual credit losses may
differ from those estimates used to establish the allowance.
Derivative and Residual Securities. Income on certain derivative and
residual securities is accrued using the effective yield method based upon
estimates of future cash flows to be received over the estimated remaining lives
of the related mortgage securities. Reductions in carrying value are made when
the total projected cash flow is less than the Company's basis, based on either
the dealers' prepayment assumptions or, if it would accelerate such adjustments,
management's expectations of interest rates and future prepayment rates.
Recent Accounting Pronouncements In January 1997, the Company adopted the
Statement of Financial Accounting Standard No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" ("FAS
No.125"). FAS No. 125 provides accounting and reporting standards for transfers
andservicing of financial assets and extinguishments of liabilities based on a
financial components approach that focuses on control of the respective assets
and liabilities. It distinguishes transfers of financial assets that are sales
from transfers that are secured borrowings. The impact of adopting FAS No. 125
did not result in a material change to the Company's financial position and
results of operations.
The Company also adopted the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 128, "Earnings Per Share" ("FAS
No. 128") in 1997. FAS No. 128 replaced Primary EPS and Fully Diluted EPS with
Basic EPS and Diluted EPS, respectively.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 129, "Disclosure of Information about
Capital Structure" ("FAS No. 129"). FAS No. 129 summarizes previously issued
disclosure guidance contained within APB Opinions No. 10 and 15, as well as
Statement of Financial Accounting Standard No. 47, "Disclosure of Long-Term
Obligations". This statement is effective for financial statements for periods
ending after December 15, 1997. There are no significant changes to the
Company's disclosures pursuant to the adoption of FAS No. 129.
In June 1997, the Financial Accounting Standards Board issued 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 by their nature in the financial statements and display the
accumulated balance 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. This statement is effective for
financial statements issued for fiscal years beginning after December 15, 1997.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("FAS No. 131"). FAS No. 131 establishes
standards for reporting information about operating segments and is effective
for financial statements issued for fiscal years beginning after December 15,
1997. There will be no significant changes to the Company's disclosures pursuant
to the adoption of FAS No. 131.
In January 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 132, "Employers' Disclosure about Pensions
and Other Postretirement Benefits" ("FAS No. 132"). FAS No. 132 revises
employers' disclosures about pension and other postretirement benefit plans and
is effective for financial statements issued for fiscal years beginning after
December 15, 1997. There will be no significant changes to the Company's
disclosures pursuant to the adoption of FAS No. 132.
NOTE 3 - COLLATERAL FOR COLLATERALIZED BONDS, MORTGAGE SECURITIES AND OTHER
INVESTMENTS
The following table summarizes the Company's amortized cost basis and fair
value of investments, as of December 31, 1997 and 1996, classified as
available-for-sale and the related average effective interest rates:
<TABLE>
<CAPTION>
- ------------------------------------------ --------------------------------- ------ ------------------------------------
1997 1996
- ------------------------------------------ --------------------------------- ------ ------------------------------------
Effective Effective
Interest Interest
Fair Value Rate Fair Value Rate
- ------------------------------------------ ---------------- -- ------------- ------ ----------------- ---- -------------
<S> <C> <C> <C> <C>
Collateral for collateralized bonds:
Amortized cost $ 4,317,945 7.5% $ 2,664,681 7.9%
Allowance for losses (24,811 ) (31,732 )
- ------------------------------------------ -- ------------- -- ------------- ------ -- -------------- --- --------------
Amortized cost, net 4,293,134 2,632,949
Gross unrealized gains 94,825 73,696
Gross unrealized losses (12,398 ) (8,303 )
- ------------------------------------------ -- ------------- -- ------------- ------ -- -------------- --- --------------
$ 4,375,561 $ 2,698,342
- ------------------------------------------ -- ------------- -- ------------- ------ -- -------------- --- --------------
Mortgage securities:
Adjustable-rate mortgage securities $ 403,117 7.7% $ 780,315 6.9%
Fixed-rate mortgage securities 21,463 9.1% 30,703 10.9%
Derivative and residual securities 97,848 16.3% 87,479 16.4%
- ------------------------------------------ -- ------------- -- ------------- ------ -- -------------- --- --------------
522,428 898,497
Allowance for losses (5,692 ) (7,294 )
--------------------------------------- -- ------------- -- ------------- ------ -- -------------- --- --------------
Amortized cost, net 516,736 891,203
Gross unrealized gains 18,144 23,591
Gross unrealized losses (21,130 ) (24,582 )
- ------------------------------------------ -- ------------- -- ------------- ------ -- -------------- --- --------------
$ 513,750 $ 890,212
- ------------------------------------------ -- ------------- -- ------------- ------ -- -------------- --- --------------
</TABLE>
Collateral for collateralized bonds. Collateral for collateralized bonds
consists of securities backed by adjustable-rate and fixed-rate mortgage loans
secured by first liens on single family and multifamily residential housing,
commercial properties and manufactured housing installment loans secured by
either a UCC filing or a motor vehicle title. 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 by the
limited-purpose finance subsidiaries are non-recourse to the Company.
The components of collateral for collateralized bonds at December 31, 1997 and
1996 are as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Collateral, net of allowance $ 4,199,777 $ 2,555,903
Funds held by trustees 2,092 2,637
Accrued interest receivable 28,891 18,575
Unamortized premiums and discounts, net 62,374 55,834
Unrealized gain, net 82,427 65,393
-------------------------------------------- -- --------------- ---
$ 4,375,561 $ 2,698,342
-------------------------------------------- -- --------------- ---
</TABLE>
<PAGE>
Mortgage securities. ARM securities consist of mortgage certificates
secured by ARM loans. Fixed-rate mortgage securities consist of mortgage
certificates secured by mortgage loans that have a fixed rate of interest for at
least one year from the balance sheet date. Derivative securities are classes of
collateralized bonds, mortgage pass-through certificates or mortgage
certificates that pay to the holder substantially all interest (i.e., an
interest-only security), or substantially all principal (i.e., a principal-only
security). Residual interests represent the right to receive the excess of (i)
the cash flow from the collateral pledged to secure related mortgage-backed
securities, together with any reinvestment income thereon, over (ii) the amount
required for principal and interest payments on the mortgage-backed securities
or repurchase arrangements, together with any related administrative expenses.
Other investments. Other investments consist primarily of model homes
purchased from home builders which were simultaneously leased back to the
builders, principally through operating leases. At the end of each lease,
generally after a twelve to eighteen month lease term, the Company will sell the
home. Model homes included in other investments amounted to $121,834 and $33,268
at December 31, 1997 and 1996, respectively. The expected future lease receipts
based on the outstanding leases at December 31, 1997 totaled $8,915--1998,
$1,022--1999, $639--2000. $373--2001 and none--2002. In addition, other
investments include a note receivable in connection with the sale of the
Company's single family mortgage operations in May 1996 (see Note 9) and
property tax receivables purchased by the Company. The balance of the note
receivable was $38,000 and $47,500 at December 31, 1997 and 1996, respectively.
Sale of investments. Proceeds from sales of mortgage securities totaled
$847,339, $505,708 and $634,364 in 1997, 1996 and 1995, respectively. Gross
gains of $2,743, $4,489 and $15,513 and gross losses of $2,163, $6,887 and
$13,237 were realized on those sales in 1997, 1996 and 1995, respectively. Gross
realized losses in 1996 includes writedowns for permanent impairment of certain
mortgage derivative securities of $1,460.
NOTE 4 - LOANS HELD FOR SECURITIZATION
The following table summarizes the Company's loans held for securitization
at December 31, 1997 and 1996, respectively.
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------
1997 1996
----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Secured by multifamily and commercial properties $ 125,338 $ 208,230
Secured by manufactured homes 56,497 40,745
Secured by single family residential properties 35,209 24,076
----------------- -----------------
217,044 273,051
Deferred hedging positions 27,677 190
Net discount (7,968 ) (5,363
Total loans held for securitization $ $235,023 $ 265,537
----------------------------------------------------------------------------------------------------------
</TABLE>
The Company originates fixed-rate loans secured by first mortgages or deeds
of trust on multifamily properties, commercial properties and land home
financing on manufactured homes. The Company also originates fixed-rate and
adjustable-rate installment loans on manufactured homes which are secured by
either a UCC filing or a motor vehicle title. While the Company originates these
loans throughout the United States, over 50% of the multifamily and commercial
loans are located in California, South Carolina and Texas. Over 50% of the
manufactured housing loans are located in Texas, Michigan, South Carolina and
North Carolina.
Net discount on loans held for securitization includes premiums paid and
discounts obtained on loans held for securitization. Deferred hedging positions
includes the gains and losses generated from corresponding hedging transactions,
primarily used to hedge the pipeline of commitments to fund multifamily and
commercial loans. Deferred hedging positions are deferred as an adjustment to
the carrying value of the loans until the loans are funded and either
securitized or sold.
The Company funded loans with an aggregate principal balance of $565,058,
$744,001 and $893,953 during 1997, 1996 and 1995, respectively. Additionally,
the Company purchased bulk loans, principally single family ARM loans, totaling
$1,271,479, $731,460 and $22,433 in 1997, 1996 and 1995, respectively.
<PAGE>
NOTE 5 - ALLOWANCE FOR LOSSES
The following table summarizes the activity for the allowance for losses on
investments for the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
----------------------------------------- --- -------------- --- -- --------------- --
1997 1996
----------------------------------------- --- -------------- --- -- --------------- --
<S> <C> <C>
Allowance at beginning of year $ 41,423 $ 12,534
Provision for losses 5,833 3,106
Provision recorded due to sale of
single family operations (see Note 9) - 33,670
Credit losses, net of recoveries (14,144)
(7,887)
----------------------------------------- --- -------------- --- -- --------------- --
Allowance at end of year $ 33,112 $ 41,423
----------------------------------------- --- -------------- --- -- --------------- --
</TABLE>
Collateral for collateralized bonds. The Company has limited exposure to
credit risk retained on loans that 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 collateralized bonds issued,
excluding price premiums and discounts and hedge gains and losses. The allowance
for losses for collateral for collateralized bonds totaled $24,811 and $31,732
at December 31, 1997 and 1996 respectively, and is included in collateral for
collateralized bonds in the accompanying consolidated balance sheets.
Mortgage securities. On certain mortgage securities collateralized by
mortgage loans purchased by the Company for which mortgage pool insurance is
used as the primary source of credit enhancement, the Company has limited
exposure to certain credit risks such as fraud in the origination and special
hazards not covered by such insurance. An allowance was established based on the
estimate of losses at the time of securitization. The allowance for losses for
mortgage securities is $5,692 and $7,294 at December 31, 1997 and 1996,
respectively, and is included in mortgage securities in the accompanying
consolidated balance sheets.
Other Investments. The Company is exposed to potential losses if the
builder defaults on the lease payments or, if at the sale of the model, there
has been a decline in the value of the model. The Company's potential loss is
equal to the difference in the cash proceeds from the sale of the model and the
net purchase price of the model less reserves. The Company evaluates the
financial condition of the homebuilders as well as the market conditions where
the homes are located to determine the amount of reserves necessary. The Company
has established reserves for potential losses on other investments of $879 and
$56 at December 31, 1997 and 1996, respectively.
Loans held for securitization. The Company has exposure to credit losses on
loans held for securitization until those loans are securitized. Upon
securitization, the Company's exposure is generally limited to its net
investment in those loans as discussed above. The Company has established
reserves for potential losses for the loans held for securitization totaling
$1,730 and $2,341 at December 31, 1997 and 1996, respectively.
<PAGE>
NOTE 6 - NON-RECOURSE DEBT
The Company, through limited-purpose finance subsidiaries, has issued
non-recourse debt in the form of collateralized bonds. Each series of
collateralized bonds may consist of various classes of bonds, either at fixed or
variable rates of interest. Payments received on the collateral for
collateralized bonds and any reinvestment income thereon are used to make
payments on the collateralized bonds (see Note 3). The obligations under the
collateralized bonds are payable solely from the collateral for collateralized
bonds and are otherwise non-recourse to the Company. The maturity of each class
is directly affected by the rate of principal prepayments on the related
collateral. Each series is also subject to redemption according to specific
terms of the respective indentures, generally when the remaining balance of the
bonds equals 35% or less of the original principal balance of the bonds. As a
result, the actual maturity of any class of a collateralized bonds series is
likely to occur earlier than its stated maturity.
The components of collateralized bonds along with certain other information
at December 31, 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
- ----------------------------------- ---------------------------------- -- -----------------------------------
1997 1996
- ----------------------------------- ---------------------------------- -- -----------------------------------
Bonds Outstanding Range of Bonds Outstanding Range of
Interest Rates Interest Rates
- ----------------------------------- ------------------ --------------- -- ------------------- ---------------
<S> <C> <C> <C> <C>
Variable-rate classes $ 3,192,049 5.9% - 7.4% $ 1,922,021 5.6% - 6.0%
Fixed-rate classes 433,028 6.5% - 11.5% 220,185 6.5% - 11.5%
Accrued interest payable 5,949 3,004
Deferred bond issuance costs (4,875) (3,952)
Unamortized net premium 5,928 6,126
- ----------------------------------- -- ------------ -- --------------- -- --- ------------ -- ---------------
$ 3,632,079 $ 2,147,384
- ----------------------------------- -- ------------ -- --------------- -- --- ------------ -- ---------------
Range of stated maturities 1998 - 2031 1998-2030
Number of series 33 31
- ----------------------------------- -- ------------ -- --------------- -- --- ------------ -- ---------------
</TABLE>
The variable rate classes are based on one-month London InterBank Offered
Rate (LIBOR). The average effective rate of interest expense for non-recourse
debt was 6.5%, 6.5% and 7.2% for the years ended December 31, 1997, 1996 and
1995, respectively.
<PAGE>
NOTE 7 - RECOURSE DEBT
The Company utilizes repurchase agreements, notes payable and warehouse
credit facilities (together, "Recourse Debt") to finance certain of its
investments. The following table summarizes the Company's recourse debt
outstanding and the weighted-average annual rates at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
- ----------------------------------- ---------------------------------------- -- ----------------------------------------
1997 1996
- ----------------------------------- ---------------------------------------- -- ----------------------------------------
Weighted- Weighted-
Average Market Average Market
Amount Annual Rate Value of Amount Annual Rate Value of
Outstanding Collateral Outstanding Collateral
- ----------------------------------- ------------- -- ---------- -- --------- -- ------------ -- ----------- -- ---------
<S> <C> <C> <C> <C> <C> <C>
Recourse debt secured by:
Collateralized bonds $ 494,493 6.18% 523,907 $ 366,688 5.69% $ 381,417
Mortgage securities 394,551 6.23% 418,611 756,448 5.82% 806,025
Other investments 60,983 7.93% 128,248 11,582 7.87% 33,319
Loans held for securitization 51,423 6.95% 64,043 119,500 6.98% 235,845
Other assets 3,534 7.25% 3,619 - -
---------- ---------- --------- ----------
1,004,984 1,138,428 1,254,218 1,456,606
Unsecured debt:
7.875% senior notes 98,380 7.883% - - -
Series B 10.03% senior notes 34,795 10.03% - 34,722 10.03% -
Series A 9.56% senior notes 5,932 9.56 % - 8,895 9.56% -
Acquisition notes due 1999-2001 1,604 8.41% - 2,041 8.43% -
- ----------------------------------- -- ---------- -- ---------- - ---------- -- -- --------- -- ----------- - ----------
$ 1,145,695 1,138,428 $ 1,299,876 $ 1,456,606
- ----------------------------------- -- ---------- -- ---------- - ---------- -- -- --------- -- ----------- - ----------
</TABLE>
Secured Debt. At December 31, 1997 and 1996, recourse debt consisted of
$889,044 and $1,123,136, respectively, of repurchase agreements secured by
investments, and $101,971 and $128,220, respectively, outstanding under
warehouse credit facilities. At December 31, 1997, substantially all recourse
debt in the form of repurchase agreements had maturities within thirty days and
bear interest at rates indexed to LIBOR. If the counterparty to the repurchase
agreement fails to return the collateral, the ultimate realization of the
security by the Company may be delayed or limited. The excess market value of
the assets securing the Company's repurchase obligations at December 31, 1997
did not exceed 10% of shareholders' equity for any of the individual
counterparties with whom the Company had contracted these agreements.
At December 31, 1997, the Company had three credit facilities aggregating
$600,000 to finance the funding of loans, $300,000 expiring in 1998 and $300,000
expiring in 1999. The interest rates on these facilities range from one-month
LIBOR plus 0.875% to one-month LIBOR plus 1.375%. The contractual rates paid on
these facilities may be reduced by credits for compensating cash balances. One
of these facilities includes a sub-agreement that allows the Company to borrow
up to $30,000 unsecured for working capital purposes. The Company expects that
these credit facilities will be renewed, if necessary, at their respective
expiration dates, although there can be no assurance of such renewal.
During 1997, the Company entered into capital leases for financing its
furniture and computer equipment. Interest expense on these capital leases was
$52 for the year ended December 31, 1997. The aggregate payments due under the
capital leases for five years after December 31, 1997 are $627, $900, $970, $598
and $439.
Unsecured Debt. In July 1997, the Company issued $100,000 unsecured 7.875%
senior notes due 2002. Interest is payable semi-annually in arrears. The
Company's Series A 9.56% senior notes are payable in annual installments through
1999. The Company's Series B 10.03% senior notes are payable in annual
installments through 2001. The Company also has various acquisition notes
payable totaling $1.6 million at December 31, 1997. The aggregate principal
payments due under the unsecured notes for five years after December 31, 1997
are $12,154, $12,662, $8,894, $8,894 and $100,000.
<PAGE>
NOTE 8 - FAIR VALUE AND ADDITIONAL INFORMATION ABOUT FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standard No. 107, "Disclosures about Fair
Value of Financial Instruments" ("FAS No. 107") requires the disclosure of the
estimated fair value of on-and off-balance-sheet financial instruments. The
following table presents the carrying values and estimated fair values of the
Company's financial instruments as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
- ----------------------------------------- --------------------------------------- -- -------------------------------------
1997 1996
- ----------------------------------------- --------------------------------------- -- -------------------------------------
Notional Amortized Notional Amortized Cost Fair
Amount Cost Fair Value Amount Value
- ----------------------------------------- ----------- ------------- ------------- -- ----------- --------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Recorded financial instruments:
Assets:
Collateral for collateralized bonds $ -$ 4,285,079 $ 4,375,626 $ -$ 2,624,337$ 2,695,735
Mortgage securities - 510,456 512,220 - 880,790 887,717
Interest rate cap agreements 1,499,000 14,335 1,465 1,499,000 19,025 5,102
Loans held for securitization - 213,477 233,037 - 262,960 277,710
Other investments - 214,120 224,360 - 96,236 98,378
Cash - 18,329 18,329 - 11,396 11,396
Liabilities:
Non-recourse debt - 3,632,079 3,632,079 - 2,147,384 2,147,384
Recourse debt:
Secured by collateralized bonds - 494,493 494,493 - 366,688 366,688
retained
Secured by investments - 510,491 510,491 - 887,530 887,530
Unsecured - 140,711 147,477 - 45,658 45,658
Off-balance sheet financial
instruments:
Financial futures contracts 538,500 5,179 (4,904) 274,000 - (1,804)
Options on futures contracts 50,000 (195) 90 100,000 - (55)
Interest rate swap agreements 1,378,778 - (3,940) 1,452,801 - (843)
Forward delivery contracts 74,200 (8,270) (8,270) 267,400 (1,026) (1,026)
Commitments to fund loans 697,840 11,750 758,542 536,931 (2,452) 552,560
-------------------------------------- -- --------- -- --------- --- --------- -- -- -------- -- --------- -- ---------
</TABLE>
The fair value of collateral for collateralized bonds, mortgage securities,
interest rate cap agreements, loans held for securitization and other
investments is based on actual market price quotes, or by determining the
present value of the projected future cash flows using appropriate discount
rates, credit losses and prepayment assumptions. The carrying amount of cash is
a reasonable estimate of fair value. Non-recourse debt and secured recourse debt
are short-term borrowings that reprice frequently. Therefore, the carrying value
approximates the fair value. The fair value of the unsecured debt was determined
by calculating the present value of the projected cash flows using appropriate
discount rates. The fair value of the off-balance sheet financial instruments
was determined from actual market quotes.
Derivative Financial Instruments Used for Interest Rate Risk Management The
Company may engage in derivative financial instrument activities for the purpose
of interest rate risk management and yield enhancement. As of December 31, 1997,
all of the Company's outstanding derivative financial positions were for
interest rate risk management. For all derivative financial instruments, the
Company has credit risk to the extent that the counterparties do not perform
their obligation under the agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the conditions of the agreement.
Interest rate cap agreements. The Company has LIBOR and one-year Constant
Maturity Treasury Index (CMT) based interest rate cap agreements to limit its
exposure to the lifetime interest rate caps on certain of its ARM securities and
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
11.5%, with expiration dates ranging from 1999 to 2004.
Financial futures, forwards and options contracts. The Company may utilize
financial futures and forward contracts to moderate the risks inherent in the
financing of its mortgage securities with floating rate repurchase agreements.
The Company utilizes these instruments to synthetically lengthen the terms of
the repurchase agreement financing, generally from one month to three and six
months. Under these contracts, the Company will receive additional cash flow if
the related index increases above the contracted rates. The Company will pay
additional cash flow if the related index decreases below the contracted rates.
As of December 31, 1997, the Company had no such financial futures and forward
contracts outstanding.
The Company will also use financial futures, forward and option contracts
to reduce exposure to the effect of changes in interest rates on funded loans,
as well as those loans that the Company has committed to fund. As of December
31, 1997, the Company had entered into commitments to fund multifamily and
commercial loans of $641,903 at fixed interest rates ranging from 7.65% to 8.80%
and manufactured housing loans of $55,937 primarily at fixed interest rates
ranging from 7.50% to 11.25%. The multifamily and commercial commitments had
original terms of not more than 27 months. The manufactured housing commitments
generally had original terms of not more than 90 days. The Company has deferred
net hedging losses of $15,088 at December 31, 1997 and deferred net hedging
gains of $2,022 at December 31, 1996 related to these positions.
Interest rate swap agreements. The Company may enter into various interest
rate swap agreements to limit its exposure to changes in financing rates of
collateral for collateralized bonds and certain mortgage securities. The Company
has entered into a series of interest rate swap agreements which caps the
increase in borrowing costs in any six-month period to 1% for $1,020,000
notional amount of short-term borrowings. Pursuant to the terms of this
agreement, the Company pays the lesser of current six-month LIBOR, or six-month
LIBOR in effect 180-days prior plus 1%, and receives current 6-month LIBOR.
These agreements expire in 2001. The Company has also entered into a an
amortizing interest rate swap agreement related to variable-rate collateralized
bond classes with a remaining notional balance of $148,513. Under the terms of
this agreement, the Company receives one-month LIBOR and pays 6.15%. This
agreement expires in 2000. The Company entered into an amortizing interest rate
swap agreement with remaining notional balance of $185,131 related to
prime-based ARM 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 three months prior.
The Company has also entered into interest rate swap agreements with a
total notional balance of $25,134 related to tax-exempt bonds for which the
Company facilitates the issuance. As the facilitator of the issuance of the
bonds, the Company is required to pay interest due to the bond holders in excess
of a fixed rate. The bonds are floating rate based on the current weekly Public
Securities Association index ("PSA"). The Company, simultaneous to the issuance
of the bonds, entered into an interest rate swap agreement to pay fixed and
receive weekly PSA.
Derivative Financial Instruments Used for Other Than Risk Rate Management
Purposes The Company may enter into financial futures, forwards and options
contracts to enhance the overall yield on its investment portfolio. Such
derivative contracts are considered trading positions, and generally are for
terms of less than three months. The Company realized gross gains of $9,862 and
$360 from these contracts in 1997 and 1996, respectively, primarily from premium
income received on options contracts written. The Company realized gross losses
of $281 and $3,687 from these contracts in 1997 and 1996, respectively. There
were no open trading positions at December 31, 1997 and 1996.
NOTE 9 - SALE OF SINGLE-FAMILY MORTGAGE OPERATIONS
On May 13, 1996, the Company sold its single family correspondent,
wholesale and servicing operations (collectively, the "single family mortgage
operations") to a subsidiary of Dominion Resources, Inc. for $67,958. The terms
of the purchase included an initial cash payment of $20,458, with the remainder
of the purchase price paid in five annual installments of $9,500 beginning
January 2, 1997, pursuant to a note agreement. The note bears interest at a rate
of 6.50% and is classified as other investments in the consolidated balance
sheet. As a result of the sale, the Company recorded a net gain of $17,285. Such
amount included a provision of $33,670 for possible losses on securitized single
family loans where the Company, which performed the servicing of such loans
prior to the sale, has retained a portion of the credit risk on these loans.
<PAGE>
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the numerator and denominator for both the
basic and diluted EPS for the years ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------- --------------------------- ---------------------------
Weighted-Average Weighted-Average Weighted-Average
Number of Number of Number of
Shares Shares Shares
Income Income Income
----------- --------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Income $ 73,998 $ 73,048 $ 36,910
Less: Dividends paid to preferred (14,820) (10,009 ) (2,746 )
stock
----------- -------------- ----------- --------------- ----------- --------------
59,178 43,031,381 63,039 40,889,581 34,164 40,245,545
Effect of dividends and additional shares of preferred stock:
Series A 3,948 2,953,413 3,687 3,105,000 - -
Series B 5,500 4,138,945 5,218 4,393,648 - -
Series C - - 1,104 771,585 - -
----------- ------------- ---------- --------------- ----------- -------------
$ 68,626 50,123,739 73,048 49,159,814 $ 34,164 40,245,545
=========== ============== =========== =============== =========== ==============
Basic EPS $1.38 $1.54 $0.85
============== =============== ==============
Diluted EPS $1.37 $1.49 $0.85
===== ===== =====
Reconciliation of anti-dilutive
shares:
Dividends and additional shares of preferred stock:
Series A $ - $ - $ 1,817 1,552,685
- -
Series B - - - - 929 811,646
Series C 5,372 3,679,474 - - - -
Expense and incremental shares of
stock
appreciation rights 2,019 207,395 1,827 165,542 - -
----- ------- ----- ------- ------- ---------
$ 7,391 3,886,869 $ 1,827 165,542 $ 2,746 2,364,331
=========== ============== =========== =============== =========== ==============
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTE 11 - PREFERRED STOCK
The following table presents a summary of the Company's issued and outstanding
preferred stock:
<TABLE>
<CAPTION>
- ----------------------------------------------------------- -------------- ----------------------------------
Liquidation Dividends
Preference Per Share
----------------------------------
Per Share 1997 1996 1995
- ----------------------------------------------------------- -------------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Series A 9.75% Cumulative Convertible Preferred Stock $24.00 $2.710 $2.375 $1.170
Series B 9.55% Cumulative Convertible Preferred Stock 24.50 2.710 2.375 0.423
Series C 9.73% Cumulative Convertible Preferred Stock 30.00 2.920 0.600 -
- ----------------------------------------------------------- -------------- ------------ ---------- ----------
</TABLE>
The Company is authorized to issue up to 50,000,000 shares of preferred
stock. For all series issued, dividends are cumulative from the date of issue
and are payable quarterly in arrears. The dividends are equal, per share, to the
greater of (i) the per quarter base rate of $0.585 for Series A and Series B,
and $0.73 for Series C, or (ii) two times the quarterly dividend declared on the
Company's common stock. Each share of Series A, Series B and Series C is
convertible at any time at the option of the holder into two shares of common
stock. Each series is redeemable by the Company, in whole or in part, (i) for
two shares of common stock, plus accrued and unpaid dividends, provided that for
20 trading days within any period of 30 consecutive trading days, the closing
price of the common stock equals or exceeds the issue price, or (ii) for cash at
the issue price, plus any accrued and unpaid dividends beginning after June 30,
1998, October 31, 1998 and September 30, 1999 for Series A, B and C,
respectively.
In the event of liquidation, the holders of all series of preferred stock
will be entitled to receive out of the assets of the Company, prior to any such
distribution to the common shareholders, the issue price per share in cash, plus
any accrued and unpaid dividends.
During 1997, the Company issued 620,425 shares of common stock due to the
conversion of Series A and Series B preferred stock.
NOTE 12 - EMPLOYEE BENEFITS
Stock Incentive Plan Pursuant to the Company's 1992 Stock Incentive Plan,
as amended on April 24, 1997 (the "Employee Incentive Plan"), the Company may
grant to eligible employees stock options, stock appreciation rights ("SARs")
and restricted stock awards. An aggregate of 2,400,000 shares of common stock is
available for distribution pursuant the Employee Incentive Plan. The Company may
also grant dividend equivalent rights ("DERs") in connection with the grant of
options or SARs. These SARs and related DERs generally become exercisable as to
20 percent of the granted amounts each year after the date of the grant. The
Company expensed $1,830, $1,664 and none for SARs and DERs related to the
Employee Incentive Plan during 1997, 1996 and 1995, respectively. There were no
stock options outstanding as of December 31, 1997 and 1996.
Stock Incentive Plan for Outside Directors In 1995, the Company adopted a
Stock Incentive Plan for its Board of Directors (the "Board Incentive Plan")
with terms similar to the Employee Incentive Plan. On May 1, 1995, the date of
the initial date of grant under the Board Incentive Plan, each member of the
Board of Directors was granted 7,000 SARs. Each Board member has subsequently
received a grant of 1,000 SARs on both May 1, 1996 and 1997 and will receive an
additional grant of 1,000 SARs on May 1, 1998. The SARs granted on May 1, 1995
will become fully vested on May 1, 1998. Each successive award will become
exercisable as to 20% of the granted amounts each year after the date of grant.
The maximum period in which any SAR may be exercised is 73 months from the date
of grant. The maximum number of shares of common stock encompassed by the SARs
granted under the Board Incentive Plan is 200,000. The Company expensed $189 and
$163 for SARs and DERs related to the Board Incentive Plan during 1997 and 1996,
respectively. There was no such expense recorded in 1995.
The following table presents a summary of the SARs activity for both the
Employee Incentive Plan and the Board Incentive Plan.
<TABLE>
<CAPTION>
------------------------------ ---------------------------------------------------------------------------------------------
Years ended December 31,
------------------------------ ---------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------ ----------------------------- ----- --------------------------- ---- ------------------------
------------------------------ -------------- -- ----------- ----- ------------ -- ----------- ---- --------- -- -----------
Weighted-Average Weighted-Average Weighted-Average
Exercise Exercise Exercise
Number of Price Number of Price Number Price
Shares Shares of
Shares
------------------------------ -------------- -- ----------- ----- ------------ -- ----------- ---- --------- -- -----------
<S> <C> <C> <C> <C> <C> <C>
SARs outstanding at
beginning of year 631,818 $ 669,020 $ 423,920 $
8.98 8.38 8.97
SARs granted 208,300 13.75 152,130 10.43 301,170 11.81
SARs forfeited - - (23,034 ) 9.48 (49,946) 11.01
SARs exercised (145,228 ) 6.82 (32,228 ) 5.25 (6,124) 10.14
SARs terminated at sale of
single- family mortgage - - (134,070 ) 8.43 - -
operations
-------------- ------------ ---------
SARs outstanding at end of 694,890 $ 10.87 631,818 $ 8.98 669,020 $ 8.38
year
------------------------------ -------------- -- ----------- ----- ------------ -- ----------- ---- --------- -- -----------
SARs vested and exercisable 223,638 $ 9.71 234,094 $ 8.37 188,056 $ 7.66
------------------------------ -------------- -- ----------- ----- ------------ -- ----------- ---- --------- -- -----------
</TABLE>
The Corporation adopted the disclosure-only option under Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
("FAS No. 123"). If the fair value accounting provisions of FAS No. 123 had been
adopted as of January 1, 1996 the pro forma effect on the 1997 and 1996 results
would have been immaterial. The exercise price range for the SARs outstanding at
December 31, 1997 was $6.38 - $14.50 with a weighted-average exercise price of
$10.87 and a weighted-average contractual remaining life of 5 years.
<PAGE>
Employee Savings Plan The Company provides an Employee Savings Plan under
Section 401(k) of the Internal Revenue Code. The Employee Savings Plan allows
eligible employees to defer up to 12% of their income on a pretax basis. The
Company matches the employees' contribution, up to 6% of the employees' eligible
compensation. The Company may also make discretionary contributions based on the
profitability of the Company. The total expense related to the Company's
matching and discretionary contributions in 1997, 1996 and 1995 was $424, $248
and $136, respectively. The Company does not provide post employment or post
retirement benefits to its employees.
401(k) Overflow Plan During 1997, the Company adopted a non-qualifying
overflow plan which covers employees who have contributed to the Employee
Savings Plan the maximum amount allowed under the Internal Revenue Code, but
less than the Company's limit of 12% of eligible compensation. The excess
contributions are made to the overflow plan on an after-tax basis. However, the
Company partially reimburses employees for the effect of the contributions being
made on an after-tax basis. The Company matches the employee's contribution up
to 6% of the employee's eligible compensation. The total expense related to the
Company's reimbursements in 1997 was $17.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
The Company makes various representations and warranties relating to the
sale or securitization of loans. To the extent the Company were to breach any of
these representations or warranties, and such breach could not be cured within
the allowable time period, the Company would be required to repurchase such
mortgage loans, and could incur losses. In the opinion of management, no
material losses are expected to result from any such representations and
warranties.
The Company facilitates the issuance of tax-exempt multifamily housing
bonds, the proceeds of which are used to fund mortgage loans on multifamily
properties. The Company enters into standby commitment agreements whereby the
Company is required to pay principal and interest to the bondholders in the
event there is a payment shortfall from the construction proceeds. In addition,
the Company is required to purchase the bonds if such bonds are not able to be
remarketed by the remarketing agent. The Company has provided letters of credit
to support its obligations in amounts equal $25,878 at December 31, 1997. There
were no outstanding letters of credit at December 31, 1996.
As of December 31, 1997, the Company is obligated under noncancelable
operating leases with expiration dates through 2004. Rent expense under those
leases was $975, $823 and $854, respectively in 1997, 1996 and 1995. The future
minimum lease payments under these noncancelable leases are as follows:
1998--$1,116; 1999--$1,068; 2000--$798; 2001--$736; 2002--$730; and
thereafter--$645.
NOTE 14 - SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS INFORMATION
<TABLE>
<CAPTION>
- --------------------------------------------------- -----------------------------------------------------
Years ended December 31,
- --------------------------------------------------- -----------------------------------------------------
1997 1996 1995
--------------- -------------- ----------------
<S> <C> <C> <C>
Cash paid for interest $ 231,752 $ 228,969 $ 210,638
=============== ============== ================
Supplemental disclosure of non-cash activities:
Securities owned subsequently securitized $ 311,117 $ 562,757 $ -
============ =========== ================
- --------------------------------------------------- --------------- -- -------------- -- ----------------
</TABLE>
<PAGE>
DYNEX CAPITAL, INC.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE
December 31, 1997
(amounts in thousands except number of loans)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount of
Carrying Loans
Final Periodic Face Amount of Subject to
Interest Maturity Payment Prior Amount of Mortgage Delinquent
Description Rate Date Terms Liens Mortgages Loans Principal or
Interest
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
First mortgage loans:
Single family residential
358 mortgages, original 4.75% - Varies $ 38,440 $ 22,169 (1)
loan amounts ranging from 16.19%
$4 to $600
Commercial
Retail Space
Denver, Colorado 8.30% October Interest - 13,500 13,473 -
1, 2012 and
principal
monthly
Cathedral City, California 9.00% September Interest - 10,500 10,500 -
1, 2000 monthly
Office Building
Austin, Texas 7.70% November Interest - 12,975 12,975 -
14, 2007 and
principal
monthly
Multifamily Residential
Columbia, South 9.25% October, Interest - 7,600 7,542 -
Carolina 1 2014 and
principal
monthly
Columbia, South 7.95% June, 1 Interest - 6,300 6,274 -
Carolina 2015 and
principal
monthly
Nashville, Tennessee 8.05% August, 1 Interest - 8,000 7,979 -
2015 and
principal
monthly
Austin, Texas 7.90% September Interest - 8,250 8,233 -
1, 2015 and
principal
monthly
24 mortgages, original loan 7.85%- Varies - - - 49,402 -
amounts ranging from $70 to 10.00%
$6,200
- ----------------------------------------------------------------------------------------------------------------------------
<PAGE>
DYNEX CAPITAL, INC.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE (CONTINUED)
December 31, 1997
(amounts in thousands except number of loans)
- --------------------------------------------------------------------------------------------------------------------------
Principal
Amount of
Carrying Loans
Final Periodic Face Amount of Subject to
Interest Maturity Payment Prior Amount of Mortgage Delinquent
Description Rate Date Terms Liens Mortgages Loans Principal or
Interest
- --------------------------------------------------------------------------------------------------------------------------
Second Mortgage Loans
Commercial
4 mortgages, original 9.00% Varies Balloon - - 8,962 -
loan amounts ranging payments
from $1,300 to $3,500 at
maturity
- -------------------------------------------------------------------------------------------------------------------------
163,780
Net premium/discount (4,490)
Allowance for loan losses (665)
- -------------------------------------------------------------------------------------------------------------------------
Total mortgage loans on real $
estate 158,625
- -------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Delinquent loans with a principal balance of $16.4 million were subject
to mortgage pool insurance at December 31, 1997.
</FN>
</TABLE>
The loans in the table above are conventional mortgage loans secured by
either single family, multifamily, or commercial properties with initial
maturities ranging from 3 to 30 years. Of the carrying amount, $149 million or
91% are fixed-rate and $15 million or 9% are adjustable-rate loans. The Company
believes that its mortgage pool insurance and allowance of $665 are adequate to
cover any exposure on delinquent mortgage loans. A summary of activity of the
single family and multifamily mortgage loans for the years ended December 31,
1997, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
- -------------------------------------- -------------- ------------ -------------
<S> <C>
Balance at December 31, 1994 $ 518,131
Mortgage loans funded 893,953
Collection of principal (771,743)
Mortgage loans sold (392,708)
- -------------------------------------- -------------- ------------ -------------
Balance at December 31, 1995 247,633
Mortgage loans funded 1,411,161
Collection of principal (58,397)
Mortgage loans sold or securitized (1,361,969)
- -------------------------------------- -------------- ------------ -------------
Balance at December 31, 1996 $ 238,428
Mortgage loans funded or purchased 1,526,229
Collection of principal (61,188)
Mortgage loans securitized (1,544,844)
- -------------------------------------- -------------- ------------ -------------
Balance at December 31, 1997 $ 158,625
- -------------------------------------- -------------- ------------ -------------
</TABLE>
<PAGE>
DYNEX CAPITAL, INC.
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE (CONTINUED)
December 31, 1997
(amounts in thousands except number of loans)
The geographic distribution of the Company's single- and multifamily
loans held for securitization at December 31, 1997 is as follows:
<TABLE>
<CAPTION>
------------------- ------ ------------------ --------- -------------------
Number of Loans Principal
State Amount
------------------- ------ ------------------ ------------ ----------------
<S> <C> <C>
Arizona 29 $ 7,029
Alabama 4 257
Arkansas 2 162
California 141 43,431
Colorado 2 17,473
Florida 13 3,733
Georgia 20 1,770
Hawaii 1 254
Illinois 2 1,432
Kentucky 1 3,536
Louisiana 1 86
Massachusetts 1 109
Maryland 7 5,584
Maine 1 74
Mississippi 6 408
Montana 1 1,197
Nevada 2 127
New Jersey 2 217
New Mexico 1 1,339
New York 1 146
North Carolina 25 8,359
Ohio 2 3,549
Oklahoma 2 3,149
Oregon 1 50
Pennsylvania 8 723
South Carolina 27 20,474
Tennessee 10 12,285
Texas 6 22,550
Utah 1 1,080
Virginia 7 2,694
Washington 3 315
West Virginia 3 188
---------------------------- --- -------- ----------------- ---------------
Total 333 63,780
Net premium/discount (4,490)
Allowance for loan losses ( 665)
---------------------------- --- -------- ----------------- ---------------
$ 158,625
---------------------------- --- -------- ----------------- ---------------
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EXHIBIT INDEX
<S> <C> <C>
Sequentially
Exhibit Numbered Page
21.1 List of consolidated entities I
23.1 Consent of KPMG Peat Marwick LLP II
</TABLE>
Exhibit 21.1
Dynex Capital, Inc.
List of Consolidated Entities
As of December 31, 1997
Multi-Family Finance Corporation
MSC 1 L.P.
Issuer Holding Corp.
Commercial Capital Access One, Inc.
Resource Finance Co. One
Resource Finance Co. Two
SHF Corp.
ND Holding Co.
Merit Securities Corporation
Dynex Holding, Inc.
Dynex Financial, Inc.
DFI of Alabama, Inc.
National Model Homes, Inc.
KBOne, Inc.
KBMex, Inc.
RHOne,Inc.
Lev One, Inc.
Dynex Commercial, Inc.
GLS Capital, Inc.
SMFC Funding Corporation
Dynex Securities Corporation
NOTE: All companies were incorporated in Virginia except for Dynex Holding,
Inc. (Delaware).
Exhibit 23.1
Consent of Independent Auditors
The Board of Directors
Dynex Capital, Inc.
We consent to incorporation by reference in the registration statements
(Nos. 33-50705, 333-22859, 333-10783, 333-10587 and 333-35769) on Form S-3 of
Dynex Capital, Inc. of our report dated February 4, 1998, relating to the
consolidated balance sheets of Dynex Capital, Inc. and subsidiaries as of
December 31, 1997 and 1996 and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1997 and the related financial statement
schedule dated December 31, 1997, which report appears in the December 31, 1997
Form 10-K of Dynex Capital, Inc.
KPMG PEAT MARWICK LLP
Richmond, Virginia
March 18, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
(Replace this text with the legend)
</LEGEND>
<CIK> 0000826675
<NAME> Dynex Capital, Inc.
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-mos
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-1-1997
<PERIOD-END> DEC-31-1997
<CASH> 18,329
<SECURITIES> 5,103,431
<RECEIVABLES> 5,628
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0<F1>
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 5,378,172
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 3,632,079
0
130,482
<COMMON> 451
<OTHER-SE> 429,976
<TOTAL-LIABILITY-AND-EQUITY> 5,378,172
<SALES> 0
<TOTAL-REVENUES> 350,762
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 41,399
<LOSS-PROVISION> 5,833
<INTEREST-EXPENSE> 244,352
<INCOME-PRETAX> 59,178
<INCOME-TAX> 0
<INCOME-CONTINUING> 59,178
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 59,178
<EPS-PRIMARY> 1.38
<EPS-DILUTED> 1.37
<FN>
<F1> The Company's balance sheet is unclassified
</FN>
</TABLE>
